How to Cross the River

How China Escaped Shock Therapy: The Market Reform Debate, Isabella M. Weber, 2021.

Naomi Klein’s The Shock Doctrine had a big impact on me as a teenager. Probably the first ‘neoliberalism book’ I read, it became a formative influence on my politics. But growing older, I realised that while not a bad book, The Shock Doctrine wasn’t a great one either. Yes, it rightly connects the disastrous market reform programs implemented in South America, Eastern Europe, Russia and South Africa with ‘shock therapy’ economics. But the explanation is threadbare, even simplistic. Klein explains neither why these ideas gained genuine traction amongst socialist economists, nor why shock therapy produced such deleterious short-term results; in her narrative, American economists descend from above with market reforms that are doomed because they failed, without much further explanation provided.

Nonetheless, The Shock Doctrine did grasp an essential truth. Where implemented, shock therapy had severe and enduring short-term consequences, and although some countries have done remarkably well since, others, most especially Russia, have not. China undoubtedly benefited from not having gone down that road in the early nineties. So how should we explain all this?

I think Isabella Weber’s How China Escaped Shock Therapy: The Market Reform Debate provides good answers, albeit in a different context. In the period between the death of Mao and the Tiananmen Square massacre, modern China was, if not delivered, undoubtedly conceived. The story of the reform era is a familiar one. Liberalisation made slow headway in the early eighties, with agricultural reform leading the way. A dual-track price system, whereby firms produced a certain amount for the government and sold the rest on the market, was established. But as progress began to slow, the pressure for a shock therapy package grew. This would ultimately lead to an abortive attempt at massive price reform in 1988, which after it induced significant inflation and unrest, would result in crackdown, retreat, and a return to the gradualist approach.

Less well-known is how this process was contested not just between reformers and their opponents, but also amongst reformers; between those who advocated for a gradual, experimental transition and those who preferred an instantaneous and complete imposition of market relations - the aforementioned ‘shock therapy’. China would ultimately go down the first road, ‘groping for stones to cross the river’, as Deng Xiaoping famously remarked. But there were many who advocated for the other route, and they almost got their way. An intellectual history first and foremost, How China Escaped Shock Therapy first contextualises, then elucidates, the debate between market reformers during the 1980’s. Weber situates the contest over China’s economic future within an intellectual context spanning premodern Chinese history, American wartime planning, and the Chinese Civil War; arguing all exerted direct and indirect influence on the frameworks, priorities, and fears of the reformers. Moreover, she lays out the rationales behind the gradualist and package reform approaches, their pitfalls, and why gradualism ultimately prevailed despite the considerable political forces against it. Here, we find why How China Escaped Shock Therapy does more than just answer the question it poses eponymously. Through the history of the Chinese reform period, we can also remedy the deficiencies of The Shock Doctrine, and make headway towards understanding both why shock therapy gained intellectual currency within the socialist world, and why it ultimately failed to deliver what it promised.

Under Mao, Chinese development strategy operated along the Soviet principles I considered last time in the context of Robert Allen’s From Farm to Factory. Heavy industry was prioritised and urban immigration encouraged the implementation, via planning, of unequal exchange between agriculture and industry. The government forced farmers to sell grain at an artificially low price, and buy machinery at an artificially high price - the same so-called ‘price scissors’ used by the Soviets. However, unlike in the pre-war Soviet Union, this strategy failed to induce much growth. By the late seventies, a quarter of China’s 800 million peasants were still in poverty, and industrialisation had floundered. Serious reform was clearly necessary.

But how to make this reform was an open question. The need for a (socialist) market economy was widely apparent. In order to make this transition, two fundamental shifts would be needed. The market needed to be allowed a greater role in price-setting, and the unequal exchange between the rural and urban economy would need to be fixed. Further, the structure of industry would need to be transformed - entities that had been designed to meet quotas had to be reoriented towards profit. Inherently, the second task would take some time. Without resorting to Russia-style mass selloff, reorienting industrial structure was a long and complicated process. But price reform could theoretically be enacted overnight, by simply removing all quotas and controls. Hence the difference between gradualists and package reformers: the former believed that price reform had to be made alongside institutional development to create markets, whereas the latter argued a comprehensive, sudden price reform reveals the market, and was as such a necessary precondition to further institutional development.

In the eyes of the Chinese leadership, the primary risk presented by any price reform was inflation. Keenly aware of how hyperinflation brought down Chiang Kai-shek during the civil war, Chinese policy-making had always been acutely averse to price increases. Resultantly, inflation concern dominated their reform preferences. In my reading of Weber, the debate between gradualists and package reformists largely hinges on their differing assessments of inflation risk. In turn, the shifting favour for each school rested on whose inflation story was believed the most.

The package reformers argued that sudden, drastic reform, while it would produce a brief inflation - after all, prices would have to adjust to market conditions - would, if the quantity of money was strictly controlled, quickly reach a stable equilibrium. On the other hand, a gradual liberalisation would induce persistent inflation by failing to address the root cause of inflationary pressure: non-equilibrium prices, set by government and maintained by easy bank credit. Any dual-track price system was doomed to result in a return to central planning. In her conclusion, Weber argues these beliefs became popular amongst hitherto orthodox socialist economists for their symmetry with Soviet Marxism; where one idealised the visible hand of central planning, the other did the same for the invisible hand of the market. Shifting beliefs simply involved replacing one set of rigidly-defined axioms for another.

Undoubtedly, the story behind package reform has a conceptual elegance. But, as would become clear to many Chinese reformers in the mid-eighties, it is one based on very shaky foundations. In our post-New Institutional Economics era, it is no longer controversial to claim that competitive markets are not the original position of exchange, but are instead actively created. For their maintenance, they depend upon a set of institutions; institutions China did not have. For starters, strict control of the money supply - required, in the monetarist framework, to prevent runaway inflation - was not within the capability of the Chinese system at the time. Money creation by banks was integral to the financial plumbing that lay underneath the softly-constrained industrial system. But the most significant problem with package reform, according to Weber, was that “the mere removal of price controls could not transform the state owned enterprises into market enterprises. They remained socialist production units insofar that they had no power over the magnitude of capital and labour that they employed”. The state-owned companies had a factor composition designed to meet quotas, not make profits. They could not fire workers, nor go bankrupt. Hence, if presented with rising input costs, their only recourse would be to pass on those costs, using their monopoly power to increase prices. Persistent inflation, not price equilibrium, would inevitably be the result.

The empirical story behind shock therapy was also scrutinised in mid-eighties China. To pick but one example, package reformers had, after Milton Friedman, long cited the ‘Erhard Miracle’ of post-war West Germany in support of their case, Supposedly, Bizonal Economic Council chair Ludwig Erhard, through radical price and monetary reform in 1948, brought West Germany out of the ruins of the Second World War and on the path to rapid recovery. The ‘miracle’ was seen as the example par excellence of package reform in action. But the visit to Beijing of German economist Hans-Karl Schneider in 1986 disabused many Chinese reformers of Milton’s ‘Erhard Miracle’ story. On the one hand, late-forties West Germany had an intact market-oriented industrial structure underneath the planned economy imposed by Nazi wartime rule; hence, the conditions for liberalisation were radically different to those in China. But most importantly, Schneider stressed how Erhard had not actually liberated all prices overnight, despite perceptions to the contrary. In fact, essential raw materials were subjected to controls until the seventies. The ‘Erhard Miracle’ was clearly not the exemplar it had been thought to be.

Even as the evidence behind it was undermined, the Chinese leadership pushed towards package reform in the late-eighties, emboldened by early successes and the difficulties the gradualist dual-track system was encountering. But after the 1988 push created a crisis that would culminate in the Tiananmen Square massacre, package reform was abandoned. Shock therapy, for the reasons outlined above, was henceforth seen as presenting the greatest risk to price stability. Although many of the gradualist economists were cracked-down upon and imprisoned after Tiananmen, their ideas would dictate Chinese policymaking from the nineties onwards. Price reform would be conducted “from the margins”, coastal export-led development would lead the way, and the “commanding heights” of the economy - energy and raw resources - would remain under state control.

As has likely become clear, I have no serious criticism of How China Escaped Shock Therapy. If forced, it would only be that the frequent references made to ancient Chinese philosophy could seem slightly contrived at times. But that aside, I found Weber provides an invaluable corrective to not just an understanding of modern Chinese history, but also to the history of shock therapy writ large. By presenting the research of the Chinese reform economists, and the policy debates they participated in, Weber illuminates both why shock therapy became popular in the socialist world, and why it was ultimately doomed to failure. The tragedy is that these lessons, learnt by the Chinese reform economists and imparted upon the Chinese leadership, were not received by Boris Yeltsin or Jeffrey Sachs. Russia did not escape shock therapy in 1991, and with awful short-term consequences. Above all else, How China Escaped Shock Therapy teaches us that, for many Chinese reformers, this outcome would have been grimly predictable.