Essay:Difference between Chinese and russian economic reform

NOTE: NOT YET COMPLETE

Summary

An essay designed to find the qualitative and quantitative differences in the structure of both China's and Russia's economic reforms. Described as Reform and Opening Up in China and Shock Therapy for Russia. The argument of this essay is simple, the nature of China's economic reforms is not tantamount to simply "restoring capitalism" unlike what Russia did. We will measure the reforms from 1989 to around 1996, when the Russian reforms and Chinese reforms were both well under way. We will look at the effects on quality of life, structure of economic reorganization, public and private sectors, but most importantly, whether or not China has restored the capitalist road, like Russia has.

Summary on "Shock Therapy"

The US State Department’s Agency for International Development contracted the now-defunct Harvard Institute for International Development to advise the Russian government on privatization and the creation of capital markets. The policy advice given and implemented was to go for a ‘big bang’ approach. or otherwise known as shock therapy by engaging in a rapid mass privatization programme. This started in 1992, and by 1994, 14,000 medium and large state enterprises – or 70% of Russian industry – had been transformed into joint-stock companies

The architects of Shock Therapy had pressed ahead without creating the necessary laws and institutions to protect private property and to prevent self-dealing by managers. They believed that privatization would result in the emergence of private property owners who would then lobby the government to create laws and enforcement institutions that would prevent their expropriation. Except, what ended up happening was the complete opposite. Instead, company managers and other kleptocrats lobbied to oppose the strengthening of laws and institutions that would protect shareholders

The largest enterprises, mainly those in oil and metals, were not part of the voucher privatization scheme. Instead, they were auctioned off in a highly rigged manner (at very low prices) to a small number of well-connected men who had made their wealth by expropriating funds and assets from the government. Essentially creating a group of Oligarchs and Kleptocrats. The results were as follows:

• Corruption rose According to Transparency International’s Corruption Perceptions Index, based on surveys of international businessmen, Russia was ranked to 126th out of 159 countries surveyed in 2005, with a score of 2.4 out of 10,
• Russia suffered the worst peace time increase in mortality experienced by any industrialized country.
• For the years 1987 and 1988, roughly 2% of Russia population lived in poverty (surviving on less than $4 a day), by 1993-1995, it was 50%
• IMF economic reform programs are associated with significantly worsened tuberculosis incidence, prevalence, and mortality rates in post-communist Eastern European and former Soviet countries.
• Male life expectancy in Russia has fallen to just 57 years: ‘By 1993 Russia’s death rate had risen above even the level of low income countries. Russia’s death rate now stood on a par with that of such countries as Bangladesh, Nigeria, Sudan and Togo, a dreadful testimony to the awful results of the reform process.’
• The United Nations Children’s Fund (Unicef) reported at the end of 1995 that 34 per cent of Russia’s population had fallen below the subsistence minimum and that for men in the 20–39 age group in Russia, Ukraine and the Baltic states ‘the mortality increase due to heart, digestive and infectious diseases has taken on frightening dimensions unequalled in its magnitude in peacetime.’
• Russia had the dollar value of its exports nearly halved, from $63 billion in 1990 to $35 billion in 1994, and has been reduced to an exporter of raw materials and energy which, by 1993, made up 80 per cent of its exports.
• In Russia, the poor performance of Gorbachev’s early years turned into a very poor performance in the later period of his rule. It became nothing less than a disaster in the 1990s. Output declined precipitously.
• The cumulative drop of output registered over the last two to three years in some countries has attained proportions that are unmatched even by the Great Depression of 1929-1933.
• Hungarian GDP fell by 11.7 per cent, Romanian GDP by 18.6 per cent, and Polish GDP by 19.0 per cent. Czech Net Material Product (NMP) fell by 12.8 per cent, the NMP of the former USSR by 16.0 per cent, and Bulgarian NMP by 30.9 per cent.
• The beginning of 1990 to mid-1991 industrial output declined by 25.9 per cent in Czechoslovakia, 27.2 per cent in Hungary, 38.1 per cent in Bulgaria, and 40.1 per cent in Poland.
• Between 1989 and the middle of 1991, employment fell by 11.6 per cent in Rumania, 13.8 per cent in Czechoslovakia, 16.9 per cent in Poland, and 20.1 per cent in Bulgaria. As the fall in output in Eastern Europe was even more rapid than the decline in employment productivity sharply declined.
• The Eastern bloc economies saw declines of 13% to 65% in GDP.

Summary on Reform and Opening Up

Reform and Opening Up is a policy of internal reform and external opening that China began to implement at the Third Plenary Session of the Eleventh Central Committee in December 1978. The central government officially approved the implementation of special policies and flexible measures in foreign economic activities in Guangdong and Fujian provinces. Opening up to the outside world has become a basic national policy of China. This revolutionary policy set forward by the Chinese government allowed for the development of the market sector alongside the public sector. In contrast to the Russian economic reform, public ownership remained a central feature of the property rights regime in every sector. The economy remained highly protected from the forces of international competition.

The state remained at the canter of the economic process, having fundamentally shifted its approach away from economic commands towards economic planning which worked in tandem with market forces. In every major area, China pursued a reform strategy which ran counter to the transition orthodoxy. In terms of the conventional wisdom of the late 1980s about how to reform a communist system according to the Capitalist West, China had gotten all of the main policies wrong. Yet it has become the most dynamic economy, in stark contrast to Russia, who had listened to the Capitalist West, who was now miring in poverty and wasting away. While China's economy became far, far stronger.

The results of Reform and Opening Up are as follows:

• A three fold increase in average consumption of meat and eggs between 1978 and 1991.More than doubling of living space in rural areas in the same period and the television set was owned by an average of one of every two rural households and by virtually every urban household in 1991.
• By 1993, 83 per cent of city households had a washing machine, and, in Shanghai, 98 per cent of households had a refrigerator, 92 per cent a colour television, and 45 per cent a video recorder.
• Grain output grew by a third in six years, cotton almost trebled, oil bearing crops more than doubled, fruit production went up by a half. Real incomes in the countryside grew even more spectacularly – threefold in eight years.
• Between 1978 and 1991 grain consumption of the average Chinese went up by 20 per cent; seafood consumption two fold; pork consumption two and a half times; egg consumption more than three fold; edible oil and poultry consumption four fold.
• In the decade after 1979 Chinese Gross Domestic Product (GDP) grew at an average 8.8 per cent per year. The Chinese economy more than doubled in size – expanding by 135 per cent.
• Chinese industrial output expanded at an average 11.2 per cent a year. Chinese industrial production nearly tripled in 1979-89 – increasing by 195 per cent.
• Chinese employment increased by 3 per cent a year. Unemployment fell from 5.3 per cent to 2.6 per cent. Labor productivity grew by 5.9 per cent a year.
• Chinese steel output quadrupled between 1980 and 2000.
• The average annual real grown of net farm output per worker accelerated sharply from only 0.3 per cent between 1957 to 1978 to 4.3 per cent from 1978 to 1991

Thoughts On Both Economic Policies

The economic policies which have devastated Eastern Europe and the former Soviet Union since 1989 and 1991 is contrasted with the spectacular success of the reform of the world’s second major centrally planned economy – China – a model now being increasingly applied in Vietnam, Laos and Cuba.

Since 1978 China has been the most rapidly growing economy in the world. Economic growth averaged 9.4 per cent a year between 1980 and 1993, and moved into double figures after 1991:

‘China doubled its output per person in the ten years between 1977 and 1987, one of the shortest time periods for any country to achieve such a record. This impressive growth has in part been the result of significant increases in factor productivity in both the state and non-state sectors, a point of some importance given the well-documented failure of centrally planned socialism to raise productivity. The result is China’s economy is now estimated (using purchasing power exchange rates) to be surpassed in size only by the US and Japan and there is a real possibility that China will become the world’s largest economy by 2025.’

Under the guidance of the IMF, the economies of Eastern Europe, in particular, Russia , have experienced an economic collapse unprecedented in peacetime in the modern world. The former Soviet Union's output is now less than half its level prior to capitalist economic reform. In Russia productivity declined by 22 per cent in 1992 alone. So, what this means is quite simple. The nature of Chinese economic reforms inherently took a different character to the one of Russia. We can clearly see, Deng Xiaoping's "Reform and Opening Up" did not take the same path or at least, a "entire privatization" or the "adoption of liberal capitalist policies". We can clearly see that whole-sale privatization and overhauling of the socialist system completely lead inevitably to a drastic decline in living standards and the complete withering away of public ownership and being replaced wholesale by private industries.

Bourgeoisie explanations for how China succeded, despite no wholesale privatization

Considering the fact China did not do wholesale privatization nor did it reinstall Capitalism. This meant terrible things for the global image of Capitalism as a whole, especially with how China reformed its economy, while keeping a Communist Party in charge. Because it meant that China, one of the last bastions of Communism was still alive to this day. The Capitalists had to quickly figure out ways for China to either follow their path. Or to figure out an entirely new explanation to determine that China had somehow "used capitalism" or only succeded because of "special circumstance."

Milton Friedman complains and derises China for using markets within the context of a planned economy,

‘Using or not using the market is not the crucial distinction. Every society, whether communist, socialist, social democratic or capitalist, uses the market. Rather the distinction is private property or no private property. Who are the participants in the market and on whose behalf are they operating? Are the participants government bureaucrats who are operating on behalf of something called the state? Or are they individuals operating directly or indirectly on their own behalf? That is why in an earlier paper delivered in China, I advocated the widest possible use not of the market but of “free private markets”… The words “free” and “private” are even more important than the words “market”. The wide use of the market that is sweeping the world is better called “privatisation” – transferring government owned enterprises to private hands and thereby giving greater scope to the invisible hand of which Adam Smith wrote.’

The wallstreet journal argues the same point,

‘China is still a largely socialist economy… The CP in China however hasn’t found a way to retreat from central planning… Privatisation is the obvious solution, probably it would be tantamount to bankruptcy in most cases, though some firms would yield a hefty liquidation value because of their land holdings. Yet the government has decided, on the whole, that public ownership must not be tampered with. As long as that commitment stands, China’s reforms will remain blocked… the state sector still haunts the economy, and until a stake is driven through its heart, we fear an ugly reckoning lies ahead.’

We can see that, for these Bourgeoisie economists and think tanks, China did not restore capitalism or remove the element of efficient state planning from its model. That it is something to be decried and rejected, even though it was more efficient and objectively, superior. Jeffrey Sachs and Wing Thye Woo states that the public owned/state owned sector of the economy had indeed, not shrunk

‘The proportion of the Chinese labour force employed by state-owned units was 18 per cent in 1978 and was still 18 percent in 1992. This means that there were actually 32 million more Chinese working in state-owned units in 1992 than in 1978. The state-owned sector is not “withering away”.’

A similar comment is made on Vietnam by the Economist, who had adopted a similar policy to Reform and Opening Up, known as the Doi Moi policy, a survey done by the Economist in 1995 found that after four years of annual economic growth averaging 8 per cent, the weight of the state sector in Vietnamese industrial output has increased from 33 per cent in 1990 to 40 per cent in 1994. The opening up of the economy had not weakened the state sector and in fact, was strenghtening its grip. And, according to Peter Nolan:

‘At the end of this process [in China], public ownership remained a central feature of the property rights regime in every sector. The economy remained highly protected from the forces of international competition. The state remained at the centre of the economic process, having fundamentally shifted its approach away from economic commands towards economic planning which worked in tandem with market forces. In every major area, China pursued a reform strategy which ran counter to the transition orthodoxy. In terms of the conventional wisdom of the late 1980s about how to reform a Stalinist system of political economy, China got all of the main policies wrong, yet it was the world’s most dynamic economy in the reform period… The advice which flowed from this orthodoxy contributed substantially to the Soviet disaster. The decision not to follow it helped the Chinese achieve enormous success in their transitional programme.’

We can clearly see that it is the how the State maintains the commanding heights of the economy, and how the state continues to implement central planning (something not seen in social democracies, I might add. The corporatist models of Fascism and the Asian tiger model's directed planning was undertaken by Capitalist oligarchs such as the MEFO group, Capitalist cartels, Kereitsu and Chaebol's). Capitalist 'success' in Eastern Europe has lead to a drastic decline in the quality of life, while Socialist 'failure' in China has lead to far greater increase in quality of life, industrial growth, economic growth and cultural enrichment.

However, the argument against everything I have said thus far and presented with quotes is presented by Jeffrey Sachs, who believes that China's economic reforms were irrelevant and could not have been replicated in Russia. Therefore, Shock therapy was the only way forward, apparently. He goes on to argue that, China had a potential surplus labour force in agriculture which could be transferred into new private industries, whereas in Russia the largest part of the workforce was already immobilised in state industry. Therefore, making the demolition of the state sector a precondition for the development of smaller enterprises in Russia.

However, this statement's validity is dashed into dust by Naughton, who states:

‘The comparison then is between the Russian task of transferring skilled urban workers to alternative manufacturing and service sector jobs versus the Chinese task of transferring unskilled peasants to manufacturing jobs. Which is more costly? The assertion that the Russians have a more difficult task would be met with disbelief by the majority of economists who have studied the development process.

It is simply not true in general, and it is even less true in a situation where, at least at the outset of reform, the Russians have a close to full employment economy while the Chinese struggled with labour surpluses. The European centrally planned economies do not need to continuously generate millions of new jobs to absorb the workers shed by inefficient producers.

In that sense, a moderate growth of new firms should be able to gradually draw workers away from inefficient state firms, and produce a transition without massive amounts of socially destabilising unemployment. The ECEs have the same unexploited niches that China has, but fewer reserves of grossly under utilised labour in the countryside.

Thus, a strategy of opening niches to new entrants should aid the restructuring process more rapidly than in China. From this point of view, there is a mature economy variant of the Chinese pattern of economic reform. It would certainly produce less rapid growth, but it might be a strategy of reform preferable to one that induces maximum economic dislocation.’

There were fundamental similarities between the Russian and Chinese economies at the outset of reform. China’s difficulties of feeding its enormous population given the relative shortage of agricultural land, creating tens of millions of industrial and service jobs to replace those eliminated as agricultural productivity increases, the far lower starting point in terms of living standards, technology, education, industrialisation, and so on, made reform of China’s economy, potentially more, not less, difficult.

The Mechanisms of the Chinese Reform

China maintained the output of heavy industry while simultaneously divesting resources into creating light industry, farming and consumer services. Domestic producers were protected by tariffs on imports averaging around 35% (compared to an average level of 15 per cent in other developing countries).

Reform of the Consumer Sector

The starting point of the reform was a dramatic increase in individual consumption within the Chinese economy, new consumer industries could only develop if there was a large increase in demand for said products. Within these three years, 1978–81, the share of individual consumption in the Chinese economy was increased from 53 per cent to 59 per cent of China's GDP. This was achieved by reducing the share of investment in the state sector by five per cent of GDP and transferring these investments towards consumer subsidies and wage increases, according to Naughton:

"…during the first phase of Chinese reform, especially from 1979 to 1981, there were substantial reductions in military industrial output, and in heavy industry as a whole. The effect of this on output was swamped by the rapid increase in consumer goods production that occurred at the same time.’

The state determined increase in demand for consumer goods was connected to supply, throug the use of a market mechanism, that is by an increase in the relative prices of food and consumer goods. At the same time the prices of the state-owned industrial sector were held down. As a result, over the decade from 1978, agricultural prices relative to industrial prices rose by 77 per cent, and consumer prices rose by 25 per cent compared to average prices. Unlike in the former Soviet Union and Eastern Europe there was no ‘big bang’ price liberalisation. This relative increase in the prices of consumer goods increased the incentive to produce them.

When it came to demand, the population was compensated by raising, first, the level of state subsidies on consumer goods, and then, because subsidies have the defect of distorting the price structure, by phasing out subsidies and replacing them by wage increases. This is quite different from Russia's reforms where ‘price reform’ simply removed indirect subsidies to the population’s living standards. In China living standards were increased, not cut.

As a result, the demand for consumer goods was increased and the economy gradually moved to a more rational pricing system reflecting the real costs of said goods. At the same time the state maintained it's ability to intervene to limit price increases where and when this was considered necessary for the state to do so, otherwise known as instituting price ceilings.

If the price increases paid to Chinese farmers had been passed onto consumers, then there would have been no increase in the share of individual consumption in the economy. Instead consumers would merely have been forced to spend more on food and correspondingly less on other consumer goods. Food production would have increased, but other sectors such as consumer durables, like washing machines, refrigerators and televisions, would have declined, providing no overall boost to economic growth. Thus the decision in China to fully compensate the population for price increases was an core component of it's success in it's economic reforms. The population gained from the increased supply of consumer goods and was fully protected against price rises. So the changes were greeted by popular support. By this mechanism a large shift in prices in favour of the consumer sector of the economy was created, stimulating a great increase in their production.

Reform of the Agricultural sector

To allow the price change in favour of consumer goods to take effect, all prohibitions on the formation of enterprises to serve the consumer sector were removed – resulting in the formation of millions of small farms, private and cooperative small businesses, shops and workshops.

On this basis huge resources flowed into the consumer sector – with spectacular results, In the decade 1979–89 total agricultural production increased by 49 per cent and total food production by 45 per cent. Food production per capita of the population increased by 29 per cent. The increase in production of higher quality foodstuffs was even more impressive, In the decade 1979–89 production of pork increased at 7.7 per cent a year, milk at 8.4 per cent a year, butter at per cent a year, eggs at 9.7 per cent a year, grapes at 17.9 per cent a year, bananas at 26.1 per cent a year and so on.

Overall the result was a long term increase in agricultural production productivity:

‘The real gross value of crop output per arable acre rose by around three quarters during the reform period. The average annual real grown of net farm output per worker accelerated sharply from only 0.3 per cent between 1957 to 1978 to 4.3 per cent from 1978 to 1991.’

This shift in production was accompanied and made possible by the creation of an enormous number of new small businesses linked via the market. In the agricultural sector, where reform began, responsibility for production was transferred from large communes to individual household collectives and purchases by contract replaced mandatory state procurement. After a number of experiments, by 1984 the household responsibility system emerged as the dominant arrangement. Two hundred million small farms came into existence. However, while land use operated on market principles, landownership was not privatized. Households contracted to use farmland for a fixed period – by 1984 the contract period was 15 years for annual crops and 50 years for tree crops. Farmer contracted to supply specified crops to the state and production over and above the contract could then be sold at market prices.

Reform of Light Industry

In 1988 the government legalised the existence and development of privately owned enterprises. These, particularly very small enterprises, grew rapidly. By 1986 there were 500,000 industrial enterprises in China of which 420,000 were small or medium scale. The expansion of consumer services was equally rapid. In 1977–88 China’s total workforce increased by 35 per cent, but employment in restaurants increased by 327 per cent, in retailing by 380 per cent, and in other services by 750 per cent. Total employment in these three service sectors increased from six million to 30 million – which meant an enormous increase in the quality of life for the Chinese people.

But to this day the specifically private sector accounts for a very small share of China’s overall industrial output because, as we shall see, the biggest change of all was in the spectacular growth of collectively owned enterprises at village, town and city level – chiefly owned by local government structures. These, together with the small scale private sector, were able to soak up the labour released by the rapid rise in productivity in agriculture and were the basis on supply for meeting the mushrooming demand for more and more sophisticated consumer products.

‘The Chinese experience is based on industrialisation; industry represented 35% of GDP in 1970 to 42% in 1990. The decline in percentage terms of agriculture, went from 38% of GDP in 1970 to 27% in 1990… The pattern of industrial growth during the 1980s has favoured light industry, much of it in collective enterprises and, to a lesser extent, private firms as compared to substantially lower, though supposedly still rapid, growth in heavy industries in state-owned enterprises.’

Industrialisation was not confined to the urban sector: ‘the share of agriculture in total village gross income declined from 69 per cent in 1978 to 36 per cent in 1992, alongside the rapid growth of the rural non-farm sector.’

This planned increase in the weight of consumer production in the Chinese economy was only made possible by maintaining state ownership of the industrial core of the economy. That allowed the government to coordinate a shift in relative prices in favour of consumer goods. If industry had been privatised and prices fully liberalised (like in Russia) then Chinese agriculture and consumer goods industries would have been caught in precisely the price scissors which crushed light industries and agriculture in those countries after 1989. In a Capitalist China, the capitalist-ran heavy industries and energy producers would have raised their prices more rapidly than was possible for the farmers and consumer goods producers who were subject to much greater competition as a result of the smaller scale of their units of production and the greater ease of starting up new small firms.

Thus, far from state ownership of heavy industry being a relic of the past which should be discarded as rapidly as possible, it is at the heart of the mechanism which made the Chinese economic reform a success.

The Positive Feedback Loop of the Chinese Economic Reform

As the consumer services rapidly increased, it had an increasing effect upon the state-owned industrial sectors of the Chinese economy. The increased income of farmers and small businesses created a demand for rapid expansion of production of materials for construction, farm equipment, fertilisers and all kinds of machinery necessary for the further expansion of consumer production, which were produced within China's state owned industrial sectors.

‘The pace of growth of light industry accelerated sharply in the reform period. From 1978 to 1992, light industry (real gross value of output) grew at a reported rate of almost 15 percent per annum. However, in a relatively closed economy such as China’s, such growth can only be sustained through simultaneous rapid growth of output from heavy industry to provide the inputs for light industrial products. ‘Consequently alongside a boom in output of light industrial products often from the small-scale sector, went a simultaneous rapid growth of output from the heavy industrial sector… The real growth rate of heavy industrial output was reported to be almost 11 per cent per annum in the period 1978 to 1992… Paradoxically, an economy which had shown large heavy industry bias under the communist command system continued to require rapid growth of output from the heavy industrial sector during the reform period. The inter-sectoral relationship under reform had shifted from unbalanced heavy industry growth to balanced growth path, rather than to the emphasis of light industry to the neglect of heavy industry. Indeed, between 1978 and 1992, China’s ranking in total world output shifted from fifth to fourth largest in steel, from third to first place in coal, from eighth to fifth in crude oil, from seventh to fourth in electricity, and from fourth to first in cement.’

As a result of the growth of the agricultural and consumer sectors, the expansion of heavy industry was also driven forward. In this sense, the Chinese experience since 1978, is superior not only to the IMF-inspired disasters in Eastern Europe and the former Soviet Union since 1989 and 1991, but also shows the mistake of the USSR's strategy of developing heavy industry at the expense of consumer goods and services (outside of such emergencies as war). Both end up strangling and slowing down the process of improving the living standards of the working class and peasantry.