Overview Origins of TVEs Golden Age of TVEs Regional variation in TVEs Transformation of TVEs Conclusions

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2 Overview Origins of TVEs Golden Age of TVEs Regional variation in TVEs Transformation of TVEs Conclusions

3 , TVEs played key role in transforming China from command to market economy Helped increase rural incomes, absorbed labor from farms, narrowing urban-rural gap Developing in China s rural areas, provided competition for SOEs, driving marketization Evolving out of rural communes, they were a case of publicly owned enterprises challenging state monopoly of SOEs Post-1996, TVEs were privatized, faced competitive pressures, and less able to absorb rural labor

4 Pre-1949, traditional economy bottom-heavy - household-based production, flexible and market-oriented Link between growing/processing agricultural output broken during Maoist era, with harmful economic effects Household incomes declined, specialized handicrafts fell into decay, and some regions had difficulty supporting populations Attempts to develop non-agricultural enterprise during GLF failed, and loss of manpower in agriculture proved disastrous

5 During Maoist leap forward in 1970s, statesponsored rural industrialization, focused on supplying producer goods to agriculture Communes/brigades key organizational structure Emphasis on Five Small Industries iron and steel, cement, chemical fertilizers, hydroelectric power, and farm implements Capital-intensive, employing only a small proportion of rural labor force By 1978, China lacked network of small-scale nonagricultural activities typical of countryside elsewhere in Asia

6 With relaxation of state monopoly on agricultural products, new potential for rural processing TVEs were collective firms, ideologically safe urban firms encouraged to sub-contract with them Once they could perform agricultural processing free to produce other goods they could find a market for Local government officials recognized TVE potential often only route out of poverty for many localities

7 (i) What were causes of rapid growth of TVEs? Faced factor-price ratios reflecting China s factor endowments, i.e., low wages and high opportunity cost of capital As a result, specialized in sectors with low capital/labor ratios, where TVEs benefited from access to low-wage labor L/K ratios nine times larger than in state-run industries (ii) TVEs proved very profitable shared in monopoly rents of SOEs High profitability for initial entrants in niche markets not covered by the central plan, eventually eroded through competition

8 Village Enterprise Share of Total Figure: 1 Village Enterprise Share of Total Output X Capital Intensity % Furniture 40% 35% 30% Building Materials Metal Products 25% 20% Ordinary Machinery Food Processing 15% 10% Textiles 5% 0% Capital per Worker (National Average = 100) Source: Naughton (2008)

9 (iii) Institutional framework favorable strong support from local governments, TVEs providing money and employment to local economies - formal taxes low, so money stayed local, while part of profits paid to local government recycled back into TVEs - local governments willing to act as guarantors to TVEs, enhancing access to credit, i.e., risks absorbed by entire local community - rural credit cooperatives (RCCs) able to take advantage of high rates of household saving in 1980s, thereby increasing share of loans to TVEs

10 (iv) Proximity to urban areas aided growth TVEs mostly evolved in suburban areas/hinterland of cities - highly concentrated regionally, especially in coastal provinces, e.g., Jiangsu, Zhejiang and Shandong accounted for 50% of TVE output - TVEs benefited from spillover effects, e.g., transportation networks, and also sub-contracting with urban state-run firms - often based on family ties - SOEs trying to reduce costs as they gained greater interest in profit, and ability to escape control of state sector -

11 (v) Organizational diversity compared to SOEs, no single organizational structure that TVEs had to follow - sometimes government-run, but often and increasingly private; worker cooperatives as well as employee-owned corporations evolved - flexibility of organization created adaptability within TVEs themselves, as well as for localities, e.g., local officials formed alliances with entrepreneurs - after late-1990s, stigma attached to notion of private business dissipated

12 TVE development followed different patterns in different parts of China: (i) Southern Jiangsu Model: prosperous, developed area of Yangtze Delta around Shanghai - dominant model of TVE development township/village/collective ownership - larger, more capital-intensive than TVEs elsewhere, and relatively technologically sophisticated - TVEs remained collective, generating profits for local government - developed into corporate villages, focused on benefits for local population

13 (ii) Wenzhou model: town on coast of Zhejiang province, south of southern Jiangsu - different model in rugged remote area, removed from urban influence, based on private ownership - individual households producing goods for daily use, e.g., buttons, ribbons etc. typically not supplied by state-owned firms - peddlers sold goods throughout China - Wenzhou-type model appeared where TVEs based on collectives were unsuccessful, but farmers were willing to be entrepreneurial, e.g., specialization in stages of button-making process

14 (iii) Pearl River Delta Model: region between Hong Kong and Guangzhou, TVEs developed with foreign investment - pioneered by Hong Kong businessmen starting businesses in home villages - role of urban businesses and local governments critical - factories typically produced export-oriented, light, labor-intensive products - more open domestically and internationally, e.g., largest destination for migrant workers in China

15 TVE sector underwent major transformation in mid-1990s: tougher external environment, restructuring through privatization, and new forms of economic cooperation Changing Economic Environment: Focus on reform of regulatory environment, tighter monetary policy, and greater financial independence and accountability of banking system

16 Resulted in tougher competitive environment for TVEs, and rapid growth came to an end Pace of TVE job creation slowed, reflecting tougher macroeconomic environment urban firms also had to adapt, putting them in direct competition with TVEs As urban incomes rose, consumers sought higher-quality goods than TVEs could supply TVEs less able to absorb agricultural workers, focusing instead on raising labor efficiency

17 Million Figure 2: TVE Employment Individual, Household and Private Firms Total Employment Collectives (Township and Village Level) Source: Naughton (2009)

18 Restructuring through Privatization: Since 1995, employment structure has changed such that collectives now account for less than 10% of total TVE employment , public ownership seemed to be pivotal various explanations being put forward for this success: - cooperative nature of Chinese culture, with little need for explicit contracts (Weitzman and Xu, 1994) especially early-phase of TVE development

19 - adaptations to political constraints and insecure property rights imposed by central government (Chang and Wang, 1994) - with missing/under-developed markets, local governments able to leverage access to credit, land and relationships in service of local economic development (Qian and Jin, 1994) - public ownership protected local interests from central government expropriation, while local government officials given strong incentives and hard budget constraints (Che and Qian, 1998)

20 Changes in economic environment reduced benefits of public ownership privatization increasingly wide response to conditions National policy changed around 1995 with taboo of private business lifted, but means and pace of privatization locally determined Links between markets and privatization: - need to restructure via laying off workers - after Asian financial crisis, banks pushed TVEs toward privatization - without privatization, better managers would have left TVE sector

21 Insider privatization very common, i.e., incumbent managers/local government officials owned significant share of firms Typically discouraged, with attempts to drive up share price through outside bids insider privatization presents opportunities for corruption and public-asset stripping Insider privatization has some benefits managers experienced/familiar with firm, also many managers were entrepreneurs who set up firms under collective auspices

22 Whether or not there has been sufficient oversight of privatization, much local variation in process: - some TVEs converted into worker-owned joint-stock cooperatives enfranchise workers with unambiguous property rights of joint-stock company - local governments formed joint ventures with new private managers - privatization with a tail, managers given choice buy outright at high price or buy at low price and pay local government share of profits over 5-10 years mechanism designed to reveal information about expected future performance (Li and Rozelle, 2003)

23 Transformation of TVEs TVE Employment by ownership, 2003 Million % Domestic capital enterprises Private firms Other Individually run Collective Limited liability Stock cooperatives Joint stock Jointly operated Hong Kong/Taiwan invested Foreign invested Total Source: TVE Yearbook, 2004

24 Emergence of New Forms of Rural Industry: Emergence of industrial clusters in rural and suburban areas large number of firms contributing to single specialized product Fine division of labor among different stages of production process light consumer goods, e.g., sock industry cluster in Zhuji municipality (Zhejiang province) 35% of global production! Clustering of small firms linked to market by intermediate-good markets has long tradition in China

25 Evolution of TVEs cannot be seen in isolation from command economy: - destroyed traditional diversified rural economy in 1950s - also created conditions for TVEs to emerge in 1980s, e.g., differential tax treatment, close links to staterun urban economy, supply of capital Cannot ignore more fundamental factors: - China s underlying factor endowments - organizational experimentation - large number of townships (40,000), created significant competition, and each TVE faced hard budget constraints, i.e., had to try to be successful