Thirty Years of Chinese Economic Reform: Reasons for Its Success and Future Directions

What are the principal reasons for the highly successful Chinese economic reform that began in 1978? One may say that they are the strong Chinese economic fundamentals-surplus labor, abundant savings, huge domestic market, etc. But the strong fundamentals have always been there, at least since the 1950s. Why did the Chinese economy not take off earlier?

The introduction of the market system, first in the rural area, and then in the urban area, must be regarded as the primary reason for the success of the economic reform. But the former Soviet Union and subsequently Russia also introduced the market system, with disastrous economic results for the entire first decade. Why was China able to do it while others failed?

Three important reasons can be identified: First, Chinese economic reform is characterized by openness-China welcomed international trade with and direct investment from all countries and regions, including Hong Kong, Taiwan, and the United States, and with trade and direct investment came technology, business models, and ideas that were new to China. Second, the Chinese economic reformers are characterized by their pragmatism-they are willing to try almost anything-whatever works-but they will just as readily abandon whatever that proves not to work. Third, Chinese economic reform has been implemented in such a way that it is mostly Pareto-improving, that is, almost everyone is made better off by the economic reform and no one is made worse off, which maximizes support, minimizes opposition and preserves social harmony.

What are some future directions of reform? They should consist of various ways to perfect the market mechanism in China. First, China has reached a stage of development that it needs to make and keep the markets truly competitive, through anti-monopoly laws and other means-and this applies to the both the goods market and the factors (including capital) market. When markets are not competitive, they may result in outcomes that are worse than those under central planning. Second, the markets can also be made more competitive, and hence more efficient, if information asymmetry can be reduced or eliminated. Thus, the Chinese Government can set standards for goods and services and assure quality through government-mandated and operated testing agencies. Third, markets frequently fail when there is moral hazard. The Chinese Government can reduce the incidence of moral hazard by limiting leverage and requiring bonding. Fourth, the Chinese Government can also make the market system more complete by establishing and maintaining socially desirable markets that do not arise naturally without government intervention, for example, a long-term market for bonds backed by qualified long-term owner-occupied residential mortgages. Finally, the market system is not equipped to redistribute, but redistribution is often necessary on grounds of fairness and social harmony. The Chinese Government should design an equitable tax system as well as undertake public investments in education, health care, environmental protection and mass transportation so that the benefits of the continuing economic reform can be shared by the majority of the people.