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The Institutional Foundations of China's Market Transition

Interpreting China's Transition to Markets: The Institutional Perspective

In the two decades between 1978 and 1998, China has transformed itself from a centrally planned

economy to an emerging market economy and at the same time has achieved nearly a 10 percent average growth

rate. During this period, China's per capita GDP has more than quadrupled and the living standard of ordinary

Chinese people has improved significantly. For instance, per capita consumption has increased four times for

eggs and eight times for poultry, the per person living space has more than doubled in the urban areas and

nearly tripled in the rural areas, and total household bank deposits, measured against the GDP, increased from

less than 6 percent in 1978 to more than 60 percent in 1998. The benefits of the reform were also shared by

the people on a broad basis. The number of people living in absolute poverty has been substantially reduced

from over 250 million to about 50 million in two decades, a decline from one-third to a twenty-fifth of China's

population. Life expectancy on the other hand has increased from 64.37 in the 1970s to 70.80 in 1996 (68.71

for men and 73.04 for women), with infant mortality falling from over 50 per thousand in the 1970s to less than

30 per thousand in the 1990s (China Statistical Yearbook, 1997; Almanac of China's Population, 1997). In

1998, the World Bank moved China's ranking up from a low-income to a lower-middle-income country.1

Such a performance appears more impressive when compared with the average performance of the

transition economies in Eastern Europe and the former Soviet Union. By 1998, with only a few exceptions,

the great majority of these countries still have not recovered to their 1989 output levels according to the official

statistics. The Chinese performance looks even more impressive when considering the fact that transforming

large countries is much more complicated than transforming smaller ones; conceivably, the tasks of

transforming Russia or China are more challenging than those of transforming Poland or Vietnam. At the

outset, China's reform went against all odds: Coming out of the disastrous decade of the Cultural Revolution,

it was poor, over-populated, lacked human capital and natural resources, and was constrained by adverse

2 According to Maddison's (1998) calculation based on purchasing power parity, without taking into account the

1998 Russian economic crisis, China's per capita GDP will surpass that of the 15 former Soviet Union countries by

2010.

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ideology and political opposition. Two decades ago few economists would have bet on today's outcome of

reform in China.

Even so, China's reform experience has been always viewed as an anomaly in terms of transition to

a market economy, and it has not been properly accounted for by mainstream economics and thus appreciated

by mainstream economists. For example, From Plan to Market: World Development Report 1996 on

transition economies (World Bank, 1996) gave China short shrift because it couldn't figure out where to put

China on the various measurement parameters, and instead illustrated the Chinese experience mainly in boxes

rather than in the text. China simply does not fit the general description of the report. However, the data point

of China is too important to ignore: It has been one of the most successful transition economies, it produced

more than all other transition economies combined in 1998 in terms of GDP, and, moreover, its per capita GDP

is very likely to surpass that of the 15 former Soviet Union countries in the next decade, which was unthinkable

a decade ago.2

Still, economists tend to underestimate the significance of China's reform experience. The most

popular argument is that China was a poor agricultural country and thus reform was easy. Of course China

was much less developed than Eastern Europe and the former Soviet Union at the outset of reform and the latter

faced some difficulties that China did not have, such as problems of excess industrial capacity and

comprehensive welfare coverage. However, this argument does not explain how and why China's reform was

successful, especially considering that it faced double difficulties: As a planned economy, China faced many

problems similar, although not identical, to Eastern Europe and the former Soviet Union, such as a lack of

property rights and markets, persistence of a predatory government, and the difficulty of maintaining financial

stability. In addition, as an underdeveloped country, China also faced many problems that do not exist in

Eastern Europe and the former Soviet Union, such as enormous population pressure, severe shortages of human

capital and natural resources, very poor industrial and infrastructure bases, and a lack of democracy. The fact

that China faced the double problem of transition and development presented a bigger challenge and it is far

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