(Reprinted from HKCER Letters, Vol.13, March 1992) 


Economic Reform: The Guangdong Experience

Lau Pui-king


The economic development of Guangdong Province in China, particularly in the Pearl River Delta region adjacent to Hong Kong, has been recognized as a successful case of transition from a planned to a market economy.

The economic reform in Guangdong began with price reform for agricultural products and certain essential consumer goods. Prices were first adjusted administratively and subsequently allowed to find their own level in the open market. As the agricultural sector prospered, farmers began to switch from agricultural production into other economic activities. When household income from these new sources grew, migrant laborers from less developed areas were increasingly hired to take over the farm work.

The government responded to the changing circumstances by relaxing the restrictions on private businesses and hiring of labor, requiring only that the farmers fulfill the agricultural output targets set by the state. These farmers became the first generation of post-reform entrepreneurs. The industrialization of the rural sector is to a large measure the result of their pioneering efforts.

Before 1985, many of these new businesses tried to expand their economic activity into other provinces. Many suffered severe losses due to the lack of market information and the absence of an effective mechanism for enforcing contractual obligations and protecting property rights.

The situation began to change after 1985 with the influx of manufacturing investments from Hong Kong into outward processing activities. This new development was in part a response to the official policy of promoting joint ventures, which were given greater autonomy and preferential treatment. Aside from management expertise, these joint ventures brought with them overseas markets and access to the legal and financial infrastructure in Hong Kong, thereby allowing the investors to minimize their reliance on the rudimentary market institutions for doing business in Guangdong.

The standard of living improved enormously and created a demand for consumer goods and services. The growth of privately owned restaurants and foodstalls operated by local people is the most obvious example. Many of these owners have since become millionaires. These private enterprises were licensed and had to pay a local tax, sometimes specified explicitly in licenses.

Local authorities also began to invest in and operate collective enterprises to compete with the private enterprises. The managers were appointed by local authorities. As officials, they have to fulfill profit targets and provide revenue for the local government. Such arrangements allowed officials to claim that the system was socialist in nature, but at the same time, to transform local officials into productive managers motivated by profit incentives.

Throughout the reform period, the state enterprises continued to lose money and became dependent on government subsidies to survive. Their workers could not get bonuses, and they received only part of their wages. The situation of those in the service sector was particularly bad: bureaucrats, doctors, teachers. In a bid to improve their standard of living and to catch up with inflation, many started to look for employment in the private market. Some worked as private tutors, taxi drivers, street vendors, home decorators, and others even set up training institutes, or clinics, or became builders and contractors.

These people created a vast economy outside the state sector. This informal market economy created income, provided employment, increased supply, stabilized prices, and improved the quality of goods and services. They complemented and competed with the formal state economy. The state accepted the informal market sector because it provided relief for social discontent resulting from inflation and tight government budgets.

Enterprises in the informal market sector played an important role in easing the general shortage of supply. Over time, some of these enterprises were able to develop long-term contractual relations as suppliers for their clients. The state monopoly over supply had clearly been eroded.

The huge subsidies given to the state enterprises to cover their losses became increasingly unacceptable to the state. By the mid-1980's, many of the state enterprises, including heavy industries like iron and steel, petroleum, chemical, metallurgy, and light industries like textiles, began to devise a new strategy to survive. The state decided to allow them to diversify into other activities, like property development, hotels and restaurants, trading supplies, and import and export, through subsidiary corporations which were held accountable through the contract responsibility system.

Some of these corporations were joint ventures with foreign firms. They were often accorded preferential treatment and greater autonomy in decision making. These secondary businesses have since become a major source of revenue to help cover the losses incurred by the parent state enterprise. The policy to allow the state enterprises to engage in secondary business was an attempt to resolve the financial difficulties of the state enterprises. It did not, however, improve the productivity of their primary business. Clearly the ability to diversify into a profitable secondary business was facilitated by the growth of the market economy.

An important consequence of the contract responsibility system is that cadres were being evaluated on the basis of their ability to manage a business. At the county and village levels, cadres function more as managers and professionals than as bureaucrats. In the provincial government, most of the eight deputy mayors possess management experience or are professionals. This change implies that cadres are becoming economic rather than political agents. The introduction of the bonus system has also made it possible for these cadres to receive some of the rewards of their enterprise.

The complexity of the various types of enterprises that have emerged in Guangdong often defies simple classification into either private or state. Many contracts negotiated with these enterprises include practices and arrangements which do not have a legal basis in existing Chinese law. Nevertheless, the contracts have been approved by the authorities.

Many contractual practices and arrangements found in Guangdong are simply borrowed from Hong Kong. Over time, some have become well established and are written into the law. For China, the opportunity to experiment with various contractual arrangements and practices free from ideological shackles and before they become legislation is politically convenient and economically practical. It also helps to foster an environment conducive to further experimentation and reform. While the risk of doing business in Guangdong is not immaterial, what has happened in Guangdong has shown that pragmatism seems to be working.

The success of Guangdong demonstrates that the transition from a planned to a market economy need not result in a worsening of the economy before it starts to improve. It also shows that sustained economic growth requires more than just cheap labor and land. The emergence of a market economy and private enterprises has been far more important for economic success than the attempts to improve the performance of the old state enterprises. The authorities were able to facilitate the growth of the private sector by relinquishing control over the economy step by step in response to changing circumstances. The costs of doing business has been progressively reduced over time by putting in place the appropriate legal and administrative framework. The process of creating laws and regulations that recognize successful market practices ex post is nothing other than building market-oriented institutions.

Ms. Lau Pui-king is the Associate Head of the Department of Business Studies at the Hong Kong Polytechnic.


| Index | Research Projects | HKCER Letters |
| Speaker Program / Conference | Index of Economic Freedom |
The Hong Kong Centre for Economic Research
School of Economics and Finance
The University of Hong Kong
Phone: (852) 2547-8313 Fax: (852) 2548-6319
email: hkcer@econ.hku.hk