Macroeconomic Development of China: 'Overheating' in 1984-1987 and Problems for Reform

After the Chinese Communist Party had embarked on economic reform in 1978 China's macroeconomic performance had been quite satisfactory until the autumn of 1984, but since then the Chinese economy ran into "economic overheating", with rapid inflation and large trade deficits, which is nothing but a typical case of demand-pull inflation. Its two major causes are high rates of increase in money supply caused by rapidly increasing bank lending and of increase in wage payments, both accompanied by some mismanagement in the process of economic reform. A third cause is too high an increase in government expenditures financed by the central bank credit. Chinese leaders seemed to believe "economic overheating" coming under control in 1986, but it appears that appeasement was only temporary and that "overheating" was still going on throughout 1987. Through this "economic overheating" in 1984 through 1987 China's net international assets-liabilities position deteriorated severely: by 12.5% of China's GNP in 1986. China's present macroeconomic management is deficient in several ways and needs to be improved. Money-supply must be firmly controlled through a two-tier quota system with quotas set for each quarter, both for central bank lending to each of non-central banks and for the latter's lending to their customers. Both non-central banks and non-financial enterprises should be transformed into a full-fledged independent enterprise operating on a commercial basis, free from political and nepotistical influences. China's present balance of payments management also needs to be improved in several ways. Imports should be controlled on a centralized basis under a "foreign-exchange budget," while the competitive price mechanism should be fully used in promoting export and directive planning as well as the complicated foreign exchange retention system currently in force should be abolished. The dependence on foreign borrowing should be lowered by promoting export and restricting import more efficiently. China's annual investment, ratio to GNP is still too high, and should be lowered, and the efficiency of investment raised.