Incremental Reform, 1979-’93. State and private sectors coexisted.
By Wu Jinglian 08 October 2009
(Caijing Magazine) Numerous failed attempts at reforming the planned economy system forced Chinese leaders to reflect and reconsider the direction of reform. Allowing operational “microenvironments” outside the public system was the most important positive adjustment during this stage. This built a foundation for non-state economic development with an incremental reform strategy.
Allowing economic activity outside the public arena was a landmark decision. It began with agricultural land reform in the village of Xiaogang, Anhui Province. Of course, it was a massive undertaking to conduct systematic, theory-based analysis following small-scale testing, leading to gradual institutionalization and promotion of successful results. This was a “crossing the river by feeling the stones” strategy, which seemed to follow no clear theory. But it was inherently rational, as small, separate cases were permitted to test the direction of social development, ensuring positive results throughout society.
When incremental reform begins to take vigorous hold and win society’s approval, it attracts an increasing amount of resources, provides an important center of support for the national economy and assumes a superior position due to pent up competition. An important thing to consider is that incremental reform gradually reflects scarcity of resources and forms a pricing system for resource allocation, turning a public economy in many areas toward a new pricing system. So in China, as soon as the door to reform was thrust open, the pros and cons of the new and old systems were immediately apparent. And the push and pull of economic forces meant the country would never return to the past.
In October 1976, members of the Gang of Four led by Jiang Qing, Mao’s wife, were arrested and the Cultural Revolution ended, allowing a change in direction for the Chinese economy. Reform began with an expansion of decision-making power among large SOEs.
When these reform tests failed, Chinese leaders placed hope in the non-state economy. They created a flexible system for a private economy to sprout and gradually develop into a new source of growth for the Chinese economy. We call this reform strategy incremental. Economic reforms and successful economic development since then can be traced back to this strategy.
However, perpetuation of a two-track system presented a series of difficulties.
The traditional planned economy proved unsustainable. But some combination of ideology, public awareness and inertia from the original system meant a new system was unlikely to simply fall from the sky. While a reform trend was clear, its direction had been disputed. Now, to improve the system, many wondered whether the change should emphasize an unraveling of power to local governments, or give more autonomy to enterprises. Another question was whether to use planning to fully regulate the market or establish a full market economy.
A mild reform held the upper hand in debate and practice, but its intrinsic shortcomings once again came to the fore. At the same time, market-oriented reform, including property rights reform, was tried in the private sphere and showed great vitality.
After the decade-long Cultural Revolution, during which hundreds of millions of people were persecuted, most Chinese had lost faith in a total dictatorship. Society had come to a unanimous conclusion that the old system could not be sustained. Thus, the consensus was that reform and opening the country was necessary to save the nation. As Deng Xiaoping said, “We must reform. We must open up. The sealed-off situation of the past 20 years must change. In implementing a policy of reform and opening, we are of one mind. This is tied to the 10-year Cultural Revolution. The lesson of this disaster has been too profound.”
The first reform step was “thought liberation” to break the fetters of leftist thinking at a historical meeting -- the 3rd Session of the 11th CPC Meeting. Hu Yaobang, then-chairman of the CPC Central Committee Party School, supported the newspaper Guangming Daily in publishing a commentary entitled Practice Is the Sole Criterion for Testing Truth. This essay marked the start of a national movement promoting “enlightenment” with a foundation based on “thought liberation.”
Thought liberation meant ideas such as “class struggle as the guiding principle” and “continuous revolution under the dictatorship of the proletariat” were opened for debate. The once-sacred planned economy system and a total dictatorship imposed on the bourgeoisie within and outside the party (including so-called bourgeoisie intellectuals) could be changed. The campaign broke the shackles of decades of rigid thinking and inspired workers, peasants, intellectuals and cadres to open their minds, solve problems and seek development. Leaders heeded personal lessons and reviewed experiences from other countries. These elements allowed them to craft various transformation visions. The government sent delegations to the United States, West Europe, East Europe and East Asia to study systems in other lands, seeking methods for promoting rapid development.
In this atmosphere, decision-makers pushed forward reform. At an internal brainstorm from July to September 1978, documents were released describing rapid economic development in Yugoslavia and Romania that had been brought on by foreign investment and enterprise reform. Vice Premier Li Xiannian, in his final report at the meeting, said the top priority was to change backward production forces and ensure a multifaceted transformation in relations for production as well as changes in industrial and agricultural enterprise management, state management of industrial and agricultural enterprises, personal activity, and thinking.
There were two ideas about how to reform the economic system. The first mainly called for giving more decision-making autonomy to major SOEs. The second had a broader scope: It said reform should result in a socialist commodity economy, one completely unlike the Soviet model.
One advocate of the later was Xue Muqiao, a veteran Chinese economist and participant in central government economic leadership since 1949. Working at the State Council Office for Restructuring in the summer of 1980, Xu wrote a draft called Preliminary Views on Economic Reform that said, “China at its present stage of a socialist economy is dominated by public ownership of the means of production and a commodity economy, in which many economic sectors coexist. The principle and direction of China’s economic reform should be to develop the commodity economy by consciously using the law of value and shifting from a pure, planned economy to planned regulation that lets the market adjust the economy while maintaining dominant public ownership of the means of production.”
In September 1980, at the First Secretarial Meeting of Provinces and Cities, Xue offered a work called Opinion in which he said, “So-called economic reform is meant to answer the question of what type of socialist economy to establish in China. This is the basic direction of socialism’s construction. The economic management system reform plan that will be released is an ‘economic constitution.’” Although Xue’s Opinion was approved by Hu Yaobang and other leaders, it was not included in the government’s final decisions.
Another person who influenced theory and policy regarding China’s economic reform was Du Runsheng, a long-time rural economy researcher and one-time assistant to Deng Zihui, a rural work leader criticized by Mao Zedong. Following the village contracting reform of the early 1980s, Du proved his ability to influence rural economic policy. Drawing on the theoretical achievements of modern economics, he stood for the complete establishment of a market economy.
The first line of thought received support from workers and SOE leaders. Sichuan Province, based on this line of thinking, began reforms based on expanding enterprise autonomy. In October 1978, Sichuan selected six, state-owned factories to act as pilots for the experiment. The results were positive, so the experiment in Sichuan was expanded to 100 SOEs. By the end of 1979, more than 4,200 enterprises were participating in the test nationwide. And the next year, the number grew to 6,600. The value of their output accounted for 60 percent of budget projections nationwide. They also accounted for 70 percent of China’s corporate profits.
The Chinese have a saying: If the route cannot be traversed by land, go by sea. As reforms inside the system hit roadblocks, decision-makers who oversaw reform displayed tolerance and flexibility by shifting from implicitly allowed, small-scale free market experiments to gradual institutional recognition. With the household contract system as a foundation, ownership reform began, setting the private sector afire. From then on, opening doors to the world and internal reform went hand-in-hand.
Private ownership and a pricing system outside the planned economy were officially recognized as they grew and developed. The non-public sphere and market prices put pressure on the public sector, adding additional impetus for reform. But the planned economy and market economy continued to run in parallel, leading to a two-track system.
After expanded SOE autonomy hit a roadblock, Deng Xiaoping shifted reform’s focus to the rural, non-state economy from urban SOEs. His most important immediate change was to repeal commune-supporting prohibitions on a household contract responsibility system.
In September 1980, the CPC Central Committee decided to let farmers voluntarily submit to a household contract responsibility system. Within just two years, the system had replaced the commune system almost nationwide, reshaping the rural economy. From this foundation, collectively owned village and township enterprises began to flourish. And on this point, China differentiated itself from countries in East Europe that had started reforms by using large, SOEs to create market-leading enterprises in the private sector, before relying on these companies for economic growth. China’s strategy became known as incremental reform, or “reforming outside the system first.”
After incremental reform saw initial success in the agricultural sector, CCP and government leaders extended the experiment to other sectors. While maintaining state-owned dominance, restrictions on private entrepreneurship were gradually relaxed. Combined with the previous easing of restrictions on private investment, the non-state economy was able to develop from the bottom up.
The development of the non-state economy was apparent in three areas:
First came allowing non-state enterprise growth. Non-state economic development has always been politically sensitive in China. Even during the post-Cultural Revolution period, doctrines of the Mao Zedong era still dominated. These were reflected in slogans such as “larger, more public is better,” “cut off the tail of capitalism” and “let capitalism die.” Thus, as the reform era began, a circuitous route was needed to develop the non-state economy. But after the household contract responsibility system succeeded, these old thinking patterns finally faded. Restrictions on private enterprise hiring were eased in 1983. In other words, private enterprises finally achieved legal status. Since then, the private sector has grown at an astounding rate.
Second was the use of “special economic zones” as a “microenvironment” for linking certain areas of China to the global market. In the history of global economic development, domestic market development has always been a protracted process. China’s previous commercial culture had been extremely weak, and under a planned economy during the first 30 years of the People’s Republic, market forces were almost completely wiped out, making building a domestic market difficult.
Considering the situation, it would be nearly impossible to create a domestic market with links to the global economy within a short period. Therefore, building on the experience of other countries in establishing export and industrial processing areas, China used coastal areas and those close to Hong Kong, Macau and Taiwan as well as other areas with large overseas Chinese populations to create microenvironments as bases for opening to the outside world.
In 1979, the central government enacted so-called “special policies” with “flexible implementation” in Guangdong and Fujian provinces to take advantage of their proximities. In 1980, special economic zones were created in Shenzhen, Zhuhai, Shantou and Xiamen. Another 14 port cities were opened in 1985. Opening to the outside world created trade regions in coastal areas, along rivers and in border areas.
The strategy’s most important achievement was allowing a private economy to develop from the bottom up. This gave it strength. In the 1980s, private industry grew at twice the rate of its state-owned counterpart. By the mid-1980s, the non-state sector was playing a pivotal role in industrial production and the national economy. The private sector had risen to comprise more than one-third of industrial output. In the retail sector, the non-state sector was growing even faster.
Thus, more than a decade of incremental reform brought rapid growth to the Chinese economy. From 1978 to ‘98, the total value of domestic production increased an average 14.6 percent annually, while per capita disposable income among urbanites grew at an average annual rate of 13.1 percent.
Continued development of the non-public economy and market pricing system eventually clashed directly with the public economy and state price-setting. The two-track system was unsustainable. One track lacked impetus for reform and left the non-state economy at a competitive disadvantage, since swathes of the economy had been protected by price command for so long. The other track risked rent-seeking and corruption, upsetting economic order, because resource holders could take advantage of differences in command system and free market prices to make huge profits. The two-track system made an important contribution to the economy at one historical stage. But in time, it fell out of sync with requirements of economic development – even to the point of impeding the next reform step.
While maintaining the dominance of the state-owned economy, incremental reform allowed development of the private economy and brought about a partially free market system. That led to the two tracks of command and market.
Under the planned economy, means of production were uniformly distributed among economic units, and prices were only an accounting tool. Consumer goods were uniformly managed by state-owned businesses and prices fixed by price-management departments.
At the beginning of the reform and opening period, SOEs were given autonomy to sell products. The State Council released in 1979 its Provisions for Expanding the Operating Autonomy of State-run Industrial Enterprises, which let companies sell products through their own channels beyond quotas. This opened the second track for circulating products -- the market.
At the same time, the birth and development of quota-free private enterprises made obtaining raw materials and other resources from the market a necessity. By the mid-1980s, 31 percent of nationwide industrial product value was private, and market allocation of the means of production was constantly expanding.
In January 1985, the State Price Bureau and State Materials Bureau issued a notice entitled On the Opening of Pricing for Over-Quota Industrial Means of Production, which let enterprises buy and sell products “outside the plan” at market prices. This began the two-track system for supplying means of production. The approach was set 1983 as a base year and for SOE production quotas; anything produced over 1983 levels could be sold at market prices.
Because state and private sectors coexisted under incremental reform, the two-track system existed in a number of areas beyond production allocation and pricing. For example, its influence was evident in lending rates at national banks, market interest rates, foreign exchange swap market prices, and official currency exchange rates.
Economist views on the advantages and disadvantages of the two-track system varied widely. Lawrence J. Lau, Qian Yingyi, Gerard Roland and Zhang Jun gave positive evaluations of the two-track system’s role in stabilizing production in the state-owned economy and realizing Pareto improvement. Through general equilibrium analyses, they described Pareto improvement characteristics of two-track price liberalization.
A 1986 study by the National Institute of Economic System Reform described the positive role of the two-track system from both economic and political perspectives. The report said that under the two-track system, from an economic point of view, “Whether an enterprises increases or decreases production or inputs, the price of the increased or decreased portion is decided by the market. This also means the market price has, in reality, played a deciding role in marginal corporate outputs and inputs, and through this marginal use acts to adjust the signals and impact of short-term supply.”
From a political perspective, the report continued, “Within the two-track system exists an administrative system for allocating resources. Under certain conditions, the monetization of vouchers will be transformed into the monetization of power. That is, the power of voucher allocation is in fact the power to allocate money, meaning power to allocate vouchers itself can be measured in monetary terms; it can make power a type of currency. This type of degenerative behaviour in economic terms is extremely reasonable. As long as the voucher monetization mechanism is effective, and administrative power derived from the planned economy continues, it is completely natural to consider the allocation of every kind resource as capital.”
American economists Kevin Murphy, Andrei Shleifer and Robert Vishny took a different view. They thought that if all prices were not simultaneously liberalized, distortions of resource allocation would result. Moreover, unequal operating conditions would surface among SOEs, which could obtain hidden subsidies, and private companies, which could only obtain raw materials, equipment and loans from the market, and that these conditions would increasingly impede development of the private economy over time.
Other Chinese scholars, including myself, are now paying close attention to the social and political consequences of the two-track system. We think there are two consequences of this institutional arrangement. On the one hand, as some scholars have said, it gives people a certain amount of space for entrepreneurial activity, allowing all sorts of private enterprises to grow. On the other hand -- and we must be on guard against this -- if this type of institutional arrangement of “power monetization” or “power capitalization” continues or intensifies, a rent-seeking environment will result. And that would plant seeds for spreading corruption. If we are unable to adopt further market-oriented reforms in time, and eradicate the roots of corruption, we will face serious economic, social and political consequences.
To be continued.
Wu Jinglian is one of preeminent economists in China. He is a senior research fellow for the Development Research Center of the State Council.
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China’s Economy: 60 Years of Progress (Part III)
Incremental Reform, 1979-’93. State and private sectors coexisted.
By Wu Jinglian
08 October 2009
(Caijing Magazine) Numerous failed attempts at reforming the planned economy system forced Chinese leaders to reflect and reconsider the direction of reform. Allowing operational “microenvironments” outside the public system was the most important positive adjustment during this stage. This built a foundation for non-state economic development with an incremental reform strategy.
Allowing economic activity outside the public arena was a landmark decision. It began with agricultural land reform in the village of Xiaogang, Anhui Province. Of course, it was a massive undertaking to conduct systematic, theory-based analysis following small-scale testing, leading to gradual institutionalization and promotion of successful results. This was a “crossing the river by feeling the stones” strategy, which seemed to follow no clear theory. But it was inherently rational, as small, separate cases were permitted to test the direction of social development, ensuring positive results throughout society.
When incremental reform begins to take vigorous hold and win society’s approval, it attracts an increasing amount of resources, provides an important center of support for the national economy and assumes a superior position due to pent up competition. An important thing to consider is that incremental reform gradually reflects scarcity of resources and forms a pricing system for resource allocation, turning a public economy in many areas toward a new pricing system. So in China, as soon as the door to reform was thrust open, the pros and cons of the new and old systems were immediately apparent. And the push and pull of economic forces meant the country would never return to the past.
In October 1976, members of the Gang of Four led by Jiang Qing, Mao’s wife, were arrested and the Cultural Revolution ended, allowing a change in direction for the Chinese economy. Reform began with an expansion of decision-making power among large SOEs.
When these reform tests failed, Chinese leaders placed hope in the non-state economy. They created a flexible system for a private economy to sprout and gradually develop into a new source of growth for the Chinese economy. We call this reform strategy incremental. Economic reforms and successful economic development since then can be traced back to this strategy.
However, perpetuation of a two-track system presented a series of difficulties.
Reform Frustrations
The traditional planned economy proved unsustainable. But some combination of ideology, public awareness and inertia from the original system meant a new system was unlikely to simply fall from the sky. While a reform trend was clear, its direction had been disputed. Now, to improve the system, many wondered whether the change should emphasize an unraveling of power to local governments, or give more autonomy to enterprises. Another question was whether to use planning to fully regulate the market or establish a full market economy.
A mild reform held the upper hand in debate and practice, but its intrinsic shortcomings once again came to the fore. At the same time, market-oriented reform, including property rights reform, was tried in the private sphere and showed great vitality.
After the decade-long Cultural Revolution, during which hundreds of millions of people were persecuted, most Chinese had lost faith in a total dictatorship. Society had come to a unanimous conclusion that the old system could not be sustained. Thus, the consensus was that reform and opening the country was necessary to save the nation. As Deng Xiaoping said, “We must reform. We must open up. The sealed-off situation of the past 20 years must change. In implementing a policy of reform and opening, we are of one mind. This is tied to the 10-year Cultural Revolution. The lesson of this disaster has been too profound.”
The first reform step was “thought liberation” to break the fetters of leftist thinking at a historical meeting -- the 3rd Session of the 11th CPC Meeting. Hu Yaobang, then-chairman of the CPC Central Committee Party School, supported the newspaper Guangming Daily in publishing a commentary entitled Practice Is the Sole Criterion for Testing Truth. This essay marked the start of a national movement promoting “enlightenment” with a foundation based on “thought liberation.”
Thought liberation meant ideas such as “class struggle as the guiding principle” and “continuous revolution under the dictatorship of the proletariat” were opened for debate. The once-sacred planned economy system and a total dictatorship imposed on the bourgeoisie within and outside the party (including so-called bourgeoisie intellectuals) could be changed. The campaign broke the shackles of decades of rigid thinking and inspired workers, peasants, intellectuals and cadres to open their minds, solve problems and seek development. Leaders heeded personal lessons and reviewed experiences from other countries. These elements allowed them to craft various transformation visions. The government sent delegations to the United States, West Europe, East Europe and East Asia to study systems in other lands, seeking methods for promoting rapid development.
In this atmosphere, decision-makers pushed forward reform. At an internal brainstorm from July to September 1978, documents were released describing rapid economic development in Yugoslavia and Romania that had been brought on by foreign investment and enterprise reform. Vice Premier Li Xiannian, in his final report at the meeting, said the top priority was to change backward production forces and ensure a multifaceted transformation in relations for production as well as changes in industrial and agricultural enterprise management, state management of industrial and agricultural enterprises, personal activity, and thinking.
There were two ideas about how to reform the economic system. The first mainly called for giving more decision-making autonomy to major SOEs. The second had a broader scope: It said reform should result in a socialist commodity economy, one completely unlike the Soviet model.
One advocate of the later was Xue Muqiao, a veteran Chinese economist and participant in central government economic leadership since 1949. Working at the State Council Office for Restructuring in the summer of 1980, Xu wrote a draft called Preliminary Views on Economic Reform that said, “China at its present stage of a socialist economy is dominated by public ownership of the means of production and a commodity economy, in which many economic sectors coexist. The principle and direction of China’s economic reform should be to develop the commodity economy by consciously using the law of value and shifting from a pure, planned economy to planned regulation that lets the market adjust the economy while maintaining dominant public ownership of the means of production.”
In September 1980, at the First Secretarial Meeting of Provinces and Cities, Xue offered a work called Opinion in which he said, “So-called economic reform is meant to answer the question of what type of socialist economy to establish in China. This is the basic direction of socialism’s construction. The economic management system reform plan that will be released is an ‘economic constitution.’” Although Xue’s Opinion was approved by Hu Yaobang and other leaders, it was not included in the government’s final decisions.
Another person who influenced theory and policy regarding China’s economic reform was Du Runsheng, a long-time rural economy researcher and one-time assistant to Deng Zihui, a rural work leader criticized by Mao Zedong. Following the village contracting reform of the early 1980s, Du proved his ability to influence rural economic policy. Drawing on the theoretical achievements of modern economics, he stood for the complete establishment of a market economy.
The first line of thought received support from workers and SOE leaders. Sichuan Province, based on this line of thinking, began reforms based on expanding enterprise autonomy. In October 1978, Sichuan selected six, state-owned factories to act as pilots for the experiment. The results were positive, so the experiment in Sichuan was expanded to 100 SOEs. By the end of 1979, more than 4,200 enterprises were participating in the test nationwide. And the next year, the number grew to 6,600. The value of their output accounted for 60 percent of budget projections nationwide. They also accounted for 70 percent of China’s corporate profits.
Outward Looking
The Chinese have a saying: If the route cannot be traversed by land, go by sea. As reforms inside the system hit roadblocks, decision-makers who oversaw reform displayed tolerance and flexibility by shifting from implicitly allowed, small-scale free market experiments to gradual institutional recognition. With the household contract system as a foundation, ownership reform began, setting the private sector afire. From then on, opening doors to the world and internal reform went hand-in-hand.
Private ownership and a pricing system outside the planned economy were officially recognized as they grew and developed. The non-public sphere and market prices put pressure on the public sector, adding additional impetus for reform. But the planned economy and market economy continued to run in parallel, leading to a two-track system.
After expanded SOE autonomy hit a roadblock, Deng Xiaoping shifted reform’s focus to the rural, non-state economy from urban SOEs. His most important immediate change was to repeal commune-supporting prohibitions on a household contract responsibility system.
In September 1980, the CPC Central Committee decided to let farmers voluntarily submit to a household contract responsibility system. Within just two years, the system had replaced the commune system almost nationwide, reshaping the rural economy. From this foundation, collectively owned village and township enterprises began to flourish. And on this point, China differentiated itself from countries in East Europe that had started reforms by using large, SOEs to create market-leading enterprises in the private sector, before relying on these companies for economic growth. China’s strategy became known as incremental reform, or “reforming outside the system first.”
After incremental reform saw initial success in the agricultural sector, CCP and government leaders extended the experiment to other sectors. While maintaining state-owned dominance, restrictions on private entrepreneurship were gradually relaxed. Combined with the previous easing of restrictions on private investment, the non-state economy was able to develop from the bottom up.
The development of the non-state economy was apparent in three areas:
First came allowing non-state enterprise growth. Non-state economic development has always been politically sensitive in China. Even during the post-Cultural Revolution period, doctrines of the Mao Zedong era still dominated. These were reflected in slogans such as “larger, more public is better,” “cut off the tail of capitalism” and “let capitalism die.” Thus, as the reform era began, a circuitous route was needed to develop the non-state economy. But after the household contract responsibility system succeeded, these old thinking patterns finally faded. Restrictions on private enterprise hiring were eased in 1983. In other words, private enterprises finally achieved legal status. Since then, the private sector has grown at an astounding rate.
Second was the use of “special economic zones” as a “microenvironment” for linking certain areas of China to the global market. In the history of global economic development, domestic market development has always been a protracted process. China’s previous commercial culture had been extremely weak, and under a planned economy during the first 30 years of the People’s Republic, market forces were almost completely wiped out, making building a domestic market difficult.
Considering the situation, it would be nearly impossible to create a domestic market with links to the global economy within a short period. Therefore, building on the experience of other countries in establishing export and industrial processing areas, China used coastal areas and those close to Hong Kong, Macau and Taiwan as well as other areas with large overseas Chinese populations to create microenvironments as bases for opening to the outside world.
In 1979, the central government enacted so-called “special policies” with “flexible implementation” in Guangdong and Fujian provinces to take advantage of their proximities. In 1980, special economic zones were created in Shenzhen, Zhuhai, Shantou and Xiamen. Another 14 port cities were opened in 1985. Opening to the outside world created trade regions in coastal areas, along rivers and in border areas.
The strategy’s most important achievement was allowing a private economy to develop from the bottom up. This gave it strength. In the 1980s, private industry grew at twice the rate of its state-owned counterpart. By the mid-1980s, the non-state sector was playing a pivotal role in industrial production and the national economy. The private sector had risen to comprise more than one-third of industrial output. In the retail sector, the non-state sector was growing even faster.
Thus, more than a decade of incremental reform brought rapid growth to the Chinese economy. From 1978 to ‘98, the total value of domestic production increased an average 14.6 percent annually, while per capita disposable income among urbanites grew at an average annual rate of 13.1 percent.
Two-Track System
Continued development of the non-public economy and market pricing system eventually clashed directly with the public economy and state price-setting. The two-track system was unsustainable. One track lacked impetus for reform and left the non-state economy at a competitive disadvantage, since swathes of the economy had been protected by price command for so long. The other track risked rent-seeking and corruption, upsetting economic order, because resource holders could take advantage of differences in command system and free market prices to make huge profits. The two-track system made an important contribution to the economy at one historical stage. But in time, it fell out of sync with requirements of economic development – even to the point of impeding the next reform step.
While maintaining the dominance of the state-owned economy, incremental reform allowed development of the private economy and brought about a partially free market system. That led to the two tracks of command and market.
Under the planned economy, means of production were uniformly distributed among economic units, and prices were only an accounting tool. Consumer goods were uniformly managed by state-owned businesses and prices fixed by price-management departments.
At the beginning of the reform and opening period, SOEs were given autonomy to sell products. The State Council released in 1979 its Provisions for Expanding the Operating Autonomy of State-run Industrial Enterprises, which let companies sell products through their own channels beyond quotas. This opened the second track for circulating products -- the market.
At the same time, the birth and development of quota-free private enterprises made obtaining raw materials and other resources from the market a necessity. By the mid-1980s, 31 percent of nationwide industrial product value was private, and market allocation of the means of production was constantly expanding.
In January 1985, the State Price Bureau and State Materials Bureau issued a notice entitled On the Opening of Pricing for Over-Quota Industrial Means of Production, which let enterprises buy and sell products “outside the plan” at market prices. This began the two-track system for supplying means of production. The approach was set 1983 as a base year and for SOE production quotas; anything produced over 1983 levels could be sold at market prices.
Because state and private sectors coexisted under incremental reform, the two-track system existed in a number of areas beyond production allocation and pricing. For example, its influence was evident in lending rates at national banks, market interest rates, foreign exchange swap market prices, and official currency exchange rates.
Economist views on the advantages and disadvantages of the two-track system varied widely. Lawrence J. Lau, Qian Yingyi, Gerard Roland and Zhang Jun gave positive evaluations of the two-track system’s role in stabilizing production in the state-owned economy and realizing Pareto improvement. Through general equilibrium analyses, they described Pareto improvement characteristics of two-track price liberalization.
A 1986 study by the National Institute of Economic System Reform described the positive role of the two-track system from both economic and political perspectives. The report said that under the two-track system, from an economic point of view, “Whether an enterprises increases or decreases production or inputs, the price of the increased or decreased portion is decided by the market. This also means the market price has, in reality, played a deciding role in marginal corporate outputs and inputs, and through this marginal use acts to adjust the signals and impact of short-term supply.”
From a political perspective, the report continued, “Within the two-track system exists an administrative system for allocating resources. Under certain conditions, the monetization of vouchers will be transformed into the monetization of power. That is, the power of voucher allocation is in fact the power to allocate money, meaning power to allocate vouchers itself can be measured in monetary terms; it can make power a type of currency. This type of degenerative behaviour in economic terms is extremely reasonable. As long as the voucher monetization mechanism is effective, and administrative power derived from the planned economy continues, it is completely natural to consider the allocation of every kind resource as capital.”
American economists Kevin Murphy, Andrei Shleifer and Robert Vishny took a different view. They thought that if all prices were not simultaneously liberalized, distortions of resource allocation would result. Moreover, unequal operating conditions would surface among SOEs, which could obtain hidden subsidies, and private companies, which could only obtain raw materials, equipment and loans from the market, and that these conditions would increasingly impede development of the private economy over time.
Other Chinese scholars, including myself, are now paying close attention to the social and political consequences of the two-track system. We think there are two consequences of this institutional arrangement. On the one hand, as some scholars have said, it gives people a certain amount of space for entrepreneurial activity, allowing all sorts of private enterprises to grow. On the other hand -- and we must be on guard against this -- if this type of institutional arrangement of “power monetization” or “power capitalization” continues or intensifies, a rent-seeking environment will result. And that would plant seeds for spreading corruption. If we are unable to adopt further market-oriented reforms in time, and eradicate the roots of corruption, we will face serious economic, social and political consequences.
To be continued.
Wu Jinglian is one of preeminent economists in China. He is a senior research fellow for the Development Research Center of the State Council.
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