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Essay Number 7
October 1998 
Economic Liberalization in Post-Mao China: Crossing the River by Feeling for Stones

thin rule
By Satya J. Gabriel

"Economic planning is not tantamount to socialism,
because economic planning is also practiced in capitalist countries;
the market economy is not tantamount to capitalism
because a socialist country can also have a market economy.
Both economic planning and the market economy are economic means.
The essence of socialism is to emancipate and develop the
productive forces, destroy exploitation, eliminate polarization,
and attain common prosperity in the end."
     Deng Xiaoping, 1987.

The current Chinese leadership, primarily the Dengist pragmatists (or, more simply, the pragmatists), have a keen understanding of the strengths and weaknesses of market exchange processes, gained over years of experimentation, a grounding in a modernist version of Marxian theory, and struggles to find public policy strategies to maintain economic growth while containing inflation.  This leadership has experienced the problems that come out of a command and control allocation system --- severe imbalances between supply and demand, lackadaisical managers, low quality output, stagnation in technological invention and innovation, low worker productivity and morale, etc.  The best way to understand the current generation of pragmatists is to recognize that they think like engineers (and in some cases were educated as engineers).  Deng set the standard for today's leadership by shifting the focus of Chinese politics from the Maoist concern for building pro-communist social relationships and restraining bureaucracy (the core goals of the Maoist Left) to a pragmatic concern for flowcharting the general steps necessary to achieve Zhou enlai's "Four Modernizations." The Four Modernizations Era, which is associated with the rise to prominence of Deng Xiaoping and the pragmatists, was grounded in the idea that it was more important to innovate the most advanced technologies available to improve the efficiency of agriculture, industry, research and development, and the military than to achieve the social objectives that had been associated with the Maoist Era. 

What were the steps in Deng's flowchart?  This Dengist path began with agricultural reforms, including decentralization of production units, the fostering of the "individual economy" (or ancientism/productive self-employment), and free markets, which would generate the surplus necessary to subsequent phases of modernization of the transportation, energy, and education systems, upgrading of Chinese industry, and ultimately leading to the advance of China's research and development capabilities to a par with the United States.  The rural reforms were followed in the urban industrial sector by a process of gradually devolving control over surplus value from government ministries (under the command of the State Council) to enterprise managers. 

This devolution was necessary to the Four Modernizations for at least three reasons: 1) enterprise mangers were understood as better positioned than higher level bureaucrats (whose perspective was embodied in the Plan) to make more efficient investment decisions (and therefore generate more future value from current investments); 2) the relative managerial acumen of enterprise managers could be better judged in an environment where firm performance was the result of firm-level decisions (creating an incentive for managers to make better decisions so as to gain the requisite rewards, including status, of outperforming their cohorts at other firms); and, 4) the existing bureaucratic arrangement was costing the central government value that could be saved under an alternative arrangement and then redeployed for modernization of infrastructure and the military. 

The first phase of this devolution was from approximately 1979 to 1983, during which enterprise managers were allowed to distribute a portion of the surplus value generated by their firms, including using some of this surplus value for investment that was outside of the Plan.  Managers were still required to meet the objectives in the Plan before they could exercise this discretion, however.  The second phase of industrial reform started in 1983 and ended in 1987 and completely severed the role of ministries as appropriators and devolved this power to the enterprise managers in toto.  The state simply taxed enterprises, rather than directly appropriating enterprise surplus value.  The cost of this freedom from bureaucratic control was the removal of the enterprise from inside the bureaucracy, where enterprise investments and other costs were treated as a line item in the overall government budget, to outside the bureaucracy.  Henceforth, enterprises were to finance their own investments and other costs, primarily by borrowing from state controlled banks.  Nicholas Lardy and others have pointed out that this transition to enterprise autonomy was not as complete as it would seem on the surface.  Although managers were supposed to face harder budget constraints, the reality was that most managers could continue to count on the state controlled banks to bail them out of financial trouble, providing low interest rate loans to patch holes in the income stream, helping managers to meet claims on surplus value, even when the amount of surplus value generated internally was insufficient to do so. 

Phase three of the industrial reforms moved the relationship between the state-owned firms and the bureaucracy even further from the old patriarchal/Confucian arrangement (with the state as father and the firm as dependent).  This phase lasted from about 1987 to 1992/3, was marked by legalization of the private sector as a "complement" to the public sector, and inaugurated a "contract system," loosely based on the baogan daohu (individual contract) system already in place in rural China (where the communes had been terminated in 1985). Enterprise managers negotiated their level of taxation with the ministries, rather than having the tax rate simply imposed from above, as was the case during phase two, and the first tentative steps towards creation of capitalist labor markets, where workers' ties to the firm were less permanent, were made.  Enterprise managers became freer to operate outside of the Plan, with their own capital budgets, more control over employment, and the ability to negotiate joint venture arrangements with foreign firms.

We are currently in phase four, which began in 1992/3 and was codified in the constitution in 1993 with the phrase "socialistic market economy."  This is the period of establishment of the "modern enterprise system," as called for by the fourteenth Congress of the Communist Party of China (CPC).  This phase represents the decision of the CPC leadership to replicate the corporate governance structure common to capitalist economies of Europe and Japan, with the complete autonomy of formerly state controlled enterprises, even ones with a majority of shares owned by the state.  The labor market has become fully capitalist.  Contracts between workers and firms can be "broken and bought" (maiduan).  It has also been marked by the growing importance of share ownership, in general, with many shares of state-owned firms having been floated on financial markets and more planning to go that route.  The increasing importance of shareholding in the Chinese economy has buoyed the hopes of those promoting neoliberal strategies of development that China will, even if only gradually, follow the path of other so-called transition economies in adopting a fully "liberalized" economy.

Did this era of reforms in rural and urban China, the "Four Modernizations Era," represent a displacement of Marxism by neoclassical/neoliberal economic thought in China?[1]   While it is true that Chinese economists have become multilingual in theories, expanding their knowledge beyond the subset of Marxian theories that prevail within Chinese academia to include neoclassical, neo-Keynesian, Austrian school, and other so-called Western economic theories, it must be understood, especially in a world dominated by the neoclassical/neoliberal cult of the market (where social scientific analysis of social relationships has given way to arguments grounded in a supernatural notion of "the market" --- the market as God), that this theoretical shift from Maoism to Dengism (or from the radical Left to the pragmatic Right) was not a sign that the Chinese leadership had joined the neoliberal congregation.  Their promotion of greater reliance on the market was not based on neoclassical scripture, but on Deng's own version of Marxism (much as the Soviet's adoption of the "New Economic Policy" had been based on a particular understanding of Marxism).  In other words, the policies of the pragmatists could be constructed completely within indigenous theoretical frameworks.  Nevertheless, in a world of relatively open communication of ideas, indigenous ideas are always, in part, the result of cross-fertilization with "foreign" ideas.  There is no doubt that the theoretical underpinning of the pragmatists (just like that of the various oppositions within and without the Communist Party of China) are shaped, to some extent, by the full range of intellectual traditions common to academic discourse in France, Japan, Great Britain, the United States, Italy, and so on, as well as intellectual discourse within China itself.

In this sense, the pragmatist modernists in China are considerably more eclectic (and less ecclesiastical) than the neoliberal modernist leadership that dominates policy making in the West.  The pragmatists are aware (as was Marx himself) of the efficiency of market exchange processes in sending signals from consumers to producers, from retailers to wholesalers, from wholesalers to producers, and from producers to producers.   They understand that the relatively low cost and rapid transmission of information via the interaction of and negotiations between buyers with sellers (and the effects of failed negotiations, such as unintended inventory buildups) provide a key ingredient in improving the effectiveness of economic institutions.  This is particularly the case when these institutions are subject to the "discipline" of the market, i.e. are allowed to suffer, even cease to operate, because of an inability to meet the rigorous demands of market transactions.  In this sense, the pragmatists share with the neoclassical/neoliberal conservatism of the "West" a respect for the importance of "the market."  But they also understand that there is no magic in market exchange processes.  Markets, as collections of buyers and sellers transacting, are not infallible. By the very nature of the interactions among market participants, mistakes (from the standpoint of the society taken as a whole) can be made. The problems that are called "negative externalities" in neoclassical orthodoxy are understood by the Chinese leadership to be innate to the very process of transacting.  For example, the Chinese leadership is acutely aware that allowing agricultural production and marketing decisions to be made purely on the basis of private market transactions could lead to shortages of certain staple foods in certain regions and cause human-made famines.[2]  In a society that has significant centrifugal forces at work, it is considered necessary to keep a greater degree of control over these transactions than might be thought appropriate in a more "free market" environment (as embodied in neoliberal policies). 

Thus, the Chinese leadership remains fairly conservative in their "liberalization" or "reform" efforts. They continue to follow the approach embodied in Deng Xiaoping's phrase "Mozhe shitou guo he" or "Crossing the river by feeling for stones." The building of the "socialist market economy" is, then, understood to be another of those great Chinese experiments, a continuation of the "permanent revolution" that Mao espoused, albeit a revolution that the Maoist Left might have considered reactionary. To be sure, it is hardly an experiment on the magnitude of the Great Leap Forward. The version of market socialism being constructed in China builds on ideas that had already been tested, even if to a limited extent, elsewhere. And the experimentation was in the context of a carefully thought-out "path" of development, which can be identified in ideas dating back to Zhou enlai and embodied in the Selected Works of Deng Xiaoping. In other words, the experiments (the stones) were designed to find a workable way to traverse the theorized developmental path (the river).

The pragmatist leadership recognized, from direct experience, as well as from evidence gathered more indirectly, that economic rewards and punishments were an important way to motivate economic agents to avoid waste and to respond to a rapidly changing economic environment. Government bureaucrats were neither motivated nor equipped to respond in such a manner.  Shortages can go undetected or uncorrected for a very long time if it left up to bureaucrats to solve the problem. But if an economic agent is in a position of being rewarded for correcting such a problem, by supplying the product, for example, then economic efficiency can be greatly enhanced. This is a fundamental lesson of the difference between the speed of functioning and efficiency of market exchange processes versus command and control systems. Lenin, Trotsky, Bukharin, Preobrazhensky, and other members of the Bolshevik leadership in the USSR had some rudimentary understanding of this when they pushed forward the New Economic Policy. The Chinese leadership had a similar rudimentary understanding of this from the period prior to the 1949 Revolution when they governed "liberated" areas of China and, for clearly pragmatic reasons, did not interfere, to any significant extent, in local markets. 

But why does the Chinese leadership continue this careful " feeling for stones . . . " approach to economic liberalization? Why not take the approach preferred by Jeffrey Sachs and others who argue for a "big bang" strategy to re-forming socialist economies? The answer is, in part, that the Chinese leadership doesn't have Jeffrey Sachs' faith in the so-called market. They see market exchange processes as an institutional tool, but not a panacea. They have, therefore, rejected the self-adjusting-equilibrium (or market-as-God) discourse of mainstream neoclassical economics. Zhu Rongji, the new premier and top economic reformer, is a strong advocate of making use of the "market mechanism" and of minimizing the role of the bureaucracy in the economy. But Premier Zhu, like most of the current leadership, also believes that market exchange processes are capable of "getting out of control" and producing chaos. President Jiang Zemin, the first paramount leader to have a childhood spent in preparing for an intellectual life (as an engineer), has even shown an interest in "chaos theory" as a tool for social analysis. Chen Yun, China's paramount economist and a guiding intellectual force in the reform era, has described the market as a bird and the state planning institutions as a cage. Chen warned that a bird without a cage would fly away, but he also warned against making the cage too small. Markets, in the conception of the Chinese leadership and many academic economists advising them, are not naturally equilibrating, as in the Sachs' world-view, but are chaotic, though rapidly responding, relationships constrained from flying apart into chaos by strictly enforced institutional rules and relatively rigid institutional structures.

Whether it is falling investment and rising unemployment, debt crises, work stoppages, "runaway" inflation, oil shortages, excess supplies and rapidly rising inventories, or any number of other problems, the transactions that make up the so-called market are always capable of generating social problems and sometimes very severe social problems. For Zhu Rongji and the other Chinese leaders, these problems are not aberrations or the simple result of external shocks, but are simply possible outcomes of normal market functioning, given that markets are nothing more or less than the interactions of various economic agents, with differing economic power, knowledge, and social connections. And Premier Zhu no doubt recognizes that market-determined crises are not always undesirable, at least from the standpoint of some subset of economic agents. The Chinese leadership may very well make use of the market as a tool for the destruction of some "inefficient" state owned enterprises (that have acted as a drain on the government's revenues) --- leaving the blame for any subsequent rise in unemployment to the impersonal market mechanism, rather than to conscious government policy. Thus, even though the ideas of Marx and contemporary Marxian theorists play a relatively minor role in shaping public policies in the post-Mao China, there remains among the Chinese leadership a latent Marxian ontology of economic life as a continuous series of tensions and struggles which are sometimes unresolved, sometimes resolved favorably for the parties involved, sometimes resolved favorably for only some of the parties and not so favorably for others, and sometimes result in a generalized crisis that threatens social cohesiveness (or some combination of these outcomes). 

In this conception, releasing market exchange processes from regulation (doing away with the cage) always runs the risk of unleashing the chaotic (and potentially catastrophic) elements of these processes (the aforementioned generalized social crisis). For example, rather than controlling the number of state-owned enterprises destroyed by the market mechanism, a complete release of such enterprises from any government support or authority might result in a massive collapse of the industrial sector and widescale unemployment. There have already been large-scale demonstrations against the closing down of state-owned enterprises. The Chinese leadership would not want to see this process become too generalized. In other words, given their theoretical understanding of markets, the Chinese leadership is behaving in a manner consistent with risk aversion. They are being careful in how far they go in deregulating markets. They want to make sure the stones are firm before planting their feet on the next one. The "feeling for stones . . ." strategy is based on an understanding of liberalization as a series of tradeoffs between efficiency and increased risk of market-determined social problems (or, at the extreme, of market initiated social disintegration). 

The pragmatist leadership is, therefore, willing to allow more "hard budget" constraints on state-owned enterprises, resulting in some increase in bankruptcies and unemployment, for instance, but not too much or too fast. They are open to continued liberalization of financial and housing markets in order to entice more of China's citizen's savings into productive use, but want to keep a tight rein on speculation and inflation. In other words, the Chinese leaders believe the market can operate efficiently in sending information and generating responses to information, but sometimes the information sent and the responses initiated are not conducive to social welfare, social peace, and the long term development of the Chinese nation. Indeed, it is considered possible that an unfettered market could generate an economic crisis that would have among its outputs increased poverty, increased crime and corruption, and a diminution of China's ability to remain a cohesive nation-state. For the Chinese leadership, the market mechanism is rife with contradictions. It is an effective tool for solving some problems, yet creates other problems. It is akin to a wild horse that, when tamed, can be used effectively to get more done, but always has the potential to once again go wild and cause havoc. 

The practice of gradual liberalization ("feeling for stones . . .") has clearly paid dividends for the Chinese leadership. China's leadership has built up foreign reserves in excess of $100 billion and has avoided the excessive foreign debt that now plagues nations such as South Korea, Indonesia, and Thailand. They have had greater success in continuing rapid economic growth with relatively low inflation than most governments of less industrialized nations or of the governments of the former Eastern Block (CMEA) nations.[3] Indeed, the double-digit growth rates that China has experienced during the so-called Reform Era have far exceeded even the most optimistic economic projections. Twenty years ago, most economists would have reacted with extreme skepticism to anyone predicting that China (or any country even close to China in size) could grow in a sustained fashion at such rates, much less do so with relatively low inflation and under the tutelage of a communist party. This is, without question, a noteworthy achievement of the gradualist approach followed by the pragmatists that have governed for most of the period since the death of Mao.


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[1] The most notable proponent of neoliberalism in "transition" economies is Jeffrey Sachs. See, for example, Jeffrey Sachs and Wing Thye Woo, 1994, "Structural Factors in the Economic Reforms of China, Eastern Europe, and the Former Soviet Union," in Economic Policy 18 (April): pps. 101-146 for a well written explication of the neoliberal view. Alternatively, you can read any of the World Bank reports on China.

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[2] Amartya Sen's insights on the dynamics of famines as market-determined phenomena were among the reasons for his receiving the 1998 Nobel Prize in Economics.

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[3] China's leadership has generated more rapid economic growth than any of the former socialist nations of the Eastern Bloc and per capita income in Coastal China is double that of countries like Bulgaria and Romania and higher than per capita income in Russia. Coastal Chinese household incomes are, in nominal terms, as high as household incomes in Poland, the economy that many see as epitomizing the so-called Big Bang approach to the transition from centralized, command planning to market allocation and which has received substantial financial and other forms of support from the NATO bloc.

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Copyright © 1999 Satya J. Gabriel, Mount Holyoke College.  All Rights Reserved. 

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