Justin Yifu Lin on China's reform path and "shock therapy"

Ex-World Bank Chief Economist & SVP on why "Collapse of China" narrative persists

This newsletter features a translation of the Chinese article《 “中国崩溃论”为何挥之不去？》Why the “Collapse of China” narrative persists. Sourced from a recently-published book in China and attributed to Prof. 林毅夫 Justin Yifu Lin, currently Dean of Institute of New Structural Economics at Peking University and former Chief Economist and Senior Vice President of the World Bank (2008-2012).

This is not a long article, and the original Chinese is posted at the end. Again, thanks go to Dot Dot Stand, a China tech news site, for graciously doing the key and first round of copyediting the translation here.

The translation hasn’t been approved by Prof. Lin.

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Why the “Collapse of China” narrative persists

We embarked on a different development path in 1978 and have achieved impressive results, but why has the narrative of the “Collapse of China” persisted over the past 40 years? How come we keep hearing the narrative about the imminent collapse of China’s economy? The main reason is that our way of thinking on transformation is different from the prevailing one in the world at that time.

We initiated reforms in 1978. In the 1980s, reforms were underway in almost all developing countries. For the reforms in developing countries, the mainstream international view at the time (what we now call the “neoliberal” view) held that developing countries fared poorly because the government had made excessive interventions in the market and caused its distortion, resulting in a misallocation of resources. Rents emerged as a result of government intervention and market distortion. In terms of economics, there were issues including rent-seeking, corruption of all types, and unfair income distribution. 

For the transition from a planned economy to a market economy, it was necessary to replace government intervention in the market with the establishment of a sound market economy system. In other words, to develop the economy, the governments of these developing countries should withdraw from the market and establish a market economy system as sound as that of developed countries.

How to establish a sound market economy system? What was proposed at that time were privatization, marketization, balancing the fiscal budget, and liberalization. Why were the views at the time? Because in a market economy system, the prices should be determined by the market. This is what marketization implied. The market determining the price of products is the basis of a market economy.

The view at the time was that: a state-owned enterprise (SOE) will be subsidized by the state when it operates at a loss. In this situation, the company will not be responsive to price signals. For one thing, the SOEs do not care even if the price of the production factors is high, because they will be subsidized by the government. For another, even if the price of their products is high, SOEs will not necessarily increase production, because they think that any profit earned will be given to the state and their directors and managers do not benefit from higher profits. Only the owners of private companies, who pursue higher profits, would make targeted decisions in response to price signals. Therefore, the second idea at that time was that enterprises must be privatized.

At the same time, prices at the macro level must be stable. If hyperinflation occurs, the price will lose its effectiveness in allocating resources. To stabilize prices, the prerequisite is that government must have a balanced fiscal budget. That’s because if there is a large budget deficit, monetary approaches will be adopted - to print more money - to compensate the government’s fiscal deficit. Inflation will occur in the wake of the additional currency supply. If inflation is running high, the price will lose its effectiveness in guiding resource allocation.

These ideas about reform at that time all seem to be linked: In order to establish an institutional mechanism for the market economy, the allocation of resources must be determined by prices. However, only with institutional arrangements for private property rights, will companies make decisions based on price signals, and will the allocation of resources be determined by the market. At the same time, governments must maintain the stability of the macroeconomy to bring into play the price signals. This is later called by many as the “Washington Consensus”.

China initiated reform in 1978, but instead of adopting the approach considered the best at the time, China took a gradual, dual-track approach to transformation. This gradual and dual-track approach was adopted because there were many large capital-intensive SOEs in the early days of reform and opening up. And these SOEs would not be able to survive without protection or subsidies, because they were capital-intensive and against China’s comparative advantages.

Therefore, the transformation approach at that time was that necessary protection and subsidies were still provided to these enterprises. For labor-intensive processing industries, whose development was suppressed in the past and stands in line with China’s comparative advantages, the government relaxed access - township and village enterprises, private enterprises, and foreign enterprises could all enter.

In addition to relaxing access, governments proactively seized the momentum and guided the development of these enterprises, by establishing industrial parks, export processing zones, special economic zones, promoting investment, and rolling out favorable policies, so that labor-intensive industries could develop.

There was an international consensus at the time that a gradual, dual-track reform like that adopted by China was the worst approach to transformation. If the transformation was carried out in this way, the Chinese economy would perform worse than it was in the planned economy period. Their view was that: in the planned economy period, what the government did was just direct resources to SOEs.

If a gradual, dual-track approach was adopted for transformation as what China did, government protection and intervention in the market would cause market distortion on one hand, and, on the other hand, if market access was partially liberalized, extensive corruption could occur. There is a price difference between the government-controlled price and the market price, which will lead to rent-seeking.

All the students here today may not have heard the Chinese word “Dao Ye (倒爷)”, meaning a profiteer, but the teachers here know that there were many so-called “profiteers” in the 1980s. If the government-controlled prices were low and market prices were high, “profiteers” sought approvals to buy stuff from the government and resold them on the market at a profit. Corruption occurred in this way, and bribery was common. Therefore, it was believed that the Chinese economy at this time was worse than the planned economy.

This indeed emerged in China. However, what happens to the countries which adopted the “shock therapy,” thought to be the best way for transformation and prescribed by the “Washington Consensus”? The result was that their economy either collapsed or stagnated, and crises cropped up one after another. Moreover, the problems of corruption and income distribution were more serious in those countries than in our country.

How come the neoliberal theory seems to have a coherent and clear logic, but the result of its implementation is just the opposite of what was expected? How come the countries that adopted the “shock therapy” ended up with a collapsed or stagnated economy, continuous crises, and more rampant corruption problems? I think the principal reason is that this theory does not take into account the purpose of economic intervention and distortion. The purpose of intervention and distortion was to provide protection and subsidies for capital-intensive and large-scale SOEs. Those SOEs were against the comparative advantages. After privatization, they would not survive without protection or subsidies. What would happen if they did not survive? For one thing, SOEs were large in size with a large number of employees. Many of them would be laid off if SOEs went bankrupt, which may cause social and political instability. For another, the products of some SOEs are related to national defense and security. National defense and security would be jeopardized without these SOEs and their products.

After 40 years of reform and opening-up, China has now become an upper-middle-income country. As capital accumulates, many old industries have evolved to conform to comparative advantages and they should be able to make a profit and face market competition in an open and competitive market as long as they are properly managed. In this situation, the protection and subsidies lose their meaning. From the perspective of enterprises, the more protection and subsidies, the better for them. From the perspective of the nation, granting protection and subsidies will result in rent-seeking and corruption. It comes with social and political costs.

Therefore, in 2013, the Third Plenary Session of the 18th Central Committee of the Communist Party of China put forward comprehensively deepening reforms. One of the main goals of comprehensively deepening reform is to allow the market to play a decisive role in resource allocation. How can the market play a decisive role in resource allocation? The answer is to eliminate the protection and subsidies. Conditions are ripe for elimination.

Many industries that could not survive without protection or subsidies are now highly competitive. For example, Sany Heavy Industry in the equipment manufacturing sector is highly competitive internationally. Xuzhou Construction Machinery Group, a state-owned enterprise, can also compete internationally. The Chinese automobile industry has an annual output of 30 million vehicles, the largest in the world, and Chinese vehicles can compete with imported automobiles. Some of them can compete internationally because they have comparative advantages now. 

Therefore, the protection subsidies granted in the 1980s and 1990s to enterprises for their survival can now be abolished. After that, the market can play a decisive role in resource allocation. Of course, the government has to play its due role.

【Note: 找市长 (through the mayor) or 找市场 (through the market), which have similar spelling and pronunciation, is a common metaphor in the history of China’s reform illustrating economic activities leaning on state power or the market economy.】

This gradual reform actually creates the necessary conditions for subsequent reforms. At the same time, if protection and subsidies of all types are abolished, corruption can be rooted out, because corruption stems from rent-seeking behavior caused by government intervention. If the market determines the prices and allocates resources, most people would rely on the market instead of the mayors. Government intervention is still ongoing, so enterprises turn to the mayors instead of the market and corruption occurs consequently. If resources are all allocated by the market, it would be useless to turn to the mayors. Enterprises would have to turn to the market. There would naturally be no corruption if the mayors were not involved. Therefore, the abolition of protection and subsidies will help root out corruption.

Due to a mistaken way of thinking, many countries adopted the wrong approach to transformation and ended in failure. We actually had the best approach to transformation, but economists at the time generally held that this was the worst way. When our economic development slows down a bit, they think that China’s economy is about to collapse, because they think the economy is unlikely to develop sustainably under the worst approach. From 1978 onwards, our economy has grown by 9.5% per year on average. It does not mean the annual growth rate has remained at 9.5%. The growth may have reached 11% or 12% at its height and fallen to 8% at its low point. As long as there is a slowdown in growth, they tend to talk about a coming collapse of China’s economy. I think this is largely caused by misunderstanding.

(Excerpt from Lectures at Peking University Hall for Well-known Masters on Theory (volume 1), People’s Publishing House, October 2021. Translated from the Chinese version available on the app of Beijing Daily 北京日报.)

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林毅夫：“中国崩溃论”为何挥之不去？

1978年以后，我们改变了发展思路，取得了这么好的成绩，可是为什么这40多年当中老是听到“中国崩溃论”的声音？老是在讲中国经济即将崩溃？为什么会有这样的情形呢？主要的原因是我们转型的思路跟当时国际上主流的转型思路不一样。

我们1978年开始改革。到了80年代，基本上所有的发展中国家也都在进行改革。对于当时发展中国家的改革，国际上的主流认识（我们现在称为“新自由主义”的观点）认为，发展中国家之所以发展不好，是因为政府对市场进行了太多的干预、扭曲，导致了资源的错误配置。政府的干预、扭曲形成了租金，用经济学的话来讲就是会有寻租的行为，会有各种腐败现象，造成收入分配不公等问题。既然要转型，从计划经济向市场经济转型，就要从政府对市场的干预转变为建立完善的市场经济体系。也就是说，这些发展中国家如果要把经济搞好，政府就应该退出市场，就应该建立一套像发达国家一样的完善的市场经济体系。怎么样建立一个完善的市场经济体系呢？当时提出的就是要私有化、市场化、政府财政预算平衡、自由化。当时为什么是这样的看法呢？因为你要建立市场经济体系，价格应该由市场决定，这就是市场化的含义。各种产品的价格应该由市场决定，这是市场经济的基础。

当时的看法是：如果企业是国有的，国有企业亏了本，国家会给补贴，在这种状况下，企业对价格信号不起反应：一方面，如果用的生产要素价格高，国有企业不会在乎，因为即便生产要素价格高、企业亏损，政府也会给补贴；另一方面，即使产品价格高，企业也不见得会多生产，因为他们认为赚的钱再多，也要交给国家，厂长和经理没有得到更多的收益。只有私有企业，老板为了多赚钱，才会根据价格信号作出准确的决定。所以当时的第二种思路就是必须要私有化。

同时，宏观的价格必须稳定，如果出现了恶性通货膨胀，价格就会失掉配置资源的功效。稳定物价，前提就是政府的财政预算必须要保持平衡。因为如果政府的预算有很大的赤字，必然用货币化的方式增发货币，弥补政府的财政赤字。如果增发货币，就会导致通货膨胀。通货膨胀高了以后，价格就失掉了引导资源配置的功能。

当时的这些改革思路好像是一环扣一环：要建立市场经济的制度机制，就要由价格决定资源配置。但是必须要有私有产权的制度安排，这样企业才会按照价格信号来决策，资源才会由市场来配置。同时，必须要由政府维持宏观经济的稳定，价格信号才会起作用。这些后来被大家称为“华盛顿共识”。

中国在1978年以后开始改革，并没有用当时被认为最好的办法，中国是按照一个渐进的、双轨的方式来转型。所谓渐进的、双轨的方式，就是我们在改革开放初期的时候，有很多资本很密集的大型的国有企业，当时如果不给这些国有企业保护补贴，它们是活不了的，因为资本非常密集，违反我们的比较优势。所以当时的转型方式基本上就是老人老办法—继续给这些企业必要的保护补贴，新人新办法—对那些劳动力密集的加工业，这些传统上受到抑制的、符合我们比较优势的产业，政府开放准入，乡镇企业、民营企业、外资企业都可以进入。而且不仅是开放准入，同时还积极地因势利导它们发展，包括设立工业园、加工出口区、经济特区，招商引资，给予各种的优惠政策，把那些劳动力比较密集的产业发展起来。

当时国际上还有一个共识，就是像中国那样渐进的、双轨的方式的改革是最糟糕的转型方式。如果按照这种方式转型，中国经济会比在计划经济的时候还要糟。他们的看法是这样的：在计划经济的时候，政府无非就是把资源提供给自己的国有企业。但如果像中国那样推行渐进的、双轨的方式转型，一方面，政府的保护和对市场的干预会造成市场扭曲，另一方面，放开了一些市场的准入，就会出现很多腐败现象。因为在政府控制的价格跟市场价格之间有一个价差，就会有人去寻租。在座的同学们可能没有听过“倒爷”这个词。在座的老师都知道，20世纪80年代有很多所谓的“倒爷”，政府规定的价格低、市场价格高，“倒爷”就到政府那边去批条子，把政府廉价的产品倒到市场上去卖，转手之间就能赚钱。这样就有了腐败，就会有很多的贿赂现象出现。所以他们认为这时候的中国经济比计划经济更糟。

这个现象在中国确实是出现了。可是我们现在看到，当时认为最好的转型方式是“华盛顿共识”所讲的“休克疗法”，但是推行“休克疗法”的国家结果怎么样呢？结果经济都崩溃了、停滞了，危机不断。而且出现在我国的腐败和收入分配问题他们也遇到了，并且比我国还严重。

为什么新自由主义的理论听起来好像非常清晰，好像在逻辑上一环扣一环，但是推行以后的结果却跟原来预期的效果正好相反呢？为什么按照“休克疗法”这种被认为最好的方式转型，结果经济却崩溃了、停滞了，危机不断，而且腐败问题还更严重呢？我想最主要的原因是这样的理论忽略了原来对经济干预、扭曲的目的是什么。干预、扭曲的目的是为了对资本非常密集、规模非常大的国有企业进行保护补贴。那些国有企业违反了比较优势，私有化以后，不给保护补贴，还是活不了。活不了会有什么结果？一方面是规模很大，雇了很多人，让它破产，就会有大量的失业，可能造成社会不稳定、政治不稳定。另一方面，这其中的一些企业的产品跟国防安全有关，如果没有这个产业，没有这些产品，就没有国防安全。

现在，经过40年的改革开放，我国已经是一个中等偏上收入的国家了，随着资本的积累，许多老产业已经从违反比较优势变成了符合比较优势。既然符合比较优势，在开放、竞争的市场当中，只要管理好，就应该能赚钱，就应该能够面对市场竞争。在这种状况下，保护补贴就失掉意义了。从企业的角度来讲，肯定是保护补贴越多越好；从国家的角度来讲，给保护补贴就会有寻租、腐败的问题，会有社会代价、政治代价。

因此，2013年，党的十八届三中全会提出全面深化改革。全面深化改革的一个主要内涵就是让市场在资源配置中起决定性作用。怎么样让市场在资源配置中起决定性作用呢？就是要把政府的保护补贴取消掉，现在取消是水到渠成。很多过去没有保护补贴就活不了的产业，现在很有竞争力了。比如装备制造业，像三一重工，在国际上很有竞争力。又比如徐州工程机械，是国有的，同样可以在国际上竞争。还有汽车产业，我们现在汽车产业年产3000万辆，全世界最多，产品可以跟进口汽车竞争，有一些汽车也可以到国际上竞争，有比较优势了。所以就可以把在20世纪80 年代、90年代为了帮助企业生存所给予的保护补贴取消了。取消了以后，市场才能在资源配置中起决定性的作用。当然政府还要发挥政府好的作用。

这个渐进式的改革，实际上是给我们后面的改革创造了必要的条件。同时，如果把各种保护补贴都取消掉，也可以对腐败现象产生釜底抽薪的作用，因为所有腐败就是因为政府的干预产生的寻租行为。如果说价格都由市场决定了，资源都由市场配置了，一般人就不用找市长了，就要找市场。我们现在有政府干预，所以要找市长，不找市场，那就有腐败了。如果各种资源都由市场配置，你找市长也没有用，只好找市场了。你不去找市长，当然就不会有腐败了。所以说，取消保护补贴对腐败有釜底抽薪的作用。

由于认识上的错误，很多国家采取了错误的转型方式，结果导致了失败。我们采取的实际上是最好的转型方式，但是当时经济学家普遍认为这是最糟的方式，所以只要我们的经济发展速度放缓一点，就认为中国经济快崩溃了，因为他们认为你既然采取了最糟糕的方式，经济怎么能够持续发展呢？所以我们讲，从1978年到现在，我们的经济平均每年增长9.5%，但是并不是每年都增长9.5%，高一点可以达到11%、12%，低一点可以到8%。那么只要出现了增速放缓，就马上说你经济要崩溃了。我觉得这主要是因为认识错误造成的。

（本文摘编自《北京大学理论名家大讲堂（第一辑）》，人民出版社2021年10月出版）