consequences and their relative magnitude for any particular mix of military expenditures which may be chosen.

A second qualification which must be emphasized at the outset is to repeat that our results are indicative or illustrative of the types and relative magnitudes for the economic consequences of China's military expenditure choices; they are not meant to be taken as the accurate or absolute point estimates of real costs which would be incurred were the Chinese to pursue the particular options studied. The lack of sufficient empirical data on a sector-by-sector basis, especially for the defense sector, precludes an attempt to obtain accurate estimates. Moreover, the methodology used to obtain our results, although it may appear to be somewhat sophisticated, is really rather crude and relies on too many simplifying assumptions to permit us to claim a high degree of accuracy for our results, even if the data base used were accurate. No matter, accurate estimates would really tell us little more than our crude estimates of relative magnitudes inasmuch as it is probably only a vague impression of these relative magnitudes for the economic consequences of these military expenditure alternatives, rather than specific cost-benefit calculations, which actually influence the Chinese leaders decisions.

Finally, as any observer of the Chinese experience over the past 25 years must know by now, the Chinese leaders do not passively accept the unexpected or expected, but underestimated, economic consequences of their policy decisions. Undesirable or unaccepted results of one policy soon generate new policies to ameliorate those results; the Chinese leadership has shown itself to be remarkably willing and able to experiment within the basic context of their ideological premises and innovate with considerable ingenuity to counter and eliminate the undesirable consequences of their policies. The estimates for the economic consequences of any particular military expenditure choice presented in this paper, however, are obtained by simply tracing the expected direct and indirect effects of that choice throughout the economy, without allowing for any corrective reaction on the part of China's leaders. In short, the undesirable economic consequences estimated for any military expenditure choice represent an overestimate in that they exclude from consideration the almost certain reaction to these consequences by China's leaders which would aim to prevent any undesirable consequences predicted from actually taking place.

Our estimates for the economic consequences of any particular military expenditure choice, therefore, are determined by analyzing the effects of that choice alone while holding all other economic and military policies unchanged. Our analysis would become terribly complicated, if not impossible, if we were to try and derive our estimates while continuously introducing new policies. Events in the real world, of course, do represent the two-directional interaction between observed results and policy formation, but we are forced to analyze that reality by means of a more simplified and tractable model in which the policy chosen is the initial cause and the ensuing changes in economic events is the effect. Nonetheless, the first approximation for determining an optimum policy mix is the prior knowledge of the economic consequences of each individual policy and the purpose of this paper is to estimate the economic consequences of a few alternatives in the area of military expenditure choices.

These estimates are obtained by using an econometric model of the Chinese economy which identifies 17 different economic activities in the economy and specifies the relative magnitude or structure of resource and commodity flows among these activities.*

This econometric model is little more than a simplified flowchart or blueprint of how given resources can be allocated to several major productive activities in the Chinese economy and how the resulting output of commodities and services can be allocated among their various end uses. Admittedly a great many simplifying assumptions must be made in the development of such a model. A less formal approach would also allow us to derive quantitative estimates for the relative costs of China's alternative military strategy policies, but only by making these same assumptions explicitly or; if we choose to ignore the problems of consistency and specificity altogether, by hidden implication. The use of an econometric model, on the other hand, enables us to obtain quantitative estimates for the relative costs of possible alternative military expenditures in China which are consistent with assumptions which must be made explicit, and will take into account at least the most important interactions among the various economic activities in the economy and their most important indirect effects. These benefits are of even greater significance when we are faced with the problem of limited quantitative economic data.5

To claim that the use of an econometric model allows us to obtain estimates for the relative costs of China's alternative military strategy policies on the basis of explicitly stated assumptions and methodology without presenting the reader with the model itself would be a neat trick of evasion. Unfortunately, however, limits of space do not permit a detailed discussion of the econometric model in this paper. What follows is a brief summary statement of the important operational features of the model; appendix 1 presenting the essential specifications of the model for those who are interested. To the latter group, I apologize for not being able to explain in greater detail the methodology used to obtain the estimates presented in this paper.

The model identifies the scarce resources to be considered (unskilled labor, skilled labor, and capital), determines the supply of these resources, specifies the quantitative relationship between inputs and outputs in each of the four production sectors (the aggregate, sectoral production functions in the agricultural, heavy industrial, light industrial, and defense industrial sectors), and specifies how the outputs of these sectors is allocated to their end use (consumption, foreign trade, and defense) or as inputs in other productive sectors.

The effect, therefore, of any given policy choice as to the allocation of resources and of the resulting output, on the rate of growth, struc

This econometric model of the Chinese economy is basically the same as the one I developed in an earlier study to estimate the past, present, and future real costs of defense expenditures in the People's Republic of China for a project sponsored by the U.S. Arms Control and Disarmament Agency. It is a significantly modified and simplified version of Shigeru Ishikawa's econometric model of mainland China's economy. The model used in this study has been used to simulate the actual course of events in the economy between 1953 and 1957, being able to come within 5 percent of the levels actually observed, i.e., as reported in the official statistics or as estimated by students of the Chinese economy. For the period after 1957, the model was able to replicate an economic boom, a crisis, and a period of restoration very similar to the picture revealed in the available information for the post-1957 period.

5 Even with an econometric model of the Chinese economy, however, empirical economic data still must be used to obtain our estimates and the saying "garbage in-garbage out" could be used as a valid criterion of our estimates if the empirical economic data we use are judged to be "garbage." Nonetheless, the use of an econometric model to obtain our estimates does economize on the amount of empirical economic data which must be used and forces us to use that data in a consistent and explicitly specified manner to obtain our estimates.

ture of the economy, standard of living, balance of payments, and any other indicator of economic development or military capabilities can be directly estimated. In this paper, our estimates of the relative costs of various alternative military expenditure choices are obtained by determining the level of resources available and existing level of economic activity in the various sectors in the initial or base year (1975), projecting the future course of economic activity if there were no change in the present mix of economic and military expenditure policies, and comparing these results with those which would emerge under different military expenditure policies. The difference between the projected evolution of the economy under the present policies compared to its projected evolution under alternative military expenditure policies is the real cost to the economy of these alternative policies. These real costs (or benefits) of the alternative policies, therefore, are measured by the extent to which they reduce (increase) the standard of living of the Chinese labor force; aggregate supply of consumer's goods, the rate of employment, and the rate of growth for the economy as a whole; the extent to which they change the structure of the economy as between civilian and defense production; and the extent to which there is a worsening (improvement) in China's balance of payments. In brief, the real cost of any change in military expenditure policy is not measured by a particular amount of resources or commodities directly required to make that change possible; it is the net effect of this reallocation of resources and commodities upon all sectors of the economy and it is the ability of an econometric model to provide us with estimates for these net effects which is the strongest argument for the methodology used in this paper.

THE BASE YEAR: THE CHINESE ECONOMY IN 1975

7

Our analysis of the real costs of alternative military expenditure choices in the future must begin with a brief assessment of the state of the economy in the present. Obviously, as reflected in the other papers presented in this volume, the attempt to spell out the quantitative dimensions of economic activity in China today is not an easy task. What follows, therefore, is a somewhat tenuous set of "guesstimates" which are made necessary by the methodology used in this paper. Nonetheless, these quantitative estimates are presented in the belief they do represent a reasonable picture of the Chinese economy today and are consistent with the limited evidence available. Unfortunately, the limits of time and space preclude any extended discussion of the means by which these estimates are derived or the necessary supporting documentation for why they are said to be reasonable. In any event, the latter judgment must be made by the reader. The method of their derivation, however, does require some explanation.

The reason why we must have a quantitative picture of the present level of economic activity in the Chinese economy, as well as those estimates for the possible evolution of the economy over the next few

6 When an alternative military expenditure policy is introduced in the economy, that new policy will generate either an increased demand for or an increased supply of resources inasmuch as an increase (or reduction) in defense expenditures will be provided by (or allocated to) some other sector of the economy; the sector supplying or receiving these resources being determined by the policymakers. In this paper, the consumption or the foreign trade sectors are designated as the sector chosen to balance any inbalance in the overall supply and demand for resources in the economy.

7 Actually, I have not been able to read the other papers included in this volume before preparing my own, but this conclusion is based on studies of China's contemporary economy which have been published in the past few years.

years, presented in the next section of the paper, is to provide us with a benchmark for estimating the real costs or economic consequences of an alternative military expenditure choice. To determine these economic consequences, we must have some idea of what would occur in the absence of any change in military expenditures. The initial attempt to derive this desired "benchmark" in the detail desired soon revealed that exercise would not only be extremely time-consuming, but also indicated the results of that effort itself would be little more than a weak set of intuitive conjectures.

Rather than devote a large amount of time to the derivation of a new set of conjectures concerning the present state and future course of economic activity in China, merely for the purpose of using these conjectures as a benchmark for the analysis in this paper, a complete and detailed set of quantitative estimates already is available for this purpose; those projections for the future course of economic development in China during the 1970's generated by the same econometric model used in this paper which were obtained in a study completed several years ago. I do not mean to imply my earlier projections were accurate, only that the economy they describe is a reasonable facsimile of the Chinese economy today and, therefore, can be accepted as our "benchmark" for our analysis in this paper. Only the most important quantitative economic indicators given by the estimates are presented

here.

8

9

In 1975, China's gross domestic product (GDP) is estimated as amounting to 196.6 billion current U.S. dollars and, in constant prices, is growing at an annual rate of approximately 8.4 percent. Existing estimates for the early 1970's tend to agree that China's GDP in 1971 was approximately 125 billion current U.S. dollars, 10 consistent with

8 Robert F. Dernberger, "The Opportunity Costs of Defense Expenditures in Communist China," (mimeo) prepared for the U.S. Arms Control and Disarmament Agency and submitted in 1970. (ACDA/E-114 IV). The estimates appear in ch. VII, "The Projections." The particular set of projections adopted to depict the present state of the Chinese economy for our purposes in this study are those which were generated under the set of policy assumptions labeled "balanced growth" in the earlier study.

This estimate of GNP is derived by starting with the model's estimate of net domestic material product (NDP) in 1952 yuan for 1975 and assuming the ratio of services to NDP is 25 percent, the rate of depreciation in the Chinese economy averages 6 percent, and the relevant exchange rate between 1952 Chinese ¥ and 1952 U.S. dollars is 2.34 ¥ per U.S. $1. This ratio of services (including transportation) to NDP is consistent with Perkins' estimate of 20 percent as the ratio of services (excluding transportation) to GNP. Dwight Perkins, "Growth and Changing Structure of China's Twentieth Century Economy" in Dwight Perkins, ed., China's Modern Economy in Historical Perspective, Stanford University Press, 1975. The resulting estimate of GDP in 1952 U.S. dollars is converted into current 1975 U.S. dollars by means of the implicit price deflator for U.S. GDP between 1952 and 1974. 10 Citations are restricted to those sources which specifically estimate China's GDP and provide an explanation of how those estimates were obtained, ie., these estimates are not intuitive guesses. Two estimates are available for China's GDP in 1970; Eckstein's estimate of 171.4 billion (1952) and the Liu-Yeh estimate of 152.8 billion (1952) ¥. Alexander Eckstein, "Economic Growth and Change in China: A Twenty-Year Perspective," The China Quarterly, April/June 1973, p. 232. Ta-chung Liu and Kung-chia Yeh, "Chinese and Other Asian Economies: A Quantitative Evaluation." The American Economic Review, May 1973, p. 218. When these 1952 ¥ totals are converted into U.S. 1952 totals at a rate of 2.34 ¥ per U.S. $1 and transformed into 1970 current U.S. dollar values by means of the implicit price deflator for U.S. GDP, we obtain estimates for China's GDP in 1970, in current U.S. dollars, of 113.1 and 100.8 billion U.S. dollars respectively. Three estimates are available for China's GDP in 1971; Ashbrook's estimate of 128.39 billion (1970) U.S. dollars, Rawski's estimate of 194.1 billion (1952) ¥, and Perkins' estimate of 193.36 billion (1957). Arthur G. Ashbrook, Jr., "China Economic Policy and Economic Results, 1949-71," in People's Republic of China: An Economic Assessment, Joint Economic Committee, Congress of the United States, U.S. Government Printing Office, Washington, 1972, n. 47. Thomas Rawski, "Recent Trends in the Chinese Economy," The China Quarterly, January/March 1973, p. 21. Dwight Perkins, op. cit. (the estimate presented in the source by Rawski is for NDP and the estimate for GDP presented here assumes a depreciation rate of 6 percent). When these estimates are converted into U.S. dollars of various base year prices and transformed into 1971 current U.S. dollars by means of the implicit price deflator for U.S. GDP, we obtain estimates of 134.4, 134.3, and 120 billion (1971) U.S. dollars, respectively.

51-174 O 75 - 31

11

a GDP of 196.7 billion current U.S. dollars in 1975 if the growth rate, in current prices, were 12 percent a year or an annual growth rate, in constant prices, of 8.5 percent. By assumption, the service sector (including transportation) in our estimates accounts for 25 percent of GDP in 1975, compared to 27 percent estimated by Perkins (1971, in 1957 prices) and Liu-Yeh (1970, in 1952 prices). Although the contribution of the industrial sector (38 percent) is larger than that of the agricultural sector (37 percent), our estimates do depict the Chinese economy as being slightly less industrialized with a somewhat more dominant agricultural sector than suggested by the estimates of others.12

The value of industrial output in 1975 is 74.7 billion current U.S. dollars and 21.8 percent of this total, or 16.3 billion current U.S. dollars, consists of military goods production. The size of China's armed forces is assumed to be approximately 3 million men and total defense expenditures are estimated to be 21 billion current U.S. dollars, or 10.6 percent of GDP.13 No estimate is made for the rate of investment, but the net accumulation of new producers goods through domestic production and imports as a share of GDP in 1975 is 23.9 percent, which is almost identical to Perkins' estimate for 1970 of 23.8 percent. The rate of investment in the economy would obviously be greater than the rate of accumulation of new producers goods, and although the estimated per capita GDP is approximately 246 current U.S. dollars in 1975, per capita personal consumption expenditures are estimated to be only 118.6 current U.S. dollars.15

Finally, in the foreign trade sector, the estimates were made with the assumption that China would maintain a balanced merchandise trade; imports being determined as the excess demand for producers goods necessary to achieve the desired level of investment and for agricultural products necessary to achieve the desired level of per capita

11 Dwight Perkins, op. cit., and Ta-chung Liu and Kung-chia Yeh, op. cit., p. 218. The service sector share of GDP estimated in the latter source is the residual share of the nonindustrial and nonagricultural sector. Perkins' estimate for the sectoral shares of GDP have been adjusted to make them comparable by transferring his estimate for transportation from the "manufacturing" sector to the "service" sector.

12 Perkins' estimate for 1971 (in 1957 prices) are industry 42 percent and agriculture 31 percent; Liu Yeh estimates for 1970 (in 1952 prices) are industry 44 percent and agriculture 29 percent.

13 According to the estimates of the U.S. Arms Control and Disarmament Agency, China's military manpower (including paramilitary) totaled 3.1 million in 1970 and total defense expenditures were 10 billion current U.S. dollars, or 8.3 percent of GDP. The Bureau of Economic Affairs, ACDA, World Military Expenditures, 1971, U.S. Government Printing Office, Washington, D.C., 1972, p. 12. In real terms, my estimates indicate an annual rate of increase of 11 percent a year between their estimates for 1970 and my estimates for 1975. 14 Dwight Perkins, op. cit., table B-1, appendix B. The reason no estimate is made for the rate of investment is that the accumulation of producers goods, which are the only capital inputs in the production functions in the econometric model used to generate these estimates, is the only investment activity included in the model, i.e., the services and monetary sectors are excluded.

15 To obtain this estimate for per capita personal consumption expenditures, the econometric model estimates for the net value of light industrial and agricultural products distributed to the personal consumption sector are converted into market values and this total is assumed to represent 75 percent of total personal consumption expenditures. The total population in 1975 is assumed to be 800 million. While this estimate of per capita personal consumption expenditures. being only 48.2 percent of per capita GDP, may appear to be very low, it must be remembered per capita GDP also includes per capita Investment and per capita government expenditures. For example, personal consumption expenditures for commodities in the United States in 1973 accounted for only 36 percent of GDP; when services are included, the personal consumption expenditures account for 62 percent of GDP. Thus, in China, where the service sector is much smaller relative to that in the United States, the rate of investment is much higher than in the United States, and government expenditures are approximately the same relative portion of GDP, the per capita personal consumption expenditures estimate for China presented in the text, while obviously subject to a considerable margin of error, would appear to be a reasonable approximation.