To think that China’s ruling elite can control an economy of 1.2 billion people is a fatal conceit. The failure of central planningand of communism throughout the world is testimony to the ill‐fated desire to engage in social engineering. Indeed, recentstudies have shown that those countries that have fostered economic freedom have experienced greater wealth creation thanhave those that have failed to protect economic liberties. And as people have acquired greater economic freedom, they havedemanded other significant rights, including the right to participate in political life. That demand is exactly what worries China’shard-liners.
Institutional innovation in China since 1978 has produced the fastest economic growth in the world and enlarged opportunitiesfor many people, but it has not eliminated the main obstacle to China’s future prosperity — the CCP. The party’s monopoly ofpower has been eroded by the market‐based reforms of China’s paramount leader Deng Xiaoping, but with the Deng eraending, China is at a crossroads. The nation must decide whether to deepen reform and risk pressures for political change orslow reform and risk alienating China’s newly emerging middle class and fomenting social unrest. The dilemma is complicatedby the advent of democracy in Taiwan and the return of Hong Kong in 1997.
China at a Crossroads
In less than two decades China has become one of the top 10 trading nations in the world. Over the past decade nearly $90billion in direct foreign investment has flowed into China’s emerging markets. If the Chinese economy continues to grow at anaverage annual rate of 9 percent, it could soon become the world’s largest.
The challenge for China is to develop the hard institutional infrastructure of a market economy. The centerpiece of thatinfrastructure is a rule of law that protects property rights and limits the power of government. Therein lies the difficulty, for theCCP is unlikely to give up its power and let freedom reign. Nevertheless, there are internal and external forces at work thatmay push China in the direction of greater liberalization and democratization. Internally, China’s reformers have created aneconomic space that allows individuals the freedom to improve their living standards outside the state sector. Externally,China’s “open‐door” policy has allowed foreign competition and know‐how to help the nonstate sector grow. In the process,new business practices have evolved along with legal norms associated with a market‐liberal order.
The Ninth Five‐Year Plan may slow China’s march toward the market, but it won’t stop it. The forces for change are toostrong. And the further the market advances, the more costly it will become for the CCP to try to reverse it. Yet it is clear fromChina’s saber rattling on the eve of Taiwan’s ascension to democratic rule that China’s authoritarian rulers are willing to incurconsiderable economic losses to protect their positions of power and privilege. That willingness is further evidenced by China’svow to crush any democratic movement in Hong Kong after 1997.
The dilemma facing Western leaders is whether to contain China and risk military confrontation or to peacefully engage Chinawith the knowledge that the best way to foster human rights is by opening markets and cultivating exchanges — not by using theblunt instrument of economic sanctions or the rhetoric of China bashing.
In evaluating their options, Western leaders should heed the lesson of Taiwan — a police state that turned into a free‐marketdemocracy because economic liberalization led to political liberalization. Taiwan’s leaders were willing to experiment withinstitutional change and had the courage to let the people speak — in the market and in the polity.
China, too, has created a new economic space but has resisted political change. Even so, there is reason to believe China mayfollow Taiwan’s “quiet revolution.” According to Lee Teng‐hui, Taiwan’s first democratically elected president, “Vigorouseconomic development leads to independent thinking. People hope to be able to fully satisfy their free will and see their rightsfully protected. And then demand ensues for political reform.” Thus, he predicts, “The model of our quiet revolution willeventually take hold on the Chinese mainland.”
The key to China’s progress has been its willingness to allow institutional change on a trial‐and‐error basis and to promotesuccess. Like Taiwan, China has reduced the relative size of the state sector by cultivating the nonstate sector, not byprivatizing large state enterprises. State‐owned firms now account for only 25 percent of China’s total output (includingagriculture and services), and their share of industrial output has fallen from 80 percent in 1978 to 40 percent today.
On the heels of the failure of central planning, Deng had no grand vision for institutional change, but he was willing toexperiment. His guiding principle was, “Once we are sure that something should be done, we should dare to experiment andbreak a new path.”
Deng began to break a new path in 1978, when he launched his agricultural reform. Communal ownership of land wasabolished and a system of contractual relations was introduced through the “household responsibility system.” Rural familieswere allowed to hold long‐term leases and acquired the right to use the land at their disposal. They could sell their crops in theopen market, provided they first satisfied the state quota. Under the new incentive structure, farmers increased production andbegan to invest their profits in town and village enterprises (TVEs), which are beyond the reach of state ministries.
Although TVEs are legally owned by local governments, individual households are allowed to share profits, hold(nontransferable) shares, and receive dividends. Wages are tied to profits, and the managers of TVEs face hard budgetconstraints, unlike the politically motivated managers of state‐owned enterprises (SOEs). As a result, TVEs have mushroomedwhile SOEs continue to whither on the vine of state subsidies.
In addition to creating new ownership arrangements, Deng’s reforms decontrolled prices, opened China to the outside worldthrough trade liberalization and the establishment of Special Economic Zones, devolved power from the central government tolocal governments, and instituted a system of fiscal contracts that limited Beijing’s share of tax revenue and provided localofficials with an incentive to promote markets — a system Yingyi Qian and Barry Weingast have called “market‐preservingfederalism.” Those institutional changes resulted in a parallel economic structure to compete with the SOEs, reduced thecentral government’s share of tax revenue from 60 percent in 1978 to 40 percent in 1993, and helped weaken the centralgovernment’s grip on everyday life.
Those reforms, however, have failed to create a genuine market system founded on the principles of private ownership andfreedom of contract. The goal of China’s born‐again planners is not market liberalism but market socialism. The resultant lackof clear rules at the enterprise level and attempts to plan the market are, in the absence of a constitution that protects propertyand contracts, reflections of what F. A. Hayek aptly called the “fatal conceit” of socialism.
Revitalizing Civil Society
The quiet revolution that has been taking place in China’s economy since 1978 is combining with the information revolution tostrengthen the fabric of civil society and weaken the CCP. As China has expanded the freedom to earn a living outside thestate sector, individuals have gained greater control over their lives. In its 1994 report on human rights, the U.S. Department ofState noted the connection between economic rights and human rights: “A decade of rapid economic growth, spurred bymarket incentives and foreign investment, has reduced party and government control over the economy and permitted everlarger numbers of Chinese to have more control of their lives and livelihood.”
People are learning how markets work by participating in the growing nonstate sector and by engaging in foreign trade. As themarket has replaced Marx, newly acquired ideas and wealth have given rise to a spirit of independence and to a rebirth of civilsociety, especially in China’s southern coastal provinces. Commenting on China’s cultural transformation, Jianying Zha writes inher book China Pop,