FRBSF Economic Letter
98-26; September 4, 1998
Could Russia Have Learned from China?
Just as October is the month for stock market crashes, it seems July
must be the month for currency crises. Last year, of course, witnessed
the collapse of several Southeast Asian currencies, with a fallout that
is still being felt. This year it was Russia's turn. During the first
two weeks of July, Russia came dangerously close to defaulting on its
international debt. Short-term interest rates reached triple-digit levels,
and foreign exchange reserves were nearly depleted. A default would have
almost certainly triggered a collapse of the ruble, setting the stage
for an Indonesia-style meltdown.
So far, a serious crisis has been averted. On July 14th it was announced
that the IMF and a Russian negotiating team had reached a compromise that
involves $17.1 billion in new loans, $12.6 billion of which will be disbursed
this year, and the rest the following year. In exchange, the Russians
agreed to fiscal reforms that will be painful and politically unpopular
in the short run, but will hopefully fortify a tottering tax base that
has been a constant threat to the sustainability of the current reform-minded
government. At least for the time being, the promise of new money seems
to have quelled the markets.
These recent events raise the obvious question of how Russia got into
this mess. In particular, one question that is often asked is whether
Russia could have learned from China. Despite some valid concerns over
the integrity of its banking system, China's reform program has achieved
a record of success that is the envy of the developing world. Since its
reforms began in 1978, China's per capita income has more than quadrupled.
In contrast, since Russia's reforms began in 1992, its per capita income
has declined 20-40%, depending on how large you think the black
market economy is.
The reform strategies of Russia and China differed in two fundamental
respects. First, in Russia political reform preceded economic reform,
whereas in China, political reform seems to be lagging well behind economic
reform. Second, there was a dramatic difference in the speed
of economic reform. Russia pursued a so-called "big bang" approach,
which entailed rapid and comprehensive privatization and price liberalization.
China, on the other hand, has pursued a "gradualist" approach,
which introduces market forces in an incremental manner to an ever widening
array of activities. Given China's success and Russia's ongoing struggles,
many argue that Russian reforms should have been more gradual.
This Letter provides a critical evaluation of this conclusion.
It argues that the comparison of China with Russia is fundamentally misleading,
and that China's successes offered few lessons for Russia. In fact, in
the long run, Russia and China may turn out to be a case of the tortoise
and the hare. China got off to a fast start by removing the easy obstacles
first, saving the tough ones for later. Russia started slowly by trying
to remove them all at once. It remains to be seen who will win the race.
I start by providing a broad overview of economic reforms in China and
Russia. Then, following Sachs and Woo (1997), I argue that differences
in political circumstances and economic preconditions made rapid economic
reform necessary in Russia, and gradual economic reform possible in China.
China's economic reforms
The economic reform process in China began with the Communist Party
Plenum of December 1978. This called for an immediate and comprehensive
liberalization of the agricultural sector. Agricultural communes were
disbanded and replaced by privately run household farms. Although households
were not allowed to own land, they were granted 15-year leases that were
freely tradeable. (In 1995, these leases were extended to 30 years.) This
provided some incentive to maintain, and even improve, the value of the
land. Household farms also remained responsible for delivering a quota
of output to the state at below-market prices. However, the size of this
quota as a share of total output has steadily diminished, so that by the
mid-1990s less than 5% of agricultural output was being siphoned off by
the state. Currently, state planning in agriculture amounts to a small
non-distorting tax. That is, on the margin Chinese farmers now base their
decisions on world market prices.
Agricultural decollectivization led to an immediate and dramatic improvement
in productivity and rural standards of living. Between 1978 and 1984 agricultural
value-added grew on average five times faster than it had during the previous
two decades. Per capita consumption in rural areas more than doubled.
In response to this success, the government extended liberalization
to other sectors. In 1980, four southern coastal cities (Shantou, Shenzhen,
Xiamen, Zhuhai) were designated "Special Economic Zones" (SEZs).
SEZs are exempt from many parts of the central plan. Most importantly,
firms in these regions are given preferential access to foreign exchange
and imported intermediate inputs. Regulations concerning foreign direct
investment were also relaxed. These measures produced a boom in China's
international trade. Trade (exports plus imports) increased from 10% of
GNP in 1978 to nearly 50% in 1996. Most of this international trade takes
place within the SEZs.
Before the mid-1980s, capitalism in China was confined to the farms
and the SEZs. However, in 1984, elements of market competition began to
creep even into the domestic industrial sector. Large state-owned enterprises
(SOEs), located mainly in cities, were given greater autonomy, and more
importantly, restrictions on the formation of new firms were
relaxed. This produced an explosion in the growth of private and semi-private
firms. Most of these new firms, so-called Township and Village Enterprises
(TVEs), took root in rural districts, and since the mid-1980s TVEs have
been the catalyst of China's growth.
Currently, the large SOEs are the last bastion of Chinese socialism.
However, as a share of total output, the SOEs are steadily diminishing
in importance. Their share of industrial production declined from 78%
in 1978 to only 29% in 1996. Competition from the TVEs is putting increasing
financial pressure on the SOEs. During the past few years the SOEs have
stayed afloat only because of loans financed by the central bank, i.e.,
the government has simply printed money to cover the losses of the SOEs.
This has raised the specter of uncontrolled inflation.
Most experts agree that restoring the economic viability of the SOEs
is the last, and certainly most challenging, item on the Chinese reform
agenda. Despite their diminished economic significance, the SOEs remain
vitally important to the Chinese people, particularly those living in
cities. Due to employment guarantees, few urban workers have left the
SOEs to work in the more dynamic TVEs. Instead, employment growth in the
TVEs has come almost entirely from the agricultural sector. In fact, the
employment share of SOEs has remained virtually constant throughout the
reform process. Getting SOE workers into the riskier private sector could
be extremely difficult, as the Russian experience well attests.
Russia's economic reforms
As noted earlier, political reform preceded economic reform in Russia,
with Gorbachev's rise to power in March 1985. From the beginning, Gorbachev
had a clear mandate to reform and revitalize the Soviet economy. The USSR
was obviously falling behind the West, and Soviet leaders were desperate
to maintain their superpower status. Thus, like China, economic reforms
were initially undertaken in order to preserve the political
system. What is often overlooked is that Gorbachev initially tried a gradual
Chinese-style reform strategy but failed. The reason gradual reform failed
highlights a crucial difference between Russia and China, one that limits
the applicability of the Chinese experience to Russia.
The tragedies of the Great Leap Forward (1958-62) and the Cultural Revolution
(1966-76) had greatly discredited Chinese communism by the time of Mao's
death in 1976. Faith in central planning, in particular, had waned. Consequently,
when Deng took over, the bureaucracy was receptive to change, and the
old guard in Beijing could not resist. In contrast, Marxist ideology was
still very much alive in the USSR during the mid-1980s, and the bureaucracy
still had a firm grip on the reigns of power. Moreover, Russian socialism
had a longer history, and the bureaucracy had engulfed a much larger share
of the economy. Estimates suggest that around 1,200 commodities were subject
to central planning in China. In Russia, this number exceeded 25 million!
Thus, whereas Deng was able to push through economic reforms over a
relatively limited set of activities, Gorbachev's reforms were sabotaged
by the bureaucracy. Local managers and administrators simply used their
greater autonomy to line their own pockets. Any reform that threatened
the power of the bureaucracy was simply ignored. Massive diversion of
state profits caused a collapse in the central government's tax revenue.
This precipitated a fiscal crisis that set the stage for future macroeconomic
instability, further limiting the scope for reforms while at the same
time increasing their necessity and urgency. In the end, it turned out
that Gorbachev was unable to accomplish any significant economic reform.
By the time he lost control in the autumn of 1991, the economy was in
shambles. Drastic action, or "shock therapy," was the only option.
The importance of
Political differences were undoubtedly a crucial factor in the contrasting
reform experiences of Russia and China. However, as Sachs and Woo (1997)
note, the structure of their economies also differed, in ways that favored
gradual reform in China and rapid reform in Russia.
First, at the outset of its reforms, China was basically an agrarian
peasant economy. In 1978, 71% of the labor force was employed in agriculture.
Much of the reform process involved shifting workers out of agriculture,
where productivity was low, and into more productive pursuits in the TVEs.
By all accounts, this reallocation has been very successful. By 1994,
only 54% of the labor force was in agriculture. At the same time, due
to greater productivity, agricultural output has increased.
Russia didn't have this option. At the start of its attempted reforms,
85% of the labor force was employed in non-agricultural state enterprises.
To hire workers, fledgling private firms had to lure them away from state-owned
firms, where employment was secure and wages were generous. Thus, before
the private sector could get going in Russia, subsidies to state-owned
enterprises had to be eliminated. Politically, this is difficult, as China
is currently discovering. Gradual liberalization gives managers and local
bureaucrats time to plunder state assets, while sudden liberalization
causes social unrest.
Evidence that the availability of surplus agricultural labor was more
important to China's success than the gradualness of its reforms comes
from Vietnam's experience. During 1985-88 Vietnam tried a gradual Chinese-style
reform strategy. Like China, Vietnam is an agrarian economy. Unlike China,
however, Vietnam had pre-existing macroeconomic imbalances, which caused
liberalization to have perverse effects: inflation soared and output stagnated.
In 1989, Vietnam switched to a Russian-style "big bang." Inflation
stopped and the economy took off. Sachs and Woo (1997) argue that Vietnam's
experience proves that there is no necessary link between big bang reforms
and economic contraction.
Besides lacking a surplus pool of agricultural labor, Russia's incipient
private sector suffered from a second disadvantage relative to China.
New firms are risky, and it can therefore be difficult for them to raise
capital. Chinese firms had a tremendous advantage in this regard due to
the presence of an overseas network of successful Chinese entrepreneurs,
particularly in Hong Kong and Taiwan. These individuals had the resources
and the desire to establish a beachhead in the homeland. As soon as China
removed restrictions on foreign direct investment, this money came pouring
in. Russia, on the other hand, had to go begging to the IMF.
Overall then, the answer to the question in the title appears to be
no. The benefits of trade liberalization and a high savings rate are probably
the only lessons from China that are directly applicable to industrialized
countries. The speed of reform, in particular, is dictated by political
exigencies. Russia moved fast because the political situation required
it to move fast. If Russia should have moved slower, it was in the political
arena, not the economic one.
Sachs, Jeffrey D., and Wing Thye Woo. 1997. "Understanding China's
Economic Performance." NBER Working Paper 5935.
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