Econ Notes #7: How China Escaped Shock Therapy, p. 40.
This week might be a good time to consider this new classic by Isabella M. Weber, just days after the State of the Union Speech by Joe Biden expicitly named "greed" as a driving factor of inflation. The so hated mechanism of seller's inflation, 'inexplicable-by-neoclassical-economics', has reached the status of a government doctrine after just two years.
In her book about Chinese economics, Isabella Weber already establishes the core of her paradigm shift: The policies (or "state intervention") in pricing as a means to make the economy more efficient. Remarkably, the German translation is titled "Das Gespenst der Inflation".
Isabella M. Weber (2021): How China Escaped Shock Therapy. The Market Reform Debate. Routledge Studies on the Chinese Economy. New York: Routledge.
INTRODUCTION
PART I: Modes of Market Creation and Price Regulation
1. Bureaucratic Market Participation: Guanzi and the Salt and Iron Debate
2. From Market to War Economy and Back: American Price Control During the Second World War and Its Aftermath
3. Re-creating the Economy: Price Stabilization and the Communist Revolution
PART II: China's Market Reform Debate
4. The Starting Point: Price Control in the Maoist Economy and the Urge for Reform
5. Rehabilitating the Market: Chinese Economists, the World Bank, and Eastern European Émigrés
6. Market Creation versus Price Liberalization: Rural Reform, Young Intellectuals, and the Dual-Price System
7. Debunking Shock Therapy: The Clash of Two Market Reform Paradigms
8. Escaping Shock Therapy: Causes and Consequences of the 1988 Inflation
INTRODUCTION
In the foreword, Isabella Weber explains her motivation behind the book. As a German she had experienced the fall of the GDR and its subsequent "shock therapy" by capitalism first hand or, at least, by proximity. In China, however, the shift from a communist society to a capitalist or "neoliberal" one (as she calls it) has been much smoother than in any comparable country (in the USSR, for example). The comparison between Russia and China in the Introduction is quite devastating: collapsing GDP, falling real income, rising mortality (to heights not experienced by any industrialized country previously in peacetime, 2). Behind China's alternative way, evading the typical neoliberal state form, were the "reform debates" in the 1980s, which the book is setting out to depict. Such a state, as she clarifies, is not the opposite of a state or a planned economy, so it is not a question of state/no state but of which rules its policies follow:
"The neoliberal state is neither small nor weak, but strong. Its purpose is to fortify the market. In the most basic terms, this means the protection of free prices as the core economic mechanism." (3)
Also, she explains the mechanism of shock therapy, which has been called a "Washington consensus doctrine of transition" by Stiglitz. Leaving aside the problematic connotations of "shock therapy" in medicine, where the term is borrowed from, in the economic domain the idea is quite clear. Weber summarizes four measures to "shock the planned economies into market economies at once" (4):
- Liberalization of all prices in one big bang
- Privatization
- Trade liberalization
- Stabilization (tight monetary and fiscal policies)
The actual application of "shock therapy" often only focussed on the first measure, at least in the short term. "This one-sidedness was not merely the result of feasibility, however. The deeper reason for the bias toward price liberalization lies in the neoclassical concept of the market as a price mechanism that abstracts from institutional realities." (4)
The short shock does not turn out to be very short: Russia experienced a prolonged inflation and a devastating recession after the price liberalization under Boris Yeltsin January 2nd 1992. China on the other hand "pursued an experimentalist approach that used the given institutional realities to construct a new economic system." (7)
The alternative to the shock therapy is the gradual "dual-track system" of China: "set the prices of essential goods, while the prices of surplus output and nonessential goods were successively liberalized." (7)
Before delving into the debate itself, Weber prepares it with some theoretical and historical background.
1. Bureaucratic Market Participation
In the first chapter, Weber looks at some of the underlying historical ideas in the history of China. She rejects a Sinocentric approach and a colonial view of China's economics as a derivative of a Western one, and she does not argue for a linearity from the historical debates to the reform debate in the 1980s at the center of this book. Still, by opening with an ancient text in the history of China she wants to carve out some fundamental ideas that serve as reference points for later arguments.
The Guanzi
The Guanzi is a "core text in ancient Chinese economic thought on price stabilization". (18) Assumably during the times of the "Warring States" (575-221 BCE), "the Guanzi was written by several anonymous authors, probably state planners and economic advisors".
"The guiding question in the treatment of economic issues was how to govern change in the context of the transition to a new kind of economy. Most parts of the Guanzi were written in the form of dialogues between Duke Huan (桓公, 685–643 BCE) of the state Qi and his advisor Guan Zhong (管仲, ca. 710–645 BCE), with the latter providing answers to the pressing questions of the duke." (20)
In the context of a huge centralization of several "hundred agrarian city-states", the new monarchy was faced with new realities: the land, having been in the hands of the nobility, was handed over to peasants and family farms. Previously, prices were fixed by the government officials and only fluctuating on local markets, now a more or less free trading system had emerged.
In the Guanzi, commodities are categorized along the "Light-Heavy Principles", "where heavy represents “important,” “essential,” or “expensive,” and light connotes “unimportant,” “inessential,” or “cheap.” (18) A clever balancing is needed, to use them to the advantages of the people. But which are heavy or light is subject to circumstances and changes. In the words of the Guanzi: "To use the thing that is “heavy” to shoot at that which is “light,” to use the cheap to level down the dear, these are the great advantages that can be drawn from the application of the “light–heavy” doctrine." (22)
The Principles have four important mechanisms: Scarcity (scarcity can make something heavy, abundance light). Distribution (concentrated goods are heavy, but light if "scattered about"). Demand (Goods "worth hoarding" become heavy). Taxation (if the good is about the be collected as taxes, it becomes heavy - but only if there is little time or "urgency").
"All these principles build on the idea that relative value depends on supply and demand. But rather than focusing on the equilibrium between supply and demand, as economists are accustomed to doing in modern neoclassical economics, the Guanzi explores reasons for change". (23)
One of the central goods was grain, because it was regarded as more important than money. "When grain is expensive, all other things are cheap, when grain is cheap, all other things are expensive", states the Guanzi. (24) Grain was regulated by the introduction of granaries. "The government has a responsibility to stabilize the price of grain in order to stabilize the overall price level and the value of money." (25) The granary worked countercyclical and stabilized the seasons:
"This principle manifested as government purchase of surplus grain from the peasants in autumn, at harvest time, when it was oversupplied and its price was low—in other words, grain was “light” and money was “heavy.” By demanding relatively large amounts, the government drove up the price of grain." (25)
But there are important nuances to this logic: "[A]lthough the state balanced the price movements, it did not aim for complete stability—“When water is perfectly level, it will not flow” (ibid., 308). The price of grain in autumn would still be higher than in spring and summer, but the price difference would be smaller than it had been without the state’s participation in the market" (26) Also, this was an important revenue stream for the state because it was easier to extract a surplus from these transactions than getting it back via taxes. Or at least, the people were not as angry with the state.
The Salt and Iron Debate
The Salt and Iron Debate revolved around the question, whether the policies that had been recommended in the Guanzi were helpful or not after Emperor Wudi had passed away in 81 BCE. His economic advisor Sang Hongyang had introduced (or rather reintroduced) some of its ideas: "The state should [...] generate revenue “by managing the mountains and seas” (Guanzi as in Rickett, 1998, 373), that is, by bringing salt and iron under state control."
"For salt, Guanzi envisioned a partial monopoly in production and marketing (Hu, 2009, 157), which was to be established by “tak[ing] advantage of the season” (Guanzi as in Rickett, 1998, 427)." This means a partial monopoly for salt that was in accordance with the seasonal changes: "At times when people were not busy with their agricultural work, the state would employ large numbers of people “for boiling salt water” (ibid.)" "'When agricultural work begins in the spring,” the ruler would “issue orders that the people are not allowed … to hire labor to boil salt”". (28)
The monopolies on Salt, Iron and - newly invented - Wine were successful "at overcoming the fiscal deficit, stabilizing the price level, filling up the public granaries, and supplying the army", but people were unhappy with the high prices of salt and the poor quality of iron. (31) The "literati" (which are confusingly called "Confucians" without really relying on Confucianism) attacked Sang and his policies in the Salt and Iron Debate, because they wanted to return "to the old ways, when subsistence agriculture had been the dominant occupation and barter exchange and taxation in kind were prevalent". (32) Sang was not only opposed to this view, he also argued much more pragmatically and in accordance with the changing technological situation. In an interesting argument, he claimed that "natural resources were usually located in out-of-the-way places", which means that they were prone to fall under a monopoly. (33)
Sang's policies survived the debate, except the wine monopoly which was to be abolished (he himself, however, did not survive the insurrection as he was killed in 80 BCE). Similar debates reoccurred again throughout history, as Weber shows, and finally, after a highly developed granary system built around 1740, there was a trend to get away from state monopolies that got stronger in the 19th century (also with rising influence from Europe/US). "One of the first acts of the new government—after the 1911 revolution that overthrew China’s last imperial dynasty and established the Republic of China—was to abolish the public granary system and, with it, the price–stabilizing mechanism." (36) Still, the logic of state participation propagated by Guanzi and the Salt and Iron Debate "must be considered a legacy relevant also to modern economic governance in China". (37)