China's Liberation

2006-11-24T01:31:00.000+08:00

1. Introduction

There has been a myriad of arguments on the transition from a socialist economy to one that is market driven. Most academic literature contrasts the unraveling of the spectacular failures of Eastern Europe and Russia with the relative success of China’s transition. The materialization of the two separate paths taken has been categorized as being either adopting a ‘big bang’ or gradual approach.

However, contrary to this dichotomy, I will be arguing that instead, China did not have the luxury of a choice between a gradual or ‘big bang’ approach. In actuality, China’s move towards market liberalization started without any well-defined time-line or a goal towards a market economy. It entailed instead, a gradual process where China was encouraged by the progress made at each stage of its reform, which resulted in the evolution of the current socialist market structure.

In this article, I will first provide a background on the main policies that had the greatest impact on China. I will then go on to describe the gradual evolutionary process of China’s liberalization and how it was needed to prevent political dissonance resulting from the conflicting nature of marketisation and socialism. The final section of the article will deal with the weaknesses and problems that this gradual approach has brought and I will conclude by weighing the pros and cons of a gradual approach and its applicability to other transition economies.

2. The evolution of socialism – the 1st stage

Much of the academic literature has been in congruence that the liberalization of China’s economy came about in two stages. The first stage involved the incremental reformation of increasing incentives through enterprise autonomy and widening the radius and influence of the market system in the allocation of resources. The second stage however, constituted the process of developing new institutions to replace the incumbent bureaucracies and to improve the macroeconomic control of the central government. To gain a deeper insight into the transition from a socialist to a significantly market-driven economy, it is pertinent to understand the path dependence of China’s unique decentralized socialist structure and the ideological conflicts that marketisation would have with socialism.

2.1 Decentralisation and the bedrock of a market system

Unlike the Soviet Union, China’s socialist structure was relatively decentralized since 1958 during the introduction of the commune systems. However, due to its lack of success, there was a spontaneous development of what was later known as the ‘household responsibility system’. In this system, peasants were given control of the land for fixed periods and could retain whatever surplus they had after fulfilling the government set quota. The success of this model gained widespread adoption and was adopted nation-wide by 1984.

Following this, a second major reform that served to solidify the administrative decentralisation was the establishment of ‘the contract responsibility system’ in 1987. In this reform, an enterprise would be able to retain profits after remitting the required revenues to the central government. This was initiated to increase the efficiency of the state-owned enterprises (SOEs). However, in retrospect, we now realized that the loosening of restrictions (i.e. fiscal decentralization, dual-price, etc.) paved the way for the emergence of the future underlying drivers of China’s economy, the townships and village enterprises (TVEs).

The phenomenon of the emergence of the TVEs in China was not a planned reform of the central government. These TVEs were controlled by local governments and by 1993 constituted a total labour force of fifty-two million. The role that the local government played in promoting the TVEs was important as it provided the much needed property rights and was also able to improve the local infrastructure by reinvesting the revenue generated back to the region. In addition, the TVEs also added a dimension of competition between regions. Intuitively, you would be able to observe that the presence of competition at inter-firm and inter-regional level would therefore provide the groundwork necessary for the fostering of a market economy.

2.2 The fiscal federalisation

This decentralized administrative structure that China adopted, was later labeled as fiscal federations. In this section, we continue to discuss the implications that fiscal federalism had on China’s transition. By decentralizing authority and increasing its autonomy, the local government was able to regulate licenses and business developments. This was beneficial as the local government was in a better position to allocate budgets for urban development and provision of public goods due to its proximity to the market. This proximity also allowed for better access to local market information and could therefore allow the local government to implement better strategies.

After understanding the benefits of this institutional structure, it leads on to show how fiscal federalism affected the political and ideological balance in China. In summary, from the decentralization and reforms like the ‘household responsibility system’, the benefits received at grassroots level helped build up momentum to continue the push towards liberalization. With the increased amount of substantial autonomy given to the regional government, it acted as a counterbalance to power of the central government. Therefore, once the momentum towards market liberalization started, it eroded the ability of the opposition from the central government, to curtail and suppress this movement.

In short, this bottom-up approach helped overcome the political inertia by loosening the grip that the central government had over these fiscal federations. Considering this further, it would also be evident that the gradual shift towards market liberalization was initiated by the local governments. The decentralisation of power also assisted the push towards liberalization that could not have occurred if the central government had absolute authority. Therefore, I will argue that with this sequential process of decentralisation, an adoption of a ‘big bang’ approach was not viable. This therefore made the evolutionary route of gradualism the best choice under the circumstances.

2.3 Circumventing the political opposition from central-planning

After establishing that the gradualism approach that China took towards increasing the role of the market was due to its evolutionary path-dependence. The next important factor was determining how the gradual process managed to circumvent opposition from the proponents of central planning. Intuitively, the concept of socialism contradicts that of a market economy, which is largely a capitalist ideology. This next section shows how the gradual approach was the most feasible solution to harmonizing these two contradicting ideologies.

In a sense, the transition towards a market economy would have the greatest impact on the old guards of the central planning ideology. These old guards consisted of the officials in the upper echelons of the central-planning ministries and bureaucracies. Due to their vested interest, they would naturally not be willing to relinquish their positions and lose the power and rent-seeking opportunities that they held in the old system. Additionally, there was also potential opposition arising from politicians still convinced that a market economy had no place in China. This was a tricky problem and any sudden or radical changes in policies would have definitely garnered massive opposition or even a political uprising.

One of the solutions to this problem came in the form of the dual-track approach. Under this scheme, there was a planned price that was fixated with a stated quota. After this quota was met, the surplus products were allowed to be transacted through a market system. This served as a win-win situation as it satisfied the opposition by protecting their interest through the maintenance of the planned track and rewarded the reformers with the economic gains from the market track. This enabled a gradual transition towards increased marketisation as the government pinned down the required state quotas and allowed the market to grow out of the state allocation system.

Besides the dual-track system, the significance of a gradual approach towards the reformation process cannot be understated. With a gradual approach, it allowed less outright resistance and enabled the marketisation process to gain momentum. Once the general population and local governments were able to experience the benefits of the reforms, this weakened the influence that the opposition from the central government could wield in trying to resist market liberalisation.

3. The second phase of reforms

As mentioned, the first phase of reforms was targeted at increasing the incentives and efficiency of the socialist economy. With the vast improvements in living standards of the general population that the reforms brought, there was continued support which helped ease the transition into the second phase. This second stage of reforms was crucial and focused on loosening the restrictions and control of the central government and to establish new institutions to replace the old bureaucracies which used to be the bedrock of socialist China.

The second stage commenced in 1993 when the government made a credible commitment by advocating the ‘decision on issues concerning the establishment of a socialist market economic structure’. Throughout the initial transition process, it was argued that China adopted an easy-to-difficult approach towards liberalization. Thus, with the commitment from the government, this paved the way to tackle the deeper and more difficult issues that it has bypassed thus far, namely; rule-of-law, intellectual property, financial market governance and the unification of the exchange rate and property rights. This decision was crucial as it allowed for the creation of a common set of rules which was needed to integrate its market driven economy internationally.

Since then, major changes that took place were the incorporation of private ownership laws, having a single-track market for the foreign exchange and the taxation and financial reforms. It must be noted that it is still early stages to determine the success and implications of these difficult changes. However, the ability of China’s reforms to reach such a stage and even gaining entry into the WTO showed the benefits of a gradualism approach.

4. From Central planning to Market driven - the subtle evolutionary process

To fully understand the evolution from a purely socialist state to the current socialist market economy, it will be interesting to follow the gradual softening of the pure socialist stance of the government. From a stance where the market was a supplementary part of the economy, it became a ‘planned commodity liberalisation’ in 1992. During 1993, the shift in paradigm was more obvious when the government advocated ‘the decision on issues concerning the establishment of a socialist market economic structure’. By 1997, this transition actually promoted private ownership as ‘an important component of the economy’.

Following the unraveling process of a purely socialist economy, I will argue that this gradual change was needed as the government had no specific intentions to become a real market economy in the interim stages. However, it felt encouraged by the benefits and increased productivity of the economy at every stage of implementation. This further convinced the government to press on and adopt a more market-oriented approach. In addition, by slowly and subtly changing their stance, the impact felt by the opposition will be lessened and massive protest could be avoided as is frequently associated with a ‘big-bang’ approach.

5. The weakness of a gradual approach

It must be stated that despite the benefits and ease of transition that the gradual approach brought about, the criticism was that many of the underlying problems were not adequately dealt with. The biggest problem that remains in China is the underperformance of the SOEs. Due to the soft budgetary constraints and initial dual-structure system that served to create a no-losers policy, SOEs could continue operating at unproductive efficiency levels due to its access to low and skewed market prices of raw materials.

In addition, the government also intervened to prevent the bankruptcies of SOEs and delayed the establishment of a social safety net. This lack of a social safety net could prove detrimental if a spiral of bankruptcies occurs in the future resulting in mass unemployment. Such a scenario could result in social upheaval which in turn would affect the progress of China’s economy.

Academics also argue of the need to establish a proper financial and banking system before a market can fully operate. However, China’s putting off on the development and institution of governance over its financial and banking institutions could be a future stumbling block. Taking into light the inefficiencies and high debt levels of the SOEs, experts are estimating the non-performing loans of the state banks to be at least 30%. Such high levels would have crippled other economies and some forecasters are predicting a financial crisis looming over the horizon. This is further worsened by the banking sector’s lack of exposure and experience in operating in a market economy and its inadequate risk and credit assessment systems.

The final problem leads us to address the role of the Party in China. Despite the many disagreements on China’s transition, the academic world is in consensus about the interruption that the Party system has brought to the liberalization process. Besides the argument that the intervention of the Party in SOEs has resulted in vast inefficiencies, a second problem arises in that the Party is also above the rule-of-law. This would thus undermine the equality needed to run and integrate its market economy into the international environment.

In summary, unlike a ‘big bang’ approach which serves to address the fundamental and more difficult issues of establishing a market economy first. China’s gradual approach chose to ignore some of these more difficult issues. However, by putting off the reforms during the initial transition, China would have more difficulties implementing such changes during a later stage and any mistakes made would cause serious damage to China’s economy.

6. Conclusion

In conclusion to this paper, I would like to reiterate that China had no real goal of establishing a socialist market economy at the start of its reforms. Therefore thinking of China as adopting a path-dependent evolutionary process and tackling this issue as being historically dependent would make more sense then simply fitting China’s transition into an over-simplified dichotomy. This also allows us to better understand how China was able to incorporate a market economy into a socialist ideology which goes against conventional wisdom that the two forms cannot coexist and that democratization has to happen before a market economy can be established.

Additionally, a ‘big bang’ approach would also seem to be less viable due to the decentralized structure of the government. With the benefit of hindsight, we have also realized the inefficiencies of the SOEs in China. These inefficiencies would have been a serious burden on China’s economy during the initial stages as the SOEs constituted 80% of the nations output. Thus, a spiral of bankruptcies would have severely crippled the economy. The final factor that would have made the implementation of a ‘big bang’ strategy difficult was that the vast majority of the Chinese population was concentrated in the rural sectors. This resulted in a lack of proper market mechanisms, infrastructure and knowledge, therefore making the rapid implementation of a market economy difficult.

The main problem facing the gradualism versus ‘big bang’ debate lies in its ambiguity. As many scholars have agreed, China did adopt two big bang approaches; The Great Leap Forward and the Cultural Revolution. No doubt that these were not geared towards marketisation, but the failures of these two ‘big bang’ reforms would reside in the government’s minds and instill a sense of reluctance to adopt another radical approach. A second point to consider would be the definition of a gradual reform. Scholars attempt to categorise China as adopting a gradual approach. However, what construes gradualism and more specifically what is the time-line? Unless consensus can be reached, the blurring between gradualism and a ‘big bang’ cannot be properly established.

At the end of this paper, I would like to advocate that the adoption and success of China’s gradualism process does not signify that a ‘big bang’ strategy is always inferior and that China’s example is a perfect model that should be emulated. Instead, the Chinese model is in actuality a piecemeal reform strategy with no official blueprint and each reform moved along slowly from the accumulated knowledge of its previous stage. Thus, environmental, political and institutional path-dependent factors should not be neglected and China’s strategy should not be blindly followed.

Do you believe in what I believe...

2004-07-08T23:46:00.000+08:00

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China's Liberation

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