Deng Xiaoping and China’s reform

Deng Xiaoping and China’s Reform

Deng Xiaoping and China’s Reform: In 1980 after joining the World Bank, Deng Xiaoping, president of China from 1978-1989, famously said: “We can do it with or without the Bank, but with you, we can do it faster.” Despite being known today as one of the most dominant, capable countries in the world, as well as an economic powerhouse, China had been struggling economically and could barely support its people just 40 years ago.

Knowing that Communist economic policies were, and had so far been unsuccessful at promoting economic growth, Deng Xiaoping knew that a considerable amount of economic reform and opening was needed to right China back onto a path of economic prosperity.


Deng Xiaoping and China’s reform

Looking for help with the economic reformation of China, Deng Xiaoping began working with a branch of the World Bank: The International Finance Corporation (IFC), who would give the Chinese central government ideas on how best to reform and develop a thriving economy in China, particularly one where foreign and private businesses could thrive.

The work, reports, and suggestions the IFC gave China would lead to considerable economic reform, which would help China become the economic powerhouse it is known as today.

To understand the International Finance Corporation’s mission, which helped China reform its economy, allowing it to reach the levels it has today, it is essential to first examine the creation of the International Finance Corporation, its purpose, and its evolution over time as well as gain a first-hand perspective from someone who was there. 

During the tail end of World War 2, when victory against the Axis powers seemed inevitable, forty-four countries met on July 1, 1944, at Bretton Woods, New Hampshire, to formulate and agree upon an international economic organization that would help recover and reconstruct the many countries left completely war-torn and devastated during the second world war.

During the conference, it was agreed upon that two international economic organizations would be created: the International Bank for Reconstruction and Development (IBRD), which would provide loans and financial assistance to the previously mentioned war-torn countries, as well as less developed countries, and the International Monetary Fund (IMF), which would help guide and facilitate international trade, economic growth and development, and reduction in global poverty. 

On July 22, 1944, most conference members agreed upon the IMF articles, and on December 27, 1944, the IBRD section of the articles was agreed upon and fully ratified. The IBRD would officially begin operations in 1946 and was known as the World Bank Group.

It soon became apparent that the World Bank could not meet the international demand for aid at the time and often ran into hurdles organizing loans with foreign governments, such as their unwillingness to approve loans for projects proposed by private enterprises, as they feared it could be seen as them favouring one private company over another. 

Deng Xiaoping and China’s reform

For example, IFC helped launch Korea’s first Development Finance Corporation (KDFC) with a combined investment of 23 million dollars from IFC, the World Bank, and outside investors. The KDFC, which would later be called KB Kookmin bank, would help facilitate massive growth in Korea and became one of the IFC’s most significant success stories.

William Diamond, an IFC member who worked on the project, reacted to the significant growth that took place in Korea, saying: “When we helped to set up the KDFC in 1967, exports were around $250 million a year,” “When I went back for a review of their structure with them in 1977, 10 years later, exports had hit $10 billion a year. The city of Seoul was a different world compared to the one I had first gone to in ’67. 

While this had considerably bolstered the IFC’s impact potential, there were still considerably more things that could be improved, which the World Banks’ fifth president Robert McNamara sought to implement. Speaking at the annual World Bank Group meeting in 1970, he stressed the need to “give greater emphasis to the development implications of its [IFC’s] investments.”- (Deng Xiaoping and China’s Reform)

Essentially, he believed that the IFC emphasized profit rather than the impact, growth, and potential for change their investments held. To achieve this, the IFC began focusing on development in developing countries, which would eventually help create jobs, reduce poverty, and establish entrepreneurship, leading to a reduced need for IFC aid. 

In 1971, IFC’s Capital Markets Department was created to facilitate the development IFC wanted to achieve. The effects of this development were seen in Thailand from 1970-1991, where IFC helped build their capital market from the ground up, including advising the creation of the Stock Exchange of Thailand (SET), the only stock exchange in Thailand.

IFC’s development aid enabled it to become one of the strongest economies in east Asia. It would be these same principles of development and reform that IFC would use to help China, lifting over 800 million people out of poverty and guiding it to becoming the second-largest and fastest-growing economy in the world. 

In the mid to late 1970s, Deng Xiaoping put in motion a plan for Chinese economic reform that involved regions called special economic zones or SEZ’s. These zones were designed to test multiple things, including introducing foreign capital, advanced technologies, and equipment and distributing foreign money, technology, and equipment from SEZ’s to other regions.

They created new job opportunities in new fields, and most importantly, “serve[d] as experimental units in economic structural reform” The first special economic zones: Guangdong and Fujian, were implemented in July 1979, and were instructed to develop tourism and foreign trade and investment as best they could.

Deng Xiaoping confirmed his thoughts on China’s need for reform after the capitalist reforms he enacted in Special Economic Zones had stimulated massive economic growth in their respective areas. China further emphasized its desire for economic reform and growth by becoming an official World Bank member in 1980.

 In 1985, China asked for help from IFC to “liberalize its economy and open itself to foreign investment” While China had already opened the country to foreign investment some years prior, its local laws made China highly unappealing to foreign companies.

As a result, China had a highly minuscule foreign investment, especially their potential. The IFC agreed to help and, as they had already invested in China earlier that year, had some idea of what they could do to help China appear as an open and appealing place for foreign direct investment (FDI). 

One such problem was that joint venture and foreign investment candidates faced trouble exchanging Chinese Yuan for their currency, as there were restrictions against it in China’s foreign exchange policy. To convince China that their reform ideas were well-founded, IFC formulated and presented the survey results of 100 foreign companies interested in doing business in China.

The IFC survey found: “The companies’ biggest concern was the difficulty of exchanging currency.” As China had been a World Bank member for six years and trusted IFC, China agreed to ease restrictions and began implementing reforms IFC saw necessary to encourage investment in China from foreign entities.

By 1990, the reforms had been fully implemented, and China immediately saw a colossal increase in foreign direct investment.

Graph figures of FDI projects in China show that from 1990 to 1993, just a few years after the reforms, the number of FDI projects per year had risen from 15,000 to 85,000, representing an over 500% increase. In fact, by 1993, China had become the second-largest market recipient for foreign direct investment in the world, only beaten by the United States. 

Paralleling their work in China, in 1985, IFC worked with the World Bank to create a branch called the Foreign Investment Advisory Service or FIAS, a sole body responsible for helping developing countries captivate foreign direct investment.

Throughout the next 12 years, FIAS would reform over 108 countries and oversaw the growth of foreign direct investment in those countries from “$12 billion in 1986 to $120 billion in 1998,” according to the World Bank.

The same review had found that “most countries’ by design or consequence’ had policies that discouraged foreign investment, the opposite was now the case.” IFC’s FDI reform was fundamental to the economic success that propelled China into being an economic superpower. 

To further help China, IFC would also help it make reforms to bolster another essential part of its economy: domestic private businesses.

China’s economy had grown a considerable amount since the initial set of reforms in 1985 and at the same time had moved away from complete dependence on state-owned enterprises to a mixed economy that included private foreign enterprises as well. However, the impressive growth of China’s private sector was mainly rooted in the surge of FDI rather than domestic private enterprise. So, IFC set out to answer the question: “what needs to be done for domestic private enterprise to flourish?” 

To evaluate where reform was needed, IFC took an approach similar to the FDI reforms, which was “to take stock of the evolution of the domestic private sector thus far and to identify constraints and opportunities for its future contribution to China’s development.

To find this information, an IFC team carried out multiple surveys and interviews with businesses, entrepreneurs, financial associations, government officials, and many more in 6 of China’s most populous cities in the domestic private sector.

Immediately, IFC saw multiple things holding back the growth of the domestic private sector, particularly the informal, semi-legal status that domestic private enterprises held within Chinese law. Mainly, IFC found that private entrepreneurs “did not yet enjoy a clear identity, their property rights lacked protection, and they had to function in an environment of significant legal and political and economic uncertainties.”

Because of China’s restrictions, domestic entrepreneurs and other parts of the domestic private sector had gained this informal, semi-legal status. In order to fix this, IFC suggested the Chinese government establish the rule of law, transitioning the domestic private sector from a state dominated structure to the more private structure it should be.

IFC believed that with the rule of law, China could transform its domestic private market into an environment which “guarantees transparency, predictability, stability and the protection of private property rights.” All of which would be necessary to create a legally formal, functioning domestic private sector. 

IFC also cited a need for other reforms such as banking reforms, which had massively favoured state-owned enterprises, and financial disclosure reforms, which had previously prevented disclosing important information to potential investors, hurting overall profitability.

Acknowledging the importance of IFC’s findings, China’s attitude of reforming towards full private ownership changed, and in 1999, an amendment was made to the Chinese Constitution, which fully combined domestic private ownership and the rule of law.- (Deng Xiaoping and China’s Reform)

The New Amendment

Deng Xiaoping and China’s reform

The new amendment stated: “Individual, private and other non-public economies that exist within limits prescribed by law are major components of the socialist market economy.” “The State protects the lawful rights and interests of individual and private economies, and guides supervises and administers individual and private economies.” This additional set of reforms would birth an official domestic private sector, further helping China’s economy thrive, and represented another successful IFC project. 

This growth and the reforms IFC helped implement in China would not go unnoticed.

By the early 1990s, newspapers began to take notice of the private sector revolution taking place in China the IFC had helped influence.

In 1992 The Wall Street Journal wrote an article on the private sector growth taking place in China, reporting that “the state sector of Chinese industry is poised to be overtaken by the private sector,” noting that contribution from the state sector had gone from 80% of Chinese industry to only 52% following the rise of the private sector, particularly foreign enterprise which had grown 56% in 1991.

Furthermore, they reported that the private sector had again had record profits in 1991, while state industries lost almost 6 billion dollars the same year.

This shows the significant role foreign direct investment had already come to occupy in China’s economy, a role which would only grow more and more over time as the private sector became further reformed and developed. 

This was shown in 1998 when the Washington Post wrote a similar article on private sector growth. By then, private enterprises had surpassed state-owned enterprises and accounted for over half of the economic activity in China.

Commenting on this, Steven Mufson, the writer, stated: “The once suppressed private sector is growing fast… China’s private businesses are outpacing China’s lumbering state-owned enterprises with harder work, newer technology, and better management.” Furthermore, the private sector acted as an engine for economic growth, taking in the 25 million people per year in China looking for employment.

The Washington Post found that around 2/3 of people laid off by state-owned enterprises found work in the private sector. Not only had the private sector surpassed state-owned enterprises, but they had also provided millions of jobs for both people entering the workforce and people whom state-owned enterprises laid off. 

There are many different ways historians have viewed China’s economic reform over time. Around the time reform was being implemented, many historians who analyzed the economic climate in China were sceptical of their potential success and focused on problems that remained with the economy.

One example of this perspective came from development economist Dr Albert Keidel in his thesis paper China’s Economy: A Mixed Performance, where he stated, “China’s economy in 2000 and early 2001 is performing moderately well. – (Deng Xiaoping and China’s Reform)

However, it is still not performing well enough to provide the job growth needed to facilitate fast-paced market reforms.” Keidel’s argument reflected many historians’ thoughts at the time, mainly the scepticism on whether China would successfully implement reforms, citing its potential lack of job growth to facilitate such change.

In his thesis paper, economics professor John Frankenstein shared a similar apprehension to Keidel, warning: “it is important to keep in mind that while China may be making progress toward becoming a market economy, it is not there yet.” Notably, he cited the control China retained to control or change any reform, stating: “the government’s vermilion brush can still suddenly descend from heaven and cause unexpected disruption.” While these analyses were undoubtedly well-founded, they would not become a reality.

China would successfully implement enough reform to have its economy enter a period of significant economic growth. After the success, historians changed their opinions drastically, praising the Chinese economy as one of the most significant economies in the world. This change in sentiment is shown by the praise Dr Nguyen Thi Thuy Hang gives in her thesis The Rise of China, saying: “The Chinese government has achieved a great success in economic reforms which have brought prosperity to millions of Chinese people and made the Chinese economy more efficient.” 

Deng Xiaoping and China’s Reform: Since the success of the reforms, China’s economy would see astronomical improvements and quickly rose to become the world’s second-largest economy.

Since the last reforms IFC helped within 1999, Chinese gross domestic product (GDP) would increase from just over 1 trillion dollars to nearly 15 trillion dollars in 2020*, and gross national income (GNI) per capita increased from 860 dollars to well over 10,000 dollars in the same time frame.

A World Bank analysis stated the primary factors that contributed to this unprecedented growth, saying: “China gradually reformed its economic system to allow more economic decisions to be made by market forces, which drove productivity increases, innovation, and rapid economic growth;” and “China opened up to the outside world to trade, foreign investment and ideas, which is adapted for its particular circumstances as reforms progressed.”

Deng Xiaoping and China’s Reform: These critical factors had been primarily influenced, motivated, changed, and reformed by the work IFC did in China, especially in the private sector, enabling China’s meteoric rise and resulting in what is undoubtedly one of the most significant development successes in not only IFC but world history.

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