UK CONFIDENTIAL
During this three year period, which was in many ways a period of experimen- tation, long term planning was to be abandoned; only when the experiments had been evaluated would it be possible to plan comprehensively for more than one year at a time. Formulation of the succeeding long term plan seemed likely to cause real problems, in particular over the division between central and local powers and over price reforms. It was always clear, and it was accepted by the leadership, that elements of this policy would have to be continued beyond 1981 and this too could have presented problems, primarily political, in writing them into the longer term plan.
Problems
4. During 1980 Chinese leaders acknowledged that application of the new policies was creating political and economic strains and that they were experiencing - difficulties in achieving the desired cutback in investment. They also readily admitted to long-standing economic problems stemming from China's size and back- wardness and the poor production results in certain sectors such as energy. Nevertheless leadership speeches at the National People's Congress last September, while recognising the problems, were optimistic about economic progress and put considerable stress on the reforms of economic management.
5. Since September, however, the leadership's view of the success of economic strategy has changed. From early December they have openly admitted that attempts to cut back capital construction - seen as the key to readjustment - have failed, that the 1981 budget deficit could be double the planned level, and that rising prices have become a major problem.
6. These problems were allowed to develop for a number of reasons. Perhaps most important, the central leadership seems to have been preoccupied by the policies of reform, inspite of paying lip service to the primacy of readjustment. In addition in the absence of any medium or long term plan to work to, overall integration of economic policies became more difficult to achieve and the estab- lishment and application of a clear system of priorities languished. Further with out such a plan, the monitoring of trends becomes more difficult (this being compounded by the acknowledged weakness of the statical system) and corrective action becomes less likely at an early stage. From the points of view of middle and lower level planners and decision makers, the absence of a firm set of directives, either based on longer term plans, or even imposed ad hoc by the centre, left them to carry on much as before and they seem to have been reluctant to restrain their traditional appetite for investment and growth. In the particular case of capital construction, the centre, inspite of cuts in its own capital construction budget, was not able to control (or get lower level authorities to control) their own expenditures; the centre neither had the machinery to control all the sources of investment which lower levels could tap, nor did their exhortations to reduce capital construction seem to have much effect. We do not know why the central budget deficit has grown so unexpectedly, but it is probable that the devolution of authority has restricted revenue and also allowed expenditure to creep up. Increased inflation has arisen both from the relaxation in central controls, which has allowed prices to rise, and from financing of the budget deficit, which according to the Chinese has been done more and more by increasing the currency in circulation.
7. Although shortage of foreign exchange is in general a problem in terms of the requirements of China's overall modernisation (and in specific cases may be a problem because of limited allocations by the centre), we have no evidence that this has directly influenced the leadership in this recent policy reformulation. The basic constraints all seem to have been internal ones.
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UK CONFIDENTIAL