Prisoner of the State: The Secret Journal of Premier Zhao Ziyang

by Adi Ignatius

  After my proposal was passed in principle at the enlarged Politburo Standing Committee meeting in spring of 1988, Yao Yilin was assigned to lead the State Planning Commission in a study of the specifics of implementation. In the summer of 1988, the proposed plan by Yao Yilin and the State Planning Commission was passed, after back-and-forth discussions at an enlarged Politburo Standing Committee meeting in Beidaihe [the beach resort where Party leaders convene each summer]. The implementation was set to begin in the fourth quarter of 1988 or in early 1989, but it was canceled because of high inflation.

  Since the Third Plenum of the 12th Central Committee, our strategy for pricing reform had combined readjustments with a relaxation of controls. Some prices were adjusted by the government in a top-down fashion, while others were allowed to adjust according to market forces. The same commodity whose price was set by the government within the planned sector’s quota might then be sold in the market at an open price. This was the two-track pricing system.

  The intent was to respond to the market and gradually relax price controls, to let the market take over. However, the proposed pricing reform was not in line with the gradual reform strategy but relied on large-scale government-administered price adjustments. This reflected the sentiments of the time: to rush through price reforms, and to eliminate the two-track pricing system in order to unify or at least reduce the gap between set prices and market prices.

  This was not the correct way to carry out price reform, because ultimately it was not a shift from price controls to market mechanisms. It was using planning methods to adjust prices. It was still the old way of planned pricing. It is clear now that if high inflation had not occurred, and this price reform plan had been carried out, it would not have resolved the problem and could have set back price reform.

  The most direct cause of the high inflation of 1988 was that before plans for price reform had even been drawn up, the media campaign started. All of a sudden, rumors were widespread: “prices will rise by 50 percent, wages will double.” The rumors caused a public panic, greatly affecting people’s anticipation of rising prices. “Psychological anticipation” was an issue that we did not understand at that time. However, nations with market economies paid a lot of attention to this issue when they needed to control inflation. They tried to find ways to avoid causing an overreaction through “psychological anticipation”; we on the contrary had encouraged and stimulated it.

  In the end nothing happened, but people believed that prices were going to rise, and we could not provide reassurances to the contrary by, for example, raising interest rates for bank savings, which would have meant a pledge to people that their bank savings would grow at a rate exceeding inflation; or providing value-guaranteed deposits. While people were anticipating that a big price hike was coming, there were no reassurances given about the interest on their savings, so everyone worried that the rising prices would devalue the years of savings they’d deposited in the bank. Since the Third Plenum of the 11th Central Committee [1978], people who had been living frugally had deposited more than 100 billion yuan into the bank. When they anticipated that their hard-earned savings would be devalued by inflation, they rushed to withdraw their savings from the bank and purchased commodities. This caused bank runs and panic buying in the summer of 1988.

  Panic buying for certain supplies had occurred many times in the past, so it was not unfamiliar to us. But this time it was different. In the past, panic buying had been caused by shortages; people were worried about the future availability of soap, table salt, flour. But this time, the purpose of purchasing was not for personal use, but value saving, so the situation was more prevalent and serious than ever before.

  Many shops and enterprises raised their prices, and bank savings dropped 40 billion yuan more than anticipated. Banks had to print money to cover withdrawals, resulting in a big increase in currency in circulation.

  As soon as the panic buying started, we should have immediately and decisively taken measures to raise deposit interest rates, or announce value-guaranteed deposits. If we had, the situation could have been better and the losses suffered would have been less.

  At the time, the Central Economic and Financial Leading Group had proposed the measure to the State Council, but Li Peng and Yao Yilin were worried that raising interest rates on deposits would have resulted in higher interest rates on bank loans to enterprises beyond what enterprises could afford, thereby affecting production. They did not take immediate measures and, as a result, losses that could have been reduced instead continued to grow.

  Ultimately, though, they were left with no choice but to take action. After the announcement of value-guaranteed deposits, bank deposits quickly stabilized and gradually bounced back. This proved that when faced with bank runs and panic buying, if we had provided guarantees on savings, we could have greatly reduced the losses.

  The high inflation of 1988 saw prices rise by 18.5 percent. The problem was not a loss of control over credits and loans, nor was it overspending on infrastructure. These two factors had not exceeded the limits set under the policy for “soft landing.”

  The main problem was the drop in savings deposits caused by the mistakes in price reform. In hindsight, if we had continued the policy of mixing readjustments and relaxation of controls, or even if we had moved faster to relax price controls while raising interest rates beyond the level of the price increases to guarantee the value of deposits, then 1988’s high inflation might have been avoided.

  Facing high inflation and bank runs and panic buying, to quickly stabilize the situation we announced the cancellation of price reform and shifted economic policy to “adjustment and reorganization.” These proposals were initiated by me and passed by the Politburo meeting and plenum of the Central Committee. In retrospect, I believe that canceling the price reform package was correct but shifting from the original policy of “stabilizing the economy and deepening reform” to “adjustment and reorganization” was inappropriate.

  Even though the proposed “adjustment and reorganization” did help to quickly stabilize the economy, it caused yet another setback to reform.

  First of all, in order to slow the rise in prices, almost all of the administrative measures for controlling prices had been restored. Officials at all levels of government were made responsible for the implementation. This meant that years of revitalization had been retracted in favor of the old ways of price controls.

  In the name of “adjustment and reorganization,” Li Peng and others at the State Council took back power that previously had been handed down to lower levels and put controls back on measures that had been freed. Everything was going in the opposite direction set by reform, setting back what had already been reformed in the economic system. Precisely for this reason, in less than a year there was an economic recession and market slump, and other serious economic problems continued until Comrade Xiaoping’s speech during his tour to the south [in 1992].

  In summary, we made one mistake after another. I learned a very profound lesson from this.

  In the spring of 1988, I sent Comrade An Zhiwen [deputy director of the State Commission for Economic Reform] and other comrades to Hong Kong and invited some economists to discuss China’s problems. Six economists participated, all members of the Taiwan Academia Sinica. They included the chief of the Chung-Hwa Institution for Economic Research, Tsiang Sho-Chieh, who had tremendous influence in Taiwan.

  During the discussion, they expressed opinions on the inflation of 1988. First, they agreed that the mainland had achieved a great deal during the ten years of reform, and that even though there were problems, from an economic point of view they were not serious, including the 18.5 percent rise in the price index. If appropriate measures were taken, they were resolvable.

  Second, on price reform, they believed that economic development needed to obey market rules, regardless of the political system. Since inflation had worsened last year, there was talk of price reform being slowed down and a return
to administrative control over some prices. However, though it was understandable for this action to be taken as a temporary measure, it should not be in place for long. If the incorrect pricing system were not reformed, the economy could not continue to run. The way out was the balance between supply and demand, and to bring the currency under control. Under these conditions, most commodity prices could be relaxed, while a small portion of prices, such as for public services, could be determined by the government according to a certain profit ratio. They emphasized that pricing must be decided by the market. Otherwise, there would never be correct pricing.

  Another issue they discussed was the policy for tackling inflation. They believed that the reason for the mainland’s inflation was mainly the fiscal and financial deficit and that the key to resolving this was raising the interest rate above the growth rate of the price index and letting it float freely according to the market’s supply and demand for currency. This would yield benefits in increased savings and controlling the size of loans.

  After I read the recommendations of Tsiang Sho-Chieh and the others, I referred the summary to Comrade Xiaoping and ordered the State Economic Reform Commission to organize relevant agencies to discuss the issue.

  I had intended to reevaluate our entire approach to the economy and price reform, but because of the student demonstrations, this matter was set aside.

  9

  The Magic of Free Trade

  Restoring foreign trade is one of the crucial steps in transforming the Maoist economy of “self-reliance.” Zhao’s experiences as a provincial administrator have made him an outspoken advocate of free trade. Still, how is it possible that Zhao, a product of the Maoist era, has such confidence in Western economic principles? Zhao reveals his thinking and argues that reforms have simply made China smarter.

  For many years, our economic development efforts yielded poor results. They demanded a great deal of effort while providing few rewards. Besides the economic system, there were other problems, such as the closed-door policy, which made self-reliance an absolute virtue. It became an ideological pursuit and was politicized.

  Consider agriculture, for example: if it is to achieve efficiency, the first principle should be to apply the strengths of local land conditions. One should plant whatever is most suitable to the land. However, for a long period of time, we were not allowed to do that.

  One incident in particular had a profound impact on my thinking. In 1978 [actually 1979], when I was still working in Sichuan, I led a delegation to visit England and France, and stopped in Greece and Switzerland on my way back.

  I arrived first in southern France on the coast of the Mediterranean Sea, a region world-renowned for economic development. The climate there was very dry and no rain falls in the summer. Under such conditions, according to our past way of thinking, in order to plant crops we would “change the conditions defined by heaven and earth” by creating huge irrigation projects. They did no such thing, but instead planted grapes and other crops that were suited to the dry climate. The result was the natural formation of the French wine industry. The farmers there are very wealthy.

  I saw another example in England, where wheat was growing very well along the east coast, while the west coast was covered with meadows. It was my first trip abroad and, puzzled by the scene, I asked the reason. I was told that there was enough sunlight on the east coast to make it suitable for wheat, while the west coast had plentiful rainfall but less sunlight and was better for grass. Hence the development there of animal husbandry, cattle raising, and milk production.

  On my way back through Greece, comrades in the embassy accompanied me for a tour of the hilly regions where the weather was dry and there was no rainfall in the summer. According to our approach, the conditions would have been considered very tough for agriculture. We would have replicated the Dazhai model,* using terraced fields and irrigation projects. But they did not do that. The hills were covered with olive trees and the olive oil industry flourished. The farmers’ living standards were high. Why were they able to do this? Because they were not living in an autarky, but instead relied on trade with the outside world and utilized their strengths to export their goods in exchange for what they needed.

  In 1981, after I had come to work in Beijing, I went to Lankao County [in Henan Province] and spoke with farmers there. It was a sandy region, capable of high yields of peanuts. But since the policy was to make grain production a priority while focusing on self-reliant food production, they were not allowed to plant peanuts, but instead planted corn. Their corn yields were low, and the farmers were highly critical of the policy.

  Another example was the northwest region of Shandong Province, where the soil had a high alkali salt content. Most of the region was suitable for cotton growing at considerably high yields. But for years, policy had prevented them from growing cotton, allowing only wheat. The result was that the more wheat they planted, the lower yields they got and the more likely the farmers were to be starving.

  In 1983, I spoke with comrades in Shandong and asked if they could plant cotton. They said the problem was a lack of grains. Later, we decided that northwest Shandong should switch to planting cotton. They would sell cotton to the state (at the time, the state was importing large quantities of cotton) and in return the state would provide them with grain supplies.

  The result was that it took only one to two years for them to overturn a difficult economic situation and attain high yields in their cotton production. For a time, cotton flooded the market, resulting in oversupply. The farmers’ incomes quickly increased and rural conditions greatly improved. Their cotton production also yielded a by-product: cotton seeds. What was left over after extracting for cottonseed oil became fertilizer. The land that was not high in alkali salt continued to plant wheat and also saw an increase in yields from the supply of fertilizers. Everyone benefited.

  Local folklore held that “one catty of wheat will feed all, half a catty of cotton yields extra.”* Before, when they planted one and a half catties of wheat, they were hardly able to feed themselves; later, one catty of cotton was enough and they were even able to sell the extra back to the state.

  Shandong and Lankao were able to plant what was suited to their environment because we were practicing the open-door policy and importing large amounts of wheat from abroad—as much as several tens of millions of tons annually during those years. So long as we allowed farmers to plant whatever was appropriate and had the highest yields, agriculture improved. Without the open-door policy, we would have been forced to produce everything ourselves, and if we remained fixated on self-reliance, nothing could have happened.

  One reason that huge efforts yielded measly results in agriculture was public ownership. The other was the self-imposed autarky that prevented us from taking advantage of the land and resulted in “double efforts yielding half the results.” For years we forced the planting of wheat in areas that were not suited to wheat production, so we had to make great efforts to build agricultural infrastructure and irrigation projects. Some of the projects were indeed necessary, but if we could have utilized the natural advantages of the land, we wouldn’t have needed them all. Also, the irrigation system could have been more efficient, and focused on places where it was most needed.

  The same was true in industry. Our industrial development strategy in the past was “Don’t start cooking without first having rice.” We attempted to start everything from the very beginning, down to the raw materials.

  For example, in steel manufacturing, we started first with the search and selection of iron mines, then coal, railroad building, iron smelting, steelmaking and processing, and finally the building of machinery. But we have only low-quality iron mines with a low percentage of iron. Many tons had to be mined to yield one ton of iron. Our main iron and coal mines were in the west, so long-distance transportation was required. Imagine how long it took to build a steelmaking firm; the scope of the infrastructure; the length of time for investments to yie
ld a return; how much of the investment could be recovered.

  With reform, we are much smarter. We import ore from Canada and Australia, where it is cheap and high in quality; transportation by ship is cheaper than by train. Some coastal cities can handle downstream processes, starting with steel rolling. Where do they get the ingots? From imports. As soon as processing started, there were profits. The investment was quickly recovered from the revenue, which was then invested in upstream steel processes and in the importing of iron from abroad.

  The production of synthetic fibers had the same problem. Previously, if we were to produce synthetic fibers, we had to first start with oil production and oil refineries before making synthetic fibers. Later, some of the synthetic fiber factories started with production first, then proceeded with upstream processes afterward. In 1981, during the adjustment period, we had imported a set of synthetic fiber production lines, from raw material processing to wiredrawing. It was put on hold. When it was resumed we were already smarter, so we started with the wiredrawing process for the end product. This was how Yizheng Synthetic Fiber Factory of Jiangsu Province started. It grew quickly and soon had revenue that it reinvested in upstream processes.

  All of this illustrates that only under the conditions of an open-door policy could we take advantage of what we had, and trade for what we needed. Each place and each society has its strengths; even poor regions have their advantages, such as cheap labor. That is a great advantage in international competition.

  The result of doing everything ourselves was that we were not doing what we did best. We suffered tremendous losses because of this. I now realize more and more that if a nation is closed, is not integrated into the international market, or does not take advantage of international trade, then it will fall behind and modernization will be impossible.