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Ebook Viability, Economic Transition and Reflections on Neo-classical Economics

In the 12 years from 1978 to 1990, China‘s reform and opening up achieved remarkable progress, with its GDP growing 9.0% annually and trade volume growing at 15.4%. During this period, urban per capita income grew 5.9% annually, but that of rural areas grew at a spectacular rate of 9.9% annually (NBS, 2002 pp.17, 94,148). People‘s living standards and incomes increased significantly and urban-rural disparities fell.

The achievement of China‘s reform can be called a miracle in economic history. However, in the late 1980s and early 1990s, international economic research community did not understand much about China‘s reform, and many economists were far from optimistic. Most economists believed that a market economy should be based on private property, a feature that the Chinese economy apparently lacked at that time. China‘s state-owned enterprises (SOEs) were not privatized; a dual-track resource allocation system was prevalent with state planning still playing a very important role. They thought that although China‘s economic transition was blessed with beneficial initial conditions such as high proportions of cheap rural labor, low social security subsidies, a large population of overseas Chinese, and a relatively decentralized economy that helped to achieve some short-term progress, the dual-track system would soon lead to efficiency loss, rent-seeking, and institutionalized state-opportunism, which constituted an inferior institutional arrangement. (Balcerowicz, 1994; Woo, 1993; Sachs and Woo, 1994 and 1997; Qian and Xu, 1993.). Some economists even claimed that China‘s transition would finally fail due to incomplete reform (Murphy, Schleifer, and Vishny, 1992; Sachs, Woo, and Yang, 2000).

At that time, most economists were optimistic about reform in the Former Soviet Union and Eastern Europe (FSUEE hereafter) due to the fact that these countries reformed their economies according to the fundamental principles of neo-classical economics. The most representative of these principles was the —shock therapy“ implemented in Poland, the Czech Republic, and Russia, which consisted of three main components: price liberalization, rapid privatization, and macroeconomic stabilization by removing fiscal deficits. (Lipton and Sachs, 1990; Blanchard, Dornbusch, Krugman, Layard, and Summers, 1991; Boycko, Shleifer, and Vishiny, 1995.) These components are considered the base of an efficient economic system in neoclassical economic theory.

Economists recommending shock therapy also knew that it took time to make the transition from one economic system to another and that it was costly to cast aside previously vested interests. But they optimistically assumed that the national economy would grow after six months or a year following an initial downturn stemming from the introduction of shock therapy (Brada and King, 1991; Kornai, 1990; Lipton and Sachs, 1990; Wiles, 1995). According to their beliefs, the FSUEE would overtake China through their reform, though the former started their reforms much later, and China‘s difficulties would loom larger due to inconsistencies inside the economic system brought about by incomplete reforms.

Ten years have elapsed since the predictions of many renowned economists were put forth in the early 1990s. Contrary to these predictions, China‘s economy has grown in the past decade while those countries that implemented the shock therapy experienced serious inflation and economic decline. Russia‘s inflation reached 8414% in 1993, and that of Ukraine reached 10155%. In 1995, Russia‘s GDP was only half of what it had been in 1990, and Ukraine‘s situation was worse with a 60% decline during the same period. With significant declines in per capita income and extreme exacerbation of income disparities, all social indicators slid–male life expectancy in Russia decreased from 64 years in 1990 to 58 in 1994 (Gregory and Stuart, 2001, p. 470). Overall, the countries that implemented shock therapy experienced great difficulties in reform, in contrast to the optimistic expectation of most economists. In eastern European countries, Poland scored best in economic transition with only a 20% decline in its GDP. Poland did not really implement reform based on shock therapy, however. Although prices in Poland were liberalized, most of its large SOEs have yet to be privatized (World Bank, 1996; Dabrowski, 2001).

In the 1990s, the Chinese economy did suffer from a myriad of problems. For example, the SOE reforms initiated in the early 1980s have yet to be completed; inter-regional and urbanœrural disparities have enlarged; and there are still many serious problems in financial system awaiting solution. However, the national economy grew 10.1% annually in the 1990s, 1.1% higher than that of the previous 12 years. International trade grew also at a rate of 15.2% in the last decade (NBS, 2002, pp. 17,94),. Moreover, people‘s living standards improved rapidly, especially in urban areas. Economic development in China not only promoted the welfare of the Chinese people, but also contributed greatly to the world economy. During the Asian Financial Crisis, the Chinese currency (RMB) did not depreciate, which played an important role in Southeast Asian economies‘ quick recovery and growth.

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