It's an honor to comment on Prof. Lin's paper. He is not only a scholar (AER, Cato J.) but an entrepreneur in ideas, and a doer--having founded the China Center for Economic Research in Beijing, where he and his colleagues have helped officials understand the importance of market-supporting institutions for China's future prosperity.

The essence of Lin's paper is that

--induced institutional change in China since 1978 has led to the shrinking of the plan and the widening of the market,

--the increase in economic freedom has led to an unparalleled expansion of economic activity, and

--serious problems still exist due to the incompatibility of the newly emerging market system and the outdated Soviet-style planning system that continues to distort the allocation of investment funds and provides SOEs with a soft budget constraint. This "institutional incompatibility" has led to a boom-bust cycle, corruption, and a heavy burden on the state budget. What needs to be done, in Lin's opinion, is to complete the transition to a market economy by establishing "a transparent, rule-based, legal system that protects property rights so as to encourage innovations, technological progress, and domestic as well as foreign investments in China" (p.36).

Prof. Lin hits the nail on the head: What China needs, as Milton Friedman pointed out in 1988, is not a planned market but a "free private market." What China needs is not market socialism but market liberalism.

To make that transition will require, as Lin notes, a change in thinking--the planning (HIODS) mentality must give way to new thinking (xin si wei) about the role of government in a market order. Corruption will continue in China as long as economic decisions are government-driven instead of market-driven. When the government holds interest rates at below-market levels and causes a shortage of loanable funds, politics not prices will determine who gets the scarce capital. Thus, whenever prices are suppressed, people will lose part of their economic freedom and become subject to the arbitrary rule of officials rather than the just rule of law.

The Soviet System failed because it disregarded reality; namely, the reality that (1) individuals wish to improve themselves and pursue happiness; that information is costly, constantly changing, widely dispersed, and cannot be usefully centralized; and (3) voluntary exchange leads to mutual gain. Soviet-style planning destroyed the institutions of property and contract that underpin the free private market and created a rigid economic system that ultimately collapsed of its own weight. The fatal conceit inherent in the Soviet vision was that government planners could run an economy like a machine and create long-run prosperity (F.A. Hayek). Although China has recognized the error of central planning and has introduced a market system, that system is still half-baked. The question is--will China move all the way to a genuine free private market?

In making that transition China could learn from the West and also from its own ancient culture. The philosophy of Lao Tzu as found in the Tao Te Ching, written some 2,000 years before Adam Smith's Wealth of Nations, has many parallels to that great work in terms of its emphasis on nonintervention and the principle of spontaneous order. In 1776, Smith argued that if "all systems either of preference or of restraint" were "completely taken away," a "simple system of natural liberty" would evolve "of its own accord." Each individual would then be "left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man, or group of men," provided "he does not violate the laws of justice."

Smith's system of natural liberty, the government would no longer have the obligation of overseeing "the industry of private people, and of directing it towards the employments most suitable to the interest of the society"--an obligation "the proper performance of which no human wisdom or knowledge could ever be sufficient." Government would not disappear under Smith's market liberalism, but it would be limited to three major functions: (1) "the duty of protecting the society from the violence and invasion of other independent societies"; (2) "the duty of protecting, as far as possible, every member of society from the injustice or oppression of every other member of it"; and (3) "the duty of erecting and maintaining certain public works and certain public institutions" (Smith [1776] 1937: 651). In the private free-market system advocated by Smith, people get rich by serving others and respecting their property rights. Thus, the system of natural liberty has both a moral foundation and a practical outcome. Private property and free markets make people responsible and responsive. By allowing individuals the freedom to discover their comparative advantage and to trade, market liberalism has produced great wealth wherever it has been tried, with no better example than Hong Kong.

idea that people have a natural tendency to make themselves better off if left alone to pursue their own interests, and the notion that a laissez-faire system will be harmonious if government safeguards persons and property, are the foundation of the West's vision of a market-liberal order--but they are also inherent in the ancient Chinese Taoist vision a self-regulating order--an order we might call "market taoism." Just as the principle of spontaneous order is central to economic liberalism, the principle of wu-wei (non-action) is fundamental to Taoism. Rulers rule best when they rule least; that is, when they take "no unnatural action" (Chan 1963: 791). When government is limited, it can help cultivate an environment in which individuals can pursue happiness and practice virtue (te). "The philosophy of the Lao Tzu," writes Wing-Tsit Chan (1963: 137), "is not for the hermit, but for the sage-ruler, who does not desert the world but rules it with noninterference." The Taoist system of natural liberty, like Smith's, is both moral and practical: moral because it is based on virtue and practical because it leads to prosperity. In the Lao Tzu (or Tao-Te Ching), it is written: "Take no action and the people of themselves are transformed....Engage in no activity and the people of themselves become prosperous." Moreover, "when the government is non-discriminative and dull, the people are contented and generous" (Chan 1996: 167). On the other hand, "the more laws and orders are made prominent, the more thieves and robbers there will be" (ibid.: 166). Like bamboo, the free market is resilient, and like water, the market will seek its natural course--a course that will be smoother, the wider the path the market can take and the firmer the institutional banks that contain it. The challenge for China is to widen the free market and provide the institutional infrastructure necessary to support private markets. The problem is to discard market socialism and make the transition to market Taoism. In the long run, market socialism, like central planning, is bound to fail because it is contrary to human nature.

China has been willing to experiment with institutional change since 1978 and has made great progress in reducing poverty and has increased economic freedom--China now ranks above Russia in the economic freedom index. Much of China's success has come from spontaneous or induced institutional change, as Prof. Lin and others (e.g., Kate Zhou) have shown--especially in the creation of the household responsibility system (baochan daohu). It's time for China to reclaim her heritage and once again cultivate the idea of spontaneous order. that order market taoism not market socialism?

In conclusion, I would like to remind you of Vaclav Havel's words, as he reflected on the Czech Republic's transition from plan to market: "Though my heart be left of centre, I have always known that the only economic system that works is a market economy, in which everything belongs to someone--which means that someone is responsible for everything. It is a system in which complete independence and plurality of economic entities exist within a legal framework, and its workings are guided chiefly by the laws of the marketplace. This is the only natural economy, the only kind that makes sense, the only one that can lead to prosperity, because it is the only one that reflects the nature of life itself." China's leaders would do well to heed Havel's advice and to listen to economists such as Justin Lin who understand the nature of markets and prices. I wish China well and I congratulate Prof. Lin on a fine paper.