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Nisseluren Nisseluren
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7 years ago

I was wondering if someone with a course hero account could please help me get this document:

I would really appreciate it. Thanks!
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ew questions:
1. What are the major geographical similarities and differences when China is compared
to the U.S. and India? Explain geographical advantages and disadvantages for China’s
economic development.
In terms of climate and location, China and US cover similar latitudes and thus share similar
range of climate conditions, while India has lower latitude, located at tropical region.
In terms of geographical formation, the big difference between China and US is the inhospitable
land area: despite the similar land size, China has more mountains and valleys, and thus less
arable land. On the other hand, the US has relatively more plains and basins.
Another difference is that China only has a single seacoast, while both the US and India have
two­sided coastal line.
The geographical advantage: diverse climate plays a big role in agriculture sector, and huge
population will be a merit in labor­intensive sector.
Disadvantage: one­sided coast line, scarce resource and limited environment in the west side of China,
sets limitation to Chinese economic growth.
2. In 1840, there was a major event in China’s modern history involving international
trade. Explain how this event changed China.
Opium War. China lost its relatively dominant position in the international relation among Europeans and
some Asian countries. Since the war, China had been declining economically and politically, leading to
the century of humiliation.
3. Before 1949 there were two distinct patterns of economic development in China.
The two patterns are following. In south side of the great wall, industrialization was concentrated in a
few treaty ports such as Shanghai, Tianjin, Qingdao. Textile and food products for domestic markets
were the main economy. Some firms started by foreigners were soon dominated by native Chinese
capitalists. In the northeast part of China, there was Japanese­sponsored industrialization due to the
Japanese invasion during the war period. Those were mostly associated with the heavy industry and
railroads that exploit coal and iron ore.
4. Was China’s reform performance anticipated by the economists and political scientists
in the 1980s? Why or why not?
Economists have not anticipated China’s unusual path of transition from plan to market economy. In
1980s, China’s fundamental economic level was so low compared to other countries, such as the Soviet
Union, that most economists thought it would be unlikely for China to even surpass the Soviet Union in
near future. Political scientists as well have not predicted China’s economic success today because their
point of view was that political liberation should come before economic liberation in order for a country
to be successful. China’s success totally does not accord with political scientists’ prediction.
5. China’s economic reform has evolved in two stages between 1979 and 2001. Describe
the major themes of each and the differences between them.
The first stage: reforming the planning system. The theme was “reform” and “opening up.” The
framework was planning as a principle part and market as a supplementary part.
The second stage: building the market system. The theme was “socialist market economy.” The
blueprint for building a market system and private ownership were the main points. The differences: the
first stage was mainly an establishment of fundamentals to the market economy and the second stage
was the transition and building­up of the socialist market economy.
6. What were the main elements of China’s development strategy in the 1950s? What
were the major achievements and problems?
It was a socialist heavy industry priority development strategy (Big Push Strategy) similar to
the Soviet Union’s.
       ­High investment rate (investment rate was >30% of GDP
       ­Mostly in heavy industry (producer goods)
       ­rapid industrial growth rate
The result was a rapid structural change:
       ­Agriculture decreased from 51% of GDP to 28%
       ­Industry+construction increased from about 20% to about 50%
       ­Services decreased from 29% to 24%
       ­Slow individual consumption growth
       ­slow employment creation
       ­much of industrial investment capital intensive and demanding technologically
àeconomic return low, capital tied up for many years without producing output
­new industries created such as motor vehicles, electric generating equipment,
       ­economic growth jump started
7. Give the three common systemic features of the socialist system shared by China and
the Soviet Union. What in China has changed and what has not since the reform?
3 common features:
Communist Party in power, guaranteed by the Constitution
Dominant public ownership
Central planning as the main mechanism of resource allocation
Things changed:
       ­core planning system in china much less centralized and much less tightly
controlled than that in Soviet Union
      ­small firms dominated
      ­decentralization within the Chinese state sector entailed regional governments
having some recognized property rights
      ­ideological and social control especially tight
Things not changed:
­party state­monopoly on political power, controls everyone and every aspect of society
      ­state ownership & collective ownership
      ­government control over investment
8. Explain the differences and similarities between state ownership and collective
ownership of firms in China.
State ownership:
       ­highest form of public ownership
       ­nominally, ownership belongs to the “whole people”
       ­The government exercises all the rights,
­incomes go to the state budget
              ­government bureaucrats decide how to use property
              ­government bureaucrats decide how to transfer property
Collective Ownership
       ­lower form of public ownership
       ­nominally ownership belongs to a group of people
       ­in reality government control and intervention
9. Was the price set under central planning to equate supply and demand? How might
prices under central planning have been? Why?
Prices not set to equate supply and demand.
       ­were set by government
       ­reflect the social necessary costs and prices should be stable
­serve the purpose of channeling funds to/from the government and income redistribution
­low prices for consumer basic needs (food, rent, health care etc.) and raw materials
       ­high prices for manufactured goods and luxury goods
       ­low factor prices (wages, interest rates, exchange rates)
­factory products (govt owned) were expensive and farm products (peasant collectives
owned) were cheapàa lot of government revenue, state owned industrial enterprises
extremely profitable (cash cow)
       ­gave Chinese government the fiscal capacity to mobilize resources for Big Push
industrialization and other priorities
10. Explain how the plan output target could lead to bad production decisions under
central planning.
Central Planning:
­there was an output target for each producer
­there was a supply plan that transfers resources between producers
­a schedule of usage coefficients linking inputs and outputs
Bad Production Decisions:
­management incentives problematic (eg. If plan target is “total number of nails”, tiny nails
will be produced to maximize number”. If plan target is “total weight of nails”, one huge nail
will be produced to maximize the weight.)
­managers bargain with planner to lower output quotas and raise input supplies
11. Compare the central planning in China with that in the Soviet Union and discuss
some of the major differences.
China share the fundamental features of the socialist system with the Soviet Union: communist
party, public ownership (State and collective& cooperative), and central planning.
China’s central planning, however, had special features that departed from the standard Soviet
model. While Soviet concentrate everything in the hands of the central authorities, China
incorporated Regional Decentralization that delegate SOEs to local governments.
China’s industrial structure also differ from that of Soviet’s. Soviet Union is large factories
dominated, China is smaller factories/enterprises dominated.
12. Could regional decentralization in China be attributed solely to its low level of initial
development? Explain.
Mao promoted regional decentralization, in opposed to Soviet’s centralized planning model
because China’s initial condition differ from the Soviet Union­­China’s vast territory, large
population, scarce resource, low stage of development all adds up to complexity. “It is far better
to have the initiatives come from both the central and the local authorities than from one source
alone”, Mao argues.
However, China’s peculiar planning system cannot be solely attributed to its state of economic
development. It was the decentralization that produced the systematic differences.
13. Is the urban and rural divide in China a natural result of market competition? Explain.
No. The urban and rural divide is an administrative decision created by management system to
restrict migration from rural to urban. The Hukou and Danwei system created dividing line
between urban and rural residence and barrier of labor mobility.
14. What are the possible ways in which the official data on China’s growth could be
China’s growth rate, which is based on GDP is not reliable in the following ways: GDP deflator
may be miscalculated (inflation/price), growth rate could be overstated, reporting incentives (ie.
proud parent syndrom) also leades to overstating and understating, and data may be missing.
15. Specify and explain the conditions under which China’s GDP might overtake that of
the U.S. in 20 years?
According to growth compounding theory, China’s GDP (9% growth rate) can double in 8 yrs. If
China’s economy in 2000 is 0.5 of US, and growth rate differ>4%, China’s GDP might overtake
that of the U.S by 2018. If China’s economy in 2000 is 0.4 of US, and growth rate differ = 5%,
China’s GDP can overtake that of US in 2020.
16. Describe the structural changes in China’s labor allocation and GDP components
respectively over the past 20 years and explain the forces behind those changes.
The share of the labor force in agriculture has declined significantly since 1978, and it fell
significantly below 50% for the first time in 2004. The absolute number of agricultural workers
reached a peak of 391 million in 1991, and it has since started its long, steady decline. By the
end of 2004, the number of agricultural workers reached 353 million, for a cumulative decline of
about 10%. China no longer has a clear majority of its workers in agriculture; China is thus no
longer a predominantly agricultural economy. The service sector’s share of the work force has
climbed steadily to more than 30% in 2004. Since the late 1990s, as industrial restructuring has
caused a reduction in manufacturing employment, service employment has begun to grow
somewhat more rapidly and has taken up some of the workers displaced from industry.
The share of GDP originating in industry jumped from 32% in 1990 to 42% in 1995, and then
continued to trend upward, surpassing 46% in 2004. The share of services has leveled off
around 40% of GDP since 1990. Agriculture’s share of GDP has resumed its rapid decline,
sliding from 29% of GDP in 1990 to 13% in 2004.
China’s command economy and Big Push industrialization strategy included policies restricting
labor mobility and controlling prices as well as neglecting agriculture and serivces. These
policies all had ramifications for China’s growth and structural changes that caused a divegence
from the development­process benchmark.
17. Does an increase in capital input lead to an increase in labor productivity? Does an
increase in capital input lead to an increase in total factor productivity? In the context of
China in the 1980s, what caused the increase of its total factor productivity?
Labor productivity depends on many factors
• Physical capital
• Human capital (skills)
• Technology
• Labor participation rate
• Number of working hours
TFP can not be measured directly. Instead it is a residual, often called the Solow residual, which
accounts for effects in total output not caused by inputs.
(HELP!! I couldn’t find any answers in the book. ) Technology Growth and Efficiency are
regarded as two of the biggest sub­sections of Total Factor Productivity.
18. What are the major differences in the growth accounting estimates between China
and the U.S. (hint: examine both the production function and input growth)?
Growth accounting of the U.S. economy:
1990­95: 2.5%=0.6%+(1/3)(3.7%)+(2/3)(1%)=0.6%+1.2%+0.7%
1995­98: 3.5%=1.4%+(1/3)(4.3%)+(2/3)(1%)=1.4%+1.4%+0.7%
Accounting growth of China’s economy:
Before reform (1952­78): 5.5%=0%+(3/4)(6.1%)+(1/4)(3.6%)=0%+4.6%+0.9%
After reform (1978­98): 9.3%=2.7%+(3/4)(7.6%)+(1/4)(3.6%)=2.7%+5.7%+0.9%
Capital accumulation has been the most important factor for growth, contributing about 62% of
growth. Labor reallocation from agriclture to industry contributes to about 10% of growth. TFP
growth contributes to about 28% of growth.
19. Did the peasants own the land under the household responsibility system? Why was
the work point system under collective farming not efficient and why did the household
responsibility system improve agriculture production?
The peasants still didn’t own the land. It’s still owned by the village collectively.
The lack of completely secure land tenure affects farmer incentives. The rewards for investment
in the land’s long­term productivity are diluted. Land cannot be used as collateral for borrowing,
and land use­right markets have been slow to develop. Families that migrate away permanently
may have to surrender their land to the collective; such a move is costly, and as a result, few
make it.
The household responsibility system links the remuneration of a small group or household to the
output of a specific plot of land. Peasants begin to have incentives since individual households
pay a fixed amount to the government and keeps the rest. Although the land is still owned by
village collectives, the agriculture reform stabilize the rural population. The land means a security
and insurance.
20. What are Lester Brown’s arguments for China to import massive amount of grain in
the near future? What are the other logical arguments?
Lester Brown writes in “Who Will Feed China?”, “There is no precedent by which to assess the
extraordinary growth in the demand for food that is occurring in China today”. So he suggests,
“To feed its 1.2 billion people, China may soon have to import so much grain that this action
could trigger unprecedented rises in world food prices.” He describes China’s growth and its
effect on the world economy: “China’s rising food prices will become the world’s rising food
prices. China’s land scarcity will become everyone’s land scarcity. And water scarcity will affect
the entire world.”
Scott Rozelle has a different opinion that he expresses in “How China Will NOT Starve the
World” along with Professor Roland­Holst’s argument, “China will reverse a 50 year downward
trend in global food prices.”
21. Why did China import and export grain at the same time? Why is China a net grain
import country? Will this continue in the near future?
    ● China both imports (wheat and maize) and exports (rice) grain.
    ● why a net grain import country?China has a great need in land­intensive products like
      wheat, corn, soybeans.
    ● Yes. 1) China has small and shrinking land area for farming. 2) National water is scarce,
      most major aquifers are already in overdraft. 3) the above resource constraints are
      serious despot impressive productivity growth. 4)therefore, output growth might sustain
      current trends for the next decade, but it is unlikely to accelerate in any major categories.
      5) on the demand side, average incomes and the resource intensity(like meat) of
      consumption are rising fast. 6) China’s growth can only be sustained with increased
      absorption of resources and resource­intensive products. 7)with the imbalances between
      supply and demand, China will emerge as a leading global importer of agricultural
22. What are the conditions for the Green Revolution crops to produce high yields?
Where are these conditions easier to be met, Northern or Southern China?
    ● improved seeds (like hybrid rice and wheat; R&D; multi­level facilities); Fertilizer
      (domestic production, imports); Water (Irrigation facilities)
    ● Southern China.
23. What are the major explanations for the agriculture production increase in 1978­84?
What are the explanations in 1984­87?
    ● 1978­84, relaxation of policy in the countryside 1)an across­the­board increase in
      agricultural procurement prices 2)a reaffirmation of the right to self­managenment of
    ● under the expanded antimony of collectives, a nationally defined program of contracting
      land to househould­ “household responsibility system” emerged by 1982.
    ● 1984­87, the result of national agricultural reform.
24. In what ways is the distinction between “non­state ownership” and “private
ownership” important in China? Explain it by using the example of TVE.
    ● non­state ownership includes private ownership and non­private ownership. therefore,
       the important distinction is that non­state ownership also include collective firms like rural
       township­village enterprises, which is semi­privatized enterprises.
    ● TVE belongs to rural collectives. It is a form of local public ownership—entrepreneurs
and Community form the Government’s coalition.
25. Why are TVEs a puzzle? Explain it by their unique ownership features and the
economic and institutional environment in China in the 1980s.
      ● TVES are neither state­ownership, nor private ownership. a form between entrepreneurs
           and community government.
      ● while government ownership is bad and reform is often to transform government
           ownership to private ownership, TVEs represent a major anomaly: government
           ownership is the key to reform success.
      ● economic conditions for rural industry:
           1)Distortions under central planning created enormous opportunities for rural industry to
enter (Very cheap labor in rural areas; High prices for industrial goods due to state monopoly;
Persistent shortages, especially in consumer goods; Small scale operation advantage: low
overhead, flexibility)
           2)Early entry is very profitable: average rate of profit on capital was 32%, or 40% if tax
revenue also included, in 1978, Even without state subsidies in input prices and capital
      ● government policies: from tolerance to encouragement (increased lines of business;
           provided tax relief)
      ● effects of agricultural reform:
      ●          —Township and Village government focused on rural industry after the household
           responsibility system
      ●          —The success of agriculture reform supplied labor, capital, and market for rural
           industry growth
26. Why couldn’t private enterprises compete with TVEs in the 1980s? Why couldn’t
TVEs compete with private enterprises after mid­1990s?
From 1979 to mid 1990s is the golden age of TVE. It has the great advantage of both
entrepreneurs with ideas and connections and township which provides political protection and
access to loans. Private enterprises did not have the benefits of township and village gov.
In the 1980s they were majorly developing rural industries, private property rights had not
emerged at that time.
After mid­1990s, both economic and political condition in China changed. Gov ownership has
• Changing economic conditions
␣ Markets became more competitive, profit rates declined rapidly, risk of picking winners
␣ Private firms enter, attracting able entrepreneurs away
␣ When TVEs grew larger, more costly to manage with government involvement
• Changing political conditions ␣ Private property rights continue to emerge
27. In the early 1980s, what were the favorable and unfavorable conditions for new firms
to enter a market? How did these conditions change in the late 1990s?
In the early 1980s
Favorable: not really competitive
Unfavorable: hard to start and thrive without government assistance, hard to get loans, major
focus in rural area industries, private property rights not yet complete.
In the late 1990s, condition totally changed, era of the private enterprises. Easy to enter the
market, better private property rights. But since many firms entered, competition is fierce.
28. What are the major themes of SOE reform in the 1980s and 1990s respectively?
What underlying conditions have changed between the two periods?
• Expanding enterprise autonomy
- Production decisions
-Marketing decisions
• Increasing profit incentives
-Workers bonuses
-Profit retention for welfare improvement (housing etc.)
• “Managerial contract system”
- Link manager’s pay to enterprise profit
-Wants to mimic agricultural household responsibility system
-Industry is much more complicated than agriculture
-Land vs. capital
• What hasn’t done
- No privatization
-No layoffs of workers (SOE employment continue to expand)
Since 1994
• Government policy changes
• 1996: A general policy: “Grasping the large, letting go the small”
• Privatization of small SOEs
• Layoffs of excess workers
• 1999: the state sector retreats from “competitive
sectors” and concentrates to four subsectors: (1) industries related to national security (2)
natural monopoly (3) industries providing important public goods and services (4) pillar industries
and backbone enterprises in high­tech industries.
Economic and political condition changed btwn the 2 periods
29. Were SOE managers under the “managerial contract responsibility” system
interested in increasing profits? What were the problems?
Even though the managers’ pay were directly related to the profit, the managers were not really
interested in increasing profits. The system was created to motivate managers to perform well
like the agricultural household responsibility system, but industry is different from agriculture.
They were not really worrying about losing their jobs. Also the SOEs was not really about money,
it’s about political (? not sure, heard sth like this in class)

since the managers’ pay were directly related to the profit, they were interested in
increasing profits, but in short contract time.
The system was created to motivate managers to perform well like the agricultural
household responsibility system, but industry is different from agriculture.
Contracts are short term – Incentives are biased toward short run profits
Contracts are tailor made to each enterprises – negotiation on contractual terms more
important than performance
managers are negotiating profit conbtrats with their bureaucratic superors, adn the firm's
retained funds were determined by how well it was able to meet the profit targets
negotiated by the manager
managers and superiors woked closely together, understand each other well and had
broad scope for mutually beneficial deals
Limited ways to punish failure

30. What is the nature of the “soft budget constraint?” Why is it more a problem of
socialist and transition economies than a market economy?
The nature is that gov keeps bailing out enterprises that are performing bad financially. Gov does
it bcz of political ideology (communism, socialism), also laying people off is bad for the society.
Closing firms is also bad economically, good money chase bad money. This could cause
serious problem because people won’t be motivated to perform well, they will spend more than
they have to because someone will pay eventually. The gov threats to punish is also not credible.
This is more a problem of socialist and transition economies than mkt economy bcz in a mature
economy everything is profit­driven. If you are performing badly you will just be driven out of the
mkt naturally, no gov is going to save you. Losing one firm is not a big loss and many other firms
will enter. Also no political ideology.
31. How did Xiagang (furlough) work? Why does China use it to restructure SOEs?
Those workers “who went home from enterprises due to poor performance of enterprises but
still maintained some nominal relationship with their enterprises” as these employees received
“subsistence level of salary” or other kinds of benefits (such as housing or health care) from
their enterprises.
I didn’t attend the lecture, but I guess the reason why might be the relative low productivity in
the SOEs and the attempt to decentralized the economy?
32. What is the universal problem of corporate governance? What kind of laws address
this issue and in which way?
– Conflict of interests between managers (corporate insiders) and investors (outsiders)
–        Conflict interests among different types of investors: large shareholders vs. small
     shareholders(tunneling: controlling shareholders use their control to extract resources from
     the firm to the detriment of minority shareholders), shareholders vs. creditors, private
     investors vs. institutional investors etc
–        Company laws governing all firms (state corporate laws in the U.S.)
Chinese Company Law: policy makers' attempt to create a level playing field for competition,
improve SOE governance; it’s a uniform legal framework into which different ownership forms
fit. "corporatizing SOEs".
– Securities laws governing publicly traded firms and securities firms (federal laws in the U.S.)
– Bankruptcy laws governing creditors and debtors
33. What are the special problems of corporate governance in China in addition to the
usual agency problem?
The central issue: appointment power; CCP does not own stake in the SOEs; thus party
appointees might not have the incentive to profit maximization. CCP hence continues to shape
the career paths and incentives of enterprises managers.
Delegating more control rights to managers provides them with incentives, but also enables
them to plunder state assets. Maintaining Party control over the selection and dismissal of
managers serves to check managerial asset stripping but also gives rise to political interference
Ownership issues: Tension between SASAC’s effort to increase government shareholder value
and its rationale for continuing government ownership.
As a result of both control­based and market­based system of managerial oversight, SOE
managers have a great degree of independence ad autonomy, resulting in possible f&@!
irelated­party transactions and asset stripping. Party interference reduced the problem, but its
interference with the board of directors reduce the SOEs performance as well.
34. Why is corporate governance reform in China particularly difficult even for those
companies already listed on the New York Stock Exchange? Explain.
There are two major obstacles in the way of corporate governance reform. The first one is
government intervention. CCP has to maintain tight control over these large state controlled (or
at least holding a significant share) enterprises for strategic and stability concerns. Thus, CCP
retains the nomenklatura role to appoint key personnel for the enterprises who are for most of
the time, not the best candidate to run the company in an economic rational way, such
politicization leads to inevitable inefficiency since they do not have strong incentives to maximize
the profits. The second one is China’s regulatory institutions are far from sophistication. As a
consequence, moral hazard of managers, lack of outside performance checks from banks pose
serious challenges to corporate governance reform.  Even for the company trading on NYSE, the
transparency and accuracy of the financial statements that are essential in the market economy
might not be able to reflect the true situation of the company because of the loosely enforced
disclosure requirement and government interference.
35. What is the meaning of “financial deepening?” Explain it in the context of China’s
economic reform between 1978 and 2000.
Financial deepening means the increase of financial asset as shares of GDP. During 1978­2000
of Chinese economic reform, as private firms and foreign invested companies entered the
market, SOEs inevitably faced serious challenge and its monopoly profit was considerably
reduced. Consequently, government could no longer provide sufficient capitals for the SOEs,
which turned to banks for financing. Thus, banks started to finance long term investment in
addition to the commonly practiced trade credit. Thus, lots of debt were lent out to enterprises
through indirect financing. Hence, the process of financial deepening accelerated during the
economic reform period. (didn’t go the lecture..not exactly sure).
36. What are the major differences between debt and equity as financial instruments?
Are they necessarily linked to indirect and direct financing respectively?
Equity: shares in stock market, no fixed payment obligations.
Debt: bonds in securities market, fixed payment obligations.
No, they are both direct financing. Indirect financing is where borrowers borrow funds from the
financial market through indirect means, such as through a financial intermediary. This is
different from direct financing where there is a direct connection to the financial markets as
indicated by the borrower issuing securities directly on the market.
37. Explain the asymmetry of the banking reform in China in the two sides of deposit and lending. What
can the US learn from this experience?
Deposit side: very impressive and successful
Vast deposit facilities all over China Chinese households trust state banks for safety
State banks never collapsed before. Inflation was generally moderate, only two brief periods had annualized
inflation rates above 10%. Real interest rates on deposits are generally positive. In these periods (1988 and
1993), bank deposit rates were indexed to inflation to prevent real rates from falling below zero.
Lending side: very problematic and fragile
The size of the stock of non-performing loans are hard to estimate. 30-40% total outstanding
loansànon-performance loans to GDP ratio is very high (1/4 GDP=300 billion US $)
US should also create some programs like this to get rid of banks bad debts even though it costs tons of money
for the government to do this. The benefits outweigh the loss. US should also use taxpayers' money to bail out
the banks.
38. Evaluate the non-performing loan problem in China’s banking sector from the both stock and low
perspectives. For what purpose did the government create Asset Management Companies?
           In order to improve balance sheet, four AMCs were created.
∙         Bad loans were transferred from banks to AMC at book value. AMC sells the bad loans to a third party
such as foreign investment and asset management companies. AMC then converted the debt into equity stakes in
the debtor SOES, reducing leverage ratio of SOEs and sell the equity to buyers. The costs are borne by the
Ministry of Finance, and ultimately by tax payers.

The non-performance loans to GDP ratio is very high.
Assets: own capital, outstanding loans, provisions, reserves with PBOC
Liabilities: deposits and equity

The stock problem refers to the difficulty of clearing up the existing stock of bad loans
already on the bank’s balance sheets. Total accumulated NPLs in the Big Four before the AMC
buyout were about 3.5 trillion RMB, almost exactly one-third of GDP. By the end of 2005, the
AMCs had disposed of two-thirds of their total NPLs, but recovered only about 13% of the

The flow problem refers to the need to prevent new lending decisions from creating new
non-performing loans, and instead making current lending decisions on a commercially
sound basis. Today’s bailout raises the likelihood of additional bailouts in the future and
signals that bank managers may not be held responsible for today’s decision making.

AMCs: The government established four state-run assets-management companies, one for
each of the Big Four. The tasks of AMCs were to clean up NPLs; as a result, the healthier
banks can avoid bankruptcy, attract more foreign investments, and strengthen competition
39. In what sense does the fragility of China’s financial system differ from other East Asian countries
that experienced financial crisis such as Thailand, South Korea and Indonesia?
China is exceptional compared with other East Asian countries because banks are state owned. All deposits are
insured by the state. There is no possibility of bankruptcy. Bad loans become government public debts.
40. Give three most prominent peculiarities of China’s securities markets as compared to developed
country securities markets such as those in the U.S.? Explain
1. share types: A-share (23%), B-share (3%), and H-share (6%)
2. circulation: only personal shares are circulating
3. all IPOs are SEOs: almost all IPOs are former SOEs, the state retains a majority of the equity, not circulating.
Almost all of the very largest SOEs have been listed, and the government’s bonds are not traded. There are little
corporate bonds.
Econ 162: Final Examination Information
Lecture notes: topics 1­16
Chapters in the textbook: all
Officially Scheduled Time and Place:
Time: Thursday, May 12, 2011, 8­11AM
Location: 1 Pimentel
Last minute questions? This Wednesday 1­5PM, in my office at 338 Giannini.
Closed book exam. No calculators, PDAs, books, or notes please.
Format similar to midterm. More short answers, one long essay.
Cumulative: 1/3 first half of course, 2/3 second half of course.
For the earlier material, review your midterm preparation. For the new material, review
the following topics:
1. Define the concept of a fully funded pension system. What is the demographic
argument for China to adopt a funded pension system?
A fully funded pension system is in which people have personal accounts. Assets and money
are set aside to meet future need of paying the pensions.
The second part I’m not quite sure because I can’t find it in slides. Both funded and unfunded are
defined benefit systems. Thus no matter who pays and pay how much, in the end the people will
get a certain amount as pension. China’s funding system is through some proportion by
employees and a large proportion by enterprises. The request for enterprise funding is
mandatory. The government cannot fund for the entire country, thus a funded pension system is
sunny says “ Pension plan in which all liabilities are fully funded.
China's multi pillar system involve funds contributed by state, employers, and individuals: consists of three
elements: basic public pension funded on a pay­as­you­go basis­basic old age security, fully funded pension
funded by mandatory contributions, and voluntary personal savings
Fully funded pension: funded by contributions from the enterprises(rest) and employees (2­5%)­
why?­not to overburden the fiscal authorieties with a huge public pension system:
2. What are the major features of age structure in China in the near future (2000­2010)
and beyond? What the medium and long term economic implications of this?
• Present situation
– High working age population and low dependency rates for both young and old dependents
– Share of population of ages 15­64 is very high China 67% Low income countries 57%
Middle­income countries62%
– Opposite of Japan
• Near Future (till 2015)
– The trend continues (the share of working age population increase to 70% before decline)
• Longer term (from 2015 on)
– The trend reverses
• Dual problems
– In the immediate future: Serious unemployment risk, job creation is a primary concern
– In the distant future: Serious pension problem, how to finance it and provide support services
3. How did local governments react to the problem of “floating migrants?” Explain the
economic consequences of their responses.
• Competition between urban dwellers and floating migrants
• Local government regulations
– Barriers (numerous licenses, restrictions of employment)
– Entitlement to local public goods (schools, health care)
• Policy accommodation
– Temporary or permanent permits (“Green cards”) based on jobs and investment (housing
– Varied by region
It caused inequality in rural areas, and between rural areas and urban areas. Even though
income is rising all over China, inequality is also rising. With those restrictions by the local
governments. The floating migrant’s living condition will be worse.
4. What are the three trade regimes in China in the post­1949 period? Describe and
discuss the major features of each regime.
• Trade regimes
– Pre­Reform: central planning
– Post­reform and pre­WTO: dual trade regime
– Post­WTO: convergence to a uniform, international standard
• 1950s
– Major trading partners were other centrally planned economies
– 1/2 of foreign trade was with the Soviet Union
– Trading patterns: import machinery, export food and textile products
• 1960s and 1970s
– Became isolated from both capitalist and socialist spheres
– “Self­reliance” development strategy
– Major trading partners were Western countries, EU and Japan in the 1970s
– Trading pattern: import grain and machinery (fertilizer plants and steel mills), export textiles
and light industrial goods
• Foreign trade regime was part of central planning, generally a residual category w.r.t. domestic
• 12 foreign trade companies, monopoly in each market (e.g., grain, machinery, textiles)
• Foreign exchange strictly controlled, serve the purpose of trade plan
• Import
– Ease severe domestic shortages (food, materials)
– Overcome bottlenecks in domestic production (capital equipment)
• Export ­ Earning hard currency to finance import
5. How did the dual­track foreign exchange market work? How did the dual­track in
foreign trade work?
In a dual­track foreign exchange market, exporters outside the plan could sell their
foreign­exchange earnings on a lightly regulated secondary market. Under the EP regime
exporters­predominantly FIEs­were allowed to sidestep the entire complex and unwieldy
apparatus of import controls, canalization, and regulatory monopolies that restricted
development of trade under the OT regime. In the dual track in foreign trade, there were the old
sector concentrated on “ordinary trade” and the new sector, focused on “EP trade.” In the new
sector, many foreign invested firms were located mainly in SEZs. Imports for EP purposes were
duty free.
6. Why a dual­track instead of a single­track? Use the examples in foreign exchange
and foreign trade to explain the advantages and disadvantages of a dual­track.
Advantages: In foreign exchange market, the existence of official exchange rate and swap
market rate allows exporters to keep a proportion of foreign exchanges and use the swap
market. They effectively allocate foreign exchange and increase their foreign reserve. Public
sector can maintain the growth, so university can continue sending professor aboard at lower
price. In foreign trade, free market is introduced w/o disrupting the existing old sector, while
benefiting the new sector. The old sector imports while the new exports.
Disadvantages:  In foreign exchange market, the Chinese currency devalued. In foreign trade
market, state enterprises granted direct export & import rights. Although the number of foreign
trade companies increase, FTC insulates exporters from the world market. The dramatic growth
of SEZ has contributed to the income inequality within China. Coastal provinces subject to EP
regime have been developing one step further than the rest of China.
7. Why is there a huge discrepancy between the average statutory import tariff and the
actual tariff revenue share in import values in China?
Chinese policy­makers proceeded cautiously about the system of tariffs. They were wary of
making mistakes, afraid of import surges, trade deficits, and hard currency debt. As reformers
dismantled the planned trade system, they erected high tariff walls and substantial nontariff
barriers to maintain protection of the domestic market. In the early 1980s a new set of tariffs
were promulgated that raised tariffs, which stayed high for the next decade. In 1992, according to
the analysis in World Bank, China’s tariffs wee similar to other highly protected developing
countries. The unweighted tariff was 43%, and the trade­weighted mean tariff was 32%. Indeed,
NTBs(nontariff barriers) and tariffs were “used in a complementary fashion to achieve the
government’s objectives”. There are many exemptions such as SEZs. And smuggling is a
8. What are the major structural changes in China’s exports in the last 20 years? What
were the forces behind such changes? Explain.
Between 1985 and 1995, there was a dramatic shift to labor­intensive commodities and a
correspondingly large decline in natural­resource­based products. But the trade growth slowed
in the 1996­2001 period. After 2002 growth of both exports and imports surged above 20% per
annum, and stayed high. The surge has been associated with a dramatic increase in the share
of machinery and electronics items. Growth of labor­intensive manufactures has remained
robust. China’s increased market share in export is matched by the declining shares of Hong
Kong and Taiwan. It was a natural process, and Hong Kong and Taiwan firms benefit too. The
really fundamental changes in the composition of China’s exports date to 1985, when we begin
to see the impact of the Coastal Development Strategy, the full­fledged rollout of the EP trading
regime, and the increased participation of FIEs in export growth. Different coastal regions have
responded to the stimulus of trade opportunities in significantly different fashion.
9. Why was China so eager to join the WTO?Explain the top three reasons.
    ● Trade and Growth
         ○ CHina’s trade integration with the world remains shallow
         ○ growth slow down after Asian financial crises calls for more foreign investment
    ● reform and restructuring
         ○ use WTO as an anchor to push for further reform
         ○ introducing international competition
    ● joining the international club
         ○ being part of the civilized world
         ○ more weight in international world
         ○ china is an exception among developing countries to enthusiastically and
             unconditionally embrace globalization
10.Discuss the special challenges for China’s accession to WTO, both in negotiation
and implementation.
   ● 15­year negotiation
         ○ china’s economy is not a complete market economy: close domestic market,
             dualistic trading regime
         ○ china’s economy is a developing economy

      china’s economy is large and growing fast: competitive advantages and
      antidumping actions
   ○ the complex bargain of China entry to WTO: granting boarder and fairer access to
      its economy in exchange for greater access for its light manufactured exports to
      other countries
   ○ open up the OT(ordinary trade) regime and reduce the dualism of its trading
   ○ commitment to extend trading rights without restrictions, including giving trading
      rights to domestic and foreign private companies
   ○ tariff reduction: china committed to a system of TRQs to certain products,
      agreeing to lower tariffs up to a certain ceiling
   ○ removing non­tariff barriers: eliminate most licensing, quotas, other quantitative
      restrictions by 2005; eliminate some quotas or increase the quotas upon
   ○ extension of trade areas: telecommunications, financial services, audiovisual,
      professional services, and wholesale and retail trade
   ○ Protocol issues: transparency in trade administration; judiciary review,
      government procurement, trade­related investment measure

11.What is “Tariff­Rate Quota” (TRQ) system? What are the three important parameters
in TRQ? What is the purpose of TRQ?
    ● TRQ: low tariff within the quota, higher tariff out­of­quota
    ● three parameters: quota, low tariff, higher tariff
    ● purpose:
          ○ China no longer limited trade to certain state­owned FTCs, giving trade right to
             domestic and foreign private companies
          ○ assure minimum market access of non­state traders, but limit domestic producer
12.Under the terms of China’s accession to WTO, can the U.S. impose quantitative
restrictions only on imported goods originating from China? Can the U.S. do the same to
other WTO members? Why?
   ● Yes, only to China.
   ● Safeguards is exception to goods originating in China, which is used to impose
       quantitative restriction on imported goods provided certain conditions are met
   ● but it is easy for a country to impose quantitative restriction for goods from China for 12
   ● China’s retaliation is more restricted; while the import of textile and apparel quotas
       continue until 2008 for China, general expiration of quotas is in 2005
13. In antidumping cases, why can China not use its domestic production costs as a
basis for calculating the normal value of its export? What can China do in this
Normal values is the prices at which the good is sold in the exporter country or in a third country
or the cost of producing the product, plus reasonable amounts for administration, selling and
other costs, and profit. WTO allows countries to impose countervailing duties on imports when a
firm is selling a product abroad at less than its “normal value.”
China cannot use its domestic production costs as a basis for calculating the normal value of its
export. Because it is treated as “no­market economy”. It is not yet a complete market economy
and the production cost is unusually low.
This is justified because China’s economy is still in transition and the government still has
control over pricing and other market activities, it cannot be granted Market Economy Status.
China is one of the countries that have the cheapest labor force. Therefore, it is unreasonable to
compare China’s goods prices to countries that have a relatively expensive labor force. This is
especially disadvantaged to China’s labor­intensive products. In this circumstance, China should
improve its market regulations and conquer the free trade barriers to improve the situation and
produce a properly judged pricing level to assess the “dumping” behavior.
14. What are the risks for China’s agriculture sector after it enters the WTO? What are
the possible solutions?
WTO essentially imposes limits on how much China can protect its agriculture, ie, TRQs.
Terms of WTO accession requires the government to eliminate subsidies, reduce tariffs and
end the state monopoly of grain.
China will lose out on land intensive grains due to the scarcity of land, and expensive grains like
cereals. Reduced tariffs will lower domestic grain prices. Farmers will be severely negatively
affected as they are already suffering from low market prices. There will be huge job losses in
agri sector. Abundant labor will move to lab intensive sectors. The migration problem in China
thus will be more severe. China’s entering international grain market would cause dramatic price
increases and consequently force China to import more grain.
Solution China should be more efficient w/ its scarce arable land. specialization and efficiency of
agricultural production demand less labor and more technological inputs  1. provide incentives to farmers to
further invest into research and development, in order to compete with international competition 2. to
increase productivity, the govt should provide subsidies to technology and productive inputs like fertilizers
rather than subsidies to farmers in their production. 3. create more job opportunities for laid off farmers.
provide them training and access to labor intensive sectors. Finally move abundant labor from agri to other
15. Why do economists consider China’s financial sector very fragile after the WTO
accession? What are their arguments?
The reform of the financial sector lag behind other sectors. And at the beginning of reform, China
sacrifices the banking sector to subsidize losers in other sectors, keeping the process of economic
transition on track, ie, soft budget constraint for SOEs.
China’s financial sector is dominated by banking. 1. The banking system is over regulated.  2. the 4 state
banks, which dominates the banking system, still have NPL problems due to SOEs bad loan, the stock
problem  3. the 4 state banks lack profit incentives and risk sensitivity due to over regulation and bailing out
during its NPL crisis, which may lead to new bad loans, the flow problem.  4. the whole banking system
lacks market competition, is inefficient and never encounters international competition.  5. the difference
between borrowing and lending rates are too narrrow. 6. Now foreign banks are allowed to conduct local
currency services to both enterprises and households. With better service and management experience,
they compete aggressively for the most attractive borrowers, especially those in the most advanced
coastal cities.  7. expect huge job losses in state banks.
China’s capital markets, including stock markets are 1. it is over regulated.  2. it lacks transparency.  3.
price does not reflect value but on the other hand reflects govt policy…
Chinese banks and financial institutions previously had all the local demand and no outside competition.
Now they will have to compete for business with foreign firms. In addition it is predicted that there will be
1million job losses in Chinese state banks to foreign banks because of salary incentives. Economists
believe that China’s competitive advantage in terms of labor costs will reduce, because foreign firms will
take advantage of this as well. Foreign firms have the right to equal access to markets and equal
opportunities to compete for business. Economists also believe that China’s self­sufficiency and lack of
FDI, makes it difficult for them to open their borders to new investment and new growth from foreign
firms. In the past, state­run financial institutions were very much focused on building China’s financial
sector through government sponsorship and exporting.
16. What are the distinct patterns of foreign investment in China? Name some
government policies that are directly responsible for such patterns. Explain.
1. Mainly foreign direct investment (FDI) . Among loans, there is few short term loans. Little
portfolio investments
2. Among FDI, an unusually large proportion are in manufacturing, as opposed to services or
resource extraction.
3. FDI inflows predominatedly come from other asian economies especially HK and TW.
4. FDI mainly in coastal provinces.
FDI is the major motor to transform chinese economy.
1. Deng opened SEZs since 1978, the initial four SEZs are located in GD and FJ, to target HK
and TW investors. Such action express purpose of reviving traditional connections w/ HK and
TW and stimulating global economic integration.
2. the SEZs are initially for EX manufacturing, as the EP regime. The service sector was in
general not open until WTO.
3. in 1984, 14 new zones along the coast were opened for FDI, as part of the coastal
development plan.
4. in 1992, Deng made a southern tour, smoothed over uncertainty from investors due to TAM
square fiasco
5. new policies in 1992 selectively opened dom market (ie, real estate) to foreign inv, so FDI
grew rapidly.
First government policies: establishment of special economic zones (SEZs) in 1979, which
started the gradual liberalization of the investment regime. SEZs became a symbol of the
government’s commitment to external liberalization. They served as a powerful marker of
China’s commitment to policy changes encouraging liberalization. After 1992, 2/3 of EX
increment came from foreign invested firms. FDI play an important role in indistrial grwoth, tech
transfer and trade expansion. 14 new “open cities” were designated: Economic and
Technological Development Zones (ETDZs), which were basically the same as SEZ except they
were specifically encouraged to bargain aggressively with potential foreign investors to facilitate
investment flow.
Government policies were in four waves:
1.  First Wave 1978­1980 – joint venture laws (no limit on foreign shares)
2.  Second Wave 1984­1987 – Coastal developmental strategy
3.  Third Wave 1992­1993 – more developmental zones, competition among regions to attract foreign
4.  Fourth Wave 2001 – Joining of WTO
17. In what aspects are Special Economic Zones in China special? How are Special
Economic Zones in China compared with Export Processing Zones in other Asian
In 1980, Special Economic Zones were set up in Shenzhen, Zhuhai, Shandou and Xiamen. The
establishment of the first SEZs in China was a signal of commitment to economic opening. China has
marked every major wave of liberalization with the establishment of a new batch of zones. Zones
also permitted incremental progress within a rigid system. SEZs became a symbol of the
government’s commitment to external liberalization. The establishment of the SEZs serve served as
a powerful commitment device. By demonstrating to foreign businesses that China would maintain
an open environment in a specific, easily monitored location, the SEZs enhanced the credibility of
the reform process.
The SEZs in China and EPZs in other Asian economies were similar in that both were regions in which
foreign investment was encouraged by lower tax rates, fewer and simplified administrative and
customs procedures, and duty-free imports of components and supplies. However, the SEZs were
bound to be different than the Asian EPZs since Asian EPZs were established in economies that were
basically market economies. In contrast, Chinese SEZs were created in a planned, bureaucratic
economic system despite being market oriented themselves. In addition, Chinese SEZs served as
laboratories for experiments with economic reforms. They were also seen as “windows” on the
world, absorbing advanced experience in technology, administration and business.
18. What are the three major forms of foreign direct investment in China? What is the
dynamics in the relative importance of each form over time? Explain the reasons.
The three major forms of foreign direct investment in China are contractual joint venture, equity
joint venture and wholly foreign owned.
The contractual forms in which FDI is embodied in China have evolved steadily toward modes that
permit the foreign investor a higher level of control. In the early 1980s, FDI was dominated by
contractual JVs which are flexible agreements of association that do not necessarily create an
enduring legal entity, and they are particularly useful in situations in which investment is combined
with some kind of service agreement.
After the mid-1980s, equity JVs became the dominant mode of investment. From 1987 through 1996,
more than half of incoming FDI was in the form of EJVs. EJVs create a new legal entity in which the
foreign and domestic firms have a stake. Their predominance during this period reflected the
commonly held beliefs that long-term partnerships were necessary to operate in the Chinese
environment and that such partnerships would facilitate the sharing of information and technology.
As China evolved toward a market economy, foreign investors increasingly felt they could operate
independently and preferred wholly owned subsidiaries. The share of FDI in the form of wholly
owned subsidiaries of foreign companies has climbed steadily and in 2004, it accounted for exactly
two-thirds of total realized FDI inflows.
19. What are the comparative economic advantages of Hong Kong and Taiwan
respectively in the near future?
Hong Kong has long been an independent member of some international organization, including the
WTO. Since Hong Kong is close proximity to China also means that it has better information about
policy changes inside China than investors in other countries. With inside information, Hong Kong
businesses move quickly to take advantage of new opportunities in China when policy shifts. They
will enjoy earlier access to some of the sectors being opened up in China as part of WTO accession.
Furthermore, Hong Kong is the home of many subsidiaries of corporations based elsewhere. Hong
Kong have an advantage with investments that are channeled through Hong Kong and show up in the
data as Hong Kong investment. There are about 1,000 foreign company regional head quarters in
Hong Kong. Finally, Hong Kong also has a very strong banking and legal environment. Taiwan
investment in mainland China soured after 2000. Taiwan is able to shift to high margin services such
at R&D and design. While much of the ordinary manufacturing had moved to PRC, Taiwan can
specialize in high value services and technologically more intensive and sophisticated production.
Hong Kong and Taiwan will both experience success in upgrading to higher-skilled activities.
20. What are the three categories of government fiscal revenue in China? How should
one calculate the true government debt in China?
The three categories of total revenue were budgetary revenue+extra-budgetary revenue+off budget
revenue. The budgetary revenue were the taxes. In 1994 the Chinese government had a tax reform
that introduced value added taxes levied on most manufactured goods at the uniform rate of 17%.
Individual businesses pay 6% sales tax instead of VAT and corporate income tax had 25%. Also a 33%
profit tax was introduced, with uniform rates for state, collective, and private enterprises. The
extra-budgetary revenue were fees, for example fees collected by public institutions and
administrative agencies; contributions to social insurance funds. Off-budgetary revenue were
varieties of income.
On the books, government debt is 20% of GDP in China. But to calculate the true government debt in
China is to include bad bank loans that consist of up to 25% of GDP, as well as recapitalization of Asset
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