The Political Economy of China’s “Reform and Opening-up”

Market in Xinjiang put up slogans of "Insist reform and opening-up" in 1992 © fdecomite/ Public domain/ Pixabay

Only seven economies experienced an average annual per capita GDP growth above 3.5% for the past fifty years. Leading those is China’s growth at 7% (McKinsey, 2018), an unprecedented and unreplicated feat.

The “Chinese economic miracle” has become a model for a legion of countries as China’s economy overtook that of the US (in Purchasing Power Parity (PPP) term) in 2016. Over the past fifty years, the People’s Republic of China (PRC) has lifted 800 million of its citizens out of absolute poverty, eradicated malaria, multiplied its per capita GDP by more than 30, presided over the formation of an impressive pool of human capital, and built the largest high-speed rail network in the world. Yet, contrary to Fukuyama’s (1992) belief (i.e., that economic development would lead to the “end of history”: the reign of liberal democracies), the country’s advances with regards to the “four modernizations” did not yield to the realisation of the “fifth modernization”. The country remains classified as an “authoritarian regime” on the Democracy Index (EIU, 2020), and the Chinese Communist Party retains almost complete control over the daily life of citizens. It is therefore unsurprising that China’s phenomenal economic successes puzzle development economists, as the country lacks some of the elements traditionally required for sustained growth: “stabilisation, liberalisation, and privatisation, following political democratisation” (Qian, 2003).

How was China able to achieve incredible modernization despite its exceptionally singular political and economic environment?

This article will investigate the PRC’s ability to grow in such a peculiar environment. We will focus on the period of Deng Xiaoping’s reforms, as it offers a clear depiction of the political economy of the PRC.

At the death of Mao in 1976, the PRC was not significantly richer than when the Chinese Communist Party had secured power a quarter of a century earlier in 1949. “Seeking truth from facts”, Chinese leaders adopted a reformist approach to bring “socialist modernization” to the Middle Kingdom. Coase and Wang (2013) highlight that the initial phase is a “tale of two reforms”, beginning with Hua Guofeng’s “Leap Outward” (a vast programme of state investment in heavy industry), followed by Chen Yun’s rebalancing aiming at reaching an equilibrium between “income and expenditure, loans and the ability to repay, and foreign currency income and expenditures”. Those reforms kickstarted an economic rejuvenation after the disastrous decade-long cultural revolution, while allowing for more flexibility – although all leaders were adamant that planning should remain primary. Crucially, it also provided “material incentives” and introduced “competition” at all levels (economic producers and officials) to achieve the “four modernisations” (Coase and Wang, 2013).

The “four modernisations” refer to former premier Zhou Enlai’s programme to modernise the economy. Introduced at the 1963 Conference on Scientific and Technological Work held in Shanghai, they were intended to revitalise agriculture, industry, national defence, along with science and technology. Their implementation was delayed by the onset of the Cultural Revolution, but the programme was proposed again by Zhou Enlai at the 1975 4th National People’s Congress, only to be implemented by Mao’s designated successor Hua Guofeng. A fifth modernization - democratisation - was later promoted by Wei Jinsheng (1979) in a dazibao on Beijing’s democracy wall.

Importantly, those initial reforms also accompanied the crucial bottom-up “four marginal revolutions” (namely private farming, rural industrialization (the famous township-village enterprises, TVEs), private enterprises, and Special Economic Zones), which originated in China’s economic periphery, and were enshrined as fait accomplis by the CCP leadership. Indeed, as highlighted in Thaxton’s (2008) Catastrophe and Contention in Rural China, rural peasants became increasingly dissatisfied with the local cadres (and thus the CCP’s) failure to ensure basic food security during the Great Leap Forward and the early stages of the Cultural Revolution, and therefore decided after Lin Biao’s death to begin “to reclaim market space before the Cultural Revolution had ended, before the CCP’s Eleventh Congress, and before the baochan daohu system gained acceptance by the party’s Central Committee.”. This is corroborated by Dikötter’s (2018) assessment of the “silent revolution” resulting from a disengagement of rural tillers which refused to procure grain to the party-state that had starved them. Markets began to sprawl, plots of lands were decollectivised, village enterprises and factories were open, often with the tacit approval of local authorities which knew this constituted a blatant violation of Chairman Mao’s wish for central planning. The importance of those marginal revolutions cannot be understated: in Jiangsu, industry jumped from accounting 13% of GDP to more than 40% in 1976, whilst in Puning county markets fed over a million people, a radical shift from the previously commune-dominated agricultural system.

In Deng’s own words: “This result [rural industrialisation] was not anything that I or any of the other comrades had foreseen; it just came out of the blue” (Coase and Wang, 2013). Instead, the CCP’s pragmatic approach to economic management is the paramount element in the adoption of those reforms: precisely because some market mechanisms were compellingly more efficient, thus enabling to achieve productivity gains, were they adopted. In this regard, the account on pages 46-50 of Coase and Wang’s How China became capitalist about spontaneous decollectivisation in the villages of Nine Dragon Hill and Small Hill reveals how small villages could outproduce much larger towns through the introduction of market mechanisms. Such mechanisms would align private incentives with production targets, a problem which had plagued China’s agricultural sector since the introduction of the communes in the mid-fifties.

Those initial reforms illustrate two crucial elements: China’s transition was not master-minded by Deng Xiaoping, and market mechanisms were not reintroduced because leaders believed in their superiority but because their superiority was de facto demonstrated. In fact, market mechanisms were only very gradually reintroduced, and often coexisted with the centrally planned economy. Indeed, the CCP leadership remained reluctant to use capitalist tools, and the “individual economy” – private businesses – was at first viewed as a temporary solution to occupy the “youth waiting to be employed” (an acute problem in the second half of the 1970’s as millions of students returned from their countryside experiences), before its superiority over central planning was recognized. Thus, a free pricing system was theoretically introduced at the Third Plenum in 1984, although in practice, both “fang” and “tiao” (free and fixed price systems) coexisted for years after 1984. Deng and Chen also created a “two-tiered banking structure”, and when the Shanghai stock exchange was re-opened in 1990, SOEs were listed on the exchange under different conditions than private companies.

Those examples epitomise what Lau et al. (2000) calls China’s “dual-track” approach to market liberalisation. Indeed, China adopted a mix of two concurring methods of liberalisation, whereby “on one track, economic agents are assigned rights to, and obligations for, fixed quantities of goods at fixed planned prices as specified in the pre-existing plan. At the same time, a market track is introduced under which economic agents participate in the market at free market prices” (Qian, 2003). Such a Janus-faced course presents several benefits.

First, it allows those in power to retain control, and protects existing rents. This is a “mechanism [to] reform without creating losers” (Qian, 2003), which is crucial. Acemoglu and Robinson point to the “fear of creative destruction” of absolutist rulers because reforms which could improve overall social welfare might decrease theirs and weaken their control. This partly explains why Fukuyama’s prophecy was not fulfilled, but most importantly clarifies why Chinese leaders did not oppose the reform: their rents and power were preserved.

Second, this procedure always yields Pareto improvements, although it fails to reach a Pareto optimal situation (i.e., a first-best situation in which no change can leave everyone at least as well-off and at least someone better-off). Indeed, by simultaneously introducing efficiency enhancing reforms (such as a free price-system) and ensuring that rents are preserved, such an approach leaves everyone better-off. However, because of the reciprocal of the first theorem of welfare, such an allocation can never be Pareto efficient because state intervention distorts the market equilibrium. This can be observed to this day: the Chinese economy suffers from bloated SOEs, a score of artificially surviving “zombie” firms, and tight governmental control.

Third, it builds on existing institutions, and transforms them. Qian (2003) illustrates this with the TVEs, which were the main propeller of Chinese growth in the 1980s. Those built on the organisational structure of the commune system – a huge failure – and improved it. Similarly, the CCP is famous for its highly hierarchical structure: public servants must climb every step of the institutional ladder to reach the top and must therefore ‘signal’ their successes to their hierarchy. In the early 1980s, the central government realigned incentives of public servants and economic growth. Indeed, Bai and Zhou (2019) show that under Mao, the balance of the “loyalty-competence trade-off” severely tilted in favour of the former. This was corrected after 1979, and average GDP growth became the main determinant of promotion for public servants at the provincial level (Li, Zhou, 2005).

In China’s decentralised economy, this last point is especially crucial at local governments’ level. Those can either be the “helping hand” or the “grabbing hand” (Shleifer, 1997). Competition between provinces became the main driver of reform after Deng’s southern tour (Coase and Wang, 2013), largely because they were granted large fiscal prerogatives, namely the possibility to collect and invest tax revenue (Qian, 2003). They therefore became the “helping hands” for local businesses, which served both their personal interest (promotion) and the country’s national interest (economic growth).

China thus explored a previously undiscovered path to transition from planned to market economy and has largely succeeded in this endeavour. Through a combination of carefully crafted incentives, repurposed institutions, and “dual-track” reforms, the PRC modernised swiftly. Those reforms were timely introduced and compounded the tidal wave of the “four marginal revolutions”, unleashing the ingenuity and creativity of a country that had largely been straightjacketed under Mao’s socialist experiments.

Several challenges remain. Chief among those is the soaring debt, both public and private. We previously mentioned fiscal prerogatives being granted to local governments: those were a double-edged sword, as those led to soaring levels of local government’s debt. Unsurprisingly, Xi named this one of the country’s main challenges. The second challenge relates to China’s “debt-fuelled infrastructure investment” growth model, which exhibits decreasing marginal returns, and has therefore largely produced all of its benefits. New initiatives such as Xi’s “dual circulation” epitomised by the titanic Greater Bay Area plan, could reinvigorate Chinese growth. However, with its population ageing, China has largely exploited its demographic dividend, and is in a race against time to escape the “middle-income trap”.

Besides, the “dual-track” reform system has reached its limits: SOEs are bloated, and ineffective, private companies bridled. Distortions, restrictions, and regulations hinder the Chinese economy by decreasing productivity, while inequalities are reaching levels similar to the US. Xi’s promising anti-corruption campaign could disturb the political economy and attack rent-seekers, thus finally enabling transparent and objective policymaking.

But the main threats come from its political system: the CCP (and as of 2022, the sole Xi Jinping) concentrate almost absolute power and has scarcely any checks and balances. A famous problem in Chinese history is the “bad emperor syndrome”, and this could be repeated if the next generation of Chinese leaders forgoes the pragmatic approach which has characterised the CCP’s rule since 1979.

China’s reforms are unfinished, and China could become stuck in a “partial reform trap”. As the CCP tied its destiny to that of China’s economy, leaders should seek to further those reforms. Because their incentives are largely aligned with those of China’s economy, one can hope that as long as the leaders remain competent and well advised they will ensure China’s economy thrive.

Nicolas Guignard is a master student candidate within the Economics and Public Policy track of Sciences Po school of Public Affairs. He holds two bachelor’s degrees from Sciences Po and the University of Hong Kong (in Economics and Finance). A curious and eclectic mind, he has developed a long-time interest for China’s development framework. His main area of expertise revolves around economics and economic policymaking. You can find him on LinkedIn.

The opinions expressed here are those of the writers and do not represent the views of European Guanxi.

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