How China escaped shock therapy

Renê Burri, Old Summer Palace. Dead lotus flowers in Kunming Lake. Beijing, 1964.
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By ISABELLA M. WEBER*

Newly Released Book Introduction

Contemporary China is deeply integrated into global capitalism. However, the dizzying Chinese growth did not lead the country to complete institutional convergence with neoliberalism. This challenges post-Cold War triumphalism, which predicted the “unconditional victory of economic and political liberalism” around the world. Although the era of revolution ended in 1989, it did not result in the expected universalization of the “Western” economic model. It turns out that gradual commodification facilitated China's economic growth without leading to widespread assimilation. The tension between China's rise and this partial assimilation defines our current moment and finds its origins in China's approach to market reforms.

The literature on China's reforms is wide and diverse. The economic policies that the country adopted in its transformation from state socialism are well known and investigated. Much overlooked, however, is the fact that China's gradual, state-led commodification was anything but an inevitable conclusion or a “natural” choice, predetermined by Chinese exceptionalism. In the first decade of “reform and opening up” under Deng Xiaoping (1978-1988), China's mode of commodification was chiselled in fierce debate. Economists who advocated shock therapy-style liberalization fought for China's future against those who promoted gradual commodification from the margins of the economic system. Twice, China had everything ready for a “big bang” in price reform. Twice he refrained from implementing it.

What was at stake in the market reform debate is illustrated by the contrast between China's rise and Russia's economic collapse. Shock therapy – the quintessentially neoliberal political prescription – had been applied in Russia, the other former giant of state socialism. Nobel laureate Joseph Stiglitz attests to "a causal link between Russia's policies and its poor performance". Russia and China's positions in the world economy have reversed since they implemented different modes of market entry. Russia's share of the world's Gross Domestic Product (GDP) has almost halved – from 3,7% in 1990 to around 2% in 2017 – while China's share has increased almost sixfold – from just 2,2% to around one-eighth of global production (see figure 1).

Russia underwent drastic de-industrialization, while China became the notorious factory of world capitalism. The average real income of 99% of Russians was lower in 2015 than in 1991, while in China, despite the rapid increase in inequality, this number more than quadrupled in the same period, surpassing that of Russia in 2013 (see figure 2). As a result of shock therapy, Russia experienced an increase in mortality beyond any previous experience in an industrialized country in peacetime.

Given China's low level of development compared to Russia at the start of the reform, shock therapy would likely have caused human suffering on an even greater scale. It would have undermined, if not destroyed, the foundations for Chinese economic growth. It's hard to imagine what global capitalism would look like today if China had gone the way of Russia.

Despite its important consequences, the key role that the economic debate has played in China's market reforms is largely ignored. Noted development economist Dani Rodrik, a professor at Harvard, represents the economics profession more generally when he responds to his own question whether “one [can] name the (Western) economists or [was] research that played a key role in China's reforms” asserting that “economic research, at least as conventionally understood”, has not played “a significant role”.

Figure 1. Share of China and Russia in world GDP (1990-2017)

Source: World Bank, “GDP (Constant 2010 US$)”. The World Bank Data, 2019.

Figure 2. Average income per adult in China and Russia by population quantiles (1980-2015)

In the chapters that follow, I go back to the 1980s and ask what intellectual reasons led China away from shock therapy. Revisiting the debate over market reform reveals the economics of China's rise and the origins of Chinese state-market relations.

China's deviation from the neoliberal ideal lies not in the size of the Chinese state, but primarily in the nature of its economic governance. The neoliberal state is neither small nor weak, but strong. Its objective is to strengthen the market. In basic terms, this means protecting freedom of pricing as a core economic mechanism. In contrast, the Chinese state uses the market as a tool in pursuit of its broader development goals.

As such, it preserves a degree of economic sovereignty that protects its economy against the global market – as the 1997 Asian financial crisis and the 2008 global financial crisis so powerfully demonstrated. dates back to the neoliberals, and our current global governance was designed to do away with national protection against the global market. The fact that China escaped shock therapy showed that the state retained the ability to isolate the strategic sectors of the economy – those most essential for stability and economic growth – as it integrated into global capitalism.

To lay the groundwork for my analysis of the China escape, I will first briefly recap the rationale for shock therapy.

The logic of shock therapy

Shock therapy was at the heart of the “Washington Consensus transition doctrine”, propagated in developing countries, eastern and central Europe and Russia by institutions linked to the Bretton Woods agreements. In appearance, this was a broad package of policies that would be implemented in one fell swoop, to shock planned economies into market economies at once. The package consisted of: (i) liberalization of all prices in a single big bang; (ii) privatization; (iii) trade liberalization; and (iv) stabilization, in the form of tight fiscal and monetary policies.

The four measures of shock therapy, implemented simultaneously, should, in theory, form a comprehensive package. A closer look reveals that the part of this package that could be implemented in one fell swoop boils down to a combination of items 1 and 4: price liberalization and strict austerity.

David Lipton and Jeffrey Sachs spoke for proponents of shock therapy more generally when they admitted to complications regarding the speed of privatization in practice. They recognized the magnitude of the privatization task in an economy with primarily public ownership. Comparing the large number of state-owned enterprises in socialist economies with the history of privatization in the United Kingdom, they pointed out that “Margaret Thatcher, the world's greatest advocate of privatization”, had led the transfer of only a few dozen state-owned enterprises to the private sector over the course of of the 1980s.

Thus, they noted that the “big puzzle is how to privatize a wide range of companies in a way that is equitable, quick, politically viable and likely to create an effective structure of corporate control”. They vaguely recommended that "privatization should perhaps be done by many means" and that the "pace should be rapid but not unrestrained". The joint report on the economy of the Soviet Union also warns against moving privatization too quickly, "when relative prices are not yet stabilised". Likewise, trade liberalization in the eyes of shock therapy advocates has as a precondition the liberalization of domestic prices. A big bang in price liberalization thus appears as a condition for both privatization and trade liberalization and constitutes the real “shock” of shock therapy.

What was presented as a broad package of reforms turned out to be a policy that was extremely biased toward just one element of the market economy: market pricing. However, this one-sidedness was not merely a result of viability. The deeper reason for the bias toward price liberalization lies in the neoclassical concept of the market as a price mechanism that abstracts from institutional realities. More generally, in the view of neoliberals, the market is the only way to rationally organize the economy, and its functioning depends on free prices.

According to the logic of shock therapy as understood by, for example, Lipton and Sachs, the liberalization of all prices “at once” would correct distorted relative prices, which, as a result of the Stalinist heritage, were too low for heavy industry and capital goods and very high for light industry, services and consumer goods.

Similarly, the joint report on the economy of the Soviet Union by the International Monetary Fund (IMF), the World Bank, the Organization for Economic Co-operation and Development (OECD) and the European Bank for Reconstruction and Development (EBRD) warned: “Nothing will be more important to the successful transition to a market economy than the release of prices to guide the allocation of resources. Widespread and early liberalization of prices is essential to end shortages and macroeconomic imbalances that increasingly afflict the economy”.

Such widespread price liberalization would need to be combined with a stabilization policy to control the general price level. Provided complementary macromeasures were implemented, price liberalization "could lead to a one-time jump in prices, but not to sustained inflation", advocates of shock therapy claimed. According to them, the real causes of persistent inflation in the socialist state economies were excess demand (due to large budget deficits), “soft budget constraint”, loose monetary policies and wage increases resulting from the zero unemployment policy. In their view, these problems could be alleviated with a “heavy dose of macroeconomic austerity”, as they were, in essence, monetary and not structural.

The “single jump in prices” expected as a result of widespread price liberalization was welcome as it would “absorb excess liquidity” and thereby reinforce austerity. In other words, an increase in the general price level would devalue saving and thus reduce the chronic excess of aggregate demand that was experienced in socialist economies. The cost of depriving citizens of the modest wealth they had accumulated under state socialism was considered a necessary evil. In effect, it was a regressive redistribution that benefited the elites holding non-monetary assets. Bottom-up redistribution was part of shock therapy from the beginning, going back to post-war monetary and price reform in West Germany under Ludwig Erhard. Forcing market relations into society overnight depended on imposing greater inequality.

The nature and structures of the prevailing institutions that would make up the new market economy have not received much attention from advocates of shock therapy. The package recommended by Lipton, Sachs and many others, including economists from the socialist world at the time, did not “create” a market economy, as the title of the important study by these economists on Poland suggests. On the contrary, the destruction of the command economy was expected to automatically give rise to a market economy. It was a recipe for destruction, not construction. Once the planned economy was "dying under the shock", it was hoped that the "invisible hand" would operate and, somewhat miraculously, allow the emergence of an effective market economy.

This is a perversion of Adam Smith's famous metaphor. Smith, a keen observer of the Industrial Revolution unfolding before his eyes, saw the "human propensity to barter, barter, and exchange one thing for another" as the "principle giving rise to the division of labor," but he immediately warned that this principle was “limited by the extent of the market”. The market, according to Smith, developed slowly as the institutions that facilitated market exchanges were built. In this process, the invisible hand would come into play only gradually, and with it the price mechanism. On the other hand, the logic of shock therapy leads us to believe that it is possible for a country to “leap into a market economy”.

The destruction prescribed by shock therapy does not stick to the economic system. A second condition must be fulfilled: a “revolutionary change in institutions”. Or, as Lipton and Sachs put it, the “collapse of the one-party communist regime was the condition sine qua non for an effective transition to a market economy”. Indeed, it took the collapse of the Soviet state and one-party communist regime in December 1991 for the big bang could be implemented; Russian President Boris Yeltsin lifted nearly all price controls on January 2, 1992. Under Secretary General Mikhail Gorbachev, radical price reform had been on the agenda since 1987 but was never carried out as Russian citizens complained en masse and intellectuals warned of possible social unrest. Gorbachev tried Chinese-style gradualism, but in vain.

Promising long-term gains, the big bang it prescribed short-term ills that immediately affected the interests of workers and companies as well as government departments. Radical price liberalization became politically feasible only after the dissolution of the Soviet state. “The collapse of the one-party communist regime” turned out to be, in fact, “the condition sine qua non” to the big bang, but the big bang failed to achieve “an effective transition to the market economy”. Instead of the expected one-off rise in price levels, Russia entered a long period of very high inflation, falling output and low growth rates (see figure 3).

Almost every post-socialist country that implemented some version of shock therapy experienced a long and deep recession. In addition to the devastation documented by economic indicators (see figure 2), most well-being indicators, such as access to education, freedom from poverty, and public health, have collapsed.

*Isabella M. Weber is professor of economics at the University of Massachusetts Amherst, USA.

Reference


Isabella M. Weber. How China escaped shock therapy. Translation: Diogo Fernandes. Technical review: Elias Jabbour. São Paulo, Boitempo, 2023, 476 pages (https://amzn.to/447aDoD).


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