Microsoft Word EcRefChina Oct06. doc

 
II. Social Advance and Regress 
 
The Chinese authorities have been much less active, and much less successful, in the 
social field than in the case of growth-promoting economic reforms. This contrasts with 
the pre-reform period. While aggregate output growth then was modes, and total factor 
productivity hardly increased at all, there were important achievements in some social 
fields. The main examples are basic health and elementary education – although the 
authorities during this period also were responsible for the devastating famine in 
connection with the “Great Leap Forward” in the late 1950s and early 1960s and the 
educational regress during the “Cultural Revolution” in the late 1960s and early 1970s.
What, then, have been the most important social
 
developments in China during the period 
of economic reform? And what are the consequences of the economic reforms for the 
functioning of previously established (“inherited”) social arrangements? I start with the 
second question.
II:1. Consequences for Inherited Social Arrangements 
Even to a larger extent than in the Soviet Union and the socialist countries in Eastern 
Europe, social arrangements in China during the first decades after World War II were 
organized by work units (
danwei
).
60
For the workforce, the job guarantee was probably 
the most important component of income security. The compressed distribution of wages, 
although largely motivated on ideological grounds, added to income security, since not 
only the economic reward for success but also the economic punishment for failure was 
quite limited. In urban areas, work units also provided pensions and various cash benefits, 
as well as “human services”, such as basic education, health care, housing, kindergartens, 
and recreation facilities – indeed even barber shops. In other words, in addition to serving 
as executors of centrally assigned production and investment tasks, work units functioned 
as mini-welfare states. In a typical Chinese formulation, they were “enterprises running 
60
For a brief survey of social arrangements in China prior to the economic reforms see, for instance, 
Guan (2000).

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small societies” (Xiaoyi, 1996).
61
Besides these arrangements by firms, public-sector 
authorities provided social assistance and care to some of the urban 
three no’s
(individuals with no working ability, no family, and no income).
Although both cash benefits and publicly provided human services were much less 
prevalent and generous in rural areas, agricultural communes did provide both job 
guarantees (with job obligations) and some arrangements for basic sanitation, simple 
health care (largely by “barefoot doctors”) and elementary education. Moreover, under the 
so-called 
wu bao hu
system, rural collective organizations provided some benefits and 
care also for elderly and disabled individuals without family support.
Since government authorities during this period were responsible for major production 
and investment decisions (a rough type of input-output planning) we may, with some 
overstatement, say that the division of tasks between the government and the work units 
in China was just about the reverse of the corresponding division in developed countries 
today, where firms are in charge of production and investment, and the government 
(particularly in Western Europe) runs most of the social arrangements.
Before the economic reforms, the budgets of individual SOEs were to a considerable 
extent integrated with the government budget: the surpluses (profits) of individual firms 
were delivered to the central government budget, and the government covered their losses. 
Some of the social costs borne by individual SOEs were therefore pooled across the 
nation as a whole. Thus, the financing of the social arrangements in urban areas formally 
resembled high (close to 100 percent) profit taxes with “full loss-offset”. However, wages 
were kept down to generate sufficiently high profits to finance these social benefits. It 
may therefore be more appropriate to say that the financing of social spending in urban 
areas, 
in fact
, was largely equivalent to payroll taxes with the incidence on wage 
earners.
62
It is easy to understand why the economic reforms rendered these social arrangements 
dysfunctional. Benefits tied to specific work units simply do not sit well in a market 
61
There is an obvious parallel with the social role of some large firms in small towns (“company 
towns”) during the early industrialization period in today’s developed countries.
62
Before the economic reforms, the social costs of firms seem to have been about the same size as the 
wage bill; see Hussain, 2000a, p. 70. 

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economy, since an efficiently functioning labor market requires social benefits to be 
portable. At the same time, the market risks increased for employees as a result of 
recurrent structural changes and related job losses. New high-risk economic agents, such 
as private entrepreneurs and the self-employed, also emerged. Moreover, while the 
previous agricultural communes, many of which comprised thousands of households, 
could achieve some pooling of income risk, family farms cannot easily do so – at the 
same time as new market risks emerged for the farm population as well. 
During an early phase of the reform period, the decline in firms’ financial surplus also 
made it difficult for many of them to live up to their social responsibilities.
63
In Chinese 
parlance, work units “no longer guarantee either the iron rice bowl or the iron chair” 
(Warner and Zhu, 2000) – a formulation referring to the fact that firms were no longer 
able to take responsibility for either income or jobs. 
Ad hoc
selective subsidies and soft 
loans to state-owned firms with financial problems functioned as a “stop-gap solution” to 
the problem. In other words, loans by state banks have to some extent functioned as a 
substitute for traditional social policies. As a result, the discrimination of private firms in 
credit and capital markets was accentuated, which further reduced their ability to expand 
production and employment. The “double bind” – state firms constrained in shedding 
labor, and private firms constrained in acquiring loans – has entailed a kind of catch-22 
situation during much of the reform period. It is difficult to remove this “double bind” 
until non-state firms can expand their employment sufficiently to absorb a much larger 
fraction of the redundant labor force, and before a more comprehensive system of income 
security is in place.
64
Inadvertently, households have also helped finance firms’ social obligations, since 
households’ deposits in state banks (at low, and during some periods even negative, real 
interest rates) have been intermediated into loans to state firms. As a result, the social 
63
According to official statistics, the financial surplus is reported to have fallen from about 20 percent of 
firms’ aggregate revenues in 1978 to about 4 percent in 2003 (Chinese Statistical Yearbook, 1996 and 
2004). There has, however, probably been a substantial recovery of these surpluses from about year 
2000; see, for instance the survey of papers on this issue in The Economist, 2006, October 21. Agarwala 
(2004) has argued that statistics of surpluses (or profits) in Chinese firms are not fully comparable with 
statistics in western countries, largely because investment spending in China is not periodized in the 
same way.
64
Although the employment level in the non-state sector in urban areas has increased considerably, from 
12 to 43 million between 1990 and 2003 (Chinese Statistical Yearbook, 1990-2004), this has clearly not 
been sufficient to absorb redundant workers in state-owned firms and collective firms, new entrants into 
the labor force, and the flow (in particular the potential flow) of labor from agriculture. 

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obligations of state firms have, in fact, been partly financed by an “inflation tax” on 
households’ financial saving (although less so during years with low inflation). This, in 
turn, implies that much of the real return on household saving has been transferred to the 
beneficiaries of various social arrangements – much like a tax-financed pay-as-you-go 
(“paygo”) system, although in this case the “tax” was imposed on the return on saving 
rather than on work. 
Moreover, fewer and fewer workers are employed in firms with explicit social 
responsibilities. One reason is the lay-offs of workers in state firms (about a third of the 
initial work force from the peak level), another is the increased number of employees in 
private firms without similar social responsibilities.
65
Indeed, among the 260 million 
regular workers in urban areas (with urban 
hukou 
status) in 2005, no more than between 
110 and 150 million, or 40-60 percent, seem to be covered by social insurance 
arrangements (depending on which specific arrangements we have in mind).
These developments are important background factors for recent attempts to reform the 
social arrangements. Before I turn to China’s policy options in this field (Section III), it is, 
however, useful to highlight some recent social developments in the country.