The single most stunning economic story of the last few decades has been the rise of China.
From 1980 to 2020, China’s economy grew more than 75-fold. Huge new cities were built.
Hundreds of millions escaped poverty. It was the largest
and most rapid improvement in material conditions on record in modern history.
Let’s go back. When the economist Adam Smith was writing in the 1700s,
he considered China to be one of the wealthiest countries that had ever existed. But after decades
of war and instability in the 19th and early 20th century, China began a rapid decline.
Up until a few decades ago, China was one of the poorest countries on earth.
But now China is an economic powerhouse.
Economists predict that it will overtake the US as the largest economy in the world in this decade.
People called it “the Chinese miracle.” You can hear some people describe this
“miracle” as a straightforward story of the free market. They say it’s a simple story:
“China was poor. Then the economy was freed from the grip of the state. Now China is rich.”
But this is misleading. China’s rise was NOT about the triumph of the free market. To understand why,
we have to look at what happened to other countries which remade their own economies in
the same period, often to disastrous effects. Since the 1980s, free market policies have
swept the globe. Many countries have undergone far-ranging transformations:
liberalizing all prices, privatizing entire industries, and opening up to free trade.
But many of the economies that were subjected to markets overnight have since stagnated or decayed.
NONE have had a growth record anything like the one seen in China. African countries
endured brutal economic shrinkage. Latin America experienced twenty-five years of stagnation.
If we compare China to Russia, the other giant of Communism in the 20th century,
the contrast is even more staggering. Under state socialism,
Russia was an industrial superpower, while China was still largely an agricultural economy.
Yet during the same period that Chinese reform led it to incredible economic growth,
Russia’s reform led it to a brutal collapse. Both China and Russia had been economies that
were organized largely through state commands. Individual players could only act within the
structures set by state planning. Think of playing foosball. Each individual player
can only be moved along with the rod to which it is attached. It is a rigid set-up,
you can only go back and forth or rotate. Market reforms in both Russia and China was
like moving from foosball to an actual soccer game. Players now could move freely. But while
Russia jumped right into the game without setting up a proper stadium, rules, or jury,
in China the state took the lead in setting up all infrastructure. The state built the team,
it trained the players, educated the coaches and designed an overall strategy.
Russia followed the recommendations of the most quote-unquote scientific
economics at the time, a policy of so-called “shock therapy.” As a basic principle,
the idea was that the old planned economy had to be destroyed to make space for the market
to emerge. Think of shock therapy like knocking over a Jenga tower. After a short period of pain,
Russia was supposed to emerge as a fully-fledged capitalist economy, almost overnight.
The leader of the plan announced it was “a way of destroying Communism in Russia.” When Russian
president Boris Yeltsin took power, he eliminated all price controls, privatized state-owned
companies and assets, and immediately opened Russia up to global trade. So, what happened?
In a word: catastrophe. Shock therapy was a fatal
blow to the Russian economy. The shock therapists had predicted some short-term pain,
but what they didn’t see coming was how severe, destructive, and permanent the effects would be.
Consumer prices spiraled out of control. Hyperinflation took hold. Government
coffers were looted. GDP fell by 40 percent. The “shock therapy” recession in Russia was deeper
and longer than the American Great Depression by a large margin.
This was a disaster for ordinary Russian people. HIV infections, alcoholism, childhood
malnutrition, and crime went through the roof. Life expectancy for Russian men fell by SEVEN
YEARS, more than any industrialized country has ever experienced in peacetime. In 2006, Russian
life expectancy was still several years LOWER than it had been in 1986, under the Soviet Union.
It turned out that Russia didn’t get a successful “free market” overnight.
Instead it went from a stagnating economy to a hollowed-out wreckage dominated by oligarchs.
If simply getting rid of price controls and government employment
didn’t make a country prosper – and in fact, destroyed its economy and killed huge numbers
of people – then clearly the rapid application of “free markets” was not the simple solution.
But what did China do differently? Let me explain.
When Deng Xiaoping took over the leadership of China in 1978,
the country he inherited was STILL desperately poor. In 1980, China had a per capita GDP of just
one hundred and ninety-four dollars. That was less than Sudan and Haiti – and almost HALF of Niger.
The Chinese leadership knew they needed reform. As I show in my book “How China
Escaped Shock Therapy,” throughout the 1980s, the Chinese leadership repeatedly considered
implementing the same type of sudden reforms that Russia pursued. The idea of starting from a clean
slate seemed attractive, and shock therapy was widely promoted by quote-unquote “scientific”
economics. Programs for rapid price liberalization were prepared and then withdrawn, twice.
But in the end, they decided not to pursue shock therapy. Unlike the
free-market economists in Russia, the Chinese leadership approached change like a game of
Jenga. Take out many pieces at once and the whole thing falls apart. Take out one piece at a time,
and you can win the whole game.
Instead of knocking over the Jenga tower, China reformed itself in an experimental and gradual
way. Market activities were tolerated or actively promoted in non-essential parts of the economy.
China implemented a system of what they called “dual-track pricing.” State-owned enterprises
and farmers had to deliver their quotas to the government at a certain price set by the
government. But if they managed to produce more, they could sell their surplus at market prices.
China was learning from the real story of the world’s most developed nations:
countries like the United States, Britain, Japan, and South Korea. Each of these in their own way
managed and planned the development of their economies and markets,
protecting early-stage industries and controlling investment.
Western free-market economists thought this system would be a disaster. The
American economist Milton Friedman wrote an open letter to Deng’s premier Zhao Ziyang.
He said that the dual-price system was a bad idea, and that China should “free
prices and wages…[in] one bold stroke.” Just like in Russia.
But China’s leaders didn’t listen. And while Russia collapsed after following the “shock
therapy” program, China saw remarkable success. The state kept control over the backbone of the
industrial economy, as well as the ownership over land. As China grew into the new dynamics
of its economy, state institutions were not degraded to fossils from the past but were often
the drivers at the frontier of new industries, protecting and guaranteeing their own growth.
China today is not a free-market economy in any sense of the word.
It is a STATE-LED MARKET ECONOMY. The government effectively owns all land,
and China leverages state ownership through market competition to steer the economy.
The “shock therapy” approach advocated around the world was a failure.
While Russia collapsed after its sudden transformation,
China’s gradual reforms allowed it to thrive. And that made all the difference.
I’m Isabella Weber, assistant professor of economics at
the University of Massachusetts Amherst, for the Gravel Institute.