How China Went Capitalist

After Mao’s death, members of the communist elite were able to go abroad. They discovered that China, with what they believed was the world’s best economic system, was by world standards desperately poor. A vice-premier visiting England found that the oppressed working classes of the capitalist world were strikingly better off than Chinese peasants, workers, even officials; a London trash collector had six times his salary.

Visiting countries of eastern Europe, in particular Yugoslavia, officials concluded that socialism might take different forms in different countries. In attempting to discover the right form for China they got many things wrong but one thing right. Having observed the catastrophes produced by Mao’s attempts to fit the real world to his theories, they concluded that it should be done the other way around. Theories were all very well but facts trumped them. The conclusion, as seen and expressed most clearly by Deng, was that the right approach to making socialism work was to experiment with many different approaches, discarding those that failed and adopting those that succeeded.

Changes thereafter proceeded along two quite different lines. One was the official process of economic reform, largely an attempt by the central authorities to improve the functioning of the state owned enterprises, the part of the economy most directly under their control. The other consisted of what Coase and Wang, authors of the book this post is based on, refer to as marginal revolutions, changes originating on the periphery of the system, for the most part opposed by the authorities but not actively suppressed.

Unofficial economic revolutions proceeded in three different areas, at first only reluctantly tolerated by the officials: Privatization of agricultural land, production by firms nominally run by local governmental organizations, and small scale private employment in the cities. The first was illegal and at first covert. The second and third were legal but discouraged.

The first recorded incidence of private farming in post-Mao China occurred in Pengxi county of Sichuan province, in a village called “Nine Dragon Hill.” This village was one of the poorest in Qunli Commune, widely known in the region as a “village of beggars.” One evening in September 1976, Deng Tianyuan, the Party secretary of the commune, summoned a small group of cadres to discuss the problem of agricultural production. After a long and heated debate, they agreed to try private farming as a solution to the managerial and incentive problems that had dogged collective farming. Aware of the political risk, they decided to allocate only marginal land to households in two production teams, while keeping collective farming intact elsewhere. That year, the output of the marginal but privately cultivated land was three times higher than that of the collectively cultivated fertile land. The next year, more land was privatized in more production teams. By 1978, before the Third Plenum was held in Beijing, private farming was practiced across the whole commune, but was kept secret from the local authorities. In 1979, at a meeting organized by the county government to discuss improvements in agriculture, Deng Tienyuan disclosed the secret of Nine Dragon Hill’s success and won the endorsement of the county Party secretary. The following year, a delegation from the Ministry of Agriculture and Forestry visited Nine Dragon Hill. While he criticized private farming in principle, the head of the delegation praised Deng Tianyuan for improving agricultural production and even proposed considering the village as an experimental site for private farming. (Coase and Wang, pp. 46-47).

Two years later in another village, also poor, privatization was secretly agreed on by eighteen peasants. It was sufficiently successful so that, as word of what they were doing spread, nearby villages joined in. Private farming shifted, over the next thirteen years, from illegal to permitted for villages that had been doing very badly to legal and widely practiced.

Mao’s failed attempts at rural industrialization during the Great Leap Forward had spawned a multitude of township and village enterprises. Many closed down after the failure of the Great Leap, but not all. Such enterprises were legal but disfavored, viewed as inferior competitors to the large state owned enterprises. They bought inputs that state owned enterprises produced beyond their required output at market prices not the lower official prices, received no subsidies from the center. They were, however, free to make their own decisions about personnel, compensation, what they produced and how. To the surprise of the authorities, they turned out to provide the success that the centrally planned system failed to provide. By the mid-1980’s, township and village enterprises produced one quarter of China’s industrial output.

Under Mao, China had had a continuing problem of urban unemployment; he solved it by sending unemployed urban youths out to the countryside to be peasants. His successors instead legalized small scale private employment in the cities. Private firms were in theory limited to a maximum of seven employees. In practice, ones that grew beyond that point could put on a red hat, put themselves under the nominal authority of a local street committee or township or village government.

That part of the economy prospered.

Self-employed barbers, for example, came to earn higher incomes than surgeons in state hospitals. Street vendors who sold noodles and snack foods earned more than nuclear scientists. Traders, small shop and private restaurant owners, many of them the former “youths waiting to be employed,” were among the highest income groups in China during the 1980s. Not surprisingly, the number of self-employed household businesses and single proprietorships increased from 140,000 in 1978 to 310,000 in 1979, 806,000 in 1980, and reached 2.6 million in 1981. (Coase and Wang, p. 68).

Each of these successes occurred despite the intentions and expectations of the authorities, not because of them. The thing the authorities did right, in each case, was not stopping them.

The fourth marginal revolution was different.

Capitalist countries such as Japan were much more productive than China. To learn why, special economic zones were created, areas within which Hong Kong businessmen and other foreign investors would be permitted to start businesses. The plan was to use such zones to experiment with capitalist principles that might be useful to a socialist economy, to “appropriate capitalism for the good of socialism.” The initial zones were located in places of little importance to the Chinese economy so that if the experiment proved a failure nothing much would be lost. They were intended as a way of quarantining dangerous ideas to prevent them from infecting the greater society while at the same time extracting whatever in them was of value.

Over the next thirty years the first, Shenzhen, expanded from a village of 30,000 inhabitants to a city of fourteen million, pulling in ambitious Chinese from all over the country. In 1984, the authorities responded to the success of the first four zones by authorizing fourteen more. Still more followed.

The exception ate the rule.

By the early 1990’s, the success of the marginal revolutions was enough to convince the Chinese leadership to endorse what they had before only tolerated, to shift the economic model from one dominated by central planning to one controlled mostly through the market, a “socialist market economy.” In 1992, the number of items whose prices were set by the central government was reduced from 737 to 89. In 1990, Shanghai started a stock exchange, following one in Shenzhen that had opened without official permission in 1988 and was finally approved in 1991. In 1992, the Pudong New District, a special economic zone adjacent to Shanghai, was approved. By 1996, town and village enterprises were employing 126 million people and producing 26% of Chinese GDP.

Socialism is Dead. Long Live Socialism.

China’s transition to capitalism was, from beginning to end, done under the banner of socialism.¹ At the beginning, the leaders were united in wanting to make China “a powerful, modern, socialist country” (1978). It did not take long for them to revise their mission to put in place “socialism with Chinese characteristics” (1982) and “a commerce economy with plan” (1984), before finally embracing “a socialist market economy with Chinese characteristics” (1992).

Economists define socialism as a system of government ownership and control of the means of production but in the political context it had and has a much vaguer meaning, often little more than an approving (or disapproving) label almost empty of content. By the end of the transition, the Chinese authorities were defining it as:

The essence of socialism is liberation and development of the productive forces, elimination of exploitation and polarization, and the ultimate achievement of prosperity for all. (pp. 116-117)

And Deng could write that “The essence of Marxism is seeking truth from facts.”

Between Mao’s death in 1976 and 2010 the per capita GDP of China increased roughly twenty fold. Judged by the magnitude of the change and the number of people affected, it is arguably the most rapid increase in human welfare that has ever occurred.

[For a much more detailed account, including the lessons that Coase drew from the Chinese experience, see A Very Coasian Revolution, my extended review of How China became Capitalist by Ronald Coase and Ning Wang.]

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1. See Chapter 23 of The Machinery of Freedom, “Creeping Capitalism,” for an early discussion of how a socialist economy might become capitalist under the banner of socialism. For a still earlier (fictional) portrayal of the gradual conversion of a communist state to capitalism, see Henry Hazlitt, The Great Idea, 1951.