by Adi Ignatius
This statement could have constituted a problem. The expression had been used in the years before the Third Plenum of the 12th Central Committee, but since then the decision to reform had been made, and we had agreed that the socialist economy was a commodity economy and that we must fully realize market potential. We had also discarded the idea that “planning comes first, pricing comes later,” which Mao had upheld. How could we still say “planned economy as primary, market adjustments as auxiliary”? It was clear that if the statement were to be circulated, it would conflict with the decision made at the Third Plenum of the 12th Central Committee.
Chen Yun sent me the draft of his speech for review, and I felt uneasy reading it. His speech was an obvious retraction of his statement at the Party Congress a year earlier. If he proceeded with this speech, it was sure to cause confusion at the conference. Yet I also knew that because he had already written it, even though it hadn’t been delivered it would be impossible to persuade him to change his view.
I visited him at his home and suggested that he add a paragraph: “The so-called ‘market adjustments as auxiliary’ applies to the scope of production in which the level is set in accordance to market demand without planning. It is an adjustment free of planning.” He himself had used similar expressions in the 1950s, so he gladly accepted my suggestion and asked his secretary to add it to his speech immediately.
Why did I make such a suggestion? Because by adding this phrase, we could limit the scope of “market adjustments as auxiliary” to small commodities that were free of state planning. We would not include the large bulk of commodities, referred to by the Third Plenum of the 12th Party Congress as “indirectly planned,” that followed market demand.
By adding the phrase, commodities were divided into three groups: the first was “planned commodities”; the second “indirectly planned,” which included the majority of commodities; the third was the so-called “secondary market-adjusted” small commodities. The latter two groups, which together consisted of at least half of all commodities, were produced according to market demand. By adding the phrase, we could explain all of this, and there would be no apparent contradiction with the Decision on Economic Reform.
Of course, Comrade Chen Yun would not have explained things in this way; he meant something altogether different. But at least we could explain them that way. Without the phrase, he would have simply said “planned economy as primary, market adjustments as auxiliary” and limited the scope of adjustments according to market demand.
It all seems like a game of semantics, but there was nothing else that could have been done. Chen Yun was enormously influential within the Communist Party and in economic policy. If we had distributed his statement without modification, it would have caused major confusion within the Party.
In 1987, I said in the Political Report of the 13th Party Congress that going forward, the economic mechanism should be “the state intervenes in the market, and the market drives the enterprises.” Since the overall political climate was very positive toward reform, the drafts of my reports were always sent to Chen Yun for his opinion. Even though he never openly expressed opposition, he never approved, either.
He never again formally expressed his support as he had in the Third Plenum of the 12th Central Committee. When I was starting to deliver my Political Report at the opening of 13th Party Congress, he got up and left the conference room. This was his way of expressing disapproval of my report. Why do I think so? At the time he was not in bad health, so he should have had no problem staying to listen. By contrast, when I delivered the Ten Strategies for Economic Development after I became the Premier in 1981, at a time when he was not in good health, people tried to persuade him to leave the hall to rest, yet he refused to leave and had said, “I need to listen to the end of Ziyang’s report.” His action then was a sign of support. In general, Party elders often left a conference during the proceedings, but by contrasting these two incidents, his attitude was clear.
(As an aside: after the June Fourth incident in 1989, Yao Yilin, who regarded Chen Yun as his economic mentor, proposed “breaking out of Zhao Ziyang’s policy influence” by publicly condemning the expression “the state intervenes in the market, and the market drives the enterprises.”)
I also progressed through stages in my understanding of the planned economy. In the beginning, I was concerned that in a country as big as China, with its divergent conditions and underdeveloped communications and transportation networks, if all commodities from production to distribution were centrally directed and planned, then bureaucratic red tape, breakdowns, and mistakes seemed inevitable.
Later, after I’d come to work at the Central Committee, I realized that economic inefficiencies and the breakdowns between production and consumption had an inherent cause, and that was the planned economy itself. The only way out was to realize market potential by allowing the laws of supply and demand to take effect. I had no idea, though, whether or not we, as a socialist country, could adopt the free-market fundamentals of Western nations.
Because of my uncertainty, in my government work report of 1981 on “Ten Strategies for Economic Development,” I divided the planned economic system into four sectors according to the natures of enterprises and commodities. The first sector was defined as production wholly under the control of the state, including key enterprises that formed the backbone of the economy and major commodities essential to people’s livelihoods. The second sector was made up of the numerous small commodities produced according to the planning of producers and distributors themselves in response to market forces. I also identified two other sectors: one in which planning played the dominant role while market demands took on a minor, adjusting role; and the other where market forces played the primary role while state planning took on a minor role. At the time these classifications were approved by Chen Yun as well.
When the document drafts for the Third Plenum of the 12th Central Committee were being prepared, I presented the drafting group with several concepts, which later were included in a letter I wrote to the Politburo Standing Committee. These concepts were as follows.
The Chinese economy is a planned economy, not the free market economy of the West.
The nature of the Chinese economy is a “commodity economy,” not a “product economy.”*
Planning consists of direct planning and indirect planning; direct planning must be reduced as indirect planning is expanded.
Indirect planning means mainly responding to market demand with intervention by economic means, while direct planning must also respect the laws of supply and demand.
These concepts were ultimately included in the Decision on Economic Reform passed at the Third Plenum of the 12th Central Committee. After that, the “commodity economy” was clearly defined. Aside from unplanned small commodities, the “indirect planning” sector that was to rely on market adjustments would continue to expand. In this way, the proportion of the Chinese economy that relied on market adjustments would grow.
By the time of my report to the 13th Party Congress, it was clear that the mechanism for the Chinese economy was to be “the state intervenes in the market, and the market drives the enterprises.” In other words, we had already realized an economy dependent on free-market principles. It was only because of ideological barriers that the term “free market” wasn’t being used.
7
One Step at a Time
There have been two basic approaches to reforming the economies of socialist countries. One involves “shock therapy,” changing the rules all at once; the other adopts a far more gradual process. By taking a step-by-step approach, China has largely been able to avoid the economic dislocations experienced in the former Soviet Union and Eastern Europe. Zhao offers insights into how China made that choice.
How did China come to adopt an approach of gradualism?
In my ten years running the economy for the Central Committee—until the time that I stepped down—we pursued a gradu
al transition. There were two major aspects. The first was the emergence of a new, market economy that gradually matured beyond the realm of the planned system. For example, as rural reform got under way, state quotas for mandatory procurement were reduced; as the mandated quantities were reduced, agricultural production increased, so the proportion of the state quotas dropped year after year. There was an increasing quantity of products making it to market.
In 1985, taking things a step further, we eliminated the mandatory procurement program in agriculture, and basically became market oriented, freed from the planned economy, with the exception of a few products like cotton.
The emergence of township and village enterprises, private manufacturing and commercial enterprises, joint ventures and solely owned foreign enterprises—all of these were set up outside the planned economy. Together they formed an economic sector that responded only to market forces. This sector started from nothing, and has experienced vigorous development in recent years, growing at levels far exceeding the state-owned or collectively owned sectors. It has brought prosperity to the Chinese economy and a new economic system: the market economy.
As the market sector grew day by day, China’s economic system eventually experienced a qualitative change, even without fundamental reforms of the original economic model of state planning. This is the principal reason that economic reform in China has not only promoted prosperity, but also maintained political stability.
The other important aspect was the reduction of the planned economic sector. The change was not instantaneous. Instead it began with a small number of minor changes, but it gradually involved bigger changes.
Policies and measures were introduced to shift more power to lower levels of administration and expand the autonomy of enterprises. To reform economic planning, there was a gradual reduction of direct planning, an expansion of indirect planning, a reduction in material resources allocated by the state, and an expansion of the types and quantities of products that were traded by state-owned enterprises themselves. Trading was permitted for key material resources beyond the fulfillment of state-allocated quotas, and even within the quota, a portion could be directly traded as well. In addition, we also introduced a contract scheme for enterprises and pricing reform. All of these measures played strong ancillary roles while the market sector continued to grow.
At the time, the major components of the market sector were agriculture, rural products, light industries, textiles, and consumer products. Products involved with the means of production were mostly still controlled by state-owned enterprises.
There have been criticisms of the transitional approach: “no overall strategy,” “taking one step and waiting to see what happened,” “no foresight,” “blind,” etc. There are fewer such criticisms these days.
However, there have been shortcomings resulting from the coexistence of the two systems that should not be underestimated. When the negative impacts exceed what society can endure, problems will erupt. Only by achieving further economic and political reforms can such problems be resolved. It was correct to adopt gradualism in the early stages, but that cannot continue over the long term.
8
The Economy Gets Too Hot
In 1984 and again in 1988, China’s economy overheats. Zhao justifies his response to the first crisis, contrasting it with the failure of the government’s policies four years later. In 1988, following a botched effort to reform the pricing system, the inflation rate shoots up and sparks bank runs and panic buying. Zhao expresses regret for his handling of things.
The economic readjustments made in 1981 reduced the growth rate for agricultural and industrial output to 4 percent. The next year, the economy started to grow faster and eventually got on a healthy track. Economic development in 1983 and 1984 was very good; not only did the economy grow rapidly, but demand and supply were relatively in sync. Various indicators were healthier; economic efficiency had noticeably improved and people’s living standards had risen a great deal.
However, starting from the fourth quarter of 1984, the growth rate became excessively high, credit was overextended, and the scale of national infrastructure construction was too great. As a result, prices rose even faster.
In the beginning of 1985, as these signs of overheating emerged, the Central Economic and Financial Leading Group and the State Council tried to cool the economy by strengthening macroeconomic control, reining in credit and lending and reducing infrastructure construction. However, since the banking system had not yet been reformed, control over credit and lending had to be done through administrative means, assigning credit quotas to lower levels.
Reactions from all sides were strong and caused considerable difficulties for the smooth running of the economy. Credit quotas were passed down from the State Council through the Central Bank to provincial and district level branches. As a result, local governments filled their credit quotas with preferred projects, especially special construction projects, and had nothing left for projects that could not afford to be ignored. This forced the central government to raise the credit quota.
For example, as soon as credit controls were imposed, many local governments complained they lacked funds for the annual grain procurement, though they used the assigned credit elsewhere. The credit limits were tightened only to be relaxed soon thereafter.
So in 1985, the growth rate was still exceedingly high, even though macro controls had been implemented in the beginning of the year. The overheating got worse.
How could we handle the situation? Two approaches were considered. We could use the traditional method: repeat the readjustments of 1981 by again putting the brakes on the economy and cutting infrastructure construction.
The other way was to address the problem gradually. The first method would result in great losses all around; and it wasn’t practical, since many infrastructure projects had just been resumed after being delayed by the 1981 readjustment. Cutting them again would have caused considerable domestic and international damage. That’s why I decided to take measures for a “soft landing,” that is, to make gradual adjustments over several years rather than in only one.
A decision was made to continue relatively tight control over credit and financial policies for two more years. Infrastructure construction was to remain at 1985 levels with adjustments made to the priority and timing of specific projects. If the growth rate remained the same for two years, the situation could ease back to normal. With the execution of this plan, overall conditions were good in 1986.
The positive results continued. In 1987, GNP and GDP each expanded by more than 10 percent. Industrial output grew more than 17 percent. Agriculture grew nearly 6 percent. Retail prices rose by 7.3 percent. The situation with fixed-asset investments and infrastructure construction was basically good.
Overall, after two years of the “soft landing” approach, the situation improved. The overall economic environment was no longer tense. When the Central Committee and the State Council reviewed the situation at year’s end, they acknowledged that instead of taking abrupt adjustment measures, the “soft landing” method could work.
That was originally the strategy for 1988 as well. When we were discussing plans for 1988 at the national planning work congress in September 1987, I made a speech on behalf of the Central Committee. I pointed out that in order to implement policies for stabilizing the economy—especially the rise in prices—finances and credit needed to be tightened, infrastructure construction needed to be reduced, consumption funds needed to be controlled, and at the same time steady production growth needed to be maintained. The strategy for the economy in 1988 can be summarized in two points: further stabilizing of the economy and deepening of reform.
With the strategy set, why was inflation in 1988 so high, with the retail price index rising 18.5 percent? Since the beginning of reform, this had never happened.
The inflation resulted from a combination of factors. I mentioned then, and I still believe today, that the pr
imary cause was the inappropriate response taken in 1988 to reform the pricing system.
Price reform—the gradual adjustment of the pricing mechanism—is an extremely important issue in economic reform. We had always believed that if pricing were not sorted out, then economic reform could not be accomplished.
After two years of the “soft landing” approach, in 1986 and 1987, the conditions were in place in 1988 for taking a bigger step in reforming the pricing system. However, the proposed reform—“making a breakthrough in the pricing system difficulties”—was all wrong in its guiding principles and in its implementation. The result was a grave error that caused a serious setback for the economy.
How did this occur? As I mentioned before, the “soft landing” policy had originally been expected to continue. But in the spring of 1988, there was a strong reaction to the rise in prices and to the two-track pricing system, which encouraged corruption. Also, Deng Xiaoping had repeatedly urged us to be decisive in price reform, which he believed required a breakthrough, saying, “a quick sharp pain is better than prolonged pain.”
With all this in mind, I started to be swayed away from incremental steps and toward the all-at-once idea. Though fixed prices had risen, the situation with incorrect pricing had not changed, so perhaps it was better to make a major adjustment all at once. Over a period of time, say two to three years, we could increase prices at a certain rate, for example 30–50 percent, to bring prices of commodities to reasonable levels and thereby eliminate the twisted and unreasonable pricing system.
