MIT Sloan School of Management

This paper is the first chapter of a forthcoming book, Capitalism with Chinese Characteristics (New York: Cambridge University Press, July 2008). The book is a narrative account of the evolution of capitalism in China in the last three decades. (The year 2008 marks the 30th anniversary of economic reforms in China.) The research is based on detailed archival examinations of policy, bureaucratic and bank documents as well as several waves of household and private-sector firm surveys. As an example, I have examined a 22-volume collection of memoranda, directives, operating manuals, rules of personnel evaluations issued by the presidents of China’s central bank, all the major commercial banks, rural credit cooperatives, etc. A detailed synopsis of the book appears after this page. This paper presents the framework for and the summary findings of the entire book. The highlights are: --Many economists used output share of private sector as evidence that China’s business environment became more liberal over time. Measured by output share, China’s private sector has grown enormously since 1978. But output share is not an accurate measure of private sector policy because it is correlated with efficiency differentials between private-sector firms and state-owned enterprises (SOEs). During the 1989-1991 period when China cracked down on private sector, the output share of private firms still increased. Another example is from the former Soviet Union. Private agricultural output was quite high because private farming was so much more efficient than state farming. This is not evidence that the former Soviet Union was pro-private sector. --A superior measure of policy evolution is capital allocation. By this measure the most liberal policy period, by far, was in the 1980s and in the 1990s the investment share by purely privatesector businesses fell substantially. (The share only began to rise after 2002.) --The changing investment share by the private sector suggests a development few Western academics have noticed—a substantial policy reversal in the 1990s. Survey and documentary evidence suggests that private access to finance was easier in the 1980s than in the 1990s and this was especially true in rural China. --Evolution of capitalism in China is a function of a political balance between two Chinas— the entrepreneurial, market-driven rural China vis-à-vis the state-led urban China. In the 1980s, rural China gained the upper hand but in the 1990s, urban China gained the upper hand. Although China made notable progress in the 1990s in terms of FDI liberalization and reforms of SOEs, this book assigns greater weight to the rural developments in determining the overall character and the pace of China’s transition to capitalism. --Many economists rely on GDP data to formulate their view of Chinese economy. The tale of the two decades is not reflected in the GDP data but is reflected in the household income data (obtained through surveys). Rural household income grew substantially faster in the liberal 1980s than in the illiberal 1990s. Also social performance deteriorated in the 1990s as well.