First published: May 1996
The most conclusive indictment of the economic policies which have devastated Eastern Europe and the former Soviet Union since 1989 and 1991 is their contrast with the spectacular success of the reform of the world’s second major centrally planned economy – China – a model now being increasingly applied in Vietnam and Cuba. China’s success shows that the suffering inflicted upon the peoples of Eastern Europe and the former USSR, under the guidance of the IMF, was totally unnecessary.
Since 1978 China has been the most rapidly growing economy in the world. Economic growth averaged 9.4 per cent a year between 1980 and 1993, and moved into double figures after 1991: ‘China doubled its output per person in the ten years between 1977 and 1987, one of the shortest time periods for any country to achieve such a record. This impressive growth has in part been the result of significant increases in factor productivity in both the state and non-state sectors, a point of some importance given the well-documented failure of centrally planned socialism to raise productivity. The result is China’s economy is now estimated (using purchasing power exchange rates) to be surpassed in size only by the US and Japan and there is a real possibility that China will become the world’s largest economy by 2025.’ 
By contrast, under the guidance of the IMF the economies of Eastern Europe and, even more so, the former Soviet Union, have experienced an economic collapse unprecedented in peacetime in the modern world. In the former Soviet Union output is now less than half its level prior to capitalist economic reform – and falling. In Russia productivity declined by 22 per cent in 1992 alone.
The rise in living standards in China and rise in death rates in Russia
The driving force of China’s sustained economic growth has been a vast rise in the living standards of its population (see table 1): ‘In per capita terms, there have been impressive increases in living standards evidenced by a three fold increase in average consumption of meat and eggs between 1978 and 1991, by a more than doubling of living space in rural areas in the same period, and by the fact that the ultimate basic consumer good, the television set was owned by an average of one of every two rural households and by virtually every urban household in 1991.’ 
|Table 1 Changes in the material standard of living in China, 1978-92|
|Index of real per capita consumption||100||252|
|Consumption per capita of:|
|Ownership of consumer durables (no. per 1100 people):|
|Retail outlets and food and drink establishments (no. per 10,000 people):|
|Health provision (no. per 10,000 people):|
|Housing space per capita (sq.m.)|
|Source: SSB. ZGTJZY: 1991, p. 42;.S5B. ZGTJZY, 1994, pp. 48. 51; SSB ZGTJNJ. 1993. pp. 279. 283-4. From Nolan, 1995|
By 1993, 83 per cent of city households had a washing machine, and, in Shanghai, 98 per cent of households had a refrigerator, 92 per cent a colour television, and 45 per cent a video recorder. 
As the Economist noted: ‘China’s economic performance in… 14 years… has brought about one of the biggest improvements in human welfare anywhere at any time… By 1994 China’s economy is almost sure to be four times bigger than it was in 1978; if China hits its targets, which are reasonable, by 2002 the economy will be eight times bigger than it was in 1978…
‘The overall figures mask a startling rise in living standards… grain output grew by a third in six years, cotton almost trebled, oil bearing crops more than doubled, fruit production went up by a half. Real incomes in the countryside grew even more spectacularly – threefold in eight years… Between 1978 and 1991 grain consumption of the average Chinese went up by 20 per cent; seafood consumption two fold; pork consumption two and a half times; egg consumption more than three fold; edible oil and poultry consumption four fold.’ 
These figures reflect a vast increase in production of food and consumer goods. China’s output of black and white TVs, refrigerators, washing machines, electric fans and irons has risen from negligible levels to become the largest in the world. 
The contrast with Russia and Eastern Europe could not be more stark. In Russia living standards fell by 50 per cent in 1992 alone. Far from the consumer society which many hoped capitalism would bring, output of food and consumer goods collapsed more comprehensively than any other part of the economy.
The social consequences have been horrific. The United Nations Children’s Fund (Unicef) reported at the end of 1995 that 34 per cent of Russia’s population had fallen below the subsistence minimum and that for men in the 20–39 age group in Russia, Ukraine and the Baltic states ‘the mortality increase due to heart, digestive and infectious diseases has taken on frightening dimensions unequalled in its magnitude in peacetime.’
Male life expectancy in Russia has fallen to just 57 years: ‘By 1993 Russia’s death rate had risen above even the level of low income countries. Russia’s death rate now stood on a par with that of such countries as Bangladesh, Nigeria, Sudan and Togo, a dreadful testimony to the awful results of the reform process.’ 
China’s rapid domestic economic growth became the basis of its much publicised trade performance. Since 1979 China’s exports have expanded at an annual rate of 16 per cent and moved steadily upmarket. Manufactures now make up 80 per cent of China’s exports: ‘The growing sophistication of Chinese products is also reflected in the shift towards exports of manufactured items from 50 per cent to 80 per cent last year… exports of machinery, electronic products and transport equipment are the fastest growing areas… capital intensive areas spawned an increase of about 86 per cent in exports of machinery and transport equipment in the first nine months of 1992, compared with 1991. Trade in these items accounted for 16 per cent of exports last year, compared with just 6 per cent in 1988.’ 
Russia by contrast has seen the dollar value of its exports nearly halved, from $63 billion in 1990 to $35 billion in 1994, and has been reduced to an exporter of raw materials and energy which, by 1993, made up 80 per cent of its exports.
With a Communist Party in power, China has become one of the largest recipients of foreign investment in the world – far greater than the whole of Eastern Europe and the Soviet Union put together. Foreign investment is drawn into China because it is the fastest growing economy in the world – major international companies simply cannot afford to keep out. Far from representing a weakening of China’s international position, this reflects its strengthening. China’s economic growth gives it the leverage to demand significant transfers of technology and training from foreign investors.
Russia, on the other hand, carrying out the policies prescribed by the IMF, has faced capital flight – $2Obn a year on Western estimates – far exceeding the combined total of foreign investment and transfers from the IMF, because its economy is collapsing.
In short: ‘The contrast in performance under reform policies is breathtaking. Almost every major indicator in the two countries moved in an opposite direction. At every stage of China’s reform programme commentators predicted that growth would shortly run out of steam. Instead, its economic boom continued almost uninterrupted right through to the mid-1990s Moreover, the most important indicators of all, those concerned with the physical quality of life, almost all showed substantial improvement alongside the accelerated growth of output and real income. In Russia, the poor performance of Gorbachev’s early years turned into a very poor performance in the later period of his rule. It became nothing less than a disaster in the 1990s. Output declined precipitously. While foreign investment poured into China, it shunned Russia. Most important of all, the indicators of the physical quality of life showed a sharp downturn with a large rise in death rates.’ 
Bourgeois explanations of the Chinese economic reform
Given their consequences for such a large proportion of the world’s population, explaining these contrasting economic performances should be a principal task for anyone seriously interested in improving the well-being of humanity. The IMF, for example, is perfectly aware that the contrast between Russia and China presents them with a serious political problem. Their view is that China is on route to the same destination as Eastern Europe, but it has only travelled half-way and must ‘catch up’ by privatising and bankrupting most of its state-owned industry. In other words, they want China to emulate Eastern Europe’s ‘success’!
Milton Friedman argues: ‘Using or not using the market is not the crucial distinction. Every society, whether communist, socialist, social democratic or capitalist, uses the market. Rather the distinction is private property or no private property. Who are the participants in the market and on whose behalf are they operating? Are the participants government bureaucrats who are operating on behalf of something called the state? Or are they individuals operating directly or indirectly on their own behalf? That is why in an earlier paper delivered in China, I advocated the widest possible use not of the market but of “free private markets”… The words “free” and “private” are even more important than the words “market”. The wide use of the market that is sweeping the world is better called “privatisation” – transferring government owned enterprises to private hands and thereby giving greater scope to the invisible hand of which Adam Smith wrote.’ 
In other words, for Friedman, China’s success in introducing markets within the framework of a planned economy must be rejected because it does not place private property in command.
The Wall Street Journal argues the same case even more emphatically: ‘China is still a largely socialist economy… The CP in China however hasn’t found a way to retreat from central planning… Privatisation is the obvious solution, probably it would be tantamount to bankruptcy in most cases, though some firms would yield a hefty liquidation value because of their land holdings. Yet the government has decided, on the whole, that public ownership must not be tampered with. As long as that commitment stands, China’s reforms will remain blocked… the state sector still haunts the economy, and until a stake is driven through its heart, we fear an ugly reckoning lies ahead.’ 
If what concerned the Wall Street Journal, the IMF or Milton Friedman were economic efficiency, let alone living standards, the only rational approach would be to reject the policies which brought disaster to Eastern Europe and apply those which brought success in China. This is not done because for the IMF et al everything is subordinate to the irreversible and rapid restoration of capitalism – irrespective of the social and economic consequences for the peoples affected.
As a Western advisor to the Russian government put it: ‘In 1992 Russia re-discovered capitalism – one of the main events of the century. Yet many people say the reforms have failed, since inflation is still rampant. This line of thought is flawed. For the aim of the Russian reform is to change from communism to capitalism.’ 
Thus the real concern was to destroy the planned economy as rapidly and irreversibly as possible, not raise living standards: ‘The experience to date shows that most of us looking at the transition process beforehand paid too much attention to the need to shatter the old system, and insufficient attention to the dangers of institutional breakdown and self-reinforcing fiscal and macroeconomic collapse. Indeed, the absence of these worries from the early literature is, in retrospect, quite striking.’ 
The Chinese road is rejected because its destination is not capitalism. Jeffrey Sachs and Wing Thye Woo, for example, conclude, that whatever China’s successes the critical issue from a capitalist point of view is: ‘The proportion of the Chinese labour force employed by state-owned units was 18 per cent in 1978 and was still 18 percent in 1992. This means that there were actually 32 million more Chinese working in state-owned units in 1992 than in 1978. The state-owned sector is not “withering away”.’ 
The Economist’s 1995 survey of Vietnam, which is applying a variant of the Chinese economic reform, points out that after four years of annual economic growth averaging 8 per cent, the weight of the state sector in Vietnamese industrial output has increased from 33 per cent in 1990 to 40 per cent in 1994. The Economist wryly comments: ‘The opening of the economy, far from weakening the state’s grip, is strengthening it.’ 
There is also a left version of the view that China is moving in the same direction as Eastern Europe but at a different pace. In this perspective, China is either on the road to capitalism, or already capitalist, because it is departing from an implicit model (derived from Stalin, not Marx or Lenin) that a planned economy must be based on the nationalisation of everything.
Even if this were the case – which it isn’t – no person concerned about raising the living standards of the majority of humanity, as socialists must be, can simply dismiss the extraordinary economic performance of China over the last 18 years. Whatever its mechanisms, it is obviously preferable to the fate which has befallen Africa, India, Latin America, the Middle East, the former Soviet Union and Eastern Europe. Therefore it has to be explained, not explained away.
However, the very facts which lead Sachs et al to reject the Chinese economic reform – that the state-owned sector is not ‘withering away’ – also refute the left variant of the view that China is on the road to capitalism, albeit more slowly than Eastern Europe. There has been no privatisation of large scale industry in China. Publicly owned enterprises (owned by the state and local government) continue to account for 80–85 per cent of China’s industrial output. Land remains publicly owned.
Far from different applications of the same economic medicine, China’s economic success derives from policies diametrically opposed to those pursued in Eastern Europe at the behest of the IMF: ‘At the end of this process [in China], public ownership remained a central feature of the property rights regime in every sector. The economy remained highly protected from the forces of international competition. The state remained at the centre of the economic process, having fundamentally shifted its approach away from economic commands towards economic planning which worked in tandem with market forces. In every major area, China pursued a reform strategy which ran counter to the transition orthodoxy. In terms of the conventional wisdom of the late 1980s about how to reform a Stalinist system of political economy, China got all of the main policies wrong, yet it was the world’s most dynamic economy in the reform period… The advice which flowed from this orthodoxy contributed substantially to the Soviet disaster. The decision not to follow it helped the Chinese achieve enormous success in their transitional programme.’ 
In reality, as we shall see, it is the retention of the industrial core of the Chinese economy under public ownership and the planning which this makes possible which is the key to the success of the Chinese economic reform. Those who claim that China, the most successful economy on earth in terms of economic growth, must ‘complete’ its success, by adopting the policies which caused the catastrophe in Eastern Europe, are living in an Alice in Wonderland world.
It is because China has been less ‘ successful’ than Eastern Europe in privatising industry and has not attempted to re-introduce capitalism that the Chinese economy has achieved a level of growth almost unprecedented in history. While Eastern Europe’s ‘success’ in this has produced economic collapse.
A second line of argument by the thinktanks of international capital is that whatever its strengths, the Chinese economic reform has no relevance to Russia. Jeffrey Sachs argues that China had a potential surplus labour force in agriculture which could be transferred into new private industries, whereas in Russia the largest part of the workforce was already immobilised in state industry – making the demolition of the state sector a precondition for the development of smaller enterprises in Russia.
In fact it is far more difficult to transform unskilled peasants into manufacturing workers than to transfer workers from one sector of manufacturing to another: ‘The comparison then is between the Russian task of transferring skilled urban workers to alternative manufacturing and service sector jobs versus the Chinese task of transferring unskilled peasants to manufacturing jobs. Which is more costly? The assertion that the Russians have a more difficult task would be met with disbelief by the majority of economists who have studied the development process. It is simply not true in general, and it is even less true in a situation where, at least at the outset of reform, the Russians have a close to full employment economy while the Chinese struggled with labour surpluses. The European centrally planned economies do not need to continuously generate millions of new jobs to absorb the workers shed by inefficient producers. In that sense, a moderate growth of new firms should be able to gradually draw workers away from inefficient state firms, and produce a transition without massive amounts of socially destabilising unemployment. The ECEs have the same unexploited niches that China has, but fewer reserves of grossly under utilised labour in the countryside. Thus, a strategy of opening niches to new entrants should aid the restructuring process more rapidly than in China. From this point of view, there is a mature economy variant of the Chinese pattern of economic reform. It would certainly produce less rapid growth, but it might be a strategy of reform preferable to one that induces maximum economic dislocation.’ 
In fact, as we shall see, there were fundamental similarities between the Russian and Chinese economies at the outset of reform. China’s problems of feeding its enormous population given the relative shortage of agricultural land, creating tens of millions of industrial and service jobs to replace those eliminated as agricultural productivity increases, the far lower starting point in terms of living standards, technology, education, industrialisation, and so on, made reform of China’s economy, potentially more, not less, difficult.
The distortions of the Chinese and Soviet command economies
The strength of the Soviet economy, and to a lesser extent China’s, was that it had created an independent heavy industry and sustained over a long historical period a relatively high rate of economic growth. In fact, the USSR and Japan, and latterly China, are the only large countries in the twentieth century to significantly reduce the gap in GDP per capita between themselves and the advanced capitalist countries (see Angus Maddison). This economic achievement, which would not have been possible without the October 1917 revolution, allowed the USSR to create scientific, cultural and academic resources unmatched in any country outside the United States. The USSR became one of the only centres of machine tool production, the nucleus of investment goods industries, in the world – the others being the United States, Western Europe and Japan. These economic achievements allowed the former USSR to eradicate extremes of poverty, create welfare services, achieve a high level of education and create a military capacity far superior to Japan and Germany which had threatened it in the past. Starting at a much lower level of development China also succeeded in creating a heavy industrial sector of its economy.
But the strategy of socialism in one country – formulated by Bukharin and applied by Stalin and subsequent Soviet and Chinese leaders – that the Soviet Union, on the basis of its own resources, could create a self-contained socialist economy also deeply distorted its economic development. Agriculture and light industry, and therefore the living standards of the working class and peasantry, were totally subordinated to heavy industry. Through forced collectivisation of agriculture in the USSR and the Commune system in China, attempts were made to eliminate the peasantry as a class. Consumer services, like shops and workshops, were grossly underdeveloped as a result of the largely successful attempts to eliminate the urban petty bourgeoisie. To take just one example, the problems of the Soviet retail system are easily understood when it is seen that only 6 per cent of the Soviet workforce was employed in retailing and wholesaling compared to 15 per cent in Germany and 22 per cent in the United States.
While the protection of industry from more advanced capitalist competition was necessary, the attempt to isolate the economies from the international division of labour was not. On the contrary, the most important single advance of the productive forces under capitalism, from which socialism must start and advance, not retreat, is precisely the international division of labour.
From these distortions flowed others – a pricing system which made rational planning impossible, shortages of consumer goods imposing an enormous burden upon women, and so on. These distortions in turn destroyed the incentive to work and to economise labour time – even where greater effort was rewarded by higher wages, there was little to buy with them.
This economic system required the suppression of democracy – because were the working class given the choice, it would have chosen economic priorities which raised, not lowered, its living standards. In the absence of both the market and any direct influence of the working class over planning, waste and corruption proliferated. This produced the characteristic disproportions of the bureaucratically centrally planned economies – in particular, a level of living standards manifestly lower than the degree of development of the economy permitted.
In the United States total individual consumption made up 68.6 per cent of the economy in 1991. In the former Soviet Union only 55 per cent of the economy was devoted to consumption. In China, in 1978 prior to economic reform, private consumption made up just 53 per cent of the economy.
This unnecessary underdevelopment of the consumer oriented sectors of the economy also undermined productivity of both labour and capital. It meant that the Soviet and Chinese economies were least developed in the most rapidly growing parts of the world economy – which are not steel, shipbuilding, etc, but consumer goods and services. Finally, this economic structure also impacted onto trade because heavy industry requires far higher levels of investment per unit of output than light industry, making it far more difficult to create industries capable of competing in the world economy.
The Chinese economic reform
To correct these structural imbalances in the Soviet and Chinese economies would have required a large shift in the economy into the production of consumer goods and services. The only rational strategy for achieving this would have been to maintain the economies’ achievements, the creation of heavy industry, while correcting the distortions – by prioritising the production of food, consumer goods and services.
The vast unsatisfied demand for consumer goods in both countries could have made the necessary ‘straightening out’ of the distortions of the planned economy relatively painless – because it would be accompanied by rising living standards.
As one recent study put it: households in both Eastern Europe and China ‘found their consumption aspirations frustrated, regardless of their level of money income. Supply of many goods was erratic, shortages were common, and household members often had to queue for available supplies, in the Eastern and Central European economies and China alike. Thus there was not only a low level of real resource allocation to households, there was also substantial unsatisfied demand at prevailing income levels.
‘These factors suggest that, in a sense, radical reform of systems such as these should have been “easy”. The persistent lack of consumer goods means that there were many unexploited opportunities for production of consumer goods and services. Transferring even modest amounts of resources into consumer goods would increase output rapidly. Moreover, because there was such large unsatisfied demand, the “pull” of resources into consumer goods production would be strong.’ 
This is what China has done since 1978 – the demand for consumer goods and services was increased, this stimulated an enormous increase in their production, which later also led to rapid growth in heavy industry not as an end in itself but to produce the inputs necessary for light industry and agriculture.
The IMF-inspired economic reform in the former Soviet Union produced the opposite result. As living standards collapsed, so too did demand for consumer goods and services. Light industry and agriculture were crushed leading in turn to collapse in heavy industry as the demand for its products fell.
Thus: ‘It is obvious that the ECEs did not stumble into a “virtuous circle” in the way that China did. Is this because the constituent elements of China’s virtuous circle were absent in the ECEs? Surprisingly, when we turn to the actual transition process itself, we find that all the elements of China’s virtuous circle were also present or potentially present in the ECEs… There seems to be nothing about China’s economic structure or level of development that limits the Chinese approach to that one unique country. The ECEs could also have adopted such an approach… it is likely that these countries would have been better off had they followed an approach more similar to the one followed by China.’ 
Neither the free market, nor the command economy, could correct the distortions of socialism in one country. At the outset of the economic reform in China, there was a discussion about the purpose of socialist production. The Stalinist model, that the highest possible rate of capital accumulation must be maintained at the expense of the living standards of the workers and peasants, was explicitly rejected. Instead, it was recognised that too high a rate of accumulation, at the expense of consumption, reduces the efficiency of investment. This was the roadblock which the Soviet Union had run into. The neglect of consumption undermined the incentive of the workforce to produce and worsened the quality of goods, created shortages of materials and reduced the resources available for the development of agriculture and light industry. The conclusion of this debate in China in the 1970s was the precise reverse of the Stalinist orthodoxy. Agriculture was given first priority, followed by light industry and then heavy industry.
The policy of developing consumption was then implemented by scaling down investment and military spending to correct the previous imbalance in favour of heavy industry. Under the Chinese economic reform the development of consumer production and consumption was to be the driving force of the economy, with investment fixed at levels consistent with rising living standards.
However, a shift to prioritise the production of consumer goods was impossible to implement without markets. The structure of consumer supply is quite different to heavy industry in that it requires a network of many millions of far smaller units of production. That is why the attempts to solve the problems of consumer goods production under Gorbachev failed. It is simply not possible to create a vast network of small farms, shops, workshops and consumer goods producers by administrative command. It can only be created, and linked, by a market mechanism. The development of heavy industry could be carried out under Stalin administratively because it involved the concentration of resources into a relatively small number of heavy industrial units – the small business and farm sector were taxed to the point of extinction and legally prohibited while prices were skewed to favour heavy industry. But this process cannot be run in reverse. It is impossible to administratively create millions of small consumer producers and services.
The attempt to entirely eliminate the market by bureaucratic fiat in the USSR had been an adventure. Market relations have to be progressively outgrown, not suppressed. As Trotsky put it in his critique of Stalin’s first Five Year Plan: ‘The innumerable living participants in the economy, state and private, collective and individual, must serve notice of their needs and of their relative strength not only through the statistical determinations of plan commissions but by the direct pressure of supply and demand. The plan is checked, and to a considerable degree, realised through the market. The regulation of the market itself must depend upon the tendencies that are brought out through its mechanism. The blue prints produced by the departments must demonstrate their economic efficiency through commercial calculation.’ 
The market is a set of social relations which will ‘wither away’ over a long historical epoch. The attempt to abolish it administratively simply threw the Soviet economy backwards in the spheres most important for the living standards of its people.
On the other hand, the instruments of intervention into the economy created by the overthrow of capitalism in China and the Soviet Union did make possible major incursions into the operation of the international and national markets to regulate their effects and establish priorities which would have been overturned by unfettered market forces. Thus in China’s economic reform: ‘the role of the state has been evident in mediating between world market forces and national interests – both in setting key prices (such as the exchange rate and the long-term interest rate) as well as in guiding the economy along a particular path. Whilst the market has served as a useful bench mark which has given planners useful information it has never been allowed to be an all-pervasive influence.’ 
In Russia, on the other hand, after 1992 the mechanisms for protecting the domestic economy from the more powerful forces which dominate the international market economy started to be dismantled. This made impossible what Peter Nolan accurately describes as a pre-condition for successful reform – planning: ‘Success in the transition was conditional upon learning how to plan.’ 
The capitalist economic programme launched in Russia in January 1992 – price liberalisation, privatisation and subordinating the economy to the forces of international capital – could not solve the problem of developing the consumer sector either. The reason for this is that, under full price liberalisation, the demand for consumer goods collapsed as living standards fell, while the prices of industrial inputs, produced by larger more monopolised units, rose much more rapidly than the prices of consumer goods. Finally, whole sectors of consumer production are simply eliminated by imports from more productive economies. That is why the greatest collapse of all in the former Soviet Union has occurred in the light industrial and agricultural sectors. They are crushed between more rapidly rising industrial prices, foreign competition and collapsing consumer demand.
The IMF’s policies made the distortions of the former Soviet economic structure worse, not better.
The mechanism of the Chinese economic reform
Given that neither an administrative command mechanism nor full price liberalisation could correct the distortions of the command economies, what was necessary to do so? This was the problem which the Chinese economic reform solved. It maintained the output of heavy industry while simultaneously pumping resources into) creating light industry, farming and consumer services. Domestic producers were protected by tariffs on imports averaging 35 per cent (compared to an average level of 15 per cent in other developing countries). The starting point of the reform was a radical increase in the share of individual consumption in the Chinese economy – new consumer industries could only develop if there was a vast increase in demand for their products. In the three years, 1978–81, the share of individual consumption in the Chinese economy was increased from 53 per cent to 59 per cent of GDP. This was achieved administratively by reducing the share of investment in the state sector by five per cent of GDP and transferring this to consumer subsidies and wage increases: ‘…during the first phase of Chinese reform, especially from 1979 to 1981, there were substantial reductions in military industrial output, and in heavy industry as a whole. The effect of this on output was swamped by the rapid increase in consumer goods production that occurred at the same time.’ 
The administratively determined increase in demand for consumer goods was then connected to the supply side, not administratively, but via a market mechanism, that is by an increase in the relative prices of food and consumer goods. At the same time the prices of the state-owned, monopoly, industrial sector were held down. As a result, over the decade from 1978, agricultural prices relative to industrial prices rose by 77 per cent, and consumer prices rose by 25 per cent compared to average prices. Unlike in the former Soviet Union and Eastern Europe there was no ‘big bang’ price liberalisation. This relative increase in the prices of consumer goods increased the incentive to produce them.
On the demand side, the population was compensated by raising, first, the level of state subsidies on consumer goods, and then, because subsidies have the defect of distorting the price structure, by phasing out subsidies and replacing them by wage increases. This is quite different from Eastern Europe where ‘price reform’ simply removed indirect subsidies to the population’s living standards. In China living standards were increased, not cut.
As a result, the demand for consumer goods was increased and the economy gradually moved to a more rational pricing system reflecting real costs. At the same time the state retained the ability to intervene to limit price increases where this was considered necessary.
If the price increases paid to Chinese farmers had been passed onto the consumers, then there would have been no increase in the share of individual consumption in the economy as a whole. Instead consumers would merely have been forced to spend more on food and correspondingly less on other consumer goods. Food production would have increased, but other sectors such as consumer durables, like washing machines, refrigerators and televisions, would have declined, providing no overall boost to economic growth. Thus the decision in China to fully compensate the population for price increases was an indispensable condition for the success of the economic reform.
The population gained from the increased supply of consumer goods and was fully protected against the price rises. So the changes were greeted by popular support. By this mechanism a large shift in prices in favour of the consumer sector of the economy was created, stimulating a spectacular increase in their production.
Second, to allow the price change in favour of consumer goods to take effect, all prohibitions on the formation of enterprises to serve the consumer sector were removed – resulting in the formation of millions of small farms, private and cooperative small businesses, shops and workshops. On this basis huge resources flowed into the consumer sector – with spectacular results, In the decade 1979–89 total agricultural production increased by 49 per cent and total food production by 45 per cent. Food production per capita of the population increased by 29 per cent.
The increase in production of higher quality foodstuffs was even more impressive, In the decade 1979–89 production of pork increased at 7.7 per cent a year, milk at 8.4 per cent a year, butter at per cent a year, eggs at 9.7 per cent a year, grapes at 17.9 per cent a year, bananas at 26.1 per cent a year and so on.
Overall the result was a long term increase in agricultural production productivity: ‘The real gross value of crop output per arable acre rose by around three quarters during the reform period. The average annual real grown of net farm output per worker accelerated sharply from only 0.3 per cent between 1957 to 1978 to 4.3 per cent from 1978 to 1991.’ 
This shift in production was accompanied and made possible by the creation of an enormous number of new small businesses linked via the market. In the agricultural sector, where reform began, responsibility for production was transferred from collectives to individual households and purchases by contract replaced mandatory state procurement. After a number of experiments, by 1984 the household responsibility system emerged as the dominant arrangement. Two hundred million small farms came into existence. However, while land use was effectively privatised, landownership was not. Households contracted to use farmland for a fixed period – by 1984 the contract period was 15 years for annual crops and 50 years for tree crops. Farmer contracted to supply specified crops to the state and production over and above the contract could then be sold at market prices.
In 1988 the government legalised the existence and development of privately owned enterprises. These, particularly very small enterprises, grew rapidly. By 1986 there were 500,000 industrial enterprises in China of which 420,000 were small or medium scale. The expansion of consumer services was equally rapid. In 1977–88 China’s total workforce increased by 35 per cent, but employment in restaurants increased by 327 per cent, in retailing by 380 per cent, and in other services by 750 per cent. Total employment in these three service sectors increased from six million to 30 million – which meant an enormous increase in the quality of life for the Chinese people.
But to this day the specifically private sector accounts for a very small share of China’s overall industrial output because, as we shall see, the biggest change of all was in the spectacular growth of collectively owned enterprises at village, town and city level – chiefly owned by local government structures. These, together with the small scale private sector, were able to soak up the labour released by the rapid rise in productivity in agriculture and were the basis on the supply side for meeting the mushrooming demand for more and more sophisticated consumer products.
While its starting point was a tremendous stimulus to agriculture, the overall process of the economic reform led to a further and deeper industrialisation of the country, with a very large proportion of the growth of small private and collective enterprise located in the rural areas.
Thus: ‘The Chinese experience is based on industrialisation; industry represented 35% of GDP in 1970 to 42% in 1990. The decline in percentage terms of agriculture, went from 38% of GDP in 1970 to 27% in 1990… The pattern of industrial growth during the 1980s has favoured light industry, much of it in collective enterprises and, to a lesser extent, private firms as compared to substantially lower, though supposedly still rapid, growth in heavy industries in state-owned enterprises.’ 
Industrialisation was not confined to the urban sector: ‘the share of agriculture in total village gross income declined from 69 per cent in 1978 to 36 per cent in 1992, alongside the rapid growth of the rural non-farm sector.’ 
This planned increase in the weight of consumer production in the Chinese economy was only made possible by maintaining state ownership of the industrial core of the economy. That allowed the government to coordinate a shift in relative prices in favour of consumer goods. If industry had been privatised and prices fully liberalised – as in Eastern Europe – then Chinese agriculture and consumer goods industries would have been caught in precisely the price scissors which crushed light industries and agriculture in those countries after 1989. The more monopolised heavy industries and energy producers would have raised their prices more rapidly than was possible for the farmers and consumer goods producers who were subject to much greater competition as a result of the smaller scale of their units of production and the greater ease of starting up new small firms. Thus, far from state ownership of heavy industry being a relic of the past which should be discarded as rapidly as possible, it is at the heart of the mechanism which made the Chinese economic reform a success.
[Continued in Part 2]