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and managers of the economy can be brought together to plan and regulate the entire economy with effectiveness. Only then can we hope to discern the direction in which the economy is going.

For the moment, one might speculate that the central authorities in Peking probably control little more than what one would call the commanding heights of the economy, in particular, the heavy capital goods and producer goods industries that are mostly related to defense.

There is a local industry drive and a high degree of decentralization seems to prevail. However, these moves are not just by choice; they may also be a matter of necessity. Ironically, the inability of the central authorities to engage in very rigorous control of the economy may have had the advantage of enabling the population both to produce and to consume more than they would otherwise be able to.

I turn next to the question of resource allocation and especially the matter of investment and defense.

If, as in the illustrative sketch used in the study, 18 percent of the GNP is allocated to investment in any one year, and given the 4 percent long-term rate of growth, there is an implied incremental output ratio of 4.5. The investment of 18 percent would then be just sufficient to provide for an improvement in per capita consumption in the following year at a little over 3 percent, if there is a population growth of 2 percent.

But this is based on an assumed incremental capital output ratio of 4.5. Now, if we were to use a ratio of 3, which is quite common to underdeveloped countries, or 2.3, which is the one derived for China (in 1952–57) from one of the papers of the 1967 Committee study, then even at a 5-percent improvement in per capita consumption the amount of investment necessary for that purpose would not be as high as 18 percent, and there would be a “surplus,” so to say, that could be allocated to defense. In other words, defense could then be not 10 percent but easily 13 percent or 16 percent, and so on.

This is to illustrate how the percentage figures could change quite readily and that to assume that 15 percent is perhaps the ceiling for defense may be unwarranted.

But a more important point is whether a rigid and clear distinction can or even should be maintained when we explore the implications of GNP allocations by end use for China's defense effort and future economic development. Is the construction of a plant in any given year for making tanks or weapons carriers that later can be converted to the production of civilian vehicles or other machinery for civilian use an allocation to investment in that year, or is it an allocation to defense? Do we include under the GNP allocation to defense only the current maintenance of the Armed Forces and the production of end items that have no civilian application? How about the construction or expansion of plants for weapons production? Chinese arsenals are not always distinguishable from Chinese machine manufacturing plants, and vice versa. The issue is not purely semantic because it touches on the coordination of China's strategy of economic development with its defense planning.

A defense program that stresses the current expansion of defense plants rather than end items could be simultaneously expanding the potential base of production for the civilian sector in the future. Not every kind of defense spending is at the expense of future economic

growth. How soon China can switch its growing capital stock, expanded originally for defense, from defense orientation to the civilian sector is, of course, a function of Chinese policy in the future.

It suffices in the present discussion to point to two things: that is, the risk of drawing wrong conclusions on the basis of (1) an apparently relatively small allocation of the GNP to defense and (2) the opportunity cost of defense to Chinese economic development if we only look at the end-use allocation pattern very statically.

Next, I would like to note in passing that the assumption that 72 percent of the GNP is allocated to personal and governmental consumption, excluding defense, should not be taken too literally. The actual allocation to personal consumption may be smaller and it can perhaps be reduced, at least in the short run.

In discussing Chinese defense potential, another caveat for the unwary is that the cost of weapons systems should be derived in a manner consistent with the pricing of the GNP estimates. If weapons costs are translated into Chinese terms in one way, for instance, by converting non-Chinese costs into Chinese currency units in some aggregative manner, while the GNP is derived in a different manner in terms of its pricing, we may obtain quite misleading impressions about China's ability to bear the burden of certain sophisticated weapon programs and of force modernization.

If I may just take one more minute to wind up, if Peking can successfully utilize its economic potential to the full, and if it focuses its immediate attention on a small number of objectives, it should be able to expand its nuclear arsenal and modernize its conventional forces steadily. Nor should we overlook the possibility that China may decide to take technological paths in weapons development that bypass some of the stages other nations have traversed. Such an approach would be quite consistent with China's past policy on R. & D.

Finally, this does not mean that China poses a direct military threat to the United States at present. If there is any threat it is more indirect and it is more political.

Thank you.
(The prepared statement of Mr. Wu follows:)

PREPARED STATEMENT OF YUAN-LI WU The 10 papers brought together in the volume, People's Republic of China: an Economic Assessment, contain a fair summary of available information on Chinese economic development since the “Cultural Revolution,” especially if they are read in conjunction with the two volume study issued by the Committee in 1967. They provide the reader with an evaluation of the PRC's past record of economic performance, as well as its current economic profile. I have no particular quarrel with the general thrust of the evaluation of the papers' expert authors, and this is hardly the time or place to debate details. However, studies like these always have to be read with special care and with the caveats of possible misinterpretation in mind. They may not warrant deductions that one may be tempted to make.

1. THE TIME SERIES OF OUTPUT INDEX DOES NOT LEND ITSELF TO EASY, "SHORT

HAND” INTERNATIONAL COMPARISONS To begin with, it should be noted, for instance, that the GNP series, as presented in Table 3 (page 5), is really more an index of relative performance over time than reliable measure of the size of Chinese output in any given year. Thus, one can speak with much more confidence that China's GNP in 1970 was probably about 20% above that of 1968 than that it was 100 billion dollars in 1968 (at 1970 prices) and 122 billion dollars in 1970. All this has been made clear to the

reader who painstakingly goes through the step-by-step derivation of the “GNP estimates” in Appendix A (pp. 41-43), but not many readers, I suppose, are likely to do that. Actually, the derivation of the Chinese GNP for any given year involves the use of a geometric mean of two separate estimates, one based on valuation at Chinese prices and the other at dollar prices. One can of course construct a GNP index in this manner, especially if one wishes to arrive at a single value. I am not sure, however, what it means if, for instance, one then compares the 1970 Chinese GNP at 145 dollars per capita with that of the United States, estimated at United States prices and by a different process, at 4800 dollars per capita. We have to remember that we are dealing with orders of magnitude. However, it is tempting to draw conclusions about relative capability after noting that the Chinese GNP per capita in 1970 was only 3% of that of the United States, ignoring for the moment the uncertainty surrounding the actual size of the population. To do so could be quite misleading.

II. TWO CHARACTERISTICS OF THE PRC ECONOMY: FLUCTUATIONS AND RESILIENCE

I share with the authors of the papers what seems to be their general conclusion that the Chinese economy has exhibited a remarkable degree of resilience in the last 22 years. It has successfully recovered from two major setbacks, first from the aftermath of the “Great Leap Forward” and then again from the Red Guard excesses during the more recent “Cultural Revolution.” I am not sure, however, that the available data justify the generalization that there is some inherent tendency for the amplitudes of the swings in output to be unfailingly held in check by certain institutional forces that would prevent extreme orders from Peking to be fully carried out in the entire country. This happens, but not necessarily. The crisis brought on by the Great Leap Forward was at least in part a result of the unthinking, but zealous implementation of impractical and extreme orders issued from Peking. During the major setback in the “Cultural Revolution" there was probably less physical damage to capital equipment than there was disruption of production and transportation which reduced current output, but averted long-term damage. However, the "restraint” exhibited should not be interpreted necessarily as progress in the learning process of economic planning. It is also far too early to conclude that the reported improvements in production during 1970 and 1971 constituted a long-term shift of economic policy toward pragmatism or that orderly national economic planning has already resumed.

It may be more correct to say that a strenuous effort is being made under Chou En-lai to become more pragmatic and to engage in more rational planning. However, the effort has barely begun and it will take more time before the dismantled planning machinery and statistical report system and the banished and downgraded planners and managers of the economy can be brought together to plan and regulate the entire economy. Only then can we hope to discern the direction the economy will take.

For the moment, one might speculate that the central authorities in Peking probably control little more than the commanding heights” of the economy, in particular, the heavy capital goods and producer goods industries that are mostly related to defense. There is a "local industry” drive, and a high degree of decentralization seems to prevail. However, these moves are not just by choice, they may also be a matter of necessity. Ironically, the inability of the central authorities to engage in very rigorous control of the economy may have had the advantage of enabling the population both to produce and to consume more than they would otherwise be able to.

III. RESOURCE ALLOCATION: INVESTMENT AND DEFENSE

While the economic recovery during the last two to three years does not yet justify any definite conclusion about China's long-term economic system and policy and Chinese planners may repeat their errors in areas where their writ runs, it would be a mistake to assume that the Chinese potential is not quite high or that the Chinese defense effort cannot be very substantial both relatively to the Chinese GNP and in the absolute sense. More often than not Peking's economic problem is its inability to utilize all its available sources without sharp disruptions. The potential capacity and resilience of the economy are both quite remarkable.

The potential of the economy, and especially that of the defense sector, can be illustrated with an example. Consider the “illustrative sketch” (p. 45) of the allocation of Chinese GN to different end-uses. The example given in the study suggests that 70% of the country's GNP may be devoted to personal consumption and 2% to government consumption or administration, excluding defense. The remaining 18 and 10% are allocated to investment and defense respectively. Let us inquire what would happen if we begin with such an allocation in a given year.

First, if the population grows at 2% a year, personal consumption would have to expand at the same rate in order to keep per capita consumption unchanged. Some additional allocation of output to consumption would have to be allowed if per capita consumption is to improve. In terms of the percentage points of base year output, the following increments would be required:

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Personal consumption in the base year.
Personal consumption in the following year at 2 percent annual growth of the population:

Zero improvement in per capita consumption.
1 percent improvement..
2 percent improvement.
3 percent improvement.
4 percent improvement.
5 percent improvement..

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In order to produce the increment in the consumption over and above the level of the base year, let us assume that new investment is required and that some of the investment in the base year needs to be earmarked for this purpose. How much depends upon the types of goods produced, the technology adopted, the “construction period” required for new plants, etc. Allowing for a one-year lag between investment and incremental output, the 18% allocation to investment assumed in the “illustrative sketch” and the 4 percent long-term GNP growth rate assumed in the same text (p. 8) would give us an implicit incremental capital-output ratio of 4.5, meaning that for every single percentage point of increment in output, 4.5% points of output must be devoted to investment. On the other hand, we could take other ratios, such as 1 to 2.3, which was developed for China for the 1952–57 period in one of the papers in the 1967 study issued by the Committee (An Economic Profile of Mainland China, vol. 1, p. 126), or, say, a ratio of 1 to 3, used sometimes in textbooks on economic development. We can derive in this manner an estimate of the amount of investment required to sustain the assumed increment in consumption at various rates of improvement. If the investment required is then subtracted from the 18% of GNP alloted to investment in the base year, the remainder, or, more precisely, the amount of “allocable surplus" represented by the remainder, would be available for either (1) investment in order to expand the country's productive capacity for non-consumer goods, including defense-related products, or (2) without adversely affecting the supply of consumer goods required during the following year, the production of end-products for defense purposes.

If this process is followed through, we should find that the amount of investment required to provide for the increment in consumption, expressed in terms of percent points of the base year GNP, is as follows:

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It can be seen that if the 18% of the GNP is allocated to investment in the base and if the incremental capital-output ratio is 4.5, the investment would just be sufficient to provide for an improvement in per capita consumption in the following year at a little over 3%, assuming a natural population growth rate of 2% a year. On the other hand, if the incremental capital-output ratio is 3 or 2.3, even at 5% improvement in per capita consumption, an 18% allocation of the GNP to investment in the base year would leave 2.7% points (18–15.3) and

can or even

and 6.2% points (18-11.8) respectively as what we have called the "remainder" or “allocable surplus.” If this “allocable surplus” is fully assigned to defense, the proportion of defense in the base year ĜNP would rise from 10% of the “illustrative sketch” to 12.7 % and 16.2% respectively. This range is consistent with the 15% suggested in the study (p. 45) although it tends to raise the question whether 15% should be regarded as the probable ceiling in China's GNP allocation to defense.

A more important point is whether a rigid and clear distinctio should be maintained when we explore the implications of GNP allocations by end use for China's defense effort and future economic development. Is the construction of a plant in any given year for making tanks or weapons carriers that later can be converted to the production of civilian vehicles or other machinery for civilian use an allocation to "investment” in that year, or is it an allocation to defense? Do we include under the GNP allocation to defense only the current maintenance of the armed forces and the production of end items that have no civilian application? How about the construction or expansion of plants for weapons production? Chinese arsenals are not always distinguishable from Chinese machine manufacturing plants, and vice versa. The issue is not purely semantic, because it touches on the coordination of China's strategy of economic development with its defense planning.

A defense program that stresses the current expansion of defense plants rather than end-items could be simultaneously expanding the potential base of production for the civilian sector in the future. Not every kind of defense spending is at the expense of future economic growth. How soon China can switch its growing capital stock, expanded originally for defense, from defense orientation to the civilian sector is, of course, a function of Chinese policy in the future. It suffices in the present discussion to point to the risk of drawing wrong conclusions on the basis of (1) an apparently relatively small allocation of the GNP to defense and (2) the opportunity cost of defense to Chinese economic development if we look at the end-use allocation pattern statically.

One should note in passing that the assumption that 72% of the GNP is allocated to personal and government consumption (excluding defense) should not be taken too literally. The actual allocation to personal consumption may be smaller and it can perhaps be reduced, at least in the short run. In this respect estimates by different authors and for different periods vary. A smaller personal consumption allocation would increase the potential for “investment cum defense.”

In discussing China's defense potential, another caveat for the unwary is that that cost of weapons systems should be derived in a manner consistent with the pricing of the GNP estimates. If weapons costs are translated into Chinese terms in one way, for instance, by converting non-Chinese costs into Chinese currency units in some aggregative manner, while the GNP is derived in a different manner in terms of its pricing, we may obtain quite mis leading impressions about China's ability to bear the burden of certain sophisticated weapons programs and of force modernization.

The preceding comments should not, however, be construed as an estimate of a very large actual Chinese defense program at a relatively low cost to China's future economic development. The comments are intended to demonstrate (1) the many pitfalls in interpreting certain statistics and the necessarily incomplete observable events in China and (2) the possible, even probable, existence of a large Chinese potential. However, the potential may not be fully realized at a given time. Past under-full utilization of resources can perhaps be explained by specific deficiencies in technology, specific shortages in some industries, planning and management errors-often a result of ideological blinkers and political errorsand, more recently, the possibility that the writ of the central authorities does not run in the country as a whole or in every segment of administration, and at all levels of control.

IV. DIRECT VERSUS INDIRECT CHINESE THREAT If Peking can successfully utilize its economic potential to the full and if it focusses its immediate attention on a small number of objectives, it should be able to expand its nuclear arsenal and modernize its conventional forces steadily. Nor should we overlook the possibility that China may decide to take technological paths in weapons development that bypass some of the stages other nations have traversed. Such an approach would be quite consistent with China's past policy on R & D.

Yet all this does not mean that China will necessarily pose a direct military threat to the United States, at least in the next few years, or as long as the present

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