The chinese economic strategy emphasizes an explosion of production and jobs outside the state enterprise sector. The fruits of rising productivity are then used to manage the problems of debt, state enterprise deficits, security threats, unemployment, infrastructure scarcity, and discontent over unequal degrees of progress by different sectors of society. This emphasis on construction produces more rapid growth, less inflation, and a greater sense of common interest than the Eastern European approach, which gives priority to destruction of the institutions of socialism rather than to construction of a productive market economy. The absence of a plan is not the same thing as the existence of a market.

The differences between Chinese and Soviet performance derive from profoundly different economic and political strategies. Much of the West long believed a myth that China was an impoverished version of the Soviet Union which must inexorably follow the latter's failures—because, after all, both were communist countries. On the contrary, China has been following a model of development more similar to South Korea than to its formerly communist bedfellows.

Based on analysis of neighboring Asian countries, including most notably South Korea, Taiwan, Hong Kong, and Singapore, China's strategy of development has been distinctively Asian. For the Western shopper, there is very straightforward evidence. In major department stores the shoes, shirts, sweaters, and toys that once carried labels saying "Made in Korea" or "Made in Taiwan" now mostly say "Made in China." Virtually none say "Made in Russia."

From the lessons of the neighboring small countries, then, Deng Xiaoping and his colleagues derived superior strategies in four areas: economics, politics, administration, and financial markets.

Economics

China gave priority to industries and sectors where limited government investments would produce rapid growth. First, they gave the farms back to the farmers

Following the examples of the newly industrializing economies (NIEs), China gave priority to industries and sectors where limited government investments would produce rapid growth. First, they gave the farms back to the farmers, generating huge increases in productivity, income, and output with negligible state investment; the state's role was largely limited to issuing a legal ruling and using the existing administrative apparatus to enforce its decisions. Second, China was very encouraging to foreign investment. Although the incentives and rules governing foreign investment have required continual refinement, they were sufficiently generous to attract huge amounts. This produced enormous gains in both output and exports at negligible cost to the government.

Finally, China gave priority to light and medium industry, where limited initial investment quickly yields a surge of output. Just as Taiwan and Hong Kong had flooded world markets with textiles, garments, shoes, toys, and consumer electronics in the 1960s and 1970s, China quickly became a global force in these same products for the 1980s and 1990s. As in the smaller Asian economic takeoffs, these policies caused an explosion of growth, consumer goods production, personal income, exports, and foreign exchange earnings.

In contrast, the Soviet Union neglected agriculture, was so ambivalent about foreign investment that it attracted very little, and devoted excessive attention to heavy industry. Gorbachev's early programs emphasized massive equipment imports, building more machines, intensified use of machine tools, organization of industry under super-ministries, improvement of the petroleum industry, and reorganization of the automobile and high-technology sectors—all of which were capital-intensive industries. The later debate over privatization also focused excessive attention on industries with huge capital requirements and long lead-times, rather than the sectors of low costs and quick payoffs.¹

Theories of development

These priorities pervade Soviet history and Marxist theory. They reflect obsolete views of development based on Marx's analysis of eighteenth-century Britain and the momentum of Soviet overinvestment in military-related heavy industry. These failed policies also owe much to a premature emphasis on the privatization of giant state enterprises encouraged by Western European and (especially) American professors.

Gorbachev achieved a first in economic history, namely a depression caused by a lack of supply rather than inadequate demand

The result of this Soviet strategy, and of some other Eastern European strategies, including most notably Poland's, was a collapse of production simultaneous with unbearable inflation. One leading scholar argues that Gorbachev achieved a first in economic history, namely a depression caused by a lack of supply rather than inadequate demand. Many of the Eastern Europeans achieved a similar result.

We should not be surprised. The Chinese revolution, for all its flaws, had deep roots in peasant society, whereas the Soviet revolution was just a Leninist coup brutally imposed from above. Guiding and relying upon energy from below came naturally to legatees of Mao Zedong, even though Mao would have despised the private enterprise and foreign presence that accompanied this particular energizing of the masses. There was also more energy available in China. The Soviet regime destroyed agriculture more thoroughly and had 70 years to do it. China's peasants never lost their entrepreneurial streak.

I am less inclined than most writers to emphasize cultural differences. The stereotype of the hard-working Chinese and the culturally lazy Russian is inaccurate. In collective agriculture and state enterprises, Chinese proved to be world class at laziness, just like Russians.

Not that all in the Chinese revolution was rosy. When reliance on the initiative of the masses went wrong, it resulted in the bloody egalitarianism of China's brutal land reforms and the Cultural Revolution. When channelled into a drive for wealth, however, it results in the clothing, sheltering, and feeding of tens of millions of the world's poorest people. As a result, China's growth curve after reform resembles an aeroplane taking off, whereas the USSR's resembles a submarine descending (see Exhibit 1).

The importance of creating consumers

An important consequence of the Chinese strategy is the generation of millions of jobs for the people who need them most. In this strategy, the growth and income are focused on ordinary farmers and ordinary workers. Large numbers of workers, for instance, produce cheap shirts, and they generate the income to buy some of those shirts for themselves. In contrast, the Soviet or Latin American focus on heavy industry creates a much smaller number of much higher-paid jobs, while leaving a huge fraction of the labor force unemployed; moreover, products such as steel have less immediate impact on people's lives.

Guangdong Province has become second only to the United States as a market for shampoos

China's strategy has created a vast class of new consumers who wear modern clothing and use modern amenities. Market research commissioned by Procter & Gamble indicates that there are now many tens of millions of Chinese who can afford five dollars to buy a bottle of Rejoice shampoo. China's Guangdong Province has become second only to the United States as a market for Procter & Gamble shampoos. Avon has more than 18,000 Avon ladies successfully selling Western-style cosmetics door-to-door in Guangdong Province. Motorola, which rates China the best place in the world to manufacture electronic equipment, expects China to become its second-largest market in the world for second-generation cordless phones.

All of this has revolutionized a society where only a decade ago a billion people dressed in the same shabby blue outfits and seemed to have had their hair cut with the same lawn mower.

Politics

Great reformers divide reform into manageable phases

Reform is a domestic political process. Great reformers like Turkey's Kemal Atatürk divide reform into manageable phases, and in each phase build a politically overwhelming coalition of groups who see reform as serving their interests. Unsuccessful modernizers like the Shah of Iran antagonize so many groups simultaneously that they become overwhelmed by reaction. Deng Xiaoping was a model reformer in this respect, whereas Mikhail Gorbachev, notwithstanding his admirable record as one of the great international statesmen of the twentieth century, was a caricature of failure. It is noteworthy that virtually all Western writers about China have praised Gorbachev's strategy of doing everything at once, and attacked Deng Xiaoping's strategy of carefully sequencing reforms, whereas historically those reformers—from Joseph II of Austria to Kuang Hsu of China—who have tackled the whole range of reforms at once, have mobilized opposition and seen their reforms defeated.

Mobilizing support for reform

Deng's initial farm reforms doubled the incomes of China's farmers (see Exhibit 2), winning the support of a group that comprises over 800 million people—not a bad start on a coalition. He then facilitated the rise of a class of small-scale entrepreneurs and stimulated the takeoff of light and medium industry, thereby gaining the support of tens of millions more workers and managers. While there were losers as well as winners within these groups, most were winners and—the key political fact—the winners were sufficiently numerous as to include almost all of the brightest and most energetic members of these sectors.

Deng revolutionized China's financial system, and somewhat loosened the restraints on travel and the exchange of ideas by China's intellectuals and students, thereby winning to the side of economic reform these smaller but extremely influential groups. (After the Tiananmen Square incident, Deng decisively lost the support of intellectuals and students for his personal power and for the power structure generally, but these groups remained enthusiastic supporters of economic reform.)

Deng Xiaoping even managed to obtain the support of a majority of the military leadership for economic reform, despite the necessity of severely constricting military budgets in order to finance rapid economic advancement. Coincidentally, 1979 was both the year when implementation of reform began and the year when China clashed with Vietnam over the latter's involvement in Cambodia. While China achieved its objectives, its army was unacceptably bloodied by Vietnam.

China's military has been among the strongest supporters of reform

Deng successfully convinced much of the leadership that the army's only salvation lay in access to Western weaponry. This required economic success to finance the trade, accommodation with Western countries to obtain access to weapons, and drastic cuts in the army's budget and manpower in order to fund domestic economic progress. The Chinese military has not in fact had a pleasant time during the reforms. In addition to large personnel and budget cuts, it fell far behind the rest of society in income gains, and it has had to go into business to support itself, but on balance it has been among the strongest supporters of reform.

Enlisting the power élite

Likewise, most of the top leadership of the government and the Communist Party became advocates of reform. After the tragedies of the Great Leap Forward (1958-61) and the Cultural Revolution (1966-76), the radical ideologues were completely discredited, and the top Party leaders knew that they had to try something drastically different in order to save both the country and themselves. Chen Yun, the most devoted to central planning of all the octogenarians, actually led the first phase of reform and never advocated reversing the extraordinary successes of his tenure in the early 1980s. Premier Li Peng, a younger devotee of central planning, eventually found himself giving speeches about the virtues of socialist stock markets.

Some top leaders believe that the market is the right direction for the country

Some top leaders (often described as liberals) have strong convictions that the market is the right direction for the country. Others (often described as conservatives, better described as the bureaucratic socialists) have discovered that they can maintain their constituencies only by providing economic benefits, and that the only way they can do so is by increasing efficiency through reform. Meanwhile, the families of both groups, and the families of senior army officers, were bought for reform by the special advantages of their situation: they could use socialist connections to get special advantages at making money in the marketplace. Thus, through a combination of idealism, expedience, and corruption, the nation's power élite was enlisted in reform.

By the end of the 1980s, the extreme socialists were mostly confined to the propaganda organs, and in late 1991 and 1992 Deng began a concerted drive to dislodge them even from those posts. Among prospective leaders in younger generations, some would move forward more slowly and some more quickly on market-oriented reforms, but none would move backwards or stand still.

In contrast, Gorbachev quickly lost the support of virtually all important social groups for economic reform. Farmers remained as neglected and alienated as they had been since Lenin's time. Workers faced stern demands for harder work as their real wages collapsed and their vodka was curtailed. The managerial class found its power and perks curtailed, while its real income fell and the overall strategy of industrial revival failed. The Communist Party leadership was told to run for election after nearly three generations of alienating the population. The military, which already had access to high technology, lost much of its budget and access to new technological advance just as all the country's major allies were revolting and aligning with the former enemies to the West.

The principal beneficiaries of Gorbachev's reform were intellectuals and foreigners

All these groups had their reasons for despising the consequences of Gorbachev's reforms, and for resisting further reform. The principal beneficiaries of Gorbachev's reform were intellectuals and foreigners, the former because freedom of speech was so overwhelmingly important to them, the latter because of Gorbachev's historic statesmanship in ending the cold war peacefully. Other groups were more affected by economic decline and by shame over the collapse of their country.

A question of ideology

In politics, as well as economics, China was the beneficiary of successful Asian models, whereas the USSR and Eastern Europe were the victims of inexperience and ideology—this time Western democratic capitalist ideology, but ideology nonetheless. The notion that one can have all good things (democracy and all forms of economic liberalization) instantly and simultaneously has proved to be an ideological assumption in the strictest sense: a deeply held belief that has no grounding in practical historical experience.

One cannot build a modern glass-and-steel skyscraper just by putting dynamite under an old brick building

In this case, we Westerners are in fact caricaturing our own ideology: there is an explicit set of assumptions—such as efficient information flows—in capitalist economics, which clearly depend on institutional structures that have not been present in Eastern Europe and take time to build. Likewise, there is a literature on the prerequisites of democracy that dates back to the Greeks, and few of these prerequisites are satisfied by countries in the third world or Eastern Europe. One cannot build a modern glass-and-steel skyscraper just by putting dynamite under an old brick building. Trying to create modern market democracies just by blowing up old socialist structures is equally futile.

Economic administration

China has emphasized gradual, carefully sequenced reform, whereas the former Soviet Union and Eastern Europe have been more attracted by spasmodic approaches, most notably Poland's "big bang": precipitous liberalization of prices and privatization of enterprises. Sudden liberalization risks unacceptable inflation and currency collapse; overnight privatization creates economic chaos. The Shatalin Plan, for instance, which received widespread Western approbation in the Gorbachev era, envisaged privatization of much of Soviet industry within 500 days. The same professors who applauded that plan would have recognized instantly that a plan to change the ownership and management of all the major firms in New York or London within less than two years could only result in chaos and collapse.

Price liberalization

Sudden liberation of prices in the context of the severe supply shortages typical of socialism leads directly to hyperinflation

China's approach argues that price liberalization must be measured so as to avoid panic that results in such hyperinflation, currency collapse, and political disillusionment with economic reform. Sudden liberation of prices in the context of the severe supply shortages typical of socialism leads directly to hyperinflation. Poland's sudden liberation of prices produced inflation rates in excess of 2,000 percent during the last four months of 1989.² The former Soviet Union experienced 91 percent inflation in 1991, and rates around 2,000 percent in 1992. Simultaneously, it suffered a potentially catastrophic collapse of its currency.

The social consequences of such developments are severe: for instance, in June 1992, Soviet farms were collapsing because "new equipment now cost 70 times what it did a year ago, while the price ... for milk has gone up only sevenfold ... Animal feed on the free market is priced out of reach."³ Severe inflation frightens away both domestic and foreign investment, thereby destroying the country's potential for economic growth. Inflation itself can be the cause of extensive unnecessary bankruptcies.

Such problems throughout Eastern Europe and the former Soviet Union led to widespread political disillusionment (in these cases, with democracy) by early 1992. In mid-1993, starvation was occurring in the Biezcady region of Poland, and polls showed that a majority of Polish voters had become convinced that communism was a better system.⁴

China, on the other hand, has liberalized prices gradually and, like other Asian countries such as Indonesia, has been careful to ensure that the price of rice is not allowed to become so volatile as to endanger the lives of subsistence-level rural people. During liberalization, China has built the institutions that will enable it to control inflation, namely credit controls and bond markets. The result has been rapid growth with a manageable inflation cycle. China's inflation never exceeded 20 percent (less in the countryside where most of the people live, and about double that level in major cities).

Privatization

If one privatizes before price reforms have taken full effect, many firms go bankrupt ...

China has been particularly cautious about privatization. If one privatizes before price reforms have taken full effect, then many firms are bankrupted not because they were inefficient but because their product prices were set below market level. It is not unusual in some socialist countries, for instance, for prices of a commodity like coal to be set at only 5 to 10 percent of market levels; having to sell so far below market prices will quickly bankrupt the coal company if it suddenly loses subsidies and has to pay market prices for inputs.

... not because they were inefficient but because their prices were set below market level

Moreover, this problem is not really solved by "big bang" price liberalization. An effectively liberalized price system means not only an instant freeing of prices, but also a network of institutions that can receive price signals, analyze trends, and take appropriate action; such a network of institutions takes years to develop. If one privatizes rapidly at a time when inflation is high and growth low, as is typical in the early phases of spasmodic liberalization, then one creates mass unemployment at just the time when the economy is least able to absorb extra workers.

Just as important, premature privatization can starve the nation's retirees because, in many of these systems, pensions are paid by the enterprises. It can expropriate the rights of long-serving employees, who had a right to company housing, pensions, medical care, and education under socialism and would have earned a private home under capitalism, but who may find themselves suddenly homeless and bereft as a result of premature privatization. Such privatization can also cause the collapse of a banking system which has been forced for generations to carry loss-making state enterprises by making ever-larger "loans" to them.

Finally, an efficient national privatization program requires stock market analysts to assess the value of companies, and brokerages to communicate the analysis and to manage stock transactions. Without such a system for assessing the efficiency of companies, analyzing economic trends, communicating the findings widely, and trading efficiently, capitalism cannot function and may produce worse results than socialism.

Hence China has a policy of delaying privatization until it has successfully liberalized prices, created a national pension system, provided alternative medical and education programs, undertaken major banking reforms, and created working stock markets. It is characteristic of China's reform that it has moved its currency to near-market levels and opened its stock markets to foreigners in a much earlier phase of reform than South Korea and Taiwan, but has been much more determined than Eastern Europe to create the institutions necessary to make markets work properly before undertaking widespread changes of ownership.

Proceed with caution

No policy has been more criticized in the West than China's caution regarding privatization. No policy, however, has been more central to China's success

No policy has been more criticized in the West than China's caution regarding privatization. No policy, however, has been more central to China's success than its gradual but steady emplacement of the foundation stones for successful privatization. Spasmodic privatization of major industries followed by collapse of production deters foreign and private investors. In contrast, China has focused on stimulating an explosion of investment and production by foreign and private investors, and using the new production to alleviate its people's poverty and to fund the solution of the problems of the state sector. Ironically, the West has not followed the advice it gives to China: the European Community embarked on a long program of market liberalization before its members initiated widespread privatization.

The central symbols of China's economic success are the small farmer pottering to market on his new motorbike, the young male worker wearing a shirt with a little crocodile insignia from his own factory, and the woman worker trying out her new cosmetics after a day spent assembling Teenage Mutant Ninja Turtles and other pinnacles of Western culture. The central symbol of Russia's economic strategy is a puzzled housewife with a sheaf of vouchers valid for the purchase of shares in state enterprises; these vouchers may constitute a valuable pension or may not be worth the price of a weekend in the countryside.

Financial markets

China realized that inflation could be controlled even as prices were being freed if the money supply could be kept under control

China has created the basic financial markets that are necessary to manage a market economy. After suffering a severe bout of inflation in 1988-89, China realized that inflation could be controlled even as prices were being freed if the money supply could be kept under control. Given a reasonably tight fiscal and credit policy, the key to control of the money supply was a bond market: bonds issued with attractive interest rates could soak up the excess money that threatened to fuel inflation. China's subsequent encouragement of bond markets, regulation of them, and decisive use of high real interest rates proved successful at controlling the 1988-89 inflation. Beijing now has one of the world's more modern computerized bond-trading systems.

China is also moving quickly to develop its still-diminutive stock markets and futures markets. Stock markets will mobilize the country's savings for productive use and allocate those funds competitively. They will also provide a method for smoothly mixing foreign and local capital, for merging firms, and eventually for privatizing a substantial proportion of state enterprises. They will create a nucleus of trained accountants who can value companies and will build a national information network to spread economic and market information efficiently. Futures markets will facilitate price stability, price predictability, and knowledge of the direction in which the prices of price-controlled commodities should be steered.

China's leaders have shown remarkable insight into the institutional requirements of market systems

In all of this, China's leaders have shown remarkable insight into the institutional requirements of market systems, and have thoughtfully constructed sequences of liberalization that build the necessary institutions while avoiding fatal damage to price stability, social welfare, or political support for future economic reform. They have made many mistakes, but so far their analysis has demonstrated the intellectual bankruptcy of the spasmodic strategies favored in the West. Above all, the Chinese experience has shown that a socialist economic system can indeed be transformed into a market system without an intervening social catastrophe—a conclusion that would be very much in doubt if the world had experienced only the Soviet and Eastern European approaches.