Comparison of the transition process in the former Soviet Union and China

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Abstract:

Transitions from state socialism generated a startling array of early economic outcomes, ranging from severe economic crises to steady economic growth, and igniting debates about the causal role of policy choices, institutional design, and initial economic circumstances. The worldwide transformation of state socialism during the 1990s yielded a series of surprises, generating widespread controversy and an enduring intellectual puzzle. The distortions typical of Soviet-style economies led most analysts to expect short-run hardship as manufacturing was downsized to correct decades of overinvestment in heavy industry, and as a shift to market pricing in economies of shortage led to price inflation and lowered living standards. In this paper, we will do a relative comparison between China and Former USSR.

Introduction:

The race to transform centrally planned economies into market economies has led, ten years later, to one group of countries approaching the finish line, others languishing at various points along the track, and a few barely off the starting blocks. Some Central and Eastern European economies (CEE) and the Baltics are knocking on the doors of the European Union. But in many economies in the Commonwealth of Independent States (CIS), including Russia, there has been uneven progress and prospects remain murky.

At the start of the transition, most economists agreed that, to get market price mechanisms working, liberalization and macroeconomic stabilization should proceed quickly, despite the economic hardship they might impose. The view was that the hardship would be temporary and less severe than if the process were dragged out over time.

The transition thus started in most economies with prices being rapidly liberated from artificially low levels, which led to an immediate burst of corrective inflation. The pent-up demand that had built up during the period of central planning sustained the inflation. Early in the transition inflation averaged 450 percent a year in CEE, nearly 900 percent in the Baltics and over 1000 percent in the CIS. By 1998, however, annual inflation had been lowered to the single digits in the first two groups and around 30 percent in the third.

Along with the burst in inflation, the transition began with another shock: output fell in all three groups of countries at the start of the transition, on average by 40 percent before it bottomed out, far more than was expected.

What were the starting economic, social and political conditions of market oriented reforms in the Soviet Union and China?  :

It is widely acknowledged that China has been vastly more successful than Russia in her transition from a planned socialist economy to a market-based economy.  The primary cause of the outcome was the policy choice taken by the respective governments.  On the other hand, the position, taken by most orthodox western economists, is that the initial conditions rather than the policies the governments of these countries chose, was the primary cause of the different outcomes. This is not to say that policies did not affect the outcome of the economy; rather, they assert that initial conditions played a larger role than policies or, even at times, constrained the possible outcomes of the policies.

I take this position for a number of reasons.  First, it is difficult to reach a firm conclusion about the relative advantage of gradual over radical reform or vice versa, as the variables involved are as complex as those involved in planning the Soviet economy.  Furthermore, it is difficult to separate the initial conditions of the country from the policy choice because, often, the policy choice was the consequence of the initial conditions.

The pace of reforms and their sequencing; their economic and political determinants:

Big Bang versus Gradualism:

It may be argued that Russia undertook both radical and gradual reforms.  During the end of the Soviet Union, Gorbachev tried to push through gradual reforms.  Unfortunately, the Soviet Economy was already too diseased to be fixed.  When the Soviet government collapsed, the new regime had to decide whether to continue gradual reforms by maintaining state control over a large portion of the economy or whether to follow the advice of Western economists and undertake radical reform.  The regime chose the latter options, first undergoing rapid liberalization of prices and then privatization of most of the economy. In practice however, Russia achieved less than full liberalization because of political constraints. Radical reforms entailed a centralization of fiscal policy, tightened monetary policies, deregulation of prices, liberalized domestic trade, freely convertible currency, free trade, privatization, and a new social safety net for groups in need. While these reforms were pushed through during the first years of the transition, many of these reforms were later eroded by political compromises.

China on the other hand chose the gradualist path.  This model favored step-by-step price liberalization and increased openness to the outside world, while the political regime maintained a strong grip on its power. Thus, they chose to first reform only foreign trade and agriculture, while maintaining control over other parts of the economy.  Then, the government opened the economy more and more for market-based incentives while maintaining control of certain state owned industries.

Results of reforms in economic and social terms:

The difference between the results of the Russian and Chinese transition has been enormous.  China’s economy has grown tremendously since its reform while Russia has had a difficult transition period, only recently stabilizing. The economic success of China is clear, as the GNP grew an average of 8.5% per year until 1994 since the start of reforms in 1978. This is not merely economic growth, but also economic development that benefited a large portion of the population.  Housing condition and food supplies greatly improved; even television sets became accessible to the poor during this period of expansion. The Russian Federation on the other hand has not fared nearly as well. 

The real GDP of Russia contracted over 35% during the first years of reform from 1989 to 1993; from 1993 until 1997 the GDP decreased at a more gradual rate. Russia’s standard of living has also fallen during the transition years.  In sharp contrast to the improving living standards in China, the Russian people have faced deteriorating qualities of life with a lower life expectancy, a phasing out of housing subsidies, and a marked decrease in consumption. The results of Russian reform have led to worsening shortages, decline in output, increases in income inequality, and an increase in corruption.

Comparison of the current economic systems in China and in the successor countries of the former USSR:

In a historic reversal of fortunes, China is overtaking the territory of the former Soviet Union in GDP per capita. China’s rapid economic development has been driven by ‘regionally decentralized authoritarianism’ (RDA). But only the economy is decentralized. Political centralization, the objectives and patronage of the centre, and the centre’s relative performance evaluation are essential elements of the model. It has been said that China’s advantage over the Soviet Union was that it carried out economic reforms while postponing political reforms. In reality, this is not true. The Soviet Union made reforms similar to China’s, but without the same success.

China’s success so far owes much to its unique circumstances: the great opportunities of initial poverty, exceptional economic size, and the commitment of its leaders, supported by long-standing traditions of RDA. China’s stock has risen most obviously in the West, where the major economies are burdened by recession and debt.

To break out of relative poverty and catch up with the world technological leader, an economy must undergo continuous policy and institutional reforms. When a country is some distance from the technological frontier, its growth is aided by institutions that implement technologies developed elsewhere. At very low levels of development, such as China’s in the 1970s, large gains may be realized simply by allowing workers to move from agriculture to factories and towns, working with established technologies. As the economy begins to close the gap with the global technological frontier, however, the emphasis must shift gradually away from implementation to autonomous innovation, which can be fostered by opening product markets to more stringent competition and, for example, raising the quality of education.

China presents an obvious contrast. In 1978 Deng Xiaoping, the Chinese leader, pointed the way to the ‘four modernizations’, namely agriculture, industry, science and defence.  In 1989, unlike President Gorbachev (USSR), he blocked demands for a ‘fifth modernization’ (democracy), thereby preserving the Communist Party’s monopoly as well as China’s state capacity.

The Russian economy has undergone massive changes since the fall of the Soviet Empire, transitioning from a state controlled, socialist structure to a more market-based and globally integrated economy. Economic reforms in the 1990s privatized most industries, and some energy and defense related sectors. The Russian economy has averaged 7% growth since the 1998 crisis, resulting in the emergence of its middle class. But Russia’s heavy reliance on commodity exports made the country vulnerable during the global economic crisis of 2008, though recovery signs were evident in 2010. This was due to the rising oil and commodity prices, and the government’s $200 billion rescue package to increase liquidity in the banking sector.

Russia is one of the most industrialized of the former Soviet republics. However, years of low investment have left much of Russian industry antiquated and highly inefficient. Besides its resource-based industries, it has developed large manufacturing capacities, notably in metals, food products, and transport equipment. Russia is now the world’s third-largest exporter of steel and primary aluminum. Russia inherited most of the defense industrial base of the Soviet Union.

Differences between successor countries of the former USSR in their reform strategies and outcomes:

Initial expectations envisioned a dramatic early payoff to the transition from plan to market. Reality proved different, as output collapsed amid surging inflation. While the picture has substantially brightened since the mid-1990s, income levels in all but a handful of transition economies remain below their 1989 levels. Close to thirty countries embarked on the path from plan to market at roughly the same time, but starting from rather different initial conditions, selecting different strategies and proceeding at different speeds.

Fischer and Sahay conclude that “the most successful transition economies are those that have both stabilized and undertaken comprehensive reform” and that “more and faster reform is better than less and slower reform.” In like vein, Wyplosz (1999) concludes that “Clearly the countries that bit the bullet early and hard are those that have done better over the last decade.”  Belarus and Uzbekistan provide prima facie counter-examples to the notion of a uniform positive link between reform and economic performance.

To understand the trajectories of growth we group together seven contributions, covering two rapidly reforming countries (Poland and Lithuania), four reform laggards (Slovakia, Romania, Bulgaria, Croatia) and one reform laggard from the Commonwealth of Independent States, or CIS, Ukraine.

Ukraine was once described as the breadbasket of Europe, producing more than a quarter of the Soviet Union’s agricultural output. But the country went through a period of rapid economic decline and runaway inflation after independence. Although trade with EU countries now exceeds that with Russia, Moscow is the largest individual trading partner. Ukraine depends on Russia for its gas supplies and forms an important part of the pipeline transit route for Russian gas exports to Europe. A dispute over price rises in 2006 and 2009 prompted Russia briefly to cut supplies. The economy’s dependence on steel exports made it particularly vulnerable to the effects of the global financial crisis 2008.

Forthcoming economic and social challenges in China and successor countries of the former USSR:

China has succeeded where the Soviet Union failed. RDA has allowed competition among China’s provincial leaders to harness the private sector to the objectives of national economic modernization. China’s modernization has thus proceeded without universal market freedoms, the enforcement of third-party property rights, or the subjection of leaders to the rule of law. Linked to this pattern of reform and modernization are genuine risks that deserve urgent attention, and these could undermine China’s success in future as the country develops towards middle-income status.

Lack of government accountability:  While GDP measures market output, social welfare and market output are only imperfectly correlated. Along with a heavy emphasis on boosting measured output have come greater income inequality, excessive spending on military projects and urban infrastructure, abuses of power and rising social discontent.

Losing the momentum of policy reform:  In the past, China has often been spurred on to further innovative reforms as a result of external difficulties. Indeed, reforms took place in the 1980s when China emerged as one of the poorest countries in the world. Precisely because China was still so poor, reforms were eased by the spectacular gains that were quickly realized and could be widely shared – an advantage that Soviet reformers lacked. Continuous policy reform is essential to modern economic growth. China’s RDA so far has provided a mechanism for continuous policy reform, but it is inherently fragile.

As the country moves towards middle-income status the question is whether its leaders will cease to pursue reforms in the national interest and acquiesce to the private interests of bureaucratic or corporate incumbents. If they do, China’s economic modernization will come to a halt. This could happen in two ways, which can be characterized as the complacency trap and the conflict trap.

The end of the Soviet era brought about fundamental changes in Russia’s economy and its conditions. The transformation from a command to a market economy was painful and caused numerous derivative problems. Privatization paved the way for the oligarchs, who were able to accumulate immense riches due to their connections with politicians and secret-service officials. The old structures in the country’s economic life dissolved but were not replaced. This, in turn, resulted in a tangle of corruption involving the state, the secret service, and the mafia which, working hand in hand, drove the country’s economy into a decline in the long run.

The economy logged high growth rates which, however, have been declining again since 2003 and would hardly have been achieved in the first place without the exports of crude oil and natural gas.

According to plans, 13 to 15 million new consumers are to be connected to the gas supply system each year. To do this, new deposits would have to be developed which, however, are located in Eastern Siberia and the Far East, where there is no suitable infrastructure and nobody who could address themselves to the tasks on the spot.

Domestic capital formation is absolutely insufficient, so that Russia’s industry is forced to draw on foreign capital resources. At the moment, the foreign debts of the government and Russia’s enterprises total 527 billion US Dollars.

The social situation of the population is problematic. The reasons for this lie in low wages and the constantly growing inflation (officially put at 16 percent at the moment), against which the state takes little or no action, and which is exacerbated by the international financial crisis. Moreover, the public-health system must be improved. The state does talk about providing health care free of charge, but most Russians cannot afford medication. Finally, housing shortage is another highly explosive issue, especially in the cities.

Note: This paper was originally submitted as a mandatory requirement to finish a MOOC  “Economics of Transition & Emerging Markets”  on Coursera.

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