Recent exchange rate experience of china

CHINESE ECONOMY

Lecture 13

Belton Fleisher, Haizheng Li, Min Qiang Zhao: Human capital, economic growth, and regional inequality in China.

China’s rapid growth in the past 30 years was fuelled by substantial physical capital investments applied to a large stock of medium-skill labor acquired before economic reforms began. As development proceeded, the demand for high-skill labor grew, and in the past decade China has made substantial investments in producing it. Infrastructure capital is hypothesized to affect GDP through TFP growth, as is FDI. The estimated output elasticities of the three inputs: physical capital, two categories of labor: (i) less-educated workers and (ii) educated workers are used to calculate factor marginal products and also TFP at existing provincial factor quantities. The paper then estimates a TFP growth model in which the arguments are human capital operating directly and through regional technology spill overs, infrastructure capital, physical-capital vintage effects, foreign direct investment, and marketization. FDI is treated as an endogenous variable. Should a large country like China have increasingly large regional development gap and income distribution gap during its rapid growth period?

By the year 2000, China found itself with not only one of the highest rates of economic growth but also one of the highest degrees of rural–urban income inequality in the world. The rural–urban disparity feeds the wide regional economic inequality. As the figure 1 shows, from the beginning of the Mao era through 1986, inequality across major regions trended downward, but it rose sharply in the decade of the 1990s. This trend is also apparent from regional per capita GDP. The gap between the coastal region and other regions has increased rapidly since 1991. The figure 2illustrates the rising regional inequality in China since 1978, the start of economic reform, using the ratio of per capita GDP between the three non-coastal regions and the coastal region. China's investment in human capital beyond the level of secondary schooling has been small in comparison with nations at similar levels of per capita income and economic development, and its geographical dispersion has been large. In 2004, the government expenditures on education were 2.79% of GDP and had been below 3% in most years since 1992, much lower than the average of 5.1% in developed countries. The proportion of the population with some college education (including graduates and postgraduates) was 0.6% in 1982 and had risen to only 1.3% by 1992. Starting in 1999, the Chinese government increased the enrolment of college students sharply. The annual growth rate in new college enrolment between 1999 and 2003 was 26.6%.However, by 2003, the proportion of those with at least some college in the national population was still quite low, at 5.2%. The proportion of these individuals in the coastal, far west, and northeast regions was at least 6% in 2003, while in the interior (with nearly 52% of the national population) it was only 4.2%. The proportion of adults who had at least some senior high school education or above was approximately 20% in the coastal region, 21% in the northeast, but 17% in the far west and 18% in the interior regions. Although it has long been believed that human capital plays a fundamental role in economic growth, one reason for this uncertainty is that the impact of education has varied widely across countries because of very different institutions, labor markets and education quality, making it hard to identify an average effect. However, a body of research has shown that total factor productivity (TFP) growth has played an important role in post reform growth in China.        
China's path toward a market economy has been much more gradual than that of most other formerly planned economies, but it has not been a smooth path, periods of gradualism alternating with stagnation and sharp jumps. A significant force pushing the economy toward marketization has been the spontaneous growth of local private enterprises, some originating from township and village enterprises (TVEs). Another major force has been the introduction of (partial) foreign ownership through foreign direct investment (FDI). FDI has facilitated the transformation of the state-owned and the collective sectors. Moreover, there is likely to be a degree of endogeneity in these relationships between FDI and TFP growth if TFP growth encourages FDI.         
Another major source of growth has been investment in infrastructure capital. In fact, the transportation and communications infrastructure were poor, but governments have invested in various levels, such as rail systems, and development of electronic communications facilities. An important aspect of China's transformation is its uneven pace. It is generally agreed that a sharp acceleration in China's gradual “growth out of the plan” (Naughton, 1995) followed Deng Xiaoping's famous spring, 1992 “South Trip”, it thwarted the conservative force that tried to stop market oriented reform following the Tiananmen Square events of 1989. By doing so, it speeded the pace of transition to a market system. The year 1994 marked the beginning of withdrawal of government subsidies for loss-incurring SOEs, and this hardening of budget constraints became much more earnest in 1997. There was also a shift toward fiscal federalism after 1994 that, through separating central and local government taxation and relaxing ties between provincial and sub-provincial treasuries and the center, reinforced imposition of hard budget constraints on SOEs. Despite the potential contribution of these reforms to improved economic conditions, implementation was by no means perfect. Therefore, we account for the intensification in the impact of market reforms after 1994 in the specification of our empirical models.

We estimate provincial aggregate production functions with the three inputs physical capital, two categories of labor quoted in the introduction. This strategy permits us to investigate two possible channels through which human capital may influence output. One channel is a direct effect, in that educated workers should have a higher marginal product than less-educated workers. The second channel is indirect, through TFP growth. The intensification of the exposure of Chinese firms must be addressed in specifying the aggregate production function, in particular SOEs, to market competition, and government decisions to accelerate the hardening of budget constraints for SOEs since 1997. The figure 3 illustrated the impact of the acceleration of market reforms. The real GDP series and capital stock series are in sharp contrast to the labor series. While GDP and capital stock increase at steady annual rates of about 10% and 9% per year, respectively, throughout the period 1985–2003, employment declines abruptly between 1997 and 1998 and grows very slowly through 2003. A direct impact of tightening budget constraints was on redundant workers in SOEs. SOEs employed more production workers than would have been implied by cost minimization or profit maximization, the so-called hidden unemployment problem. Because, when SOEs were restructured, a large number of workers were laid off. Moreover, the paper has incorporated alternative proxies for the productivity change in specification of the aggregate production function. The provincial specific quadratic trend variable is designed to capture the effect of improvement in employment efficiency in the SOE sector that began in 1997.  An alternative way to estimate the improvement in employment efficiency is to incorporate the xiagang series directly in the production function. To construct FDI instruments, we divide the different type of SZs into three categories, i) National Special Economic Zone; ii) Duty-free, or High-tech, or Economic Development cities or zones; iii) Opening City. For each province, we create the three instruments defined above. These instruments capture preferential tax policies. The degree of tax preference increases from Zone1 to Zone3. . There are sufficient changes in the zone variables over space and time to permit reasonable variation in these variables on both dimensions.

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