19852 THE WORLD BANK August1999 SAheftz Nyberg scott Kozelle fil# Accelerdfing Ch ind s IKurdl Transforn-tion Albert Nyberg Scott Kozelle The Vodd Bdnk Vshington, D.C. Copyright © 1999 The Intemational Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing August 1999 This study is among the many reports originally prepared for internal use as part of the continuing analysis by the Bank of the economic and related conditions of its developing member countries and of its dialogues with the governments. Some of the reports are published with the least pos- sible delay for the use of governments and the academic, business and financial, and development communities. The typescript of this paper therefore has not been prepared in accordance with the procedures appropriate to formal printed texts, and the World Bank accepts no responsibility for errors. 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ISBN 0-8213-4576-1 Library of Congress Cataloging-in-Publication Data has been applied for. ii I - _ I I I I I I c I I CONTENTS A b stra ct ......................................................................................................................... v P refa ce ........................................................................................................................ v i Acknowledgments ................................................................................................................vii Abbreviations and Acronyms ...............................................................................................viii Executive Summary ............................................................................................................. ix Part I. The Rural Sector Challenge .............................................................................. 1 1. A Vision for the Rural Sector ............................................................................... 1 Part II. An Enabling Environm ent for Rural Developm ent........................................... 7 2. Rural Income and Macroeconomic Linkages ........................................................ 7 A. Domestic Macroeconomic Dim ensions ............................................................. 7 B. The International Market .............................................................................. 14 3. Rural Public Finance ........................................................................................ 17 4. Rural Credit and Finance ................................................................................. 25 5. The Development of Markets ............................................................................. 35 6. International Trade and Foreign Capital Flows .................................................. 43 A . T ra d e ........................................................................................................... 4 3 B. Capital and Technology Flows....................................................................... 51 Part III. M anaging Rural Developm ent ...................................................................... 59 7. Cultivated Land................................................................................................ 59 8. Water Resources............................................................................................... 65 9. Technical Change and Technology Transfer ....................................................... 75 A. Agricultural Research .................................................................................. 75 B . E xten sion ................................................................................................... 8 3 10. Rural Industry ................................................................................................. 87 11. Poverty Reduction ............................................................................................ 95 12. Natural Resource Management and the Rural Environment ............................ 103 Annex: Policy and Action Matrix ............................................................................. 113 Bibliography ............................................................................................................ 119 TABLES IN TEXT Table 2.1: Resource Flows from Agricultural and Rural Sectors to Nonagricultural and Urban S ectors .............................................................................................................. 8 Table 3.1: Township Finance in China, 1986-93................................................................ 20 Table 4.1: Percent of Households Engaged in Different Activities that Finance Activity with Loans and Average Loan Amount, by Activity .............................................................. 26 Table 4.2: Deposits, Loans, and Assets of China's Financial Institutions, 1996 ................... 26 Table 5.1: Cost of Carryover Stocks ................................................................................... 38 f. , iii Table 6.1: China's Agricultural Trade Balance, 1992-97 .................................................... 45 Table 6.2: Grain Price, Production, and Supply Volatility (1990-97) .................................... 48 Table 6.3: Agricultural Subsector Distribution of Contracted FDI Inflows (1994-96) ............ 53 Table 6.4: Financial Indicators of Agriculturally Related Foreign-Financed Enterprises '95.. 54 Table 6.5: Distribution of Foreign-Financed Enterprises in Agriculturally Related Manufactur- ing, by Factor Intensity, 1995 ........................................................................... 55 Table 6.6: ODA Allocations by Subsector ........................................................................... 56 Table 8.1: Water Balance and Estimated Water Requirements, 1993, 2000, and 2010......... 65 Table 8.2: Average Grain Output and Revenue per Cubic Meter of Irrigation Water ............. 71 Table 9.1: Agricultural Research Budgets and Research Intensity, 1986-96 ........................ 77 Table 9.2: Agricultural Extension Expenditures in China, 1986-95 .................................... 83 Table 10.1: TVE Em ploym ent, by Ownership ....................................................................... 87 Table 12.1: Indicators of Rural Environment and Natural Resource Conservation ............... 103 Table 12.2: National Investment in Environmental Protection, 1991-95 .............................. 105 Table 12.3: Reforestation in China (1980-93) .................................................................... 109 FIGURES IN TEXT Figure 1.1: Gross Value of Agricultural Output ..................................................................... 3 Figure 1.2: Rural Incom e by Source ..................................................................................... 4 Figure 2.1: Rural-Urban Per Capita Income Ratios .............................................................. 12 Figure 3.1: China, National and Subnational Shares of Revenues and Expenditures ............ 17 Figure 3.2: Rural-Urban Per Capita Incom e Ratios .............................................................. 18 Figure 3.3: Investment to Wage Spending Ratio, Shaanxi, 1983-92 ..................................... 19 Figure 5.1: Free Market Sales Index of Agricultural Products ............................................... 35 Figure 6.1: Major Commodity Groups as a Proportion of Agricultural Trade ......................... 45 Figure 6.2: Domestic and International Grain Price Volatility ............................................... 48 Figure 6.3: Actual Capital Flow s ................................................. .......... . .......... -.... 51 Figure 6.4: FDI Inflow as Percent of Gross Fixed Capital Formation, 1991-95....................... 51 Figure 8.1: W ater Regions and Irrigation Zones ................................................................... 67 Figure 8.2: Proportion of Investments in Water Conservancy, by Type ................................. 67 Figure 10.1: Percent of TVE Output Value, by Ownership Type .............................................. 88 Figure 10.2: Managerial Contract Evolution in TVEs, Sample Data, 1984-93 ......................... 88 Figure 10.3: Bank Borrowing as a Percent of TVE Output Value ............................................ 91 Figure 11.1: R ural A bsolute Poor ......................................................................................... 96 Figure 11.2: Real Investment in Poor Areas Poverty Reduction Program ................................. 96 BOXES IN TEXT Box 9.1: India Growth Accounting Analysis .................................................................... 79 Box 9.2: Agricultural Research Considerations ................................................................ 81 Box 10.1: Types of TVE Ownership and Control in Rural Industry ..................................... 89 Box 10.2: TVE Credit Constraints..................................................................................... 90 Box 11.1: M icrofinance in Yilong County .......................................................................... 97 Box 11.2: India: Government Spending, Growth, and Poverty ........................................... 99 iv Abstract China's rural economic achievements of the past two decades-rapid growth and declining pov- erty-have been remarkable. However, replicating these achievements and improving sustainability during the next two decades will be difficult as many underlying conditions have changed. Eco- nonic reforms were initiated when supply shortages constrained growth, but currently, weak demand is more constraining. Furthermore, the productivity gains are largely exhausted from transition policies and institutions; future productivity gains will come from efficiencies, stimu- lated by market forces, and improved productivity of scarce water and land resources, through resource conservation and new technologies. The rural-agricultural sector will remain dependent on a robust urban-industrial sector to create jobs and absorb surplus rural and agricultural labor-thereby permitting the remaining farmers access to additional land resources. Several cru- cial rural institutions need to be fostered-an effective fiscal system, a more efficient financial system, a workable land tenure arrangement with marketable land-use rights, and improved agri- cultural investment incentives. Continued reform will entail further liberalization of production, pricing and marketing policies and strong government promotion of a market environment and investments in public services and infrastructure. V Preface The primary purpose of this report is to identify and consolidate information on crucial issues that impact on rural development in China. The report, prepared with the assistance of Chinese and non-Chinese scholars and analysts, assesses strategic options from the perspective of effi- ciency, equitable development and growth. The authors acknowledge that many reforms in the macroeconomic environment and in other sectors are ongoing and that additional reforms are planned; many of these go beyond the scope of this report. We recognize that concurrent macroeconomic policy and institutional reforms across all key sectors would be unmanageable and destabilizing; therefore, priorities consistent with Government's gradualist reform approach need to be established. Such economy-wide reform priorities and individual reform sequencing are the responsibility of Government, giving due con- sideration to social stability issues (food security, employment, etc.) that temporarily override economic efficiency criteria, and require "second-best" reform solutions during the transition. The report is presented in the spirit of assisting government officials and World Bank staff to prioritize policy and institutional reforms and public investment decisions in the rural sector. Also, it is hoped the report will support the Government in defining rural reform priorities and programs for the Tenth Five-Year Plan. As priorities are established, the World Bank is ready to work with government officials to move beyond strategy and help design and prepare the tactical approaches to implement priority rural subsector reforms. vi Acknowledgments The scope of this report was determined in discussions with the Director and staff of the Institute of Rural Development, Chinese Academy of Social Sciences during a visit to Beijing in April 1998. The report was written by Albert Nyberg (East Asia and Pacific Region, Rural Develop- ment and Natural Resources Sector Unit) and Scott Rozelle (Consultant) based on inputs and working papers from many individuals. Major inputs were provided by Huang Jikun (Center for Chinese Agricultural Policy, Chinese Academy of Agricultural Science), Du Zhixiong and Li Zhou (Institute of Rural Development, Chinese Academy of Social Science), Wen Tiejun (Research Center for Rural Economics, Ministry of Agriculture), Christine Wong and Albert Keidel (East Asia and Pacific Region, China Resident Mission), John Weatherhogg (FAO), Loren Brandt, Albert Park, Chen Chunlai, Colin Carter, Andrew Walder, Gary Kutcher, and Madeleine Varkay (Consultants). Inputs and discussions with Abraham Brandenburg, Alan Piazza, Richard Scobey, and Juergen Voegele (East Asia and Pacific Region, Rural Development and Natural Resources Sector Unit) also contributed to the development of ideas and conclusions. The report benefits from discussions with staff of various international organizations (Interna- tional Food Policy Research Institute and Asian Development Bank), international nongovernmen- tal organizations (Ford Foundation), and bilateral agencies (Economic Research Service, United States Department of Agriculture). The report includes ideas generated during discussions and interviews with numerous Chinese and international scholars, particularly those associated with Chinese research institutions. Also, it cites the findings and conclusions contained in a wide selection of literature. The authors worked closely with counterparts from the Rural Development Institute, Chinese Academy of Social Science, and particular thanks are due Professors Chen Ji-yuan (Former Direc- tor), Zhang Xiaoshan, (Current Director), and Associate Professor Du Zhixiong for their insights, discussions, and assistance. Also, particular thanks are due Dr. Huang Jikun, Director of the Center for Chinese Agricultural Policy, Chinese Academy of Agricultural Science, and his col- leagues who provided significant staff time and effort in preparing working papers as well as reading and commenting on various portions of the report. Several agencies and individuals provided photographs for inclusion in the report. The World Bank Photo Library provided several slides; other institutional contributors were the CGIAR photo library, the National Hybrid Rice Research and Development Center (Yuan Longping), and the National Zoological Park (Jesse Cohen). In addition, R. Jaisaard, A. Piazza, F. Crook, A. Whitten, S. Shen, R. Zweig, G. Li, T. Tsutsumi, and F. Gillam contributed photographs and slides from their personal collections. vii Abbreviations and Acronyms ABC Agricultural Bank of China ADBC Agricultural Development Bank of China bcm Billion cubic meters CAAS Chinese Academy of Agricultural Science CASS Chinese Academy of Social Science CCAP Center for Chinese Agricultural Policy DDT Dichloro-diphenyl-trichloro-ethane EPBs Environmental Protection Bureaus FAO Food and Agriculture Organization FDI Foreign Direct Investment FFW Food for Work HRS Household Responsibility System GDP Gross Domestic Product GVAO Gross Value of Agricultural Output HRS Household Responsibility System IFPRI International Food Policy Research Institute IOU I Owe You IPM Integrated Pest Management IPR Intellectual Property Right IRD Institute of Rural Development LGPR Leading Group for Poverty Reduction MFIs Microfinance Institutions MOA Ministry of Agriculture MWR The Ministry of Water Resources NEPA National Environmental Protection Agency (now SEPA-State Environmental Pro- tection Agency) NGO Nongovernmental Organization ODA Overseas Development Assistance PBC People's Bank of China PPP Purchasing Power Parity R&D Research and Development RCCs Rural Credit Cooperatives RCFs Rural Credit Foundations RFIs Rural Finance Institutions SMEs Small and Medium Enterprises SOE State-Owned Enterprise SPC State Planning Commission (now SDPC-State Development Planning Commission) TFP Total Factor Productivity TVEs Township and Village Enterprises VAT Value-Added Tax WUA Water User Association WTO World Trade Organization viii Executive Summary In its two decades of reform, China has the constraints that are preventing the emer- achieved remarkable agricultural and rural-in- gence of institutions that fully incorporate mar- dustrial growth, impressively reduced poverty, ket principles. In the long run, the government and reversed some of the environmental and should divest itself of industrial and other com- natural resource degradation. The population mercial activities and focus investments on growth rate also continues to decline. Since 1978 public services, research and extension, and aggregate gross domestic product (GDP) has infrastructure. Policy should focus more on grown at an average annual rate of 10 percent; developing government's regulatory role and less agricultural GDP, at 5.2 percent; and rural in- on direct market intervention. Our ultimate vi- dustrial output, at 31 percent. The number of sion of China's rural economy is one in which residents living in absolute poverty has declined economic administrators focus on promoting by 210 million, to about 6 percent of the rural policies, creating institutions, and targeting population. However these trends have slowed public investments that improve resource allo- noticeably in recent years and China's rural sec- cation and comparative advantage, enhance tor still faces considerable challenge in achiev- productivity, and facilitate more efficient mar- ing further development. kets. In this vision, economic administrators Rural reforms have been gradual, deliber- intervene only where markets are inefficient or ate, and largely effective as the rural sector has have the potential to positively affect national increasingly moved away from a planned welfare, such as alleviating poverty and redis- economy-despite several remaining remnants tributing wealth, controlling environmental pol- of the planning legacy and continuing market lution, and improving management of natural interventions by government. However, the pro- resources. ductivity gains from transition policies are largely exhausted. Sustaining rural income growth will Rural Fiscal Policy's Undermining of require a carefully crafted effort for several rea- Sectoral Growth sons: Many of the conditions that facilitated An inefficient rural fiscal system is one of earlier growth no longer prevail. In addition, the most important problems hampering rural China's rural products, input, labor, and land development. Decentralization has led to a self- markets, while improving, are still in their in- sufficient rural fiscal structure that, coupled fancy. Finally, China still needs to foster sev- with a development legacy oriented toward the eral critical institutions, such as an effective urban-industrial sector, has hardened budget fiscal system, a more efficient rural financial constraints and distorted rural investments system, a workable land tenure arrangement, toward developing potentially taxable local in- and a revamped trade and investment environ- dustry at the expense of rural-agricultural in- ment for agriculture. frastructure and development investments that Increasing rural standards of living, elimi- are long term and growth oriented. Over the nating poverty, and reversing the divergence in two decades of reform, national tax revenues rural and urban income levels will require a have declined to about 12 percent of GDP-a delicate balance of productivity-enhancing in- portion that is among the world's lowest. The vestments and bold policy measures to remove 1993 fiscal reform and adoption of avalue-added I I I . . . . I 1 11 1 , I . . . I . I I . . 1 1 . I . , I . I z I i Accelerating China's Rural Transformation tax increased central control over revenues and costs. Also, to generate revenue some protec- stemmed the declining trend in collections in tive agencies resort to exploiting the resources both rich and poor regions. However, revenue they are charged with protecting. reallocations are still urban biased, regressive, Further fiscal reform is imperative to enable and ineffective in redistributing resources. Thus, China to maintain rural infrastructure and ser- the equalization of taxation, redistribution, and vices, sustain long-run growth, and reduce pov- expenditure for public goods has declined, par- ertv. Further assessment of the consequences ticularly in the poorest regions. Furthermore, of such a highly decentralized economy is net rural-to-urban fiscal outflows have increased needed, along with options for additional rev- and now exceed Y 100 billion annually. starv- enue sources and expenditure reduction. A radi- ing the rural sector of investment and operat- cal option would be to transfer the basic unit of ing resources. The massive movement of funds fiscal responsibility from townships to counties out of the rural economy indicates its impor- (except perhaps for the most industrialized towns tance in the national economy and emphasizes with surplus budgets). This would reduce ad- the necessity of keeping it healthy. ministrative staff. a move that would significantly General (untied) fiscal transfers to townships reduce costs, as wages are the primary expen- and villages have declined by two-thirds, in real diture at the township level. Reducing numbers terms, over the past decade. Thus in the envi- of "grass roots" staff, however, may hinder policy ronment of reduced subventions and in the implementation. Local government consolida- absence of taxing authority, local governments tion and reform should be high on the policy have imposed unofficial, nontax levies and fees agenda. on rural producers and consumers and rely on other creative mechanisms to finance gover- Rural Incomes, Off-Form nance, social obligations, and unfunded cen- Employment, and Township and tral government mandates. Since the most easily Village Enterprises tapped source of off-budget revenues are de- Recent increases in agricultural income have rived from miscellaneous fees assessed on ru- resulted, in part, from increased farmgate com- ral enterprises, poor areas that lack such modity prices. This option has been fully ex- enterprises are further disadvantaged. Off-bud- ploited as domestic prices are near international get collections are not officially sanctioned, are price equivalents-unless government decides not transparent, frequently are regressive, are to embark on a costly farmer subsidy program inconsistently levied, distort investment alloca- and ignore the commitments made in the yet tions, and have occasionally caused rural dis- unfinished World Trade Organization accession sention. Because ofthe urgent needfor additional negotiations. Other options for improving agri- resources, the government should consider con- cultural income growth include (a) increasing verting some of thesefees and levies into trans- factor productivity; (b) diversifying production parent components of the tax system. into labor-intensive, higher-value commodities: Inadequate budgets for rural social service and (c) investing in transport and other mar- and advisory institutions (for example, nature keting infrastructure to reduce marketing costs and forest preserves, agricultural research and and enable farmers to increase their share of extension, schools, and rural clinics) frequently consumer expenditures. Factors affecting these result in the diversion of staff and financial re- alternatives are reviewed in this report and in sources from their primary mission to commer- other recent World Bank publications. cial activities to supplement budgets. The transformation of China into a more Infrastructure investment funds are often redi- affluent, modern industrial economy depends rected to potential tax-producing enterprises or on sharply increasing incomes and shifting a diverted to meet salaries and other recurrent large part of the population out of agriculture. X Executive Summary Obtaining off-farm employment has been the arise between laid-off urban workers and city- surest route to improving incomes. In the past, bound rural migrants, China should promote rural and urban institutions restricted the move- policies that encourage the efficient expansion ment of labor off the farm. The recent explosion of rural industries. of off-farm work proves that many of these bar- riers have been removed. (Nearly 140 million of Consolidating Past Gains from Rural China's 450 million rural labor force work in Enterprises. nonfarm jobs.) However, obstacles still prevent The contribution of TVEs to China's rapid farm families from moving to locations that economic growth during the reform period has promise them higher returns, particularly fea- been extraordinary. TVEs contribute 40 per- tures of the urban economy, such as strict pro- cent of the national gross industrial output and hibitions to job access, urban resident permits, employ about 130 million workers-represent- and restricted access to urban services. Rural ing the major employer of rural nonfarm labor. barriers are less restrictive, although debate Unfortunately, output and employment growth continues regarding how land tenure arrange- are decelerating, access to credit has been cur- ments, quotas, and other institutions affect tailed, and severe debt problems are appear- household decisions to seek employment or ing. However, ownership and management are residence outside of agriculture. China should evolving from collective and cooperative to pri- make every effort to eliminate the barriers to the vate ownership in response to the changing movement of labor off the farm. economic environment. By 1997, 90 percent of Typically, off-farm employment is associated TVEs were privately owned and accounted for with rural-urban migration, but in China's case more than half of TVE employment. Also, the township and village enterprise (TVE) employ- management structure of those firms that re- ment and rural-rural migration also is an op- main collectively owned is rapidly shifting away tion. Millions of rural workers have migrated to from fixed-wage management contracts to more urban jobs in the past decade, but for the next responsive profit-sharing and fixed-lease ar- decade such migration may become a less vi- rangements. able option, as restructuring of state-owned The initial conditions that favored the rapid enterprises (SOEs) and rationalization of em- development of rural industries no longer pre- ployment has begun. A surplus of unemployed vail; product competition has increased, pro- urban-industrial workers will have priority for duction has become more efficient, and deployment in any newly created urban jobs, competitive pressures have eliminated the large making agricultural labor's search for nonrural profits of earlier years. However, the inland prov- employment in cities more difficult. Off-farm inces have a few advantages that tend to offset migration to rural industries could play an im- the disadvantage of being distant from major, portant job-creation role. Rural industry pro- high-income markets along the coast, includ- vides the fastest-growing subsector of the ing lower-cost labor and often better access to off-farm labor market. Continued out-migration agricultural raw materials. Some coastal TVEs would permit those remaining in the agricul- have sought to relocate inland to take advan- tural sector to combine additional land, water, tage of these benefits. However, an attempt by and capital with their labor and improve income. the less developed regions to emulate the poli- Improvement in the land/labor ratio will be a cies and institutions of an era that no longer crucial element in increasing future income exists would be counterproductive. Local gov- within agriculture, particularly if water devel- ernments in inland and other disadvantaged opment and conservation schemes and credit- areas should promote, but not subsidize, small- institution reform increase water and capital scale family enterprises that target local niche availability. Given the inevitable conflict that will markets and enterprises that can exploit local I- II . xi Accelerating China's Rural Transformation comparative advantage, or aidfirms that emplha- incur losses. Concentrating policy lending in a size agriculture and related sideline production single institution would permit better monitor- more than industry. Officials promoting rural in- ing of costs, subsidy requirements, and impacts. dustry inland should also seek to elicit the man- China must decontrol interest rates if rural agement and capital inputs of those who have credit institutions are to adequately serve the successfully developed enterprises in other ar- sector. Rural financial institutions (RFIs) focus eas. primarily on lending, but they could improve The financial needs of TVEs are not well met service to the rural community by creating new by the financial markets, which is a serious savings deposit instruments that provide attrac- constraint. Rural financial reforms have cur- tive combinations of return and liquidity. Such tailed formal credit, and as credit becomes re- instruments, combined with improved rural strictive, TVEs are among the first to lose access. markets, may persuade farmers to hold in- A portion of the credit problem is due to uncer- creased savings in the form of deposits and less tain creditworthiness of the TVEs. However, this in the form of grain. Regulation must be pru- is paradoxical, as TVEs are the most dynamic dent to ensure stability and safeguard deposits segment of the industrial sector. Given their while avoiding excessive restrictions. importance in the national economy, China must Rural credit is constrained, in part, by the find a way to increase their access to credit. lack of technical and financial skills of RFI staff, Explicit financing (for onlending or loan guaran- which limits their ability to evaluate alternative tees)for small and medium enterprises channeled projects and monitor loans appropriately. China through existing fnancial institutions is an op- should develop institutions that support RFIs tion. However a training program to improvef- in improving their capacity to screen loans, nancial management and operational skills of enforce repayment, improve the use of loan his- both the lending institution and borrowing en- tories and credit ratings, develop and standardize terprise should accompany, or be a component accounting and reporting procedures, evaluate of afinancing program. assets and collateral, and develop resale mar- kets for collateral. Also, China should create a Reforming Rural Credit. diversity of RFIs to compete and specialize in The financial sector has reformed more slowly meeting the needs of different demand charac- than some other sectors, and the government teristics-which might range from full-service maintains strong controls. Several financial banking to specialized banks for rural industry institutions have developed to serve the rural to microfmance institutions. sector, but most lending is to rural enterprises and to state agencies to procure grain and cot- Productivity-Enhancing Policies and ton (policy lending). The Rural Credit Founda- Investments tion system, the smallest and newest quasi-state creditinstitution, istheonlyinstitutionalcredit Research and Extension: A Means for source that lends primarilyto agricultural house- Raising Total Factor Productivity. holds. Informal credit among villagers, both with Historically, the agricultural sector has been and without interest, is an important compo- well served by the public research system. By nent of agricultural production credit. creating new technologies and crop varieties and A definitive separation of policy and com- improving agronomic practices, the research mercial lending is clearly needed. China should system raised total factor productivity in agri- fully understand that policy lending to state culture, expanded production frontiers, reduced agencies for mandatory procurement of grains- long-term production costs, and improved ru- particularly that which goes into grain procure- ral incomes. Growth accounting analyses indi- ment, strategic reserves or buffer stocks-will cate that crop growth over the past decade was xii Executive Summary overwhelmingly attributable to research invest- sure broad scientific representation on judging ments. Unfortunately, agricultural research panels and access for younger recently trained investments have declined in real terms and scientists. To increase research financing, the research expenditures as a proportion of agri- government could impose cesses on agricultural cultural GDP have fallen below the average of cornmodities that are processed (such as cotton, developing countries, creating concern for long- tobacco, and tea) or at transit points where a term agricultural growth. Without access to new cess can be administratively collected, such as efficient production technologies, China's farm- an export port. After enforcing of intellectual ers will be disadvantaged in competitive inter- property right (IPR) protection and licensing national markets. become better established, commercial activi- Government has several options: (a) increase ties of research institutes should be discontin- public investments in agricultural research and ued. However, in the shorter term, implementing technology transfer to develop a continuing a matching grant program to provide funds equal stream of applicable modern agricultural tech- to an institute's commercial earnings, rather nology for agriculture; (b) encourage domestic than automatic funding reductions, could private sector investment in new agricultural strengthen the research program. China coop- technology; (c) provide incentives for foreign erates with several of the International Agricul- entrepreneurs to develop and produce new tech- tural Research Centers. Increasing its interaction nologies for the domestic market; and (d) en- with these institutions and with additional cen- courage the import of technology developed ters that focus on livestock and crops in arid elsewhere through minimal import constraints and semiarid zones could improve China's ac- and tariffs. The most efficient process is likely cess to agricultural technologies suited to pov- to be a combination of these activities; some erty areas. government-financed research is necessary to Extension services suffer from substantial ensure priority issues and public goods are financial problems, staffing shortages, and staff addressed. This is especially true where research skill deficiency. Funding shortages have driven benefits are long term or cannot be readily cap- away many field staff. Those remaining in-post tured and would not be undertaken by the pri- require increased training to upgrade their ex- vate sector (such as research on subsistence isting skills and acquire new skills related to commodities for resource-poor areas and natural production of nontraditional commodities, and resource management). new methods of understanding and addressing A large quantity of fiscal resources continue marketing issues. Given the small scale of its to be directed into the grain subsector. These farms, China must revitalize its public extension resources consist primarily of storage facilities, system. Some activities of the public extension stocks, and monetary subsidies-all of which service could be assumed by the private sector if absorb finances but have no investment multi- commercial companies were permitted greater plier effect on growth. Redirecting some of these participation in domestic marketing. Such activi- resources to agricultural research would have ties would include introducing new seed variet- a better impact on long-term growth. However, ies, managing pests, applying agrochemicals pending fiscal restructuring, several actions (including fertilizer), and controlling the quality could improve the efficiency of the existing re- of commodities. search funds, increase research financing, and increased access to nongovernment research Foreign Direct Investment in results. To ensure the most important research Agriculture. issues are addressed, the government should China has been enormously successful in make the competitive grants-awarding process attracting foreign direct investment (FDI)-pri- fully transparent and widely publicized and en- marily in labor-intensive manufacturing-which I I . III II. xiii Accelerating China's Rural Transformation has been an important source of new job cre- in northern China-and the government has ation. However, only about 4 percent of actual identified several hundred water development FDI inflows during the 1990s was for agricul- projects to assist in alleviating this constraint. tural and agriculturally related manufacturing Despite massive investments in water develop- investments. FDI in technology-intensive ment and conservation over the reform period, agroindustries (seed, agrochemicals, veterinary water available for irrigation in 1993 was mar- pharmaceuticals, and agricultural machinery) ginally less than that of 1980. Given the unmet have important modernization potential and water requirements in some sectors and the could supplement or substitute for research that higher productivity of water in other sectors, is currently being carried out by China's own, large investments in developing new resources already-stressed research system. Given the and in improving distribution and use efficiency potential contribution to sectoral growth, the gov- are needed if supplies to agriculture are to be erinent might actively seek foreign investment maintained. The most probable source of new in technology-intensive industries as well as supplies are water transfers from the more capital-intensive industries, such as fertilizer water-abundant south, as both surface and which is in short supply domestically. groundwater resources are fully or overexploited Although the government has enacted IPR in most northern locations. China should ini- legislation, legal protection is perceived to be tiate work on one or more ofthe south-north trans- poor and China's large potential market for new fer routes as early as possible, as completion input technology has not attracted significant will be costly and time consuming. private investments. Consequently, technology While water transfers from the south will developed by transnational corporations and help shortages in the north in the near term, made available for Chinese farmers primarily they will not increase long-term water supplies comprises inputs that are very difficult to repli- in the north, as the transfer volumes will likely cate, thus the property rights are technically be less than current overabstraction of ground- protected. If transnational corporations are to water in the North China plain. Investing in provide and promote proprietary technology, projects for improving irrigation efficiency is China must show that it will resolutely enforce equally important. These would include improv- its recently enacted IPR legislation. In addition, ing delivery efficiency through rehabilitating officials of transnational corporations have in- systems and lining canals (or building pipelines), dicated that the weak regulatory environment, and improving on-farm efficiency through imple- opaque foreign investment policy, and frag- menting advanced application techniques and mented wholesaling and retailing networks in- new water-saving technologies. Achieving the hibits investment in technology and targeted delivery efficiency of 78 percent would capital-intensive industries. Incentives need to deliver an additional 100 billion cubic meters be crafted to stimulate investment and resolve of water to farmers' fields-increasing produc- the various marketing and distribution con- tion and farmers' income enormously. straints. Applying financial resource constraints means that farmers will be required to shoul- Resource Development and der the costs of managing, operating, and main- Production Inputs taining lateral canals. Some successful pilot programs in transforming irrigation manage- Water: The Major Constraint to ment agencies into self-financing entities have Future Agricultural Productivity. developed and should be replicated as rapidly China has abundant labor but other resource as institutional managers can be trained. How- inputs are in short supply. Water is agriculture's ever, farmers have little incentive to conserve most limiting agricultural resource, particularly water and alter their cropping patterns if water xiv Executive Summary costs are low or unrelated to the amount used. Despite the benefits that farmers would re- Therefore, to ensure water conservation and ceive if land were privatized or if land rights efficient on-farm water use, we encourage rapid were more secure, a number of household sur- implementation of full-cost volumetric water veys have determined that most farmers prefer charges. China must begin to address ways to collective ownership and periodic land adjust- begin to implement water pricing schemes. ments based on demographic dynamics. There- In southern China, controlling the flow of fore, an abrupt change in land property rights, abundant water is the greater issue. Flood con- such as privatization, would have significant trol is an integral component of an investment social costs and be ill advised. Given the impor- program, and China should clearly direct addi- tance of land in China's rural society, continuing tional attention to watershed management. experiments in the land market and tenure to carefully assess impacts on security, income, Land Resources and Land Use Rights. equality, investments and efficiency are crucial. Nearly every farm household in China is endowed with land. Bylaw, land ownership rests Improving Resource Use and with the village (or collective), which contracts Allocation Efficiency or otherwise allocates the use of the land to households. The central government recently External Agricultural Trade. extended legal tenure security on contracted land Agricultural trade increased about 50 per- from 15 to 30 years, but village leaders frequently cent over the past decade-somewhat less than do not follow these policy directives. The dy- overall trade-and the agricultural trade bal- namics of household and village demographics ance has been positive in all but one of those and other policy pressures often induce local years. Although the trade data series are short, authorities to reallocate land before contract they imply that the composition of agricultural expiration. Although significant long-term gains exports increasingly reflects a production and to productivity would likely be associated with trade pattern consistent with comparative ad- better tenure, several analyses have demon- vantage-exports of labor-intensive horticulture strated that China's land tenure system has only products and imports of land-intensive cereals a marginal impact on agricultural production. have both risen. However, the absence of secure tenure rights In the interest of stabilization, state trading does prevent farmers from using land as collat- companies continue to monopolize much of eral and limits their access to formal credit China's agricultural trade. But several factors markets. combine to deny achieving the stabilization goal. Formal land-rental markets are infrequently State trading companies respond slowly to found in China. Informal arrangements allow changing trade conditions, implement trade households to transfer short-term use rights to quotas planned far in advance of harvest (by others for a fee-including tax and quota liabili- the time the trade occurs it may be unrelated to ties-although the proportion of land rented is prevailing supply conditions), and in the ab- very small. Farmers find renting out their land sence of competitive efficiencies destabilize, increasingly difficult as increasing numbers of rather than stabilize, supplies and prices. Prices rural residents migrate or otherwise obtain nona- in some of China's grain markets have been gricultural employment, leading to inefficien- more volatile than international prices and grain cies in land utilization. Finding a mechanism imports/exports have exacerbated domestic to permit the remaining full-time farmers to supply fluctuations over the past decade. access additional farm land, and thus improve A liberal, open, and competitive grain mar- incomes by raising the land/labor ratio, is im- ket-including state and nonstate enterprises perative. operating under the same constraints, incen- 1 . 1 1 - - 1 - 1 - . . 1 1 - I I . I I I I I I XV Accelerating China's Rural Transformation tives, and commercial standards-would facili- security objectives. Savings resulting from de- tate more rapid trade responses to grain sur- creasing grain storage could be redirected to pluses (including surplus stocks) and shortages, assist those groups most affected by trade lib- and be more stabilizing than the current mar- eralization. Growth and income also might be ket. More open trade would require removing increased by discontinuing grain quotas and trade quotas and replacing the two-tier grain permitting farmers to select their own produc- tariff regime (1 to 3 percent for within quota tion combination on the basis of their resource and more than 100 percent for above quota) availability and prices. with a single tariff rate that would provide farm- From a financial perspective, China is food ers with downside price protection and protect secure because its foreign exchange reserves consumers from exorbitant price increases. and balance of trade are highly favorable. In- If China maintained tariffs at the binding ternational grain prices are expected to con- rates that it has offered in its World Trade Or- tinue their long-term decline, although ganization (WTO) negotiations, grain and oil- short-term volatility is likely. International grain seed prices for domestic producers and reserves exceed 100 million tons, and the ma- consumers could be maintained at about 60 jor grain-exporting countries could rapidly pro- percent above world prices. While such bind- duce and export much larger volumes if a steady ings are low by international standards, they growth in export demand were anticipated. would prevent China from adopting the extreme China also has the infrastructure and bureau- protectionist policy of its East Asian neighbors, cratic expertise to run an effective buffer-stock and prices could be kept at a level that would system as part of its domestic marketing strat- significantly benefit grain and oilseed produc- egy. This system could also be used in conjunc- ers. If China's objectives focused more on con- tion with imports to buffer domestic prices. sumer welfare, it would lower the tariff rate, Liberalizing international cereal and oilseed trad- making production of these crops less attrac- ing would be an efficient option for managing tive and directing productive resources into al- trade and supporting the objective of 95-percent ternative high-value crops. This would improve grain self-sufflciency. the long-run welfare of both producers and con- sumers. To the extent that rural poverty groups Domestic Marketing: Room for More are not self-sufficient in food staples, a high Improvement. import-tariff regime would increase their food Marketing and pricing policy reforms have costs, but liberalized trading rules would hurt led to unprecedented market development over those who specialize in grain production, a part the past decade. Most food commodities are now of the rural population that is still relatively poor. sold at market prices, and statistical analyses indicate domestic grain markets are well inte- Reevaluating Food Security. grated and increasingly competitive and efficient. Some national objectives will require com- The rise of a private trading class has resulted promise if other objectives are to be effectively in 25 to 35 percent of China's grain procure- addressed. This particularly applies to 95 per- ment going through private channels. cent cereal self-sufficiency and maintaining large Despite the rapid emergence of China's buffer stocks, which compromise poverty re- markets, problem areas remain, including con- duction and efficiency objectives and exert a tinued intervention by government grain agen- substantial drain on the national and provin- cies, incomplete separation of policy and market cial treasuries. Evaluating national food secu- functions, the continuance of producer quotas, rity from a financial perspective and placing and the high expense involved with a large and greater reliance on domestic and international costly grain reserve. The marketing channels of markets would address both efficiency and food- the grain bureau continue to incur losses, ex- xvi; Executive Summary tend overdue loans, and require large subsi- comes. Commodity transporters meeting na- dies-inefficiencies that result in part from the tional standards should be able to transit all conflict of their operating commercially while provinces unhindered upon presentation of cer- implementing policy directives. Grain stocks tified documents at provincial border check- have continued to rise and require expensive points and payment of officially sanctioned maintenance from the fiscal and financial sys- transit fees (based on weight, number of axles, tem. An appropriately budgeted government or other objective criteria). agency should be responsible for maintaining Producer marketing associations are insti- grain reserves or buffer stocks, knowing that it tutions designed to improve farmers' bargain- will incur losses directly related to their size. ing power with respect to downstream Therefore, China should carefully evaluate the purchasers. A few farmer organizations have need for reserve stocks from the perspective of developed in rural China, but these focus pri- minimizing requirements. India and Indonesia marily on production rather than marketing. employ buffer stocks to stabilize grain prices, The government could assist their development albeit at significant cost, but procure only 20 to by establishing a positive legal and regulatory 25 percent of the marketed grain. framework for their existence and obligations. If the proposed grain reforms of 1998 had The lack of prohibiting legislation is insufficient been successfully implemented, the government to encourage them to develop. Also, farmers need would have met its complex set of policy objec- technical, managerial, and training assistance tives of improved efficiency, protection of farmer to develop the expertise required to establish income, and reduction in government's fiscal such an organization and to develop associated burden. However, policy implementation de- market intelligence units. Without marketing parted from the design and will likely fall short organizations, farmers are unlikely to be able of meeting the core objectives. Recent measures to exploit market niches and meet supply defi- adopted in mid-1998 are reminiscent of those cits that may exist in scattered markets. of the 1980s, which were costly and relatively The government could assist market devel- unsuccessful. These measures include opment by making market information com- remonopolizing farmgate procurement at gov- prehensive and by consolidating the information ernment-determined prices, prohibiting the system under the auspices of a single agency. grain bureau enterprises from selling grain at To ensure adequate information was provided prices below the government-determined pro- to the central market information agency, China curement prices, and clearly separating com- could make licensing of wholesale markets con- mercial and policy functions and central and ditional on timely submission of market infor- local government responsibilities in price sta- mation. bilization and buffer stock management. Imple- mentation of the new policies will likely lead to Poverty Alleviation substantial grain overprocurement-stressing In the early years of reform, rapid growth financial and physical storage capacity. was associated with rapid reductions in pov- Although the marketing of fruit, vegetable, erty-which was achieved, in part, by labor and livestock products was liberalized more than migration to the coastal areas, where growth a decade ago and has grown rapidly, several and job creation were occurring most rapidly. policy and institutional constraints impede The 50 million residents still living below the marketing efficiency. Standardizing national national poverty line are believed to live in ar- quarantine and phytosanitary inspection pro- eas that are remote, less accessible, and very cedures and shipping documents applicable to resource poor- limiting potential for increas- all interprovincial commodity transport would ing agricultural production. The large wage-rate improve marketing efficiency and farmers' in- differentials between poor rural areas and pros- . 1 .I I . xvii Accelerating China's Rural Transformation perous urban (and rural) areas provide power- the hands of rural households. In some areas, ful migration incentives and means to overcome "grassroots" rnicrofinance programs that are able poverty. To alleviate poverty, these areas will to reduce the transaction costs involved in evalu- need nonagricultural employment and improved ating projects, issuing loans, and monitoring linkages with the rest of the economy. Educa- repayment by using peer monitoring and group tion, which makes individuals more marketable lending have succeeded in alleviating poverty. in the labor force, also contributes to poverty Such programs must be carefully designed, alleviation. staffed, and implemented, and their impacts Effective poverty alleviation requires getting must be carefully evaluated. Also, it is impor- well-designed programs to those who need it. tant that credit policies be sufficiently flexible, Properly targeting poor households rather than particularly regarding interest rates, that the just poor counties is crucial-subcounty admin- programs can be sustained. istrative units need to the considered. Target- ing in some provinces has improved in recent Natural Resources and the Rural years, but targeting in some other provinces has Environment been less effective. Designing and implement- Natural resource degradation and pollution ing poverty reduction programs on the basis of of the rural environment are a serious concern. detailed consultations with local leaders and Anecdotes, quantitative assessments of small planned participants is particularly important. circumscribed areas, glaring visual impacts of Community participation has been an integral erosion and pollution, and the 1998 Yangtze element in designing the World Bank-supported River flood create an impression of very severe poverty reduction projects, which also involve degradation. However, little nationwide quanti- concentrated resources and intensive monitor- tative assessment of the extent and severity of ing. Food-for-work projects apparently have been natural resource and environmental problems quite successful, in part because the funds by- has been conducted. The natural resource base pass the fiscal system and in part because the suffered from widespread deforestation and projects are narrowly defined, easily monitored, pasture conversion to cultivated land, leading and focus on high-return investments. Invest- to serious erosion problems during the 1950s ments in agriculture, rural enterprises, roads, and 1960s-situations that were reversed in the and other rural infrastructure have increased 1980s and 1990s. The evidence on environmen- the productivity and income of the poor. How- tal degradation is ambiguous; statistical data ever, resource constraints in many poor areas indicate that forest cover is increasing and sedi- limit efficient infrastructure investments. Invest- ment traps along the Yellow River have reduced ments that do not have reasonably favorable sediment concentrations by 25 percent in the rates of return should be reconsidered unless lower reaches. However, many rivers are pol- poverty alleviation considerations are compel- luted along lengthy stretches, coastal wetlands ling. continue to be drained, and desertification is While economic growth is clearly associated said to be increasing. with poverty reduction, programs for reducing Also, interpretations of the impact of envi- poverty have had mixed success in increasing ronmental degradation on growth conflict. Vari- growth. If poverty programs are to contribute ous estimates of the cost of environmental to long-term growth, they must be based on degradation range from zero to 15 percent of efficiency criteria and add to investment stock. GDP, but the highest estimates are based on The subsidized credit program for poverty alle- gross assumptions that are not credible. One viation generally has not reached the poor, of the more comprehensive studies on the im- achieves low repayment rates, and should be pact of environmental pollution and ecological replaced with programs that place funds into degradation estimated the cost at 7 percent of Xviii Executive Summary GDP. However, the cost of degradation reduc- recurrent expenses. Such income-generating tion and prevention has not been analyzed. activities may exploit the resource and contrib- Better information is needed to determine what ute to further degradation. The fiscal resources prevention and reduction measures would be for environmental protection, maintaining economically efficient. Also, minimal effort has biodiversity, and sustainable management of been made to determine the proportion of deg- long-term natural resources must come from the radation that is occurring naturally. A thorough public treasury. quantitative assessment ofthe impact on growth Poverty is an important contributor to envi- ofnatural resource degradation and environmen- ronmental degradation. The present, rather than tal pollution and the costs and benefits of pre- the future, is the concern of the very poor. Con- ventive and remedial actions is essential to sequently, denuding hillsides to cultivate sub- support an effective natural resource policy. sistence crops and deforestation to meet Several factors contribute or lead to envi- immediate fuelwood needs have led to erosion ronmental degradation. The legal framework to and natural resource degradation. Various conserve natural resources and protect the en- projects have found that improving erosion con- vironment exists; however, the fiscal system often trol through increasing vegetative cover and provides insufficient financial resources for improving cultivation techniques are economi- environmental protection services to properly cally efficient and should be replicated. Simi- perform their jobs. Consequently, agencies re- larly, expanding the forest resources to support sponsible for conservation and protection are continued growth in construction and often encouraged to use natural resource as- agroprocessing has been an economically effi- sets to generate revenue for wages and other cient investment. SIII ,xix Part I The Rural Sector Challenge 1. A Visionfor the Rural Sector Since the founding of the People's Republic, central to the government's rural development the leaders of China have been preoccupied with objectives: food security and poverty alleviation. one overarching goal; the modernization of the China has made remarkable progress in meet- nation. Our vision for the early part of the 2 1V ing these goals; the economy, including the rural century perceives the rural economy as an in- sector, has grown at phenomenal rates during tegral part of this modernization effort, with the reform period. The growth of food supplies equitable increases in income, and the elimi- has exceeded the growth of domestic demand nation of poverty, achieved in large part by trans- and China exports horticultural, livestock, other ferring rural labor to the urban-industrial agricultural, and aquacultural products. The economy-all accomplished in an environmen- growth of rural industry has been an important tally sustainable manner. We envision an enor- element of recent growth as the rural economy mous government effort in transforming its role continues to diversify. Increased productivity into an investor for public services and goods and income growth have reduced the massive and fostering a market environment-enabling pre-reform poverty problem, improved the stan- individual farm and nonfarm producers, con- dard of living of most residents, and launched sumers, and traders to make more efficient the structural transformation of China from a decisions and improve their welfare. traditional rural to a modern society. In pursuit of this vision, two issues remain However, growth will be difficult to sustain Accelerating China's Rural Transformation and many challenges face those responsible for international trade (Chapters 5 and 6); and China's modernization. The economic base is encouraging new productivity-enhancing invest- considerably greater than it was two decades ments in land, water, and new agricultural tech- ago, the easy sources of growth have been nology (Chapters 7 to 9). Further attention is tapped, and several underlying conditions have focused on efforts required to revitalize town- changed. Further expansion and intensification ship and village enterprises (Chapter 10), pov- of China's cultivated land base will be difficult erty alleviation (Chapter 11) and environmental and input levels for agriculture are already high. and natural resource protection (Chapter 12). Development of additional water resources will We briefly review recent rural economic and require massive investments. Future growth will income growth and achievements, examine the increasingly rely on technology, capital, in- sources of growth, delineate a number of chal- creased cropping intensity, and production shifts lenges still facing China's rural sector leaders, to higher-value commodities. The early rapid and recount some of the basic strategies that growth of township and village enterprises (TVEs) leaders have at their disposal to address them. and the expansion of jobs they created were We discusses the State's roles and options in possible because of large, unfulfilled domestic establishing an enabling environment to main- demand-a situation that exists much less to- tain the growth momentum into the next cen- day. Past growth also relied partially on new tury, including governance, regulatory export markets and foreign direct investment framework and market interventions, invest- inflows. Increased global competition will make ments in rural infrastructure and public ser- further expansion of export markets more diffi- vices. Some weaknesses in the rural fiscal and cult. financial policies and institutions are exposed that, unless resolved, could seriously under- Objectives and Structure of mine future growth. Public interventions in this Report domestic marketing and international trade are The objective of this report is to identify and then discussed, followed by a review of invest- develop strategy options that will assist ments in rural infrastructure and public ser- policymakers and donors to prioritize invest- vices. Finally, the necessity to reduce poverty ment decisions, policy and institutional reform while maintaining growth is emphasized, as is efforts, and continue to guide China's progress the importance of sustainable growth through toward modernization. This volume presents our natural resource and environmental protection vision of the growth and development of rural and pollution control. China in the 2 1 century. To this end, we sys- Although this vision statement addresses tematically review the institutions, state of problems across the rural economic spectrum, China's resource base, and the policies that several important topics have been excluded. transformed the rural economy in the following The problems of village governance, barriers to chapters. We explore the macrolinkages with the emergence of rural producer and market- the rural sector and impacts of industrial and ing organizations. the development of agricul- external sector interactions on rural incomes tural input markets (such as seeds, fertilizer, (Chapter 2). We examine the state of China's pesticides, and custom services), and rural in- rural fiscal and financial service systems, and frastructure are not examined Their exclusion try to assess how further reform and perfor- does not mean they are unimportant but that mance can be enhanced (Chapters 3 and 4). We time and budget constraints precluded a more search for options in which government can comprehensive assessment of the sector. Some assist producers manage their resources more recently completed and impending World Bank efficiently by improving domestic markets and studies address some of these issues. 2 Chapter 1: A Vision for the Rural Sector Post-Reform Growth and creation. More than 135 million people found Achievements off-farm jobs by the mid- 1990s-contributing Historically, agriculture has been the pri- to the 63 percent increase in real per capita mary contributor to rural growth, but the ex- incomes between the mid-1980 and mid- 1990s. ceptional growth of the output value of TVEs Rural reforms have been gradual and me- (averaged 24 percent, 1985-95) has made them thodical and often based on policy experiments a major factor since 1987. By 1995 the output These experimental options are limited to spe- value of TVEs was more than that of agricul- cific geographical locations to ensure that ac- ture. Total agricultural output grew at an an- tual and theoretical results are sufficiently nual rate of 4.2 percent between 1985 and 1997. consistent to proceed with wider implementa- Growth in the major agricultural components tion. If the experiment is judged unsuccessful, is illustrated in Figure 1.1. Crops continue to it is discontinued; however, if it meets a declared contribute well over half of the output value objective, the policy is promoted nationwide. This despite rapid growth in livestock and fisheries. format is perceived to have been successful and Livestock contributes about 30 percent of the will likely remain the norm for future rural re- output value; fisheries, less than 10 percent; forms. Thus reforms in areas of major impor- and forestry, about 3 percent. Recent analyses tance (e.g., land) will proceed slowly until by Zhong (1998) concluded that China's agri- sufficient experiments indicate the selected cultural databases tend to overstate produc- policy will meet a complex of objectives. Experi- tion, particularly livestock statistics; thus these mental approaches to policy reform may be costly growth rates may well be upwardly biased. Not- in efficiency terms and should be discouraged withstanding adjustments that will follow the in the longer term; but "Big Bang" reforms prac- evaluation of the recent agricultural census data, ticed in some other transition economies, are the statistics will likely confirm exceptionally unlikely to be practiced in the near term in China. high agricultural growth. Rapid economic growth and active poverty Sources of Past Growth alleviation activities lifted more than 210 mil- A significant part of output and productiv- lion from poverty and reduced the number to ity has come from improved incentives for house- around 50 million in 1997-about 6 percent of the rural population. Figure 1.1: Gross Value of Agricultural Output Theexplosionofruralin- (1985 = 100) dustrial growth and off Index farm employment has 450.0 been an important ele- 400.0 ment of China's overall rapid economic growth, 3500 rapid increase in rural 300.0 incomes, and poverty reduction. TVEs ex- 250.0 panded rapidly during 200.0 the reform era, contrib- AH Agn 42% uting more than 40 per- 150.0 cent of China's 1000 co _5 industrial output. Rural Forestry 06 enterprisesalso9werean 50185 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 important source of job I - I . . I . . I 1 0 1 . . I I . C . I 1 4 1 I 3 Accelerating China's Rural Transformation holds, TVE owners and managers, and local gov- remain an important element in policy-making. ernment officials. Replacing communal respon- Grain fundamentalism, the provision of rela- sibility with the household responsibility system tively inexpensive and stable supplies of grain (HRS) contributed 30 to 60 percent of the growth for the urban population, still prevails in the of agricultural output during the early reform form of quotas, marketing regulations, direct years. Improved incentives for managers of ru- and indirect subsidies (albeit reduced from pre- ral industry and the rise of private rural firms vious levels), and by social pressure from local made the sector one of the most dynamic ele- officials. Such policies obligate farmers to ig- ments of China's economy. However, institu- nore market developments and cultivate lower tional reforms provide one-time, incentives. profitability crops such as grain and cotton. The Investments in agricultural technology, ru- emphasis on grain production also has resulted ral infrastructure, and social welfare also have in the conversion of some fragile ecosystems- increased productivity in the rural economy. wetlands, forests, and pastures-into cultivated Over the entire reform period increased pro- lands, contributing to biodiversity losses and ductivity from investments in agricultural re- soil erosion. search and extension system exceeded The structure of rural income earnings has productivity increases generated by HRS. Im- evolved slowly. Wage labor as a proportion of provements in irrigation and water control also net income has increased to only 25 percent continued to help expand yield frontiers, espe- despite the extraordinary growth in TVEs (Fig- cially in North China. These are the types of ure 1.2). Household income from nonagricul- investments that will increase resource alloca- tural activities, such as trading, construction, tion efficiency in the long run. and transport, also increased but is often not Increased domestic market integration and an option for many households and individu- linkages have further improved efficiency in the als, particularly in inland provinces. Although rural economy. The rise of markets has increased the importance of agriculture continues to de- specialization and resource allocation efficiency. cline, it still provided 58 percent of rural house- Domestic resource use patterns are increasingly hold income in 1997. But income inequality has more consistent with regional comparative ad- increased rapidly and income gaps between rich vantage. Markets for most agricultural connodi- and poor, urban and rural, and coastal and ties, farm inputs, and labor have increased inland are growing. Relatively equitable income income earning opportunities for many rural distributions prevailed in the late 1970s, but households and have contrib- uted to the decline in poverty. Figure 1.2: Rural Income by Source Persistent Challenges Yuan (constant 1995) While past growth and de- 2000 % Income Transfers Services (transport, trading etc) velopment achievements have 1800 Wage Labor been impressive, future growth 1600 Household Agriculture X will be more challenging as much 1400 11 of the potential gains from tran- 1200 522 sition have been achieved. An 1000 8 - unnecessarily large component 800 of the agricultural economy re- 600 mains focused on cultivating 400 66 66 relatively low-valued cereals, due 200 in large part to the policy envi- i 0 1985 1990 1995 1997 ronment. Food-security goals _ 4 . . . . Chapter 1: A Vision for the Rural Sector by the mid- 1990s income distribution in China Future Vision: Meeting the was among the world's most inequitable. In- Challenges and Modernizing come growth rates in rural areas are less than Rural China half the level of urban residents. China's miracle growth is aptly titled and Decentralization generally has been a growth with good governance China should continue stimulus, but it has also created fiscal prob- on a sustained growth path. This positive vi- lems and retarded potential growth as the rural sion of the rural economy will require numer- tax base is exceptionally limited. The fiscal cri- ous policy initiatives and institutional reforms, sis is an overriding problem factrig the rural sec- accompanied by an enabling macroeconomic tor. The rural economy has neither viable fiscal environment that treats rural-urban, agricul- nor financial institutions. Declining real invest- ture-industry-service, and government-private ment for virtually all agricultural and rural in- sectors as equally important and mutually sup- frastructure, and declining recurrent porting partners. China will approach moder- expenditures for services and activities, bodes nity when these sectors are integrated, ill for future growth. Mandated expenditures ab- self-reinforcing partners. Each sector would have sorb a large and increasing portion of the bud- equal access to efficiency-priced resources, en- get, leaving little for activities such as technology suring no cross-sector subsidization except for development and transfer. Many public-service targeted subsidies to poverty groups. institutions and staff are encouraged to under- As part of the policy and institutional re- take commercial activities to supplement bud- form, the government would not only balance getary resources agricultural-rural with other sectors but iden- Increased support of agricultural research, tify and separate the roles and activities that it water control and management, rural infrastruc- will retain as public goods and services and those ture and social services is needed. But the agri- it will permit nongovernment entities to under- cultural research and extension system is weak take without intervention. Government also and deteriorating, and restrictions on import- would embrace the private sector as an integral ing high technology from international sources component of the development process and for agriculture inhibit farmers' access to better encourage it to become the new engine of growth. agricultural practices. New production technolo- Newjobs for productively absorbing the under- gies and many services could be developed and employed, redundant labor from government provided by the private sector-domestic and downsizing, state-owned enterprise (SOE) re- international-but weak enforcement of exist- structuring, and new labor-force entrants must ing intellectual property rights and poor whole- come from nonagricultural and nongovernment sale and retail channels discourage interest and sectors. investment by such firms. Government reconsideration and reexami- Poverty and environmental degradation re- nation of several policies-including those re- main serious problems. Millions of people re- lated to domestic production and marketing, main in poverty pockets in resource-poor rural external trade, and 95-percent grain self-suffi- areas-particularly in the southwest and north- ciency-with the objective of consistency and west mountainous uplands. Poor regions, char- efficiency would likely alter policies enabling acterized by poor physical and human capital, farmers to produce, and merchants to trade, receive lower levels of investment in basic ser- more labor-intensive and higher-value commodi- vices and infrastructure. Poverty disproportion- ties. Reforming the domestic-market and inter- ately affects minority groups and is an important national-trade structures to make them more cause of natural-resource degradation. market responsive would have mixed impacts, and the impacts of specific reforms should be carefully assessed before being implemented. A . I I I I I , I I I I 5 Accelerating China's Rural Transformation reconsideration of national fiscal policies would Agricultural income would be increased by include identifying methods and procedures to ensuring farmers had access to more nonlabor generate more tax revenue from the rural sec- resources (land and water, credit, capital, and tor and to allocate more resources to poverty technology) to permit them to move toward more areas and to subprovincial jurisdictions, and optimum input and output combinations, in- to either discontinue off-budget revenues and eluding higher-value livestock, aquatic, and expenditures or incorporate them into the bud- horticultural products. However, land is a unique get. Financial policies would be reexamined to production input that performs an exception- ensure that financial flows were driven by fi- ally important social-security role in China; thus nancial incentives-not by administrative deci- legal changes in tenure forms would be imple- sions to support or subsidize state-owned mented only after careful assessment. Never- industry-and assist in leveling the playing field. theless, a land-use market would be developed The rural-agricultural sector would have equal to provide a mechanism for full-time farmers to access to credit, although conditions of lending access additional land resources and optimize may well differ to cover various risks and higher (or move toward optimum) inputs and improve administrative costs of smaller rural loans. income. 6 Part H An Enabling Envir onmentfor Rural Development 2. Rural Income and Macroeconomic Linkages The rural and urban sectors are dualistic A. Domestic Macroeconomic and poorly integrated. China's rural sector has Dimensions continuously transferred resources to the ur- As China has moved from a planned to a ban-industrial sector, including capital, wage more market-oriented economy, balanced goods (food), industrial inputs, and to a lesser sectoral growth and integration have become extent, labor. However, constrained labor flows more important. The urban-industrial sector have contributed to the large differential in ru- provides the demand for the rural sector's mar- ral and urban labor productivity and income. keted surplus, and as the agricultural economy The rural sector has also served to buffer the becomes an increasingly smaller component of impact of macroeconomic shocks on the urban the national economy, changes in growth rates economy. The spread of market forces and in- of the industrial and service sectors strongly creased reliance on competitive prices has tended affect the agricultural and rural economy. to increase the flow of labor and other resources and improve integration in recent years. Un- Domestic Terms of Trade less labor movement constraints are lifted the In most countries growth in the total pro- dualistic nature will remain. ductivity of all production factors (land, labor Accelerating China's Rural Transformation and capital)-total factor productivity, or TFP- ban investors and discriminate against rural has led to declining rural terms of trade-de- borrowers. Rural residents, on the other hand, spite various price support and subsidy havebenefitedfromlowerincreasesinconsumer programs. In China, however, rising domestic prices relative to urban residents over the past demand, the phasing out of administered pric- decade and rising opportunities to remit wages. ing, and the adoption of market prices improved farmer terms of trade over 1990-97, as reflected Resource Flows in the ratio of prices received by farmers to prices Over the reform period direct budgetary ex- paid by farmers. Domestic commodity prices penditures to agricultural activities have ex- are now similar to international border-price ceeded agricultural tax receipts, but the netfiscal equivalents; thus China's trade and price policy flow to agriculture declined during the early and decisions will influence future trends in terms mid- 1990s. Fiscal expenditures include alloca- of trade. If China liberalizes its trade, domestic tions for investments in irrigation, land improve- terms of trade should decline over the near term ment, specialty crop production bases, etc. consistent with international expectations. If not, However, a net outflow from the rural economy demand will likely rise faster than supply in the has occurred as taxes from rural-based indus- near term, meaning prices will rise unless im- tries were considerably greater than the net flow ports are expanded. Other national policies and to agriculture. The net annual rural-to-urban events not effectively captured in terms of trade flow averaged aboutY 113 billion (constant 1995) calculations, such as output planning and quota over the 1994-96 period (Table 2.1); but the procurement, enforce both implicit and explicit official resource flow may have reversed in 1998 transfers from rural to urban sectors. In addi- as above-market prices for grains directed sig- tion, national credit policies generally favor ur- nificant resources into the agricultural sector. Table 2.1: Resource Flows from Agricultural and Rural Sectors to Nonagricultural and Urban Sectors (Y billion, constant 1995) Fiscal System Financial System Grain Total Resource Flow Agricultural Rural Agricultural Rural Marketing Agricultural Rural to to to to (implicit tax) to to non- Urban non- Urban non- Urban agricultural agricultural agricultural 1980 -38.5 -30.0 13.2 3.7 46.0 20.8 19.7 1985 -18.4 11.8 23.5 7.4 15.6 20.7 34.8 1990 -31.1 16.1 68.9 47.8 43.0 80.8 106.9 1991 -35.6 20.0 59.4 28.3 27.9 51.6 76.2 1992 -35.8 38.5 536.9 17.3 20.8 41.8 76.5 1993 -28.5 103.8 49.1 8.6 24.9 45.5 137.4 1994 -26.4 105.2 53.4 38.3 59.5 86.4 203.1 1995 -21.3 122.5 51.1 27.8 50.2 80.0 200.6 1996 -22.1 113.2 44.0 27.6 32.9 54.7 173.7 Source: Derived from China Finance Yearbooks and China Statistical Yearbooks, various years 8 . . . . . . - - , , - Chapter 2: Rural Income and Macroeconomic Linkages Regardless of the direction of official fiscal commencing in the fourth quarter of 1998. Much and financial resource flows, it is improbable of the investment will focus on rural infrastruc- that the "farmer's burden" has been lifted. Large ture that employs rural labor for irrigation, road, amounts of off-budget funds (not included in and rail construction and on rehabilitation of Table 2.1) are generated in the rural sector the rural electrical grid. through unofficial taxes (levied particularly on The investment program described above TVEs), various fees, and corv6e labor levied on may be having an impact-fixed-asset invest- rural households. Farmers are legally subject ment rose 28 percent in the third quarter (year- to a maximum total payment (township fee, vil- on-year basis). However, the composition of the lage fee, and labor-or monetary equivalent) of investment effort remains a concern as invest- 5 percent of the previous year's net income. ments during the first nine months of 1998 rose However, several county-level surveys have con- by 20 and 19 percent, respectively, for SOEs cluded that a plethora of additional fees and and property development. Thus a real risk re- charges are levied by provincial and mains that investments may be diverted from subprovincial jurisdictions that increase actual financing public goods to SOEs, where overca- tax and "tax-like" payments of rural households pacity is already serious and returns are low. to 20 percent or more of their income (Wen 1998). China's financial sector, like those in other To the extent that these resources are spent on Asian economies, has not evolved in parallel with salaries of township or village officials (and sur- real sector performance, remains structurally veys indicate that many farmers perceive their weak and potentially puts rural growth and village is overstaffed with officials), instead of development at risk. Government intervention, rural infrastructure and services, such fees are in the form of policy lending, pervades the bank- a pure tax. Furthermore, if the resources are ing system; and government remains involved not spent in rural areas, additional outflow of with SOE investment in nonpublic goods. Lardy rural resources may occur through unofficial (forthcoming) reports that, if properly accounted channels that are not captured in the consoli- for, the banking system's nonperforming loans dated fiscal statements. would be 30 to 40 percent of GDP. Stock and Investments in land and water resources are commodity futures markets remain underde- obviously necessary for continued sector growth, veloped and under-regulated, and many have but investments in energy (electricity), trans- been closed or consolidated. port (road, rail, waterway and port), and other Analysis of data from the banking system infrastructure that reduces marketing costs are indicates a net transfer of financial resources equally important for promoting rural-sector from agriculture to industry throughout the growth. Analysis by World Bank staff indicates reform period, although such findings need to that the infrastructure investment elasticity in be interpreted with caution because of concerns East Asia is 1.0, implying that for every 1 per- on the coverage of the available statistics. Con- cent of per capita growth, infrastructure stock solidated data on rural savings and loans ex- needs to increase by 1 percent of gross domes- clude transactions of Rural Credit Foundations tic product (GDP). Therefore, if applicable to (RCFs), the smallest of the rural credit institu- China, infrastructure investment will need to tions, and results in a modest understatement be 6 to 7 percent of GDP if GDP growth goals of the financialflows. Conversely the inclusion are to be achieved (World Bank, undated). of Agricultural Development Bank of China To stimulate domestic demand and develop (ADBC) data contributes to overstating finan- infrastructure, the government has embarked cial flows, as its lending is almost exclusively on a three-year $1.2 trillion infrastructure in- for agricultural procurement by government vestment program. A recent component was a marketing agencies. Many deposits in the Agri- Y 100 billion bond issue to finance investments cultural Bank of China (ABC) are by urban resi- 9 Accelerating China's Rural Transformation dents. After making allowances for these short- Labor comings, it is clear that although rural indus- In general, the rural labor force acts as a tries (TVEs) absorb a portion of these transfers buffer stock for the urban economy, providing of agriculture to industry, a significant rural- labor under booming economic conditions and to-urban financial flow (Y 30 billion per year in absorbing labor back from the city when job 1995 real terms) remained during the 1994-96 growth slows (Zhang et al., 1999). The buffer- period. Whether the financial flows reflect the ing capacity provides a stabilizing influence for response of rational investors moving funds from the overall development of the economy, but low-return to high-return sectors or whether continued access of rural workers to urban jobs they result from distortions in the financial and is a crucial element of China's modernization, fiscal system is undetermined, but the massive providing income-earning opportunities for poor movement of funds out of agriculture and the rural residents and increasing the efficiency of rural economy highlights the importance of the urban enterprises. Recent reforms in SOEs have sector and emphasizes the importance of keep- resulted in layoffs for large numbers of urban ing it healthy. workers and, as a consequence, many cities have About 40 percent of the SOEs incur losses enacted regulations restricting employment for and survive on subsidies and bank overdrafts rural migrants to low-quality. low-paying job -which then become nonperforming loans of categories. Such regulations and general ur- the banking system. A government priority is ban investment slowdowns affects the rural SOE restructuring, of which a major element is migrant labor force and its families. The ad- employment rationalization. This, combined with verse consequences of layoffs and urban reces- downsizing the civil and military services, will sion could be mitigated by placing the move large numbers of workers to the ranks of unemployed in retraining programs, instead of the unemployed. Labor reductions should im- granting them privileged access to jobs without prove SOE performance, but the reduced labor regard for their skill level. income will certainly erode demand and em- phasizes the need for rapid growth to create Rural-Urban Migration and newjobs for redundant labor. This overhang of Employment unemployed urban-industrial workers will have Natural population growth is slower in ur- priority for employment in newly created jobs ban than in rural areas but over the past two and make it difficult for rural workers to stay decades China's urban population increased and work in urban enterprises. To mitigate the from 18 to 30 percent (in 1997) of total popula- impact of income losses, government has bud- tion-due partially to expanding urban bound- geted Y 1.5 billion for a new welfare program to aries and partially to rural-urban migration, assist laid-off, retired, and disabled workers. which has been continuous despite restrictions Tight credit that has hampered growth and on population movement. A changing complex expansion of small and medium enterprises of incentives and disincentives influences both (SMEs)-which account for 60 percent of in- the decision of rural residents to migrate and dustrial output-has been relaxed. Lending by the characteristics of migrants. The rural-ur- state-owned commercial banks to SMEs, includ- ban income differential has been a powerful ing TVEs, has been increased by several billion stimulus to migrate (officially or unofficially) but yuan. This should bode well for expansion and the household registration system made it dif- employment, but it is as important to ensure ficult for rural residents to obtain access to ur- borrowing proposals and loans meet appropri- ban social services and obtain well-paid jobs; ate financial and economic efficiency criteria. also, village "use it or lose it" land policies may inhibit family migration. Jobs available to mi- 10 Chapter 2: Rural Income and Macroeconomic Linkages grants were primarily in traditional male-domi- clines have previously occurred. nated construction or transportation sectors as TVE growth and expansion has been impres- industrial SOEs are still obliged to hire urban sive over the entire reform period-except dur- residents. Thus, urban-bound migrants are typi- ing 1989-90. Despite rapid growth in rural cally young males whose families remained in industrial employment, output, and wages (TVE the villages to till family plots. wages have grown at 18 percent annually), and Market development, relaxation of labor the substantial direct and indirect contribution movement and urban employment restrictions, to the rural economy, rural-urban income dis- and discontinuance of the grain coupon sys- parities have worsened since 1985. Doubtlessly, tem in the early 1990s removed some of the rapid TVE expansion prevented the income ra- migration disincentives. Meanwhile, the continu- tio from being even more adverse, but it was ing rural-urban income gap has maintained the unable to reverse the worsening trend. Jin and migration incentive. During the 1990s urban Qian (1998) found that TVEs did not increase job creation and employment increased at five average per capita rural income given the levels times the rate of rural employment and up to of nonfarm employment and/or local public 100 million rural laborers and self-employed goods provision. Furthermore, the local nature traders have migrated to cities and coastal re- of rural industry also has contributed to rising gions (Chan 1996, Huang and Cai 1998). intrarural inequality (Rozelle, 1994). Barriers to migration appear to be primarily TVEs not only have successfully generated on the urban side, implying rural-urban mi- off-farm work opportunities for the local rural gration will increase as the constraints and labor force, but for workers from other villages barriers are removed. Whether such migration as well, creating rural-to-rural migration. Ru- will result in the creation of megacities or whether ral-to-rural migration in China is a paradox new medium-size towns will be developed as internationally-it has previously not been ob- job centers remains under debate. Regardless, served on such a large scale, and yet in China it however, increasing pressure will be placed on is the fastest growing subsector of the rural la- urban infrastructure and services and additional bor force. The rise of private sector ownership urban investments will be required. A strong, can, in part, account for the shift in hiring and open, urban sector is important for the rural nonvillage residents, since their owners are economy as migration reduces the agricultural unconcerned with noneconomic criteria, such labor force and improves the ratio of nonlabor/ as employment priority for local workers. From labor resources and income potential. the migrant's viewpoint, common backgrounds Agricultural employment reached an abso- permit rural in-migrants to better integrate into lute peak of about 350 million in 1991 and then the work environment. These factors, in addi- declined by 19 million by 1997-but agricul- tion to the fact that most TVEs engage in labor- tural employment as a proportion of total em- intensive light industry, mean that in-migrants ployment declined continuously over the reform are more likely to be women, older, and less period and now accounts for less than 50 per- educated; rural-to-rural migration is one of the cent of total employment. However, China is most important new windows of opportunities unique as a large share of industrial output is for rural residents into the wage economy. produced by rural industries that employ about An analysis of factors influencing migration 25 percent of the rural labor force. Thus, dur- found few village institutions that constrained ing the same period the rural industrial sector migration (Lohmar, Zhao, and Rozelle 1999). created about 38 million additional off-farmjobs. Village "use it or lose it" land policies may in- Although TVE employment suffered a decline hibit family migration, but land tenure and grain in 1997, it is too early to determine if the em- delivery quotas, per se, do not influence migra- ployment trend has reversed as temporary de- tion. However, the ability to rent out land while Accelerating China's Rural Transformation maintaining nominal use rights appear to fa- come data are applied. In nominal terms, the cilitate out-migration as does the existence of rural/urban per capita income ratio declined informal credit markets. from 0.54 in 1985 to 0.35 in 1994, then recov- There are, however, several factors that fa- ered by five percentage points between 1994 cilitate out-migration. The overwhelmingly im- and 1997 (Figure 2.1). These ratios compare portant migration determinant was a "village poorly with Vietnam where the 1997/98 rural network." Past migration leads to future migra- per capita income level was 67 percent of that tion-fellow villagers who can be relied upon of urban incomes (Bales). Even when adjusting for information (and possible financial assis- official rural and urban income data for hous- tance), including potential job prospects, pro- ing costs and other poorly measured or excluded vide a chain to attract additional villagers into components of income, rural/urban income the migrant labor force. A similar linkage has ratios do not improve. Further, Yang and Zhou's been found for Mexican laborers working in U.S. (1996) analysis of rural-urban income ratios, agriculture-where it is common for contractors for 36 countries over the 1985-95 decade, dem- to solicit additional labor from the same village onstrated that urban incomes are rarely more as previously recruited labor. Education gener- than twice rural incomes. The urban/rural in- ally improves the chances of obtaining off-farm come ratio of only one country (out of 22 for employment-although that factor is more im- which 1995 data were available) exceeded that portant for workers who live and work at home of China. Using consumption as an income than those who engage in rural-to-rural migra- proxy, China compares unfavorably with India tion. Urban in-migration continues to be severely in terms of its rural/urban inequality. In 1993- inhibited by the household registration system 94 the per capita rural/urban consumption and limited access to urban social services. ratios were 0.28 and 0.61, respectively, for China and India. Rural-Urban Income Dichotomy The rural/urbanincome ratio using constant Inequality, among other things, is a barom- 1985 prices, reflects the differential increases eter of the efficiency of an economy as well as in the cost of living between rural and urban its political stability, and the fact that during areas, and illustrates a similar but slightly more the reform era China has experienced an ex- modest decline in relative incomes. However, ceptional increase in inequality is cause for con- these data underestimate both rural and ur- cern. Gini ratios have been above 0.40 since ban in-kind income. Price deflators adjust for the early 1990s and have continued to rise. differential price changes but not price levels. China's rural-urban income gap is large by in- Adjusting for this differential (15 percent), im- ternational standards-particularly when the puting rent to rural incomes and adjusting ur- recent 1998 revisions to urban per capita in- ban incomes to include in-kind income for housing, education, health care, pensions and Figure 2.1: Rural-Urban Per Capita other subsidized services provides more accu- Income Ratios rate income estimates. These adjustments low- ered rural incomes to 31 percent of urban incomes in 1990-substantially less than the 50 45 percent suggested by official data (World 1>-0- P, qBank, 1997c). The large rural-urban income gap points to 30 a large differential in labor productivity and to constrained factor mobility, especially labor and 20 1985 1987 1989 1991 1993 1995 1997 capital; it also reflects the arbitrary nature in which compensation levels are set. Although 12 Chapter 2: Rural Income and Macroeconomic Linkages only examining data through 1992, Yang and 1996). The World Bank (1997a) has shown that Zhou (1999) determined that the marginal pro- one of the largest gaps exists between coastal ductivity of labor in agriculture, TVEs, and SOEs and inland provinces. Some of the gap may be was Y 601, Y 1,211, and Y 9,346 respectively, due to factors restricting the flow of labor and in 1992 . Such large productivity gaps indicate other resources between rich and poor rural barriers to labor mobility prevent a narrowing areas. With rising market integration, the bar- of the differential-despite large numbers of riers may be declining, but large initial discrep- sanctioned migration and larger numbers of ancies in resource, human capital, and locational "floating" population. The government attempts endowments may require generations to equal- to control the pace of migration to ensure ur- ize wealth levels. ban services are not overwhelmed, and in part It will be very difficult to improve the trends to assure urban grain sufficiency. Other fac- in rural/urban income ratios without improv- tors also constrain migration, including; lack ing labor efficiency and productivity through ofjob information, housing, medical, education increased capital/labor and land/labor ratios and other social services which are unavailable in agriculture. While the former ratio can be to rural migrants. Government policies continue increased by making capital more accessible, to support and subsidize urban standards of significant increases in the land/labor ratio can living, including the absence of hard budget be achieved only by transferring labor out of constraints for SOEs (protecting urban jobs), agriculture. During the early and mid- 1990s and low-cost capital for urban enterprises al- increasing agricultural prices contributed to though housing and enterprise reforms and fis- increasing rural incomes, preventing further cal constraints are mitigating these benefits as deterioration in the rural/urban income ratio urban workers now pay higher rents and con- but additional reliance on agricultural price tribute more to their pension and medical ben- policy is limited since the prices of many com- efits. modities are now above international prices. Intrarural inequality has also risen rapidly Shifting production to higher-value commodi- during the 1980s and early 1990s, a type of ties and continued improvements in TFP will inequality that may be more socially sensitive permit modest income growth in agriculture, since rural residents may be more aware of the but without additional land and capital per ag- differences in standard of living between them- ricultural laborer, future per capita income selves and other rural counterparts (Rozelle, growth in will be slow in agriculture. The production oflabor-intensive, high-value commodities such asfruits and vegetables (particularly greenhouse vegetables), uses land resources more efficiently than does the production ofgrain crops - but more importantly, provides higher incomes. - . . . .-.- . . .- . .-.. . 1 .1 1 - ,. I. s l l ' ' 1 13 Accelerating China's Rural Transformation B. The International Market principal export destinations-absorbing about 70 percent of its agricultural exports. Total ex- Internationally, exchange rate policies, grain ports to these destinations have declined over trade quotas, and monopoly state trading in- the past year, but the share of agricultural com- fluence the performance of China's rural modities has remained relatively constant. Thus, economy and trends in rural incomes and con- the recovery of the Japanese and Korean econo- sumption. Also the ongoing Asian financial cri- mies is crucial to maintaining and expanding sis and the continuing lack of economic growth China's agricultural exports. and reduced demand for imports in Japan and As the manufacturing sector is less regu- Korea have the potential to hinder rural growth lated and more important in the external mar- and development. ket than agriculture, it will likely absorb most China's agricultural export value (food and of the market changes brought about by the tobacco, but excluding natural fibers) is only 7 Asian crisis. TVE export destinations are un- percent of total export value-considerably less specified, but TVEs export about 40 percent of than most of its neighbors; also agricultural their output. Thus, TVE export demand will likely exports are only 7 percent of agricultural GDP. be reduced, which in turn will reduce TVE em- Thus while $11 billion of annual agricultural ployment and rural incomes but the impact on exports is obviously important, it is relatively agriculture should be marginal. unimportant in relation to total production and to the share of total exports. The impact on ag- Exchange Rate Policies ricultural imports likely will be minimal given Since consolidating the two-tier exchange the relatively high quota and tariff protection rate in late 1993 the nominal exchange rate has for agricultural commodities. Several models appreciated about 5 percent against the U.S. (e.g., IIE model described in Noland et al. 1998 dollar (through 1997). The real effective exchange and the G Cubed model described in Stoeckel rate (trade weighted), however, appreciated by et al. 1998)1 have been developed to measure 30 percent (International Monetary Fund). To the devaluation impact of Asian-crisis countries the extent that international prices influence, on trade patterns. The IIE model indicates or establish an upper bound. for domestic prices, China's trade balance could decline by $12 bil- the impact of exchange rate appreciation has lion-primarily through reduced exports, with been to limit the domestic price increases. Thus, 50 percent of that reduction accruing to Japa- had the real effective exchange rate not appre- nese and Korean markets. The balance of the elated, farngate prices for grain, cotton, oilseeds, reduced exports would be derived through third- and other traded commodities could have been country markets lost to competition from the 30 percent higher. Instead, the appreciation devaluing Asian countries. The G-Cubed model benefited urban consumers. indicates that China's import adjustments would Although prospects seem increasingly un- be relatively rapid and would return to their likely, the international community remains baseline trend by 2000. However, three factors concerned about a currency devaluation by will mitigate against increased imports: (a) quota China and its impact both internally and exter- and tariff protection of agricultural commodi- nally. A devaluation would erode domestic and ties are relatively high; [b) with the exception of international public confidence, reduce foreign palm oil, the major agricultural imports are tem- direct investment (FDI) inflows, and increase perate commodities that are not produced in domestic debt but would yield relatively small the devaluing countries; and (c) internationally gains. While China could theoretically benefit traded commodities are internationally priced by regaining some comparative advantage in and will be largely unaffected by devaluations. labor-intensive manufacturing previously lost Japan, Korea, and Hong Kong are China's to devaluing countries, actual gains would be 14 Chapter 2: Rural Income and Macroeconomic Linkages limited-particularly if it precipitated a further fluctuations imply that, periodically, inflation round of devaluations. Actual gains would ac- will emanate from a combination of diminished crue in competing third markets, as bilateral production and restrictions on imports. Eco- trade between China and the Asian-crisis coun- nomic logic suggests that low-value, land-in- tries is relatively small. These factors, plus the tensive, and nonperishable products (such as large positive trade balance, appear to substan- grain) should be produced less and imported tially mitigate this risk. more, so that higher-value, labor-intensive com- A devaluation would have different impacts modities, like fresh vegetables and animal prod- on different components of the rural and agri- ucts, could be produced more efficiently, cultural sector. Producers of tradable commodi- abundantly, and competitively. Nevertheless, ties, both farmers and industrial TVEs, would grain imports are restricted. Possible explana- experience increasing costs because fertilizers, tions include concerns for: (a) famine, which agrochemicals, and various other raw materi- occurred as recently as 1958-60; (b) overreli- als are imported. However, output values would ance and high cost of importing large quanti- increase more thereby increasing incomes for ties of grain (i.e., China is too large to rely on that component of the rural sector. Producers substantial imports of grain, as it would increase of nontraded goods, subsistence farmers, pov- world prices and deprive other importing coun- erty groups, and urban wage earners would tries of supplies); and (c) managing rural-ur- experience an income decline, and the number ban terms of trade (i.e., transfer investable and of residents living in poverty would increase. consumable resources from rural to urban ar- The impact models suggest that a very modest eas). Nevertheless, the impact of this restric- devaluation would return the real effective ex- tion is suppression of the value of overall rural change rate to the pre-crisis level. output and rural household incomes. In contrast to many other Asian economies, China has a continental market-most domes- State Trading tically produced goods are domestically con- Grain exports and imports traditionally func- sumed, with modest reliance on external tion as balancing mechanisms to dispose of markets. Although exports and worldwide de- domestic surpluses or to acquire stocks to make mand are important to domestic growth, con- up production deficits. However, China's exter- tributing about 3 percent to recent economic nal grain trade also serves political interests as growth, the health of the domestic economy is grain trade targets are planned, but of far greater consequence. Total trade as a per- unpublicized, in advance of the crop year. Trade cent of GDP, or trade intensity, demonstrates is intended to be stabilizing, but unfortunately, the relative importance of external markets. In China's execution of trade plans has tended to the Asian-crisis countries, trade intensity ranges exacerbate fluctuations in domestic cereal sup- from about 50 percent (Philippines) to almost plies (rice, wheat, and corn), and prices (Carter 200 percent (Malaysia). China's trade intensity et al. 1997; World Bank 1997b). is 35 percent, with exports composing 20 per- cent of GDP. However, using purchasing power Conclusions and Recommendations parity (PPP)-adjusted estimates of GDP reduces The rural and urban sectors are strongly the trade intensity ratio to about 10 percent. linked, but full integration is impeded by vari- ous policies and institutions that fosters or hin- Import Restrictions ders resource flows. The policy framework China's scarcity of land and abundance of transfers fiscal resources from the rural sector; rural labor imply that market forces will ulti- the net flow of financial resources to the urban mately make land-intensive products expen- sector may be policy directed or may represent sive-if imports are restricted. Normal weather efficient markets that transfer resources to I . ... I I . I _ 15 Accelerating China's Rural Transformation higher return uses. Regardless, the rural sec- favorable environment for removing these re- tor provides a large net capital flow to the ur- strictions without social disruption. ban sector and illustrates the importance of * Support policies and social services that fa- maintaining a vibrant rural economy. Con- cilitates migration. This would include sup- versely, rural-urban labor flows are policy-in- port of a land use market that would permit hibited, leading to adverse rural/urban per migrants to lease their land to others yet pro- capita income ratios. It is improbable that long- vide a minimal amount of security if urban term sustainable increases in agricultural in- employment was terminated. Additional sup- come can be achieved without removing large port to rural education to improve vocational numbers of agricultural laborers from the sec- skills would increase the marketability of the tor and increasing the average land/labor ra- rural labor force and encourage migration. tio. Removal of the constraints on urban non- The following medium term steps to progres- residents' access to urban social services, sively transfer labor from the agricultural sec- such education for their dependents, would tor and reverse the diverging trend in rural/ also promote migration, urban income ratios are recommended: * Encourage the creation of labor-intensive off * Remove migration constraints, This would in- farm jobs. To modernize its economy China clude disassembling administrative and in- must support technology-intensive indus- stitutional barriers to rural laborers seeking tries, which are typically capital-intensive as urban employment. However, for this policy well. However, some industries have the op- measure to be effectively implemented, the tion of operating in either capital- or labor- current rise in unemployment in urban la- intensive modes; where this option exists the bor markets must be reversed. As the State labor-intensive mode should be pursued given completes its labor adjustment over the me- the large number of jobs that must be cre- dium term, it is expected that urban unem- ated to absorb agricultural labor, improve ag- ployment will decline and create a more ricultural land/labor ratios and incomes. Although CGE models have been developed to analyze the impacts of the Asian crisis, only the results from two of the more comprehensive models are mentioned in this report. They are (a) the model developed by Noland Liu, Robinson, and Wang (described in Noland et al. 1998), hereafter called the IIE model, and (b) the Asia Pacific G-Cubed model [described in Stoeckel et al. 1998). 16 3. Rural Public Finance China needs a healthy public finance sys- in China, however, are largely self-financing, a tem to enable government to provide basic in- trend that has increased during the reform pe- frastructure and social services and an enabling riod. China's provincial county and township environment for equitable and sustainable in- governments in rural areas financed 48 per- come growth. For the rural sector, this includes cent of budgetary expenditures from local providing or facilitating investments in farm- sources in 1990, but collected 66 percent of the land improvements, agricultural research and revenues (Figure 3.1), a level much higher than development, extension services, infrastructure in most countries. such as roads and communications, and social services (such as education, health, and social The Conduct of Rural Public Finance security). The fiscal system also sets incentives A typical county budget is divided into three that guide the allocation of resources and in- main parts, with roughly 40 to 45 percent of fluence development, the total spent on social services, 25 to 30 per- China has one of the world's most decen- cent on administration, and 10 to 15 percent tralized systems for providing government ser- on capital expenditures. The expenditure shares vices. In many countries subnational are changing as an increasingshare ofthe budget governments provide day-to-day administrative is spent to meet social services mandated by and social services, but financing typically comes the central government and pay nationally set from the national treasury. Local governments salary levels. A distinguishing feature of China's fiscal system is that rural government func- Figure 3.1: China, National and Subnational Shares of tions overlap and are Revenues and Expenditures performed jointly by 1990 1990 jo indtlb Revenue Expenditure the county and the cons on a . township or town, with L.:31 F,.., njw l some help from village residents'committees. At the end of 1997 China had nationwide some 2,100 counties and county-level cities, 1997 144,700 townships and Revenue Expenditure towns, and 740,000 village residents' com- mittees. This large gov- ernmental apparatus is staffed by a large and rapidly growing num- ber of officials, whose salaries and benefits Accelerating China's Rural Transformation have commanded an increasing share of the tural inputs (fertilizers, fuel, and electric power) budget. In contrast, while agricultural invest- and investment in industries that produced ag- ments absorbs an important share of both capital ricultural inputs. As these price-based taxes and and administrative expenditures, its share has subsidies have disappeared, the tax contribu- declined over time. tion by agriculture and allocations to the rural The expenditure responsibilities of township economy have fallen. governments have two primary foci: social ser- These changes to rural public finance have vices, principally education, health and welfare; occurred in the context of overall fiscal reform and administration of law and order and of di- that has lagged behind China's transition to a saster relief. Providing infrastructural support market economy throughout the past two de- to the economy-agricultural extension, water cades. The revenue-generating capacity of the conservancy, farm mechanization, and other old system has been eroded with dismantling capital investments in the rural sector is the of planning mechanisms, and the nationwide responsibility of the county government. budget (all jurisdictions) has declined from more Although villages are not a formal part of than 30 percent of GDP in the late 1970s to the the government and do not have independent current 10 to 12 percent of GDP (Figure 3.2). In fiscal power, they still play an important role in contrast, treasuries in other East Asian and China's fiscal system. When people's communes developed countries command 20 to 30 per- were disbanded in the early 1980s, production cent of GDP (some highly socialist nations such brigades and teams reverted to their traditional as Denmark and Israel approach 50 percent).' name of "village." However, they inherited a This fiscal decline has reduced the capacity and framework of governance from the collectives willingness of higher-level government to transfer and exercise significant expenditure duties, such resources to the rural sector. as salary or subsidy payments to village offi- cials, social welfare for the aged and infirm, and Tax Reform in the 1990s sometimes supplementary educational or health Concern with central revenue decline led to provision. During the collective era, these obli- a comprehensive reform of the fiscal system in gations were financed from local proceeds. To 1993, as part of the effort to modernize macro- the extent that many villages continue to carry economic policy. The main issues were defin- on these functions, they have had to find off- ing a more stable and rising revenue base; budget mechanisms for financing them, usu- making the tax structure more transparent and ally through nontax levies on rural incomes and less distortionary; and modifying national- production. A legacy of the planned economy is the treat- ment of the agricultural sector as marginal to Figure 3.2: Rural-Urban the fiscal system-it is neither a significant per Capita Income Ratios source of revenues nor a major recipient of fis- Percent 40 cal transfers. In the planned economy, the real fiscal transfers took place through the price mechanism ("the price scissors") that extracted 30 surpluses from the agricultural sector by set- 25 Expenditures ting low prices for agricultural raw materials 20 and high prices for manufactured consumer 15 goods (Huang and Rozelle). Support to agricul- ture included subsidies that were external to 5- the fiscal system; they were provided through government controlled low prices for agricul- 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 18 Chapter 3: Rural Public Finance subnational revenue sharing. Key provisions grain subsidies; rights to these quota taxes (the included the adoption of a value-added tax (VAT) difference between market and quota prices) are and revenue-sharing arrangements. The new unclear. The Ministry of Agriculture is experi- tax policy appears to have met some of its goals. menting with changing all farmer tax burdens It has stemmed the rapid fall of tax revenues as into a grain tax, which has met with some suc- a share of GDP (Figure 3.2), and central gov- cess and some problems. ernment control of revenues and expenditures has reversed (Figure 3.1). Government Transfers The tax system remains centered on indus- Subventions from national and provincial try. (The VAT is assessed primarily on indus- governments still are an important component trial products.) Rural governments have become of the budgets of counties and townships. How- increasingly dependent on VAT revenues gen- ever, the untied transfers that formerly provided erated by TVEs, and the increased remittances resources to counties and townships for gen- of VAT to the national government has almost eral expenditures are increasingly replaced by certainly increased rural budget deficits as little specific, earmarked transfers for agricultural progress has been made in revenue redistribu- infrastructure investment, education and health tion. The reforms did not address regressive care support, welfare, and disaster relief. A 1988 intergovernmental tax sharing and redistribu- national policy fixed general transfers in nomi- tion issues, and thus created serious shortfalls nal terms, irrespective of requirements; in real in many rural counties and townships. Tax terms, inflation has since eroded more than two- sharing is based on collection, so that rich prov- thirds of their value. The impact is most seri- inces receive more central transfers and rebates ous in poor counties. than poor provinces (Rozelle, Zhang, and Huang Targeted transfers are eroding less rapidly, 1998a). Thus, overall intergovernmental trans- but the reforms have imposed more fiscal de- fers are strongly disequalizing. For example, mands on localities, as transfers are inadequate Guizhou, Shaanxi, and Sichuan Provinces had to meet mandated expenditures. Unfunded budget deficits exceeding 20 percent in the mid- public-service mandates abound; for example, 1990s, after including central government trans- the central government often announces tar- fers. gets, such as specific reductions in school drop- The grain quota tax (during times when the out rates or improvements in infant mortality, market price is above the state-set procurement but the funds to achieve the goals are not pro- price) is no longer targeted at supporting urban vided. To meet these mandates county and town- ship governments must raise the financial resources. Figure 3.3: Investment to Wage Spending Ratio, Shaanxi, 1983-'92 Impact on Investment and Provision of Rural Social Services Persistent fiscal gaps, or shortfalls between Ratio 0.3 - - required expenditures and fiscal capacity, have 0.25 -_---_--_-several adverse effects. One is that many rural 0.2 - -- -- -- --- governments are unable to provide the level and 0.15 quality of social services mandated by national 0.1 -policy. 0.05- 0 0 Investments 1983 1985 1987 1989 1991 I Deferred investment is an immediate victim of fiscal shortfall. As officials struggle to meet . - I . I 1 - 1 1 1 1 1 19 Accelerating China's Rural Transformation wages and other immediate needs from dimin- Rural Health ishing revenues, these needs are displacing Ministry of Public Health goals call for 8 development-oriented investments (Figure 3.3). percent of rural budgets to be spent on health Even if budgetary officials are directed to allo- care. National officials have mandated improved cate funds to fixed investment, the funds are facilities, expanded coverage, and minimum often diverted or borrowed, and if not returned, training for doctors. Rules describe what is ex- the investment is not just delayed but perma- pected of county and township leaders for es- nently deferred. tablishing ideal rural health systems. However, like education, the actual resources allocated Rural Education to achieve national objectives fall far short of Calls from the national government to bol- needs. The national government allocates only ster rural education are not matched by ear- 2.4 percent of its recurrent budget for health marked allocations. National officials have set care services, and only 1.2 percent of the capi- an education expenditure target of 4 percent of tal construction fund. The situation is more GDP by 2000, up from 2.66 percent in 1994. severe in poor areas. Imploring local governments to increase edu- School fees and health charges have soared cation funding more rapidly than the growth in in recent years. West (1998) reports in many financial revenue has gone largely unheeded, areas there are both rising dropouts due to dif- and meeting this target appears improbable. ficulty in meeting these new schooling costs, Insufficient fiscal revenues have undermined and falling maternal and infant health care vis- the quality of education as measured by a num- its because of rising costs. In areas where funds ber of human capital indicators. For example, cannot be raised, education and health services a State Statistical Bureau survey shows that have disappeared or declined in quality, result- 30 million Chinese students have never been to ing in the large-scale out-migration of teach- school or have dropped out, 4 million drop out ers, doctors, and other professionals. of school each year because they cannot afford the cost, and only 64 percent of rural students Extrabudgetary Revenue Sources complete primary education without repeating A second adverse effect of fiscal pressure is a year. the growing reliance on off-budget finance. The Table 3.1 Township Finance in China, 1986-93 (Percent) 1986 1987 1988 1989 1990 1991 1992 1993 Total revenue 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Budgetary revenue 83.3 82.7 80.0 75.9 74.6 72.0 71.5 73.8 Extrabudgetary revenue 5.0 4.7 5.6 6.0 6.4 6.9 7.1 6.5 Self-raised funds 11.7 12.6 14.4 18.1 19.0 21.1 21.5 19.8 Total expenditure 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Budgetary expenditure 77.4 76.6 74.3 69.4 69.0 66.4 65.9 67.6 Extrabudgetary expenditure 6.4 6.1 7.0 7.2 7.4 7.7 7.6 7.0 Self-raised funds 16.2 17.3 18.7 23.4 23.6 25.9 26.5 25.4 Source: Ministry of Finance, 1994. 20 Chapter 3: Rural Public Finance ability of local governments to raise revenues regulatory agencies control over the assets they varies greatly and determines the quantity and regulate or operate (or the resources they are quality of local public services. County and town- charged with protecting). Officials then encour- ship officials are evaluated on their fulfillment age agency officials to use these assets to gen- of mandates. This is an important reason for erate income for staff salaries and other the increasing of local fee assessments and ris- expenses. This is a pervasive issue and will re- ing burdens (Wen 1998). surface in subsequent discussions of natural- To meet the revenue requirements of these resource management and agricultural expenditure demands, county and township extension. governments attempt to increase revenue from off-budget sources. Without legal taxing author- Equalization Issues ity or ability to borrow, counties and townships Previous studies have noted unusually large have developed of-budget sources, primarily differences in per capita budgetary revenues extrabudgetary funds (EBFs) and self-raised among provinces (World Bank 1992a; Wong, funds (SRFs). From the late 1980s through the Heady, and Woo 1995). However, revenue and early 1990s, the proportion of total funds from expenditure differences are also large at these sources rose continuously, reaching 28.6 subprovincial levels; and with decreasing trans- percent in 1992 (Table 3.1). At the township fers, per capita revenue and expenditure have level, EBFs are fewer (compared to cities), and become increasing correlated. While the VAT consist mostly of rural education and agricul- was designed to permit the central government tural tax surcharges. The majority of off-bud- to control more fiscal resources, negotiations get revenues come from SRFs, which include have enabled provinces to keep a large propor- miscellaneous fees (assessed on local enter- tion of the taxes they generate. This retention prises), rental income (from leased collective of taxes, combined with the regressive rebate, assets), and remittances from TVEs. The Min- mitigated the more progressive nontax trans- istry of Finance has reported that, on a national fers and intended redistribution impact. basis, off-budget revenues bring total revenue collection to about 30 percent of GDP (Agency Fiscal Crises in Poor Counties France Presse, Beijing, Sept. 22, 1998). In recent years deficits have become persis- The growth of off-budget revenues has eased tent in poor counties. In 1994, half of China's fiscal pressures for many localities, but it has counties had difficulties meeting even basic also produced adverse consequences. It has expenditures, such as wage disbursements (Park hastened the decline of the formal fiscal system et al. 1996). Counties can generate extra rev- by providing an alternative tax source that is enues by selling urban permits, borrowing funds 100 percent retained. It has created a tax sys- earmarked for other uses (such as family plan- tem beyond the reach of the formal fiscal sys- ning or school construction), or borrowing from tem that is ad hoc, nontransparent, and local SOEs or banks-a frequent, although le- regressive; the lack of legitimacy may be more gally prohibited, practice. Poorer counties are of a source of rural discontent than the total revenue starved even more than is reflected in burden. Also, local officials rely almost exclu- acknowledged net deficits; hidden deficits are sively on enterprises for SRFs, thus the most represented by budgetary funds diverted from rural and poorest jurisdictions have the weak- prescribed uses to pay salaries and wages. Sal- est potential for supplementing budgets from ary and wage payments are often deferred, and these sources. some county and township governments have Perhaps the most egregious consequence of declined to pay for employee benefits, such as off-budget financing is the tendency of county health reimbursements. (Counties can appeal and township governments to give policy and to upper-level governments for special subsi- . . .I . I .I I . II. . . ICI . 2 1 Accelerating China's Rural Transformation dies or increases in fixed subsidies, but these Conclusions and Recommendations adjustments are only made in special cases, such The conduct of rural public finance affects as natural disasters.) These hidden deficits in- the entire nation's stability and long-run growth dicate that financial statistics systematically prospects. However, the rural fiscal system gen- underestimate true fiscal deficits. erates inadequate revenues and poorly redis- tributes collected revenues, which, unless Effect of Budget Pressures on Public improved, will constrain long-term development. Expenditure Patterns Fiscal decentralization has transferred con- The pressure to eliminate deficits may re- trol over most resources and residual rights over sult in underinvestment in public goods, espe- most incremental revenues to subnational ju- cially in poorer areas (where needs are greatest) risdictions. National directives and tax-collec- and increase incentives for local governments tion problems have also reduced resource to maximize revenues rather than social wel- redistribution (Wong 1997). Fiscal reforms have fare (Wu 1994). Local governments' placing pri- hardened budget constraints for all subnational ority on meeting their wage bills has led to jurisdictions; and fiscal sharing rules have in- deferred maintenance and deteriorating capi- creased tax collections in both rich and poor tal stock in many of the poorer counties-and regions (Park et al. 1996; Wong 1997). Some consequently to declining efficiency of resource scholars have identified growth-inducing effects use (Gallagher and Ogbu 1989). in China's fiscal reform, supported by empiri- The impact of fiscal reforms on the ability of cal evidence (Lin, Liu and Zhong 1997). How- county and township governments to make ever, the reforms are incomplete, as widespread productive investments in infrastructure and fiscal crises suffered by so many rural govern- social services has important implications for ments has reduced potential economic growth, economic development in poor regions. Some welfare, and equity, and has led to investment of the fall in investment in poor counties might starvation. Some 70 percent of the counties and be expected to be compensated by increased townships have net deficit budgets, and their spending through other channels, especially policy obligations continue to rise. China's poverty program. Recent research in China's tax system is characterized by defi- Sichuan, shows that local investments in edu- cient revenue generation and public service cation, health, and agriculture lead to growth, spending at all levels. The tax system is heavily but poverty program investments typically re- industry-dependent and has neither made tax place, rather than supplement, budgetary in- assignments clear, nor given rural communi- vestments (Rozelle, Zhang, and Huang 1998a); ties a revenue base on which to build rational and on-budget investments and social services fiscal plans. The 1994 tax reform increased the have declined from the mid-1980s to the 1990s. tax collection power of the central government, Deficit counties have begun to reduce their which would allow more equitable redistribu- wage obligations through wage suspension, staff tion. While more revenues have flowed into cen- termination, and reorganizations that reassign, tral coffers (reducing local revenues), little has but do not terminate, local government person- been shifted to poorer areas, and the new tax nel. Some county and township government policy continues to favor relatively affluent ar- bureaus have been redesignated as companies, eas, exacerbating rather than alleviating the rural with worker pay linked to profits. Other bureaus fiscal crisis. and agencies are urged to design and pursue Fiscal resources in poor deficit areas are revenue-generating activities; and many staff insufficient to meet the rural sector's develop- (both those reassigned and still in government) ment investment requirements. Increased pres- pursue entrepreneurial activities, such as open- sure at county and township levels to generate ing restaurants and hotels or engage in trade. revenues leads to biased development policies 22 c - - - - - - Chapter 3: Rural Public Finance and may become distortionary and inimical to * Continue evaluating the consequences ofman- economic development. For example, invest- aging such a highly decentralized economy, ments in revenue deficit regions may tend to be including both benefits and costs of decen- industry biased, because of the relative ease of tralizatiort. Alternative fiscal structures to be tax and fee extraction, even if investments in considered include returning basic fiscal re- agriculture might better serve growth and dis- sponsibility to the county, from the town- tributional goals. ship-for all but perhaps the most We recommend the following steps to im- industrialized towns. Such a move would have prove public financing of the rural sector: a number of consequences and tradeoffs. For Continue financial reform to rectify a poten- example, the incentive for townships to moni- tially serious constraint to long-run sustain- tor policy and reduce administrative costs able growth and poverty alleviation. might decline and policy implementation Mechanisms to broaden local tax bases and might suffer. In return, however, the scope generate more on-budget revenue from all for redistribution would broaden; adminis- sectors, including agriculture, and improve trative personnel could be reduced; and un- revenue redistribution to reallocate revenues authorized taxes, fees, and levies may be more equitably are sorely needed. China must reduced. reconsider the regressive components of the * Track grain quota taxes and design ways to overall fiscal system, especially the new VAT capture them for county and township bud- and rebate policies, to improve fiscal flows to gets or eliminate all or convert it into a more poorer areas. Given the magnitude and sen- easily collected tax, such as a progressive sitivity of the problem, it must be solved in- land or head tax. Assistance could be pro- ternally; outside agencies can assist only vided in evaluating the results of converting marginally by providing assistance in iden- all farmer tax burdens into a grain tax and tifying the strengths and weaknesses of the in expanding these efforts to look at a broader current system, designing and assisting with array of fiscal instruments. experimental programs, and assisting in pub- lic fiscal policy training. World Bank. World Development Report, 1997, World Bank, Washington, DC, 1997. Traditional (backyard) livestock and poultry production balances crop production by utilizing crop residues and surplus farm labor - and adds to farm income. 23 4. Rural Credit and Finance Mobilizing and efficiently using available fi- rural enterprises have been the most dynamic nancial resources is important for achieving high sector of industry, the rural sector is a major rates of economic growth, especially in devel- source and target of financial resources fueling oping countries where such funds typically are China's growth. Concern over the performance in short supply. As economies grow, financial of China's RFIs stems from several factors. First, institutions often play an important role in di- the banking system's hunger for financial re- recting resources to their most productive use. sources may unduly tax RFI deposits and policy As a result, greater financial intermediation goals may influence lending. Second, regulated (loans as a share of GDP) usually accompanies interest rates imply credit rationing, making higher incomes (Gertler and Rose 1996; Levine private entrepreneurs and farmers, especially 1997). However, governments in developing the poor, likely to have difficulty gaining credit countries often use state control of the banking access. TVEs also have had difficulty gaining system to pursue policy goals that are not al- access to bank credit, especially during periods ways consistent with efficient intermediation. of macroeconomic stabilization (Zhu and Brandt The recent Asian financial crisis highlights 1995. Even without interest rate regulation, the potential dangers ofweak financial systems. small farmers are often rationed out of formal The crisis has heightened scrutiny of China's credit markets (Carter 1988). Field researchers state banking system, whose fragility stems from observe that in some poor villages, local credit the continued use of the financial system to cooperatives have stopped lending to farmers. support urban-based state-owned enterprises Between 1988 and 1995, rural financial inter- and other policy lending. The government has mediation has not deepened; in fact, farmers also implemented strict lending controls peri- have reduced credit financing for key activities, odically to combat inflation. Recently, steps have such as fertilizer and livestock purchases (Table been taken to reduce the amount of 4.1). nonperforming loans, which account for at least a quarter of outstanding loans of China's four Types of Rural Financial Institutions major state-owned banks (Lardy 1998). Pursuit The rural sector is serviced by financial in- of these goals has led to strict regulation and stitutions that differ in size, branch numbers, efforts to control emerging financial institutions. and role in the rural economy. The largest RFIs Despite a number of important financial sector are the Agricultural Bank of China (ABC), the reforms, financial markets have been liberal- Agricultural Development Bank of China (ADBC), ized more slowly than most sectors (Tam 1995). Rural Credit Cooperatives (RCCs), and Rural Significant progress in reforming China's rural Cooperative Funds (RCFs).I Each plays a unique financial institutions (RFIs) thus will likely de- role in providing deposit and lending services pend upon the success of overall SOE and bank- to the rural sector and overall economy. Together, ing system reform. the ABC, ADBC, and RCCs account for 24 per- Given that the majority of China's popula- cent of total assets, 27 percent of total deposits, tion resides in rural areas, rural incomes have and 34 percent of total lending (Table 4.2). grown markedly during the reform period, and Accelerating China's Rural Transformation Table 4.1: Percent of Households Engaged in Different Activities that Finance Activity with Loans and Average Loan Amount, by Activity Year Fertilizer Livestock Small Business Illness Construction Other Percent of Households Engaged in Activity that Finance Activity with Loans 1988 30 25 32 38 56 25 1995 22 18 34 37 56 24 Average Loan Amount of Household Receiving Loan (yuan, in 1988 prices) 1988 125 238 1,205 494 1,667 499 1995 90 143 3,767 849 2,161 550 Note: There are 32 observations for Zhejiang, Sichuan, Hubei, Shaanxi, and Shandong; and 24 observations for Yunnan. Source: Village survey by Rozelle, Pork, Huang et al., 1996. Table 4.2: Deposits, Loans, and Assets of China's Financial Institutions, 1996 Deposits Loans Assets National Total (billion yuan) 6,853 6,433 12,856 Of which (percent): Policy Banks 0.6 14.1 7.9 Agricultural Development Bank 0.6 9.7 5.5 State Development Bank 0.0 4.1 2.2 Export/Import Bank 0.2 0.2 State Commercial Banks 65.7 64.5 72.6 Agricultural Bank 13.9 14.0 11.4 Industrial and Commercial Bank 27.7 28.0 28.2 Bank of Communication 7.1 7.1 16.4 Construction Bank 17.0 15.5 16.5 National Commercial Banks 6.6 4.7 6.0 Regional Commercial Banks 1.8 1.5 1.6 Credit Cooperatives 20.8 14.0 10.1 Rural Credit Cooperatives 12.8 9.8 6.8 Urban Cooperative Banks 2.1 1.2 0.2 Urban Credit Cooperatives 5.8 3.1 3.1 Postal Savings 3.1 Trust and Investment Companies 1.3 1.2 1.8 So-urce: Data fro m China -Finoa-nc-ia lYearbo-o-k 19-97,-compiled by-Sehrt-((199-8).-- Interest rates, both deposit and lending, are regulated by the central bank, the People's Bank Working capital loans -6 mos. 6.57 of China (PBC), and are adjusted at irregular Working capital loans - 1 yr. 6.93 intervals. Effective rates as of July 1, 1998 were Construction loans - 3-5 yrs. 7.65 as follows: Demand Deposits 1.44 Time Deposits - 1 yr. 4.77 Source: China Statistical Year Book, 1998 26 Chapter 4: Rural Credit and Finance Agricultural Bank of China lem, administrative responsibility for poverty and The ABC was established to support state other development loans was returned to the trading units and enterprises in rural areas, ABCs in 1998. and farmers. It has branches in nearly every county, and has township-level business offices Rural Credit Cooperatives (which approve loans) and smaller deposit-tak- RCCs are the most numerous RFIs and the ing branches in urban and rural areas. Until only financial institutions with well-developed 1994 loans from the PBC were an important village networks. Although cooperatives in name, source of funds-which financed policy loans, they are closely supervised by the state bank- mainly for agricultural commodity procurement ing system. Historically, they have had a close by state trading companies. When policy lend- administrative relationship with ABC, and un- ing responsibility was transferred to the ADBC til placed under PBC supervision in 1996, served in 1994, the sources and uses of funds changed. as a conduit to channel rural household say- Deposits, primarily by individuals, are now the ings to the ABC. More than 50,000 township- major source of funds, although deposits by level RCCs exist, operating as independent firms are growing more rapidly. Households accounting units, complemented by more than receive only 16 to 17 percent of the lending port- 250,000 village credit stations. The RCCs are folio; the major use of funds is working capital the major depository for rural household say- loans for industry, commerce, and TVEs. As the ings and, in principle, have greater flexibility in ABC has become more commercial, it has in- meeting local credit demands. They have few creasingly served as an intermediary in trans- policy loan responsibilities, more leeway to ad- ferring funds out of rural areas. The ABC was just interest rates, and provide greater conve- requested to resume responsibility for a large nience through deeper village penetration. and growing group of policy loans in 1998- However, they are subject to local political in- they now compose about 10 percent of lending fluences and portions of their extensive branch activity. Repayment on these loans remains network are unprofitable. RCCs have been more problematic because of an inability to monitor effective (than the ABC) in meeting the credit loans effectively and credibly demand repay- needs of rural households and enterprises (Park, ment. Brandt, and Giles) but the lending portfolio is primarily TVE loans; agricultural households Agricultural Development Bank of receive only 24 percent of the lending volume. China The ADBC was established in 1994 to as- Rural Cooperative Funds sume policy loan responsibility and allow the RCFs emerged in the 1990s in many parts ABC to become a fully commercial bank. The of China as new and dynamic quasi-state fi- ADBC's policy loans increased rapidly from Y nancial institutions, organized at the township 356 billion at the end of 1994 to Y 625 billion in level under the administrative supervision of 1996. About 90 percent of policy lending is fi- the Ministry of Agriculture, with lending focused nanced by PBC low-interest loans, mainly for on local households and rural enterprises. Be- procuring agricultural commodities (primarily cause they are unofficial, RCFs are less strictly grain, but including cotton, pork, and oilseeds) regulated and cannot accept deposits or make by state trading companies. ADBC lending to loans; instead they collect shares and allow bor- grain bureaus has become a significant share rowing-but have stricter collateral and guar- of nonperforming loans in the banking system antor requirements than other RFIs. Share funds and was an important reason for reform of the were estimated at about Y 100 billion at the grain marketing system in 1997. To allow the end of 1996 (Cheng, Findlay, and Watson 1997), ADBC to concentrate on addressing this prob- 44 percent from households (Park, Brandt, and - a .I . . I . I I I . 1 . . 27 Accelerating China's Rural Transformation Giles 1997). RCFs are the only RFI primarily than in the early reform period.3 Also, the wealth concerned with agriculture. Loans to TVEs were profile of rural households suggests that siz- initially prohibited but later permitted as capi- able savings are not held in the form of depos- talization increased. In 1995 households received its or other financial assets. Combining financial 45 percent of RCF loan volume; TVEs, 24 per- and State Statistical Bureau data, a four-com- cent.2 Their success suggests a large unmet ponent wealth profile (housing, deposits, grain, demand for rural credit. RCFs compete with and fixed assets) of rural households was con- RCCs for deposits (shares), and because of fewer structed. Deposits accounted for 17 percent of interest-rate restrictions and tax exemptions, this wealth in 1996, and grain, which sits idly provide higher shareholder returns than RCCs. and is not intermediated for productive use else- In 1998 The State Council announced its in- where in the economy, accounted for 12 per- tention to incorporate RCFs into the RCC sys- cent. Also, holdings of cash balances reportedly tem. However, local government leaders and the are nearly as great as savings deposits in some Ministry of Agriculture support the RCFs, as regions. Rural residents have a high propensity they are locally controlled and focus more on to invest in residential housing, by far the larg- household agricultural activities. Implementa- est component of wealth. tion of this policy is still under discussion among Informal lending plays a slightly more promi- ministries and regulatory agencies. nent role in Chinese villages than in other Asian countries (Park 1998). Informal borrowing has Other Financial Institutions been 10 to 11 percent of income during the Several other financial organizations oper- 1990s, and a national survey found that more ate in rural areas. Some rural households re- than 65 percent of farm loans were derived from ceive loans directly from the local government informal sources. Informal loans are more im- budget or Ministry of Civil Affairs relief programs. portant than formal loans, especially for con- In some provinces, that ministry has set up sumption. Mutual Assistance Credit Groups (MACGs) that Eighty-five percent of informal loans are at provide production and consumption loans to zero interest, but when interest is charged, it is help poor households to smooth income shocks. at least twice that charged for formal loans. In MACGs were estimated to hold about Y 1.2 bil- a national survey, the number of villages re- lion at the end of 1993 (Zhu, Jiang, and Braun porting positive interest rates for private lend- 1996). However, most MACGs have encountered ing doubled between 1988 and 1995. The difficulties of falling capitalization due to the average monthly rate on informal loans was 1.9 low interest rates and relief orientation, which percent (25 percent per year), considerably provides poor incentives for loan repayment. In- higher than the rate set by the state (about 8 to formal organizations, such as rotating credit 10 percent). While this rise in informal lending societies, have also been revived in the reform is a positive trend, and has been shown to in- era. crease labor mobility (Rozelle et al. 1998), fer- tilizer use (Xiao 1998), and small business Performance of RFls: Savings and development, its expansion suggests a failure Intermediation of formal lending institutions to meet the credit Household savings deposits have reached demands of rural residents. high levels and rural deposits have increased In the 1990s, rural lending by RFIs has not steadily along with rising rural incomes. How- increased significantly as a share of rural eco- ever, they have increased more slowly than ur- nomic output, contrary to the expected pattern ban deposits and comprise a modest share of of greater intermediation with higher incomes. total deposits (13 percent). The marginal pro- ABC intermediation, in particular, has deterio- pensity to save is relatively high (0.32) but lower rated. While RCC intermediation has increased, 28 Chapter 4: Rural Credit and Finance many farmers and other small potential bor- sity, the government maintains control over fi- rowers are still rationed out of formal credit. In nancial resources to influence the composition addition, more developed provinces, especially and level of bank lending. The decision to sup- coastal provinces, have lower rural financial port poorly performing SOEs may reduce the intermediation rates than poorer provinces, a financial resources available to the rural sec- striking pattern that implies that richer prov- tor. This, in turn, creates pressures to tax re- inces are being taxed by the financial system. sources rather than encourage efficient financial Econometric analysis of intermediation rates intermediation. show that ABC/ADBC lending is highly influ- The priority focus of current financial re- enced by policy concerns, and that funds do form is to preserve the solvency of the banking not flow as expected to faster growing, more system while addressing the bank's developed regions. The pattern of RCC lending, nonperforming loans-a process that almost while not highly influenced by policy variables, surely will require significant bank recapital- also does not respond to economic fundamen- ization. While the annual reports of both the tals. These findings suggest significant barriers ABC and ADBC show modest profits, these fig- to interregional investment and lending. Much ures lack credibility; ADBC officials have openly of this is due to regulation. For example, recent acknowledged an inability to cover costs.' The reforms have greatly restricted horizontal move- ABC also has a large stock of overdue loans ment of funds among banks. Local governments with little prospect of repayment. Similar prob- sometimes mandate that funds be retained for lems plague the RCC. In recent years, more than lending to local enterprises and individuals. Also, one-third of RCC branches have reported losses,3 field work has shown that the lack of regula- and as of 1994, 31 percent of RCC outstanding tory protection and clear rights to monitor, con- loans were delinquent [Shen 1998). These fig- trol, and access investment earnings make ures underestimate the true amounts of over- banks reluctant to loan across jurisdictional due loans because loans are often rolled over boundaries. (refinanced with new loans) rather than being classified as overdue. Challenges of Financial Reform Improving profitability of financial institu- Financial system reform, including decen- tions is closely tied to improving loan repay- tralization and commercialization, was one of ment, which in turn is tied to effectively screening five priority reform initiatives announced at the and monitoring projects. In this way, banks' 1998 National People's Congress. Priority has pursuit of profits promotes efficient resource been given to reducing the large volume of bad allocation. Some rural financial institutions have debts held by China's state financial institu- instituted better incentive systems for their tions, but concern for rural access to credit has managers and staffs. In some areas, local also turned official attention to rural financial branches keep independent books, charting local reform. In August 1996 the State Council is- profits and loan portfolio composition, and base sued a "Decision on Rural Financial System compensation packages on each unit's perfor- Reform" and established an interministerial mance. Branch restructuring, adoptions of new Coordination Group for Rural Financial Sys- loan approval procedures, and use of credit his- tern Reform, led by PBC (The People's Bank of tories are becoming more common. China 1997).4 The reforms are not completely Regulated interest rates on deposits, loans, new, as changes in the rural financial sector and interbank borrowing and lending probably are part of a broad reform initiative that began play the largest role in distorting resource allo- in the 1980s. cation decisions by inviting misallocation and With stability a national priority and con- rent-seeking. Inflation has led to negative real tinued financial support to SOEs still a neces- interest rates on deposits and loans in some 5 - - - . . . ' ' - -1 1 . 1 1 - 1 2 - - 29 Accelerating China's Rural Transformation years. Official rates are well below those for in- separate institutions have achieved limited suc- formal lending, and without the ability to re- cess. Some ADBC loans have been diverted to spond flexibly to the demand characteristics of commercial uses and some ABC loans remained different groups, the formal financial sector must policy oriented. The ADBC took over the ABC's exclude some of them. Between 1996 and 1998 policy loan portfolio in 1994, but some of the many local branch banks reduced lending in policy loans were returned to the ABC in 1998. favor of depositing additional funds with the Delinquent policy loans continue to be a major PBC-which was more profitable given the in- problem and will require stronger measures than terest rates offered, expected repayment rates, simply isolating loans in policy banks. and the costs of transactions. In early 1998 the Part of China's financial reforms have been PBC adjusted the difference between reserve to diversify the range of financial institutions deposit and loan interest rates to encourage and to increase competition. Regional banks, greater lending. private banks, trust and investment companies, The ABC and RCC permit independent other nonbank financial institutions, and even branches to adjust official interest rates within a few foreign banks have gradually entered the regulated bands, but local governments have financial sector. The government, after segment- the authority to narrow these bands. RCFs have ing the lending responsibility of state-owned the most flexibility to adjust interest spreads specialized banks in the 1980s, has encour- by adjusting dividend payments. aged more open competition among them in the The ability to transfer funds across regions 1990s. However, the recent failure of the and institutions is necessary to diversify risk Guangdong International Trust and Investment and intermediate funds to their most produc- Company suggests that nonbank institutions tive use. The interbank market was gradually also may be saddled with bad debt, raising con- liberalized over the 1980s and early 1990s (Xia cerns about the system's ability to prudently 1995). However, in 1996. control over fund flows regulate banks. was strengthened and the interbank market Local governments that have influence over centralized. Without national office authoriza- local bank branches also may seek to protect tion fund transfers were allowed vertically, but the deposit base of "their" banks to further their only within the same bank. RCCs can freely own agendas. These factors create pressures to transfer funds to other branches in the same restrict competition from new and innovative county through the county association of RCCs, financial institutions and to resist impleien- but transfers between counties must have PBC tation of reforms that grant full independence authorization, to bank managers. In recent years, the govern- Other policy factors influencing profitability ment has sought to increase regulation over include ill-defined incentives for bank manag- urban credit cooperatives, organizing many into ers to maximize profits; excessive reserve re- Urban Cooperative Banks (Sehrt 1998). In 1998, quirements and loan quotas; poor accounting the State Council announced its intention to and credit rating systems; and the combining incorporate RCFs into the RCC system: each of policy and commercial lending in the same RCF would either become a new RCC branch institutions. Institutional constraints, such as (or merge with one) or be disbanded. Even if inability to seize collateral and a legal system these takeovers are not completed, many rules that poorly enforces loan repayment, still re- still restrict the expansion of activities of less main, making it difficult for banks to support traditional RFIs, such as RCFs and private high-return but risky ventures. banks. At the same time. prudent financial regu- A stated aim of the reforms is to more clearly lation of new financial institutions must be separate policy lending from commercial lend- maintained. ing, but efforts to separate these functions in 30 Chapter 4: Rural Credit and Finance Reaching the Poor and the Role of inBangladesh).Theirsuccessesstemfromtrans- Microfinance7 action cost reductions (by reducing traditional Most observers believe that China's regu- branch-banking structures) and the use of col- lated financial system has been especially hard lateral substitutes (e.g., harnessing peer moni- on the poor, who have had difficulty gaining toring through group-lending contracts and access to loans. However, poor areas may have improving incentives by increasing loan sizes- benefited from interregional barriers to inter- on the condition of repayment history). Pilot mediation; recent surveys in poor counties sur- microfinance institutions and programs in China prisingly find that many households have at have experienced positive results since their least partial access to formal credit.' As the introduction in 1994. However, most of these system becomes more commercial, however, have been supported financially by domestic and more funds will likely flow from poor to rich international organizations. In 1997 several areas. New microfinance institutions (MFIs), provincial governments began replacing tradi- which began in 1994, hold promise for eventu- tional subsidized loan programs with ally providing financial services to large num- microfinance programs supported by poverty bers of the poor. However, they face difficulties, alleviation funds. given the strict regulatory environment, lack of MFIs hold promise for increasing credit ac- financial expertise, influence of local govern- cess for China's poor but require very careful ments, and remote nature of poor villages. management and a flexible regulatory environ- Formal financial institutions often deny loans ment to flourish. Several factors create chal- to poor rural households because these house- lenges not faced elsewhere, including the inability holds lack collateral, face riskier environments, to use land as collateral because land and land- and need small loans that have high transac- use markets do not exist. Microfinance in most tion costs. The government has tried to reach countries also is primarily nongovernmental. the rural poor through a targeted, subsidized However, in China, pilot microfinance programs loan program begun in 1986. As with programs typically draw staff from local governments and in other developing countries, it has failed to must operate within restrictive regulatory envi- reach the poor and has achieved low repayment ronments, despite financial system reform ef- rates (Park, Wang, and Wu 1997).9 Subsidized forts. Finally, China's poor are located in interest rates of 2.88 percent per year make the mountainous, sparsely populated regions, pro- loans attractive to rich households, enterprises, viding fewer opportunities for petty traders and and local leaders. The loans are considered to small businesses that are the main demanders have a welfare dimension that encourages de- of microcredit in other countries, and which linquency. On-time repayment rates in 1991, provide cash flow enabling weekly loan repay- 1992, and 1993 averaged 53, 55, and 48 per- ment. cent (China Science and Technology Commis- Strict enforcement of official interest rate sion Research Group 1995)."o restrictions will doom microfinance programs. International experience has shown that Many microfmance programs have been allowed improved access to credit can promote entre- to charge effective rates of interest above offi- preneurial activity and help lift the poor from cial rates, and this policy should be continued. poverty. Some operational models for providing Interest rate restrictions should be lifted in ex- financial services to households have been ex- perimental or target areas to permit RFIs to reach cluded traditionally from the banking system. more of the poor in a financially sustainable These models range from expanding sustain- manner. RFIs serving poor areas should also able financial services by commercial banks (BRI be allowed to experiment with collateral substi- in Indonesia and BancoSol in Bolivia) to group- tutes in their lending operations. The govern- based loans targeting the poor (Grameen Bank ment may have a rationale to offer temporary . . I . I I I , I - - I I I . . I . I I - . . I I 31 Accelerating China's Rural Transformation subsidies or guarantees to some RFIs to en- However, a willingness to subsidize courage them to attempt changes that may be microfinance programs should not be confused risky or require a period of learning. Partially with a willingness to support inefficiently run subsidized microfinance programs that are fo- microfinance programs. Financial losses and cused on alleviating poverty hold the potential inefficiencies can significantly and quickly in- for reaching an even larger portion of the poor. crease the total cost of achieving poverty alle- The extent to which financial sustainability viation goals. How one subsidizes programs is and poverty alleviation goals conflict depends important, with an important goal being to pro- on the ability of MFIs to economize on transac- vide strong incentives for programs to maximize tion costs and reduce lending risk, and the elas- efficiency (Morduch 1997a). This requires con- ticity of credit demand of the poor to the interest tinual data collection and clear accountability. rate. Many microfinance programs around the To date no domestic microfinance program of world, including all of those operating in China, which we are aware-run by NGOs, donors, or rely on external subsidies to cover costs. Some government-has developed a time frame for mature institutions, such as BancoSol in Bo- achieving or improving cost effectiveness. Lack- livia, have achieved financial sustainability ing are careful evaluations both of financial through experience and by realizing economies sustainability and of targeting effectiveness and of scale, but do not target the poorest house- impact. Although plans exist to support im- holds. Grameen Bank does a better job target- proved accounting procedures for Chinese ing the poor but relies on subsidies. We noted microfinance programs, measures of household- earlier that the average informal loan rate of level impacts are also needed to properly con- positive interest was 1.9 percent a month (Park, sider the desirability of subsidies. This is Brandt, and Giles 1997). It is unclear how long especially true given that China's pilot it will take, if ever, for China's microfinance pro- microfinance programs are heavily subsidized grams to achieve sustainability at those rates. by international or domestic government Many times the urgency of poverty allevia- sources. tion may induce a government agency to invest in the poor by supporting MFI expansion, even Conclusions and Recommendations if such expansion is not self-sustaining. Are the Long-term solutions to China's rural finan- costs to the government and donors worth it? cial problems ultimately depend on solving or The answer depends on whether the costs of reducing the nation's SOE problem. Some gov- the subsidies are substantially below the net ernment reforms have aimed to increase com- benefits to the poor. This depends on the de- petition in the financial sector, but at the same gree to which subsidized loans actually reach time the government is reluctant to yield its the poor, the maintenance of operational effi- control over financial resources. In industry, ciency, the degree to which keeping interest rates competition from the nonstate sector has been low increases the credit demand of poor house- an important disciplining force for improving holds previously not borrowing, the degree to SOE performance (Naughton 1996). Extending vhich subsidies limit the scale of the MFI, the this strategy to the financial sector would per- confidence in continued funding over time, and mit free entry by new, innovative financial in- whether public funds would be better spent on stitutions (such as RCFs) to meet the demand other projects, such as schools and health clin- of market niches and provide greater perfor- ics. Recent surveys of pilot nongovernmental mance incentives for managers of existing in- organization (NGO) and government programs stitutions. In other transition economies, new find that repayment rates have been high, but entry has led to more reform than simply bank targeting of the poor has not been very suc- restructuring (Claessens 1996). cessful. A regulatory framework is also needed to 32 Chapter 4: Rural Credit and Finance safeguard the interests of depositors, but over- the government's desire for control of finan- regulation interferes with efficient intermedia- cial resources. Rather competition can in- tion. Widening interest-rate bands and crease performance by improving incentives, experimenting with greater decentralization and and the government should concentrate on deregulation of interest-setting authority could influencing financial flows indirectly. increase the volume of rural deposits and loans. * Develop institutions that support the ability of We recommend the following changes to the banks to screen loans and enforce loan re- policies governing rural financial institutions: payment. It should expand the use of loan * As an overall strategy, create a rural jinancial histories and credit ratings; reduce the cost sector with a diversity ofinstitutions thatface of lawsuits, asset value assessments, and re- competition and specialize in meeting the possessions; develop resale markets for col- needs of groups with different demand char- lateral items; standardize accounting and acteristics. These institutions could range reporting procedures by firms; and allow fi- from banks to cooperatives to microfinance nancial institutions to restructure branch institutions. Regulation must be prudent to systems and adjust personnel. ensure the stability of the system and safe- * Improve financial management and banking guard deposits, but must avoid excessive skills. Much of the Chinese literature cites restrictions (e.g., on interest rates and inter- the poor quality of bank employees as a key bank lending) whose effect is to exclude constraint to development of commercial groups from credit access. banking. Improving technical expertise on fi- * Permit and encourage financial institutions to nancial risk management and other bank create new deposit instruments that provide management skills should be a top priority attractive combinations of return and liquid- of the goverrunent and the donor commu- ity to better service the savings needs of ru- nity. Allowing entry by foreign banks would ral residents. This will benefit households greatly enhance such efforts. directly and increase the stock of investable * Continue to striveforaclearseparation ofpolicy funds. and commercial lending in dtfferent institu- * Deregulate interest rates. Expanded discre- tions. The following can help the ADBC bet- tionary bands for onlending interest rates is ter realize its role as a policy bank without an important step in reforming rural finance, adding a financial burden: (a) the recent de- but greater deregulation will be required. In cision to return some policy loans to the ABC the current reform environment, further lib- should be reversed; (b) the ADBC should be eralization of the rural financial system will empowered to demand accountability for likely be postponed because of the priority repayment of policy loans, which may require being given to SOE restructuring and to re- reform of the grain marketing system (be- ducing the fragility of the banking system. low), and to have the authority to refuse loans Still, government should encourage experi- with unacceptable risk; and (c) PBC financ- ments, on a local basis, with new institu- ing of ADBC lending should be gradually tional forms and deregulated interest rates, eliminated. especially in areas where higher rates are * Discontinue the subsidized credit program for necessary for profitable banking (such as poor poverty alleviation. This program, like simi- areas). lar programs in other countries, fails to reach * Encourage competition and innovation while the poor and achieves low rates of repayment. maintairingprudentfinancial regulation. This Instead, it should focus on: (a) supporting means regulating rather than eliminating or the microfinance movement to help those poor co-opting RCFs. The emergence of new insti- for whom lack of credit is an important in- tutional forms should not be held hostage to vestment constraint; and (b) provide noncredit . - I a - - I 7 . I I I I - -_ I . I I I I - I 1. 3 3 Accelerating China's Rural Transformation support (e.g., education, infrastructure) for agers in financial monitoring and account- those poor who will not benefit from credit ing skills or attract individuals with those because of other more pressing needs. skills; train program evaluators and support * Provide financial support or subsidies to research on program design; financial microfinance programs but only if linked to sustainability, and impact assessment; sup- conditions on cost effectiveness and financial port ways to broaden the scope of financial sustainability. Various organizations, whether services provided by existing RCCs and RCFs international or domestic, governmental or so that these services reach the poor, either nongovernmental, can provide this support; independently or collaboratively with however, decisions on which microfinance microfinance institutions (especially to in- programs to support and on subsidy levels clude savings as a component of should depend on a rigorous assessment of microfinance); support institutional forms the cost efficiency of different programs and that guarantee the independence of project the added benefits generated by subsidies. managers from local governments and pro- Organizations can also train program man- vide strong incentives for cost efficiency. Rural residents also save in other specialized banks, the post office. and other quasi-government institutions, purchase government bonds-, and invest shares directly in local enterprises or the stock market. 2 Credit survey in Zhejiang, Sichuan and Shandong reported in Park, Brandt. and Giles. "Giving Credit Where Credit is Due: the Changing Role of Rural Financial Institutions in China". William Davidson Institute Working Paper No. 71, University of Michigan. 1997. 3 Based on fixed effects estimate using provincial data on per capita incomes and expenditures from 1985 to 1996. New reforms aim to separate Rural Credit Cooperatives from branches of the Agricultural Bank of China, increase the collective nature of RCCs and the commercial nature of ABCs, prepare for the establishment of new rural cooperative banks in relatively advanced areas, and increase operational agencies of the Agricultural Development Bank (responsible for policy loans). Albert Park interviews in various provinces, 1997 and 1998. C Albert Park interview with national RCC, August 1997. This section draws heavily from Morduch, Park. and Wang (1997). Albert Park surveys of 450 households in six poor counties in ix provinces. See Adams (1984) for a description of problems faced by subsidized credit programs in other countries. o The programs are described in greater detail in Park, Wang. and Wu (1998). Higher risk, higher labor input, higher incomes, and increased use ofseasonal creditfor purchased inputs characterizes specialized household producers of improved livestock and aquatic products. Intensive aquatic production also makes efficient use of open waters and marginal crop land - if water is available. 34 5. The Development of Markets The Development of Markets have promoted even more efficient allocation of With the introduction of the Household Re- resources and provided policymakers indirect sponsibility System, China solved its basic food means to guide markets and stabilize prices. production problems-although production However, grain marketing policy initiatives since problems could return if agricultural research mid-1998 have reversed market liberalization and technology transfer are deprived of re- by prohibiting private sector involvement in cru- sources. Agriculture's more serious problems cial areas, and reasserting expensive and inef- now involve the continuing development of a ficient administered procurement, storage, and healthy marketing environment in agriculture, trade by parastatal organizations. one in which farmers make their resource allo- Improved marketing efficiency reduces trans- cation and marketing decisions based on actions costs and allocates an increased share undistorted price signals created by competi- of consumer expenditures to producers thereby tive traders, and in which officials shift their increasing producer incomes: but it also ben- attention to promoting more efficient markets efits consumers through reduced cost. Physi- and intervening only to buffer prices against cal markets have developed rapidly in rural and extreme fluctuations. In short, the agricultural urban areas. The number of free markets at marketing challenge is a "second-generation" the end of 1997 exceeded 87,000, of which about problem that must address both policy and in- 25 percent were located in urban areas. De- frastructure. spite the smaller number of urban markets, the While gradualism has been the hallmark of value of their transactions has exceeded that of China's rural transition, the pace of reform in rural markets since 1994. Following decontrol commodity pricing and marketing have been of perishable product marketing in 1984, free- varied. Perishable commodities have experienced market sales led by fruit, increased rapidly; but the most rapid transition. The market trans- grain and edible oil marketing continued to be formation for grain, vegetable oil, and cotton controlled throughout the 1980s. By the end of has been marked by alternating reform and the decade free-market grain sales only doubled retrenchment cycles that continues in the late while the sales value of other commodity groups 1990s. By early 1998, Figure 5.1: Free Market Sales Index China's grain markets hnabem rpmrsl of Agricultural Products (constant value) had become surprisingly 400 integrated, competitive, and increasingly effi- 350 Aquatic Prod Grain & Edible Oil Aqai rd cient. The Government's 300 Vegetables reformplan, announced 250 rutS in spring of 1998, was 200 poised to initiate a new 150 set of reforms that very Meat/Pouitry/Eggs likely could have created 100 a marketing and policy 5o 1990 1991 1992 1993 1994 1995 1996 1997 environment that would Accelerating China's Rural Transformation quadrupled or quintupled. However, as grain taxed through the early 1990s, but by 1995 policy liberalized in the early 1990s, free-mar- prices had increased to international levels (rice) ket sales of grain and edible oil accelerated to or above (wheat, maize, and soybeans). The dis- become the fastest growing commodity group equilibrium between domestic and world price on the free market (figure 5.1). Sales volume in is due in large part to the partially closed grain open markets demonstrate a similar growth markets and state-controlled trading system. pattern. Historically, the most heavily taxed grains were Policy and infrastructure constraints affect exported in most years (rice and maize), but the grain and nongrain market differentially. rising domestic prices have mitigated this price Pricing and marketing policy strongly affect bias. grains. for which most marketing and market Although the government has maintained infrastructure is under the auspices of state grain strong control over grain markets, the "free enterprises. Alternatively, the efficient develop- markets" have continued to flourish. ment of perishable product markets is con- Cointegration analyses conclude that reforms strained by information shortages. interregional have improved spatial market integration and procurement restrictions, and limited infrastruc- that subsequent policy retrenchments have not ture. reversed this integration trend (Rozelle, Pray and Huang 1997: Wu and Huang 1998; Zhou and Grain Markets Wan, 1999). Recent analyses using parity bounds The high fiscal costs of government inter- and spatial equilibrium methods (Rozelle et al. vention in the grain market caused the central 1999) also find that throughout the early and government to move increasingly toward com- mid-1990s grain markets became increasingly mercialization during the 1990s. Most grain competitive, less fragmented, and more efficient. responsibilities and policy activities, except for Transaction costs, including those for trans- a national reserve, were transferred to the prov- portation, handling, and marketing, remained inces, including responsibility for local supply- high-up to four times the levels found in de- demand balances under the Provincial veloped countries-but are likely a function of Governor's Responsibility System (GRS). In the congested transport system and antiquated theory, commercial operations of state grain grain handling methods. Unfortunately, mar- enterprises have been separated from policy ket commercialization efforts have been discon- responsibilities undertaken on behalf of gov- tinued. ernment (e.g., procurement of the grain quota and storage of State Grain Reserve stocks) to Recent Policy ensure subsidies are allocated only to the lat- Faced with rising fiscal burdens (due to ter. Commercialization policy focused on the higher levels of government grain stocks) and profitability of government grain agencies and falling farmgate prices in the late 1990s (caused rationalizing grain bureau staffing, but private primarily by record levels of grain production sector competition emerged, handling an esti- in 1995 to 1997 and a decline in demand growth), mated 25 to 35 percent of commercially mar- the government reassessed its grain policy in keted grain in the mid-1990s. early 1998. The main goals of the new reforms Over the past decade, government has en- were to: (a) correct the inefficiencies in the grain acted frequent pricing and marketing reforms, marketing system (including problems of con- which are often partially retrenched and which current commercial and policy operations by led to three-tier prices-all of which remained the grain bureaus); (b) reduce the fiscal burden below the border price, at shadow exchange of the grain system; and (c) stabilize grain prices rates, until 1994. Estimates of nominal protec- and farmer incomes. While the overall goals of tion rates indicate that all major grains were the reform were not new, a new sense of ur- 36 Chapter 5: The Development of Markets gency was present, due partially to the need for However, this agenda was not followed and fiscal savings and partially to government con- market liberalization efforts were abandoned in cerns for rising grain prices if farmers reduced mid-1998. Instead, government adopted a policy sown areas and applied fewer inputs. mix that will likely be unable to simultaneously The major measures adopted to implement meet its goals of creating a more efficient mar- the ongoing reform and meet the challenging keting system, reducing its fiscal burden, and set of announced objectives include the follow- maintaining stable prices, including: ing: * remonopolization of farmgate procurement; * Clear separation ofcommercial and policyfunc- * a renewed commitment of the government to tions to parallel the separation of commercial procure all sales by farmers at the state-set and reserve grain. Commercial companies will procurement price; and be responsible for farm procurement and * prohibition of the grain bureau from selling interprovincial grain transfers with financ- grain at a price lower than the state-set pro- ing independent of the state budget. curement price. * Clear separation of central and local govern- The new policies have many characteristics ment responsibilities. Buffer stocks for price of early grain marketing reform efforts. It is too stabilization and disaster relief stocks will early to empirically evaluate the impacts of this be the responsibility of the central govern- new reform program, but it is questionable ment. Local governments will be responsible whether the policy mix will stabilize the domes- for stabilizing local prices and the Governors' tic grain market, improve grain market compe- Responsibility System will be retained. tition, and reduce the government's fiscal burden * Clear separation of old and new grain debts. in managing the grain system. The grain financing debt is approximately Y 200 billion, of which Y 130 billion represents Grain Reservesi defaulted policy loans with the balance rep- Most efforts to control commodity supply and resenting borrowing for commercial opera- price volatility through buffer stocks, stabiliza- tions. These debts are to be repaid over a tion funds, international commodity agreements, 10-year period. and government intervention in commodity * Setting the state procurement price above the markets have ended in failure. Buffer stock current market price to protectfarmers' income programs often accumulate large reserves of and ensure a stable supply ofmarketed grain. commodities (U.S. and E.C.) with resultant high This ambitious grain policy agenda addressed costs for interest and storage, stabilization several crucial issues and if implemented as schemes typically end in bankruptcy because planned, a commercialized trading system with of their unsustainable high cost (Australia), and state-owned and private firm competition would different country objectives, alongwith high cost, have emerged. Also, a government-owned policy- have caused many international commodity oriented, stock-holding agency with sufficient agreements to lapse (World Bank 1999). Gov- reserves and storage capacity to create an ef- ernment intervention is very costly and eventu- fective buffer stock system would have been ally has been fiscally unsustainable for most created and the separation of policy and com- countries. mercial functions would have led to large fiscal Industrial country governments have been savings. Depending upon government's percep- divesting from grain storage because the cost tion of reserve stock adequacy, additional stocks of holding reserve stocks exceeds the perceived could have been purchased (and farmer incomes benefits of grain price stability. Reserves are supported) or not purchased [supporting fiscal maintained as commercial stocks by more effi- objectives)-although farmer incomes may have cient and competitive private enterprises. Food been affected until production patterns adjusted. grains in these countries comprise a small por- I . . 1 . 1 - 1 . 1 1 1 - I _ 1 -11 . f - I . 1 37 Accelerating China's Rural Transformation tion of agricultural incomes and consumer ex- available. Tying China's food grain security to penditures, and price instability is relatively the global markets and making greater use of unimportant. Nevertheless, there are economic these instruments should be more efficient at arguments for price stabilization in developing stabilizing prices and should cost less than the countries where food grains are a major cost el- large stock program currently followed. Although ement in the food basket.- Several countries, greater reliance on the international market would notably India and Indonesia, have stabilized be more efficient than maintaining stock for the prices employing modified buffer stock pro- most severe contingency, additional port and grams-but at high fiscal cost. Jha and handling capacity may be necessary. Prior to Srinivasan (1997) determined that India's buffer the mid-1 990s, when domestic grain prices were stock program was the most costly policy in- below international prices, maintaining large strument for price stabilization-compared with strategic grain reserve stocks was relatively less other options. costly however, domestic grain prices are cur- The State Administration for Grain Reserve rently above international border price equiva- (SAGR) manages reserve stocks on a noncom- lents-making it very costly to carryover stocks. mercial basis and pays Provincial Grain Bu- Estimated carryover costs are indicated in Table reaus to handle grain on its behalf. The state 5.1 based on 1998 farmgate grain prices (mar- grain reserve target of 40 million tons, together ginally different from 1997 prices). with reserves maintained by provincial and other jurisdictions, and 90 million tons of commer- Perishable Product Marketing cial and semicommercial grain procured by State Livestock and aquatic products, and fruits Grain Enterprises is an extraordinary quantity and vegetables, were the first food commodity of grain (and proportion of marketed grain) markets to be liberalized. However, these mar- handled by the State to maintain price stabil- kets can be characterized as "constrained com- ity3-and is extraordinarily costly. Information petitive" at best. A series of information and on the volume of China's reserve stocks and regulatory constraints, both legal and quasi- stock releases are unavailable; thus, costs and legal, inhibit the development of economies of efficiency cannot be evaluated. But price stabil- scale and a fully free and competitive market. ity could surely be effected with smaller reserves. This applies particularly in the area of cross- Large reserves protect against possible tran- border (township, county, and provincial) mar- sitory shortages, but less costly alternatives are keting. Table 5.1: Cost of Carryover Stocks (Yuan/ton) Farmgate Grain,a 1998 Unit Prices/b Storage Interest Storage Total Prices (1998) Import Export loss 5%/c Cost 10%!' fee/, Cost Rice 2,175 4,108 2,047 108.8 228.9 126.0 463.7 Wheat 1,445 1,560 72.3 152.1 126.0 350.4 Corn 1,270 646 63.5 133.7 126.0 323.2 /a Average of government and market prices. /b Import and export unit values derived from trade statistics. /c Grain losses in storage are assumed to be 5 percent. /d Interest costs are 10 percent of the value (per ton) of stored grain after storage losses. /e The State Administration for Grain Reserves pays Y 120/ton of grain placed in storage; these costs are increased by 5 percent to account for storage losses. 38 Chapter 5: The Development of Markets practices continues to inhibit firms from expand- ing across county boundaries, and bordering - counties continue to operate suboptimal pro- cessing plants in the same product categories (e.g., slaughtering plants, fruit juice plants). Transportation and Documentation A lack of refrigerated, containerized, and intermodal transport services further constrains marketing. Inland access to the major urban Farmers delivering seed cotton to buying station. coastal cities still largely depends on railway transport, but traffic flows must conform to the Commodity Procurement and priority routes established duringthe command Economies of Scale economy period. For example, meat can be Some joint-venture firms and wholesale shipped north from Chengdu but not south. markets have developed scale economies in pro- Rail transport is further hampered by delayed curement, processing, and distribution, but rail-car acquisition, frequent space cancellation, county-specific procurement and processing and lengthy transit time. Transit time for ex- linkages hinder the development of scale econo- press rail cargo service from Chengdu to Beijing mies by local enterprises. County food-devel- (2,000+ kilometers] is 15 days, versus 7 days opment corporations that process perishable by truck. products are prohibited from crossing county Interprovincial barriers to trade in perish- boundaries to contract (with farmers) for pro- able and processed foods include inconsistent duce, thus forcing processors to turn to in- weighing, inspection, and other procedures, and county wholesale markets that attract produce the lack of national standardized quarantine from adjacent counties. Other food marketing and phytosanitary inspection certificates and firms have begun to specialize in high-value fresh clearance documents. Inspection and control products in response to strong demand by ur- authorities at each provincial (municipal) bound- ban consumers and by hotels, restaurants, and ary may question documentation validity-par- institutions and compete with imported prod- ticularly at the boundaries of provinces ucts for market share. producing competing commodities. Jurisdictions Small county processing plants have been treat agricultural commodity transport differ- encouraged to create value-added products and entially, requiring drivers to present various li- absorb agricultural products within local ar- censes to inspection authorities. Border eas. This structure may have been justified ear- checkpoints are maintained for quarantine in- lier, when transportation networks were poor. spection, payment of transit and shipping fees, However, with improved transportation and road and other document clearances, but drivers of infrastructure, intercounty transport of prod- trucks from out of the county or province may uct has become competitive. Restricting firms face delays-which damages commodity qual- from sourcing products from neighboring lo- ity and value. Drivers also may be required to cales has often left these firms with excess ca- pay unofficial fees. Governments of most other pacity, and despite favorable lending practices countries require that trucks transiting juris- by local financial intermediaries, they often were dictions in which they are not registered pay underutilized and noncompetitive-leading to fees based on objective criteria (e.g., gross weight, insolvency. The uncertain legal framework for number of axles, etc.). firm consolidation and discriminatory sourcing I~~~~~~~ ~ ~ ~ ~ ~ I- 11 . I.I .1 39 Accelerating China's Rural Transformation Market Information modem production technologies and husbandry, In developed market economies, government- rather than marketing. Membership fees pay funded information networks-e.g., U.S. Depart- for training, specialized extension (often from ment of Agriculture (USDA)-provide ongoing an agricultural university or research center), market information for each level of industry and other services, such as publicizing appli- activity, with information access available to all cable regulations. organizations and individuals. In China, mar- The success of producer marketing associa- ket information has historically been collected tions requires a number of facilitating factors. as inputs for government policy decisions rather For positive reinforcement in establishing mar- than to help markets perform more efficiently. keting associations, a legal framework for their Public information on market prices and vol- development and a regulatory framework de- umes is limited to a few national and major re- fining the commercial obligations (e.g., contract gional wholesale markets and commodity enforcement, adjudication) of associations and exchanges. Although such data are recorded their members are necessary; the lack of pro- by other wholesale market managers, informa- hibiting legislation is insufficient. Technical, tion on production, stock, and flows is restricted, managerial, and training assistance is required and for some products, disaggregated price and to educate farmers (and local officials) on com- product turnover information is kept proprietary. mercial principles and alleviate suspicions of Producers or wholesale market managers at the collective decisions. In the absence of market county level require clearance from the provin- linkages and marketing alternatives (high-value cial State Statistics Bureau to access disaggre- processing plants or fresh markets), farmers are gated census data on county or provincial unable to obtain price premiums for higher- production statistics and regional trade flows quality products. Thus, marketing associations by product. In addition local producers and must have an integrated market intelligence and wholesale markets have limited access to infor- sales unit to assemble price, quality, and quan- mation from the Ministry (or Bureaus) of Agri- tity information in differentiated markets. Cen- culture. Public information on interprovincial tral to the development of producer associations trade is either difficult to access, or is unavail- is the ability to extend their structures across able. Contractual delivery agreements are prin- administrative boundaries into neighboring pro- cipally negotiated between producers and duction areas to assure supply access and con- joint-venture processing plants (as well as state trol. export agencies). These are proprietary agree- ments, and confidentiality of contract content Conclusions and Recommendations (e.g., prices, volumes, delivery arrangements) Determining how the new policies will meet is maintained. the objectives is difficult. The proposed mea- sures might not stabilize farm-gate prices (or Producer Marketing Associations farmer incomes), improve grain marketing effi- Historically, producer associations were ciency, or reduce the aggregate fiscal burden. formed to improve farmer bargaining power with although a portion of the burden may be trans- respect to downstream purchasers and to im- ferred from the central to provincial govern- prove farmer income. These associations are ments. administered by producers on behalf of their Consequences of the new policies will likely membership, andvirtuallyall organizational and include the following: (a) A substantial operational criteria are established and enforced overprocurement of grain may stress the pro- by members. In China, a few farmer organiza- curement and storage capacity, physically and tions have developed from village associations, financially, and inhibit commercialization of state focusing primarily on production-promoting grain enterprises. The enormous procurement 40 . Chapter 5: The Development of Markets and storage costs will also be difficult to finance, bureaus and discontinue monopoly grain pro- creating incentives to purchase grain at discount curement should be reinstated as early as prices (below the government determined price), practicable. As currently implemented, the with IOUs, or decline to procure grain beyond grain marketing policy will incur enormous anticipated sales. (b) Urban consumer prices costs and drain budgetary resources from will increase, which will reduce both grain de- other potential rural development invest- mand and discretionary urban incomes. (c) The ments. grain market gains in efficiency, integration, and * Transform the enormous stock of grain re- competitiveness acquired during the early and serves held by central and provincial govern- mid- 1990s will be reduced. ments into a transparent, market friendly The new policies will likely return the struc- buffer stock system. This would require, in- ture of the grain market to that of the late 1980s. ter alia, intensive analyses on the optimum Even with total separation of day-to-day com- size of reserves, stock locations, international mercial operations and specialized government market linkages, price bands to be defended, agencies to implement policies, commercial trad- and trigger mechanisms for open-market ing will be difficult while the government con- transactions. tinues to set procurement prices at above-market * Invest in public goods that promote market levels. development: transport and communications Although private traders will be permitted infrastructure; market institutions, such as to participate in wholesale and retail marketing wholesale andfutures markets; market infor- (after procuring supplies from the state grain mation the development ofuniform grain qual- enterprises), whether the basis for private and ity standards; and contract enforcement nonprivate competition will be equal in terms mechanisms. In an increasingly commercial of similar access to output and credit markets, environment, the government's role is to serve consistent licensing, and similar tax arrange- as an impartial arbiter of fair market compe- ments are unclear. Also, the state enterprises tition, steadfastly prohibiting rather than en- may continue to suffer from operational handi- couraging barriers to interprovincial trade. caps, such as exaggerated employment or ex- Closing or isolating markets destroys incen- cess welfare responsibilities. tives for producers and traders, exacerbates Officials disapprove of significant import inequities, and makes stabilization through reliance for grain supplies for fear of destabiliz- buffer stock operations less effective. ing the world market, if China imports very large * Encourage flexible sourcing and procurement volumes of grain. This concern is used as a structures for agroindustrial commodities. defense for intervening in production, market- Such structures are necessary to ensure ap- ing, and trade. However, the inefficiencies and propriate and efficient scale processing tech- fiscal costs of these interventions are enormous nology and to promote reinvestment in future and seriously affect farmer incomes. Elsewhere cost-reducing technologies, which in turn are in the world, governments in both developed necessary to maintain firm profitability. and developing countries are divesting their grain * Consolidate the marketing information system procurement and supply systems and buffer under the auspices of a single agency, and stocks. make it more comprehensive (i.e., include quan- We recommend the following to further de- tity and quality along with price). To ensure velop China's markets: adequate information was provided to the * Commercialization measures have been sus- central market information agency, licens- pended to accord priority to other reform ing and license renewal of wholesale mar- measures, however the policy measures to kets could be conditional on the timely commercialize the trading activities of the grain submission of market information. Situation I . I . . - . I I I . . , e I - I I I . . 1 1 . 1 1 . . 2 41 Accelerating China's Rural Transformation and outlook information (assessment of pro- * Standardize national quarantine and duction conditions and probable marketing) phytosanitary inspection procedures, certift- of perishable commodities should be dissemi- cates, and shipping documents, and apply nated similar to that currently released by them equally to all interprovincial commodity the Ministry of Agriculture (MOA) for grains transport. This would improve marketing ef- and oilseeds. ficiency and increase farmer income. If na- Assist in broadening and strengtheningfarmer tional quarantine certification conditions were association management, through training met, lower jurisdictions should have no au- programs. Few, if any, farmer associations thoritv to restrict commodity movement. The have the skills and knowledge base to advise establishment of preclearance qualifications producers on market channels for differen- and procedures would further increase effi- tiated products. However, broadening and ciency. Processing-plant certification for quar- strengthening association management to en- antine purposes has made frozen shrimp gage in market development, promotion and exports to the United States less bureaucratic other marketing activities-and thus further and more efficient than interprovincial live- empower producers in the market place- stock marketing. Inspection and certification would improve agricultural income. Producer procedures should be transparent and stan- associations could improve the planning and dard fees should apply. distribution of horticultural and livestock * Require trucks transiting provinces in which products, linking production with efficient they are not registered to pay fees based on scale processing industries. They could also objective criteria. These fees also should be extend consumer deliveries by exploiting re- transparent, standardized, and universally gional product specialization and seasonal- applied. Transit fees and levies beyond those ity, thereby improving income levels and officially sanctioned should be vigorously dis- stability. couraged. This section relies substantially on World Bank 1997b. Rice price stabilization by Indonesia's Bulog (Badan Urusan Logistik) is estimated to have contributed almost one percentage point to GNP growth in its early years, 1969-74 (Timmer 1996). Indonesia's Bulog stabilized domestic rice prices during the past three decades by relying heavily on private- sector traders and performing only a marginal market role. Bulog's moximum annual rice purchase was 25 percent of production and designed carryover stocks were 1.0 million tons. 42 6. International Trade and Foreign Capital Flows A. Trade the domestic grain self-sufficiency target was redefined as of 95 percent of consumption. Introduction Other objectives, such as improving the ef- China is an important global player in the ficiency and responsiveness of the trading sys- trade of selected agricultural commodities. At tem in meeting national requirements, are various times over the past decade China has consistentwith other efficiency objectives. Policy imported as much as 17 percent of the world's and institutional reforms initiated during the traded wheat, 25 percent of its fertilizer, and 28 1990s include; consolidation of exchange rates, percent of its soybean oil, while exporting as eliminating most government determined prices, much as 10 percent of the world's traded corn. encouraging competition by decentralizing and Agricultural trade, which in the following dis- demonopolizing the trade of many commodi- cussion includes aquacultural and maricultural ties, commercializing operations where monopo- products, was reasonably well balanced over lies remained, transforming trading companies the 1990s, with small surpluses in most years.' into handling agents, reducing the number of The nominal value of China's total exports commodities requiring import and export li- and imports grew at annual rates of 13 and 12 censes, and reducing tariffs. Removing the re- percent over 1980-96; the ratio of foreign trade maining distortions to permit trade to reflect (exports plus imports) to GDP increased mar- production comparative advantage is an impor- ginally to 7.1 percent, valued at purchasing- tant element in accelerating rural income growth. power parity, or PPP (World Bank 1998). The two-tier exchange rate was consolidated Agricultural exports and imports grew consid- in December 1993. During the mid-1990s mar- erably slower at average annual rates of 7.1 and ket determined prices for agricultural commodi- 5.9 percent and accounted forjustunder 3 per- ties increasingly replaced government cent of global agricultural trade in 1996. How- determined prices. Trade decentralization in- ever, growth in the real value of agricultural trade creased the number of firms eligible to engage averaged only 2 percent annually, from 1980 to in foreign trade-from about 1,200 in 1986 to 1997-less than half the growth rate of real about 200,000 in 1996. agriculture GDP. State Trading Trade Objectives, Policies and Rapid progress in liberalizing other aspects Institutions of trade accentuates the lack of reform in state The highly visible production and trade policy trading. While any licensed foreign trade com- goal of grain self-sufficiency is inconsistent with pany may trade certain agricultural commodi- other national efficiency objectives. This objec- ties-external trade in "strategic commodities," tive has changed only marginally over the re- such as food grains, textile fibers, and chemi- form period. Through the 1980s external grain cal fertilizers, continues to be restricted to spe- trade was basically to balance individual food cialized and monopoly national trading and feed grains. In the 1990s, as it became in- corporations. Some national trading corpora- creasingly apparent that China does not enjoy tions have been transformed into for-profit en- a comparative advantage in grain production, terprises, including the Cereal, Oil, & Foodstuffs Accelerating China's Rural Transformation Importing and Exporting Corporation (COFCO), many trading companies are permitted to im- for grain, edible oil, and sugar; China National port various agricultural commodities, monopoly Chemicals Import and Export Corporation trading corporations and import quotas still (SINOCHEM), for chemical fertilizer: and the apply to some of the major agricultural imports- Cotton Import and Export Company of China. cereals, oilseeds and vegetable oils, and wool. COFCO handles grain as a monopoly agent for Furthermore, the size of the quotas are not importers and exporters, but grain trading still publicized. remains subject to import and export licenses Comparative advantage in agriculture often and quotas. COFCO is not only a large trader, it declines in the process of economic growth, and also is an erratic one, generating wide year-to- this is expected to happen in China. In nations year swings in trade volume. Lack of informa- where arable land is scarce, the comparative tion characterizes China's trade transactions, advantage in agriculture tends to decline more causing uncertainly to both those who COFCO rapidly (Anderson 1990). In general, the com- represents and those who COFCO buys from parative advantage of China's agricultural sec- and sells to. tor has been declining for land-intensive crops. China's net grain imports will likely increase in Impact of Reforms the future; and a gradual change in trade com- Unlike many neighboring countries (where position, including import shifts from food to governments have protected agricultural prices feed grains, seems inevitable. and subsidized farmers), China consistently taxed farmers until the mid- 1990s by maintain- Shifts in Trade Patterns ing farmgate prices below border price equiva- Although the growth rate of agricultural trade lents-except for small volumes of grain sold to has been below that of industrial exports, China's nongovernment buyers at market prices. Nomi- share of the world's agricultural trade has in- nal protection rates estimated at official exchange creased, suggesting that trade liberalization has rates for the major grains, oilseeds, and cotton been effective despite the remaining barriers. clearly show declining negative protection (i.e. Trade structure changes have accompanied taxation) over the 1980s and 1990s, and now rapid economic growth. Agriculture's share of hover within a 10 percent band around zero. GDP and trade was about 30 percent in 1980, By 1997 most grain and cotton procurement declining to about 20 and 10 percent respec- and market prices approached international tively by 1997. There changes reflect improved price equivalents-and by 1998, exceeded in- sectoral resource allocation and the transfer- ternational prices. ring of comparative advantage from agricultural Exportable commodities-such as rice, to manufactured products. maize, soybeans, and cotton-were more heavily The value of agricultural exports was $20.2 taxed than importable commodities, such as billion in 1997, of which grains (Chinese defini- wheat. If the impact of the overvaluation of the tion), primarily oilseeds, composed about 11 domestic currency and the tariff protection sys- percent. China's agricultural trade balance tem is considered (recently reduced), agricul- (Table 6.1) and trade in major commodity groups tural incentives are further distorted, depressing (Figure 6.1) indicates the changing composition food prices and redistributing income from farm- of trade and suggests an export trend toward ers to urban consumers and the agroprocessing products in which China has a comparative sector. On the other hand, the gradual liberal- advantage. Import data do not yet suggest a ization of prices and agricultural markets has trend in commodities in which China is com- significantly reduced the distortions in recent paratively disadvantaged. Grain imports in 1997 years. and 1998 were particularly low-probably a While import tariffs have been reduced and consequence of the 95-percent grain self-suffi- 44 Chapter 6: International Trade and Foreign Capital Flows Table 6.1: China's Agricultural Trade Balance, 1992-97 (million dollars-nominal) 1992 1993 1994 1995 1996 1997 Bulk Commodities14 193 1,439 78 -4,955 -3,529 -1,253 Consumer Ready Products/b 1,985 2,030 2,520 3,458 3,836 1,463 Horticultural and Other Food Products/, 951 1,073 1,426 1,281 1,177 1,085 Processed Intermediary Products/d 1,129 1,208 400 -1,259 -811 -2,614 Total Trade Balance 4,259 5,750 4,424 -1,475 673 -1,319 Other Agricultural and Resource Products (OARP);e 2,746 2,885 4,761 6,130 4,580 743 Total Balance Including OARP 7,005 8,635 9,185 4,655 5,253 -576 /a Grains, seeds. raw tobacco, cotton, and raw sugar. /b Processed meat, dairy products, processed vegetables and fruits. /c Trees, flowers, fresh fruits and vegetables. /d Live animals, flours and meals, gums, saps, oils, hides and skins, raw wool. /e Seafood, beverages, leather, forest products, wool yarn and fabrics, cotton yarn and fabrics. Source: Compiled from China's Customs Statistics Yearbook, various years. ciency objective. The net exports of land-inten- tic production is increasingly moving toward sive bulk commodities, such as grains and oil- commodities in which a comparative advantage seeds, have fallen, while exports of is enjoyed. higher -valued, more labor -intensive products, - - such as horticultural and animal (including Figure 6.1: Major Commodity Groups as aquaculture) products, have risen (Figure 6.1). a Proportion of Agricultural Trade The cereal export embargo, in effect during Agricultural Exports by Major Commodity portions or all of 1994 to 1996, severely con- 100 0 strained grain trade, but grain exports did not 9ooL_ Othe noticeably recover following the lifting of the 00 m coo 52.1 700 '5iAnimal I embargo. The importance of grain exports, 0 Prods. which accounted for about 23 percent of total o- . L_ agricultural exports in the pre-embargo pe- 400 3,2 04.6 i 046 300 , 11 6 1 Hortm. riod, have fallen by about half. Thus the em- 000 s Prods. 20 D bargo appears to have simply emphasized the decliningtrend in cereal exports. In 1997 hor- I Grains ticultural products, primarily fruits and veg- etables, and animal and aquatic products, Agricultural imports by Major Commodity accounted for more than 80 percent of agri- 00 -oe 9(other cultural exports. Grains typically make up 8. more than one-half the value of imports, with , J Anima wheat and vegetable oils and fats the major - i components, but were substantially less in . Hortic 4.. 1 1997, when animal products were of major , . Prods. importance. These external trade trends re- 2. $02a .Grains inforce agricultural production patterns ob- served by Park, Rozelle, and Cai (1994), and Rozelle et al. (I 997b), who found that domes- . . 45 Accelerating China's Rural Transformation Trade Barriers: How Severe? real grains, 3 percent for soybeans, 13.8 per- China has significantly reduced tariffs over cent for edible oils, and I to 3 percent for wool. the past decade for nonagricultural commodi- The above-quota tariffs are quite high, but ties, and additional reductions are under dis- whether these high tariffs have ever been ap- cussion as part of the World Trade Organization plied is uncertain. (WTO) negotiations. China reduced its simple average import tariff from 42 percent in 1995 Impact of WTO Accession and Trade to 17 percent in 1997 (U.S. Trade Representa- Protocols tive 1998). Agricultural import tariffs of 40 to The process of WTO accession has involved 60 percent, although higher than the average several trade liberalization commitments, and for all commodities, are considerably below those additional commitments doubtlessly will follow- of most developing countries. These tariff re- all of which will impact directly on domestic ag- ductions are progressive but mask significant ricultural commodity prices and rural incomes. nontariff barriers. A variety of nontariff barri- The commitments include tenninating the trad- ers restrict imports, including tariff quotas, ing monopolies now enjoyed by state trading import quotas, import licenses, phytosanitary enterprises. This will permit nonstate trading measures, and state trading-applying particu- entities to import portions of the tariff-rate quo- larly to grains, cotton, vegetable oils, and fertil- tas, ranging from 10 percent (wheat) to 67 per- izer (U.S. Trade Representative 1998). cent (cotton) to 90 percent (soybean oil in 2006) Although China maintains a high tariff for and represents important structural reform above-quota imports, tariffs for some of the major which will improve trading efficiency. In addi- import items-such as grain, soybeans, and tion, domestic trading and distribution rights cotton-are below 5 percent, if within-quota. will be liberalized over a three-year period, per- Within the WTO context, China has offered to mitting transnational firms to engage in domestic reduce its weighted2 average, binding (i.e., maxi- distribution-including fertilizer, which hereto- mum) tariff to 41.3 percent by the year 2004, fore has been highly protected from distribu- including a reduction on grains from the cur- tion competition. Further, China has committed rent 66.9 to 51.6 percent-a very low level for to discontinue export subsidies and trade dis- developing countries and more similar to those torting domestic subsidies and base agricultural adopted by large grain-exporting nations. IfWTO import protection solely on tariffs, thereby elimi- membership is agreed and accepted on these nating protectionist (nonscientific) elements of terms, it would preclude China from following agricultural sanitary and phytosanitary regu- a protection-based agricultural trade policy op- lations. If China is to remain an exporter of rice tion used by its more-developed East Asian and corn, domestic prices will necessarily de- neighbors. cline to levels consistent with international price These tariffs must all be interpreted cau- equivalents. Although precise impacts of WTO tiously because they are often combined with accession can be determined only through de- quotas. For example, the most favored nation tailed supply modeling, it is clear that prices for (MFN) tariff on wheat was 114 percent as of and production of these crops would decline 1996 and the WTO-bound rate is 65 percent for and near-term agricultural incomes will be re- the year 2004: but a tariff-rate quota applies duced-unless yields can be increased or pro- and imports under the quota are subject to only duction costs reduced. a 1.0 percent tariff. The rate is 114 percent for Tariff bindings and tariff-rate quotas (TRQ), imports above the quota. Similar licensing of are an integral element of the tariff based re- tariff-quota imports applies to rice, maize, soy- gime. Average import tariffs for agricultural prod- beans, edible oils, and wool. The within-quota ucts would decline to 17 percent by 2004, leaving tariff rate is relatively low: 1 percent for all cc- agriculture somewhat more protected than in- 46 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . Chapter 6: International Trade and Foreign Capital Flows dustry, where the average import tariff will be by the World Bank, the Food and Agriculture reduced to about 9.5 percent. However, very low Organization (FAO), and the International Food tariffs (3 percent or less) will apply to TRQs of Policy Research Institute (IFPRI).3 Sharp short- most bulk commodities-those commodities in term (2-3 year) price increases (and decreases) which China does not enjoy a comparative ad- have and will occur in reaction to major policy vantage-cereal grains, cotton, soybeans and decisions on grain production and storage by soybean derivatives (meal and oil). The exist- major producing and trading countries, excep- ence of a TRQ does not necessarily mean that tionally favorable or unfavorable weather with imports will immediately increase to meet the resulting harvest impacts, wars, natural calami- quota. For example, the TRQ for rice is 2.7 mil- ties, and similar events. For example; the dra- lion tons in 2000 rising to 5.3 million tons in matic price spike in 1995-96 followed a sell-off 2004; but the international rice market is very of 220 million tons of international grain stocks "thin" and rarely has any country imported more during the previous decade, coupled with a 1995 than 2 million tons annually. And, if imports of drought in some U.S. grain-producing areas. that magnitude were attempted in 2000, inter- Future grain price volatility, around the de- national rice prices would increase dramatically, clining trend, is likely to be greater than of re- similar to the rapid price increases following cent decades because of policy changes in the China's import of 1.6 million tons in 1995. Nev- major exporting countries. These changes in- ertheless, given that international cotton and clude both those made due to the WTO Agree- soybean prices are below domestic prices, the ments on Agriculture and unilateral decisions availability of cotton and soybean TRQs will by the U.S. and the E.U. governments to re- inevitably result in domestic price declines and duce stock holdings for budgetary reasons. These income reduction for producers of these com- changes will keep world grain stocks low in the modities. future and lower stocks could lead to greater price volatility because the smaller buffer against Price and Supply Volatility a poor harvest. Long-term trends in global grain prices, The monopoly structure of the state trading which have been declining for well over a cen- company creates inefficiencies and distortions tury, are forecast to continue declining over the in the domestic economy and may even create next 10 to 15 years according to recent studies uncertainty in world markets. Price stabiliza- Modern bulk grain handling systems are replacing bagged grain handling in domestic and international trade. 47 Accelerating China's Rural Transformation international prices (Figure 6.2).1 Sini- Figure 6.2: Domestic and International Grain Ilarly grain supply (produce and net Price Volatility (dollars per ton) imports) fluctuations have been ex- US $ per ton acerbated by trading. Rice Price Volatility 400 The calculation of standard error 350 Chino, rural market 300 5% broken, fob Bangkok terms around price trend lines (1990- 97) clearly demonstrates that domes- 200 tic grain prices are more volatile than 150 international prices. (Table 6.2). Also, i 100 an analysis by Chen (1999), using pro- vincial average farmgate prices Wheat Price Volatility 350 (weighted average of quota, negotiated, 300 and market prices), determined that 250 Canada 200 price variation, as measured by coef- 150 ficients ofvariation (CV) had increased 100 C r m over time-CVs for rice and corn prices 50 doubled between the 1975/85 and 1985/95 decades, while the CV for Maize Price Volatility 250 wheat prices increased by 50 percent. 200 Furthermore, net trade in rice and o50 Cif, rural market corn have exacerbated production fluc- 100 tuations as net exports have tended to be less in years of high production 50 and more in years of low production. 1990 1990 1991 1992 1993 1994 1995 1996 1997 The impact of trade is indicated by the --higher standard error term for "pro- tion is becoming an increasingly important goal duction + net trade" in Table 6.2. This apparent of trade policy. However, importing during peri- anomaly probably derives from executing ex- ods of relative abundance and exporting dur- port plans which are developed several months ing periods of relative scarcity have made prices prior to harvest. Storage statistics are unavail- in China's domestic market more volatile than able, thus it is uncertain whether trade exacer- international market prices. Huang (1998) dem- bates total supply volatility. However, wheat trade onstrated that domestic prices of all three ma- dampens production fluctuations as additional jor cereals have been more volatile than supplies can be rapidly imported if needed. An Table 6.2: Grain Price, Production, and Supply Volatility (1990-97) Wheat Rice Corn S CV S CV S CV Domestic Market Price 'a 29.4 0.18 54.2 0.20 26.3 0.19 International Price /a 21.2 0.15 30.6 0.12 19.7 0.18 Domestic Production /b 5.9 0.055 8.5 0.046 8.7 0.091 Domestic Production + Net Trade/h 4.6 0.040 8.7 0.046 13.2 0.132 /a Monthly data S = Standard Error of Estimate /b Annual data CV Coefficient of Variation 48 . . .. . . Chapter 6: International Trade and Foreign Capital Flows argument could be made that corn supply, which food and consumer-ready products are first is harvested late in the year, is a function of the imported into Hong Kong and then re-exported previous year's harvest and the current year's to mainland China. Hong Kong officially re-ex- net trade. However, lagged production does not ports about 55 percent of its agricultural im- dampen fluctuations as the estimated standard ports. In addition to recorded shipments from error is similar to that for production. Hong Kong to China, a large unofficial trade During the early and mid- 1990s a number exists (USTR 1998; Wong 1998). Estimating the of futures markets, including grains, were es- dollar value of undocumented agricultural ex- tablished in China. While designed to facilitate ports from Hong Kong to China is difficult, but price hedging between suppliers, users, and trad- it could exceed $1 billion per year. Undocu- ing companies, trading was "thin" and the mar- mented shipments of fresh fruit into mainland kets were considered speculative, subsequently, China may account for up to 70 percent of Hong government closed or consolidated several fu- Kong's fruit imports (Wong 1998). tures markets. However, global commodity Also, the value of official re-exports from Hong markets and market liberalization permit short Kong to China tend to be underreported. Wong term supply and price risks to be managed (1998) reports that more than 50 percent of Hong (hedged) through commodity derivatives mar- Kong's agricultural product re-exports to China kets (futures and options). Futures hedging is had unit costs that averaged 6.2 percent less an efficient management tool when annual im- than their import value. Alternatively the ex- ports are required to meet consumption require- port-import margins for agricultural products ments but inappropriate as insurance for re-exported from Hong Kong to non-China des- possible imports. China's deficit wheat position tinations show that agricultural products im- is partially hedged in international futures ported into Hong Kong from non-China sources markets. This is relatively easy given that in- and re-exported to non-China destinations have ternational futures markets, such as the Chi- an average margin of 15.3 percent. Positive cago Board of Exchange, isveryliquid, and China margins for re-exports to non-China markets is an annual net importer of wheat-thus a and negative margins for re-exports to China, minimal amount can always be hedged. Simi- strongly suggest that the value of agricultural larly, as long as China remains a net corn ex- product exports to China is underrecorded. porter, a minimal amount of the exports could be hedged. It is much more difficult, however, Conclusions and Recommendations to manage price risk for uncertain quantities of The government largely monopolizes inter- imports and exports, because if a hedged posi- national trade in bulky strategic agricultural tion is not fulfilled, significant sums could be products (cereals, vegetable oils, cotton) and lost (or gained). It is important to realize, how- determines annual import and export grain ever, that reliance on the international market quotas; but with little transparency regarding for annual requirements usually will be less either the quantity or value of the quotas. Im- costly than attempting to store or carryover large port tariffs have little practical meaning because stocks. Futures options are relatively inexpen- numerous nontariff barriers exist. In addition, sive theoretical alternatives, but market trans- import quotas are subject to alternative tariff actions in these instruments are too few to be a schedules. viable option for China given the magnitude of As China liberalizes the trade regime, con- year-to-year fluctuations in imports. sistent with joining WTO, a continuing shift in the pattern of trade will be generated. However, Undocumented Imports it remains uncertain whether China would re- China tends to import bulk agricultural com- main a near-term, net agricultural exporter and modities directly, but a large share of processed . .I . I. . 49 Accelerating China's Rural Transformation gradually increase grain and other bulk imports take of new production opportunities. In an (Wang 1997) or if producers would meet rising open economy, grain prices would almost demand by shifting supply functions through certainly decline, according to recent analy- increased investments in agricultural research, ses by the Center for Chinese Agricultural irrigation, and other productivity-enhancing Policy (CCAP). Thus, grain farmers would activities (Huang, Rozelle, and Rosegrant forth- suffer income losses, but consumers would coming). gain, as would those producers able to pro- We recommend the following changes in trade duce higher-value specialty commodities for policy to help improve the rural sector: both domestic and export markets. The im- * Promote trade competition. Even if China pact on subsistence farmers in poor areas maintains a closed trade policy, competition would depend upon whether they were net will increase efficiency, transparency and the producers or consumers of grain. effectiveness of trade policy. * Phase out state trading. Even if China removes * Permit the market to have a greater role in explicit nontariff barriers, a monopoly state determining trade patterns to reap compara- trading firm could unilaterally block trade tive advantage gains. This would probably despite rules and regulations. Even if trade mean increased overall agricultural trade and, remains subject to quantitative controls, more in addition, a shift toward importing more competition would generate competitive effi- land-intensive agricultural products (grains, ciencies. oilseeds, and cotton) and exporting more la- * Design an effective set of release rules for bor-intensive agricultural products (fruits, grain stocks and coordinate releases of buffer vegetables, livestock and aquatic products). stock with imports and exports and main- To achieve comparative advantage gains, tain smaller grain reserves at a reduced cost. China's trade regime must be more open and Tens of millions of tons of grain stocks main- might involve removing implicit taxes on farm- tained at costs of tens of billions of yuan have ers, reducing perverse trading incentives for been unable to stabilize grain prices because state trading agencies, and making the state of conflicting incentives, unclear control trading agencies more transparent and more rights, and poorly defined release rules and accountable to market discipline. management practices. China has created a * Change the grain self-sufficiency policy. The system of granaries that is extremely expen- 95 percent grain self-sufficiency goal is in- sive and is not contributing to stable prices. consistent with an open-trade policy. A con- * Enact WIO accession related agriculturalpoli- tinuing policy commitment to (near) grain cies promptly. Some of the benefits of HWTO self-sufficiency means large inflows of grain accrue through reform of various trade in- will not be permitted even if China opens its stitutions, structures, and policies, therefore borders to (otherwise) free agricultural trade, waiting for WTO accession to implement the If this policy is pursued through future grain reforms merely delays receipt of the benefits. price subsidies, it could be achieved only by Also, China will be deprived of several agri- closing the border to less expensive foreign cultural policy instruments afterjoiningWTO, cereals-beyond the 5 percent import quota. thus the transformation to a more compara- * In liberalizing trade, assess the welfare im- tive advantage and market oriented produc- pacts, and measures required to cushion any tion structure should be initiated while all adverse impact on portions of the rural popu- policy instruments remain available to mod- lation who are at risk and less able to par- erate any negative transitional income effects. 50 Chapter 6: International Trade and Foreign Capital Flows Figure 6.3: Actual Capital Flows flow in 1996 ($54.8 billion). Contracted capital was $81.6 billion in 1996, but declined precipi- (US$ billion) 70 tously to 851 billion in 1997. 60 Globally, most foreign direct investment oc- 5o Total curs between Organization for Economic Coop- eration and Development (OECD) countries 40 (UNCTAD 1997). Eighty percent of capital out- 3o Fflow from OECD countries is to other OECD 20 countries, primarily for acquisition of existing 10 Loans manufacturing and service enterprises. Only 0. 1 o percent of FDI outflow from OECD countries is 1990 1991 1992 1993 1994 1995 1996 1997 directly for agriculture-although a portion of the manufacturing FDI involves agricultural B. Capital and Technology Flows inputs and processing. The United States receives the largest vol- An important factor in China's rapid eco- ume of FDI. However, 85 to 90 percent of the nomic and employment growth has been the inflow also is for acquisitions and mergers, investment provided by external capital inflow making the principal effect an ownership change, over recent years. Actual capital inflow has in- which often creates scale efficiency at the cost creased continuously during the 1990s (Figure of minor employment reductions. In contrast, 6.3), although, by 1997 inflow commitments China is the recipient of the largest FDI inflows (loans signed and FDI agreed) declined by 50 for new investments and expanding existing en- percent from the high of $123 billion in 1993. terprises. The source of FDI inflow also is unique, The large inflows of FDI since 1993 has been as much of it originates with the relatively the primary source of increased capital as lend- wealthy Chinese diaspora, scattered worldwide ing volumes have increased only marginally. In but concentrated in Southeast Asia. Total con- addition to providing capital, FDI has performed tracted inflows and actual utilization since 1992 an important role in transferring new technolo- have totaled $417 billion and $151 billion, re- gies and management approaches to the spectively. However the FDI inflow is somewhat economy as a whole-in many cases contribut- overstated. A portion of the inflows (estimated ing elements that otherwise would have con- at 25 percent, Harrold and Lall 1993) repre- strained growth. Understanding the role of FDI sents recycled funds-funds that originate in in China's economic growth, the policy envi- China, which are sent offshore (primarily Hong ronment that encourages and discourages ag- -___ riculturalinvestment,andtherecordthatChina Figure 6.4: FDI Inflow as Percent of has built in importing technologies from inter- Gross Fixed Capital Formation, '91-95 national sources are important in designing more effective policies to facilitate increased inflows Mexico Argentina of more advanced agricultural investment and Thailand technology and accelerate rural economic and Philippines income growth. Malaysia Indonesi. India Global Foreign Direct Investment Chino and China 0 5 10 15 20 25 Percent In 1992, however, FDI in China exceeded loans. During the 1990s FDI quadrupled, com- Source: United Nations Conference on Trade and prising three-fourths of the actual capital in- Development, World Investment Report, 1997. ..... 51 Accelerating China's Rural Transformation Kong) and return to China as FDI inflow. Such terprises is 33 and 17 percent, respectively. recycled funds enjoy preferential policies un- However, various tax and tariff incentives ap- available to domestic investors. In addition, ply to FDI. Beyond the standard set of incen- about 70 percent of the inflows are "in-kind" tives, income taxes for firms engaged in equipment and technology, which is often over- agriculture are reduced by 10 to 30 percent for valued.5 an additional 10 years. While total FDI inflow into China is mas- Copyright, patent, and other intellectual sive, the magnitude is similar to several other property right (IPR) protections have developed countries when measured relatively. During slowly. The patent law became effective only in 1991-95 (when comparable data are available 1985 but did not apply to chemicals and phar- for other countries), inflows averaged 16 per- maceuticals until 1993. Plant-variety protection cent of capital formation, somewhat less than became available with passage of the plant Malaysia and Argentina. (Figure 6.4). (Singapore breeder's rights law in 1997. and Hong Kong were omitted because of their unique characteristics as financial centers with Constraints to Inflows large capital inflows and outflows.) However, Despite improvements to the investment preliminary data for 1997 indicate that FDI in- environment, many barriers exist to the fur- flows represented 25 percent of China's gross ther inflows of agricultural technology through fixed capital formation. By other measures, transfer or investment. Extensive interviews with China ranks even lower: inflow stock represented corporate officials of transnational corporations 18 percent of GDP in 1995-and inflow stock involved with agricultural input manufactur- per capita, at S106, is the smallest in East Asia, ing or commodity processing investments in except for $100 per capita in the Philippines. China, identified four common frustrations China has modest FDI outflows for the acquisi- which restrains them from investing more funds tion of modem and proprietary technology in and transferring additional new technologies: nonagricultural industries. * Foreign investment policy is not transpar- ent, which is manifest in frequent policy FDI Regulatory Reform and the Tax changes. Environment * The extensive regulatory environment requires China's FDI policy, has evolved gradually and multiple negotiations as national regulations methodically. Following adoption of the "Open apply only if the foreign investment exceeds Door Policy" in late 1978 and the issue of the 830 million. Otherwise negotiations must be Equity Joint Venture Law in 1979, China opened held with officials in each province where four Special Economic Zones (SEZs) for FDI. products are to be sold. Conversely, it may This was followed by expanding the SEZ con- be easier to satisly provincial than national cept to 14 coastal cities and Hainan Island in regulations, resulting in several small invest- 1984, to three development triangles in 1985, ments that might be less efficient than one the entire coastal area in 1988, and all provin- large investment. cial capitals (except two) and major Yangtze cit- * The weak enforcement of IPRs is a major con- ies in 1992. Foreign investment regulations cern for corporations with copyable technolo- classify investments into categories of "encour- gies. Transnational corporations that can aged," "permitted," and "restricted"-in addition prevent technology loss by technical means to a "prohibited" category that describes char- do so; but agrochemicals are widely reported acteristics of activities in which foreign invest- to be reverse-engineered, except when the ments are disallowed (rather than identifying active ingredients are very complex molecules. specific industrial subsectors). The business * Even when technology can be protected and income tax and VAT that apply to domestic en- when market demand is high, fragmented 52 Chapter 6: International Trade and Foreign Capital Flows retailing and wholesaling networks reduce than its share of GVAO market penetration. Some of these constraints The past policy environment, unfortunately, are a function of poor physical infrastruc- has not provided equal opportunity or encour- ture. Other constraints are regulatory which agement for all to invest in agriculture. The early protect the domestic service sector from in- restrictions on FDI location, and subsequent ternational competition. liberalization, made policy the primary deter- minant of investment location. An econometric FDI in China's Agricultural Sector analysis of agriculture FDI confirmed the im- The natural incentives for FDI in China, are portance of policy and supported the conclu- (a) a large domestic market and (b) a labor sur- sion of other studies that the level of accumulated plus economy. The government typically struc- FDI stock greatly influences current inflows (Petri tures foreign investments to be labor-intensive 1995; Dobson 1993). Thus, official policy con- and about 60 percent of China's FDI inflows centrated investments along the coast in the have been in labor-intensive manufacturing 1980s and the investment accumulation con- activities. This helps create nonagricultural tinued to attract FDI in the 1990s. As late as employment and contributes to income growth 1996, some 85 percent of agricultural FDI in- generally, but does not address modernization flows were into the coastal provinces plus Beijing of the agricultural sector. and Hebei. Other important location determi- Given the smallholder nature of China's nants were transport intensity, urban popula- agricultural economy, agricultural FDI would tion (market size), and the real wage rate. be expected to be modest. Indeed, "projects that use up large tracts of farmland, that are not FDI in Agriculturally Related beneficial to the protection and development of Manufacturing land resources, ..." are prohibited (MOFTEC Regulatory, IPR, and marketing constraints 1998). Agricultural FDI inflows accounted for have been important factors in keeping the in- only 1.3 percent of the actual FDI inflows dur- flow of FDI for agricultural manufacturing rela- ing the 1990s, and were concentrated in labor- tively small-even more than direct investment intensive (horticultural crops, poultry and in crop and livestock production has. Accumu- aquatic) production (Table 6.3). The largest in- lated FDI inflows for agriculturally related manu- vestments were for crop production-but were facturing, over the 1987-96 decade were $6.0 below the crop share of gross value of agricul- billion representing only a fraction of aggregate tural output (GVAO); forestry received 15 per- FDI. cent of the investment-considerably greater Investments in agricultural inputs-includ- Table 6.3: Agricultural Subsector Distribution of Contracted FDI Inflows (1994-96) F DI Inflow GVAO Subsector $ million Percent Share Percent Share Crop Farming 1,211.9 33 58 Forestry 534.2 15 4 Livestock 845.8 23 30 Fisheries 906.5 25 8 Agricultural Services 160.2 4 Total 3,658.6 100 100 Source: Ministry of Foreign Trade and Economic Cooperaion (unpublished materials). .1 . I . I . I I I I I _ . 5 I . I . I - I 1 53 Accelerating China's Rural Transformation for only 3.0 percent of China's agricultural in- put sales. Marketing problems plague compa- nies that try to distribute their products in China's vast geographic market, in part because of wholesaling restrictions, vague rules, and poorly enforced IPR measures. The distribution of agricultural manufactur- ing FDI is shown in Table 6.4. As table 6.5 indicates, technology-intensive investments represent only 2.5 percent of agri- A modern cotton spinning mill near Shanghai cultural manufacturing FDI. ing fertilizer, pesticides (and other agrochemi- FDI and Agricultural Modernization cals), seeds, and agricultural machinery-have FDI assisted in modernizing the poultry in- substantial modernizing potential for the agri- dustry by importing grandparent genetic stock culture sector. Although China lists all of these and breeding parent genetic materials domes- inputs in the "encouraged" category (except for tically. The introduction of superior nutrition seeds of grain, vegetable oils, and cotton which feed milling and mixing paralleled the develop- are restricted), investments remain exceedingly ment of the poultry genetics. Also, almost all of small-$195 million (in 1995)-and accounted the plant breeding and screening research by Table 6.4: Financial Indicators of Agriculturally Related Foreign-Financed Enterprises, 1995 (Billion yuan) Subsector Total FDI Total Assets Total Sales Agricultural Inputs 1.58 5.55 4.64 Fertilizer 0.58 1.57 1.28 Pesticides 0.38 1.55 1.33 Veterinary Medicines 0.16 0.71 0.61 Agricultural Machinery 0.46 1.72 1.42 Agricultural Processing 38.71 150.89 128.24 Food Processing 12.00 54.85 60.58 Food Manufacturing 12.18 39.51 28.33 Beverage 11.58 44.04 28.50 Tobacco 0.20 1.20 0.56 Fiber Processing 0.80 2.65 1.61 Leather Processing 1.47 7.91 7.76 Timber Processing 0.63 1.42 0.90 Total 40.29 156.44 132.88 Note: These data may not capture all agricultural manufacturing FDI as some agrochemical and agricultural equipment may be manufactured by enterprises that are primarily involved in producing other mechanical equipment and nonagricultural chemicals. Source: Office of the Third National Industrial Census, Data of the Third National Industrial Census of the People's Republic of China: State-Owned, Foreign-Funded and Township and Village Enterprises, Zhongguo Tong i Chubanshe, Beijing, 1997. 54 Chapter 6: International Trade and Foreign Capital Flows Table 6.5: Distribution of Foreign-Financed Enterprises in Agriculturally Related Manufacturing, by Factor Intensity, 1995 (Percent) FDI Total Assets Sales Value Labor-Intensive 66.9 67.7 74.6 Capital-Intensive ' 30.5 29.8 22.8 Technology-Intensive 2.5 2.5 2.5 Total 100.0 100.0 100.0 /a Includes food processing. food manufacturing, natural fiber processing, leather and feather processing, and timber processing. /b Includes beverage manufacturing, tobacco processing and fertilizer manufacturing. /c Includes pesticide, veterinary pharmaceuticals, and agricultural machinery. Source: Office of the Third National Industrial Census, "Data of the Third National Industrial Census of the People's Republic of China; State-Owned, Foreign-Funded and Township and Village Enterprises," Zhongguo Tongii Chubanshe, Beijing 1997. foreign-financed enterprises has been on hy- foreign capital than FDI. Agricultural ODA is brids (corn, sunflower, sorghum, and rice) be- overwhelmingly sourced from multilateral agen- cause hybrid varieties are difficult to copy. As cies (80 percent), with about 20 percent pro- long as the confidentiality of the hybrid parents vided by bilaterals and a very small amount from is maintained, the IPRs are technically protected. NGOs. A recent evaluation of ODA determined In the agrochemical sector the pesticides that that $8.28 billion was granted or loaned to the allegedly have not been reverse engineered are rural-agricultural sector during the period 1994- those whose active ingredients are complex 97 (UNDP 1998): more than double the $3.66 molecules which are difficult to copy. Others, billion FDI inflow (1994-96). Loans, primarily despite official agreements, are allegedly copied from the World Bank and secondarily from the and sold without any compensation to the in- Asian Development Bank, comprise about 90 ventors. Although the legal environment pro- percent of the assistance with the balance pro- vides adequate protection for IPR, enforcement vided in the form of grants-primarily from UNDP remains weak. The current effort by Monsanto and WFP. to market its Bt variety of cottonseed will be Nearly all ODA is tied to projects, some of closely watched-if the seeds become widely which are national in scope and cannot be allo- available from non-Monsanto sources, other cated to any particular region. However, the high-technology and biotechnology firms will be Eastern, Central, and Western regions equally reluctant to invest in China. share ODA grants for nonnational projects; ODA loans have been primarily to the Central region Loans (50 percent), followed by the Western region (30 Nationally, loans were the most important percent) and the Eastern region (20 percent). element of foreign capital flows until replaced These distribution patterns contrast sharply with by FDI in 1992. These loans are largely sourced FDI inflows which have been invested over- from bilateral (50 percent) and multilateral (30 whelmingly in the Eastern Region (85 percent). percent) agencies, with only 20 percent coming The immediate impact of ODA is increased bud- from commercial sources-primarily to finance getary support for rural infrastructure and ser- exports. However, for the agricultural sector, vice investments (including on-farm overseas development assistance (ODA), loans investments), which will lead to increased rural and grants, remain a more important source of incomes. To the extent that many projects have I . . I . . . . . I . . I . I . I 1 I . I .I I .I . .I I . 55 Accelerating China's Rural Transformation Table 6.6: ODA Allocations by Subsector (Million dollars) Subsector Amount Percent Integrated Agricultural Development 2,773 33.5 Water Resources 1,608 19.5 Support Services 1,196 14.5 Agricultural Inputs 1,053 12.7 Forestry 802 9.7 Livestock 265 3.2 Crops 127 1.5 Fisheries 86 1.0 Other 366 4.4 Total 8,276 100.0 Source: UNDP China Agriculture and Food Security Resource Book: A Compendium of Donor Activities (1994-1997), Beijing, 1998. research and technology transfer components nology, either (a) FDI must be attracted into the (either domestic extension or international trans- input industry, (b) agricultural technology im- fer), longer term productivity and income im- ports must be unrestricted, or (c) domestic re- pacts will be generated. Integrated agricultural search on modern agricultural technology must development projects were the largest recipient be intensified. of donor assistance, followed by water resource The following policy initiatives would improve management and development and support the investment environment and provide incen- services (Table 6.6). tives for renewed investment in agricultural input The World Bank provided about 70 percent manufacturing and contribute to agricultural of ODA resources over the 1994-97 period, but modernization: with the phasing out of soft loans between 1997 * Design incentives to stimulate investment in and 1999 World Bank assistance to China di- those activities of priority interest. Include minished by about 45 percent. Thus, it is un- agricultural modernization as an FDI objec- certain whether ODA will continue to provide tive and actively solicit multinational invest- robust support; however. ODA comprises a rela- ment in modern crop and livestock genetics tively small portion of rural investment support and biotechnology, pesticides and other agro- and its decline is unlikely to seriously impact chemicals, and sophisticated farm machin- on rural growth. ery. * Attract investment into the country's chemical Conclusions and Recommendations fertilizer industry. The technology of modern Given the fiscal constraints facing agricul- high-analysis fertilizer manufacture is well tural research and technology transfer, FDI in known, but capital requirements are high. agricultural inputs could become much more The existing FDI stock in fertilizer manufac- important for modernizing China's agriculture. ture of about $70 million is trivial relative to Although FDI tax policy is favorable to agricul- the $350 to $600 million required for a single ture, it has been an insufficient incentive to modern scale-efficient urea or diammonium attract significant investment in agricultural phosphate plant (500,000 tons of elemental inputs. nutrients). Increased FDI in nitrogen and If China's farmers are to have ready access phosphate plants would introduce known to the latest and most modern production tech- technology and needed management skills 56. . . . . . .. . . . . . . . . Chapter 6: International Trade and Foreign Capital Flows and reduce fertilizer import requirements. If * Liberalize domestic marketing constraints. The international firms were involved in raw current requirement that Chinese partners material (phosphate rock) mining, fertilizer must have a majority share in domestic manufacture and blending, and were per- marketing enterprises makes transnational mitted to market directly to farmers, they firms reluctant to manufacture high-tech- also would be prepared to invest in technol- nology products, as they are unable to con- ogy transfer service centers6 (e.g., soil test- trol their distribution. Firms that ing laboratories). manufacture agricultural inputs need the op- * Have strict and publicized enforcement oflPR portunity to market their products directly protectionforagrochemicals, veterinary phar- to farmers. Also, market competition would maceuticals, plant and animal genetics and improve distribution efficiency. biotechnology, and other agricultural technolo- * Improve the transparency of the FDI regime. gies to reassure investors that theft of propri- Taxation, the application of import tariffs, etary technology would not be tolerated. The and foreign exchange rules are adequately legal framework is in place but its enforce- defined. However, application and approval ment remains uncertain. procedures are complex requiring separate * Eliminate the 'joint ventures with majority negotiations with officials in each province Chinese ownership" restriction onFDIforgrain, in which investment and operation is pro- oilseed and cottonseed development. This re- posed. There is also a problem of China's striction has hindered investment and tech- changing the rules after investments have nology transfer into these activities, and been made-while this may be necessary for disallowed Chinese farmers from enjoying the equity or other reasons, a provision for most modern, internationally developed seed "grandfathering" the foreign enterprises over varieties. an adjustment period is needed. These trade balance data are based on China's Customs Statistics, and are on a calendar year basis. They do not account for undocumented trade between Hong Kong and China. The data must be interpreted carefully be- cause of alternative definitions of agricultural trade, which may or may not include certain seafood and lumber products. This paper follows the USDA classification system but includes aquatic products as agricultural. The Food and Agricultural Organization of the United Nations (FAO) includes more commodities in their definition of agricultural trade and thus the FAO's value of agricultural exports and imports exceeds that reported by the USDA. In computing the average binding rates for 2004, the 1994-96 import values were used as weights. 3 Islam, Nurul (ed.), Population and Food in the Early Twenty-First Century: Meeting Future Food Demand of an Increosing Population. International Food Policy Research Institute, Washington, DC, 1995. 4 As different exchange rates applied to certain traded commodities during the early 1990s, computing an accu- rate "average" exchange rate is difficult and could introduce a distortion in these data for international compari- sons. In 1994, an investigation by the State Administration for Import and Export Inspection revealed that the actual value of equipment in 5,500 FDI Projects was 19 percent below contractual commitments. UNCTAD, Division of Transnational Corporations and Investment; World Investment Report 1995, Transnational Corporations and Competitiveness, United Nations, Geneva, 1995. 6 From discussions with planning and international sales staff of transnational fertilizer corporations. I . I I I I . I . I . I I . I I I . I- - ~ . 57 Part III Managing Rural Development 7. Cultivated Land Introduction off-farm, or whose off-farm jobs have been ter- Land ownership-or the possession of key minated. land-use rights-provides rural households Rural reforms and the introduction of the several benefits. Long-term tenure security, and Household Responsibility System (HRS) in the freedom from the arbitrary loss of these rights early 1980s radically altered the organization without compensation, is critical to providing of agricultural production and the incentives incentives for long-term investment and land facing rural households. With the extension of maintenance. Transfer or rental rights play a land-use rights and residual income rights to similar role and can be instrumental in pro- households, agriculture production shifted from moting efficient land allocation across house- a collective- to a family-based farming system, holds. By providing small farmers with a form but land was not privatized. Ownership remains of collateral, secure and well-defined land rights "collective," and local governments either con- also can help the development of rural credit trol or influence household land use and land markets. Land also serves as an important decisions. source of food security and social insurance and The initial rural reforms triggered an un- can help absorb family members unable to work precedented acceleration of agricultural growth Accelerating China's Rural Transformation in China. Empirical studies (McMillan etal. 1989; reportedly do not support it, and it is not on the Lin 1992; Huang and Rozelle 1996) attribute government's policy agenda of any group. More- approximately half of this increase to the in- over, China lacks the ancillary institutions (credit centive effects associated with better residual markets, land registration, and legal system) income rights. Following reduced growth after that could make land privatization successful. 1984, attention has increasingly focused on the land management system, the dimension of the Management, Forms of Land Tenure, farm economy that has been probably least al- and Property Rights tered since the initial reforms. Poor incentives Five major forms of land tenure are sanc- related to tenure insecurity, for example, are tioned by the national government. These ten- thought to have discouraged investment in ag- ure forms and their share of household tenured riculture, slowing productivity and economic areas are: (a) responsibility land-79.4 percent, growth. However, other factors also negatively (b) ration land-8.3 percent, (c) contract land- affect agricultural productivity. 5.5 percent, (d) private plots-5.7 percent, and The consequences of changing institutional (e) reclaimed land-1.1 percent. Responsibility arrangements governing cultivated land use are land, comprising more than three-quarters of potentially enormous. The debate on land policy the cultivated land, typically has a commodity suffers from a number of weaknesses, princi- delivery quota assigned and faces the possibil- pally the lack of an enumeration of basic facts ity of reallocation to other village households. about domestic land tenure as they have evolved These tenure forms, in turn, are packaged into over recent years. Empirical work on the deter- several types of land tenure systems, including minants of land rights and their effect on house- the two-field system (combined responsibility hold behavior and the farm sector is minimal, and ration land), and three-field system (adds thus few data exist to support the development contract land). of land policies. Although these tenure types differ in terms of household rights and obligations, they pro- Issues of Ownership vide a less than satisfactory way of differentiat- The rural reforms vested ownership rights ing land tenure systems. The residual income with the "collective," which is usually taken to and nonresidual rights that farmers have on mean the village, although ambiguity over own- responsibility land may differ in villages within ership is surfacing in an increasing number of the same region. Therefore, the following dis- areas. In some villages the village group (the cussion disaggregates the tenure forms into their old production team) is recognized defacto as component rights, including security of tenure, the owner of the land. In other villages, how- rental or transfer rights, freedom of crop selec- ever, ownership is with the village (the old pro- tion, and conversion to alternative agricultural duction brigade) and in a small minority of cases, uses. ownership reportedly resides with the township. In most villages, land-use rights are lost (or Ownership disputes have developed between gained) through village-wide reallocations (land village groups and villages, particularly where transfers among farm households initiated by land is to be converted to nonagricultural uses the village leadership). Tenure security, thus, is with a high commercial value. Nevertheless, the inversely related to the frequency of realloca- collective "owns" the land rights and the inter- tions. Survey data for 215 randomly selected nal debate focuses on how to construct a new villages in eight provinces show that the aver- set of rights on collective land. Legal privatization age number of reallocations per village since (as opposed to de facto privatization through the implementation of HRS in the early 1980s extended tenure, rental, and inheritance rights) is 1.7 (Brandt 1998). In 60 of the sample vil- is not a policy issue. The majority of farmers lages, however, land had not been reallocated 60 Chapter 7: Cultivated Land percent of gross output, and typically cannot be fulfilled in cash. Cotton quotas in parts of Hebei and Shandong appear to have similar effects. Household autonomy to convert culti- vated land to alternative agriculture uses (e.g., constructing a greenhouse or fishpond, convert- ing dry land to paddy) also is restricted. More than half of all villages report such restrictions. Although broad land policy is determined by the central government, the differences in Stocking rates on low rainfall grasslands must property rights across counties, townships, and be managed carefully to avoid degradation. villages indicate that the real locus of land-use decision making is the village (Li 1998). In fact, since HRS. The magnitude of reallocations also China's Organization Law of the Village Com- differs from community to community but on mittee vests village leaders and government with average entails about 50 percent of a village's legal authority over land rights.I The transfer of cultivated land and affects about 65 percent of decision-making power from the central to lo- households. For the entire sample, slightly more cal and village authorities is so extensive that than half of all cultivated land has been reallo- China is arguably now one of Asia's most de- cated at least once during the reform period. centralized countries (Liu, Yao, and Carter 1998). Nearly 70 percent of surveyed villages re- port that households are free to transfer their Land Reallocation use rights to other households. In the remain- Empirical literature has identified a num- ing 30 percent, constraints on transfers most ber of factors that appear to affect village real- often take the form of restrictions on renting to location policy. With the introduction of the HRS, nonvillagers and the need to obtain prior au- land was typically allocated to households in a thorization from village leaders. The transfer of fairly egalitarian way on the basis of family size, land-use rights among households is typically demographic composition, and labor supply short term, and entails the payment of a fee (Putterman 1993). Land reallocations help main- and the assumption of tax and quota liability in tain equal access to land as household-level return for use of the land. Despite the high per- demographics change. As new households are centage of villages reporting unconstrained formed, and depending upon nonagricultural transfer rights, the percentage of land rented in employment opportunities, household income China is low. In 1995, more than three-quar- disparities are created that are contrary to the ters of the surveyed villages reported some rental, village's original egalitarian distribution of land. but the rental market is thin, representing about These disparities create pressure to redistrib- 3 percent of the land area; most transactions ute use rights to maintain minimum consump- are between relatives. Thus, most interhousehold tion levels. Also, land reallocations help eliminate transfers occur administratively rather than inefficiency caused by demographic and labor through land rental markets. supply changes and poorly functioning labor In three-fourths of villages, households are and land rental markets (Turner, Brandt, and reportedly free to decide crop mix. This statistic Rozelle 1998). should be interpreted carefully, however, as Leaders in some affluent suburban villages constraints on crop choice need not be explicit. may be using their positions to extract rents Quotas and limited freedom to convert quotas through periodic land readjustments and land into cash also may affect crop choice. In Liaoning, sales to nonagricultural, nonvillage interests for example, grain quotas average about 25 (Johnson 1995). In other locations, direct rent I I . . I I I I I . Z I I 1 1 I 1 1 I I . I I I II61 Accelerating China's Rural Transformation seeking from land is less common, as nonvillage of the important aspects used tojustify the cur- demand is minimal and only a small propor- rent system. tion of farmers actually pay cash for use rights. More commonly, village leaders use their con- Land Allocation and Equity trol over land to ensure state interests are pro- Analyses of household-level data support the tected and state policies (i.e., taxes and quota view that land in many villages originally was fulfillment) are implemented. This can be allocated on the basis of family size, possibly achieved by threatening land expropriation from adjusted for demographic composition (Burgess households that do not meet policy obligations 1998). Universal and egalitarian access to land and by rewarding farmers who do with addi- increased calorie consumption in an economy tional land. (Rozelle 1994; Li and Rozelle 1997). characterized by uncertain food markets with Alternatively, land may be reallocated from high transaction costs. However, more recent farmer households with high off-farm earnings reallocations appear to be fine tuning ratios of who find agriculture relatively unprofitable land to labor to reflect household participation (Turner, Brandt, and Rozelle 1998). These ac- in off-farm labor markets. In many villages, tions also are self-promoting-if policy obliga- households with family members working off- tions are met, the village leaders may be farm receive less land per capita. In a few vil- promoted, gain status within the cadre com- lages with extreme labor shortages, leaders are munity, or receive other benefits. consolidating land into larger farms that, in turn, Tenure security, and other property rights, are often major beneficiaries of subsidies for are the outcome of a complicated interaction expenditures on current and capital inputs. If among the interests of the state, villagers, and these land allocation patterns are typical of vil- village leaders-interactions that need to be lages throughout the country, and if such trends better understood before conclusions can be continue, the original, purely equity-based, cri- derived. The infrequency of land reallocation teria may be giving way to an effort to make (averaging every six years in villages which have allocations more efficient. reallocated land) and differences in the amount With constrained rental markets, the only of land involved suggests that transaction costs way significant household land reallocation can are important in explaining reallocation behav- occur is by administrative decree, which can be ior. These costs include the direct cost of con- viewed as a market substitute. However, high ducting the reallocation, and the indirect costs information and implementation costs make of agricultural disruption and the potential im- "fine-tuning" reallocations less efficient than pact on investment behavior (i.e., tenure inse- well-functioning rental or sales markets. An curity costs). Impact of China's Land Management System Empirical work on property-right formation and its effects is quite limited and is inadequate for policy formulation. That undertaken has focused on three key dimensions of the impact of village land policy: (a) land allocation deci- sion rules, (b) impacts on static efficiency, and (c) impacts on dynamic efficiency. Unfortunately, no available work rigorously examines how land To control erosion and conserve limited rainfall rights affect income distribution, poverty alle- on the Loess Plateau, the land is terraced before viation, or provision of social insurance-three planting either annual or tree crops. 62 Chapter 7: Cultivated Land analysis of household data for 1994 for villages resource intensities and improve short-term in Hebei and Liaoning found that despite ef- allocative efficiency, but it may undermine se- forts to shift land among households, land dis- curity of tenure, thereby reducing investment tribution across households is still inefficient incentives and long-term efficiency. This illus- (Benjamin and Brandt 1998). Better access to trates the dichotomy between market and ad- off-farm opportunities and reallocations that ministrative allocations: rental transactions in redistribute land from the land rich to the land a well-functioning market would not undermine poor attenuate but does not eliminate these tenure security or lead to decreased investment. losses. This dichotomy highlights the importance of The impact of tenure insecurity on invest- understanding why rental-market transactions ment behavior is behind recent calls to extend are so few. If rental markets could be made to tenure to 30 years, but estimates of these dy- operate effectively, they might be able to replace namic incentive effects are limited. A recent leader-implemented land reallocations without analysis using household data from Hebei found the adverse incentive effects. Potential reasons that households apply more fertilizer and labor why rental may not exist, however, include (a) to their private plots that are more secure and ideological or moral restrictions on land rental, to plots they have farmed for longer periods, [b) problems of contract enforcement, (c) "use it receiving higher yields (Guo, Rozelle, and Brandt or lose it" rules that discourage rental, and (d) 1997). However, the impact of several other village leaders' discouraging rental because it important factors (e.g., size of plot, land quality makes quota fulfillment more costly. distance from plot to homestead) were not econometrically differentiated and yield impacts Conclusions and Recommendations were only minimal. Another analysis of Zhejiang Empirical studies suggest that improved households examines other long-term invest- tenure security would improve household in- ments, (e.g., wells and drainage), finds a simi- vestments and output. However, incremental lar effect, and suggests that a reduction in the productivity is marginal and these studies do frequency of reallocation by half would result not incorporate nontenure options (e.g., village in an output increase of only 5 percent (Carter investments) and factors (e.g., differences in and Yao 1998). climate, geography, and general agroenviron- These results must be interpreted carefully. ment, and increased freedom in crop choice) The studies only show the returns to alterna- that affect productivity, output, income, and tive tenure but do not capture the potential re- welfare. Nevertheless, the recent decision to turns of shifting to an alternative property-rights extend tenure on responsibility land to 30 years regime in which households enjoy more secure is generally perceived to improve farmer incen- tenure and are less constrained in other dimen- tives to invest in land improvements. Although sions. They are, also, geographically narrow, this improves tenure security, the system likely making generalization of the findings difficult. has significant short- and long-term efficiency Because of regional differences in agronomic, costs. The inability to use land as collateral may climatic, and socioeconomic traits, opportuni- be slowing the development of credit markets, ties for long-term investment would be expected as farmers have few other collateralizable as- to differ significantly between localities. The sets. If rental-market barriers are created by analyses ignore village-level investment and its nonsecurity factors, extending security may potential interaction with household investment. increase inefficiency in land allocation as rural Land reallocation that helps equalize land- residents increasingly become employed off- labor ratios between households may give rise farm-or as other demographic changes occur. to an inverse relationship between dynamic and Also, the inability of nonagricultural households static efficiencies. Reallocating land may equate to lease out their land could lower on-farm in- . . I 1 I . . I I I . I I . - I I ; . I I I , 1 . . 63 Accelerating China's Rural Transformation vestments and inhibit agricultural household turn to agriculture. A sharp decline in ur- access to additional land. ban growth, combined with a reduction in China's record for rapid rural growth, sta- local off-farm opportunities, would require bility, and poverty alleviation may-or may not- reabsorbing perhaps tens of millions of un- be linked to its flexible land system. The lack of employed in the rural sector. knowledge on alternative tenure structures * Continue to experiment with rental markets makes undertaking rigorous research on pro- and alternative tenure arrangements to de- ductivity and equity impacts imperative if in- velop someform of marketable land-use right. formed policy judgments are to be made. Given This should also include continuing to as- the uncertainties surrounding land tenure sess income, social insurance, and poverty changes. and before further tenurial reforms alleviation, equity, investment, and short- and are introduced, testing rental markets and al- long-term efficiency. Farmers' apparent pref- ternative land tenure arrangements is impera- erence for village ownership and periodic land tive for careful measurement of impacts on adjustments emphasizes the need to proceed income, equity and social security, investments, cautiously with tenure adjustments. A char- short- and long-term efficiency. acteristic of rural reform has been experi- Within this framework, we make the follow- mentation (often conducted in the Rural ing recommendations: Reform Experimental Zones under the aus- * As an interim strategy, continue to allow vil- pices of the MOA's Research Center for Ru- lage determination ofproperty rights regimes. ral Economy)-successful experiments are Difficulties and differences that exist in prop- adopted widely and those deemed unsuccess- erty rights across villages suggest that this ful are discarded. As rural households be- would be the best strategy for now. However, come more distinctly nonagricultural or the government should consider how to im- agricultural, the latter must have access to prove village governance to eliminate egre- incremental land to maintain income growth gious abuses of local power (such as illegal parity. land sales) and to ensure that the allocation * As land use rights becomes marketable, con- of property rights in land reflect the wishes duct additional modest experimentation to of the local community. develop land-use rights that allow for devel- This kind of local flexibility may be advanta- opment of collateral and to help develop credit geous should the adverse effects of the Asian markets. financial crisis and the ongoing restructur- * Ensure some form of social insurance. The ing in the SOE and collective sectors inten- social security role of arable land is so im- sify in the near term. In earlier portant that China can only ignore it by re- macroeconomic retrenchments, off-farm placing it with some other form of social employment opportunities dried up for many insurance. rural residents and migrants, forcing a re- Article 4, Organization Law of the Village Committee of the People's Republic of China, China's Agricultural Yearbook (Zhongguo Nongye Nianjian) 1988, pp. 459-460. 64 8. Water Resources As the single most important natural re- available) indicate only 518.6 bcm of water was source constraint, water management is cru- used, China would seem to have more than cial to China's continued development in all enough water to meet foreseeable require- sectors. Although additional water is needed for ments-if it were developed (Table 8.1). How- agriculture, future water requirements will in- ever, much of the runoff cannot be economically crease most in the nonagricultural sectors, par- exploited because rainfall and runoff are con- ticularly municipal and industrial uses. Without centrated in 3 or 4 summer months. Also, either more-efficient water use or the develop- China's water resources are maldistributed ment of additional supplies, economic growth spatially, similar to other large countries with could be seriously impaired. multiple agroclimatic zones. The locational im- balance results in southern China (the basins Water Scarcity and Scarcity Allocation south of, and including, the Yangtze river ba- China's renewable water resources consist sin) receiving about 80 percent of the national of 2,711 billion cubic meters (bcm) mean an- runoff, but contain only 36 percent of the culti- nual river runoff (including inflows originating vated land. in other countries, but excluding an average Although irrigation composed two-thirds of outflow of 732 bcm to lower riparian countries) the water consumed (1993), agriculture is a and groundwater resources estimated at 760 residual water user, following allocations for bcm that, generally, are not additional to the municipal, industrial, and rural household uses. renewable water resources because their re- However, many municipal allocations are sup- charge is dependent upon surface water re- ply constrained and fall seriously short of ur- sources. As water balance statistics for 1993 ban requirements and demand. The 343.4 bcm (last year in which water balance statistics are used for irrigation represents about 80 percent Table 8.1: Water Balance and Estimated Water Requirements, 1993, 2000, and 2010 (Billion cubic meters) Industry Urban Rural Irrigation Other Total Households Agriculture 1993 Requirements 83.8 24.1 24.4 424.3 36.5 593.1 Supply/Use 88.9 24.1 23.1 343.4 39.2 518.6 Balance +5.1 0.0 -1.3 -81.0 +2.7 -74.5 Requirements 2000 126.8 50.4 32.4 433.5 32.4 688.4 2010 206.5 79.7 43.1 448.3 56.1 833.7 Note: 1993 precipitation and runoff was assumed to be at 75 percent probability level. Source: Nanjing Institute of Hydrology and Water Resources, Report on the Mid- and Long-Term Plans for Water Demand and Supply, November 1996, as reported in UN-ESCAP, "China: Water Resources and Their Use," 1997. Accelerating China's Rural Transformation of the water requirement for optimum crop yields. statistical references applies to effective irrigated Rural household water use includes consump- area, which encompasses the crop land that is tion by both rural residents and domestic live- leveled and is bunded and connected to a source stock. "Other" agriculture use is primarily for of irrigation. However this area may not neces- aquaculture, but also includes forestry and sarily receive irrigation water. Effective irrigated pastures. Portions of urban and industrial waste- area was estimated at 50.4 million hectares in water are reused, thus sectoral uses are not 1996. Actual irrigated area is the area cultivated totally additive. at least once during the year and receives irri- To inhibit the existing negative water bal- gation water-although not necessarily optimum ance from worsening, water must be appropri- supplies; and stable irrigated area is the area ately priced to encourage greater efficiency in supplied with sufficient water to meet average- water use (for all applications, including indus- year crop requirements. try and irrigation), water delivery systems must China has nine Water Regions, which con- be efficiently operated and maintained, and form to the majorwater basins.' Also, the country conveyance and application efficiency improved. is divided into three irrigation zones, broadly However, improving efficiencies of local schemes based on precipitation patterns and the "irriga- will result in only modest water savings for the tion index" (the percentage of crop water re- entire water basin. This is because most of the quirements that must be met from irrigation) losses from inefficient irrigation schemes return and that cut across the water regions. The irri- to the hydrologic (surface or groundwater) sys- gation zones are defined as follows: tem and are available to downstream users. The * Perennial irrigation zone. Mean annual pre- actual water savings (available for incremental cipitation is 400 mm (15.7 inches) or less use) within a water basin, is only the reduced and the seasonal distribution is generally in- amount of nonbeneficial evapotranspiration and sufficient to meet crop needs. nonbeneficial outflow to the ocean. Actual wa- * Unstable irrigation zone. Mean annual pre- ter savings can be generated only through ag- cipitation is 400 to 1,000 mm (15.7 to 39.3 ronomic and irrigation management measures inches) and includes the major portion of that improve water use efficiency and reduces China's agricultural land. Rain-fed agricul- nonbeneficial evapotranspiration; for example, ture is possible and widespread, but optimal improved crop genetics, plastic and organic yields can be obtained only with ensured ir- mulching, and irrigation scheduling. Given the rigation and drainage. limited ability to improve the water balance * Rice irrigation zone. This zone comprises through improvements in overall irrigation sys- southern and southeastern China, where tem efficiency, developing additional water sup- rainfall is more than 1,000 mm and the cli- plies is important; but undeveloped supplies also mate is highly favorable for agriculture. Two are limited. The Ministry of Water Resources or three crops per year are common. (MWR) has proposed several hundred water de- The irrigation zones and water regions are velopment projects, including water-saving ir- shown in Figure 8.1. rigation technologies, improved irrigation efficiency projects, and new supply development Finance and Management to increase water supplies. To assist in main- Previous work has demonstrated that irri- taining agricultural and rural income growth, gation investments make important contribu- and to address food security needs, the MWR tions to agricultural (crop) growth (World Bank proposes to expand the effective irrigated area 1997; Huang and Rozelle 1997). Water convey- to 53.3 million hectares by 2000 and 58.0 mil- ance is one of the few rural-sector areas where lion hectares by 2010. real investments have increased over the past The term "irrigated area" most quoted in decade; growing at an annual rate of 17 per- 66 Chapter 8: Water Resources Figure 8.1: Water Regions and Irrigation Zones WATSE REGIONS IRRIGATION ZONES Ri-~ ig.to, cent between 1987 and 1996-and exceeding is also responsible for organizing farmer labor Y18 trillion in 1997. Budgetary resources are for maintenance and system expansion and for allocated primarily for new irrigation projects collecting water charges. Groundwater for irri- as the proportion of investments for rehabilita- gation use is largely managed by local govern- tion and expansion of existing schemes has de- ments. clined (Figure 8.2). Water charges to and The government's strategy is to transform collections by farmers, while minimally adequate irrigation management agencies into self-fmanc- for routine operation and maintenance, are in- ing, independent legal entities-a system in- sufficient to cover periodic repairs and reha- creasingly being adopted in other countries. One bilitation of system structures. (Yet farmer of several experimental institutions, the Self- obligations, including corvee labor and water Financing Irrigation and Drainage District, has fees, are substantial.) been successfully piloted for several years and The MWR is responsible for managing it, or similar institutions, will increasingly be China's water resources, but a large part of responsible for holistic water management. The MWR's responsibility is delegated to seven ma- structure comprises a Water Supply Corpora- jor river-valley commissions covering the tion and Water User Associations (WUAs). The Yangtze, Yellow, Huaihe, Haihe, Pearl, Songhua, Water Supply Corporation is for management, and Liaohe rivers and Taihu Lake. Regional- organization, and maintenance of the main ir- level responsibility rests with the Provincial Water rigation system and supply of bulk water. The Resource Bureau, with offices in each prefecture and county, and charged with Figure 8.2: Proportion of Investments in management of the main canals, sys- Water Conservancy, by Type tem improvement programs, and super- 100- vision of the Township Water Management Stations (WMSs)-the lat- rehabilitation 80- ter are responsible for maintenance and management of lower system canals and 60 - gates and, through village staff, for scheduling water and collecting water 40 - charges. At the village level, Water Man- agement Committees (WMCs)-in col- 20 - laboration with the Township WMS and Agricultural Services Station-are re- 0 sponsible for local distribution. The VMC 1987 1989 1991 1993 1995 67 Accelerating China's Rural Transformation WUAs are established by farmer groups for con- percolation saves water for individual schemes, struction, management, and operation and but improves basin efficiency only marginally maintenance of lateral canals and on-farm sys- as percolation and runoff recharges the ground- tems and would purchase the measured vol- water and downstream surface flows. However, ume of water delivered (i.e., at the head of each some agronomic and management efforts would lateral). In the pilot stage WUAs have been highly generate water saving effects. These include crop satisfactory in improving water management genetic research which has the potential to efficiency (reducing water use while increasing save water by creating new drought-tolerant production), rationalizing field channels, and varieties that produce more output using less reshaping plots to facilitate mechanical culti- water input. This will necessarily become an vation. Given the financial constraints and the increasing important research agenda as water accumulated deferred maintenance the trans- becomes increasingly scarce in the north China fer of system responsibility and management to plain and other major agricultural areas. self-ftnancing enterprises should proceed as rap- Land Leveling. Surface irrigation accounts idly as expertise can be developed. for 99 percent of the irrigated area but the plots are still leveled by traditional methods. To make Constraints and their Alleviation efficient use of water, fields must be level; pre- Few options are available to alleviate basin- cision leveling will save water as reduced water wide water shortages; development of new application will reduce evapotranspiration and water supplies, where undeveloped supplies yield per unit of-water applied will increase. Laser exist, is an obvious option. Numerous projects land leveling is a decades-old technology but is are proposed to increase water supplies from relatively new to China. Internationally the cost surface sources. The multipurpose Xiaolangdi of laser leveling is about $300 per hectare or Y and Wanjaizhai projects in the Yellow river ba- 165 per mu (assuming maximum movement of sin will collectively contribute only about 4 bcm 300 cubic meters per hectare) and generally to the annual water supply when completed. produces yield gains of 30 to 50 percent and As the cost of these two projects (excluding re- reduces water application needs by 10 to 25 settlement) is about $3.6 billion (which includes percent. This technique may not be applicable hydropower and other benefits), the magnitude to all areas but should be considered when field of the water supply capacity problem becomes sizes are large enough to efficiently accommo- clear. Certainly, the Three Gorges project will date laser equipment. increase available supplies and stabilize water Plastic Film Mulching. This technique con- resources for a large area. Also, either route of sists of covering the soil with a film to reduce the South-North transfer scheme would bring evaporation. It has developed rapidly and is now about 14 bem per year of abundant Yangtze applied to more than 1.3 million hectares. Re- water to the drier north (Liu 1996). However, markable water-saving and yield-increasing the volume involved would be less than the effects have been achieved, with water efficiency current level of groundwater overexploitation reaching 90 percent. Cotton experiments on in the north and supplies from such transfers plastic film mulching in Xinjiang has achieved would be available only about a decade after water savings of more than 70 percent. initiating the project. Full-Cost and Volumetric Water Charges. Beyond developing new supplies, only invest- The State Council document, Industrial Policies ments which reduce nonbeneficial evapotrans- on Water Conservancy (1997), addressed the piration and nonbeneficial outflows to the ocean, need for appropriate water charges. Water or that improve crop use efficiency actually con- charges for new economic projects are to be set tribute to making additional water available sufficiently high to cover operation and main- system-wide. Investments which reduce water tenance costs, pay taxes, repay loans, and yield 68 Chapter 8: Water Resources rational profits. Water prices on existing schemes Canal Lining and Pipelines. This is the most are to be adjusted upward over a three-year widely adopted water-saving practice. Canal lin- period to conform to the same principles. ing also improves operations. Antiseepage tech- Irrigation-water measurement is steadily niques for canals include linings of stone, increasing, but in most systems the measure- concrete, plastic film, asphalt, and asphalt-felt. ment is undertaken only at major offtakes and The effect of these techniques has produced branches, so farmers effectively pay flat rates. water savings exceeding 50 percent within an Water measurement is only necessary at the individual WUA. Much of the seepage is return lateral canal operated by the WtJA, which buys flow within a basin, thus the sum of individual the water and ensures a balanced allocation to scheme savings would be considerably greater the members. Also, water measurement is es- than actual basin savings. In some northern sential for correct irrigation scheduling to meet provinces, canal networks have been replaced crop requirements system-wide and flatten peak with pipelines, thus preventing seepage and demand periods. evaporation from the distribution network and Demand Management. Cropping patterns permitting the cultivation of land previously used remain determined by a combination of climatic for canals. Low pressure pipeline conveyance conditions, market forces, and government di- systems have developed rapidly in the tubewell rection. The grain quota system continues to irrigation areas. operate and, thus, water charges will not influ- Advanced Irrigation Techniques. These ence the grain area planted. techniques include sprinkler, trickle, and low System Rehabilitation and Improvement. pressure systems; gated pipes; and seepage ir- Many of China's irrigation schemes were con- rigation. They have been introduced and some structed in the 1950s. Several were inadequately equipment is manufactured domestically. Use designed and constructed and were often inad- has yet to become widespread (sprinkler irriga- equately maintained. Consequently, many tion is estimated to cover only 700,000 hect- schemes require rehabilitation and moderniza- ares), except for some medicinal and other high tion not only because of these problems, but value crops. Surgeflow irrigation systems pro- because of natural aging. A 1990 surveybyMWR vides water in a cyclical manner and has the found more than one-half of the structures and effect of reducing surface infiltration. This sys- canals surveyed had deteriorated in varying tem is more complex than conventional gravity degrees and about two-thirds of the deteriorated systems, but would conserve some irrigation infrastructure was due to natural aging (Chen water, as smaller water applications would re- and Ji 1995). Investments in these activities duce nonbeneficial evapotranspiration. would improve irrigation scheme efficiency and Wastewater Reuse. Reusing municipal and perhaps farmer equity, but may not improve industrial wastewater will improve overall wa- basin-wide efficiency significantly. ter efficiency. An estimated 37.3 bcm of mu- dW Lining irrigation canals reduces water percolation losses. . 1 - - - . . .1. N . .1 . . . .. 69 Accelerating China's Rural Transformation nicipal wastewater was produced in 1995, of income data into the water resource regions to which 23.3 bcm was treated. Wastewater con- derive total rural income. We then converted tains considerable quantities of fertilizer nutri- the results to "Income from Agriculture" and ents and thus, if treated, is particularly useful "Income from Crops," firstly by removing the for irrigation; however, careful management is proportion of rural incomes derived from non- required to avoid soil and groundwater contami- agricultural sources, and secondly by remov- nation. Treatment costs are typically Y 1.00/ ing the proportion of agricultural income derived cubic meter, but its value in irrigating high value from noncrop activities-15.8 and 20 percent, crops on the perimeter of cities is much greater, respectively. (Substantial regional variation would exist in the proportion of income derived The Importance of Irrigation to outsideof agricultureandof agriculturalincome Agricultural Production and Incomes derived from livestock.) The result indicated that In 1996 about 95.5 million hectares were about two-thirds of total rural incomes derive cultivated in China, of which about 50 million from cropping activities. Using gross revenue (52 percent) were irrigated. However, irrigated from cropping as an income proxy, we deter- areas account for far more than 52 percent of mined that 58 percent of crop revenue came crop production. Firstly, cropping intensities on from irrigated areas in the northern regions (I irrigated land are about 203 percent, whereas through IV, and IX); and 77 percent in the south- on rain-fed land they are about 114 percent. ern regions (V through VIII). Thus about 66 percent of sown area is irrigated. Secondly, the productivity of irrigated land is Crop Yield and Income Response to much higher than that of rain-fed land in most Water of China. About three-fourths of the cropland In northern China, rice, vegetables, and lies either in the perennial irrigation zone or in melons are given priority in irrigation applica- the unstable irrigation zone. Cropping in these tion decisions. Other grain crops, particularly areas is risky without ensured irrigation sup- wheat and corn, are on the margin; they re- plies. ceive supplemental irrigation when available. Available statistics do not permit directly The Shanxi experimental data and estimates comparing rain-fed with irrigated crop yields. using FAO-CROPWAT methodology produced Controlled experiments undertaken in Shanxi similar results. We discuss the CROPWAT re- Province and estimates derived from FAO's sults below. CROPWAT2 model (an irrigation scheduling The model assumed a 20 percent reduction model), under conditions of full irrigation and in irrigation supplies to each crop (from the full no irrigation indicated that in wetter locations water requirement). The results indicate that (Regions V, VI, VII, and VIII), nonrice rain-fed vegetables and melons are the highest marginal yields are nearly identical to irrigated yields revenue producers; the marginal loss was at except for vegetables and melons. In drier re- least Y 4.00 per cubic meter in all regions, and gions, yields of irrigated grains are always higher. nearly Y 9.00 per cubic meter in Region II. Veg- In the Inland Region (IX) most yields, including etables and melons would be the last crops on grains, are more than double rain-fed yields. which a farmer would reduce irrigation water. Otherwise, irrigated yields range from margin- Next would be cotton (northern regions) and ally to substantially higher, particularly in the then corn or orchards. The first crops to cut Yellow River Basin (IV), where irrigated winter would probably be wheat, soybeans, tubers, or wheat yields are about double rain-fed yields. other grains. To estimate the role of irrigation in the gen- Rice typically cannot be stressed, thus wa- eration of rural incomes, we mapped the 1996 ter reductions for rice means reductions in rice rural population and provincial level per capita area. Kutcher (1998) modeled the impacts of 70 Chapter 8: Water Resources converting all the rice area in Water Regions I in 1996. However, except for rice we do not know through IV to wheat or corn. The rice areas are whether these average crop incomes are based relatively small, (except Region I), but given their on adequate or insufficient water supplies.) And, disproportionate water requirements, could if neither the availability of water nor its cost make a substantial volume of water available were a concern, farmers would clearly prefer to for other crops if these areas were not produced. grow rice rather than wheat or corn. However, (However, rice may be grown in specific areas if water becomes the (physically or financially) because waterlogging or other factors may pre- constraining factor in these regions, as seems clude other crop production.). For the amount likely, farmers will need to consider returns to of water rice requires, up to twice as much win- water as well as land use. Farmers who pro- ter wheat area could be sown, about 2.5 times duce rice would suffer modest income loss by as much spring wheat area, and more than three shifting rice area to wheat and corn unless (a) times as much corn area. Furthermore, wheat nonrice crops are severely starved of water cur- and corn have an absolute advantage over rice rently, or (b) additional cultivated land is avail- in generatinggrain output and revenue per cubic able for cropping with the released water meter of irrigation water under P75 rainfall con- supplies. However, rice accounts for only about ditions. The table below compares these alter- 4. 5, and 6 percent of crop income in Regions II, natives on the basis of 1995 estimated yields III, and IV. respectively; thus, excluding rice from and 1997 crop prices. Wheat generates up to the cropping pattern would have minimal in- 50 percent more grain per unit of water than come impacts regionally. Income estimates per does rice, and corn, between two and three times hectare (or mu) are quite sensitive to water ap- as much. The results are similar when com- plication, thus optimizing cropping patterns on paring revenue per cubic meter of irrigation available land and water need careful study in water. each location. Average revenue, of course, is not average income. Separate surveydatafromHenanProv- The Importance of Improving ince (which includes parts of Regions II, III, and Irrigation System Efficiencies IV) for 1996 indicated the income per hectare Gross consumption of irrigation water de- for wheat-Y 3,658, corn-Y 5,349, and rice- clined marginally between 1980 and 1993, but Y 10,040 (Henan Agricultural Statistics Year- national plans call for a sharp increase by 2000 book 1996). (Rice prices were particularly high and a further marginal increase by 2010. Given Table 8.2: Average Grain Output and Revenue per Cubic Meter of Irrigation Water Crop/Region I II II IV Average Grain Output per Cubic Meter of Irrigation Water (kg): Winter Wheat n.a. 1.58 1.82 0.98 Spring Wheat 2.04 1.54 n.a. 1.21 Corn 6.07 4.09 4.36 2.22 Northern Rice 1.57 1.36 1.33 0.94 Average Revenue per Cubic Meter of Irrigation Water (yuan): Winter Wheat n.a. 2.33 2.69 1.45 Spring Wheat 3.02 2.28 n.a. 1.79 Corn 6.95 4.68 4.99 2.55 Northern Rice 2.04 1.77 1.73 1.22 n.a. = nof applicable. . 1 . 1 . 1 - 1 - 1 1 1 1 1 I I . . . - I I j - I . 1 1 71 Accelerating China's Rural Transformation competing water demands and the high invest- supplies may even decline. ment cost to increase water supply capacity, The high cost of new investments in water- coupled with a shortage of financial resources, resource development, coupled with increasing the proposed increases are unlikely to be economy-wide demands for limited fiscal re- achieved. However, improving the water deliv- sources, will likely constrain rapid development ery system is important and should be under- of new water resources. Although water can taken when economically efficient, particularly continue to be administratively allocated, it is when it also improves intra-scheme distribu- more efficient and will lead to higher growth, if tion. water is appropriately priced and market forces The national average overall irrigation sys- allocate the water to uses with higher economic tem efficiency was reported to be 54 percent in value. As the economy becomes more market- the 1980s (ESCAP 1997). Recent discussions oriented, the long-run sustainability of irriga- indicate that statistic still applies in much of tion and drainage will depend increasingly on Northern China.3 However, the ESCAP study self-financing entities that are based on hydraulic (1997) implied that the national average effi- boundaries (not administrative), with maximum ciency had improved to 66 percent by 1993. management responsibility and control accorded Thus, gross irrigation consumption of 343.4 bcm to farmer users. in 1993 could have resulted in net consump- From a macroeconomic view, the vastly tion as low as 187 bcm (using the 1980 effi- higher economic values of water generated by ciencies) or as high as 230 bcm (using the implied the urban and industrial sectors should not be 1993 efficiencies). The net consumption differ- sacrificed for increased agricultural production. ence, 43 bcm, is large and represents one of the The ability of China's industrial sector to gen- major sources of uncertainty in water resource erate trade surpluses easily offsets foreseeable information and planning. Depending on how reductions in agricultural output that may arise much irrigation efficiencies are improved be- from irrigation water shortages. However, three- fore 2000, meeting the gross irrigation require- fourths of China's population is rural, and de- ment of 433.5 bcm could result in net irrigation pend on agriculture for two-thirds of their supplies of between 236 and 337.5 bcm (ignor- incomes. Protecting and increasing these in- ing natural intrabasin return flows). The mar- comes and maintaining growth in agricultural ginal value of irrigation is at least Y 1/cubic production is a national concern-one that de- meter, implying that the range of uncertainty pends in part on more and better irrigation. due to these efficiencies is more than Y 100 Rehabilitating and completing surface irri- billion per year of agricultural output. and a gation and drainage systems-including the similar value in terms of rural incomes. installation of control structures and water measuring devices to improve efficiency-can Conclusions and Recommendations yield local benefits. Rehabilitation should be Although water resource planning calls for undertaken where economic benefits justify the moderately increasing allocated supplies ofwater investment, particularly if it provides a more to irrigation over the next decade, this will be reliable and equitable supply of irrigation water very difficult to achieve. More probable is a con- to farmers and increases deliveries to water- tinuation of recent trends, with modest reduc- deficient areas within the scheme, typically lo- tions in irrigation water allocations-because cated in the lower reaches of tertiary and most nonflood season surface water is already quaternary canals. Investments in improving consumed, and groundwater is heavily and extending existing systems would likely pro- overabstracted. Furthermore, silting of reser- vide better returns than new construction. (Be- voirs and neglect of maintenance of the irriga- tween 1989 and 1995, the marginal cost of tion system implies that local surface water irrigation expansion was about Y 10,000 per 72 ... Chapter 8: Water Resources hectare, (1990 terms), representing very effi- centive to save water and make precision dent investments. However, future investments leveling financially attractive. will prove more expensive.) * Expand collection, treatment, and reuse of If irrigation water supplies do not increase municipal waste water, particularly around as planned, or decrease, the negative impact larger urban areas, with suitable monitor- on agricultural production and incomes could ing and control to prevent contamination by be minimized by the following activities: hazardous wastes. * Conduct a comprehensive study of system- * Encouragefarmers to refine cropping patterns wide efficiency. Such a study is sorely needed. in water-short areas to more water-efficient * Rehabilitate the irrigation and drainage sys- crops. In some areas considerably more wheat tems where economically justified, to increase and corn could be grown with the water rice the overall delivery efficiency and improve on- currently consumes, with little or no reduc- farm facilities. Such investments will have tion in farm incomes. "Encouragement" would an income impact by ensuring "tail-end" farm- best come in the form of appropriate water ers receive a equitable share of water, but pricing supported by farmer education. system-wide water savings will be modest. * Introduce and enforce a rational system of * Undertake one or more routes of the South- water pricing and volumetric measuring. Over North transfer scheme, which would bring the long term, volumetric measurement would plentfful Yangtze river water to the water- considerably improve water use efficiency. starved regions II (Hat Basin), III (Huai Basin) Farmers cannot be expected to conserve water and IV (part of the Yellow Basin) as early as or alter their cropping patterns when effec- possible. Delays will increase the cost in terms tive water costs are low or unrelated to the of lost industrial and agricultural output, amount used. Water charges that fully re- social costs of chronic water shortages, and cover cost would encourage better water man- environmental damage from overuse of agement on all crops and would influence ground and surface water. nongrain cropping patterns by increasing the * Introduce improved land-leveling technology production cost for crops with higher water (e.g., use of laser guided equipment). This tech- demand. nology appears financially attractive and * Expand self-financing water enterprises to should be explored as a means of saving water manage water supplies and operate and and increasing yields, particularly on newly maintain irrigation systems as rapidly as reclaimed lands. Given China's small culti- management expertise can be developed. vated plots, land leveling may not be practi- * Ensure agricultural research and extension cal in all areas but would be feasible in new programs accord appropriate priority to crop land reclamation. Full-cost, volumetrically water use efficiency (drought tolerance). based water charges would provide an in- I . . 73 Accelerating China's Rural Transformation Water Regions: Region Name Component Provinces Major River Basins I Northeast Heilongjiang, Jilin, Liaoning, Nei Mongol Heilong, Liaohe. Songhua II Haihe Hebei, Beijing, Tianjin. Shanxi, Henan, Shandong Haihe. Luanhe III Huai/Shandong Shandong, Henan. Jiangsu, Anhui Huaihe IV Yellow Qinghai, Gansu, Ningxia, Nei Mongol, Shaanxi, Shanxi, Henan Yellow, Weihe, Fenhe V Yangtze Hubei, Hunan, Anhui, Jiangxi, Jiangsu, Zhejiang Henan, Guangxi, Sichuan, Shanghai. Guizhou Yangtze VI South Guangdong, Guangxi, Yunnan Pearl VII Southeast Fujian. Zhejiang, Guangdong giangtang, Minjiang VIII Southwest Yunnan, Tibet Yarlung-Zangbo, Nujiang, Lancang, Yuanjiang IX Northwest Nei Mongol. Qinghai, Xinjiang. Tibet Tarim, Yilo, Ertix 2 CROPWAT is an irrigation scheduling model developed by the FAO, UN. It is described in FAO Irrigation and Drainage Paper No. 46 [Rome: FAO. 1992). 2 Discussions with river basin commission officials at the Hai, Huai, and Yellow River headquarters, April/May 1998. 74. 9. Technical Change and Technology Transfer During the reform period, higher prices and A. Agricultural Research improved incentives have increased agricultural Funding for agricultural research in China input usage and substantially raised agricul- is allocated or generated in three ways. Core tural productivity. TFP, which is the basis of funding, which finances salaries and social ben- improved efficiency, increased rapidly during efits (e.g., retirement, housing, medical benefits), the early reform years, but has since tapered constitutes about 50 percent of government off. TFP improvement is, generally, the result of funding for research institutes and centers. To adapting new and improved production tech- make agricultural research more effective by nologies, which in turn rests primarily on agri- rewarding those with good ideas, successful past cultural (and allied) research and is the records, and who are working on key projects, fundamental element for long-term increases the remainder of public support consists of com- in farmers' per capita incomes. petitive grants allocated for projects proposed The comprehensive extension system dur- by scientists. Research budgets also are allowed ing the early post-revolution period played a to be supplemented by additional funds gener- crucial role in meeting expanding food needs, ated through commercial sales by the institutes disseminating technology, and modernizing large and centers. parts of China's backward and low-productiv- ity agricultural sector. In the early reform years, Public Sector Financing the extension system continued to assist tech- Historically, agricultural research has been nology transfer to farmer households much as in the public sector domain in most countries. it had earlier. Villages continued to hire staff to Market failure characterizes agricultural re- liaise with township extension agents on plant search, as it is a public good involving protection, seed and fertilizer use, and other uncapturable externalities, is risky, and is long technologies. However, financial resources have term. Without public sector involvement, sub- declined in recent years, resulting in a decline optimal amounts of agricultural research would in agricultural technology research and promo- likely be conducted-and that research would tion efforts. likely focus on easily marketable technology with Agricultural research and the extension of capturable private benefits and ignore basic and new crop varieties have been shown to be a major long-term research that maximize society's ben- engine of agricultural growth during the reform efits. In the OECD countries, the private sector (Huang and Rozelle 1996, and Lin 1992). While now accounts for about 50 percent of agricul- farmers were responsive in pursuing new tech- tural research, as IPR protection enables more nologies (e.g., hybrid rice), following introduc- of the benefits to be captured. tion of the HRS reforms the adoption rate of China's crop agriculture has been well served new technologies declined, which might be be- by the public research system, particularly rice- cause of weakening of the technology distribu- China pioneered the breeding of semidwarf, high- tion system. yielding varieties and today is still the only Accelerating China's Rural Transformation country in the world with large areas of hybrid Real agricultural research expenditures, as rice. Success in the nongrain subsectors has measured by deflating current expenditures by been less dramatic. The importance of agricul- the CPI, grew marginally during the late 1980s, tural research, in terms of high rates of return but allocations increased during the early 1990s. and contribution to growth, is well documented However, Huang, Hu and Fan's (1998) analysis in China and elsewhere. Fan and Pardey (1997) of disaggregated agricultural research budgets found that government investment in research clearly determined that after deducting expen- and development resulted in a 20-percent growth ditures for capital construction, salaries (which in agricultural productivity in China over 1965- increased much more rapidly than the general 94. Fan (1996) estimated that the internal rate price level), overheads, etc. the real expendi- of return to agricultural research over the same tures for research projects declined at an an- period was 94 percent-implying a serious nual rate of about 4 percent during the 1990s. underinvestment in agricultural research. A These facts, coupled with the rapid increase in survey of more than 150 studies of rates of re- the number of agricultural research scientists turn to agricultural research (worldwide) con- reduced the real research funds per scientist by cluded that rates of return are typically 40+ 25-30 percent during the 1990s. The ARI de- percent and often exceed 100 percent (Echeverria clined throughout the period reaching an all- 1990). Growth accounting and decomposition time low of 0.38 in 1996 and 1997 (Table 9.1). analyses demonstrated that growth in China's The declining ARI is likely to reduce future ag- rice, wheat, and maize production over 1984- ricultural growth. An international, "rule of 95 was overwhelmingly attributable to research thumb" is to spend about 1 percent of agricul- investments (Huang, Rosegrant and Rozelle 1995 tural GDP for agricultural research (FAO 1990). and World Bank 1997b) As seen above, the downward-trending ARI is below both this level and the developing coun- Declining Research Investments try average (Alston, Pardey, and Rosebloom One of the government's objectives is to in- 1997). Also, research costs are increasing as crease agricultural research investments, but additional objectives are incorporated into the that objective has been elusive. As in many other research program (e.g., pest resistance, drought facets of the rural economy, agricultural research tolerance) and research is increasingly turning suffers from fiscal constraints, as public resource to more costly approaches (such as in biotech- allocations have been woefully inadequate. The nology), leaving fewer resources for traditional Ninth Five-Year Plan recommended increasing research. The World Bank's Food Security Re- agricultural research expenditures to 29 per- port (1997b) summarizes the recent research cent of total government research expenditures, on the determinants of agricultural supply, but throughout the 1990s agriculture's share which demonstrated that increases in China's has remained at 13 to 14 percent. Agricultural cereal production, post-1985, was overwhelm- research intensity (ARI), defined as investments ingly contributed by agricultural research and in agricultural research as a proportion of agri- technology. cultural GDP, declined from 0.49 in the late 1970s to 0.38 in the mid-1990s and although Making China's Research national agricultural researchbudgets increased Investments More Productive during the reform period, the number of research In 1982 the Chinese Academy of Science scientists employed increased even more rap- initiated a competitive grants program that al- idly (Fan 1995). Recent comprehensive data on located funds directly to research scientists as government expenditures, including provinces part of a shift in national science and technol- and lowerjurisdictions, for agricultural research ogy policy that encourages research-funding activities presents an equally alarming picture. agencies to make grants based on the best pro- 7 6 - - - - - - - - - - - - - - Chapter 9: Technical Change and Technology Transfer Table 9.1: Agricultural Research Budgets and Research Intensity, 1986 -'96 Agricultural Research Research Project Agricultural Agricultural Budgets Funds GDP Imtensity (ARI) Current Constant (1995) Constant (1995) Year (million yuan) (million yuan) (million yuan) (billion yuan) (percent) 1986 1,346 3,529 766.9 276 0.49 1987 1,403 3,429 560.7 320 0.44 1988 1,782 3,674 811.2 382 0.47 1989 2,095 3,668 747.5 423 0.50 1990 2,050 3,515 522.7 502 0.41 1991 2,381 3.967 729.1 529 0.45 1992 2,761 4,366 622.8 580 0.48 1993 3,273 4,572 673.6 688 0.48 1994 4,409 5,061 627.1 944 0.47 1995 4,856 4,856 570.7 1,199 0.40 1996 5,238 4,854 548.4 1,388 0.38 1997 5,377 4,795 - 1,397 0.38 Note: The agricultural research expenditure data reported in this table include (a) agricultural research expenditure in research institute system under all ministries, the Academy of Sciences, and the Academy of Agricultural Science at national, provincial, prefectural, and county levels; and (b) agricultural research expenditure in the university system. Agricultural sector includes crop, forestry, livestock, fishery, water, and agricultural services (e.g., machinery, informa- tion). Constant prices derived by using CPI deflator. Source: The State Sciences and Technology Commission (provided by the Center for Chinese Agricultural Policy). posals. National research administrators also mercial enterprises and joint ventures as away created a number of special research funding of protecting their breakthroughs. However, programs, particularly in high technology. Funds these commercial ventures have had a number from these new programs have mostly come from of adverse consequences. Commercialization core budgets, meaning research institutions that also has diverted skilled scientists away from have not been successful in the grants compe- research. Studies by Rozelle, Pray, and Huang tition, have experienced falling support, which (1997) show that in some cases more than 20 earlier came to them on the basis of staffing percent of the scientists in research institutes levels. are engaged in activities that are not related to Since the mid-1990s China has attempted research and development (R&D). Institute staff to commercialize a portion of agricultural re- are not trained to engage in non-R&D activi- search by requiring research centers to develop ties, and thus have high failure rates when they commercial products in their institutes and sell do. Other centers have hired staff to run their their research findings. One of the overall goals new business ventures, while at the same time from the program is to use commercial profits layoffs are occurring because of a lack of fund- to finance further research. If intellectual prop- ing. erty rights were better protected, research cen- Most significantly, despite all of the effort, ters could license new technology to commercial commercialization appears to provide few, if any, entities and enjoy the royalty rights. Instead, supplemental funds for research. Research fund- the institutes have established their own com- ing regulations stipulate that 30 percent of com- I . I . -1 1 . I I I I I I . . , I . 1 1 I 1 77 Accelerating China's Rural Transformation mercial net revenue should flow back into re- producers should have a voice in determining search programs. In reality, no more than 15 the focus of research financed in this manner. percent of net revenues of profitable ventures Subsistence food commodities are unsuited for (in those centers focusing on rice research) have cess funding because only a small portion of been returned to research budgets. Most earn- production is marketed-typically in small, ings support salaries and benefits of commer- uncontrolled marketplaces. Nor are cesses a cial-enterprise staff (Rozelle, Pray and Huang practical method of obtaining funds for 1997). noncommodity research, such as farming sys- Jin (1997) determined that the actions of tems, soil conservation and other environmen- government officials, who observe the commer- tal topics. cial activity in the research sector, further un- dermines the original goal of the program. For Internationally Financed Nonprivate each 1 yuan of commercially generated income, Research government funding has been reduced by 0.80 China has access to technology generated yuan. Thus, despite absorbing large amounts by the Consultative Group on International of time, energy, attention, and capital, commer- Agricultural Research' (CGIAR) institutions and cialization has led to a net funding increase of benefits through adaptive research by the FAO, only 4 percent (Jin 1997). As government has which often includes training, and by some ac- reduced funding, research centers are forced tive NGOs. Funds for CGIAR centers come pri- to seek alternative sources, which, except for marily from developed countries (Europe, United an occasional international grant, are largely States, and Japan) and the World Bank; fund- limited to commercial income. However, the lack ing from developing countries comprised only 2 of priority for research support creates a down- percent of the total budget in 1995. Developing ward spiral. Generating additional commercial countries, including China, have benefited enor- income results in further reductions in research mously from the research of these centers at funding from the budget. little cost. China has active cooperative programs with the International Rice Research Institute, Potential New Sources of Research or IRRI (rice); the International Center for Maize Funds and Wheat Improvement, or CIMMYT (maize and wheat); the International Potato Center, or CIP Producer and User Cesses (potatoes); the International Plant Genetic Re- Nonsubsistence and processed agricultural sources Institute, or IPGRI (plant genetics); the commodities with commercial markets could ap- International Food Policy Research Institute, or propriately be subjected to cesses on sales ear- marked for specified purposes, including - commodity research. Processed commodities, such as tea, tobacco, and some nonfruit tree crops (e.g, rubber), are well suited to the collec- tion of such cesses. Whether the fee is levied on the producer or user depends on the relative _ ease of collection. For tobacco, imposing a fee on users through a stamp (or similar) tax col- lected from the manufacturer is relatively easy. For other crops, such as cotton, levying the fee on producers through deductions at the pro- An IRRI biotechnology laboratory where foreign genes are introduced into rice cells cessing point (ginnery) may be easier adminis- using biolistic process. tratively. Where such a system is employed, Courtesy of CGIAR Photo Library 78 . Chapter 9: Technical Change and Technology Transfer Box 9.1: India Growth tries rely heavily on the private sector to gener- ate new agricultural technologies, as do some F AconingfK A y i tdeveloping countries. For example, domestic and p tforeign private enterprises have provided the uiernmreIt pendinZ poverty r At sricn technology that has contributed about 36 per- cent of India's productivity growth since 1957 dia The results havt impLications for China. (Box 9.1). Most major international seed com- India , TFP crea!Eed Lit an o-erato annuA panies conduct research and sell field-crop seeds rate of 1.1 percent betwiuen 1957 and 19t7- in India-a country with agroclimatic conditions v,ith a slgtylmhraveraL4e du_riiuz the - t much different from North America and Europe 1967-771 -reen RevOlUtIonCA11 a( - and with a far smaller seed market than China. c ountmrL4 analsi- Indicated thit public re- In contrast, only two international companies searchU anrd extension con)itnbu)tred most 159 are selling small amounts of seed (other than percent) no TEE giow'.th. Howve-er. surprk- per,=nl t) FPt4r_)k,t. H\%eve. Ifpri - vegetable seed) in China. ingly domestie and forergn private- research vetalsedinCn. A few multinational organizations and id devclopment also m-tade important co- transnational corporations have research un- inbutions- 13 and 23 percent. rcspertvelv. TheIbUOni-13 bu nd 23 prcenus iac-tpers -elTE derway in China. Often the research is demon- stration in nature and serves more as an arc indii-ated in thc table below: extension or sales mechanism. These include the Potash and Phosphate Institute of Canada Toal Fo Proh,Idivit by5 7 (PPI); the American Soybean Association; and Source of Growth, lndiC A 1957-87 transnational seed, chemical, and food and feed Facon ut Pe-CtA corporations. These groups have had varying Factor Perce ntagt? Perti-nt degrees of success and have made varying con- tributions. For example, in cooperation with the PubLic dorne-sic 0. 25S 22.8 Soil and Fertilizer Institute of the Chinese Acad- Public HYYV 0.070 6.2 emy of Agricultural Sciences, the PPI has dem- Private domestic 0.145 12.8 onstrated the beneficial effects of applying more Private foreign 0.261 23.1 potassium fertilizers, which has led to increased Fi.ibbc: Extdurr4n 0.3.31 29.3 potash imports (and increased productivity). larketz. 0 035 J I Chia Tai (the China subsidiary of Charoan lrriation 0.084 7.- Pokphand) produces a large portion of China's Other --A.0l5-4 --1.7 manufactured feed as the result of poultry feed Total 1.130 100.0 demonstrations. In addition to these successes, trials undertaken with government agencies have Source IFPRI EPTD Total Factor Productivity andprdcda levinethtdpigad- Sources of Long-Term Groyth in Indian Agriculture prdcda levinethtdpigad- Sorces o5 Ltional foreign technology could significantly in- April 1995 crease productivity in crops, livestock, and IFPRI (food policy); and the International Irri- agricultural machinery and equipment. For gation Management Institute or IIMI (irrigation example, China could take advantage of for- management). eign technology for maize, rapeseed (canola), and soybeans. Research in North and South Research and Technology Transfer by America and Europe has produced varieties that Private Enterprises yield much higher than Chinese varieties un- Another alternative to government-financed der similar climatic environments. research and extension is through private sec- China benefits only marginally from agri- tor support. As noted above, the OECD coun- cultural technology developed by the private 79 Accelerating China's Rural Transformation sector. However, given the size of China's agri- cultural economy and similarity of agroclimatic conditions to those in North America, Japan, and Europe-where private research is quite important-Chinese agriculture has enormous opportunity to grow more rapidly by using tech- nology developed by commercial enterprises and foreign firms. Farmers need to be given access to that technology. Intellectual Property Rights Copyright, patent, and other IPR protection E have developed slowly. The patent law became d dl effective only in 1985 but did not apply to chemi- cals and pharmaceuticals until 1993. Plant A promising super-hybrid rice variety under development at the National variety protection became available with pas- Hybrid Rice Research and Development sage of the plant breeder's rights law in 1997- Center Changsha, Hunan, China. although the application office has yet to open. Photo courtesy of CNHRRDC The legal framework seems adequate, but en- ficial agreements, have been copied and sold forcement is perceived to be weak. In the ab- without any compensation to the inventors. Al- sence of strong IPR protection, few large though the legal environment provides adequate multinational companies do research in, or protection for IPR, enforcement remains weak. transfer cutting-edge agricultural technology to The current effort by Monsanto to market its Bt China. Only companies that can control tech- variety of cottonseed will be closely watched-if nology through means other than IPRs and are the seeds become widely available from non- confident oftheirjoint-venture partners can take Monsanto sources, other high-technology and the risk. biotechnology firms will be reluctant to invest FDI assisted in modernizing the poultry in- in China. dustry by importing grandparent genetic stock Other nontariff barriers to technology trans- and breeding parent genetic materials domes- fer include weak contract law, restrictions on tically (this could be done with some confidence the role of multinationals in the agricultural because the technology did not rely on IPR pro- input industry, and government monopolies on tection but sophisticated hybrid genetics). The the sales of some agricultural inputs. For ex- introduction of superior nutrition feed milling ample, the amount of imported cotton seed al- and mixing paralleled the development of the lowed for testing is limited to 500 kg per variety, poultry genetics. Almost all of the plant breed- seriously slowing down efforts to test the appli- ing and screening research by foreign-financed cability of foreign varieties in China. Other regu- enterprises has been on hybrids (corn, sunflower, lations dictate that companies can only import sorghum, and rice) because hybrid varieties are female pigs, and the health protocols for im- difficult to copy as long as the hybrid parents porting breeding pigs require blood tests con- are kept secret-thus the IPR was technically ducted in China at a cost of $300 per head for protected. diseases that already exist in China. In the agrochemical sector the pesticides that Relying significantly on the private sector have not been reverse engineered are those for agricultural technology development carries whose active ingredient is a complex. and diffi- potential hazards, particularly in terms of re- cult to copy, molecule. Many others, despite of- search focus and priority. The objectives of pri- vate firms are unlikely to coincide with society's, 80 Chapter 9: Technical Change and Technology Transfer as optimizing long-term financial gains is not tural research financing. These findings, al- necessarily consistent with optimizing society's though unsurprising, have serious welfare, pov- economic benefits, which include environmen- erty, and equity implications for regions where tal and poverty alleviation objectives. Some of- the positive factors are lower than the more ficials in China worry that foreign firms with economically advanced coastal provinces. advanced R&D methods and technology will Given the overwhelming contribution of re- displace domestic expertise and undermine the search to agricultural growth and poverty re- nation's ability to generate its own research. duction, real investments in research must be better managed to ensure that efficiency and Research Priorities and Efficiency long-term objectives are met. A consolidation Decentralization and financial reorganiza- and reorganization of the research system- tion has resulted in the state providing a de- eliminating unnecessary duplication and re- clining proportion of agricultural research structuring it along agroecological zones-also funding and greater reliance on provincial and would improve efficiency. This would include lower jurisdiction financing. Using provincial research applicable to poverty-stricken and re- data, Jin et al. [1997) identified several factors source-poor areas-both high elevation temper- that influence growth in government funding of ate and tropical zones. People in poverty areas agricultural research. In the study, government often rely on subsistence crop varieties and live- revenues, agricultural GDP, provincial grain stock species that have not received a signifi- exports, and number of scientists (all on a per cant research focus, particularly under adverse capita basis) were positively related to agricul- environments. These include potatoes, sorghum, Box 9.2: Agricultural Research Considerations The agncutural restarch budcct allocatt-d to vanous commodities is Unkinown. [It tood ,Vrains has been a major ficu1s-and prodctiOl ,I rereabk has increased unpress:t-lY. Icok.- ever. in recent years China has turned from a net cxpoititr of iet'tiable Ci. 1iluUal.;. and otseeds to a net importcr. rellectin increasine demand for protein siupplements tor lorestock feeds. However. China'- rape,eed i, high mi gluIciinolates arid much of the ineal _ cxporled because of it-. toXlfitNm to nonrUinant liVestrck JChina'; needs foi protein suipplemneints is primarily for poultry and piis). Canada embarked on a research prorai to tirpror.e rapeseed yield and qualiry in the 196(s and 1970s that yielded rates of rcturn of 100 percent in the early period. dechtinum to 50 pertent in more retent years. China's rapcseed vields have -rown ai only 1.6 percent annually i\-er the- late 1980s and early 1990s and reinam below those ot Canada. ArLenftfina. and France. Although soybeans originated in Cnhia. Chiesr oybean yields remain tar below that of other major producers iArgentina. Brail. Canada. and the United States). The crowth rates of China's -erreals and oilseed; yields -ire shown below. Growth Rates of Cereals and Oilseeds Yields, 1985-96 Gro,A-th Rate Commodit (,rowth Rate Corriniodity (perce rtJ Commoditv (perren li C ereas Oiseeds RILe 1.0 Rapeseed 1 6 Wheat 1.2 Sowbcans 23 Corn 3.3 Peanuts 3 7 M\illet 3.0 Sunflower, 3 2 Sor,hmm 4.6 Sesame 4 3 1 1- I I I . - 81 Accelerating China's Rural Transformation millet, barley, buckwheat, beans, goats, poul- following: try and pigs. Recent work on India's research * Finance as much of the "public goods" agri- investments (Fan and Hazell 1996) concluded cultural research as possible. The returns to that orienting additional research investments agricultural research have been found to be to nonirrigated agriculture would yield greater very high and one of the largest past and productivity and poverty alleviation benefits than potential contributors to increasing food sup- maintaining a heavy focus on irrigated agricul- ply. By giving financial support to research. ture. the government will accelerate growth and As research budgets become increasingly thus is a good investment. Creating an "en- constrained, China must use funds efficiently abling environment" to stimulate agricultural and appropriately identify research priorities. research by the private sector is also impor- While some priorities and broad financing allo- tant. cations can be established on objective criteria, * Make competitive research grants accessible such as percent of agricultural GDP or impact to the entire research system. Conceptually, on the balance of trade, other priorities must this should enhance the quality of proposals be assessed more subjectively. Obvious examples and produce improved results as proposals of the former are drought-tolerant plant variet- are rated on the basis of proposed method- ies (in anticipation of reduced irrigation sup- ology, originality, and expected contribution plies), feed grains (to support the livestock sector); to farmers, among other things. However, livestock and fisheries [which are an increasing competitive grants for projects cannot totally share of agricultural GDP), and oilseeds and substitute for long-term funding for research their derivatives (which are an increasing pro- programs, which enables more sustained portion of imports). Examples of the latter are effort on basic R&D issues and more routine farming systems and varietal improvement in research activities. This process may favor resource-poor areas (for equity and poverty al- experienced, centrally situated scientists at leviation reasons), marketing and agroprocessing the expense of younger, and perhaps better issues, and natural-resource management trained, scientists. Indeed, older scientists (where long-term benefits are not captured in at national-level institutes have been the economic assessments). principal beneficiaries of the competitive China is concerned about undue reliance grants initiative. Widely publicizing the com- on external markets to supply substantial por- petitive grants program and its evaluation tions of domestic needs. This is because China's criteria, including abroad range of scientists large size could potentially disrupt international and institutional representation on the evalu- markets and because the government has a ation panel, and ensuring program admin- latent fear that a foreign country might apply istration was fully transparent would help political pressure through trade embargoes. meet program objectives. Also, a blind first These concerns partially underlie the grain self- stage evaluation might be undertaken in sufficiency policy. which the submission excludes the proposed researchers and the affiliated institution. Conclusions and Recommendations * Develop a grant program that matched a re- Improvements and transfers in technology search center's commercial earnings allocated are crucial in improving the health of the rural to research-rather than automatic funding sector. Agricultural research, along with exten- reductions. Such a program could strengthen sion services, is a major engine of growth. To the research program and give the research ensure new and continually improving technol- staff of the centers more incentive to sup- ogy, research needs support. Steps the govern- port commercial activities (Pray 1997). ment can take to provide this include the * Rigorously supervise any cess collections to 82 . . . . . . . .-- - - - - - - - Chapter 9: Technical Change and Technology Transfer ensure they are used for their intended pur- vation, and on rain-fed and subsistence crops poses and not diverted to alternative uses. for resource-poor areas. Where cesses are employed producers should have a voice in determining the focus of re- B. Extension search financed in this manner. Increase participation ofinternationalfirms in Financing Agricultural Extension agricultural research. This would help accel- Technology development and transfer played erate agricultural modernization. Without a critical role in the past growth of food produc- greater participation of the private (domestic tion, but total real expenditures have stagnated and international) sector, China's agricultural since the early 1990s and real expenditures per productivity will be lower, as farmers will not extension staff member have declined from more be assured access to state-of-the-art tech- than Y 7,000 in the late 1980s to about Y 5,000 nology. If imported technology is to supplant in 1994/95 (Table 9.2) Little information is avail- government-supported research, an improved able about the effectiveness of the extension IPR policy environment is necessary. service, but recent declines in technology adop- Increase reliance on the private sectorfor re- tion rates and increasing fiscal problems have search in which the benefits are capturable. weakened the extension system, and govern- This would enable the government to focus ment interest in assessing and improving the more of its efforts on research issues related extension performance has increased (Huang, to natural resource sustainability, poverty, et al. 1998). and equity that commercial companies are China's small-scale farming requires inten- unlikely to address. These issues would in- sive extension input, creating high extension clude, for example, research on soil conser- cost per unit of output. However, China's share Table 9.2: Agricultural Extension Expenditures in China, 1986-95 Total Expenditures Extension Expendtr/Staff Agric. Extension Current Constant 1995 Staff Constant 1995 Intensity (million yuan) (million yuan) (thousand yuan) (yuan) (percent) 1986 1,136 2,978 385.3 7,729 0.41 1987 1,270 3,103 404.7 7,667 0.40 1988 1,406 2,899 411.1 7,052 0.37 1989 1,513 2,649 429.3 6,169 0.36 1990 1,740 2,983 454.5 6,564 0.35 1991 2,051 3,417 495.7 6,895 0.39 1992 2,275 3,598 615.7 5,844 0.39 1993 2,554 3,568 604.2 5,905 0.37 1994 3,120 3,582 733.0 4,886 0.33 1995 3,721 3,721 674.9 5,512 0.31 1996 5,706 5,269 - - 0.41 1997 6,848 6,151 - 0.49 Note: Agricultural Extension Intensity is defined as the ratio of agricultural extension expenditures to agricultural gross domestic product. Source: Huang, Jikun, Ruifa Hu, Jun Song, and Scott Rozelle, "Policy Brief: Agricultural Technology Extension in China," Working Paper, Center for Chinese Agricultural Policy, Chinese Academy of Agricultural Sciences, Beijing, China, 1988. . . I I . . .I .. I . I I I I . . . . . I I I I . . . .f . 83 Accelerating China's Rural Transformation of agricultural extension investment in agricul- Fiscal Impact on Agricultural tural GDP (agricultural extension investment- Extension Performance AEI) became one of the lowest in the world in China has a comprehensive, six-level (na- the mid- 1990s. The AEI declined by 25 percent tional, provincial, prefectural, county, township, over the 1986-1995 decade and stood at 0.31 and village) extension network, with about in 1995, but large expenditures in 1996 and 675,000 full-time extension workers employed 1997 appears to have reversed the declining at the national and subnational levels-includ- trend. International extension expenditure sur- ing a number in larger and more prosperous veys are less frequent and comprehensive than townships. The system also relies on more than research surveys; however, an FAO survey of 500,000 full- and part-time extension workers 57 countries presented regional average AEI, (farmer technicians) at township and village lev- which indicates the Asia-Pacific regional aver- els in the mid- 1990s. age was 0.56 in 1988 (down from 0.68 in 1985), Despite these impressive numbers, work by considerably above China's. The 1993 AEI of the Center for Chinese Agricultural Policy (CCAP) the United States was estimated at 0.81 (Alston in four provinces (Zhejiang, Henan, Sichuan, and Pardey 1997), a high level, especially con- and HeilongJiang) found that the extent of the sidering the large effort spent by private com- extension network had declined and continues panies in providing extension-like services, to deteriorate in some locales. More than 70 Extension staff wages and benefits have risen percent ofvillage extension personnel report that rapidly during the 1990s but remuneration lev- the frequency, scope, and coverage of their ser- els, relative to other agricultural sector person- vices has fallen in the 1990s. About 50 percent nel, declined from 87 to 79 percent between of township extension stations report similar 1985 and 1995. Compensation levels are stipu- trends. Large numbers of staff have left the ex- lated by state and provincial governments, but tension service and numerous village extension most wage mandates are unfunded; thus local offices have closed over the past decade. authorities are left with the responsibility of meeting these costs from local budgets. To meet Effectiveness of extension work costs, local authorities must assess farmers or Declines in agricultural extension expendi- divert resources from other expenditure catego- ture per worker and in relative income are dis- ries. Salary payments as a proportion of total incentives for extension workers. CCAP's study agricultural extension expenditures rose from discovered that active extension workers spent 43 percent in 1986 to more than 70 percent in 76 percent of their time on extension work in the 1990s. In some agricultural extension sta- 1996, about 10 percentage points less than in tions, actual public expenditures have fallen 1985. (Nonextension township officials report below staff salary and retirement obligations. that few extension workers spent even one-half Some local governments have declined to pay of their time on extension activities.) Regres- extension staff salaries (or only part of their basic sion analyses show that the most significant wage) and instead have encouraged staff to com- factors affecting extension workers' effort (i.e., mercialize their activities or engage in market- time allocated to extension work and frequency ing agricultural inputs (fertilizer, pesticide, and of visiting farmers) are wages and extension ex- seed). Anecdotal evidence indicates that the lack penditures. of funds greatly reduces the ability of extension Many of those who have remained in the staff to contact farmers and conduct field trials extension system are employed in part-timejobs and that, in poor inland counties, salaries were elsewhere or engage in work-related busi- as much as 12 months in arrears (Huang 1998). nesses-selling chemicals, seeds, and fertilizer- as new policies allow and encourage this. 84 - - - Chapter 9: Technical Change and Technology Transfer Unfortunately, staff also engagein activities un- Impact of Seed Commercialization related to extension, such as operating guest As the seed industry has become more com- houses, restaurants, or other business estab- mercialized, seed-enterprise managers have lishments. Diverting attention to other activi- begun to pursue profits and some of the long- ties, while helping to supplement incomes and standing ties between the extension system and keep the extension system in many areas in- seed system have begun to change (Huang and tact, also has its direct and indirect costs. In Rozelle 1997). In some cases, seed companies recent farmer interviews, only a small minority sell their seed directly to farmers to retain the acknowledged being visited or visiting an ex- margin that extension agents might otherwise tension agent, although farmers still benefit from earn. Furthermore, as seed companies attempt extension leaflets, radio programs, and other to protect their business interests, they some- services. Local leaders indicate that the fre- times do not share information on new variet- quency of village visits by extension staff has ies with extension staff. Consequently, extension fallen in recent years. Encouraging extension agents often lack information on the availabil- staff to undertake trade in agricultural inputs ity of new seed varieties. As seed companies creates potential, if not actual, conflicts of in- continue to commercialize, these problems may terest, as sales incentives may outweigh the value intensify, especially if extension agents continue of the product to farmers. Such indirect, policy- to depend on commercial income supplements. induced distortions are increasingly common in many areas of public goods provision and Conclusions and Recommendations are linked to tightening budgets. They are also China's extension system has performed an linked to a propensity for local leaders to ad- important role in boosting agricultural produc- dress the fiscal constraint by allowing policy tivity in the past. With nearly 200 million small agents to combine the public services they are farms and rising wages, China needs a cost- charged with providing and commercial activi- effective extension system to help it meet fu- ties (in this case, farm management advice and ture production goals and objectives. Currently, input sales), however, the extension system is in disarray, In industrialized countries the research and and the quality and quantity of extension ser- extension agenda is largely determined by pro- vices are declining. The government has shown ducers through farmer organizations. However, a keen interest in stemming this deterioration. in developing countries, research and extension Some options are currently being pursued institutions typically lack accountability to farm- that may point to the future direction. Although ers and often "push" technologies rather than relatively rare, farmers are beginning to form eliciting farmer needs. This was demonstrated producer groups and associations in relatively in a recent survey by CCAP that found a gap circumscribed areas that contract with profes- between the opinions of extension agents (and sional agriculturalists, aquaculturalists, forest- officials and breeders) and farmers regarding ers, and livestock specialists to purchase the the types of technologies needed. For example, latest information on varieties and species, pest higher-yielding varieties were perceived by 81 control, and other cultural practices. These percent of extension agents (but only 69 per- groups are noticeably in orchard production and cent of farmers), to be a high priority, and 19 fresh-water aquaculture. While this approach percent of the extension staff (but 31 percent of seems worthwhile for nonstaple commercial farmers) felt that farmers demanded high-quality commodities, charging for advice on staple crops varieties. in poor areas would not be feasible; for this, government extension will remain necessary and will be one of the few sources of nontraditional information for farmers in remote regions. I...I.. . . . I . I . . . . . 85 Accelerating China's Rural Transformation We recommend the following steps to main- As these responsibilities are assumed by the tain and improve agricultural extension services: private sector the responsibilities of govern- * Improve effectiveness ofagricultural extension. ment extension will be reduced. This may include improving links with the * Base restructuring of extension programs on research system and establishing formal re- their impact on agricultural production. Al- lationships with the academy system and though agricultural extension must be re- universities. Improved information systems structured, intensive analysis of extension's are needed both in terms of new ideas, tech- impact on agricultural production is needed nologies, and techniques and to speed their before government officials can redefine struc- delivery to farmers. Also, new issues, such tures and determine policy options. Deter- as marketing, will become increasingly im- mining the appropriate policy options will be portant-and need to be incorporated into difficult, as little research and information the extension program-as the economy de- exists about extension in China; with the velops and farmers increase production of exception of recent preliminary work by CCAP, nontraditional crops. Training programs to quantitative analyses of high-quality exten- upgrade the skills of local agents and pro- sion determinants and the impact of exten- vide them with the tools to understand mar- sion on agricultural production is lacking. kets and follow market trends, should provide New research should examine these issues, a high rate of return. assessing at the institutional level the traits * Permit the private sector to participate in agri- and value of successful programs, the im- cultural input markets. This would likely pro- pacts of policies, and alternative ways of de- vide some types of extension services, such livering better information to farmers in a as soil testing and fertilizer recommendation. more timely fashion. CGIAR is a loose-knit group of donors that support 16 institutes around the world with specific research foci, including specific crops, livestock, aquaculture, water resource management, food policy, and agricultural re- search systems. 86 10. Rural Industry Rural industry has made an extraordinary create jobs fell even as output continued to contribution to China's rapid economic growth increase. Employment in township-run enter- over the past 20 years. Its contribution to na- prises, the backbone of the initial rural in- tional gross industrial output rose from 10 per- dustrial movement, has fallen since 1994 and cent in 1979 to nearly 40 percent in 1996 (Dong employment in village-run firms has stag- and Putterman 1997). Output in the rural in- nated. TVE expansion may have reached a dustrial sector grew at an average annual rate turning point in 1997 when the total number of nearly 20 percent during the 1980s, and the of firms and overall TVE employment declined. sector created more than 5 million new jobs Some of the sharpest employment declines annually over 1978-96. In 1997 TVE employ- (or decelerations in the growth rates) have ment declined by 5 million from the 1996 high occurred in some of the coastal areas, the tra- of 135 million employees, but still accounted ditional stronghold of rural industries. Nev- for about 40 percent of total nonfarm employ- ertheless, total value added (which has ment (Jin and Qian 1998; Rozelle, et al. 1997). replaced gross output value as the measure Rural industry also supplied 25 percent of the of output) continued to increase in 1997. nation's total exports in the mid- 1990s (Dong Rural industry continues, however, to have and Putterman 1997). some bright spots. Private firms have increased their share of employment and output (Figure Performance of TVEs 10.1). In contrast to the shrinking collective Despite this sterling record, rural industry's sector, private and cooperative firms increased recent performance-particularly in certain their value added by 9.5 percent in 1997, in- subsectors-has raised concerns over the creasing their share of ruralindustry's total value sector's economic health and long-term added to more than 50 percent (Du 1998). On sustainability. The capacity to create employ- occasion employers in rural areas have hired ment declined in the 1990s (Table 10.1), and migrants at a higher wage rate than employers the marginal propensity of rural industries to in urban areas (Lohmar and Rozelle, 1999). Table 10.1: TVE Employment, by Ownership (millions) Year Total Township Village Othera 1980 30.0 13.9 16.1 n.a. 1985 69.8 21.1 22.2 26.5 1990 92.6 23.3 22.6 46.7 1995 128.6 30.3 30.3 68.0 1996 135.1 29.6 29.9 75.6 1997 130.5 /a Includes cooperative and private, but primarily private. n.o. = not available. Source: Zhongguo Xiangzhen Qiye Nianjian (various years). Accelerating China's Rural Transformation Figure 10.1: Percent of TVE Output Value, by Ownership Type. 1988-1990 1994-1995 Pri a?e Pr..al 26 28. Township Township 36% 34% Co-op Co-op .. Vj~Iag. *. ' Vige Sources: Zhongguo Tongi Nianlian, Zhongguo Qiye Nianjian, and Zhongguo Nongye Nianjian, various years Key Issues and Critical Questions should not be wasted on a sector that is not Facing TVEs evolving on the basis of competitive market prin- The future direction of rural industrializa- ciples. Still others argue that the current struc- tion is widely discussed and debated. Inside tural transformation signals a fundamental shift China, scholars' opinions are sharply divided towards a more market-oriented sector, with im- as to whether the current shakedown signals proved management incentives and autonomy. managerial transformation and consolidation, The incidence of private ownership has risen which would lead to an even more vibrant sector; orwhether their small Figure 10.2: Managerial Contract Evolution scale, limited capital, often remote in TVEs, Sample Data, 1984 - '93 (Percent) locations, and poor management and Percent marketing skills make rural firms 100 inherently inefficient with poor growth potential. Some argue that 80 Fixed wage the inability to let weak firms fail, in 60 part, a consequence of the quasi- public nature of a large part of the 4 fit t l 40 Profit sharing sector, could create another finan- cial crisis. This more pessimistic 20 argument asserts that the shift in Fixed payment managerial authority (gaizhiJ cur- 0 rently underway disguises the 1984 1986 1988 1990 1992 sector's poor performance and more Source: Chen, Hongyi, and Scott Rozelle, "Leaders, Managers and competitive and efficient industrial the Organization of Managerial Contracts in China,"Working Paper, firms will not reemerge. The argu-.. fmsn willher noteseemerge.cTheau- Department of Agriculture and Resource Economics, University of ment further states that fiscal, finan- Caiona.Dvs 98 California - Davis, 1998. cial, and managerial resources 88 I Chapter 10: Rural Industry Box 10.1: Types of TVE Ownership and Control in Rural Industry Type 1: Cont'nnonal Public. Manager-, are salaned employees: g!overnnient is sole rusidual claimant th1rAou!h taxCs and protits- officials are deeply Ltvol%-ed in major busines decisions: and profits. loss. and risk aru borne entirely by goxvernment. Type 2: Liberalized Public. Nlana_er- liave incentive contracts based on firm profitabil- iiy. Lovennent receives income flows both in taxes and profits. inam-ipers risk only re- duced income for poor performance. and government bear, all finaniial risks Type 3: ConlTaci Partnership. Government shares residual with n uiaers whtle firm al-o pays taxes to government. government and imana,-ers are joint residual claimants. risk is shared by both parties. and government commitment is not firmly comili ed to bailina out a loss-making company. Type 4: Leasehol. Mana:gers paY fixed rents to go%ernment in addition to taxe-;. man- axers are residual claimants. nsk is borne by managers. and government is not committed to bailing out the company. Type 5: Private. Nanaaers may seek alliances with go.ernment offi%ials Ior favors or protection. especially fo'r licensn as Type 2 or 3. but ownership and control 1ies complttel with the manager or owner, as does all de nsk: and goerniment is not financially coTmlit- ted to loss-nmakinig companies, althlIougLh profitable companies pay taxes. dramatically, and privatization of collective firms conventional leader-run firms (Type 1) to tradi- is widespread, even in regions with a strong tional private firms (Type 5), and three inter- collective heritage. Also, management author- mediate management structures that have been ity within collective firms is being decentralized, important throughout most of the reform era. as witnessed by the marked shift from fixed- These firms types are differentiated by the na- wage contract to profit-sharing and fixed-lease ture of the incentives faced by, and the scope contracts (Figure 10.2). Policy plays an impor- of, property rights assigned to firm managers. tant role in encouraging this ownership and The extent of local government's concern with managerial evolution, but these policies result losses and willingness to bail out firms in the from economic pressures to innovate. Other event of financial losses also varies along this forces (e.g., fledgling financial reforms in cer- continuum. tain areas) have also created independent and China needed participation by local leaders spontaneous restructuring/reorganizing of ru- to exploit economic opportunities and create ral firms-suggesting the sector is responding profitable enterprises in the 1980s, as the coun- to a changing economic environment (Jin and try lacked well-functioning factor and product Qian (1998); Kung 1999). Efforts to resolve this markets and had minimal expertise in business debate have been hampered by lack of infor- management, and the political environment (ex- mation on recent changes and the factors af- cept in the southern provinces) eschewed pri- fecting recent performance of rural industry. vate enterprise efforts. The strong incentive to generate tax revenues and create a source of The Evolution of Firm Management local income pushed local leaders to initiate rural Five different institutional forms have industrialization. At the same time, high de- emerged to dominate the enterprise landscape mand and the perception of rich earnings at- at different times and locations (Walder 1998). tracted them into enterprise management. In As shown in Box 10.1, these firm types can be Guangdong and Fujian Provinces, however, more arranged along a continuum that ranges from developed markets, a more liberal political en- . . . . . . ..I . .I.-. . I. . . . . I . . 1 . . 1 1 . .. . I . . . 89 Accelerating China's Rural Transformation vironment, and financial inflows from overseas mand and faltering investment. Demand has Chinese reduced the need for leaders to be in- fallen, partly because the Asian financial crisis volved. Because high demand and low interre- has affected exports and weakened domestic gional competition guaranteed high profits for consumer confidence, and partly because of do- most early entrants, various types of firms co- mestic market conditions. Lower remittances existed, even if some were relatively inefficient due to migrant layoffs have constrained rural and poorly managed. purchasing power, while SOE and government Over time, however, the opportunity to gen- reorganization have adversely affected urban in- erate quick and large profits gradually disap- comes. Concurrent tight credit policies in 1996 peared under economic pressures, causing and 1997, new regulatory limits on the activi- localities and enterprises to rethink their tradi- ties of informal financial institutions, and policy tional managerial strategies. Growth created failures related to interest rate ceilings, man- monitoring problems for leaders by increasing agement of nonperforming loans, and financial the number of firms (Chen and Rozelle 1998). sector reforms have restricted investment capi- Rising competition from the massive entry of tal. firms reduced profit margins (Naughton 1994), and declining profits created new fiscal concerns Credit Shortage and and reduced the ability of local officials to save Creditworthiness2 faltering firms (Walder 1995). At the same time, Rural financial reforms have curtailed credit improving markets for some inputs reduced the to all but the best-performing firms in the 1997- need for leadership intervention in business 98 period, an action which has severely re- activities (Pan and Park 1998; Chen and Rozelle strained TVE development. Both investment and 1998). These trends induced local leaders to operating-fund shortages continue to constrain seek enterprise divestiture and encouraged TVE growth and consolidation, including pri- privatization, and better-motivated, more-inde- vate-sector enterprises, as access to formal credit pendent managers have emerged in many of is limited. Capital access depends on the sup- the remaining collective enterprises. Economic ply of domestic savings and capital inflow, its and transition pressures also have triggered the competitive allocation, the creditworthiness of rapid expansion of private firms. the applying enterprise, and pressures by lead- Other problems affect the performance of ers to influence loan decisions. Throughout the rural industries. Economists place much of the reform period, capital from the formal banking blame for the sector's current ills on falling de- sector-ABC and RCCs-has been insufficient Box 10.2: TVE Credit Constraints Weak credit relations betrwe 1e T1VE, -.uid b.uik center,; on operatin entena. financial positinris. and Him profitablily. T\ Es frequentLh hav multiple f11inanal and aIountmlW records. whiCII are used For different purpocsIcs un.. ta authoriies. banks and credit authonties. L:overnmer-t wnersl. AlMso. TVEs lack qualified arccuntants. auditrs. and other financial staff fanuliar with incdern accIountin- methods. In the absence ot a lar.e traininiz progLra.m. this problem will reniiin. leadint to co:-ntinued misinfonned lendini dei-isiuii. Protits. taxes. and defitned fees are routnlmvY bubmitted to appropriate tio%ern- ment authorities. but [ncal go'.ernneint departments also ipose unauthorzed Ices and levie, that rmakr pirnnin ca-h floi%- difficuili. T-tE asers are often o%ertaied and debt financinQ is excesswe. and altholugh debt ratio. are generallv lower thjan tlirse (i SOEZ.. and present excessive (redit risks to iinancial irstitution 90 Chapter 1 0: Rural Industry to meet TPVE needs. Consequently, enterprise creditworthiness of some TVEs. Problems as- expansion has been closely tied to the capacity sociated with the collective ownership and man- of TVEs to generate internal funds or obtain agement of TVEs, include (a) financial position informal credit. and operation misinformation, (b) fee irregu- TVEs are disadvantaged by credit policy, as laities imposed by local governments, (c) ex- they are among the first to suffer when credit is cessive profit remittances, (d) idiosyncratic tightened nationally (Zhu and Brandt 1997). TVE management changes and strategic bankrupt- gross output value has declined only once, in cies, and (e) excessive debt. Not al TVEs suffer 1989-also the only year that ABC and RCC from these deficiencies. Neither are all these lending declined. However, other low-growth deficiencies likely to apply to any particular set periods in 1988, 1990, and 1994 similarly co- of TVEs. However, these deficiencies are found incide with low credit expansion. Thus, to the increasingly in many TVEs. extent tight credit was intended to cool off an While part of these problems stem from overheating economy, it has succeeded with underdeveloped institutions, another part arises TVEs. Other officials would argue that tighten- by conscious choice and is an inevitable conse- ing credit to TVEs is a rational policy that should quence of China's legacy. Government at vani- continue regardless of the overall macroeco- ous levels has multiple objectives beyond profit nomic environment, since the sector has an maximization, including expanding employment, inherently poor future. sales, tax revenues, and gross output value. in The falling access by TVE_s to loans from the pursuit of revenues, the local govermnents of- formal sector also has a more chronic element. ten require specific amounts of funds be remit- TWE borrowing declined appreciably between ted, regardless of whether the enterprise is 1986 and 1995-falling from 7 to 8 percent of profitable. When local governments change the national loan portfolio in the early 1 990s to management of heavily indebted TVEs, the new 3 to 4 percent in 1996/97-and, as a propor- management often will not recognize debt ac- tion of total liabilities, declined from more than cumulated by previous management. Although 40 percent to less than 30 percent. LoanS3 as a the owners (local government), not the manag- proportion of TVE output value declined from ers, are legally liable for the debt, and credit about 15.5 to 6.5 percent during the decade institutions are unlikely to seek judicial inter- (Figure 10.3). Loans as a percent of net fixed mediation. assets show a similar pattern (at a higher ___ percentage level) with large ratio declines in 1988-90 and 1994. These findings are sup- Fgr 03 akBroiga ported by a source of funds itemization for Preto collective TVEsby Cheng (1998) which shows TVE Output Value a 30 percent reduction in the proportion of Pecn funds provided by ABC and RCCs between 16 1991 and 1994 (somewhat less than the 1 4 decline shown in Figure 10. 3, which includes 12 all TVEs). 10 The plight of TVEs in their quest for fi- 8 nancial resources also may result, in part,6 from their own management and character-4 istics of the firms in the sector, generally. 0 _________________ Banks, especially those who recently have 18 98 19 92 19 been granted better incentives to earn prof- its, may have good reason to question the Source: Bank staff estimates 91 Accelerating China's Rural Transformation The continuing interest of leaders in non- jurisdictional boundaries difficult. Investing in economic criteria is an obstacle to creating more another township, county, or province frequently efficient rural firms. Leaders in many areas re- removes de facto control over assets from the main concerned with, and frequently are re- investor. In addition, because monitoring is also warded on the basis of: enterprise and difficult, investment fund users frequently have employment creation, joint venture capital at- an opportunity to under-compensate the inves- tracted, export volume, potential tax extraction tor with little fear of detection, or of redress, if or receipts, and indicators other than invest- detected. Receiving a fair hearing outside one's ment profitability and viability. To the extent own jurisdiction is perceived to be quite diffi- that nonprofit criteria receive consideration, lead- cult. ers have motive and opportunity to intervene in These judicial imperfections and undevel- management and operational decisions. In some oped capital markets mean that successfulTVEs instances, interventions have been highly distort- usually must reinvest their earnings in their ing, and may have played a significant role in home locale regardless of rate of return. In ad- the evolutionary path of rural firms. Recent field dition, most opportunities to exploit scale econo- work by Walder has shown that intervention by mies by combining investment funds with those local leaders have kept failing firms afloat for in another jurisdiction, for investment in that employment and other nonpecuniary reasons, jurisdiction, are foregone. Scarce management thus reducing loan access and volume for pri- skills and falling shadow rates of return on capi- vate industry. In contrast, extensive field work tal in areas of expanding rural industry may by a team from Stanford, Toronto, Michigan, partly explain reduced employment growth. The and California found that in many privatized lower relative value of capital makes investments and quasi-privatized firms, profits, efficiency, in labor-intensive industries less attractive, but and financial management have become the pri- field visits have noted that leaders in less-de- mary objectives of firm owners and managers, veloped areas are increasingly interested in at- and that links with local governments have weak- tracting outside investment. Some localities have ened considerably (Shen, 1998). The debate on tried to increase the inflow of investment capi- the future of TVEs centers on whether or not tal, technology, and management skills by of- structural change will lead to reduction in im- fering concession packages designed to overcome portance of nonfinancial goals. the reluctance of investors to invest outside their jurisdictions. Concessions to attract investment Capital Markets, Property Rights, include reduced taxes, guarantees against fee and Constraints to Cross- Jurisdictional Investments Underdeveloped capital markets are a seri- ous structural problem for TVEs and potentially can cause large distortions in investments and other management decisions. Also, weak prop- -ii,4 erty rights over firm assets and ambiguous bank- ruptcy rules and procedures have minimized the effectiveness of using collateral to secure loans (Shen 1998). Instead, banks rely on ex- pensive monitoring and the guarantees of local governments to reduce risk exposure. Rural industry, such as this silk reeling Fuzzy accounting procedures, weak legal factory, typically either uses local raw materials or produces commodities for local markets. Rural enforcement, and continued interventions by industry employs one-third of the nation's non- local political leaders also make investing across agricultural labor force. 92 Chapter 10: Rural Industry assessments, assurances of independent mana- by the less-developed regions to try to emu- gerial authority, and provision of infrastructure. late the policies and institutions of an era Although some cross-jurisdictional investment that no longer exists would be counterpro- has occurred (Du 1998), the perceptions of risk ductive. are still substantial and constrains increases * Use different rural-industrial strategies on the in the flow volume. basis ofgeographical and economic area. Even without rapid industrialization, incomes in Conclusions and Recommendations coastal provinces would have risen markedly Rural industry has been a huge contributor through increased yields; higher crop prices; to China's rapid economic growth. However, the and development of livestock, aquatic, and initial conditions that favored the rapid devel- sideline activities. For poorer, inland areas, opment of rural industry in the coastal prov- focusing on improvements in agriculture and inces and suburban districts around large cities sideline activities and establishing links to no longer exist. Product competition is far more the off-farm labor markets are more promis- intense, and the large profits of the early years ing strategies than establishing rural enter- are no longer feasible. Increased competition prises. For middle-income areas, one option and declining profits have forced consolidation is to establish efficient rural enterprises to of rural industrial enterprises. This is occur- meet local market demands and exploit com- ring especially rapidly in the more prosperous parative advantages-low wages, cheap land, rural regions, and has been underway since the and better access to resources such as elec- beginning of the 1990s. This consolidation will tricity, water, and raw materials. be accelerated for firms that rely heavily on ex- * Establish institutional structures that will limit ports, as the Asian financial crisis has reduced the liability of investors (and banks), reward demand in Asia, and devalued currencies make and penalize managers for their performance, competing country products cheaper. and compensate shareholders for their inter- To support rural industry, China should do ests. Jurisdictions with large-scale TVEs may the following: face increasing problems if they are unable * The advantages of the traditional leader-run to find ways to "privatize" or provide better model have declined rapidly with growth and incentives for their capital-intensive enter- increased competition, and are inappropri- prises. A major challenge to the transforma- ate for developing interior regions. The tra- tion of TVE property rights is to find ways to ditionally pro-collective regions are moving manage the risk of large firms. Private own- rapidly toward leasing and privatization so- ership (or good management incentives) is lutions to their fiscal problems caused by needed, but completing the transition will unprofitable township and village firms. The be difficult unless China can find the appro- interior regions should build on these man- priate institutional arrangements. agement and ownership trends in implement- * Increase TVE access to credit-but ONLYwhen ing industrialization programs. In less such loans are based on financial criteria. If developed regions, emphasize agriculture ard TVEs can not operate profitably, they should related sideline production more than indus- be allowed to go out of business. TVE finan- try, and small-scale family enterprises over cial needs are not well met by the financial larger village- and township-owned firms. markets. Despite being the most dynamic Markets must be allowed to guide investment component of the industrial sector, during decisions, not government-developed strate- periods of tight money, TVEs are the first to gic plans based onfiscal needs. The pattern be cut off. Given their importance in the na- of rural industrial growth, and the evolving tional economy, A way must be found to in- institutional forms, suggests that attempts crease TVE access to credit. One option for _- I I I I I . I . . . I . - . , I 1 1 - I . . ; 9 3 Accelerating China's Rural Transformation improving credit access is to provide explicit viable, China would need a training program funding for onlending or loan guarantees for for mangers of the credit institutions, and small and medium enterprises, and cross- TVEs; a program to improve management jurisdictional investment channeled through skills might include, project design, evalua- the existing financial institutions (ABC and tion, monitoring, accounting and auditing, RCCs). However, property-right reforms and and financial management. The cost of ac- the incentives to enforce them must accom- quiring these skills could be a component of pany a credit program to permit secured lend- a loan. ing and improve loan repayment. To be fully Rural industry includes construction, manufacturing, transportation, and service enterprises located and fall- ing under the purview of township (and lower-level) authorities. They are those enterprises that, because of their rural nature, are supervised by the MOA and, for statistical purposes, are classified as TVEs. 2 This section relies heavily on, Cheng. Enjiang, "Report by Senior Expert on Financial Systems" in "Asian Devel- opment Bank, Township and Village Enterprises Development Project (Part B)," Chinese Economic Research Center, University of Adelaide, South Australia (undated). 2 Outstanding loans at year-end from ABC and RCCs. Working capital loans doubtlessly roll over during the year but assuming no change in rollover frequency changes in the ratio would indicate changes in the importance of credit to output value. 94 11. Poverty Reduction Introduction village communities isolated in upland areas. Since the launching of economic reforms in Land quality in these areas is generally so poor the late 1970s, China has made remarkable that many households are unable to achieve progress in its war on poverty.' During this pe- food self-sufficiency, consume subsistence foods riod, more than 210 million rural residents es- beyond their own production levels, and are caped absolute poverty. Poverty reduction was negatively affected by food price increases. As exceptionally rapid in the early reform years, the poor are risk averse and afraid of lacking between 1978 and 1984 the number of rural food staples, they are unwilling or unable to absolute poor declined by 171 million (World rely on markets for the bulk of their consump- Bank 1992). [Applying the poverty line of $ 1.00 tion needs and devote much of their land to per capita per day suggests that 300 million grain-even if they have no comparative advan- residents escaped poverty between 1981 and tage in its production. Within these communi- 1995, and that about 176 million remained in ties, the poorest households are most often those poverty at the end of 1995 (World Bank, 1997b).] further disadvantaged by high dependency Improving incomes sufficiently to lift 171 mil- ratios, ill health, and other difficulties. Minor- lion people from the grip of poverty in six years- ity peoples are known to represent a dispro- a remarkable feat-was principally achieved portionately large share of the rural poor. No through introducing the household responsi- evidence exists that women are overrepresented bility system and the rapid economic growth among the poor. Confronted with such a chal- that followed. Real per capita income and gross lenges, authorities decided that alleviating the value of agricultural output grew at annual rates remaining poverty required a more intensive of 19.1 and 7.5 percent, respectively, during effort. this period. The poverty stricken generally live in remote Government Poverty Reduction and resource poor areas, but those residing in Program somewhat more accessible and less hilly lo- With the slowing of poverty reduction, the cations, with even mildly responsive soils, were government introduced several antipoverty pro- able to capitalize on the new economic environ- grams between 1984 and 1986. It also estab- ment ushered in with the 1978 reforms. Im- lished the Leading Group for Poverty Reduction proved markets and output prices made modest (LGPR) under the State Council to coordinate use of modern inputs attractive and led to in- those programs and expedite economic devel- creased farm output. Many officials and observ- opment in poor areas. Economic growth did ers believed that poverty reduction achieved revive, and since 1991 another 40 million resi- through rapid agricultural growth was largely dents escaped poverty-about 49 million, or exhausted by 1984. The residual poor remained about 6 percent of the rural population, remained entrenched in poverty in areas that are very in absolute poverty at the end of 1997 (Figure resource poor, with minimal potential for fur- 11.1). ther agricultural productivity gains. Alleviating The government has a strong commitment their plight will require more intensive efforts. to poverty reduction, and most government The absolute poor typically comprise entire agencies and ministries have special poverty Accelerating China's Rural Transformation 1997 funding, reversing the decade of decline. Figure 11.1: Rural Absolute Poor Subsidized credit through the Poverty Re- ons cone duction Fund has become the most important so element of the poverty program. During the late 1980s these funds were allocated primarily to 5 em households to support agricultural production and other income-generating activities (World a0 Bank 1992). However, by the early 1990s bor- rowed funds were generally perceived as finan- 1990 1991 1992 1993 1994 1995 1996 1997 cing consumption rather than production, repayment rates were very low, and economic reduction responsibilities, including, education growth in poor areas had stagnated as evidenced and health programs administered by their re- by the lack of reduction in the number of abso- spective ministries. However, like many other lute poor. The credit focus shifted away from elements of rural society, the antipoverty effort households toward "economic entities" or en- suffers from fiscal problems. The LGPR coordi- terprises that could better coordinate activities nates special development grant funds, admin- requiring new technology, greater input use, and istered through the fiscal system, and the Poverty marketing support (State Council 1991). Fiscal Reduction Fund, which provides subsidized decentralization had created a budgetary crisis in nearly all poor counties (Park et al. 1996). Figure 11.2: Real Investment in Poor which, in turn, created strong incentives forlo- Areas Poverty Reduction Program cal officials in poor areas to invest in revenue- producing enterprises rather than in Y100 mllhon 60 growth-oriented activities, or to divert earmarked Total investment funds to meet fixed expenditure ob- 50 ligations, such as wage payments. 40 Food For Work By the mid-1 990s, it became clear that sub- o- sidized credit directed to enterprises was not 20 meeting rural development and growth objec- 8'r.:.>Lme "&itives. The credit did not appear to stimulate lo- 10 -0 -cal development and loan repayment rates did 0 - ot - 0 - -------9- --- ---- - - - - not markedly improve. The investment approach 1996 1988 1990 1992 1994 1996 was often "top-down" as local officials identi- fied collective projects without due consultation loans for developing poor areas. The regional with farmers-then allegedly required their par- office of the State Development Planning Com- ticipation-in pursuit of scale economies. Rozelle, mission administers a Food for Work (FFW) pro- Park, Huang and Jin (forthcoming) have em- gram that supports the construction of roads, pirical evidence of the failure of China's subsid- potable water systems, irrigation, terracing, and ized credit program in Shaanxi during the early other capital construction works. Funds coordi- 1990s. nated by the LGPR have fluctuated in real terms, When leaders reassessed the poverty reduc- over the life of the program, with little apparent tion effort in the mid- 1990s, the focus of sub- trend (Figure 11.2). Between 1986 and 1995 sidized loans returned to poor households. Since the funds administered through the fiscal bud- then, a debate has raged about how to create get declined by two-thirds in real terms. How- an effective structure. Officials are searching ever, the government revived its commitment for a program that will lead to growth, reduce to poverty alleviation with a sharp increase in poverty, reduce lending costs, and improve re- 96 Chapter 11: Poverty Reduction Even after these adjustments, 2 of the 10 Box 11.1: Microfinance in poorest counties remained outside the program. The uncertain reliability of the income data calls into question whether the counties included were %%ithe sobetitune forOi -i.in ,i~. eprclnIn the poorest. Per capita income statistics from pits prudd1e~ sor upotiad dl;uine the MOA database generate a different list of inmrorbimi.can prod up ian_,, ipeernid- poor counties than that in the State Statistics Lrin, ieto manae ianvtstn-wii nd epal IBureau database. Riskin (1993) suggests that in 1988 more than 60 percent of the poor house- loanrs. holds lived outside officially designated poor Whle mnicrofinance has pir..n n effectiv'e counties, though his survey was not designed for testing these questions. Riskin's work ar- rarely have been evalu ated One evalu'atioin gues that the poverty program should focus on ofn UsiiINDP-fundeidd mit rCtinanlce pr.:'ramn townships or political units smaller than coun- Iin SIC huan Province's Yik.niit county founiid ties. that hou1sehold assets. especIllY hou Leho ld productive o.[ts. cf program participants impact of the Program tiwrea,.ed suIianficily Partic ipantits' othe r In the absence of a comprehensive evalu- welfare improvement s mnelutded mnoie divtr - ation of the poverty program, an impact assess- sitied cruppinG palterns. more train stor - ment must rely on provincial analysis and age. and mort- rronr-tary anecdotes. Data from Sichuan (Rozelle, Zhang, and Huang 1998b) clearly indicate that in 1985 payment rates. This has led to widespread cx- both gross and net per capita incomes were lower periments, one of the most high-profile being in program counties than in poor, nonprogram targeted microfinance programs-which, to date, counties. Over the following decade, incomes have had mixed success. Box 11.1 contains an increased in both groups, but by 1995 incomes example of an effectively managed and targeted in the program counties were considerably microcredit program that is contributing to higher. Income increases in program counties, higher growth. however, did not keep pace with increases in the nonpoor counties. Targeting: Identifying Poor Areas Our statistical analysis of the differences in Antipoverty efforts might well benefit from a growth rates between county groupings sup- narrowing of the government's targeting crite- ported the conclusion that program participation ria from counties to townships or smaller un- increased growth in poor counties. An econo- its. The government has approached poverty metric assessment of income growth in Sichuan targeting by identifying counties with low per (1990-95) indicated that growth in poverty-pro- capita income. A county was identified as poor gram counties was about 3.0 percent less than if its 1985 average rural per capita income fell in nonpoor counties (which grew about 4 per- below Y 300, Y 200, or Y 150, depending on cent annually). Growth, however, was even locational and political factors-including the slower, in the poor, nonprogram counties. presence of large minority populations. Follow- ing numerous targeting complaints, a new tar- Determinants of Growth- geting operation was undertaken in 1994 by Investment Priorities revising the poverty line and adjusting the des- Given that the poverty programs have had ignation of poor counties. Some counties "gradu- positive income and growth impacts, which el- ated," and other were added. Counties included ements have been more efficient in reducing in the poverty program now number 592. 97 Accelerating China's Rural Transformation poverty in participating counties? In the absence investments in other types of infrastructure of a comprehensive evaluation, we rely on as- should be accorded higher priority. Projects that sessments of individual provinces and anec- create an economic environment fostering en- dotes. Rozelle, Zhang, and Huang (1998b) trepreneurship and labor movement, such as estimated a series of regressions to examine the increasing human capital, also support growth. growth and level of income in Sichuan that could FFW programs have been better than sub- be explained by the poverty program. The re- sidized credit in increasing growth in poor ar- sults show that increases in economic activi- eas, although it is not always the poorest that ties that create linkages with the rest of the have benefited the most. Zhu and Jiang (1995) economy, such as the rise in nonfarm employ- show that income rises in FFW project areas, ment or an increase in sown areas for cash crop- with road investments generating the greatest ping, add to growth. Investment in agriculture, benefits. They argue that narrowly defined health and education, and electrification also projects (road building, drinking water, and ir- positively affects growth. Infrastructure invest- rigation) facilitate effective monitoring, and that ments also should positively affect growth, but diversion pressures on FFW resources are less such investments must be in true public goods than those applied to development grants trans- (e.g., roads), should be well designed, and re- mitted through the fiscal system. Unfortunately, quire close monitoring. Also, they should not projects often are not placed in the poorest ar- impose high labor investments on farmers. eas, thus the very poor gain only indirectly. Despite the investment of Y 96.1 billion (nominal) in poor program counties, poverty Investment Options programs have not increased total government expenditures into poor areas. This may be a Education and Health consequence of the fiscal stress that pervades Investments in education and health in most poor areas and the fungibility of resources, al- developing countries have high returns and are lowing officials to substitute antipoverty funds the most direct way to increase labor produc- for budgetary resources in program counties tivity. Also, education enhances labor market- and divert budgetary funds to other counties. A ability and improves the likelihood of successful common problem of poor area investment man- migration. Education and health strategies for agement is the diversion of loans and grant funds poverty alleviation are not components of the to other uses before they can reach local in- LGPR's antipoverty program but are imple- vestment agencies. Only through creative fund mented by the sector ministries. Unfortunately, management, which primarily depends on keep- the fairly regressive fiscal system requires local ing investment funds out of the fiscal system, residents to bear the costs of education, which can large investments be effected in remote rural can reach 25 percent of per capita incomes (Fan areas. 1994). Low revenue bases lead to poor quality- Rozelle et al. (1 998a) found that in Shaanxi schools and underpaid teachers; and the high the targeting of subsidized credit to farmers cost of attending school can greatly reduce the increased growth. Placing funds in the hands demand for education by the poor, who are more of farmers for agricultural investments had responsive to the cost of education. The poor positive growth impacts. However, subsidized must also have access to productive employ- investments into rural collective enterprises and ment opportunities that make education invest- local SOEs did not increase growth. Surpris- ment worthwhile, highlighting the need for ingly, investments in agricultural infrastructure economic integration and well-functioning mar- also had no positive impact on agricultural out- kets. put growth, suggesting either that the projects they selected were poorly chosen or run, or that 98 Chapter 11: Poverty Reduction Box 11.2: India: Government Spending, Growth, and Poverty IFPRI conducted one of the most onprehensixc ux-aluan,on-- ol diret t and indirect un- pacts of infrastructure unvestnets on TFP and on poverty redction. Investments in roads had htile direct inpact on poverty reduction but tiht indirect impact through impro.ed TFP \\as si,inificant and Igreater than a-n other infras nirture uwictment. The results are- repro- duLcid below: Government Expenditure Elasticities on Total Factor Productivity and Poverty Reduction Soil/Water Research & Rural Roads Education Conservation Development Irrigation Electricity TFP 0.0670 0.0427 0.02A0 0. 0160 0.0116 0.00:31 Put riy -0.2230 -40.1760 -0.0057 -0.0033 -0.0024 -0.0014 Note- The coefficients are elasticities, therefore, if government increases rural rood e..pEnditures by 1 percent TFP will increase by 0 067 percent and poertv will decline bv 0.225 percent. Source IFPRI EPTD Discussion Paper Nc. 33, Go%vernment Spending, Groath and Pckert AAnnays,s of frieilinPages in Pural Indio, 1998 Infrastructure margins (Gannon and Liu). A World Bank im- The impact of infrastructure investment on pact evaluation report on a rural road project labor productivity and poverty reduction also is in Morocco concluded that improved roads led potentially very significant. Investments in roads to increased agricultural diversification and and communications increases access to out- increased use of agricultural inputs and exten- side markets, raises returns to labor, makes sion services and led to increased value added production inputs cheaper and more accessible, per hectare. The improved roads also led to in- and facilitates labor mobility. Market develop- creased off-farm earnings, improved quality of ment will reduce price variability and allow education and improved access and use of health greater exploitation of comparative advantage. services (World Bankl1996). Reliable infrastructure is required to integrate poverty areas into the rest of an economic sys- Land Quality tem. International experience shows that rates Where land quality can be improved, doing of return and the impact of poverty alleviation so increases returns to labor. Given relatively vary widely by the type of road built; e.g., inter- equitable distribution of land, improvement in provincial expressways versus dirt roads that land quality can also meet distributional goals. penetrate into remote mountainous locations, The impact of local investment in land-enhane- and all-weather trunk lines into rural farming ing projects by local officials often has been regions (Jacoby 1998). Investments in roads were shown to have a significant impact on agricul- found to have a powerful development impact tural production-and on incomes. World Bank in India (Box 11.2). experience with investments in land improve- Improved transport networks facilitate off- ment and rural infrastructure projects have farm and seasonal employment outside home shown mixed results-indicating the need for villages and reduces the transport costs- more comprehensive ex ante (what is planned thereby reducing farmers' costs of fertilizer and compared with what actually occurs) appraisal other inputs, improves reliable access to out- of projects. While some projects have provided put markets and generally reduces marketing high financial returns to farmers, indirect sub- I I . I . . . . I I - 3 . I I . - . - 1 1 99 Accelerating China's Rural Transformation sidies have made the projects of dubious yields on the well-designed terraces were signi- economic value (see Jingtai Phase 11 project dis- ficantly greater than on unimproved moderately cussed in World Bank 1992). State investment sloping land, but yields did not improve on the in basic agricultural construction has unfortu- "traditional" terraces. Farmer perceptions of nately declined in recent years. The proportion spending time and effort on constructing tra- of the central budget devoted to agricultural ditional terraces are best summarized by the investments has declined to only 3 percent, and 1997 comment of a Henan farmer: "We work, even these are increasingly diverted to meet other we do not get paid, we cannot make other money, pressing expenditure priorities. Local invest- and we do not see our land get any better." ments in projects that enhance land productiv- However, the experience of The World Bank in ity have shown a significant impact on Shaanxi province supports the contention that agricultural production and incomes (Dong well-designed agricultural infrastructure 1998). Data from the Ministry of Agriculture, projects have high rates of return. however, show that local investments occur only in wealthier regions, which represents only a Research and Extension fraction of the rural sector; elsewhere the pro- Research and extension have been the most portion of local budgets devoted to agricultural important source of yield and TFP growth in projects has almost disappeared. the post-reform period. (World Bank 1997). The Accordingly, most land investments rely on national and provincial research system, how- labor contribution. This has many positive as- ever, has given low priority to agricultural R&D pects, but is not a "free" investment. With in- in recent years; very few technologies have been creased returns to temporary migration and developed for resource poor areas (Rozelle, other off-farm activities, corvee labor can have Huang, and Pray 1998). The bias against poor a high opportunity cost, even in the slack sea- areas is even greater for extension and agricul- son. The importance of well-designed invest- tural management services. Low salaries and ments is illustrated by comparing yields following fund shortages have left extension stations in implementation of two terracing projects on many poor areas severely understaffed (Hu, moderately sloped land in Shanxi (Li 1994). One Huang, and Rozelle 1998). used designs prepared by the local agricultural technical college and employed heavy equipment Industrial Development along with local labor to create deep, straight- Many local leaders feel that only through cut terraces with reconditioned soil in each ter- capturing the high value added of successful race bed. The other was a "traditional" terrace industrial development will the plight of poor designed by local officials and constructed with areas change noticeably. Industrial growth is local labor and hand tools. Subsequent crop also perceived as the key to resolving the fiscal Poverty is often concentrated in resource and infrastructure deficient areas where arable land, for subsistence crop production, is of poor quality and available only in small plots. 100 Chapter 11: Poverty Reduction crisis (Wong 1997). Even in poor counties, taxes poverty households. However, even without on industry and commerce account for the bulk migrant remittances, poor households benefit of government revenues. However, TVEs in poor from the decreased demand for food supplies. areas have a high failure rate and have been a Migration may also provide less tangible ben- serious drain on scarce financial capital. Tar- efits, such as access to better information and geting investment and credit to unviable TVE availability of capital. projects may be less effective in successfully Most migration occurs outside official job promoting TVEs than having long-term invest- placement programs. For example, an estimated ing in education, vocational skills, and infra- 15 percent of Shaanxi's interprovincial migrants structure (Rozelle, Park, Huang, and Jin used official labor market channels, but few of forthcoming). By 1990, only 4 percent of the these would have come from the more remote rural labor force in China's 120 poorest coun- and poorest counties. While the potential re- ties were employed in rural enterprises, in con- wards of successful migration are substantial, trast to the 22 percent in the nation as a whole. so are the risks, particularly with spontaneous migration, where there is not only the uncer- Migration tainty of obtaining employment but also the The large differences in wage rates between possibility of exploitation as migrants lack proper rural areas, particularly poor rural areas, and documentation and credentials. The overwhelm- prosperous urban (and rural) areas are power - ingly important migration determinant is a "vil- ful migration incentives. The government does lage network." Past migration will lead to future not maintain comprehensive time-series statis- migration-fellow villagers who can be relied tics on migrant labor, but various estimates have upon for information (and possible financial placed the number as high as 100 million (Rozelle assistance), including potential job prospects, et al. 1998, Huang and Cai 1998). Migration provide a chain to attract new villagers into the destinations have changed from being prima- migrant labor force. rily intraprovincial in the late 1980s to almost equally balanced between intra- and interpro- Conclusions and Recommendations vincial movement in the mid-1990s. The urban Although China has made remarkable markets in the Yangtze and Pearl river deltas progress in its war on poverty, the government are major interprovincial destinations. The char- can do more, including the following: acteristics of migrants also are changing; women * Improve targeting of poverty programs to aim are now entering the migrant labor force at rates at smaller political units, such as townships. higher than men. The poverty program has successfully tar- Migration has made an important contri- geted poor counties and has had positive bution to employment opportunities for many impacts on economic growth. However, im- rural communities throughout the nation. Mi- proved targeting is needed to ensure all the grant remittance statistics are anecdotal but poor are reached. indicate the important contribution to poor ar- * Develop and expand TVEs in poor areas cau- eas. The Ministry of Labor estimated that in 1994 tiously. Projects for carrying out any TVE some 37 million rural migrants in 23 large cit- investments should focus on simple, labor- ies remitted Y 75 billion; the Sichuan Labor intensive production technologies using lo- Bureau reported that the province's 6 million cal inputs-such as processing of agricultural migrant workers remit more than Y 16 billion products-that might offer a comparative ad- annually (World Bank 1997d) and total remit- vantage. tances were Y 200 billion in 1997 (China Daily * Promote labor market development and expand Aug. 7, 1998). Per worker remittances of this labor mobility programs targeting poor house- magnitude far exceeds the per capita income of holds. The quickest means of overcoming . . - . -, - - .1 . I q. . . . I . . . . I . . .I 1 101 Accelerating China's Rural Transformation poverty is successful migration, therefore in- continued. Correcting the mistakes later may creasing and expanding these programs prove difficult. would have an important and immediate * Invest in rural infrastructure. Investments in poverty reduction impact. Such programs agriculture, rural enterprise, roads, and other could expand the pilot poverty reduction rural infrastructure can increase the produc- activities initiated with World Bank as- tivity and income of the poor. However, re- sistance. source constraints in most poor areas limit * Explore ways to expand FFW-Type programs. efficient infrastructure investments. The gov- FFW activities have been particularly suc- ernment should avoid making investments cessful, in part because the funds bypass that do not have reasonably favorable rates the fiscal system and because projects are of return. narrowly defined, easily monitored, and fo- * Increase the amount and quality of research cused on high-return investments. Experi- and technology support, to develop new and ences from other countries that pay low, better technologies for resource-poor areas. self-targeting wages for workers on FFW Little research and technology support ex- projects show that such programs can lead ists for crops and livestock in such areas. to both increased growth and target poor Provincial agriculture bureaus extend exist- households. ing "off-the-shelf' technology packages (of- * Design poverty-reduction programs on the ten designed for irrigated lowlands) to upland basis of detailed consultation with local lead- rainfed areas. Development of applied tech- ers and planned participants. Considerable nologies for resource poor areas is urgently progress in strengthening community par- needed. LGPR should work closely with ag- ticipation has been made in two poverty-re- riculture officials to develop such technolo- duction projects supported by the World gies. Bank. * Maintain and reinvigorate the extension sys- * Expand effective microfinanceprograms. When tern. This should continue to be a high prior- properly designed and implemented, ity in all poor areas. Subsistence agriculture microfinance programs are a proven means will be characteristic of poor areas for many of achieving sustained reductions in poverty. years to come, and one way to increase pro- As experimentation with microfinance ductivity and prevent the near poor from fall- schemes expands, their design and imple- ing into poverty is investment in new cropping mentation will become more critical-and it and livestock technologies. is crucial that interest rate controls be dis- The incidence of poverty in China is calculated by applying poverty lines (two levels) to a constant price distribu- tion of per capita income. The absolute poverty line established at Y 318 per capita per year in 1990 prices reflects the income required to meet minimum nutritional (2,100 calories per day) and nonfood requirements and corresponds to about $0.70 per day in 1985 PPP dollars. The higher poverty line is set at Y 454 (in 1990 prices) equivalent to $1.00 per day in 1985 PPP dollars. Both of these measures are below the World Bank standard of 8 1.00 per day (in 1995 PPP dollars) of consumption expenditure. The Chinese definition of absolute poverty is the basis of the discussion unless otherwise indicated. 102 12. Natural Resource Management and the Rural Environment Photo Courtesy of National Zoological Park Rapid economic growth has contributed to (Table 12.1). Dust storms and "mud rains" in increasing pressure on the natural resource Beijing and other northern cities have dimin- base. Most scholars agree that environmental ished in frequency following the introduction of stress and natural resource degradation are forestry shelter belts (U.S. Embassy 1998) The primarily functions of inappropriate government Yellow river still transports more sediment than policy, lack of appropriate property rights, popu- any other river, but silt trapping has reduced lation growth, and poverty. Increased income the sediment loads from 1.6 billion tons annu- and more rational property rights have, accord- ally before 1960 to 1.2 billion tons subsequently ing to some scholars, led to improvements in (World Bank 1993). National statistics clearly China's rural environment quality. Further im- document the increase in forest cover from 12 provements, coupled with effective regulation, to 14 percent (18 million hectares) between 1980 can improve resource sustainability, soil erosion, and 1995. The area of nature reserves has tripled and land, forest, and groundwater degradation. in the past decade, although protection of these The evidence on the development of China's reserves is not ensured. natural resources in this century is ambigu- However, other measures suggest China faces ous-and subject to conflicting interpretations. a deteriorating environment. Pastures in north- Time-series data on China's land quality show west China and on the Tibet-Qinghai plateau fertility has risen and fallen during the 20th continue to be overgrazed and converted to culti- century and generally has not worsened (Lindert vated lands, although some of the conversions forthcoming). Other measures suggest that the subsequently revert to grassland. Coastal wet- land resource is improving-controls have con- lands are drained for agriculture (primarily rice) tinuously reduced the area suffering from sa- or converted for aquaculture. Statistics are dif- linity and erosion, forested areas have recovered ficult to find, but desertification is said to be from losses in the 1980s, and prevention mea- increasing. Much of the reforested area is sures have reduced the areas subject to floods monocultured, and the drop in natural and old- Table 12.1: Indicators of Rural Environment and Natural Resource Conservation Water Erodible Area Salinity Area Flood Area Forest Total Controlled Total Improved Total Improved Cover (million hectares) (percent) 1975 119.6 40.7 7.1 3.9 22.1 16.1 13-14 1980 118.3 41.1 7.1 4.2 23.4 17.8 12 1985 132.0 49.5 7.6 4.8 24.3 18.5 13 1990 136.0 53.0 7.5 5.0 24.4 19.3 14 1995 163.0 66.8 7.6 5.4 24.4 20.1 1996 182.7 69.3 7.6 5.5 24.6 20.3 n.a. n.a.S=no availabie. o R A Source: China's Ministries of Water Resources, Agriculture, and Forestry. Accelerating China's Rural Transformation growth forest may signal a decline in biodiversity, Legal and Regulatory Framework wildlife habitats, and other environmental ser- China has a hierarchy of laws to address a vices provided by natural forests. broad range of urban and rural environmental Technology's relationship to environmental issues, with the Environmental Protection Law and natural-resource degradation also is am- at the apex. Supporting it are the Water Pol- biguous. Using modern mechanized terracing lution Prevention and Control Law, the Air Pol- equipment on the loess plateau will lead to de- lution Prevention and Control Law, Marine clining erosion, increased production, and ris- Environmental Protection Law, Forestry Law, ing incomes and will initiate a positive cycle of Fisheries Law, Water Law, Wildlife Conservation rising incomes and environmental improvement. Law, Grasslands Law, and Land Management The development of new cold-tolerant varieties Law, which govern specific environmental and of cereals has encouraged their introduction into ecological issues. While the laws establish the marginal areas. In many instances, however, general environmental protection framework, technology improves resource use-new crop implementation authority is vested in the State varieties that incorporate pest resistance will Environmental Protection Commission, a State reduce pesticide use. While heavy applications Council organization. The State Environmental of chemical fertilizers and pesticides have pol- Protection Agency (SEPA-formerly the National luted rural water, this probably has been more Environmental Protection Agency, or NEPA) is a function of inadequate farmer education than the executive arm responsible for supervising the technology itself. and managing environmental protection. Be- Interpretations of the impact of environmen- low SEPA, in all provincial-level administrative tal degradation on growth conflict. Estimates regions, are Environmental Protection Bureaus range from 0 to 15 percent of GDP, but the higher (EPBs). Actual monitoring, implementation, and estimates are based on gross assumptions and enforcement is left to subnational agencies. anecdotes rather than on systematic national Direct controls, implemented through permits data analyses. The Research Center of Envi- or licenses, are the primary regulatory instru- ronment and Development, CASS estimated the ments. Effective environmental conservation and impact of environmental pollution and ecologi- protection problems lie not with the objectives cal degradation on the economy (1992) at Y 200 identified in the laws and regulations, but with billion, about 7 percent of GDP, and concluded their enforcement. that agriculture suffered about half those losses. Because of fiscal resource limitations, SEPA An analysis by Xu (1998) determined that GDP has delegated most supervision authority over losses from ecological destruction declined 7.5 natural resource and rural issues to line minis- percent in nominal terms-50 percent in con- tries and their environmental protection units stant terms-over 1985-93. A similar 1992 study (as is true in most countries) but, unfortunately concluded pollution and degradation costs were production-oriented agencies have obvious con- 4.0 percent of GDP (Xia 1997). A study and flicts of interest-their officials are evaluated analysis by Yu. based on data collected by the on, and rewarded for, meeting production tar- Ministry of Agriculture found, that ecological gets, not environmental protection efforts. losses declined in provinces where economic growth was more rapid and rose in slower- Fiscal Environment growth provinces in northwest and southwest Inadequate fiscal resources are the most China. These findings lend credibility to the serious constraint to environmental and natu- theory that growth reduces pollution and deg- ral resource protection. The government allo- radation. However, some scholars find no long- cates minimal financial resources to term impact on growth (Li Zhou 1998). environmental protection and natural resource 104 Chapter 12: Natural Resource Management and the Rural Environment Table 12.2: National Investment in Environmental Protection, 1991-95 Investments Proportion of Year Current 1990 Yuan GNP Budgetary Total Yuan Yuan Expenditures Expenditures (billion) (percent) 1991 17 19 0.81 5.0 1992 21 16 0.75 5.6 1993 27 17 0.68 5.8 4.4 1994 31 17 0.63 5.4 4.0 1995 35 19 0.57 5.1 3.8 /o Includes extrabudgetary expenditures. Source: China Environmental Yearbook, 1997; and China Statistical Yearbook, 1996. conservation, and only a small portion of that types of actions had left several nature reserves is directed to the rural environment, primarily devoid of biodiversity. The system lacks an in- for forest protection. While real expenditures dependent monitoring or overseer agency to for environmental protection increased modestly resolve growth and environmental conflicts. during the 1990s, relative expenditures declined (Table 12.2). The State of China's Rural Fiscal constraints have led to inaction and Environment and Resource Base conflicts of interest. Staffing resources are Little authoritative information exists on the modest, and local bureaus often have only part- state of China's rural environment and natural time and inadequately trained staff to imple- resource base. Several studies have been done ment and enforce antidegradation policies. on various aspects of degradation and the re- Within the constrained fiscal atmosphere, local sponse of various governmental jurisdictions. leaders frequently give resource control rights However, the evidence is fragmented, anecdotal, to the agencies responsible for protecting re- and based on data of varying degrees of reli- sources-who are then encouraged to use those ability. These problems frequently leave well- rights to generate income for staff salaries and intentioned observers confused and faced with other expenses. This can easily induce agency conflicting evidence and unclear policy options. officials to exploit the very resource they are In other countries, the World Bank has begun charged with protecting. an Environmental Indicators Program, an ef- These fiscal limitations and responses can fort that tries to make a systematic assessment lead to severe consequences for the rural envi- of the available studies, establish in a country ronment. For example, officials charged with what is and is not known about the environ- protecting the nature reserves are provided in- ment, and make the results known to inter- sufficient budgets to implement their responsi- ested parties both inside and outside the country. bilities and often encouraged to use the reserve's China faces a number of challenges but has assets to generate the required income. How- had some success in solving problems in some ever, such income-generating activities often of the most critical areas of rural environment exploit the very resource they are charged with and natural resource protection. The major rural protecting. Harkness (forthcoming) reports that environmental problems are discussed in the a nationwide audit by the Ministry of Forestry following paragraphs. and the World Wildlife Fund found that these I I . s I . I . . z I I I I I - . S . I. . z . I . . . . I I. - . I. . 105 Accelerating China's Rural Transformation Rural Water Pollution cast onto fields and volatizes or leaches nutri- Soil erosion, inappropriate fertilizer nutri- ents (particularly nitrogen) before it reaches crop ent mixtures (particularly excessive nitrogen root zones. Ammonium bicarbonate, which is a application), and excessive pesticide use, coupled particularly volatile form of nitrogen and unique with the lack of integrated pest management to China, remains a substantial portion of the (IPM), at the farm level contribute to rural wa- nitrogen fertilizer applied. In part this may re- ter pollution and create other environmental sult from the conflicting roles of extension staff problems. Industrial and municipal wastewa- who retail agrochemicals to earn revenue but ter discharges are the major polluters of rural also are responsible for educating farmers on water supplies. plant protection and restraining agrochemical TVEs are primarily producers of labor-in- use. tensive products but also produce products that Excessive pesticide application has led to generate air pollution, including cement, brick, environmental, ecological, and economic prob- and tile. While TVEs account for only 10 per- lems. Heavy and frequent applications have cent of the nation's industrial wastewater dis- eradicated the natural enemies of some pests charge, they treat only a small portion of their and led to chemical pest resistance-leading to effluent and contribute more than 10 percent even heavier pesticide applications (International of industrial water pollution. Paper-making is Organization for Pest Resistance Management the most highly polluting TVE activity and ac- 1993). This is particularly true in the control of counts for 44 percent of TVE wastewater dis- cotton bollworm, where the cost of biweekly charge-thus wastewater treatment of paper application has seriously reduced crop profit- mills must be accorded priority. ability in the traditional cotton area. Also, un- Application of chemical fertilizer surged fol- enforced chemical pesticide regulations has lowing the introduction of reforms-growing at permitted individuals and firms to concoct and an annual rate of 7.2 percent, even when price sell pest control cocktails of uncertain strength subsidies were lifted-and was important in the and composition-which has contributed to the spectacular growth of agricultural production. pest resistance problem and may be hazard- Elemental application was 38.3 million tons in ous. The government banned the use of orga- 1996. Fertilizer balance sheets for 1995 nochlorine pesticides (such as DDT) in 1983, (Sheldrick 1997) indicate that nutrient appli- but residues are still found in the soil along the cation is unbalanced, with excess nitrogen and Yangtze river. Regulations stipulate minimum phosphate applications relative to potash. While time periods between final pesticide application some of the excess nutrients may have remained and harvesting of fruits and vegetables and set in the soil, the excess nitrogen is more likely to limits for pesticide residues on food products. be either volatized or leached into the ground- However, the lack of monitoring and enforce- water, streams, and rivers. Soil and Fertilizer ment results in frequent pesticide poisoning and Institute surveys (1991-93) determined that ni- prevents the export of some food products to trate concentration, primarily from nitrogen OECD countries where the tolerance for pesti- runoff, in groundwater surpassed potable wa- cide residues in food imports is very small. Some ter standards by as much as 50 percent in a 10 to 15 million hectares of farmland are re- few locations. Runoff of excess fertilizer nutri- ported to be polluted by pesticides (U.S. Em- ents has been blamed for frequent "red tides" bassy 1997). along the southeast coast that are toxic to hu- Large-scale, continuous monocropping has mans that consume infected shellfish. Fertil- contributed to the rapid increase in grain pro- izer application methods, placement, and type duction but may also have contributed to a of fertilizer applied also contribute to environ- decline in cotton yields in the traditional cotton mental pollution. Much of the fertilizer is broad- areas. IPM research is a proven alternative to 106 Chapter 12: Natural Resource Management and the Rural Environment chemical pest and disease control. While China lands of the northwest. While the primary di- is a leader in IPM, chemical pest control remains rect effect of erosion is a decline in soil produc- the norm. If IPM is to become important it must tivity and crop yields, crop area also declines as be promoted at the farm level and in farmer erosion worsens, although this has not been training programs. captured in available statistics. Also, an area of 1.53 million square kilometers is classified as Salinization desert (Ning 1997). Increasing rates of desertifi- China's massive investment in irrigation cation (land turning into desert) have been re- facilities during the 1960s and 1970s was fi- ported, suggesting that the annual rate of nanced largely by the central and provincial desertification reached 2,460 square kilometers governments. Lower-level infrastructure, includ- in the 1990s. While the spread of desert lands ing minor and tertiary drains, was the financial may be rapid, the reported level of desertification responsibility of lower jurisdictions. Because of is untenable. If in fact the desert were expand- insufficient finances, these drains were never ing at the rates suggested, all the grasslands constructed in some areas. Much of the salin- would have been lost years ago. ization that affects 7 million hectares of irri- A report by the Research Center for Envi- gated farmland can be attributed to inadequate ronment and Development found that erosion drainage and, to a lesser extent, to inadequate and desertification had the greatest impact on water for flushing salts through the soil and GDP. Subsequent work (Huang and Rozelle into the drainage system. About 2.7 million 1995) on the impact of erosion on crop yields hectares of the salinized area is in the North determined that it was small, but statistically China Plain, affecting 12 to 15 percent of the significant. Had it not been for erosion, China's cultivated area in the Hai, Huai, and Yellow river grain yields would have grown about 5 percent basins. The mild levels of salt found will mod- per year more (1983-89). Some erosion is natu- erately reduce the yields of rice, corn, soybeans, ral, and some is caused by inappropriate agri- wheat, and even cotton, a moderately salt-tol- cultural/cultivation practices. The Loess Plateau erant crop. Work by Huang and Rozelle (1995) has been eroding for centuries, exacerbated by concluded that salinization reduced grain yields inappropriate cultivation practices, but most by an average of 7.8 percent in the mid- to late erosion is likely to be the direct result of either 1980s. About 75 percent of the salinity-affected pasture overgrazing, inappropriate conversion areas have received some remedial treatment, to cultivated cropland, and removal of vegetative cover through deforestation and clearing of Soil Erosion and Desertification marginal lands. Erosion was most serious dur- An oft-quoted statistic suggests that China ing the 1950s and 1960s when large-scale for- loses some 5 million tons of soil (including nona- est and pasture conversion was undertaken to gricultural land) to water erosion annually (U.S. meet grain production targets. In recent years, Embassy 1997), but we were unable to deter- pastureland conversion has diminished and mine how this statistic was derived, or by whom. forestry conversion has reversed, but large ar- When sloping or fragile lands are not protected eas have been severely eroded or degraded by with ground cover, or are cultivated inappro- cultivation. Erosion control measures had been priately, accelerated surface runoff and soil implemented on almost 700,000 square kilo- erosion are inevitable. Some 1.53 million square meters through 1996. kilometers are classified as more than slightly eroded (NEPA and SPC, undated). The most Grasslands seriously affected areas are the loess plateau, Converting grassland into cultivated land, the red soils area south of the Yangtze river, the and overstocking and overgrazing, are major black soils of the northeast plains, and the grass- ..-... . . .... .. , . . . 107 Accelerating China's Rural Transformation contributors to desertification. Agricultural policy, particularly the goal of increased grain production and self-sufficiency, historically has been a driving force behind grassland conver- sion and destruction. Although precise data series are unavailable to evaluate the severity - of grassland degradation and desertification, Li (1998) reports that 30 million hectares of grass- lands have been converted to cultivated land, contributing to soil deterioration and desertifi- cation. China's Environmental Action Plan . (NEPA and SPC undated) indicates that in ad- One of rnry nurseries producing conifer dition to the 1.5 million square kilometers of seedingsfor commercial tinberplantations and desertified land, that 1.3 million square kilo- reforestation of watersheds. meters of farmland in northeast, north and sion, and siltation that resulted from massive northwest China were vulnerable to wind illegal cutting of forests for fuel and lumber from erosion. the 1950s through the 1970s prompted the The conversion of grassland to crop land for government to launch a series of large-scale annual crops in low rainfall areas such as Nei national afforestation and watershed protection Mongol often is highly destabilizing unless programs. Some analysts have concluded that irrigable. Planting perennial fodder crops would forest denudation is the most serious natural provide year-round vegetative cover to limit resource problem (Smil 1996); this may have erosion and provide livestock fodder to reduce been valid in earlier years but there is little hard the pressure on the remaining natural grazing evidence to support this view in the mid-i 990s. land. However grassland is still being brought China's afforestation success in the 1980s and under cultivation on a large scale. Cultivated 1990s has been among the world's best, and land in Nei Mongol has expanded by 1.0 million China is one of the few developing countries in hectares since 1990, but the effectively irrigated which forest cover is slowly increasing-18 mil- area has increased by only 0.3 million hectares. lion hectares between 1980 and 1993. How- However, lower quality cultivated land also is ever, the net increase masks changes in the forest reverting to grassland; in the late 1980s and structure and quality (Table 12.3). early 1990s about 100,000 hectares of the an- While Table 12.3 illustrates the importance nual decline in cultivated land represented grass- and contribution of shelterbelts and commer- land reconversions. cial plantations, it also indicates declining for- Analyses by the Lanzhou Institute of Deser- est diversity through cutting of old growth stands tification concluded that 85 percent of deserti- and replanting with monoculture plantations, fication was caused by excessive land conversion, which contributes to deteriorating plant and overstocking, and denudation; 12 percent, by wildlife habitats, declining carbon sequestration, inappropriate water use and industrial construe- and loss of nontimber products (such as medici- tion; and only 3 percent, by natural dune move- nal plants and fungi) that are important income ment (Jin 1995). sources for poor households. Huang and Rozelle (1998) identified the prin- Forestry cipal factors in increasing forest cover as in- Perhaps because the consequences of their vestments that improved land quality-primarily destruction are so evident, forests have fared irrigation, which increased multiple cropping; somewhat better than other ecosystems in the growing off-farm employment; and land-tenure 1980s and 1990s. The catastrophic floods, ero- arrangements for forested land-forests under 108 Chapter 12: Natural Resource Management and the Rural Environment collective management have expanded more per and middle reaches of the Yangtze river, a rapidly than forests under state management. coastal shelter belt, afforestation in the north- Negative influences were increasing population ern grasslands, and rapid-growing commercial density and forest policy. In areas where in- forests. China plans to intensify these programs dividual property rights have improved, forest over the next decade. area has increased substantially. Nevertheless, biased forest policies have induced farmers to Biodiversity cut old growth natural forests and replant with China, rich in biological diversity, contains monoculture trees and orchards. about 10 percent of the world's plants, mam- China is in the forefront of agroforestry tech- mals, birds, reptiles, and amphibians. However, nology, including the successful development over the past few decades, increasing population of methods for interplanting trees with crops. pressures and development activities have The government, and local authorities, encour- eroded China's biodiversity resources. The com- age and finance tree planting to limit soil ero- bination of a large population and limited land sion by wind and water. The practice of planting has led to extensive loss of habitats to agricul- trees around villages, canals, and roads has been tural and aquacultural production, logging, widely adopted, and its positive impact on local fuelwood collection, and livestock grazing. The wind and water erosion has been demonstrated. Chinese Academy of Sciences reports that about The most common use of corvee labor (after road 200 plant species are believed to have become and canal maintenance) is for tree planting extinct and an estimated 5,000 species endan- (Rozelle and Huang 1998). China has embarked gered in recent years because of human activ- on a number of large afforestation programs, ity. including large shelter-belt development projects Recognizing these problems, the government in 13 northern provinces, autonomous regions, has significantly strengthened the policy frame- and municipalities to provide windbreaks, sta- work for environmental protection in general, bilize sand dunes, conserve soils and water, and and for biodiversity in particular. New environ- provide timber resources. However, many shel- mental protection and wildlife conservation laws ter-belt developments are single specie stands, were put into effect in 1989, which facilitated which reduces investment costs, but increases development of a comprehensive system of na- survival risks. Other major programs include ture reserves, and rationalized categories of pro- soil- and water-conservation forests in the up- tection for endangered wildlife. China has also - become increasingly visible in international ef- Table 12.3: Reforestation in forts; In 1992 China became party to the Con- China (1980-93) vention on Wetlands of InternationalImportance Type of Reforestation Area especially as Waterfowl Habitat (the RA1VISAR (million Convention) and the Convention on Biological hectares) Diversity in 1993. These policy changes have been accompanied by increased emphasis on Total area +18 sector planning and management. In 1987 China Timber + 5 produced a national strategy for nature con- Afforested [primarily single species) +21 servation. A National Environment Protection Clear-cut, nonreforested -16 Action Plan approved in 1994 includes Shelterbelts + 6 biodiversity objectives and priorities. The State Commercial Commission on Environmental Protection ap- plantations (including orchards) + 5 proved a Biodiversity Conservation Action Plan Other (ftielwood, national reserves) + 2 (BAP) in 1994. The BAP reviews the present sta- Source: Huang and Rozelle 1998. tus of biological diversity and conservation ef- E I I . - 1 1 I _ _ . I- . 1 . I I I q - . 1 . 10 9 Accelerating China's Rural Transformation forts in China and sets out a comprehensive Conclusions and Recommendations program of requirements for investment, policy China has had environmental protection reform, and technical assistance to strengthen achievements and failures. Beneath the national national biodiversity management and conser- trends, several characteristics appear that may vation. be unrelated to a region's natural ecosystem. As in many other countries, biodiversity pro- We cannot determine whether these patterns tection in China has focused on establishing are related to the environmental awareness and nature reserves. The amount of protected ar- commitment of local leaders, progress in pov- eas has dramatically expanded over the past erty alleviation, reductions in population pres- 10 years. China's more than 700 nature reserves sure, or improvements in property rights. total some 56 million hectares-5.5 percent of Particularly impressive progress has been made the country. The State Forestry Administration in increasing forest resources. These increases has jurisdiction over two-thirds of the reserves, are due, in part, to investments in irrigation and the State Environmental Protection Agency, and to improved incomes and economic growth. Ministry of Agriculture, State Oceanography Thus, further agricultural investments, and Administration, Chinese Academy of Science, policies that shift farmers into off-farm employ- and other agencies administer the remainder. ment will promote further improvement in for- Despite the government's strong commitment estry resources-although increased income to biodiversity conservation, staff levels, man- inequality could mitigate some of the positive agement budgets, and training and performance income effects. standards have not kept pace with reserve ex- A few scholars have attempted to quantify pansion. Few areas are protected or managed the costs of environmental and natural resource effectively, and if current trends continue, bi- degradation, but little analysis has been done ological diversity in many critical reserves will on the cost of degradation prevention or reduc- diminish dramatically. The main constraint is tion. It is the comparison of the costs and ben- fiscal resources, which leaves nature reserves efits of environment and natural resource with insufficient funds and staff to effectively protection that is relevant to policymakers. perform their protection and management re- Strong analytical evaluations of the costs and sponsibilities. Given the prevailing fiscal con- benefits of degradation prevention and reduc- straint, reducing the number and area of nature tion are needed as a basis for deriving more reserves-and improving the management of the rational policies for environmental and natu- remaining reserves may improve biodiversity ral-resource protection. China might consider protection. This would necessitate a review of initiating collaboration with the World Bank's the entire Nature Reserve system to rationalize Environmental Indicators Program to collect and public holdings. analyze the environmental research available on China. The quality of environmental research varies, and thus the findings must be inter- preted cautiously. More research is needed to define accurately the problems and remedies. Financial constraints have pushed protec- tion responsibilities to local production agen- cies, which have inadequate environmental training, few resources available for monitoring and enforcement, and-most crucially-few incentives to implement national and regional China is rich in flora and fauna biodiversity, but habitat loss has endangered regulations. However, even if other constraints some unique species. were removed, the fiscal shortages are so se- 110 Chapter 12: Natural Resource Management and the Rural Environment vere that officials may have to exploit the very As many nature reserves have local commu- resources they are charged to protect to earn nities within their boundaries, the develop- income for staff salaries and expenses. With ment of sustainable participatory appropriate incentives, rural development can mechanisms for community-based resource attract private investment into several activi- management is a high priority. ties, but environmental protection is not among * Reform agricultural regulatory institutions/ this select group. Therefore, resources to pro- agencies relating to plant protection and pub- vide environmental protection, maintaining lic health (livestock and food) processing, etc. biodiversity, and sustaining long-term use of * Provide better education for farmers on bal- natural resources must come from government anced nutrient application and timing, fertil- budgets. izer placement, soil incorporation, and pollution The issues of environmental protection, pol- implications of overuse. lution control, and sustainable management of To support the forestry sector, China should natural resources are so complex and have take the following steps: impacts over such long time horizons that with- * Eliminate remaining distortions in the policy out well designed regulations, market failure framework, particularly the high level of do- (exacerbated pollution and unsustainable ex- mestic protection that impedes efficient inter- ploitation of natural resources) is quite possible. national trade, and the very high level of Experience indicates that rapid economic taxation on timber products. growth, fertility deceleration, and poverty re- * More rigorously implement sustainable land duction contribute to alleviating environmen- use requirements in the legal_framework, par- tal degradation, but fully adequate protection ticularly greater enforcement of rules related can be provided only if a regulatory program is to annual allowable cuts in naturalforests. enforced. To make such efforts more success- * Expand forestry resources to support contin- ful, several changes are needed, including the ued growth in construction and following: agroprocessing-with an emphasis onproduc- * Make regulations specifying standards, pen- tivity gains through improvements in silvicul- alty schedules, monitoring criteria, and en- tural technologies, particularly planting stock forcement provisions more precise. development and silvicultural management. * Maintain Natural Resource policy with the line * Shift geographical focus of afforestation ac- agencies but allocate the responsibility to tivities from the more developed southern and bureaus above the county level to avoid local coastal provinces to the poorer inland prov- fiscal and staffing constraints. ices, with appropriate adjustments to silvi- * Commit more ftnancial and staff resources to cultural technologies that reflect the strengthen the capacity of SEPA and Provin- socioeconomic requirements of poor house- cial EPBs to monitor natural resource protec- holds. tion, develop databases, and provide * Develop more participatory approaches for independent advice to government on the state designing and carrying out large-scale affor- of natural resources. This should include a estation campaigns to strengthen incentives national land use mapping exercise using for sustainable resource management by lo- satellite imagery and other available data, to cal communities. provide a comprehensive baseline against * Develop comprehensive integrated manage- which further trends can be measured ment plans for forest resources, particularly * The number and size ofnature reserves should natural forests, to maximize economic and be rationalized consistent with the resources environmental benefits for local communities. providedfor their maintenance and protection. . . . . . . . . . . . . . . . . . . . . . . . . . . 111 Annex: Policy and Action Matrix Issue Action > Macroeconomic Policies and Framework * Policy framework is urban-industrial biased * Remove any remaining barriers to rural mi- * Rural incomes are low. gration. (M-L) * Rural labor force buffers urban-industrial needs * Develop programs to retrain and redeploy by providing labor during boom periods and ab- laid-off (redundant) urban laborers and not sorbing labor during slack periods. displace rural migrant laborers, forcing them * Massive rural-to-urban financial transfers oc- to return to rural areas. (M-L) cur through the banking and credit institutions * Discontinue administered interest rates and other transfer policies to ensure financial flows represent only rational transfers of funds from low- to high-return sectors. (M) O Rural Fiscal Policy and Management * Ineffective control of taxes has resulted in poor * Recentralize taxation authority and control redistribution and reallocation of collected rev- and establish reallocation mechanisms and enues. provide incentives that ensure significant * Low, inadequate and secular decline in tax rev- resources are transferred from affluent to enues (as percent of GDP) and therefore lack of poor areas. (M) resources to undertake: * Broaden tax base, including; expanded user * Rural infrastructure investment; taxes/fees, legitimize transparent off-budget * Manage and protect resources; and levies, make grain quota taxes explicit, con- * Provide public goods and services. sider transferring lowest fiscal accountabil- * Large off-budget revenue collection. ity from township to county to reduce salary * Unfunded expenditure mandates encourages and wage costs and implement if feasible. misuse of budgetary resources and undermines (M) incentives to implement policies. * Provide funds for mandated expenditures. (S) O External Trade Policy and Institutions Trade remains government controlled. Permit market to determine trade patterns. * State trading monopolies control the trade in * Promote, and phase-in trade competition, grains, cotton and major production inputs over a manageable period. Even if China * Grain tradde quotas but are maintained as con- maintains a closed trade policy, market com- fidential information, unavailable to the public petition would increase efficiency. (S-M) and exacerbates domestic supply and price vola- * Phase out state trading; even if China re- tility. moves on-tariff trade barriers a monopoly state trading firm could unilaterally block trade. (M) * Discontinue trade quotas and the grain self- sufficiency policy; address food security through trade linkages with multiple sup- pliers and long-term contracts. (S-M) Accelerating China's Rural Transformation Issue Action U Foreign Direct Investment in Agriculture and Agriculturally Related Manufacturing Lack of technology-intensive foreign direct in- * Design incentives to stimulate investments vestments in agricultural industries. in priority subsectors. (M) * Eliminate unnecessary investment restric- tions, such as joint venture requirements. (S-M) * Publicize and strictly enforce intellectual property rights for agricultural technology. (S) * Liberalize domestic marketing constraints permitting transnational firms to establish and control distribution networks. (S-M) > Agricultural Pricing and Marketing Policy and Institutions * Government intervention in grain subsector re- * Rely more on the private sector and market mains strong and costly. Roles of various gov- forces to improve agricultural resource allo- ernmental jurisdictions in implementing grain cation and farmer incomes. policy have been unclear. * Discontinue government determined grain * Farm-delivery quotas still levied on farmers. quotas and prices. (S-M) * Farmgate prices for grain are government de- * Liberalize grain procurement and permit termined. private traders to compete on an equal ba- * Farmgate procurement of grains is monopolized sis with the grain bureaus. (S) by parastatal grain bureaus. * Reevaluate self-sufficiency and grain reserve * Government maintains large volumes of grain policies with the objective of reducing gov- stocks-although exact amount is confidential. ernment grain stocks and cost. (S-M) * Price variability high and increasing. * Clearly separate the commercial and policy * The commercial and policy functions and fnan- functions of the grain bureau. (S) cial accounts of the grain bureau companies * Assess costs. benefits, and feasibility of es- overlap. tablishing price stabilization program. (S-M) * The lack of standardized phytosanitary proce- * Design, establish, and enforce national quar- dures, shipping documents, and transit fees im- antine and phytosanitary standards appli- pedes interprovincial marketing of nongrain cable to all inter-jurisdictional commodity commodities. movement. And if standards are met, pro- * The absence of comprehensive and consolidated hibit interjurisdictional embargoes on agri- information on markets (prices, quantities, and cultural commodities. (S) qualities) handicaps the marketing of farmers * Consolidate market information systems and traders. under the auspices of a single central agency. * In the absence of farmer marketing associa- (S) tions, farmers have few marketing options and * Encourage and promote farmer marketing receive relatively low prices. associations through legislation and intro- * To increase tax bases and add value locally some duce training programs for association man- counties prohibit cross border procurement of agement staff. (S) agricultural commodities for processing-result- * Invest more in rural infrastructure where ing in many scale-inefficient agroprocessing economically merited. (S-M-L) plants. * Insufficient public infrastructure impedes effi- cient marketing and transport of agricultural commodities 114 Annex: Policy and Action Matrix Issue Action > Rural Finance * Rural credit institutions more concerned with * Assign policy lending to an institution with- policy lending than commercial lending out commercial responsibilities to ensure * Rural credit institutions have weak capacity to policy and commercial lending are fully sepa- evaluate loans. rated. (S) * Both rural industries and farm households are * Permit and encourage competition and in- credit starved. novation, such as new deposit instruments * Lack of alternative deposit instruments with attractive combinations of return and * Unsustainable credit subsidies for anti-poverty liquidity. (S-M) lending * Deregulate interest rates. (S-M) * Discontinue subsidized and unsustainable credit programs for poverty alleviation and refocus on micro-finance programs or other household-based poverty alleviation pro- grams. (S-M) * Develop institutions and introduce training programs for staff of rural fnance institutions including micro-finance programs staff. (M-L) > Resource Management D1 Land * Lack of land rental market inhibits efficient use * Continue to analyze costs and benefits of of land and labor. alternative land rights regimes and experi- * Tenure security may be undermining invest- ment with rental markets and tenure arrange- ment incentives and the emergence of credit ments to improve land management. (S-M) since land cannot be used as collateral. Many farmers favor cuirent land tenure system be- cause collectively held land provides security. D Water * Insufficient water resources available in north- * Expedite construction of one or more routes ern China to meet aggregate requirements. of the South-North transfer scheme. (M] * Inefficient use of existing water supplies. * Conduct a study of conveyance and delivery * Large budgetary requirements for maintaining efficiency; rehabilitate systems, line canals systems. and introduce improved technologies where economically efficient. (M) * Expand collection, treatment, and reuse of municipal waste water. (M) * Introduce a rational system of volumetric measurement and water pricing. (S-M) * Expand self-financing water enterprises to manage water supplies and operate and maintain irrigation systems. (S-M-L) * Establish training program for management staff of water enterprises. (S-M) * Discontinue grain quotas and other produc- tion constraints to permit farmers to produce commodities consistent with their compara- tive advantage. (S-M) - 115 Accelerating China's Rural Transformation Issue Action :1 Natural Resources and Forestry Natural resource and environmental * Consolidate nature preserves and commit degradation. more financial and staff resources to natu- ral resource management and protection services. (M) * Improve training of nature reserve and for- estry staff. (M) * For nature reserves with local communities within their boundaries, develop participa- tory mechanisms for community-based re- source management. (S-M) * Develop integrated management plans and rigorously enforce regulatory framework, including price structure for exploitation and penalties for noncompliance. (S-M) * Invest in rehabilitation of watersheds and grasslands where economically efficient. (M) * Remove forest policy distortions including pricing and tariff protection that impedes efficient international trade. (S-M) * Improve farmer training on application and placement of pesticides and fertilizers. (S-M) > Agricultural Technology L Research * Decline in growth of total factor productivity in * Establish research priorities including sub- agriculture. sistence commodities for poverty groups in * Agricultural research funding has declined in resource poor areas. (S) real terms. * Centralize and increase budgetary allocations * Inefficient allocation of research resources. to agricultural research. (S) * Lack of substantive research by domestic and * Evaluate alternative financing sources, such joint venture firms. as commodity cesses; and if implemented, rigorously monitor collections to ensure funds are not diverted. (S) * Increase cooperation with international ag- ricultural research centers to obtain and adapt new technology to the Chinese envi- ronment. (S) * Encourage international firms to participate in China's agricultural input industry. (S) !J Extension * Formal extension service is ineffective and near * Restructure and revitalize extension service. collapse. (S-M) * Extension funding has declined in real terms. * Improve extension staff training, incorporat- ing new issues such as solutions to market- ing problems and understanding production technologies for nontraditional commodities. (S-M) * Permit the private sector to participate in agricultural input marketing and technical advice. (S) * Promote the formation of commodity pro- ducer groups and encourage them to retain specialists to provide up-to-date information on varieties, pest control, and other cultural practices. (S-M) 116 Annex: Policy and Action Matrix Issue Action > Rural Industry * Rural nonagricultural employment has begun * Increase TVE access to credit and improve to decline. credit agency capacity to evaluate invest- * TVE profitability is declining. ments, monitor and recover loans. (S-M) * Cautiously expand TVE investments in in- land provinces and only after careful evalu- ation of any comparative advantage. (M) * Promote private sector ownership and develop institutional structures which will limit the liability of investors, reward and penalize managers for their performance, and appro- priate compensate shareholders. (S-M) > Poverty Alleviation About 50 million rural residents continue to live in absolute poverty. * Excessive leakage of poverty reduction funding * Improve identification of the poor to permit to nonpoor, also inadequate supervision con- better targeting of antipoverty programs. (S- tributes to poor quality of program works and M) services * Augment supervision of poverty reduction * The remaining poor will require more than eco- programs at the local level to improve qual- nomic growth to escape poverty-because they ity of works and services. (S-M) live in very resource poor areas. * Invest in services and infrastructure that will * Limited funding for development of applied tech- assist the poor migrate or otherwise transfer nologies for upland agriculture-improved up- out of agriculture, including education, trans- land agriculture productivity is crucial to lifting port and communication services. [M) the poor above the poverty line. * Continue experimenting with microfinance and other poverty alleviation programs that are designed to promote household invest- ment. (S-M) * Design and implement anti-poverty programs on the basis of detailed consultation with local leaders and planned participants. (S-M) * Promote small better targeted projects, such as Food-for-Work-which have proven suc- cessful. (S) * Use a portion of central government poverty reduction funding for developing applied upland agricultural technology. 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Zhu, Ling, and Zhongyi Jiang. "From Brigade to Village Community: The Land Tenure System and Rural Development in China," Cambridge Journal of Economics, Vol. 17 (1993):441-461. 132 THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433 U.S.A. Telephone: 202-477-1234 Facsimile: 202-477-6391 Telex: MCI 64145 WORLDBANK MCI 248423 WORLDBANK Internet: http://www.worldbank.org E-mail: Books@worldbank.org This report has been prepared to identify and consolidate information on crucial issues affecting future rural development in China. Prepared with the assistance of Chinese and non-Chinese scholars and analysts, the report assesses strategic options from the perspective of efficiency, equitable development, and growth. It concludes that continued reform will entail further liberalization of production, pricing, and marketing policies; strong government promotion of a market environment; and investments in public services and infrastructure. ISBN 0-8213-4576-1