China Case

Harvard Business School 9-798-066

Rev. March 19, 1999

Professor Robert E. Kennedy and Research Associate Katherine Marquis prepared this case as the basis for class discussion

rather than to illustrate either effective or ineffective handling of an administrative situation. We are grateful for substantial

input from Professor Yasheng Huang and Research Associate Teresita Ramos.

Copyright © 1998 by the President and Fellows of Harvard College. To order copies or request permission to

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Harvard Business School.

1

China:

Facing the 21st Century

As 1997 drew to a close, economic czar Zhu Rongji considered the economic and political

challenges that China would face in the next decade. It had been a tumultuous year. Long-time

paramount leader Deng Xiaoping had died in February, trade tensions with the United States escalated

when the U.S. blocked China's membership in the World Trade Organization (WTO), and a series of

currency crises in Asia threatened regional recession and the competitiveness of Chinese exports.

Perhaps most important, there was widespread concern that China's vigorous growth was threatened

by several long-neglected issues. Should China alter its development strategy, especially in light of the

leadership change?

Since Deng had initiated China's program of economic reform in 1978, China had experienced a

stunning transformation. GDP had grown at a 9.5% annual rate, per capita income had more than

quadrupled, foreign direct investment had boomed, and trade had increased from 10% to 45% of

GDP--making China the world's seventh-largest exporter.1 Although per capita GDP was still only

$600 when measured at official exchange rates, China's economy had become the world's third-largest

when adjusted for purchasing power.2 Most observers were awed by the magnitude of the

transformation; the World Bank referred to the reforms as "spectacularly successful."3

Deng's death had settled a long-simmering dispute over succession for the top positions of the

Communist party and the country. After seven years of grooming, President Jiang Zemin, Zhu's

patron and a cautious reformer, had emerged as the top leader. Zhu was currently number three in the

hierarchy and was expected to become the prime minister when the current prime minister, Li Peng,

retired in March 1998.

Deng's death and the political ascendancy of the reformers provided an opportunity to reassess

China's economic strategy. Deng's primary goals had been political stability and rapid economic

growth. But the focus on short-term growth had left many issues unaddressed. Losses at state-owned

enterprises and banks were growing, posing a potential threat to China's fiscal health. Trade tensions

with the United States were increasing on both political and economic fronts. The Communist party's

political legitimacy was threatened by corruption and a shift of power to the provinces. Pollution was

a growing danger to public health. Finally, and perhaps most threatening in the long run, China's

market institutions remained underdeveloped.

As economic czar, Zhu was charged with addressing these issues. He was inclined to think

strategically, but radical action would be difficult. Nearly everyone agreed that China had great

economic potential, but that potential might remain unrealized unless Zhu found a way to address the

factors that threatened long-term growth.

798-066 China: Facing the 21st Century

2

Historical Background

Dynastic China China claims one of the longest histories of any civilization, dating from at least

2200 BC, when farming clans began to form in the Yellow River valley. Central government first arose

in approximately 1120 BC, when the Zhou clan established control over the Yellow River valley. The

Zhou ruled the region until 480 BC, when China splintered during the Warring States period (480 BC -

221 BC). During this period, Confucius, one of China's greatest philosopher-sages, tried to convince

the rulers of the virtues of order and the ways of maintaining it. China's first emperor, Qin Shi Huang,

unified the country in 221 BC, creating its first dynasty. Qin is credited with laying the foundation for

the birth of the Chinese state. He standardized the Chinese currency, weights and measures, and the

written language. He also created a national army and established a centralized political apparatus

that ruled much of China's present territory. Qin died in 210 BC and his empire quickly disintegrated.

Following