Comments on Brad DeLong’s capsule history of Chinese reform

http://delong.typepad.com/sdj/2007/07/delong-smackdow.htm

Brad DeLong wrote a capsule history of Chinese economic reform, with some points that I disagree with, although whether those disagreements affect the main conclusions, I’m not sure.   The first paragraph talks about corruption between 1955 and 1978 as the main reason that China was poor, and I disagree with that.  China today is far more corrupt today than in 1960.  That’s not to say that anyone wants to go back to 1960, since it is better to have a functional corrupt economy run by more or less sane people than a non-corrupt economic disaster run by a homicidal maniac, but it does make the point that in making policy decisions, you have to make tradeoffs.  It also means that China’s economic problems in the 1960’s were not due to corruption, but rather I think due to lack of political stability, and a command economy that was incapable of making basic economic calculations.

In a market economy, you make money or you lose money.  If you lose enough money you go out of business.  In a command economy, the government tells you to accept X tons of steel to make Y toasters.  The workers get benefits (i.e. housing, health care, etc.) from the factory.  The concept of “making money” or “losing money” doesn’t enter into any of this.  The other interesting thing about the system is how corruption happens.  Since there is no money involved here, corruption doesn’t take the form of cash bribes.  Instead, you trade goods and information and favors.  I can know the people that can get you a nice apartment if you do something nice for me.  One thing about market economies is that they make corruption a lot easier (here is cash) because they make *all* economic transactions simpler.

Hence Deng Xiaoping kept China closed in the early years, and used tax revenue from the productive countryside to keep the Soviet-style industrial sector running–value-subtracting as it was–while another, alternative industrial base was gradually built up, a market-oriented sector in which local party bosses had an important and very profitable stake.

This isn’t quite accurate.  The way that Chinese economic reform worked in the early years was that there were to parallel economies.  The state command economy and the market economy.  The command economy continued to function much as it had before, and basically the state was able to keep it functioning using price controls on inputs and quotas on outputs.  One part of the system was that the market economy *wasn’t* used to fund the command economy, and certainly not through taxes. Even though the industries were “value-destroying” the system of command economies hid this fact.

Starting in the early 1980’s, industries no longer received direct state subsidies.  During the 1980’s, the system gradually broke down as more and more inputs were market determined.  The basic problem with a system of “dual prices” is that there is tremendous and illegal profits to be made by getting things at the state price and selling at the market price.  Over time, more and more prices became market prices, the unprofitable nature of the state owned enterprises became more obvious.  Since they couldn’t get government subsidies, they got loans from banks, which went bad, and which lead to the bad loan situation which has only recently been fixed.  The other thing is that most of these loans *didn’t* go to corrupt communist party bosses.  Remember all of those workers that worked in the factories that got social benefits from working at the factory?

A lot of human resources and infrastructural capital was wasted becuase Deng Xiaoping did not dare risk the political consequences of the economic process of shifting resources out of the old Soviet-style industrial sector.

Two points.  One problem is talking about the “Soviet-style” command economy.  The Chinese command economy was different from the Soviet in many ways.  Soviet state-owned enterprises were largely organized along industrial lines from Moscow, whereas Chinese state-owned enterprises were more often controlled by local governments.  Soviet SOE’s were much larger, whereas most Chinese SOE’s were tiny.  Chinese SOE’s were responsible for a lot of social welfare and government control functions that I don’t think Soviet SOE’s were.  I have no idea whether these differences were relevant or not, but that makes it even more important to realize that there are differences.

Immediately opening up the industrial sector to international trade, however, would have led to (a) a rapid rise in imports of foreign-manufactured industrial goods, (b) a rapid rise in exports of agricultural products to pay for those imports, (c) mass urban unemployment as the value-subtracting Soviet-style heavy industries found that they could not compete and closed, and (d) riots and revolution as the now-unemployed urban manufacturing workers overthrew the government.

Actually it seems to me that China *did* open up the industrial sector to international trade and there *was* a rapid rise in imports of foreign-manufactured goods.  What kept (b) and (c) from happening was that China kept a very tight control over foreign exchange, and the fact that command economy was living in its own economic world.  The other thing was that the SOE’s were not really in competion with foreign manufactured goods, and foreign trade allowed for people to use their bits of otherwise useless color paper (i.e. money) to satisfy consumer demands.

Xiaoping’s power and status as paramount leader, and the wisdom exercised by him and his team, and their goal of making the Chinese rich. Dani Rodrik’s praise of policies that “protected employment while industrial capabilities were being built up” strikes an echo of Juan Peron’s development strategy in Argentina in 1950–keep the descamisados employed and the price of beef low. It was a strategy that sounded good to many at the time (including Raul Prebisch). It was was justified in economic terms by assertions about market failures and the second best. And it turned into a complete and total disaster.

Something that is important is that social systems are complex and there are consequences that people don’t forsee.  I doubt that anyone in 1978 really intended for China to transition completely to a market economy.  The market economy was seen by many as a “supplement” to the command economy, and it was only over time that it overtook it.  I doubt that Deng Xiaoping intended the market to take over, but the good thing was that once it started to happen and it seemed to work, he didn’t try to stop it.

One thing that is important to distinguish here are the two elements of capitalism.  Private ownership and market allocation of resources.  In the case of China, the market has become the dominant economic system while large amounts of the economy are still state owned.

One final note, DeLong is the second person I talked to recently who has had this idea that China has been in constant economic decline since the Song dynasty.  I added this note to DeLong’s blog about some “historical speculation” that I’d like to talk about more later…..

Something that is now becoming a consensus among Chinese economic historians is that China’s economic problems really didn’t start until the late-18th century. Kenneth Pommeranz has written an entire book describing China in 1750 and coming to the conclusion that Europe didn’t really take off until the early 19th century.

My assessment is that China’s problems through most of the 19th and 20th centuries was due to the Yongzheng Emperor’s failure to develop a centralized taxation system in contrast with England’s successful efforts to do so. No central taxes, no central armies. No central armies -> Warlords and civil war.

My theory as to *why* people talk about a decline of China after the Song Dynasty is because the Song Dynasty Buddhism was the “bad guy” among lots of mid-Qing intellectuals, and this eventually got transmitted to Western theories of economic growth in the 1920’s. It wasn’t until the 1970’s that people really started looking at the data, and the idea of a Chinese economic decline starting in the Song dynasty isn’t supported at all.