$Unique_ID{COW00831} $Pretitle{260} $Title{China Chapter 5C. Industry} $Subtitle{} $Author{Thomas R. Gottschang} $Affiliation{HQ, Department of the Army} $Subject{enterprises state percent bank system government prices goods economic industrial} $Date{1989} $Log{} Country: China Book: China, A Country Study Author: Thomas R. Gottschang Affiliation: HQ, Department of the Army Date: 1989 Chapter 5C. Industry The industrial sector employed only about 17 percent of the labor force in 1985 but, as a result of much higher labor productivity than the agricultural sector, accounted for over 46 percent of national income. Industrial units were very diverse in size and technological sophistication, ranging from tiny handicraft manufacturing enterprises to giant modern complexes producing such goods as steel, chemical fertilizer, and synthetic fibers. The majority of the country's large industrial units were clustered in the major industrial centers in the northeast, the Beijing-Tianjin-Tangshan area, the Chang Jiang (Yangtze River) Valley, and Shanghai. Small and medium-size units were found throughout the country, and a number of first-rank plants were located far from the leading cities (see Geographical Distribution of Industry, ch. 7). Ownership of industrial enterprises fell into three general categories: state ownership, urban collective ownership, and rural collective ownership. Industry was dominated by the state-owned sector, which included the largest, most technically advanced, and most important enterprises. In 1985 state-owned enterprises produced 70 percent of national industrial output by value, held 75 percent of fixed industrial assets, and employed 46 percent of the industrial labor force (including rural industrial enterprises). Although all of these units were owned by "the state" in the abstract sense, operational control and effective ownership of specific enterprises were divided among the different levels of government. A few of the largest enterprises were under the direct authority of their respective ministries in the central government. Most major enterprises were owned by the province, autonomous region, or special municipality where they were located or were subject to shared control by the central ministry and the provincial-level government. Small and medium-size units usually were owned by city, prefecture, county, or town governments. Control of some enterprises was shared with higher administrative levels. Workers in state-owned enterprises were paid regular wages according to an established pay scale, as well as bonuses that were supposed to be related to personal or enterprise performance or both. In addition, they received a number of important benefits, including free health care, subsidized housing, and subsidies for such work-related expenses as special clothing and commuting costs. The average income of industrial workers was considerably higher than that of most farmers and was much more stable. Urban, collectively owned enterprises (owned by the workers) for the most part were small units equipped with relatively little machinery. Many of these units were engaged in handicraft production or other labor-intensive activities, such as manufacturing furniture or assembling simple electrical items. In the late 1970s and early 1980s, the government promoted them as a means of using surplus labor to increase supplies of consumer and export goods. By 1985 urban collective industrial enterprises employed over 17 million people, 20 percent of the total industrial labor force. These enterprises held only 13 percent of all industrial fixed assets but produced 19 percent of total industrial output value. Rural, collectively owned industrial enterprises-commonly referred to as "township enterprises" -were the most rapidly growing portion of the industrial sector in the mid-1980s. The government regarded them as a means of expanding industrialization (without further taxing the overcrowded major urban centers), alleviating rural unemployment, and increasing supplies of industrial products in rural areas. Most of the township enterprises were operated by township and town governments, but a large number of very small units were operated by private cooperative organizations called "rural economic unions." In 1985 township enterprises employed 30 million workers, over a third of the total industrial labor force. The value of their fixed assets, however, was only 12 percent of the national total, and their output value came to less than 10 percent of the national total. Nonetheless, in 1985 their income grew by 44 percent over the 1984 levels. The most common products of township industries were building materials, agricultural machinery, textiles, and processed foods. Other Important Sectors Transportation, the postal system, and telecommunications employed over 12 million people in 1985. Long-distance transportation was carried primarily by railroads, inland waterways, and highways. The government- run railroad network was the backbone of the freight system, and rail lines extended to nearly all parts of China. In most areas, however, the rail system had too few feeder lines and was inadequately integrated. Much of the rail system had been improved in the 1980s; many heavily used stretches were converted to double track or upgraded, and several key new lines were constructed to relieve congested areas. Most locomotives in use in the early 1980s were picturesque but outdated steam engines. By 1987, however, several railroad districts had converted entirely to more modern and efficient diesel or electric locomotives, and domestic production of modern engines was supplemented by imported models. Within their limitations the railroads functioned fairly efficiently and made intensive use of the rail network. In 1986 the railroads carried 874.5 billion ton-kilometers of freight, 45 percent of the national freight total and a 7.8 percent increase over 1985. They also carried nearly 1.1 billion passengers, 20 percent of the national total. Despite reasonably good performance, the ability of the economy to move goods between cities and regions was severely limited by deficiencies in the system, and improvement of the railroads continued to be a high priority for state investment (see Railroads, ch. 8). Inland navigation grew more quickly than the rail system and in 1986 carried 827.8 billion ton-kilometers of freight, nearly as much as the railroads. The principal inland waterway was the Chang Jiang and its tributaries, which constituted the major artery linking the industrial and agricultural areas of central China and the southwest to the great port and industrial center of Shanghai. Improvements to the water routes enabled larger and faster modern vessels to use them, extended their navigable length, and reduced the amount of time they were closed each year. In addition to modern vessels, the lakes, rivers, and canals were plied by thousands of motorized and nonmotorized traditional craft of all sizes (see Inland Waterways, ch. 8). Local road networks were extensive, but many were narrow and unpaved, and all were overcrowded with trucks, jeeps, buses, carts pulled by tractors and animals, bicycles, pedestrians, and grain laid out to dry by local farmers. Owing to rapid increases in the volume of private and work-unit trucking, highway freight traffic was the fastest growing major portion of the transportation system aside from ocean shipping. In 1986 highway freight traffic totaled 259.6 billion ton-kilometers, an increase of 47 percent over 1985, and 80 percent of the volume was carried by vehicles that were not managed by state highway departments. In 1986 buses served 4.3 billion passengers for relatively short trips (see Highways and Roads, ch. 8). Civil aviation provided important links both to isolated areas of the country and to foreign nations. It carried, however, only a small fraction of total freight and passenger traffic (see Civil Aviation, ch. 8). The service sector expanded quickly during the reform period, making up for major deficiencies that had developed in the preceding quarter century. In the 1950s and 1960s, services were regarded as nonproductive and were therefore neglected. During the Cultural Revolution, they were relentlessly attacked as "remnants of capitalism." By the late 1970s, the service trades, such as food service, barbering, laundering, tailoring, and repair work, were seriously understaffed and were far from able to meet the needs of the population. Furthermore, they were all concentrated in large, inefficient state-owned units. The service occupations requiring advanced training, such as health care, education, and legal services, were decimated by the breakdown of the education system during the Cultural Revolution decade. Revival of the service sector was a well-publicized goal of the reform program. Legalization of private and collective enterprise quickly led to the appearance of tinkers, cobblers, tailors, barbers, and small food- service stands, particularly in the free markets. Between 1978 and 1985, the number of people engaged in the service trades, retail sales, and catering grew from only 6.1 million to over 25 million, of whom 21 million were in collective or individual enterprises. In 1986 the government further stimulated the growth of the sector by leasing to private individuals or groups a large number of small, state-owned, service establishments, including restaurants, repair shops, and barber shops, that had consistently been operating at a loss under state management. Other service sectors that employed significant quantities of labor included health care, education and culture, and government administration. These sectors were important to the national economy and employed over 25 million people. China produced nearly all of its own medicines and medical equipment, but most hospitals were poorly equipped by Western standards. A more serious shortage was the relatively small number of doctors and other highly trained medical personnel. In 1985 some 4.3 million people worked in health-care institutions. Of these, 1.4 million were doctors-including 336,000 doctors of traditional (rather than Western) medicine, 637,000 were nurses, and 1.4 million were midwives, laboratory technicians, pharmacists, and other technical personnel. The number of doctors of Western medicine grew by over 35 percent between 1978 and 1985, and renewed contact with the West opened training opportunities in Europe, the United States, and Japan. Only a little over 10 percent of all Chinese received free medical care. Free care was provided to government workers, military personnel, teachers, college students, and workers in state-owned enterprises. A portion of the medical expenses incurred by their dependent family members was covered by the work units. Most rural towns and villages operated voluntary cooperative medical systems (see Health Care, ch. 2). Educational and cultural institutions employed 12.7 million people in 1985. This total included 871,000 teachers and staff in institutions of higher education, an increase of 68 percent over the number in 1978, reflecting the intensive reconstruction of the education system in the 1980s. There were nearly 8 million people working in government administration in 1985. Planning Until the 1980s the economy was directed and coordinated by means of economic plans that were formulated at all levels of administration. The reform program significantly reduced the role of central planning by encouraging off-plan production by state-owned units and by promoting the growth of collective and individual enterprises that did not fall under the planning system. The government also endeavored to replace direct plan control with indirect guidance of the economy through economic levers, such as taxes and investment support. Despite these changes, overall direction of the economy was still carried out by the central plan, as was allocation of key goods, such as steel and energy. When China's planning apparatus was first established in the early 1950s, it was patterned after the highly centralized Soviet system. That system basically depended on a central planning bureaucracy that calculated and balanced quantities of major goods demanded and supplied. This approach was substantially modified during the Great Leap Forward (1958-60; see Glossary), when economic management was extensively decentralized. During the 1960s and 1970s, the degree of centralization in the planning system fluctuated with the political currents, waxing in times of pragmatic growth and waning under the influence of the Cultural Revolution and the Gang of Four. At the national level, planning began in the highest bodies of the central government. National economic goals and priorities were determined by the party's Central Committee, the State Council, and the National People's Congress. These decisions were then communicated to the ministries, commissions, and other agencies under the State Council to be put into effect through national economic plans. The State Planning Commission worked with the State Economic Commission, State Statistical Bureau, the former State Capital Construction Commission, People's Bank of China, the economic ministries, and other organs subordinate to the State Council to formulate national plans of varying duration and import. Long-range plans as protracted as ten and twelve years also were announced at various times. These essentially were statements of future goals and the intended general direction of the economy, and they had little direct effect on economic activity. As of late 1987 the most recent such long-range plan was the draft plan for 1976-85, presented by Hua Guofeng in February 1978. The primary form of medium-range plan was the five-year plan, another feature adopted from the Soviet system. The purpose of the five-year plan was to guide and integrate the annual plans to achieve balanced growth and progress toward national goals. In practice, this role was only fulfilled by the First Five-Year Plan (1953-57), which served effectively as a blueprint for industrialization. The second (1958-62), third (1966-70), fourth (1971-75), and fifth (1976-80) five-year plans were all interrupted by political upheavals and had little influence. The Sixth Five-Year Plan (1981-85) was drawn up during the planning period and was more a reflection of the results of the reform program than a guide for reform. The Seventh Five-Year Plan (1986-90) was intended to direct the course of the reforms through the second half of the 1980s, but by mid-1987 its future was already clouded by political struggle. A second form of medium-range planning appeared in the readjustment and recovery periods of 1949-52, 1963-65, and 1979-81, each of which followed a period of chaos-the civil war, the Great Leap Forward, and the Gang of Four, respectively. In these instances, normal long- and medium-range planning was suspended while basic imbalances in the economy were targeted and corrected. In each case, objectives were more limited and clearly defined than in the five-year plans and were fairly successfully achieved. The activities of economic units were controlled by annual plans. Formulation of the plans began in the autumn preceding the year being planned, so that agricultural output for the current year could be taken into account. The foundation of an annual plan was a "material balance table." At the national level, the first step in the preparation of a material balance table was to estimate-for each province, autonomous region, special municipality, and enterprise under direct central control- the demand and supply for each centrally controlled good. Transfers of goods between provincial-level units were planned so as to bring quantities supplied and demanded into balance. As a last resort, a serious overall deficit in a good could be made up by imports. The initial targets were sent to the provincial-level administrations and the centrally controlled enterprises. The provincial-level counterparts of the state economic commissions and ministries broke the targets down for allocation among their subordinate counties, districts, cities, and enterprises under direct provincial-level control. Counties further distributed their assigned quantities among their subordinate towns, townships, and county-owned enterprises, and cities divided their targets into objectives for the enterprises under their jurisdiction. Finally, towns assigned goals to the state-owned enterprises they controlled. Agricultural targets were distributed by townships among their villages and ultimately were reduced to the quantities that villages contracted for with individual farm households. At each level, individual units received their target input allocations and output quantities. Managers, engineers, and accountants compared the targets with their own projections, and if they concluded that the planned output quotas exceeded their capabilities, they consulted with representatives of the administrative body superior to them. Each administrative level adjusted its targets on the basis of discussions with subordinate units and sent the revised figures back up the planning ladder. The commissions and ministries evaluated the revised sums, repeated the material balance table procedure, and used the results as the final plan, which the State Council then officially approved. Annual plans formulated at the provincial level provided the quantities for centrally controlled goods and established targets for goods that were not included in the national plan but were important to the province, autonomous region, or special municipality. These figures went through the same process of disaggregation, review, discussion, and reaggregation as the centrally planned targets and eventually became part of the provincial-level unit's annual plan. Many goods that were not included at the provincial level were similarly added to county and city plans. The final stage of the planning process occurred in the individual producing units. Having received their output quotas and the figures for their allocations of capital, labor, and other supplies, enterprises generally organized their production schedules into ten-day, one-month, three- month, and six-month plans. The Chinese planning system has encountered the same problems of inflexibility and inadequate responsiveness that have emerged in other centrally planned economies. The basic difficulty has been that it is impossible for planners to foresee all the needs of the economy and to specify adequately the characteristics of planned inputs and products. Beginning in 1979 and 1980, the first reforms were introduced on an experimental basis. Nearly all of these policies increased the autonomy and decision-making power of the various economic units and reduced the direct role of central planning. By the mid-1980s planning still was the government's main mechanism for guiding the economy and correcting imbalances, but its ability to predict and control the behavior of the economy had been greatly reduced. The Budget The nature of the state budget also was significantly altered by the reform program. Before 1979 the state budget was the financial component of the national economic plan. It was made up of the budgets of both the central government and the local governments and included the revenues and expenditures of all state-owned enterprises. All profits from state enterprises were remitted to the state budget, and investment funds were allocated from the state budget. Under the reform, there was increased separation of enterprises from direct state control. Enterprises now paid proportional taxes on their incomes rather than remitting their entire profits to the state. Investment funds were, in principle, no longer to be allocated directly to state enterprises from the state budget but were to be obtained from the banking system in the form of interest-bearing loans. In 1985 total state revenues of -Y186.6 billion included -Y51.4 billion in income taxes from state-owned enterprises and only -Y4.4 billion in enterprise incomes. The largest category of revenues was industrial and commercial taxes, which amounted to -Y110.1 billion. Agricultural taxes were -Y4.2 billion, continuing the previous policy of levying only negligible taxes on the farm sector. Revenues also included borrowing equal to -Y9 billion, a practice followed annually since 1978. As of 1983 roughly 30 percent of total revenues were collected by the central government and 70 percent by local governments, while each accounted for about 50 percent of expenditures. In 1985 the largest category of budget expenditure was appropriations for capital construction, which received 31.3 percent of the total allotment. Culture, education, science, and public health constituted the next largest category, with 17 percent of expenditures. National defense, which averaged 19 percent of budgetary expenditures in the 1960s and 1970s, received only 10.3 percent of the total in 1985. Administrative expenses were 7.7 percent of the budget and new technology in enterprises 5.5 percent. In 1984 the state paid out -Y37 billion in price subsidies, an amount equal to 24 percent of total expenditures in that year. The bulk of the subsidies--Y32 billion-was for consumer goods. An important function of the state budget was to transfer resources from prosperous regions to poor regions. The budgets that were finally approved by the Ministry of Finance for the provinces, autonomous regions, and special municipalities allowed surplus funds from affluent areas to be transferred to cover planned expenditures in the deficit areas, while bringing the budget for the entire country into balance. The resulting pattern of revenue sharing between provincial-level administrations and the central government was one in which the advanced industrialized regions paid a much higher rate of net taxation than most areas, and the least-developed regions were heavily subsidized. For example, in 1985 Shanghai remitted -Y8.4 billion in profits and taxes, equal to 4.5 percent of national budget revenues, although it had only 1.1 percent of the national population. The Banking System The history of the Chinese banking system has been somewhat checkered. Nationalization and consolidation of the country's banks received the highest priority in the earliest years of the People's Republic, and banking was the first sector to be completely socialized. In the period of recovery after the Chinese civil war (1949-52), the People's Bank of China moved very effectively to halt raging inflation and bring the nation's finances under central control. Over the course of time, the banking organization was modified repeatedly to suit changing conditions and new policies. The banking system was centralized early on under the Ministry of Finance, which exercised firm control over all financial services, credit, and the money supply. During the 1980s the banking system was expanded and diversified to meet the needs of the reform program, and the scale of banking activity rose sharply. New budgetary procedures required state enterprises to remit to the state only a tax on income and to seek investment funds in the form of bank loans. Between 1979 and 1985, the volume of deposits nearly tripled and the value of bank loans rose by 260 percent. By 1987 the banking system included the People's Bank of China, Agricultural Bank, Bank of China (which handled foreign exchange matters), China Investment Bank, China Industrial and Commercial Bank, People's Construction Bank, Communications Bank, People's Insurance Company of China, rural credit cooperatives, and urban credit cooperatives. The People's Bank of China was the central bank and the foundation of the banking system. Although the bank overlapped in function with the Ministry of Finance and lost many of its responsibilities during the Cultural Revolution, in the 1970s it was restored to its leading position. As the central bank, the People's Bank of China had sole responsibility for issuing currency and controlling the money supply. It also served as the government treasury, the main source of credit for economic units, the clearing center for financial transactions, the holder of enterprise deposits, the national savings bank, and a ubiquitous monitor of economic activities. Another financial institution, the Bank of China, handled all dealings in foreign exchange. It was responsible for allocating the country's foreign exchange reserves, arranging foreign loans, setting exchange rates for China's currency, issuing letters of credit, and generally carrying out all financial transactions with foreign firms and individuals. The Bank of China had offices in Beijing and other cities engaged in foreign trade and maintained overseas offices in major international financial centers, including Hong Kong, London, New York, Singapore, and Luxembourg. The Agricultural Bank was created in the 1950s to facilitate financial operations in the rural areas. The Agricultural Bank provided financial support to agricultural units. It issued loans, handled state appropriations for agriculture, directed the operations of the rural credit cooperatives, and carried out overall supervision of rural financial affairs. The Agricultural Bank was headquartered in Beijing and had a network of branches throughout the country. It flourished in the late 1950s and mid-1960s but languished thereafter until the late 1970s, when the functions and autonomy of the Agricultural Bank were increased substantially to help promote higher agricultural production. In the 1980s it was restructured again and given greater authority in order to support the growth and diversification of agriculture under the responsibility system. The People's Construction Bank managed state appropriations and loans for capital construction. It checked the activities of loan recipients to ensure that the funds were used for their designated construction purpose. Money was disbursed in stages as a project progressed. The reform policy shifted the main source of investment funding from the government budget to bank loans and increased the responsibility and activities of the People's Construction Bank. Rural credit cooperatives were small, collectively owned savings and lending organizations that were the main source of small-scale financial services at the local level in the countryside. They handled deposits and short-term loans for individual farm families, villages, and cooperative organizations. Subject to the direction of the Agricultural Bank, they followed uniform state banking policies but acted as independent units for accounting purposes. In 1985 rural credit cooperatives held total deposits of -Y72.5 billion. Urban credit cooperatives were a relatively new addition to the banking system in the mid-1980s, when they first began widespread operations. As commercial opportunities grew in the reform period, the thousands of individual and collective enterprises that sprang up in urban areas created a need for small-scale financial services that the formal banks were not prepared to meet. Bank officials therefore encouraged the expansion of urban credit cooperatives as a valuable addition to the banking system. In 1986 there were more than 1,100 urban credit cooperatives, which held a total of -Y3.7 billion in deposits and made loans worth -Y1.9 billion. In the mid-1980s the banking system still lacked some of the services and characteristics that were considered basic in most countries. Interbank relations were very limited, and interbank borrowing and lending were virtually unknown. Checking accounts were used by very few individuals, and bank credit cards did not exist. In 1986 initial steps were taken in some of these areas. Interbank borrowing and lending networks were created among twenty-seven cities along the Chang Jiang and among fourteen cities in north China. Interregional financial networks were created to link banks in eleven leading cities all over China, including Shenyang, Guangzhou, Wuhan, Chongqing, and Xi'an and also to link the branches of the Agricultural Bank. The first Chinese credit card, the Great Wall Card, was introduced in June 1986 to be used for foreign exchange transactions. Another financial innovation in 1986 was the opening of China's first stock exchanges since 1949. Small stock exchanges began operations somewhat tentatively in Shenyang, Liaoning Province, in August 1986 and in Shanghai in September 1986. Throughout the history of the People's Republic, the banking system has exerted close control over financial transactions and the money supply. All government departments, publicly and collectively owned economic units, and social, political, military, and educational organizations were required to hold their financial balances as bank deposits. They were also instructed to keep on hand only enough cash to meet daily expenses; all major financial transactions were to be conducted through banks. Payment for goods and services exchanged by economic units was accomplished by debiting the account of the purchasing unit and crediting that of the selling unit by the appropriate amount. This practice effectively helped to minimize the need for currency. Since 1949 China's leaders have urged the Chinese people to build up personal savings accounts to reduce the demand for consumer goods and increase the amount of capital available for investment. Small branch offices of savings banks were conveniently located throughout the urban areas. In the countryside savings were deposited with the rural credit cooperatives, which could be found in most towns and villages. In 1986 savings deposits for the entire country totaled over -Y223.7 billion. Prices Determination of Prices Until the reform period of the late 1970s and 1980s, the prices of most commodities were set by government agencies and changed infrequently. Because prices did not change when production costs or demand for a commodity altered, they often failed to reflect the true values of goods, causing many kinds of goods to be misallocated and producing a price system that the Chinese government itself referred to as "irrational." The best way to generate the accurate prices required for economic efficiency is through the process of supply and demand, and government policy in the 1980s increasingly advocated the use of prices that were "mutually agreed upon by buyer and seller," that is, determined through the market. The prices of products in the farm produce free markets were determined by supply and demand, and in the summer of 1985 the state store prices of all food items except grain also were allowed to float in response to market conditions. Prices of most goods produced by private and collectively owned enterprises in both rural and urban areas generally were free to float, as were the prices of many items that state- owned enterprises produced outside the plan. Prices of most major goods produced by state-owned enterprises, however, along with the grain purchased from farmers by state commercial departments for retail sales in the cities, still were set or restricted by government agencies and still were not sufficiently accurate. In 1987 the price structure in China was chaotic. Some prices were determined in the market through the forces of supply and demand, others were set by government agencies, and still others were produced by procedures that were not clearly defined. In many cases, there was more than one price for the same commodity, depending on how it was exchanged, the kind of unit that produced it, or who the buyer was. While the government was not pleased with this situation, it was committed to continued price reform. It was reluctant, however, to release the remaining fixed prices because of potential political and economic disruption. Sudden unpredictable price changes would leave consumers unable to continue buying some goods; some previously profitable enterprises under the old price structure would begin to take losses, and others would abruptly become very wealthy. The Role of Prices As a result of the economic reform program and the increased importance of market exchange and profitability, in the 1980s prices played a central role in determining the production and distribution of goods in most sectors of the economy. Previously, in the strict centrally planned system, enterprises had been assigned output quotas and inputs in physical terms. Now, under the reform program, the incentive to show a positive profit caused even state-owned enterprises to choose inputs and products on the basis of prices whenever possible. State-owned enterprises could not alter the amounts or prices of goods they were required to produce by the plan, but they could try to increase their profits by purchasing inputs as inexpensively as possible, and their off-plan production decisions were based primarily on price considerations. Prices were the main economic determinant of production decisions in agriculture and in private and collectively owned industrial enterprises despite the fact that regulations, local government fees or harassment, or arrangements based on personal connections often prevented enterprises from carrying out those decisions. Consumer goods were allocated to households by the price mechanism, except for rationed grain. Families decided what commodities to buy on the basis of the prices of the goods in relation to household income. Problems in Price Policy The grain market was a typical example of a situation in which the government was confronted with major problems whether it allowed the irrational price structure to persist or carried out price reform. State commercial agencies paid farmers a higher price for grain than the state received from the urban residents to whom they sold it. In 1985 state commercial agencies paid farmers an average price of -Y416.4 per ton of grain and then sold it in the cities at an average price of -Y383.3 a ton, for a loss of -Y33.1 per ton. Ninety million tons were sold under this arrangement, causing the government to lose nearly -Y3 billion. If the state reduced the procurement price, farmers would reduce their grain production. Because grain was the staple Chinese diet, this result was unacceptable. If the state increased the urban retail price to equal the procurement price, the cost of the main food item for Chinese families would rise 9 percent, generating enormous resentment. But even this alternative would probably not entirely resolve the problem, as the average free-market price of grain--Y510.5 a ton in 1987-indicated that its true value was well above the state procurement price. There was no clear solution to the price policy dilemma. The approach of the government was to encourage the growth of nonplanned economic activity and thereby expand the proportion of prices determined by market forces. These market prices could then serve as a guide for more accurate pricing of planned items. It was likely that the Chinese economy would continue to operate with a dual price system for some years to come. Inflation One of the most striking manifestations of economic instability in China in the 1930s and 1940s was runaway inflation. Inflation peaked during the Chinese civil war of the late 1940s, when wholesale prices in Shanghai increased 7.5 million times in the space of 3 years. In the early 1950s, stopping inflation was a major government objective, accomplished through currency reform, unification and nationalization of the banks, and tight control over prices and the money supply. These measures were continued until 1979, and China achieved a remarkable record of price stability. Between 1952 and 1978, retail prices for consumer goods grew at an average rate of only 0.6 percent a year. During the reform period, higher levels of inflation appeared when government controls were reduced. The first serious jump in the cost of living for urban residents occurred in 1980, when consumer prices rose by 7.5 percent. In 1985 the increase was 11.9 percent, and in 1986 it was 7.6 percent. There were several basic reasons for this burst of inflation after thirty years of steady prices. First, the years before the reform saw a generally high rate of investment and concentration on the manufacture of producer goods. The resultant shortage of consumer commodities caused a gradual accumulation of excess demand: personal savings were relatively large, and, in the late 1970s and early 1980s, there was a booming market for such expensive consumer durables as watches and television sets. Second, the real value of many items changed as some resources became more scarce and as technology altered both manufacturing processes and products. The real cost of producing agricultural products rose with the increased use of modern inputs. Manufactured consumer goods that were more technologically advanced and more expensive than those previously on the market-such as washing machines and color television sets- became available. During the early 1980s, both consumer incomes and the amount of money in circulation increased fairly rapidly and, at times, unexpectedly. Consumer incomes grew because of the reform program's emphasis on material incentives and because of the overall expansion in productivity and income-earning possibilities. The higher profits earned and retained by enterprises were passed on to workers, in many cases, in the form of wage hikes, bonuses, and higher subsidies. At the same time, the expanded and diversified role of the banking system caused the amounts of loans and deposits to increase at times beyond officially sanctioned levels, injecting unplanned new quantities of currency into the economy.