China and Russia on Divergent Paths

Matthew Dearing

December 7, 2004

China and = Russia on Divergent Paths

China and Russia exemplified to the wor= ld the struggles of developing market economies.&= nbsp; There is no right way to develop a market; all western market econom= ies are filled with their own flaws as they continually develop. These two nations showed us the da= ngers of denying one of human beings’ most developed creations – that= of the institution. As we delve = into each story, we will find many similarities, and equally as many differences= as the two economies diverge on their own paths. One of the key components in distinguishing China&#= 8217;s path toward a market economy from Russia’s path is that w= hile one was relatively undeveloped,= the other was critically misdeveloped.

While the = role of the central government was strong in China<= /st1:country-region>, the example of a control economy was more evident in Russia. Vladimir Lenin’s New Economi= c Plan of 1921, focused on strong government control over large industries, banks,= and transportation and communications facilities. Small industries (with twenty or f= ewer workers) were given the ability to remain private (Bentley, Ziegler 1018).<= span style=3D'mso-spacerun:yes'> Not until, Joseph Stalin implement= ed his first Five-Year Plan did private ownership cease to exist in the Soviet Union. Under Stalin’s Plan all farms were collectivized, sending the fruits of agricultural production to more urban environments. The control economy emphasized hea= vy industry instead of consumer demand, keeping the focus of economic gains to= ward the long-run (Bentley, Ziegler 1019). As a means of industrializing a nation quickly, the plan was success= ful, yet the human and social consequences were severe.

The Chinese experience differed in many ways due to different historical and cultural e= xperiences. Chinese culture was highly ethnoce= ntric because of its harsh experiences with foreign merchants in years past. According to Bentley and Ziegler, = conflicts with merchants and the nations they represented led to unfair treaties on C= hina which “established a network of control over the Chinese economy that effectively prevented economic development” (1029). A sovereign China was impossible with exc= essive foreign intervention, and soon led to stirrings of nationalism among Chinese people. While nationalism bec= ame popular, so did Marxist ideology which viewed foreign manipulation as a capitalist conspiracy.

While Marx= ist-Leninist doctrine espoused the urban proletariat as the backbone of the communist revolution, Mao Zedong believed peasants were the foundation of the revolut= ion (Bentely, Ziegler 1032). Here= we find the split in communist propaganda between China and Russia. The example of China s= hows a rural sector with a “more fertile soil for entrepreneurship and econo= mic innovation than the urban population” (Naughton 282). Where one system will use the indu= strial proletariat to build an industrial nation, the other will use the agrarian peasant to build an agricultural nation. While development of heavy industry remained the first priority of Soviet developers, it was China’s agrarian system= , rich in labor power, which set first precedence.

While thei= r routes to a controlled communist economy were different, Russia and China shared many of the same characteristics which distinguish a controlled econ= omy. Barry Naughton explains that Russia and China both represented comman= d characteristics in their methods toward resource allocation and concentration of their reso= urces. Decisions on resource allocation w= ere made from the administrative hierarchy, working in a top-down style, rather than in response to market prices. Resources were at the disposal of planners who ultimately used them = to invest in areas they believed were most lacking (276). In order to ensure total control o= ver resource and production, the Communist Party controlled the elite class of nomenklatura, acting as the invisi= ble hand that moved one up or down in job status.

Corruption= was rampant, and it was not uncommon for familial relations to fill prestigious government posts. The financi= al sector was equally wrought with corruption. The state bank held a monopoly over financial assets and those in power could easily siphon money towards perso= nal endeavors. Even in the most e= thical institutions of any society; a system is vulnerable to corruption. As will later be seen, the transit= ion from control to market economics, in both examples, provided the opportune environment for further corruption to grow.

China and Russia both faced an equally difficult environment when reforms were launched. Mr. Naughton points out that the c= entral problem of economic reform is “the transformation of the predominant resource allocation mechanism from the plan to the market”, coupled w= ith this, reform “necessitates the creation of new institutions and new m= acroeconomic relationships” (279). T= his is a lesson China would e= nvision over time, as it evolved and implemented step-by-step reforms, but a lesson that Russia would ultimately be blind to on the eve of its Big Bang.

------China’s “Plan”------

China’s reforms, accord= ing to Naughton, were “without a blueprint” and, “without even a sense of what the ultimate objective of reform should be” (299).   One of the best decisions China made, in one sense, was to begin without a plan. This allowed for greater flexibili= ty toward new initiatives without the pressure of sticking to a stringent, but possib= ly fatal blueprint. Two main initiatives began: expanding enterprise autonomy and combining plan and mar= ket into a Dual Track program (Naug= hton 299).

Reforms be= gan by implementing experimental industries in specified regions of China.<= span style=3D'mso-spacerun:yes'> The process was meant to act as a test-run to see if the quasi-market firms could meet or surpass production standards. The experiments pr= oved well and economic planners announced implementation of the reforms for enterprises “selected” to have higher levels of autonomy. The firms were given limited sover= eignty in building profits. Whatever= was created above planned output could be kept as entrepreneurial gain. The notion of holding profits soon transferred over to financial institutions whose role would be to aid infant industries. Like Japan in the 1950s through the 1980s, China’s financial system remained closed while household savings was funneled toward investment projects (NYT C1). Reforms continued to be experimental and the level of freedom a firm held was done under watchful eyes. Contrary= to the Russian example of state enterprises transformed into private monopolie= s, large Chinese industries were an appendage of the state and compelled to move big profits into the state budget.

Another im= portant plan the Chinese implemented was the dual-track system. This plan allowed the state price = system to work alongside a market price system.&n= bsp; A single commodity would have two-tier pricing: low for state prices= and higher for market prices. Tho= se companies who had outputs higher than state mandate could sell their additi= onal outputs on the market for a higher profit.= The implications of this were great for bringing the invisible hand = into the picture and providing the entrepreneurial spirit that would drive a com= pany to increase production past simple quotas.= All factories were introduced to the market and thus offered a sense= of competition into the framework (Naughton 267).

Mr. Naught= on coined a phrase: “growing out of the plan”. This is a very important contrast = from the Soviet controlled system. By China implementing these market oriented reforms, it allowed itself the opportuni= ty to grow out of the controlled economy plan, until it became “less and less important” (267). = This was a long-run goal which the Soviet Union never envisioned. When the realization of change took place in Russia, short-term achievemen= ts took precedence over any long-run manifestations.

------Russia’s Big Bang is a = Big Bust------

We title t= his short-term ambition, Russia’s Big Bang. It called for rapid= and immediate privatization; and why not? Russia sits over one of the greatest oil and gas reserves on Earth and is endowed = with vast natural resources including metals and energy. Its level of industrialization was= a colossus to China̵= 7;s, second only to the U= nited States.= With so much wealth, how could its economy plummet in so little time?   As Douglas North = would say, institutions matter.

Learning (…) is an increm= ental process filtered by the culture of a society which determines the perceived pay-offs, but there is no guarantee that the cumulative past experience of a society will necessarily fit them to solve new problems. Societies that get ‘stuck= 217; embody belief systems and institutions that fail to confront and solve new problems of societal complexity.

When the nearly 75 years of= Soviet control was swept under the rug, no one knew what to expect. While others waited for official o= rders, the future oligarchs plotted. The breakdown of a centralized bureaucracy and the absence of any form of administrative control over a newly instituted capitalist system doomed it = to failure. Failure in planning = for this huge reform with qualified institutions to safeguard against the ills = of privatization allowed a capitalist-oligarchy to rule the Russian economy.
            While the Chinese started with an unwritten plan towards reform they held onto th= e structure and order imposed by the command economy.&= nbsp; Russia dropped this safety net, allowing highly motivated individuals to acquire v= ast ownership over state-owned enterprises.&nb= sp; Russia became a land of survivalists vs. entrepreneurs, where the survivalists cro= wded out investment the gangster way. For a nation to drive a system of free market capitalism with no training wheel= s or governing rules was economic suicide. As Cohen and Schwartz explained, the “hazards” of using capitalist markets in Russia were clear because of the “complete lack of experience in using these markets” (384).

        &= nbsp;   Today Russia experiences around 7 percent annual growth, however this number is misleading. With the rise of = oil prices taken into account, real GDP is around 4 percent. Putin desires to double GDP in a d= ecade, but in order for this to occur it would rely on oil prices remaining high a= nd Russia blessed with 8 percent unbroken annual growth. With Russia’s meager surplus= es from oil profits, this money is redistributed to suffering regions stricken with mass unemployment instead of improving infrastructure or raising capit= al growth.

What reall= y holds back growth according to the Economist, is = Russia’s bureaucracy, p= lagued with bad management and corrupt officials.= The main question is, “whether Russia can become a long-term= home to successful, competitive companies” (421). So far the answer to that is ̶= 0;not unless you play ball with the state”. If the horrors of small Russian businesses being swallowed up by phony corporate entities go unresolved in = the Russian judicial system, few foreigners will feel compelled to invest[1]. Bernie Sucher at Alfa-Capital expl= ains, “The judicial system is 100 percent corruptible. There isn’t a single case th= at can’t be influenced by money” (443).

Cohen and = Schwartz correctly noted the coming tide of corruption in Russia: regulators unable to police market activity because they lacked experience, stocks sold to “invisible partners” allowing the old nomenklatura to cash in on millions, and c= ertainly the rise of the black market – which provided a glimpse back in the p= ast of America’s 19^th century crony capitalists or 20^{th
century robber-barons (382).}

            Russia&= #8217;s set of robber-barons are those tycoons who gobbled up the state industrial sector for dirt-cheap prices. Today, many believe the industrial magnates in Russia flourish only from = 220;a protected home market, helped along by political connections”, but wh= en those magnates step out of bounds of the economic sphere to enter into political debate against President Putin, the political connections disappe= ar.

Corruption= has grown in recent years in Russia. President Putin’s plans at reforming the structure of government may or may not help. Like an old-fashioned autocrat, he= has securely placed himself around individuals who do as their told. The Economist explains that: “Cabinet purges have been aim= ed at those loyal to the oligarchs (…)” (439). Putin’s “power people,= ” come from his former line of work: intelligence, military, and law enforcem= ent (439). Putin has amended legislation to allow the Kremlin to appoint the 89 district governors of Russia, bypassing popular vote. These reforms are clearly used to build a front against the power of the oligarch= s. As changes are made, Putin commonly refers to their significance as combating = the “war on terrorism”. As praetorian as this may seem, Putin could bring a level of stability to an otherwise chaotic environment. Crony capitalism only stunts the growth of capitalist endeavors for many small businesses and industrial enterprises and reduces the flow of foreign capit= al investment. As Putin continue= s to build a more authoritative regime, one can only wonder how far he will go.<= /p>
------China’s Economic Woes Remain------

The state = of the Chinese economy today can be characterized by a glass of water, depending on how you look at it, half-empty, or half-full. Today’s industrial organizat= ions in China= are mainly run by state enterprise. The state however, is failing to efficiently maintain the industrial sectors. While the state owns= over two-thirds of industrial assets, these assets contribute only one-third of output. Much of their technology is over 50 years old being operated by individuals supplying low levels of productivity and governed by poor management. Many factories are operating at less than 60 percent capacity (Hughe= s 349). It is no surprise that productivit= y is low since most workers receive meager wages, no benefits, and work in hosti= le environments. Those on fixed = income suffer the most as runaway inflation has hit annual levels of 15 – 30= percent [2]. The perspective for employment in = the state industrial sector is bleak. Government statistics show that 78 percent of the Chinese work force had joined state pension plans by the end of 1996 (Hughes 350). As Chinese retire they will find a= government unable to fulfill their promises.

The other = side of the work force is governed by private ownership, collectives of private fir= ms, and a massive, mobile work force. Collectives, on the whole, outperform state enterprises and account = for 40 percent of total industrial output.&nbs= p; While these individuals have a higher level of disposable income it = has hardly remained equivalent to rising inflation. Ch= ina has tens of millions of unskilled workers willing to work for less than $10= 0 a month hardly enough money to buy the vast amount of products China p= roduces (NYT C1). While the standard = of living has increased for many in China, as much as to create a= small middle class, wages remain substandard for the majority. Li Qingyuan, a Chinese government economic advisor, points out the need for an increased standard of living: “(…) if you want to make the market work, then you have to have some incentives”[3]. One of those incentives must be hi= gher wages in order to increase domestic consumption.

One need o= nly visit an urban rail station one morning to find a few thousand migrants looking f= or work. Migrants in China number more than 100 mi= llion as jobs become scarce in rural regions.&nb= sp; They take the trains to the large urban sectors in hopes of landing a job. Those not lucky enough t= o find one are stuck at the station with out even the money to purchase a return ticket home³.

A lot ride= s on the continued progress of the Chinese economy.= For the Communist regime, the Party’s rule is, “(…) only possible to the extent that the government delivers economic growth= 221; (NYT C15). The United States relies upon a continued econ= omic relationship of cheap imports from China, and China relies upon = the U.S. to= consume their over-production of goods to keep unemployment levels from skyrocketin= g. The resiliency of this relationshi= p is only now being tested as the U.S. dollar plummets.

Corruption= is not only limited to the Russian failed economy. China has its own devils secr= etly tucked away, far from the sights of human rights observers. Corruption is most abundant within= the government system itself. Off= icials paid meager salaries will frequently siphon funds to put food on the table.= Those in power, like one mayor in = Shenyang, was name= d the “bastard mayor” for running his own “virtual fiefdom̶= 1; (361). Democracy is nonexistent for there= is only one legal political party. Newspapers, internet web servers, and mass media are controlled, if = not run, by the state. Political dissent can easily land one in prison or worse. It is a structure that will ultima= tely hurt the Chinese economy, but in all likelihood will be razed as the power = of the middle class heightens.

------Russian Life is “Normalno= ”------

The standa= rd of living is no less bleak in Russia. While Russian advertisements and television routinely portray the “new Russian” as dignified, se= xy, and hip, reality describes him as wretched, cheated, and forgotten.

The end of Communism meant the end of state support towards the loyal and faithful. The foremost problem for the common Russian is avoiding an early death. The most common ways range from health-related issues. Nearly two-thirds of men smoke, and= vodka remains cheaper than water. H= IV is becoming an epidemic with roughly 10 million infected and as the Economist = explains, “condoms are about as popular as seatbelts” (431). The decline in the birthrate does = not bring any condolence to the issue. Some figures show the population declining from 145 to 55 million by 2075 (431).

            Given the shabby state of the Russian economy, as the Big Bang approached, it bec= ame a priority to move towards total privatization. Any other move would be an “unthinkable move backwards to the Third World= ”[4]. And yet today Russia remains in a backward-state because of its failure to realize something China d= id: institutions must be developed first, and then a stock market and an approa= ch toward private property and ownership.&nbs= p; Economic man can not create himself from a vacuum. There must be structure and a set = of external forces to govern the game. Any attempt to subvert an institutional framework will prove disastr= ous to the plan.

China held onto its structure= even without the strength and power of its Russian rival. The dual-track system and an idea = to grow out of the plan helped China build a model dependent upon both the plan and the market. This achieved high growth rates ov= er many years, and continues to grow the economy to a point in which it could = pass the United States by 2034 (NYT C1). While these controls put in place were essential for the infant Chinese industrial sect= or it is unknown how far autonomy could have been granted without inflicting similar failures as were seen in Russia (Noughton 300). One thing is for sure, the administrative structure and supportive institutions were, and remain, an essential bridge towards creating the system of free and fair markets in China.

The Russia= n and Chinese experiences are far from over.&nbs= p; This analysis can only briefly touch upon the key decisions which pl= ace them where they are today. As= each nation goes its separate way, they will realize there is no right path, rat= her many that are wrong.

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6 Dec. 2004: C15.