1 Theory and Policy Debates “Shock Therapy” vs. Gradual Reform

2 “Shock Therapy” vs. Gradual Reforms Shock Therapy –Western economists (like Harvard’s Jeffrey Sachs) and the IMF recommended that every element in the old system be simultaneously eliminated, to be replaced by private property, free markets, individual rights and representative government— in that order of importance.

3 “Shock Therapy” On July l, 1991, the central planning agencies, Gosplan and Gossnab, were abolished. –Supply relationships were thrown into disarray. On January 2, 1992, all price controls were lifted –Prices increased 25-fold in one year. –Price increases far outpaced wage increases Industrial production collapsed because enterprises were unable to get credit –By the end of 1992 Russia’s G.D.P. had fallen by 22 percent Insight: there’s no such thing as a “free” market (Karl Polnayi)

4 A 1993 joke in Moscow went: “What has one year of capitalism achieved in Russia that seventy years of Communism were unable to accomplish? Answer: It has made Communism look good.”

5 Gradual Reform Recall core elements of the planned economy: –State monopoly ownership of industry –State control over prices In China –No immediate privatization Rather, allow new entry/competition adjust managers’ incentives –No immediate price de-control Rather, “dual-track” price reform

6 Note China’s multiple sources of economic growth Note that the former Soviet Union had long- ago made the developmental transition from an agricultural to an industrial economy China simultaneously made the gradual transition from –plan to market (better incentives, higher efficiency) –agriculture to industry  big opportunity for growth

7 Recall--positive implications of ag reform legitimacy--improved living standards, rural incomes –rural per cap income incr’ed 70% (almost doubled in 4 yrs) –% of rural pop w/ food intake of <2200 cals/day decr’ed from 31% to 13% (cut in half)

8 Implications for transition from ag to industry Ag reform Revealed surplus labor –For alternative employment in industry Increased household savings –For alternative investments in industry Develop rural industry  2 nd major success

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10 Collective Enterprises: TVEs Develop rural collective enterprises –Run by townships and villages (formerly communes and production brigades) Legacy of Great Leap Forward (walking on 2 legs) Use surplus labor Invest savings deposited in state-run banking system Redefine role for local officials Reduce tax/fee burden on farm households

11 Private enterprises Emergence of private enterprises –Absorb surplus labor –Use private investment resources (initially where few state/collective resources)

12 Private Enterprises (1981) State Council allows individual household firms (getihu 个体户 ) 1982 constitutional revision to recognize individual household firms 1987 “primary stage of socialism” 1988 further constitutional revision and State Council regulations for larger private firms

13 Political conflict over reform Elite policy conflict in lead-up to Tiananmen Square (1989) Conservative backlash 1992 Deng’s Southern Tour” –People’s Daily: “Without Reform There is No Way Out”

14 Private Enterprises: Changing Ideological Justifications th Party Congress –“socialist market economy” th Party Congress –Private sector “important” 2001 private entrepreneurs allowed in CCP 2004 further constitutional revision –Private sector not just permitted; encouraged

15 Increase in share of private enterprise, Songjiang County,

16 Increase in share of private enterprise, Wuxi County, (known as a “bastion of collectivism”)

17 Industrial Sector Reform gradual reform –competition for SOEs from new entry of non- state enterprises –early reforms to increase efficiency of SOEs –no privatization initially –contrast gradual reform in China w/“shock therapy”

18 Gradual Reform in State Industry competition for state sector from new entry of –Collective enterprises –Private enterprises –Foreign enterprises (stay tuned) Early competition in profitable labor-intensive sectors: garments, toys, shoes, consumer electronics, etc.

19 SOE and Price Reform limit plan, expand market –dual-track price system: 1984 Freeze plan obligations in place Allow sale on market of above-plan-quota output –gradual approach to price reform Use information from marginal prices on above- plan-quota sales –most prices at market levels by ~1992

20 SOE Reform measures to improve authority and incentives of SOE managers –factory manager responsibility system (reduce influence of party-sec) –managerial incentives -- long-term contracts –changes in labor management contrast w/“shock therapy”

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22 Major challenges for continued reform interrelationships between SOE reform tax/fiscal reform banking reform

23 SOE Reform Large share of SOEs losing money in 1990s –began selective privatization and bankruptcy for state and collective enterprises