Starting in 1979, China embarked on profound economic reform that has led to a transformation of the country from a centrally planned economy to a market economy and at the same time produced one of the most spectacular growth records in human history. In 2015, the nominal GDP of China was nearly $11 trillion, surpassing 60% of that of the United States. In comparison, China’s nominal GDP in 1978 was only $148 billion, merely 6% of that of the United States. If measured by purchasing power parity (PPP), in 2015, China’s GDP was $19 trillion, larger than the $18 trillion of the United States, which has been the world’s largest economy for the last 100 years.
China must have done something right for nearly four decades, and the question is what. Academic economists have tried to understand and interpret the Chinese reform ever since its inception. Most of the analyses fall into one of two schools of thought: the first, I call the “School of Universal Principles,” and the second, the “School of Chinese Characteristics.”
The School of Universal Principles believes that the success of China’s economic reform stems from universal reasons underlying economic success everywhere in the world. Specifically, government gets out of way and lets the market work, the market provides private incentives, and the economy is opened up to the global market. Therefore, under this school of thought, the key to China’s success is all about its adoption of free market policies, and China’s story offers nothing new to our understanding of reform as it shows only a glimpse of the fundamental principles of the market.
The School of Chinese Characteristics believes that China’s reform has been successful because it did not follow the standard economics textbook: China did not privatize all enterprises at once nor did China liberalize the market overnight. The Chinese government played a crucial role in the economy through ownership, control, and regulation, as well industrial policies. This school believes that China’s success is because of, not in spite of, the stronger government role in the reform. These Chinese characteristics explain China’s success not the conventional universal principles.
Both schools contain elements of truth, but both are only partially right. The School of Universal Principles correctly emphasizes that ultimately the market provides the driving force for growth. But it is incomplete in explaining China’s specific reform path, and it is also unable to provide policy guidance for reform. The School of Chinese Characteristics correctly observes some salient features in the Chinese reform that are inconsistent with the “best practices” elsewhere. But it does not delve deep enough to see the role these Chinese characteristics really play, and worse, it also can be used as an excuse to delay market-oriented reform or reject such reform altogether.
In this book, I offer a third perspective that takes certain elements from each school of thought, but it is not simply a middle road between the two. This perspective starts with the universal principles and uses them as a starting point and a benchmark for comparison. At the same time, it shares observations from the School of Chinese Characteristics but goes deeper to figure out the mechanisms underneath the surface. Fundamentally, this perspective is less about why reform worked, but more about how reform worked.
Economics is a science, but economic reform is applied science and engineering. To understand any reform, it is essential to focus on how to get things done. From a practitioner’s point of view, it is more useful to find a feasible reform path than the best way. This may be, and usually is, the “second best” way because implementation and execution is the key. This is the engineering of reform. In this perspective, economics as a science is the same, but economic reform processes are different. The differences depend on two elements: first, the initial historical conditions, and second, the contemporary constraints.
Therefore, from the perspective of best practices, reform often adopts the form of “flawed” institutions. But not all flawed institutions are the same. In fact, most of them are so flawed that they do not work. What needed instead are appropriate and adequate institutions. To be appropriate, an institution has to be suitable to local conditions in order to satisfy all constraints, including political constraints. To be adequate, the institution has to be sufficiently effective to unleash the standard forces of the market and incentives; that is, to be able to relax the binding constraints to allow the market and incentives to work. When both are satisfied, institutions are not only feasible but also good enough to facilitate economic growth. The idea of “appropriate and adequate institutions”— not “best practice institutions”— is a key to reconciling the apparent tension between high-speed growth on the one hand and deeply flawed institutions on the other, as many scholars on Chinese economic reform often observed.
The book consists of four parts and contains 12 published articles. The first part addresses market liberalization with Chinese characteristics—the dual track approach— and provides both a partial equilibrium analysis and a general equilibrium analysis. The second part concerns firm ownership, focusing on the variety of ownership forms with varying degrees of government involvement and covering topics from observations to theories to empirical evidence. The third part addresses the decentralization of government and its implications for economic reform; it develops a conceptual framework along the lines of fiscal federalism and offers and tests hypotheses about its link to local economic development. The fourth part concerns a specific form of initial conditions—the regional-based central planning in China (M-form)—as opposed to functional- or industrial-based central planning in the Soviet Union (U-form) and their implications for incentives and coordination during the reform.
Together, the four parts demonstrate the central theme of the book. To examine how reform worked in China, one needs detailed analysis based on universal principles, taking into account the specific initial conditions and contemporary constraints, in order to explain observed Chinese characteristics. This analysis demonstrates the benefits and costs of the reform and reveals the “second best” nature of the institutional change. By analyzing the underlying mechanisms of how reform worked, we thus understand better the process and the outcome of reform. In this way, the book offers a coherent and compelling perspective on how China’s reform worked.
The general lesson from this book is this: for a reform to be successful, it is important to use the universal principles, even if they are not enough by themselves, and it is equally important to find specific ways to implement the reform by fully incorporating the initial historical conditions as well as contemporary constraints. The perspective of reform provided by this book’s analysis on China can also be useful beyond China, precisely because it emphasizes that to make reform work, it is not enough to understand why reform works, but also how reform works.
This article is a synopsis of How Reform Worked in China: The Transition from Plan to Market (The MIT Press, November 2017).
(Yingyi Qian is Dean of the School of Economics and Management at Tsinghua University and Distinguished Professor of Arts, Humanities and Social Sciences of Tsinghua University.)