3

How China’s Market Reform Began

The Third Plenum of the Eleventh Central Committee of the Chinese Communist Party was a decisive event in the history of the People’s Republic; it re-consolidated the power of the Party and paved the way for the reunification of a fractured society. The decisions made there would re-channel the energy, enthusiasm, and creativity of the Chinese people from the politics of class conflict to socialist modernization. At the end of 1978, China once again stood at a historic moment as it had done in 1949. This time, China would be more fortunate. Both the Chinese government and academic circles worldwide view the Third Plenum as the beginning of China’s market transformation, the genesis of the extraordinary story that unfolded in the following three decades, as the world’s most populous country turned from a poor, stagnant socialist economy into one of the world’s most dynamic economies.1 It is, however, tempting to read too much into this watershed event – to think that the historical significance of the Third Plenum was preordained. After all, it did not set in motion a chain of events that meticulously brought about China’s great market transformation. Rather, it was the transformation itself that elevated the Third Plenum to historical prominence as the most recognizable turning point in the history of the People’s Republic. Had China’s economic reforms been unsuccessful, the Third Plenum would have been just another wishful attempt by the Chinese leadership to modernize the economy.

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In any case, China did not wait until the end of 1978 to begin its reforms. During the two years between Mao’s death in September 1976 and the Third Plenum in December 1978, China had already closed the door on Mao’s radical ideology and embraced economic development as its first priority. The Cultural Revolution was ended after the arrest of the Gang of Four, and socialist modernization quickly became the primary concern of Hua and the new Chinese government. The economic program of “four modernizations” was revived in 1976; the Leap Outward was launched a year later. Under the initiatives of Hu Yaobang, hundreds of thousands of Party officials and “rightists” purged during the Cultural Revolution were rehabilitated. Many resumed leadership positions, where they quickly became the foremost exponents of reform.

In his role as head of the Central Party School and as the editor of Theoretical Trends, Hu played a key role in early reform by weakening the influence of Marxist ideology on public opinion. Theoretical Trends served as a powerful mouthpiece for new ideas. The article “Practice is the only criterion for testing truth” ignited a far-reaching political debate. By the end of 1978 when the Third Plenum was held in Beijing, practice had prevailed, replacing Mao’s little red book and Marxism. This shift in ideology was later recognized as the first “massive mind emancipation” in the history of the People’s Republic.2

China had also begun to open up to the outside world immediately after the end of the Cultural Revolution. Chinese leaders made many trips abroad to rebuild relations ignored or damaged during the previous decade and to see for themselves the gap that had emerged between China and the modern world. The normalization of Sino-US relations on January 1st, 1979 and Deng’s visit to the United States shortly afterward were powerful catalysts in China’s reconciliation with the West. Ironically, after Chinese leaders were exposed to, and expressed admiration for, the economic dynamism of capitalism in Asia, Europe, and the United States, they became more committed to socialism. They believed its inherent superiority would enable China to modernize its economy even faster than the West had done, but only if China was able to appropriate the innovative strength of capitalism. These views were reinforced at the Third Plenum. With the promulgation of the 1978 Communiqué and the return of Deng Xiaoping and Chen Yun to the center of the Party, the ongoing political and economic changes gained further momentum.

Immediately after the Third Plenum, the Chinese government began a series of reforms, focused on what was perceived to be one of the weakest areas of the Chinese socialist economy, the state-owned enterprises. As the 1978 Communiqué admitted, “one of the serious shortcomings in the structure of economic management [in China] is the over-concentration of authority.”3 Consequently, more authority would be devolved to both local authorities and economic organizations so that “the local authorities and industrial and agricultural enterprises will have greater power of decision in management under the guidance of unified state planning.”4 But the idea of devolving authority directly to enterprises was totally unprecedented. After seeing Mao’s previous attempts at administrative decentralization fail to revitalize the economy, Chinese leaders wanted to try a different approach. At a meeting held by the State Council in September 1978 Li Xiannian expressed his regret that earlier attempts at reforming China’s economic system had devolved power to local governments, while enterprises had become still more shackled by red tape and rigidity.5

But the idea of enterprise autonomy was not new, at least among academics. Gu Zhun and Sun Yefang were the first Chinese economists to criticize the Soviet model of economic planning and stress the relevance of economic principles to socialism.6 Both men argued that state-owned enterprises should become autonomous and pursue profits. As early as 1956, Gu had stressed the indispensability of the market and production for exchange under socialism. A year later, he was denounced as a “rightist” and spent most of his later life in prisons and re-education centers.7 Gu did not survive the Cultural Revolution, dying of cancer in 1974. In Sun’s view, the Achilles’ heel of the Chinese socialist economy was the lack of autonomy of state-owned enterprises, and not centralization as Mao believed, nor decentralization as Mao’s critics thought.8 In 1961, Sun criticized the administrative decentralization approach favored by Mao and was promptly labeled “China’s biggest revisionist”; he was imprisoned for seven years during the Cultural Revolution. After Mao’s death, however, these ideas resurfaced and were to win the support of Chinese leaders.9

I

This change in approach from administrative decentralization to enterprise autonomy was vindicated by what the Chinese visitors had observed during their overseas trips. What impressed the Chinese delegations the most was the efficiency and dynamism within capitalist companies. In contrast to Nissan, which impressed Deng Xiaoping the most during his visit to Japan in 1978, China’s firms were notoriously inefficient and mired in endless bureaucratic complexities. Not surprisingly, the Chinese leaders took enterprise reform as a key component to revitalizing the socialist economy after the Third Plenum. An editorial in the People’s Daily on February 19th, 1979, which represented the official position of the Chinese government, stressed that “the most urgent task for the current economic reform is to expand the autonomy of big state-owned enterprises.”10 In the next few years, enterprise reform became the focal point of economic reform, and in particular the issues of devolving power to state-owned enterprises and allowing them to retain profits.11

For local authorities familiar with everyday economic realities, it was obvious that improving the performance of the state-owned enterprises was fundamental to the problems facing the Chinese socialist economy. Even before the Third Plenum, the reform of state-owned enterprises had begun. The first case was reported in October 1978 in Sichuan province headed by Zhao Ziyang, who was later promoted to premier in 1980 for his pioneering reforms.12 The reform essentially curtailed the power exercised by various government departments over state-owned enterprises; this amounted to a transfer of some decision-making responsibilities to the managerial staff. For example, enterprises were now able to appoint middle-level managers (though not to lay off employees), to retain a certain amount of profits, and increase production beyond that specified in the state plan. These reforms gained more impetus after the Third Plenum. By early 1979, the number of enterprises under reform had reached a hundred in Sichuan alone.13 In addition, fifty enterprises in neighboring Yunnan province joined.14 Based on Sichuan’s successful experience, in May 1979 the State Council selected eight large state-owned enterprises, including the flagship enterprise Capital Steel company as well as others based in Beijing, Shanghai, and Tianjin, to experiment with similar enterprise reform. By the end of 1979, more than 4200 large state-owned enterprises had been enlisted.15 By 1981, there were more than 6600 state-owned enterprises, spread across China (with the exception of Tibet).

In addition to devolving decision-making powers to enterprises, other measures were also taken to further the reform of industry. It had become widely recognized that state-owned enterprises suffered from two crushing constraints. First, deprived of basic managerial autonomy, state-owned enterprises had become pawns of various state agents. They could not decide what and how much to produce, who to hire or lay off, how much to invest, or how to compensate managers and workers. In fact, state-owned enterprises were enterprises in name only. Accordingly, the first attempt to reform state-owned enterprises was to make them more autonomous and like real enterprises.

The second encumbrance was the fragmented industrial structure. Due to Mao’s repeated attempts to make each locality (from regions to provinces to counties) as self-sufficient as possible, Chinese state-owned enterprises were small in scale but vast in number, and often completely isolated from each other. Even upstream and downstream firms in the same industry rarely interacted with each other directly, but would communicate through the government bureaucracy. State-owned enterprises in a locality thus formed a cluster under the local government.16 To address this structural problem, in July 1980 the State Council issued a provisional stipulation calling for integration and consolidation among state-owned enterprises.17 In machinery manufacturing (the most fragmented industry of Mao’s era), the National Committee on Machinery in early 1981 encouraged the state-owned enterprises to merge. This campaign even reached the government bureaucracy. By 1982 the National Bureau of Machinery was formed, consolidating four preexisting bureaucracies into one.18

In addition to industrial reforms targeted at enterprises and industrial structure, the State Council also earmarked whole cities for experiment with the “National Comprehensive Economic System Reform.”19 In October 1981 Shashi, a city of 243,000 people in Hubei province, became the first of these. In March 1982, Changzhou of Jiangsu province, another city of similar size, became the second. In February 1983, Chongqing of Sichuan province became the first sizeable city to experiment with comprehensive economic reform. In May, several more large cities were added to this project. These cities – Wuhan, Shenyang, Dalian, Harbin, Guangzhou, and Xi’an – each had populations in the millions. As a pioneering city at this stage of industrial reform, the otherwise obscure Shashi left its mark on the history of Chinese economic reform. Shashi was the first city to implement reform measures such as: consolidating firms to take advantage of economies of scale and scope; allowing enterprises to decide what to produce; allowing flexibility in labor management; and introducing the managerial responsibility system. The whole episode of “comprehensive economic system reform” is scarcely documented and has received the least scholarly attention,20 partly because of its inconspicuous performance relative to the Special Economic Zones. Nonetheless, these pilot city reforms, together with enterprise and industrial structure reforms, clearly demonstrate the concerted efforts of the Chinese government in the late 1970s and early 1980s to institute industrial reform.

In general, enterprises responded quickly and positively to the reform measures. Expanded managerial autonomy encouraged enterprises to increase production and improve efficiency. This gave rise to income growth for the workers, who had not seen any increase in their wages for many years. At the end of 1980, a managerial responsibility contract system was introduced to guarantee the autonomy of managers while detailing their specific responsibilities. At the strategic level, the most important and lasting legacy of industrial reform was to end the monopoly of state planning in coordinating industrial production. After state quotas had been fulfilled, state-owned enterprises could now decide what to produce. This provided opportunities for the socialist economy to “grow out of the plan.”21 When state-owned enterprises started producing goods outside the constraints of state planning, they became subject to the sway of market forces. This gave rise to a distinctive feature of Chinese economic reform, known as the “dual-track” system; the coexistence of central planning with the market in coordinating production in the state sector.22 As a result, China’s dominant state sector and its lack of privatization did not prevent the emergence of a fledgling market mechanism.

However, despite the progress of industrial reform, the economy as a whole had hardly improved, at least when judged by the conventional short-term macro indicators. On the contrary, since the enterprises now retained profits for investment and employee compensation, government tax revenue declined. The government slipped into deficit and the threat of inflation became very real. In 1979, the deficit reached 17 billion yuan, an alarmingly unprecedented level, and it remained high (12.8 billion) the next year. The overall price index went up 6 percent in 1980; in cities it went up more than 8 percent.23 This level of inflation was deemed highly dangerous by the Chinese government, which viewed inflation as an evil of capitalism and had long been accustomed to price fluctuations of around 1 percent. The Chinese economy was then still recovering from the financial difficulties created by the Leap Outward, and either deficit or inflation could easily have derailed the fragile economy and threatened political stability. The Chinese government was forced to introduce an adjustment policy and put the reform agenda on hold. The first wave of the post-Third Plenum reform measures pushed by the Chinese government ended with disappointment; it had led to no real breakthrough.

II

While the state-led reforms stalled, real change was smoldering along the margins of the socialist economy. The most significant developments were to occur not at the core of the socialist economy but on its periphery, where state control was at its weakest. The real pioneers were not state-owned enterprises, the privileged actors and jewels of socialism, but the disadvantaged and marginalized. On the fringe of government bureaucracy and excluded from state planning, they had suffered the worst of the existing system. Nonetheless, it was at the margins of the Chinese economy that a concatenation of revolutions brought private actors back to the economy, paving the way for a market transformation. China became capitalist with marginal revolutions.

The most significant of these marginal revolutions erupted in agriculture, the weakest sector of the Chinese economy. In Mao’s era Chinese agriculture had suffered badly, including during the catastrophe of the Great Leap Forward. Compared with industry, agriculture had been chronically underfunded. Worse, profits generated in agriculture had been diverted to subsidize industrialization, through savings forced upon the rural population and artificially depressed prices for agricultural products. As a result, starvation had been a problem for a large section of the rural population and was a looming threat for the Chinese government during Mao’s time. These problems were acknowledged in the 1978 Communiqué. Accordingly, the Chinese government in 1979 significantly increased the prices paid for major agricultural products and subsidized the use of chemical fertilizers to boost agricultural production. Such measures were effective in increasing agricultural output.

But the real agricultural reforms, decollectivization and the rise of the household responsibility system, developed from the bottom upwards.

The first recorded incidence of private farming in post-Mao China occurred in Pengxi county of Sichuan province, in a village called “Nine Dragon Hill.”24 This village was one of the poorest in Qunli Commune, widely known in the region as a “village of beggars.” One evening in September 1976, Deng Tianyuan, the Party secretary of the commune, summoned a small group of cadres to discuss the problem of agricultural production. After a long and heated debate, they agreed to try private farming as a solution to the managerial and incentive problems that had dogged collective farming. Aware of the political risk, they decided to allocate only marginal land to households in two production teams, while keeping collective farming intact elsewhere. That year, the output of the marginal but privately cultivated land was three times higher than that of the collectively cultivated fertile land. The next year, more land was privatized in more production teams. By 1978, before the Third Plenum was held in Beijing, private farming was practiced across the whole commune, but was kept secret from the local authorities. In 1979, at a meeting organized by the county government to discuss improvements in agriculture, Deng Tienyuan disclosed the secret of Nine Dragon Hill’s success and won the endorsement of the county Party secretary. The following year, a delegation from the Ministry of Agriculture and Forestry visited Nine Dragon Hill. While he criticized private farming in principle, the head of the delegation praised Deng Tianyuan for improving agricultural production and even proposed considering the village as an experimental site for private farming.

The much better known case of Small Hill village in Anhui province, which has been documented in textbooks and the official account of agricultural reform as the pioneer of private farming, actually took place more than two years later.25 Like Nine Dragon Hill in Sichuan, Small Hill was also known regionally as a “village of beggars.” Here, it was peasants themselves rather than local cadres who initiated change. At the end of 1978, eighteen peasants in the village secretly signed an agreement to experiment with private farming, and sidestep the production teams.26 At the time of harvest, peasants at this village collected so much more grain than their neighbors that many nearby villages were persuaded to join them in private farming the following season.

In addition to private farming, which was prohibited by government policy, there were milder forms of agricultural reform in many provinces. After the death of Mao, Chinese agricultural policy continued to be based on the fundamental principle of central planning. “In agriculture, learn from Dazhai” and “grain is the key link” were still held as guidelines for agriculture. The most damaging defect of this policy was to impose a model developed in the village of Dazhai on the whole nation.27 This denied local governments the freedom to take into account local circumstances. For example, areas with hardly any arable land were forced to concentrate their efforts on grain production. Developing alternative streams of income, such as fishery, animal husbandry, and forestry, was criticized as capitalist and was outlawed. In the campaign to use local resources to develop the rural economy, Chi Biqing of Guizhou, Wan Li of Anhui, and Zhao Ziyang of Sichuan were the most vocal. As early as 1977, Chi, Wan, and Zhao, as provincial Party secretaries, encouraged local government officials to allow peasants the freedom to explore all opportunities available to increase their incomes. Once peasants were allowed to engage in pursuits other than grain production, it not only helped to expand their sources of income, but also increased efficiency in grain production. At the end of 1970s and early 1980s, a popular saying, “Go to Wan Li if you want rice; Go to Ziyang if you want grain,” attested to the success of their efforts.28

After the Third Plenum, the development of fishery, forestry, animal husbandry, and craftsmanship was encouraged. Commune and brigade enterprises were also encouraged to revive the rural economy. Private farming, however, remained illegal. Two documents on agriculture that were passed at the Third Plenum singled out private farming as a criminal activity, “Decisions of the Central Committee of the Chinese Communist Party on Some Questions Concerning the Acceleration of Agricultural Development” and “Regulations on the Work in the Rural People’s Communes.” The ban on private farming was maintained throughout 1979. On March 15th, 1979, the People’s Daily published a reader’s letter from Henan province, along with an endorsing editorial, castigating private farming for eroding socialism in rural China.29 It called on peasants and local government officials to stand firm against the encroachment of capitalism. The letter and editorial might have ended private farming in Anhui, if not for the staunch support of local authorities, particularly Wan Li.30 At the Fourth Plenum held in September 1979, the government passed a document that stated that “distributing land for individual farming shall not be allowed” and “contracting output quota to each household shall not be practiced.”31 Nonetheless, private farming continued to develop in many disguised forms.

Throughout 1979, Wan Li took every opportunity he had to explain and defend private farming. A year later, leaders in Beijing began to change their position. By the late spring of 1980, Chen Yun, Hu Yaobang, and Deng Xiaoping had become convinced of the advantages of private farming. However, not all were in favor. In September, the Party reached a compromise, issuing a resolution that allowed private farming only “in those remote mountainous areas and poverty-stricken backward regions and in those production teams that have long been relying on state-resold grain for food, loans for production, and social relief,” and only “if the masses have lost their confidence in the collective.” In other words, decollectivization was allowed only where the collective economy had failed. The political reasons for this are not difficult to fathom. The main fear engendered by decollectivization was its potential to damage socialism, which was believed to rest upon collective ownership. But in rural areas where “the masses [had] lost their confidence in the collective,” there was little socialism for private farming to damage. Thus, in poverty-stricken areas where socialism had been an abject failure, the political cost of reform was essentially negative. In its efforts to minimize the potential political fallout from agricultural reform, the Chinese government had inadvertently opened the door to revolution at the weakest part of the socialist economy, where resistance to reform was nonexistent.

Even before Beijing relaxed its ban on private farming in 1980, the practice had already been adopted in many places across rural China. It was exactly because of this challenge that the Chinese government decided to soften its policy. The case of Small Hill village, forcefully promoted by Wan Li, had played a significant political role in the defense of private farming. But even after the ban on private farming was first lifted in 1980, it took more than a year of intensive debate before the Chinese government officially recognized private farming in January 1982. The ideological resistance to private farming was so strong partly because Mao had repeatedly singled out private farming as a characteristically capitalist practice, which he believed would undermine the socialist goal of shared prosperity and economic equality. Proponents of private farming evoked its undeniable effectiveness in raising peasants’ morale and increasing agricultural production. If practice really was to be the only criterion of testing truth, private farming would have to be accepted as superior to collective farming. Pragmatism eventually prevailed and private farming was promoted afterwards as a national policy.

The official account of agricultural reform sees private farming emerging clandestinely in Anhui alone and then being imposed on the rest of the country by the central government.32 But this interpretation is misleading. Not only did private farming occur more than two years earlier in Sichuan, but, more importantly, the practice must have been under-reported before it was officially sanctioned by the Chinese government. The other known cases occurred in the provinces of Guizhou, Gansu, Inner Mogolia, and Henan.33 But private farming must have emerged elsewhere.34 Without broad popular support, the agricultural reform could not have proceeded as quickly and smoothly as it did.

It is easier to understand the rapid development of private farming in rural China if we realize that the practice was not new. After Mao’s push for collectivization in agriculture, China witnessed at least three periods when private farming was revived.35 The first was in 1956 right after collectivization and rural cooperatives were first launched. Supported by Deng Zihui, then Vice Premier in charge of agriculture, private farming was widely practiced in many provinces and discussed favorably in the People’s Daily. Yongjia county in Zhejiang was the most publicized case then. But this tolerance of private farming had been reversed by 1957 and Deng Zihui was criticized harshly by Mao. The second instance was in late 1958 and early 1959, during the Great Leap Forward; many peasants resorted to private farming simply to survive. It emerged in several provinces, including Hubei, Hunan, Henan, Jiangsu, and Gansu, only to be quashed after the Lushan Meeting in July 1959. The third occurrence was in the early 1960s, after the failure of the Great Leap Forward had become clear. As a temporary solution to grain shortages, private farming was encouraged in many provinces across the country. However, even though Mao was initially supportive, private farming came under renewed political attack in mid-1962. Nonetheless, the practice survived under disguised forms in many places.36

It is also worth noting that private farming was not a single practice, but an umbrella name for a family of non-collective farming practices that had emerged spontaneously in rural China.37 Collective farming was an extreme form of socialist agricultural management where farming was organized by production teams (or communes, as during the Cultural Revolution), with households treated as employees. State farms exemplified such extreme form of agricultural production. At the other extreme, farming was privately managed by each household, with the production team acting simply as a landlord. In between there was a rich variety of intermediate contractual forms, where the rights and responsibilities of the household vis-à-vis the production team were specified. All they really had in common was their departure from Mao’s model of pure collective farming. When the Chinese government adopted private farming as a national policy, this diversity was lost. The household responsibility system, implemented nationwide since 1982, virtually eliminated production teams in rural China, except in a handful of places where collective farming survived in one form or another, including the famous Daqiu Village in Tianjin and Huaxi Village in Jiangsu. The household then became the only actor in farming.

III

This imposed uniformity is understandable from the perspective of policymaking and implementation. It would certainly have been far more onerous to accommodate multiple forms of farming and associated contractual arrangements. In an extreme but not unlikely scenario, some local cadres might simply have stuck to the status quo if given the choice, which would have effectively foiled the reform efforts. Imposing a uniform household responsibility system nationwide and disbanding production teams was an effective means of pushing forward agricultural reform in a top-down fashion. But once the household responsibility system was promoted as a national policy, the continuing presence of collective farming was deemed a direct challenge to the state agricultural policy. As a result, even collective farming that had performed well was under political pressure to close down.38

But from the perspective of institutional change, this imposed uniformity and forced breakdown of production teams was undoubtedly a setback. Before the socialist transformation in the 1950s, the family had always been the basic social unit and organizational form in rural China. Despite its disappointing performance in agriculture, Mao’s socialist experiment at least ushered in an organizational revolution in rural China. For the first time in its long history, rural China saw the rise of corporate organizations not based on family ties – the production teams, brigades, and communes. Even though this organizational revolution was largely imposed by the state, it created a new organizational infrastructure beyond family, kinship, and clan ties in rural China.

In technological change, the most recent technological innovation often renders what existed beforehand outdated or even totally obsolete. The rise of personal computers with user-friendly word processing functions, for example, has made typewriters of little use today. A new generation of computer chips often supersedes and replaces the previous one. But institutional change follows a different logic. Institutions are multifaceted and too complicated to be ranked on any single scale. Institutional diversity is more conducive to innovation.

Compared with an agrarian society, a modern society is organization-intensive, depending on a wide range of formal and informal organizations coordinating with each other through rules and norms, including prices.39 Moreover, organizations are often specialized and differ from each other in many and various ways. The constitutive rules that create organizations and specify what they can and cannot do, as well as the regulative rules that guide and police interactions among organizations, also differ. This richness and diversity in organizations, including in the ways they are formed and behave, is an important source of flexibility and resilience in social and economic life. Since production teams and communes were created in rural China by decree of the state, they did not have much organizational diversity. Nonetheless, they would have had a comparative advantage over the household for certain tasks that required collective effort, such as irrigation. Even in farming, the production team would have had to adjust and behave more efficiently to compete effectively with private farming, as shown in a few cases where production teams survived. The total disbanding of the production team in rural China amounted to the destruction of China’s own scarce organizational capital.40

In the marginal revolution that ultimately privatized agricultural production throughout rural China, peasants and local authorities were the initiators and developers. It was a bottom-up process. Private farming re-emerged in rural China even when Beijing was still firmly opposed to the practice, as it was deemed inimical to socialism. While reform measures taken by Beijing, such as the increase in the purchasing price of grain, certainly helped the recovery of agricultural production, what ultimately brought life and character to Chinese agricultural reform came from the grassroots. The two “villages of beggars” in Sichuan and Anhui are simply two recorded examples among many where private farming re-emerged triumphantly against strong political opposition. Similar incidents of private farming with the passive acquiescence of local cadres must have occurred elsewhere and their main impact was in easing the introduction of the household responsibility system.

Nonetheless, the role of the state was still critical in sanctioning an institutional revolution that started from below. Before private farming was approved by the state, peasants had been constantly worried about the legitimacy of the practice and their own safety, and hesitant to make any long-term investment. The joint efforts of peasants, who had knowledge and experience, and the state, which was the only legitimate party with coercive power to turn a voluntary agreement into a social institution, formed an effective private–public partnership to bring about an institutional change.

Institutions that emerge spontaneously take a long time to become established, that is, to be settled in the mind of the people and incorporated as part of their habits of thought and action. Institutions developed in this way are shaped by the influence of local conditions and the spirit of the times, and this gives rise to the diversity of institutions. At the same time, institutional evolution can easily be disrupted by war, social unrest, and natural disaster. Consequently, it is a gradual but hazardous process, full of uncertainty. Political power can step in and speed up the process of institutional change without necessarily subjugating it to its authority. Once an emerging institution is endorsed by a legitimate and credible state, it can readily stand out as a common point of reference and act as a guide for relevant social actors, at least in the short run. How long a state-sponsored institution can survive depends on its perceived performance relative to expectation, as well as the strength of the state’s commitment to protect it against resistance. The state faces a delicate dilemma. It can facilitate institutional change and validate it through its political support and sanction. But its helping hand can easily become an iron fist of coercion and oppression when the institution it endorses works against the will of the people. Even when the state intervenes judiciously, the coercive force of the state does not come free. Largely out of practical necessity, a collateral casualty of state enforcement is the loss of institutional diversity. This may become a serious, even fatal, liability if the performance of the institution varies significantly across regions and institutional diversity is warranted.

Fortunately, private farming worked well for most villages in rural China where the land–labor ratio was too low to allow economies of scale to prevail. After it was endorsed as a national policy, private farming did encounter some resistance, particularly in areas where collective farming had worked well and local conditions were suited to large-scale farming.41 There were a few places where collective farming survived, but in most the national policy triumphed over local requirements.

It is important to note that decollectivization and the return of private farming in rural China were not the whole story of agricultural reform. Decollectivization freed peasants from the dictates of communes and production teams. Peasants’ regained freedom to determine their own life choices was more important than decollectivization itself in bringing back commerce and private entrepreneurship to rural China. As a result, even in areas where the policy of private farming met with resistance, the economic freedom that accompanied it was wholeheartedly embraced.42 This was another important reason for the rapid implementation of the household responsibility system, and the ultimate force underpinning the revival of China’s rural economy.

IV

Along with the marginal revolution in agriculture, another revolution was taking place in rural China at almost the same time. This was rural industrialization, mainly led by the rise of township and village enterprises.43 As the principal source of non-farming jobs to peasants, these enterprises played a pivotal role in bringing about a vibrant non-public sector across China, particularly during the first twenty years of reform. Since the official recognition of private enterprises in the mid-1990s, most township and village enterprises have now been privatized. With a few exceptions, they have all but disappeared. But their spectacular rise and quiet decline reveals much about the nature of the Chinese economic transformation.

What is most striking about township and village enterprises is that they managed to survive at all. They made a crucial contribution to China’s move away from socialism to a market economy, and did so despite government hostility. Beijing had always viewed them as inferior rivals to the state-owned enterprises, and had therefore treated them with contempt and enmity. In 1987, Deng Xiaoping characterized the rise of township and village enterprises as a shocking surprise.

In the rural reform our greatest success – and it is one we had by no means anticipated – had been the emergence of a large number of enterprises run by villages and townships . . . Their annual output value has been increasing by more than 20 percent a year for the last several years. This increase in village and township enterprises, particularly industrial enterprises, has provided jobs for 50 per cent of the surplus labor in the countryside . . . This result was not anything that I or any of the other comrades had foreseen; it just came out of the blue.44

 

While Deng was completely honest in admitting the astonishing performance of township and village enterprises, his speech failed to mention the policy biases and other barriers township and village enterprises had to overcome on their rise to prominence.

Township and village enterprises did not arise out of the blue. Many of them developed from the old commune and brigade enterprises; they were a legacy of Mao’s attempts at rural industrialization. This heritage certainly eased the introduction of township and village enterprises. By 1978 commune and brigade enterprises employed more than 28 million peasants, and accounted for 9.5 percent of the rural labor force.45 However, this lineage did come with strong historical baggage. Many of the commune and brigade enterprises had developed from the “backyard furnaces” of the Great Leap Forward. Of course, these facilities had been enormously wasteful, barely turning out any usable iron or steel. They also competed aggressively with state-owned steel mills for raw materials, forcing the latter to operate below capacity. At the same time, the backyard furnaces diverted the workforce from farming, which perpetuated the catastrophic famine of that time.46 The first adjustment after the Great Leap Forward was to close down all backyard furnaces to make sure that the few big mills controlled by the central government could operate at full capacity.47 This episode led the central government officials in charge of industrial policy to view township and village enterprises with skepticism and mistrust. Furthermore, these officials, with their close administrative relations and direct economic ties with state-owned enterprises, felt threatened by the rise of township and village enterprises. In addition, most township and village enterprises often used obsolete equipment and technology discarded by state-owned enterprises. As a result, the rise of township and village enterprises was seen as a case of inferior, backward competitors crowding out superior, more advanced operations.48 In light of this view, Beijing crafted several policies to starve these enterprises of bank loans, raw materials, and access to the consumer markets.

In spite of these adversities, township and village enterprises managed to grow quickly. They were widely praised as “the most dynamic part of the Chinese economy”49 and “the major engine of China’s growth and industrialization at the early stages of China’s reforms.”50 The number of people employed in such enterprises grew from 28 million in 1978 to a peak of 135 million in 1996. During the same time period, their share in GDP grew from 6 percent to 26 percent, at a time when the GDP itself was growing rapidly.51 They outperformed the state-owned enterprises in both productivity and growth, even though they did not enjoy the same privileged access to raw materials, energy, credit and consumer markets, and were faced with many discriminatory policies.

Township and village enterprises have been one of the most heavily researched subjects among scholars of China’s economy. In academic literature, township and village enterprises are almost unanimously viewed as communal or collective property, owned and managed by local authorities. Consequently, the spectacular performance of township and village enterprises appears to run counter to a basic tenet in modern economics, which states that private property rights are indispensable to motivate entrepreneurship and discipline market behavior.

The active role of local governments is often seen to be the key factor in the success of township and village enterprises. This is true in some regions. With the privatization of agriculture and the disbanding of production teams, township and village enterprises were the only suitable places able to employ the former officials who had administered the production teams. These officials were relatively well educated. They were also more exposed to, and had better ties with, the world outside their villages. But this alone is not a convincing explanation for the success of these enterprises.

State-owned enterprises enjoyed even better ties with, and received far more support from, the government. We have to explain why the close relationship with local governments worked in favor of township and village enterprises, while a close relationship with higher-level governments worked to the detriment of state-owned enterprises. Attributing the success of township and village enterprises to local governments offers little more than a factual description of a fortuitous feature of township and village enterprises. In running township and village enterprises, the local governments had to behave like real entrepreneurs – they had to take risks and bear full responsibility for their decisions. Unlike state-owned enterprises, township and village enterprises faced genuine budget constraints. Nothing can be more misleading than to suggest that the success of township and village enterprises vindicated the strength of the state vis-à-vis the market in directing the economy.

Also, recent studies have revealed the simple fact that a significant proportion of township and village enterprises were actually genuine private enterprises, particularly in the poor inland provinces.52 Based on a sample survey, the Annual Book of the Chinese Private Economy (1994, p. 71) reported that 83 percent of township and village enterprises were private in all but name. Two years later, the 1996 Annual Book (p. 112) reached a similar conclusion.53 According to the 1984 No. 4 Resolution of the State Council, which renamed the commune and brigade enterprises as township and village enterprises, they were so named because of their location; a fact recently brought to the attention of a wider audience by Yasheng Huang.54 It certainly does not mean that they were collective enterprises run by the town and village governments.

Probably the most important advantage enjoyed by township and village enterprises was the lack of bureaucratic control from the state. Unshackled from the state industrial production plan, township and village enterprises managed their production in accord with market demand and were able to respond quickly to changing market opportunities. State-owned enterprises had to wait for approval from government agents if they wanted to deviate from the prescriptions of the plan. The flexibility enjoyed by township and village enterprises provided them with an enormous advantage. Even after the enterprise reform began, state-owned enterprises remained constrained by administrative red tape. Labor mobility between the state-owned enterprises was minimal; worker redundancies were treated as a political decision and decided by government bureaus. While state-owned enterprises were better equipped and financed, they never had the incentives available to the managers of township and village enterprises. For a long time, they did not even need to worry about how to market or sell their products – the first product advertisement made by a state enterprise occurred on June 25th, 1979, when a machine-tool firm in Sichuan advertised their products in the People’s Daily. But the privilege came with a steep price; the spirit of enterprise was lost in state-owned enterprises.55

As non-state entities, township and village enterprises were severely constrained in their access to all markets. However, their autonomy enabled them to pay bribes – a “price premium” – to purchase raw materials and sell their products. They were also free to make their own decisions about personnel management, employment contracts, and compensation. For example, bonus and piece-rate compensation were widely used to link rewards to contribution. In addition, township and village enterprises initially concentrated on making goods that were in high demand as a result of economic reform but which were ignored or underserved by the state sector. These included construction materials, residential construction, transport, light industrial products, and household items. Compared with state-owned enterprises, township and village enterprises used labor-intensive production methods with low-technology components. According to one estimate, the ratio of labor to fixed capital in township and village enterprises was eight times higher than that of state-owned enterprises.56 In addition, between 1984 and 1988 township and village enterprises enjoyed access to bank credits, which facilitated their growth.

It did not take long for township and village enterprises to pose a serious challenge to the state-owned enterprises. With high compensation and other benefits, they lured skilled workers and managers from the state sector. With their right to retain all profits, they invested heavily in upgrading their production technology. The fierce competition unleashed by township and village enterprises forced state-owned enterprises to respond in kind. With the rise of township and village enterprises, Chinese industry was no longer monopolized by state-owned enterprises, with the exception of a few sectors protected by the state. The positive impact of township and village enterprises went far beyond their contribution to GDP. Having introduced competition into the Chinese economy, they acted as a powerful catalyst for economic transformation.

V

Like their rural counterparts, the marginal forces in urban China were also a legacy of Mao’s social and economic policies. A proud boast of socialism was the lack of unemployment, at least on paper. Unemployment was viewed by socialism as an evil reality of capitalism. One of Mao’s solutions to the challenge of unemployment was to send millions of city youth “up to the hill and down to the countryside to learn from peasants.”57 Even though framed as a political campaign to re-educate the city youth, the program was enforced as it was a convenient solution to the problem of urban unemployment. At the same time, all factories, stores, hospitals, and other service providers in cities, along with governmental and educational departments, were organized into “units.”58 Since unemployment was not allowed to exist under socialism, all units in Chinese cities were tasked with absorbing as many workers as possible, even when their net product fell below their wage bill. But the problem of unemployment remained, and the practice of sending urban youth to the countryside continued from the early 1950s and reached a peak during the Cultural Revolution.

With the death of Mao and the end of the Cultural Revolution, the practice of sending city youth to the countryside was stopped, officially ending in October 1978. But long before its official termination, the young men and women had become desperate to return to the city. A phenomenon in Chinese cities at the end of the1970s and early 1980s was the sudden influx of “returned youth,” estimated to be in the range of 20 million, who accounted for 10 percent of the urban population.59 Beijing had more than 400,000 “returned youth” in 1979, accounting for 8.6 percent of the city’s total population. The situation in Tianjin was worse, with 380,000, representing 11.7 percent of the total population.60 The pressure the returned youth placed on employment was overwhelming. In addition to the government sector, the only other employers were state-owned enterprises and a small number of collective enterprises managed by street committees. These were already hard pressed and could not possibly take in such large numbers of prospective employees. Reluctant to acknowledge the specter of unemployment and admit a failing of socialism, the Chinese government coined a new term for the returning youth, “youth waiting to be employed.” Creative rhetoric, however, did not change the dire situation on the ground. Protests erupted in the larger cities as few returned youth could find jobs and no solution seemed forthcoming. In early 1979, unemployed youths in more than twenty-one provinces mounted various forms of protests, including blocking railways and encircling government buildings.

Xue Muqiao, a renowned economist and economic advisor to the State Council, published a paper in the People’s Daily on July 20th, 1979 that urged the government to permit self-employment. This strategy had been used effectively, immediately after the founding of the People’s Republic of China, to tackle the problem of unemployment that many cities faced in 1949–1950.61 As a loyal Party member, Xue was committed to socialism and the collective economy; but as an economist, Xue knew what practical measures would be effective. The mounting employment pressure and the risk of large-scale social unrest forced the Chinese government to implement Xue’s suggestion. On September 29th, 1979, at a meeting held to celebrate the thirtieth anniversary of the People’s Republic, Head of the State Ye Jianying called for the recognition of the “individual economy (geti jingji)”; this was a euphemism for private economy.62 Three months later, the first officially registered “individual economy” made its appearance in Wenzhou on November 30th, 1979. The floodgates were now open for a revival of private economy in urban China. What Mao had condemned as the antithesis of socialism was officially welcomed back as the “appendix to and complement of socialism.”63 Two years later, on October 17th, 1981, the Central Committee and the State Council jointly issued Several Decisions on Opening up the Door, Enlivening the Economy, and Solving Employment Problems in Cities and Towns, in which the “individual economy” was promoted as a “necessary complement” to the socialist collective economy.64

The rise of the “individual economy” ended the monopoly of the collective economy in Chinese cities and towns. Outside the state-controlled public sector, a completely new economic force came into being. Even though it was formally recognized in 1981, the individual economy did not earn equal protection until 1992, when the market economy was officially recognized as an integral part of Chinese socialism. Throughout the whole decade of the 1980s, the private sector, like township and village enterprises, was beset by policy constraints and social discrimination. For example, parents in cities would not marry their daughters to young men employed in the private sector – these jobs were deemed insecure, inferior, and quite disgraceful. Entities in the individual economy could not hire more than seven employees – any private enterprise of eight or more employees was deemed to be capitalist and was therefore illegal.65 To get around this and other restrictions, many private firms were forced to put on “a red hat” – affiliating themselves with a township and village government and thus turning into a township and village enterprise, or with a street committee or other local governmental branches in cities and thus becoming a collective enterprise. The Chinese government still believed that the public sector was the economic foundation of socialism, and thus remained reluctant to embrace the private economy. But the challenge of mass unemployment and the accompanying potential for social unrest forced the Chinese government to give in. As a result, the policy of “Three Nos” – no promotion, no publicity, and no ban – prevailed as a compromise during the 1980s and early 1990s.

The rise of the private sector followed a marked geographic pattern, which further illustrates the marginal nature of this revolution. Wenzhou in Zhejiang was one of the poorest regions in the province during Mao’s era.66 A mountainous area with little fertile land, Wenzhou was poorly suited to farming. Being a coastal area, Wenzhou had received little state industrial investment due to the perceived risk of a war with Taiwan. Transportation in the region at the end of the 1970s remained as primitive. Nonetheless, Wenzhou quickly became the cradle of the Chinese private economy in the early 1980s. Even though the Chinese government officially recognized the private economy in 1981, their commitment to socialism led the government only reluctantly to allow it to complement the public sector, restricting its scope of operation. In the areas where the public sector was sufficiently strong, the room for private economy would be limited. With no state sector to protect, the local authority in Wenzhou was much more tolerant of the private sector than it might otherwise have been. Once the private sector began to develop, the local authority encouraged and protected it as a substitute for the collective economy; in other places with a strong state sector, the private sector was vigilantly watched. It is also important to note that pre-1949, Wenzhou had a long history of commerce and manufacture (mostly handicrafts) and this heritage, along with the lack of a public sector, allowed the private economy to thrive. In contrast, regions that had enjoyed heavy public investment during Mao’s era, such as the northeast region of China, the most industrialized area in China at the eve of reform, saw only mediocre growth in the private economy.

VI

Among the marginal revolutions that started China’s market transformation, one in particular played a pivotal role in opening up China to the global economy. This was the development of Shenzhen and the other Special Economic Zones. Before it became a household name in China, Shenzhen was a small poor town in Bao’an county in the southeast corner of Guangdong province. Situated across the water from Hong Kong, it would become the frontline of China’s integration to the global market economy.67

Due to its unique location, Shenzhen had long been a favorite exit for illegal emigrants fleeing from China to Hong Kong.68 The largest exodus during Mao’s time occurred immediately after the failure of the Great Leap Forward. A journalist from the People’s Daily by the name of Lian Yunshan was sent to investigate this incident.69 Lian conducted investigations on both sides of the border. He spent more than a month in Hong Kong interviewing border patrol officers and residents, particularly those who had recently fled the mainland. What Lian saw and heard in Hong Kong made him acutely aware of the economic gap between the two. His investigations suggested to him that the only long-term solution was to set up a special trading zone in Shenzhen, emulating Hong Kong on the other side of the border. Lian wrote a report to his immediate boss, who thought it too radical to be publicized. Deng Xiaoping was probably the only top leader who ever saw it.

The problem of illegal emigrants arose with an unprecedented intensity in the late 1970s, mainly because of a rumor of an immigration amnesty in Hong Kong. With thousands of people rushing to cross the maritime border, many drowned and their bodies floated back to the shore of Shenzhen. Collecting and burying corpses became a regular job. In some border villages, more than half of the working population had left. Illegal emigration had escalated into a public emergency.

Deng Xiaoping visited Guangdong province in November, after his return to power in July 1977. Local officials told him of the worsening problem of illegal emigration at Shenzhen and requested more soldiers to guard the border. Deng was reported to have said, “This reflects problems in our policy. There is nothing the army can do.”70 Afraid to ask for clarification, local authorities were left puzzled. In their minds, only traitors of the motherland and enemies of socialism could possibly desert the mainland for the corrupt and backward capitalist economy on the other side of the Shenzhen River.

The Party Secretary of Guangdong province, Wu Nanshen, decided to conduct his own investigation. What he found was the tale of two Luofang villages. Many people from the village of Luofang on the Shenzhen side had fled to Hong Kong (the New Territory) and lived right across the Shenzhen River on the other side. They also named their new home Luofang. During his investigation, Wu was shocked to discover that the villagers of Luofang in Hong Kong earned almost a hundred times as much as their counterparts in Shenzhen. Now, Wu understood Deng’s comments, and he reached the same conclusion.71 Unless the economic gap was reduced, neither political nor military means could stop illegal emigration.

A year later in January 1979, Wu visited his hometown, Shantou, a coastal city in the southeast of Guangdong. In the 1930s, Shantou had been known as “little Shanghai” for its vibrant commerce and local economy, broadly comparable to Hong Kong’s. Forty years later, Hong Kong had become one of the burgeoning “Asian Dragon” economies. Shantou, on the other hand, had simply decayed. How could Shantou catch up? A businessman from Singapore suggested a solution to Wu: an export processing zone, a practice that had served Taiwan and Singapore well during the take-off of their economies, might work in China as well.

A similar idea had already been tried in Shekou, another town in Bao’an county. In this case, the pioneer was not a government official trying to revamp the local economy, but a Hong Kong-based business owned by the Chinese government, China Merchants. China Merchants was originally a shipping company set up by Li Hongzhang in 1872. It managed to survive the tumultuous war years of the late nineteenth and early twentieth centuries and, after 1949, it became part of the Ministry of Transportation of the People’s Republic. In June 1978, China Merchants appointed its twenty-ninth leader, Yuan Geng. Yuan was a war veteran; he had been a spy operating in south China, including Hong Kong, during the war of resistance against the Japanese. Then, after the founding of the People’s Republic, he worked as a diplomat in south Asia. He was then imprisoned for more than five years during the Cultural Revolution, but was freed in 1973 and took a high-level position in the Ministry of Transportation. Known for his straight talking and sharp and independent thinking, Yuan was respected by his colleagues as a capable, honest, enterprising, and open-minded individual. At the age of sixty-one, Yuan was chosen to head the by now rather neglected China Merchants. Ambitious and energetic, Yuan quickly formulated a plan to turn China Merchants into a competitive, profit-making corporation, with interests in manufacturing, trade, and shipping. Since land was prohibitively expensive in Hong Kong, Yuan turned his eyes to Shekou. In January 1979, a proposal was sent to both the Guangdong provincial government and the Ministry of Transportation in Beijing, detailing plans for an industrial park in Shekou. It was approved by Guangdong province on the 6th, and the Ministry of Transportation on the 10th, and the proposal was then sent to the State Council. On the 31st, the Deputy Prime Minister, Li Xiannian, approved the proposal. The Shekou Industrial Park, the first such area in China, thus became a reality. In approving Yuan’s proposal, Li actually offered the whole Nantou peninsula, some 30 square kilometers at least. But Yuan took only Shekou, at the southern tip of the peninsula. Yuan reasoned that, if the project failed in Shekou, which was barren land, it would have little effect. Other districts on the peninsula already had some industrial infrastructure and to incorporate them into the Park would both increase costs and multiply the political risks.

In the meantime, Wu Nanshen discussed the setting up of an export processing zone in Shantou with other provincial leaders, particularly Xi Zhongxun and Yang Shangkun. The leaders at Guangdong were aware of Yuan’s proposal, but developed an even more ambitious plan, aiming to turn the whole province into a laboratory to test various practices that had brought success to Hong Kong and Taiwan. They believed that Guangdong, which bordered Hong Kong and Macau, should be a pioneer in the coming economic reform.

At a working conference held in Beijing in April 1979, which was attended by all provincial heads and central government officials in charge of economic affairs, Xi Zhongxun, the representative for Guangdong, put their proposal on the table. He stressed that Guangdong could take advantage of its proximity to Hong Kong and strong links to overseas Chinese to begin economic and technological exchange with the outside world. Despite strong resistance from some, Xi’s proposal won majority support, including that of Hua Guofeng, who was eager to open up China and strengthen economic ties to the outside world.

Gu Mu, the Vice Premier in charge of trade, reported these discussions to Deng Xiaoping. Deng was pleased with the proposal from Guangdong and recommended the title “Special Economic Zones.” In the following months, Gu worked intensively with provincial leaders in Guangdong and also in Fujian. On July 15th, 1979, the Central Committee and the State Council issued a joint resolution, approving the development of special economic zones in Guangdong and Fujian. These special zones were to be more than industrial parks for export-oriented firms. They would also provide all educational, commercial, legal, and governmental services necessary to support the success of manufacturing and trade. Thus, in the special zones, an industrial park would be joined by a science and research district, a residential district, a commercial district, and a governmental district. Once completed, each special zone would be a fully equipped, self-sustaining economic entity.

Officials in Guangdong had one further concern: they wanted to write the Special Economic Zones into law, making them more credible to outside investors. The idea had been suggested to them by some businessmen from Hong Kong. On August 26th, 1980, the National People’s Congress passed the Regulations for the Special Economic Zones in Guangdong Province. In the process of revising the draft of the first Special Economic Zones Regulations, the concerns of the Chinese leaders were laid bare.

First and foremost, the Special Economic Zones were intended to “appropriate capitalism for the good of socialism.” After visits to Hong Kong, Macau, Singapore, Japan, the United States, and Western Europe in 1978 and 1979, Chinese officials had been shocked by the astonishing technological advancement and economic efficiency achieved by the capitalist system and the pleasant living conditions enjoyed by the middle classes. They were forced to appreciate the extraordinary strength of capitalism in innovation, technological as well as institutional, a point actually made a long time ago by Marx himself. Chinese leaders no longer doubted that China’s pursuit of socialism could learn a lot from capitalism. This desire to learn from capitalism was, however, still matched by an enduring commitment to socialism. Few in the Chinese government doubted the viability of socialism. They believed that, with capital and modern technology borrowed from capitalist nations, China would catch up with the West because of the superiority of socialism. Following the steps taken by their predecessors at the end of the Qing dynasty (1861– 1894), who had tried to borrow western technology to strengthen Chinese traditional culture, the Chinese communists were set to appropriate capitalism to save socialism.

The Special Economic Zones were expected to serve as a laboratory in which to experiment with capitalist principles in the advancement of socialism. The zones had autonomy and were given incentives to learn from capitalism. If still confined to the parameter defined by socialism, the Special Economic Zones would not be special at all. At the same time, they were not meant to be stepping stones for capitalism to conquer China; their ultimate goal was to serve socialism. But, as a Chinese idiom puts it, it is hard to keep a window open and let fresh air in but keep the flies out. The government’s fear of encroaching capitalism would haunt the Special Economic Zones throughout the 1980s.

The first four Special Economic Zones, Shenzhen, Zhuhai, and Shantou in Guangdong and Xiamen in Fujian, were selected due to a compromise. In the first instance, all four places were located in what historians call “maritime China”:72 areas with close ties to overseas Chinese and which have a long history of maritime trade with the outside world. This geographic factor had been a disadvantage for Guangdong and Fujian during Mao’s time, when Beijing invested little there in fear of a military conflict with Taiwan. But now their close proximity to Hong Kong, Macau, and Taiwan became beneficial and they were selected to spearhead China’s reopening up to the West. These four cities were not the only ones that had this geographical advantage. At the time, other cities were also considered, including Dalian and Qingdao, close to South Korea and Japan, and Shanghai. These were quickly rejected on the grounds that these cities, particularly Shanghai, were so important to the Chinese economy that a failed experiment would have devastating repercussions on the socialist economy.73 With the four places eventually chosen, the impact of failure on the rest of the economy would be minimal. This concern was clarified by a statement made by one of the vice premiers: “We [had] to put a fence around the provincial border of Guangdong so that other provinces would be sheltered from the bad influence of capitalism.”74

Among all the Special Economic Zones, Shenzhen stands out. The pioneering role played by the Shekou Industrial Park, later incorporated into the Shenzhen Special Economic Zone, was an important factor in the unparalleled rise of Shenzhen. As a company under the Ministry of Transportation, China Merchants enjoyed many advantages not available to a local government, including direct access to various ministers in Beijing and the State Council. The Shekou Model and its motto, “Time is money; efficiency is life,” shocked China in the 1980s by new ways of thinking and new practices. Shenzhen, a frontline town, now became a testing ground for market forces in China. As the first and biggest Special Economic Zone, Shenzhen attracted budding entrepreneurs and other talents from all over China, including those who were discontented with the status quo and dreamt of a better future. In the past thirty years, Shenzhen has been transformed from a fishing town of less than 30,000 people to the third largest and the fastest growing city in China with more than 14 million residents. A once perilous route of human trafficking has now become a dazzling beacon of commerce.

In 1984, after the initial success of the first four Special Economic Zones, the Chinese government decided to open fourteen other coastal cities to foreign investment. In 1988, Hainan Island, the Yangzi River Delta, Pearl River Delta, Xiamen-Zhangzhou-Quanzhou in southern Fujian, Shandong Peninsula, and Liaodong Peninsula in Liaoning were opened to foreign direct investment. In 1992, the Pudong New Area in Shanghai was created as a Special Economic Zone. After this, all provincial capital cities were gradually opened to foreign investment. The most recent ones added to the list of Special Economic Zones were Binhai New Area in Tianjin in 2006 and Kashi in Xinjiang in 2010. After three decades of reform, the Special Economic Zones have grown steadily and spread inwards from the periphery to the core of China’s economy.

VII

As we have shown, Chinese economic reform gained momentum after the Third Plenum of 1978, as the Chinese government endorsed reform measures that had first begun under Hua. If there ever was an overarching principle underpinning Chinese reform at this early stage, it must be what was then called “dispel chaos and restore order.” The new Chinese leadership centered around Deng Xiaoping and Chen Yun shared a fairly consensual view on the origin of the “chaos” and the foundation of political “order.” To a large degree, the reforms implemented in both agriculture and industry were meant to steer China back to the economic policies designed prior to the Cultural Revolution.

In agriculture, the policy of “unified procurement and redistribution” remained intact. Even though it was adopted in the early 1950s as an emergency plan, “unified procurement and redistribution” had since become the foundation of Chinese agricultural policy. The continuity of price control stood out as the core piece in the state-led agricultural reform that was intended to fortify the role of the state. The industrial reform was largely an extension of what had begun prior to the Third Plenum, giving more autonomy to state-owned enterprises. Since the Chinese leaders still viewed them as the cornerstone of socialism, they understandably pinned their hopes of reform on state-owned enterprises.

As state-owned enterprises were given the freedom to operate beyond the state quota, they started to undergo an unplanned metamorphosis, and emerged with a dual role. On the one hand, state enterprises remained a passive robot arm of central planning, receiving various factors of production from the state quota system and producing in accord with the state plan; on the other hand, they began to operate outside the state plan for economic profits. As a result, while central planning continued its function in allocating resources, a market mechanism emerged in parallel, signaling to state-owned enterprises what and how much to produce to take advantage of changing economic opportunities. There is no doubt that the state sector benefited greatly from the dual-track mechanism. At the very least, it did not suffer a severe disruption in economic coordination and consequently avoided economic recession, which was common among other transition economies in the former Soviet bloc. The presence of this dual-track mechanism and the duality of the state-owned enterprises made it a rather complicated task to assess the relative size of the state sector in the Chinese economy. The common practice of treating the total output generated by state-owned enterprises indiscriminately as in the state sector thus led to a biased overestimation.

China would probably have stayed on the intended path to socialism were it not for the marginal revolutions that reintroduced private entrepreneurship to the economy. Initially, private farming, rural industrialization, and the return of the “individual economy” in cities were all invariably treated with open hostility and even criminalized, as in the case of private farming. These grassroots reforms helped to resolve or ameliorate urgent economic problems, such as grain production, rural poverty, and urban unemployment. At the time, they posed little threat to socialism; the Chinese government learned to grudgingly tolerate them. Only after a considerable lapse of time did the Chinese government begin to embrace them enthusiastically when economic gains generated by the private sector had been recognized as indispensable for the socialist economy.

The four marginal revolutions – enacted by actors marginalized in Mao’s socialist economy – quickly gave birth to a dynamic private sector in China, freeing 800 million peasants from the state, allowing almost 20 million “returned youth” in the cities to set up their own businesses, and creating a few spots for foreign and domestic entrepreneurs to flourish and inadvertently showcase the dynamism of capitalism. Rather than the state-led efforts of Leap Outward or enterprise reform, it was these marginal revolutions that launched China onto a course of rapid economic development and transformation to a market economy. Even in the case of the Special Economic Zones where the state was deeply involved in their development, the main role of the state was to provide a relatively safe political and legal environment to allow for market competition. Instead of shoring up state-owned enterprises, the Special Economic Zones were first created in areas where socialism had failed or simply did not exist. This not only avoided the potential resistance to reform from the state sector, but kept the risk of a failed reform to the minimum.

Surprisingly, the Chinese government’s remaining commitment to socialism at the beginning of reform worked to its advantage. Its loyalty to socialism was responsible for the reform strategy that preserved the core of socialism (state-owned enterprises), while allowing marginal revolutions to develop in China. It was not that the core was kept intact. But the reform measures targeted at the state-owned enterprises were to save and strengthen the state sector, instead of bringing about privatization, the common approach implemented in Russia and other transition economies. As a result, while the reformed state sector was struggling along, a non-state sector brought about by marginal revolutions was rising up strongly and swiftly outside the state-controlled economic plan. China was taken back to a mixed economy, which had benefited China before Mao rushed China into the socialist transition in the early 1950s. The contemporary shift in ideology and mentality at the political center was also crucial. Largely due to the debate sparked by “Practice is the only criterion for testing truth,” the pronouncements of Mao and Marx no longer enjoyed the divine power to dictate economic policy. As a political party brought up on strict ideology, it would take a long time for the Chinese Communist Party to fully commit to “seeking truth from facts.” Hu Yaobang, first as head of the Central Party School and later as General Secretary of the Party, made a critical and lasting contribution. When most Chinese leaders took the Cultural Revolution as the beginning of the “chaos” that had consumed Mao’s China, Hu went further back. Consequently, while economic reform modeled itself on “four modernizations,” a program first proposed by Zhou Enlai in 1964, Hu sought to rectify the political “chaos” whose seeds were sown throughout the Party history when terror and violence were used to settle political disagreement. By recognizing the much earlier origins of the “chaos” that China had to clear up, Hu took a big step ahead of his colleagues in conceiving China’s new political order.75

In addition, we ought to credit the political acumen and judgment of Deng. In 1992, while reminiscing on the beginnings of reform, Deng thus commented:

On reform and opening up, there were disagreements at the very beginning . . . This was normal. No debate was my invention. Not engaging in debate, we thus have time to try different things. With debate, things become complicated. Time was wasted and nothing achieved. No debate, try boldly, and strike out boldly.76

 

Deng’s principle of “no debate” worked surprisingly well in reorienting the Chinese Communist Party away from Communism and towards practice. Without a clear vision of where China should be heading, post-Mao Chinese leaders opened their minds. Aware of deep and wide disagreements among the Chinese leaders then, particularly between himself and Chen Yun, Deng did not believe that theoretical debates could generate political consensus or provide solutions to questions that the Chinese government was facing. It thus forced the Chinese government to resort to “practice as the only criterion of testing truth,” encouraging bold experiments from below. This pragmatic shift in the political mindset of the Chinese leadership marked a distinct departure from Mao and his immediate successor, Hua. Without this, the marginal revolutions would not have been possible.

When reform started, the Chinese government first turned to industry and the state-owned enterprises. In launching a new military campaign, the general will surely send his strongest and best equipped soldiers to the battlefield. Likewise, the state will naturally rely upon its preferred and most resourceful actors to carry out economic reform. Not surprisingly, state investment and expectation were heaped upon state-owned enterprises in equal measure. The strongest elements of any society, however, are often not the best agents of change. It is not simply that the strongest actors are usually the beneficiaries of the status quo and are thus unwilling to change. Rather, the most powerful actors in society are often embedded cognitively in the existing system and can hardly think outside the box. Whatever they do is more likely to fine tune and perpetuate the system rather than transform it. It is the actors at the periphery who are able to bring to the stage different incentives, new skills, and fresh perspectives, critical ingredients for a revolution. In China, it was the peasants, the unemployed urban residents, and other marginalized actors in the socialist economy that turned out to be the vanguard of market transformation.

By 1984, when The Third Plenum of the Twelfth Central Committee was held in Beijing, the Chinese government had come to accept the goal of reform as building a “commercial economy with plan,” that is, a market economy in disguise. This was a landmark event in the history of the Chinese economic reform. It consolidated the marginal revolutions that had swept China since Mao’s death and officially recognized the legitimacy of the private sector under socialism. Socialist modernization – strengthening the state sector – ended its role as the leitmotif of reform. In its place, “building socialism with Chinese characteristics,” first proposed by Deng in 1982, was officially embraced by Zhao Ziyang, then General Secretary of the Party, in 1987 at the Thirteenth National Congress of the Party.77 This new unifying ideology wholeheartedly welcomed the market mechanism and, to a less degree, the private sector. The former would gradually overshadow and ultimately replace central planning; the latter would come to be treated more equally with the state sector. No one could possibly have foreseen such a sea-change in the Chinese economy as occurred in the first decade of reform.