Xu: The Chasm in the Transition: A CGE Analysis of Chinese Economic Reform

Xu, Dianqing. (1996). "The chasm in the transition: A CGE analysis of Chinese economic reform". Journal of Policy Modeling, 18(2), 117-139. http://www.sciencedirect.com/science/article/B6V82-3VW1F2C-1/1/4b8c0351741cd5992d58b843b77cdf13

“Based on the characteristics of the two-tier plan-market system in the current Chinese economic reform, this article presents a Computable General Equilibrium…model to measure quantitatively the chasm in terms of the changes in sectoral labor demand caused by a shock therapy proposal in the transition process from a centrally planned economy to a market economy” (117). The attempt of this article is to counterfactually measure the pressure that will exist on labor demand by sector by looking at a CGE model of China’s economy and comparing that with the current state of the economy. The CGE is seen as a tool that can help policy makers come to sensible interventions that take into consideration social costs and opportunities.

Initially there is an overview of the Chinese production facilities, focusing partially on the similarities with Eastern Europe (heavy industry, capital intensive, etc.).

The CGE used in this article follows closely the model developed by Benjamin, Devarajan and Weiner (1989) and Robinson, Milkenny and Hanson (1990). “The main difference between our model and previous models of this type is in the treatment of the special features of a two-tier planned-market economy in the transition process” (121).

This two-tier approach is literally a two stage development of the CGE: “Under normal circumstances, an enterprise must fulfill the state quotas first, and then it can sell the remainder of its output directly to the market. The output planned by the government must be handed over to the state according to the planned price, and the extra output is subject to market prices” (122). “Disequilibrium is one of the most salient features of centrally planned economy. In order to calibrate the benchmark data into the CGE model, we assume that the market prices reflect the equilibrium of demand and supply on the market side of the economy, while the demand and supply in the planned part of [the] economy are exogenously determined by the planners. If government reduces the planned-demand quotas, of course, the supply in the planned channel will correspondingly be reduced” (123).

He frequently, and tragically, quotes early Sachs work (1990) that has since been undermined. Early Sachs is committed to “shock therapy” and very rapid economic reforms. This should have been clearly shown to be problematic upon the 1996 publication of this article.

There is a list of 5 crucial assumptions for the model on 123: Labor and capital are fixed; China is a price-taker; household consumption doesn’t change much; taxes and tariffs are constant; ownership reform is not included; no urban/rural migration.

Production follows a Cobb-Douglas format. This production is divided into two parts: planned and unplanned. The model takes into consideration international trade, domestic consumption, exports and 10 sectors. The simulation is then run to determine how labor demand shifted by sector. It was shown that there is significant decrease in labor demand in many of the big industries, no change in agriculture and a large increase in service.

It is estimated that 13.72 million workers will need to shift sectors.