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Fan Zhang

China’s experience over the past decades is not just a story of economic growth, it is also one of institutional change. The current political-economic system is a bureaucratic market system, in which the government and the market both coexist and conflict with each other. This book gives a detailed description of the institutional evolution in China, using large amounts of documents and cases. The book provides a theory explaining the origin of China’s reform, the political and economic forces driving the reform, and the reasoning behind the stagnation and turn-over of reform.
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Fan Zhang

The first chapter reviews related literatures on the relationship between the government and the market and institutional changes in general and those specific to China. The chapter provides a framework for a political economy theory of the bureaucratic-market system. In this system, the government is the dominant force, while private firms maximise their profits under government regulation. The target of the government deviates from maximising social welfare and can be described by a utility function, with two basic components: social stability and economic growth. Economic performance has been an important source of legitimacy of the rule of the regime, while social stability is the foundation of the existence of the ruling party. The weights between social stability and economic growth change over time as national and global political and economic conditions change.

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Fan Zhang

In this period, the government controlled and operated the economy under the Soviet-style planned system. Only a small portion of consumer products were sold to households through the market. The chapter reviews the organisational structures and operating mechanism of this system, including the ‘lines’ and ‘blocks’. These structures, along with the mechanism, were the precursors of the current Chinese society, and some of them remain in the existing bureaucratic-market structure. The chapter reviews the political system, the planning system, collective farming in the rural area, urban enterprise, urban and rural households, and the financial system during the planned period. The main problems of a planned system are related to information and incentives. Shocks from the political turmoil during this period, especially the Cultural Revolution, hurt every person in Chinese society and led to a consensus on the need for reform.

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Fan Zhang

The Cultural Revolution and the experience of the planned economy in China from the 1950s to the 1970s wiped out almost all the institutions and mechanisms a market economy needed. The task of reform was to rebuild all these institutions of a market economy from nothing and to improve the efficiency of the economy. The reform was started in rural areas. In the late 1970s, attempts to distribute plots to households started in poor villages, such as Xiaogang in Anhui Province, initiated by peasants. These reforms spread nationwide, gave user rights to peasants, and were supported by the leadership. The reform was successful and ended the food shortage in several years. Instead of taking a strategy of rapid privatisation as in many transition countries, China took an alternative approach in the 1980s by giving managers of state-owned enterprises incentives by implementing a management contract responsibility system. This reform failed due to the more complicated situation in the urban area. The government also relaxed its control of prices for consumer goods by using a dual-track approach. Under this approach, a free market was allowed to emerge, while the old planned system continued to exist. Government power was decentralised and the door to foreign investors was re-opened. The Tiananmen Square events in 1989 ended the dream of a Western-style political reform.

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Fan Zhang

The leadership resolved the political crisis and reinitiated the economic reform, though it was subject to a narrower political restriction. State-owned enterprise (SOE) reform and tax reform were the major elements of the reform in this period. The reform in the 1990s was driven partly by the top-down design and partly by the enthusiasm to develop the market economy from the bottom of the society. The most important institutional changes were (i) the reform of SOEs, a silent privatisation in which the small SOEs were sold to the public, while the large SOEs were kept by the government; (ii) the setting up of the tax-sharing system between the central and local governments, which readjusted the financial sources and responsibilities of the central and local governments; and (iii) China’s World Trade Organization (WTO) entry, which further opened the door of the Chinese economy to the world. A large private sector and a financial market were formed by the end of this period. As a result of the downward shifting of power from the central government, the local government played a significant role in economic development through political competition among local governments. The leadership formed a coalition with the elites of the society, which provided a foundation for its stability.

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Fan Zhang

The distinctive features of this period are (i) the unprecedented economic growth as a result of institutional improvements that had started in the previous period, such as state-owned enterprise reform and World Trade Organization entry, and (ii) the stagnation of marketisation reform due to the social and economic problems produced by the government-led marketisation. This was a period of speeding up of economic growth and slowing down of institutional reform. The system created by reform in the previous years was successful in promoting economic development, but it ignored some socioeconomic problems, such as poverty, income inequality, rising house prices, and increasing health care costs. The new government realised that there were problems, and in response hesitated to continue the reform on such a large scale, slowed down the marketisation process, and shifted its focus onto social problems. This first wave of adjustment of the reform strategy resulted in the stagnation of the marketisation reform.

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Fan Zhang

In this period, the leadership put most of its efforts into changing the government ruling structure and fighting corruption in the party and in the government, which has been successful to certain degree. This second wave of adjustment of the reform strategy re-concentrated power into the central government in order to solve problems of corruption and loosening control. The direct cost of the re-concentration of power is the loss of incentives of government officials, especially the local government officials. In this period, the consensus on market-oriented economic reform has weakened further, and reform in the direction of marketisation has not made much progress. Economic reform is far from finished and the state-owned enterprises still dominate the upstream resource-intensive sectors.

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Fan Zhang

The chapter discusses the roles of government in a bureaucratic-market system, the institutional advantages and defects of Chinese society, and unfinished economic reform. The chapter provides an index of marketisation, which shows that there has been continuous progress in the share of the market with a diminishing annual change, and that the government’s financial power decreased at first, until the mid-1990s, but then has increased. The chapter points out several fatal flaws of China’s reform, including unrestricted government, uncompleted economic reform, and the domination of large state-owned enterprises in certain sectors. Lessons learned from the reform include (i) socioeconomic circumstances determine the means used in reform; (ii) path dependence affects the following steps of the reform once the first step has been chosen; (iii) consensus on reform is lost when the reform is intensified and affects different groups of people; and (iv) checks and balances are crucial in a system in which the government and market coexist. The equilibrium between government and market is not stable because political judgements could follow either the logic of market or the logic of government. In the long run, China should move to an improved bureaucratic-market system, absorbing the advantages of the political systems in other countries as well as learning from the experience of the traditional Chinese political system.

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Fan Zhang

This content is available to you

Fan Zhang