Transition to Market in China

In my previous post, I described the agency problem of the Soviet political elite reforming planned economies of the newly formed independent states. The following graph compared the post-1991 transitory period in Russia and a few Eastern European countries, former members of the Eastern Bloc:

The Russian privatization program kept public property away from producers. It redistributed ownership through vouchers, which were securities granting the right to privatized property. After they got these securities from the state, people sold them significantly lower their potential price. Vouchers happened to end in the hands of a few. Much of other public property had been privatized without any vouchers. For instance, through fraudulent shares-for-the-loan auctions organized by the Russian government in 1995.
Such was the essence of market reforms in Russia. Meanwhile, China had their own market reforms started one and a half decades earlier. And the Chinese elite did an interesting thing. No, the central government didn’t act like a benevolent dictator who gives away his power by transferring property to producers. Instead, it allowed independent producers to appear by themselves. First in agriculture, then in industrial production.
The rationale behind liberalization of the economy was the following one. If the government cannot encourage politically stable growth rates, let the market support it, where possible. The government neither competed nor shared property with the private sector. The market delivered additional value, which would otherwise turn out to be a deadweight loss of a centrally planned economy.
The Party not only preserved all of its property, but also gained indirect control over the private sector, which had been intensively growing over the last three decades. Naturally, it emerged as much more powerful interest group than it was under a pure planned economy. And it did so without country’s output falling to 1/2 of its pre-reform level.
That shows how various coalitions within elites lead to different policy decisions and economic outcomes. In a critical moment, the Soviet hierarchy was unable to make forward-looking decisions and balance the interest of intra-elite factions. In contrast, the Chinese counterparts came out of the similar situation as winners, through with a very powerful competitor growing next to them.

Transition from Planned Economy to Market

The Soviet Union collapsed in 1991. But this 1989 paper by Victor Nee provided an interesting insight that had closely described the forces behind Russia’s market reforms in the 1990s.

Nee outlines two centers of power in a centralized economy: producers and distributors. Producers are Soviet CEOs, running factories and other elementary economic units. Distributors comprise the Soviet government and allocate resources across the economy. Under central planning, the power of producers is weak and that of distributors is strong. Both were in the Communist Party, but producers belonged to a relatively dependent group of the privileged. Distributors from the Government made major economic decisions.

Nee’s point is that the transition from centralized planning to the market economy leads to redistribution of power in favor of producers. Distributors can’t agree with that. And they didn’t. Mikhail Gorbachev and the Soviet leadership had no plan of moving to the market.

In 1991, they had been displaced by Boris Yeltsin. It was a coup. Yeltsin represented local elites, who managed resources at the level of separate Soviet republics and led republican branches of the Party. The power shifted to the leaders of a newly formed independent republics. The 1991 events had little to do with democracy: it was the second-level distributors getting rid of some top-level distributors.

The new republics started building market economies. But the problem with the transition remained the same: distributors don’t want to lose power by introducing markets. And the didn’t. The new old elites did everything to prevent producers from gaining power. They established crony capitalism to become private owners of formerly public property.

The architects of the privatization, which started in the early 90s and still continues in Russia in a somewhat different manner, recently recognized that their main goal was to privatize property as fast as possible to avoid power going to what they called “red executives”—managers of Soviet factories and service units.

An official version sounded like “Red executives would bring communism back, so let anyone get the state property and forget about efficiency for a while.” But red executives had little incentives to bring back communism, which would deprived them of power over their factories. Effectively, the architects prevented a really decentralized market economy, when each factory is a Smithian independent firm that competes with the others and the invisible hand paves the way to wellbeing.

The property didn’t go to anyone, clearly not to the population, but to specific people, including government officials. The schemes were opaque, and it was difficult to distinguish who owned now-private businesses: government officials or their proteges from nouveau riches.

This privatization was followed by an unprecedented fall of output. That how it looks compared to countries with previously planned economies that had more democratic transitions to the market:

Though it’s important to note that the degree of central planning in these states differed, the picture is the same for most former SU countries, which had lost much of GDP before returning to the trend in late 2010s. Many had not returned. The Baltic states had fewer problems. As the Eastern Bloc minus the USSR, they also got rid of communist elites before going back to markets.

Market reforms in the former SU have been conducted by the same officials who were supposed to give away their powers. Just as a typical case of moral hazard, they had designed the transition in their own interests, so that in just five years there were no free market and no economy.