The Central Government And The Control Of Investment

The early stages of economic reform in China were dominated by a process of decentralization. But while decentralization was taking place, a countervailing movement that improved the skills, information, and control available to the central government can also be discerned. This accumulation of skills was not in any sense contrary to the ideals of reform; indeed, increased sophistication of central officials was a key objective of reform in China, as in other socialist countries. Improved government skills would be necessary to guide the economy through the complexities of an increasingly marketized economy open to the outside world. However, in the face of constant change and recurrent crises,

central leaders have understandably used their newly available skills and information, and this has involved the central government in new activities despite the general decentralization process. Moreover, the two-track or "piecemeal" reform process in China has left a wide range of activities potentially open to central-government involvement. As a result, while the volume of resources directly under the control of the central government has declined, the Center's bargaining position has in other respects been enhanced by its greater access to information and the wider range of tools at its disposal. These contrasting trends can be seen most clearly through an investigation of the crucial focus of government activity in a command economy, the investment process.

By acceding to a dramatic reduction in its direct control over investment resources, the central government created the economic space that allowed reform to proceed in the late 1970s. Enterprises were given direct control over a substantial portion of profits and depreciation allowances that had previously been drawn into the state budget, and the government budget shrank as a proportion of the economy. The clearest indicator of direct government control over investment resources is the amount of investment that is funded directly through the government budget (shown in figure 9.1 as a proportion of national income [net material product].) Between 1978 and 1981 budgetary investment fell by half, from almost 15 percent of national income to slightly over 7 percent; moreover, the decline was persistent, with budgetary investment declining each successive year. This is an extremely unusual phenomenon, virtually unprecedented in the experience of centrally planned economies.^[7] Between 1981 and 1984 budgetary investment stabilized. While it rose slightly as a proportion of national income to above 8 percent, it continued to decline as a proportion of total investment, which was increasing rapidly. After 1984 budgetary investment again entered a declining phase and fell below 6 percent of national income in 1987.

In the early reform years the central leadership acceded to this diminution in its direct control and began rebuilding the institutions that would improve the quality and volume of its information about the economy. At this point central planners had little choice, since they quite literally had no central plan: the existing planning procedures, as of the late 1970s, had produced only the grandiose Ten-Year Plan, which was widely recognized as unrealistic and had been discarded. The rebuilding of information networks began with the rehabilitation and strengthening

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Fig. 9.1.
Fixed Investment: Budgetary and Central Government

of the State Statistical Bureau. The Statistical Bureau then gradually expanded the coverage of its data-collection network, improving the reliability and meaningfulness of data. In the sphere of investment the Statistical Bureau gradually progressed from collecting information only about capital construction within the state economy to collecting information about all kinds of fixed investment economy-wide, including that carried out by individual households. Computerized information centers under the State Council now regularly collect data from all large industrial enterprises. Several new research institutes labor with increasing sophistication to interpret and analyze the available information.^[8] As the available information base improved planners began to engage in a series of long-range projections of the future of the economy, projections

that became gradually more meaningful and specific.^[9] Even as direct central control over investable resources declined, a gradually more sophisticated process of economic strategizing led to increased demands that investment accord with central-government priorities.

As central planners gradually developed a coherent vision of future economic development, they began to engage in a continuous tug-of-war with local interests. Generally speaking, central planners tried to increase the flow of investment to key bottleneck sectors, particularly energy and transport. Local governments and enterprises, by contrast, tried to develop industries with high profit rates and prospects for rapid growth. Because China's distorted price system keeps the profitability of energy low, and projects in this sector require large-scale investments often beyond local capabilities, the energy sector was rarely targeted by localities. They gambled instead that bottlenecks in transportation and energy would ultimately be taken care of by the central government, and that localities with the most promising early development of profitable industries would be able to hold on to those assets.

From the beginning of the reform process, the central government repeatedly stressed the need to develop energy production, but energy investment nevertheless stagnated between 1978 and 1982. This stagnation came about in part because central planners simply did not have workable plans for energy development. They had not carried out the detailed work of selecting sites and projects, drawing up blueprints, and working out supply arrangements. For a period they hoped the foreign multinationals would solve some of the problems by developing offshore oil fields, but this hope was disappointed. Priority to energy and transportation remained a long-range goal rather than a concrete task for operational plans. In addition, planners felt they could temporarily survive by allowing the industrial structure to shift toward a lighter, less energy-intensive pattern. The new decentralized funding mechanisms that were devised were used predominantly for light-industry investment. For example, when new programs of bank lending for fixed investment were initiated, 13 billion yuan worth of fixed investment were funded by bank loans, and of this, 68 percent went for light industry (mid-1979 through mid-1982).^[10] During this period even central-government projects were frequently in light and consumption-goods industries. Ultimately, however, the growing economy would need more investment in energy and transport.

During the early 1980s the central government gradually created a menu of projects in the energy and transport sectors that it wished to carry out. The result was a steady revival in the importance of the central investment plan. Statistics are shown in figure 9.1 on investment spending on all projects included in the central-government investment plan. (For a description of the data, see the appendix to this chapter.) Between 1978 and 1981 spending on central-government projects declined substantially but not as much as budgetary investment. Spending on central projects declined from slightly over 10 percent of national income to just below 8 percent, a reduction of 2.5 percent of national income—a very substantial change, but quite a bit less than the decline in budgetary investment. In 1978 spending on central projects was significantly less than budgetary investment. If we think of the central government as simultaneously establishing an investment-funding mechanism and a program of investment projects, these two activities in conjunction yielded a substantial surplus in 1978, equal to slightly over 4 percent of national income. Thus, after spending on central projects was complete, budgetary funds were still available to fund projects planned by local governments.

From 1981 through 1984 budgetary investment and spending on central-government projects were roughly equal. This does not mean that all budgetary investment went directly to central-government projects: some central projects were funded in whole or in part through bank loans, and some through extrabudgetary retained funds; conversely, some budgetary investment went to local-level projects. Netting out these flows, central-government projects and budgetary investment were roughly in balance, with a slight deficit amounting to about 1 percent of national income. In order to fund central-government projects the central government would have to draw in extrabudgetary funds or bank loans equal to about 1 percent of national income, even if no budgetary funds went to local-level projects.^[11] During this period, household and enterprise saving was rising rapidly, so drawing on surplus funds was not difficult, and no serious economic problems arose.^[12] After 1984 the spending trend for central-government projects diverged from that of budgetary investment.

While budgetary investment dropped further, spending on central-government projects climbed steadily; by 1987 it had surpassed 10 percent of NMP (net material product), regaining the 1978 level. In order to fund this substantial investment program, the central government, by 1987, had to borrow funds equal to 4 percent of national income. Thus, while the central government surrendered direct control over economic resources, it did not reduce its aspirations in a corresponding fashion. By the second half of the 1980s a significant disparity had developed between what the central government wished to accomplish and the resources at its disposal. The central plan had been reborn, but whereas before reform the central government had directly disposed of the resources to carry out this plan, it now had to devise additional mechanisms to draw resources into planned projects.

Central-government planners evolved three complementary strategies to attain their investment objectives: they concentrated their own resources on priority sectors; they harnessed the financial resources of the banking system to those priorities; and they drew on local financial resources through a version of "matching funds." While the first of these strategies was merely a rationalized version of the old planned system, the other two involved the central government in bargaining exercises with local officials and enterprises. Each of these strategies will be examined in detail.

The most important single component of the central government's concentration of its own resources has been the creation of a special program of priority projects. A gradually increasing number of projects had been planned with "rational time-tables and guaranteed supply of materials." These projects have first claim on materials still under state control. This is a kind of plan within the plan, and its significance can be seen from the figures in table 9.1. The priority-investment program has grown steadily, both in absolute terms and as a proportion of national income. Moreover, all these projects have access to in-plan materials provided at subsidized prices, so that real resources are concentrated on the priority program to an even greater extent than the financial data indicate. In essence, the central government is subordinating the surviving elements of the material-allocation system to its development strategy. Before reforms the material-allocation system was charged with the nearly impossible task of delivering resources to all state-run factories for all production needs. But as reform has deepened and the economy has diversified, the allocation system, now much smaller relative to the economy as a whole, has increasingly been targeted to this investment program. The central government no longer has nominal control over all the materials in the economy; but the remaining control over materials is now used almost exclusively to carry out central-government priorities.

The priority-investment program also differs from the old central plan in the quality of the design and planning activity. Unlike the Baoshan steel mill, symbolic of the low quality of planning prior to reform, today's priority projects are carried out with reasonable preparatory work, feasibility studies, and complete sets of design documents. Indeed, a number of the projects utilize international funds, such as those from the Japanese Development Bank and the World Bank, and thus have to comply with international standards for project appraisal and implementation, including competitive bidding for some parts of the work. The central plan has thus been strengthened in a technocratic sense; with a better understanding of the economy as a whole and better utilization of trained manpower, the economic returns of these projects will generally be higher than those of projects during the 1970s before reform. This is true both because individual projects are better designed and because the program as a whole is targeted more effectively on bottleneck sectors. At the same time, priority status and access to materials serves to ensure the completion of the projects. In 1987 the capital-construction expenditure plan for these projects was 109 percent fulfilled, while the remainder of the plan was only 90.5 percent completed.^[13] Although this is an improved version of the central plan, relative to what China had before, it still suffers from the inherent liabilities of central planning, as was discussed in the preceding section.

In order to carry out the broader central-government plan (including the priority plan as one component), the government still needs access to additional financial resources. As central plans grew, bank lending was harnessed to the needs of this plan. By 1985, at the latest, this had worked a fundamental change in the composition of both central-government investment and the use of bank loans. Figures are presented in table 9.2 on the proportion of different types of capital-construction investment going to three bottleneck sectors—energy, transport, and heavy raw-materials

industries—in 1985. Table 9.2 shows the striking difference between the composition of central and local-level investment and confirms the reluctance of local governments and enterprises to invest their own money in bottleneck sectors. According to the same source, 80 percent of electricity investment in the past few years has been on central-government projects. Even more striking is the extent to which bank lending conforms to central-government priorities. Originally introduced to permit flexible, decentralized financing of consumer goods industries, bank lending for fixed investment has increasingly been reshaped to serve central-government investment projects. While 68 percent of fixed-investment lending went to light industry in 1979–82, 62 percent went for a subcategory of heavy industry and transportation in 1985.^[14] Given the division of responsibility over different sectors, this means that the central government effectively preempts most fixed-investment lending, and local governments and enterprises have correspondingly fewer financial resources. The banking system is unable to serve as an independent, decentralized funding source, for it is squeezed between the demands of the central government and local officials. Banks are obligated first to fund central-government projects; subsequently, they are placed under enormous political pressure to put remaining resources in the service of projects favored by local governments.

The second source of additional financing is the retained funds of

localities and enterprises. Increasingly, the central government requires localities to contribute "matching funds" in order to see critical infrastructure projects in their regions. For example, while the projects in electricity generation are overwhelmingly central, the money for them comes to a significant degree from the localities. Through the end of 1984, twenty-six large-scale electricity-generation projects had been carried out in the central plan, but using the joint resources of central and local authorities; the localities had provided 3.5 billion yuan, or 51 percent of the total cost.^[15] Thus, the central government resolves the disparity between its limited financial resources and its responsibility for crucial sectors of the economy by negotiating for additional resources project by project. In this negotiation the central government is quite powerful: it possesses the design resources and seed money needed for large-scale energy development, and it possesses enormous leverage over the economic system as a whole, including the material-allocation and banking systems. Yet it also requires the cooperation and financial resources of local governments and enterprises. Thus, the Center and local governments are now involved in a classic bargaining situation: each has something the other needs. It is in the interests of both parties to get together, and it is in the interests of each to shape the resulting bargain to their own advantage.

One example of this bargaining process is presented by the province of Shandong.^[16] Shandong is a large, slightly above-average coastal province, which has grown rapidly in recent years and has also experienced significant energy shortages. It is estimated that energy supply is 20 percent below demand. Shandong is the site of 11 of the 190 central-government priority projects, and it accounted for 8.5 percent of 1986 national priority-investment expenditure. Shandong thus receives substantial central-government support, and central projects include two large power plants, a very large ethylene plant, and two ports. Shandong's development strategy is therefore inextricably bound up with its relations with the central government.

To obtain central-government investment projects, Shandong makes—and publicizes—major contributions to those projects. Shandong provides a significant portion of the money for these projects, and must also organize land requisition and purchase; supply of water, electricity, and transport; supply of local building materials (cement, bricks, stone, and sand); and design and construction services. Thus, a substantial part of

Shandong's investment policy consists of coordination and support for central-government investments. An important reason for this support is to demonstrate to the central government that the locality is making a contribution, thus ensuring a future flow of central resources to Shandong. A significant public relations effort goes on to reassure the central government that its money is well spent. Yet these contributions are also a substantial burden to Shandong. The central-government financial contribution to a project covers only a portion of total cost and is generally fixed at the beginning of the plan year, leaving the locality to deal with the frequent cost overruns, while quantitative controls on investment strictly limit the province's total investment. Moreover, the province has to pay taxes on its investment spending—even when that spending goes to central-government projects—whereas the central government itself is exempt from construction taxes.

The province's strategy is to publicize all contributions to central-government projects while seeking ways to minimize the actual burden of those projects. Shandong authorities argue for tax exemptions and additional investment authority in order to carry the burden of central-government projects; at the same time, their own projects have been further "decentralized," placed under the nominal control of rural collectives so that they disappear from the provincial investment quotas. Every investment decision is thus shaped by the desire to draw in the largest possible amount of central resources (including centrally approved bank loans) while simultaneously protecting local resources as much as possible. Compared with the prereform system, Shandong is much less a passive agent of central-government plans; yet its more active role is shaped by obligations as much as opportunities and is still dominated by the need to draw resources from the central government. Shandong follows a particular strategy of high-visibility support for the central government, which is consistent with its generous endowment of central projects. Other localities follow a low-profile strategy of quietly draining resources from central projects, hoping that, ultimately, the Center's commitment to those projects will insure their completion. In this way, local projects that have little protection in case of policy changes can be completed as quickly as possible.^[17] The bargaining relation between Center and locality is here in full flower.

Local governments find themselves squeezed between the Center and their enterprises. On the one hand, they must bargain with the Center to maximize central-government investments in their territory; on the other hand, they seek to retain as much as possible in the way of re-

sources and finances. They must promulgate their own development strategies, but they typically find themselves highly constrained by lack of expertise and experience. The obvious source of additional resources is the locality's own enterprises, which it can tap for a range of voluntary and involuntary contributions. But localities must strike a balance between drawing the resources they need from enterprises and allowing them sufficient resources for growth. This generally ends with local governments assuming a paternalistic, somewhat benevolent attitude toward all their enterprises, protecting them from the vicissitudes of the marketplace and encouraging their development, without regard for any particular development strategy. The relation between enterprises and their superiors will be discussed further below (see also chapter 11 in this volume), but it should be apparent that the difficult position in which localities find themselves will be reflected in their relations with their subordinate enterprises.

By following the three strategies described, the central government has managed to engineer a rebound in energy and transportation investment. Such investment was at a peak in 1978 before the initiation of reform. Energy investment as a proportion of total state fixed investment reached a low point in 1982 and since then has climbed to approximately the 1978 proportion (22–23 percent of investment); transportation investment has displayed a similar pattern, declining until 1981 and recovering since to 13–14 percent of investment. Measured both by the proportion of national income going to central-government projects and by the proportion of total investment going to central-priority sectors, central direction of investment appears as strong now as it was in 1978 before reforms began.

From the aggregate numbers, it would appear that the central government has simply been scrambling to get back to where it was in 1978. In fact, its economic role has been strengthened by access to three types of superior information. The Center's coordination of technical information has improved, so that individual projects are better. Much of the energy investment in 1978 was actually wasted; this is particularly clear in petroleum and is evident in other central-priority sectors as well, such as steel. Second, the central government has utilized better information about the economy as a whole, including long-range forecasting, to concentrate on areas where the case for central coordination is stronger. Generally leaving smaller-scale, consumer-oriented production to the localities and enterprises, the Center has focused on large-scale infrastructure projects, which often span provincial boundaries. These two factors together have caused a gradual improvement in the provision of energy and transport services; while these sectors have remained bottlenecks, industrial growth has nevertheless accelerated, and the shortages persist relative to a much

larger volume of output. Finally, the Center's increased information about local-government activities permits it to engage in specific bargains with localities about individual projects. It is this last type of information that ultimately has allowed the Center to subordinate the banking and material-allocation systems to its objectives, using the resources in those systems as bargaining chips to shape local behavior.

Nevertheless, these factors must always be seen in the context of the decline in direct central control over resources. Central planners are arguably stronger, and certainly more capable, than before reform, but they must deal with a vastly more complex economic environment in which many different agents have control over resources. This environment constantly threatens to overwhelm central-government actions. Although central actions have increased the investment share of priority sectors, the results still fall quite a bit short of central-government objectives. The Sixth Five-Year Plan, covering 1981–85 but drawn up only in 1982, called for the completion of 400 large and medium-sized investment projects, but in fact only 235 (59 percent) were completed by the end of 1985. In 1987, 63 out of 74 planned large projects (85 percent) were completed on schedule.^[18] The sustained central-government focus on energy and transportation has just barely offset the bias toward light-industry investment created by decentralization of resources.

Examination of the investment process thus shows a complex set of changes. Although the central government's direct control over investment resources has been unambiguously reduced, it has been able to use its authority over the economic system as a whole, in combination with substantially enhanced information about the economy, to increase its indirect control over investment. But the nature of the central government's "indirect control" instruments is still highly imperfect: rather than manipulating objective economic levers to control the market environment and thus shape lower-level decisions, central planners instead achieve indirect control by engaging with lower levels in a case-by-case bargaining process. In an immediate sense, this works: it has increased the flow of investment resources into bottleneck sectors. Yet this strategy is clearly a second-best alternative to more fundamental reforms, including increases in the relative price of energy and transport. The central government's expedient policies draw local governments into further complex bargaining relations with the central government, rather than confronting them with more rational costs and opportunities for their own investments. A modest recentralization of finances, bringing financial capabilities in line with central-government ambitions, combined

with price rationalization and greater autonomy for those controlling decentralized finances, would be preferable. In this way, energy shortages could be addressed without enmeshing all parties in an overly complex bargaining relationship.

More generally, the strategy that has been followed does not seem capable of resolving the fundamental problems of the command-bureaucratic economy. While the Center has better information about local activities and can bargain with localities about a relatively small number of large-scale projects, it still lacks detailed knowledge and control of the bulk of economic decisions. In a sense, the central government can achieve certain objectives precisely because those objectives are circumscribed in scope, while the economy as a whole is just as resistant to specific manipulation by administrative means as it always has been. The new bargaining relations can only compensate for some of the deterioration in authority relations. Moreover, as the central government must cover a deficit in its investment program equal to 4 percent of national income, it competes for savings and pressures the banking system to create credit at an excessive rate. The central government is powerful but needy, and this tends to destabilize the system.