China's transition from a centrally planned economy to a market system has been underway for 15 years. This has been a period of considerable economic success, a "miracle" of economic growth contrasting sharply with the output declines that have marked reform elsewhere. The Chinese approach to transition has been quite different in terms of content, timing, and sequencing from the shock treatment observed widely in Eastern Europe and the former Soviet countries.
In a previous article, Adams (1993), I described the economic impacts of transition in Eastern Europe and the former Soviet Union. The Chinese experience differs greatly; there are more differences than similarities between the Chinese and the Eastern European situation. But what is happening in China offers some useful insights into the factors that can influence success or failure in the economic transition.
China has avoided the catastrophic decline in output and income, averaging 25 percent of GDP, that occurred in most of the countries of Eastern Europe during the first few years after the beginning of reform /1-3/. Of the other Soviet bloc countries, only Poland and Hungary have had as long a period of reform as China. Hungarian reform, carried out under a communist regime, was halfhearted for a long time, while Poland opted early for radical liberalization **. In both cases, the decline in real output was aggravated in 1990 and 1991 with the collapse of COMECON trade, but recently, trends have been positive, albeit from a low level.
China has avoided sharp increases in reported unemployment, but, there is reason to believe that labor surpluses have developed. The labor released by productivity gains in agriculture appears to have been a basis for the development of communal industries in the agricultural areas of China. Since restrictions on migration have been eased, there seems to have been substantial migration from labor surplus areas to the big cities and to the rapidly growing coastal regions.
Perhaps surprisingly, moderate increases in unemployment had also been the experience in Eastern Europe and the former Soviet Union. Though recently, efforts to improve industrial productivity and privatization are causing significant increases in unemployment, in Poland, for example.
China has encountered an acceleration of inflation on several occasions. Prompt monetary policy response and tight price controls have kept inflation in check. For the period from 1980 to 1990, prices were rising only 7.2 percent annually. More recently, inflation has accelerated to some 20 percent in 1992-93, but China so far has been able to avoid the runaway inflation experience that affected most of the Eastern European countries and the former Soviet Union during the transition period. Since a much smaller part of the economy was monetized, the inflationary threat of a ruble overhang (or in this case a yuan overhang) was not as severe as in Eastern Europe. Budget deficits moreover, have been much smaller relative to GDP than in the former Soviet Union, 3% as compared to 20% There was not, consequently, the same need for restrictionary macro policies as in the other transition economies. There is reason to fear, however, that China may have difficulty in controlling inflation during the next few years.
Foreign trade has provided a substantial boost to China. Chinese exports have in US $ increased at 20.6 percent during the 1970-80 period, 11.9 percent annually between 1980 and 1991. In the past three years export growth has averaged 17 percent.
China's export trade makes it one of the dynamic Asian economies, whose export expansion has been the key to rapid economic growth. This compares to the drastic decline of trade between the COMECON countries. (Poland, the Czech Republic and Hungary have managed to offset some of this drop in export markets by turning their trade from the former Soviet bloc countries to the Western world.)
The success of Chinese exporters in foreign markets has greatly altered the transition process. Burgeoning exports are as much a result of investment and entrepreneurial participation by overseas Chinese from Hong Kong and Taiwan (and, more recently, investors from the United States, Japan, Korea and even Thailand) as they are of domestic entrepreneurship and policies ***. As comparative advantage for labor intensive industries has shifted from more advanced East Asian countries, investment flows have supported development of export manufacturing industries in China. This process has not as yet developed on a significant scale in Eastern Europe.
Control of Chines economy was more decentralized than in Eastern Europe since formal central planning procedures were effective only in the state owned heavy industrial sector and since much authority remained with regional and local government bodies. At the same time, political control had been maintained. The authoritarian government was not seriously threatened or about to dissolve, as elsewhere in the Soviet bloc.
China began its reform movement at a different stage of development from the countries of Eastern Europe and the former Soviet Union. In common with these countries, China had large scale energy-intensive heavy industry, but aggregate output was still predominantly agricultural. In the late seventies, China remained a developing economy with 33 percent of GDP, and 74 percent of the labor force in agriculture. The population was still largely outside of urban centers, 80 percent. Industry accounted for 38 percent of GDP, somewhat more than in comparable developing economies, and a little less than the more mature and much more heavily urbanized countries of Eastern Europe and the former Soviet Union.
As we note above, there was not the same need for a macro "structural adjustment" program. While China also was subsidizing the massive losses of state owned industry, they amounted to a far smaller share of GDP than in the former Soviet Union where deficits has created a massive ruble overhang. China has had fiscal and monetary retrenchment at several points, but this was not a primary consideration at the beginning of the reform program.
Finally, China was not as closely linked by trade and resource supplies as the other socialist economies, as were the former Soviet Union and the other European transitional economies.
The sequencing of the economic transition has been very different in China than in Eastern Europe and the former Soviet Union. In China, liberalization of agriculture came first, a logical step in a predominately agricultural country that had collectivized agriculture only a couple of decades earlier. The development of TVEs and the reform of state-owned enterprises followed.
In contrast to Eastern Europe and the former Soviet Union, liberalization of prices was delayed and, at first, occurred only at the margin. Exchange rates were maintained on a multi-tier basis and imports remain restricted. Finally, in contrast to Eastern Europe where there is consensus on privatization, in China private ownership still appears to be far in the future.
The politics of transition have also been sequenced differently. Political "opening" has been delayed in China. Economic reforms have been carried out under the existing authoritarian regime.
The timing of the transition in China has been not so much gradual as step-wise. The transition has been going on for many years and remains incomplete. It is certainly not in the form of shock treatment. On the other hand, the individual stages have been carried out with almost amazing speed. The introduction of the household responsibility system, a fundamental change from a system of state farms, went from experimental use to almost complete adoption in a period of five years (1979-1984). Similarly, the development of TVEs was very rapid. On the other hand, the introduction of reforms to the SOEs has been a gradual "off and on" affair. Chinese authorities have experimented with changes and have pushed state owned enterprises only gradually toward realistic accounting and management procedures guided by market prices. After almost a decade these changes remain incomplete.
Linkages to other countries represent another sharp contrast between China and the other transitional economies. As we note above, China was fortunate in that its trade was not so closely tied to the COMECON bloc and consequently, was not so much affected by the breakdown of that trading area. On the contrary, China's links to the world economy as a producer of low cost manufactures and close ties to the East Asian growth process meant that export trade was one of the dynamic growth poles supporting Chinese transition. Inflows of capital supported domestic investment and helped build the manufacturing potential for participation in world markets.
Finally, it is important to note the role of demand and supply. This is a critical difference between China and the other transitional economies. Demand has served as a driving force in China. In turn, supply has been well maintained. In the transitional countries of Eastern Europe and the former Soviet Union reductions in demand played a significant role in the sharp drop of economic activity at the time of reform /1/.
It is premature to draw definitive lessons from the Chinese experience. For one, China is a very special case in many regards. Secondly, the Chinese transition is far from complete. But it is possible to draw some broad inferences. We summarize some thoughts here.
There is clearly more than one way to achieve a transition from a planned economy to a market system. The traditional recommendations for rapid change and a sequence of 1) macroeconomic stabilization, 2) price liberalization, 3) trade and exchange rate liberalization, and 4) privatization do not seem to be required. While this, frequently recommended, sequence of changes makes sense as a basis for optimal static resource utilization, the Chinese case suggests that the dynamics of change may call for somewhat different sequencing. Specifically, the World Bank and IMF dictum "first make prices right" may not be as critical to the development dynamic as we had believed.
The maintenance of demand, whether by accident or by design, appears to be a critical factor in permitting growth and progress. Interruptions in supply played a role in the transition experience of Eastern Europe and the former Soviet Union. It would appear from the Chinese case that, when demand is sufficient, supply may be able to adapt even when price signals are not accurate.
A similar conundrum applies to liberalization of trade and establishment of a free market exchange rate. The Chinese case would suggest that liberalization can wait. Protection through tariffs or quantitative restrictions may be more important for the development of new industries than competition from unrestricted imports. This is not to argue against the importance of free trade, but to point out that new industries frequently need a period of protection until they are firmly established.
On the question of ownership and privatization, we have noted that China has not yet gone far toward privatization. Interestingly, the lack of ownership rights does not seem to be a barrier to entrepreneurial dynamism, at least in the new, not yet firmly bureaucratized, establishments like the TVEs.
Finally, with regard to political authority, it appears that stability and consistency, even when enforced by autocratic rule are more effective than instability and contradiction. In many of the other transition economies, conflicts within the government--Yeltsin and the Parliament in Russia, for example, or swings from left to right democratic government control in Poland--have made the task of stabilization cum development more difficult. In China, the maintenance of political control has not always guaranteed steady coherent policies, but it has helped. It remains to be seen whether the political transition in China's future is consistent with continued economic transition and growth.