What Have We Learned, and Not Learned, from a Quarter-Century of Transition

By Harley Balzer, Georgetown University.

This article was originally published in the October 2016 edition of NewsNet.

A quarter-century of perspective is about the point where historians take over from political scientists. It probably should be the half-life of discussions about the “Transition from Communism.” 

What have we learned? We might begin with terminology: “transition from” is a far more accurate formulation than “transition to,” especially when the “to” is followed by “democracy and the market.” Calling reforms “shock therapy” was a hideously poor choice. 

More substantively, this essay focuses on three of the many lessons: 1) Rapid reformers fared best; 2) Politics consistently trumps economics; and 3) China’s surprising success challenges many assumptions and presents a stunning contrast to Russia. After briefly summarizing the first two topics, the emphasis here will be on the less-studied third set of lessons. 

Rapid reform vs. gradualism: Strong evidence shows that across Eastern Europe and the CIS rapid reformers suffered less damage and recovered more quickly than partial/gradual reformers and non-reformers (Havrylyshyn 2016; Triesman 2014; Aslund 2014; Roland 2014). Partial reformers fared worse than non-reformers, especially during the first decade. 

The “holy trinity” of reform for Soviet bloc countries facing economic crises included stabilization, liberalization, and privatization. Some economists suggested this should be a sequence (McKinnon 1991); for others, what mattered was that all three be implemented quickly (Woo 1994). Russia’s sequencing demonstrated that privatizing before achieving stabilization and liberalization was an invitation to disaster. Appel (1997: 1435) noted Russia’s policy allowing transfer of privatization vouchers, which resulted in poor and poorly informed individuals selling them for little. The Lithuanian and Czech programs prohibited transfers. 

Many analysts have argued that institutions and a regulatory system should have been put in place prior to privatization. Kaufmann and Siegelbaum (1996: 425) provide a cogent analysis of why delaying privatization until a legal system and mechanisms to enforce it were functioning effectively would have resulted in there being nothing left to privatize; all of the assets with any value would have been seized by insiders. This reinforces arguments that speed was generally more important than establishing legal and regulatory regimes, provided those regimes did not lag too far behind.

The slow development of necessary institutions in many countries points to one of the surprises in postCommunist transitions. Contrary to the “lessons” from Latin America in the 1980s, winners benefitting from partial reform (Hellman 1998) were frequently a more serious impediment to continuing reform than the losers (Przeworski 1991). In Eastern Europe, economic difficulties resulted in elections changing governments, but not the fundamental direction of reform policies. As Abdelal (2001) noted regarding the Baltics, the elites and citizens of these countries knew they wanted to be part of Europe and were willing to pay a price to achieve this. However, winners slowing reform did not mean the danger of populist reversals ended, as recent developments in Hungary and Poland demonstrate.

Living standards and human development indicators improved in the rapid reform countries (Triesman 2014), but also for a time in hydrocarbon exporters and most impressively in China. Poverty was reduced in the successful reform countries, though China’s success, again starting from a low base, dwarfed the East European achievements.

Thick integration with the global economy (Balzer 2008) advanced reform, even if it carried risks. Countries that resisted integration were not really insulated from global economic fluctuations, especially if they exported commodities.

In politics, we learned that democracy is more likely when democrats come to power (McFaul 2002), but keeping them democrats requires strong institutions, equally strong protections, and an electorate that pays attention. The shift from emphasizing democratization to “managed democracy” (Lipman and McFaul 2001), “managed pluralism” (Balzer 2003), “virtual politics” (Wilson 2005), “patronal politics” (Hale 2014) and a slew of other terms chronicles the problem. 

The retreat from democratization accentuates the lesson that democracy and the market are mutually reinforcing, especially in the long term. Triesman (2014) shows that democratization is often followed by economic reform, but economic reform does not predict democratization. Russia and China since 2012 demonstrate that politics trumps economics. 

Critics would say that this summary amounts to an endorsement of “neoliberal globalization.” Yet most of the critics focus on the shortcomings of the reform projects rather than offering genuine alternatives (Stiglitz 1999; Murrell 1993). The recent comprehensive analysis of neoliberalism by Appel and Orenstein (2016) emphasizes competition for investment as the driving force, rather than identity. Yet overwhelming evidence that rapid reformers performed better suggests gradualism involves long-term costs and risks of capture or retreat. 

My own “bleeding-heart neoliberalism” emphasizes the most important thing that was NOT learned: how to maintain social safety nets in chaotic political and economic transformations. Reformers consistently talked about the need to protect the vulnerable, but ignored the reality of the needy lacking political power (Nooruddin and Simmons 2006). I spent about 18 months in 1991-92 trying to generate interest in Washington to have the G-7 pay the salaries of the teachers and physicians in the vanishing USSR. This might have helped preserve a middle class. When George Soros asked me to lead a project to support scientists, it seemed to be a good first step. 

When Stiglitz (1999: 23-24) lauds gradual reform, his favored example is China. The comparative lessons from China’s experience are among the most under-studied aspects of the transition from communism, and it is worth devoting the remainder of this essay to those lessons.

The narrative of China’s impressive rise since 1978 favored by Vladimir Putin’s team and by China’s rulers emphasizes gradual reform centrally administered by a wise Communist Party that achieved its goal of economic development. While attractive to authoritarians, this narrative ignores the crucial elements in China’s success. If control by the Party-State was the basis for China’s economic miracle, the state sector should be the leader rather than a continuing drag on growth. If centralization was the key, why did regions that implemented their own programs perform better, often developing approaches subsequently accepted in Beijing? Most important, despite the emphasis on “Chinese characteristics,” China’s success involved thick integration with the global economy; willingness to learn; significant foreign investment; along with rapidly growing involvement in global supply and production chains, knowledge economy relationships, and human capital exchanges. In each of these area, China presents a sharp contrast with Russia (Balzer 2008; 2010; Balzer and Askonas 2016). 

Many analysts reject learning that Russia and China are NOT a contrast between rapid “big-bang” reform and gradualism. As Havrylyshyn et al. (2016) note, “much of the writing about Russia does not recognize that the big-bang reforms were short-lived and then reversed.” Russia’s government began to run budget deficits by the second quarter of 1992. The money supply doubled by October 1. Chernomyrdin replaced Gaidar as Prime Minister in December. Russia’s Central Bank guaranteed inter-enterprise debts, making it possible for firms across the ruble zone to issue credits to each other. This drove inflation to 2000% (Woo 1994: 278). Woo concludes that “incoherence of microeconomic liberalization without macroeconomic stabilization is almost akin to shock without therapy.” 

China’s reforms were “gradual” in that they did not try to do everything at once. The Communist Party retained power, and faced no economic crisis involving linked economies. But China’s most successful reforms were neither planned nor gradual. Experiments took on a life of their own, often at a pace far beyond what leaders intended. Shue (2004) may exaggerate in saying that the Chinese leaders deserve credit mainly for getting out of the way, but Deng in particular was impressively pragmatic, admitting openly that the development of a flourishing private sector in the countryside was unexpected and welcome. 

Complete loss of control promotes anarchy. China fared best where it partially lost control. This was clearly evident in regional economic development. There is no more stunning difference between China and Russia than in the policy agendas of regional leaders. Chinese cadres are evaluated overwhelmingly on the basis of GDP growth. The resulting incentive structure induced growing numbers to promote economic development. 

In Russia, weak central control in the 1990s was replaced by heavy-handed centralization in the Putin era (Petrov 2013). The incentive structure encouraged regional and city leaders to foster local economic development only for the few years when they were elected (Konitzer-Smirnov 2003). Under Putin, the incentive structure for Russian regional officials does not reward local development. Regional executives rarely move to another region. Their calculations involve doing Moscow’s bidding, turning out the vote for the ruling party, maintaining social stability, and lobbying for funds from the center (Kuz’menko 2015; Sharafutdinova and Turovsky 2016). Many are predatory rather than entrepreneurial. 

The first and in many ways most important Chinese reform was decollectivization. While some experiments had been allowed for a decade before 1979, the rapid dismantling of China’s collective farm system was accepted, not organized. The largely spontaneous shift to “household responsibility” was not reversed (Zhou 1996; Qian 2000). Zweig (2002) describes many other policies, including special economic zones and international education linkages, creating “fevers” stemming from partial openings and uncertain time frames. Chinese rushed to take advantage of opportunities that might be short-lived; others imitated their behavior even when they lacked official approval. Rather than fostering development, Russia’s special zones became havens for smuggling alcohol, tobacco, and other goods. 

China’s decollectivization improved agricultural productivity, generating a surplus rural labor pool. Russian state and collective farms typically punished those seeking to leave. Chinese peasants made redundant found employment in burgeoning Township and Village Enterprises (TVEs) that began to satisfy demand for goods. The cooperatives in Russia were mostly parasitical, using state resources for private profit. China’s decollectivized peasants also became the labor force for new industrial zones. In Russia, the priority was to keep workers at overstaffed enterprises from becoming unemployed, creating problems that persist to this day (Kapeliushnikov et al. 2012).

Until 1994, Chinese regions were allowed to keep a significant share of increased revenue. The pro-growth incentive structure combined with regular rotation of cadres and some level of Party discipline did not prevent corruption, but often channeled it into less destructive forms. Many Chinese officials accepted a share of profits rather than stifling small and medium businesses. In contrast to Russian officials positioned to enjoy natural resource and administrative rents or strip assets, Chinese officials needed to help create wealth before they could grab a share. Improving local GDP meant career advancement. Campaigns against corruption, while always flawed, provided a stick accompanying the carrots. 

The Chinese story should not be idealized. The corruption is real, and in some cases destructive. Emphasizing growth encourages negative externalities, most notably inequality, environmental degradation, and property expropriation. The emphasis on economic reform without political reform, lauded by some analysts, has emerged as a serious problem since 2012. 

Russia, under Putin’s with much tighter central control, matches China in inequality, environmental problems, and insecure property rights, while sharing none of the economic, technological, or scientific success visible in China. 

China’s success has been due to learning and thick integration with the global economy. Russia has remained far more thinly integrated, and epistemic communities are more inclined to perpetuate Soviet practices.

China’s three-decade run of economic growth has been badly misconstrued in Russia, fueling related myths of a strong leader, centralization, and state enterprises generating economic success. The keys to China’s economic growth were 1) an unintended but accepted flourishing of private enterprise; 2) opening to and learning from the outside world; 3) some regions and many entrepreneurs pushing and sometimes altering the boundaries of the permissible; and 4) leaders willing to accept significant deviation from official policy when the results proved economically beneficial. Other explanations for Chinese success, such as diasporas or historical continuity, fail a comparative test (Balzer 2008 & 2010; Balzer and Askonas 2016). 

Developments in China and Russia since 2012 compel us to reconsider the economics/democracy debate. Alt (2000) contends that “democracy is neither necessary nor sufficient for economic growth,” and that it “has more to do with freedom and choice than welfare per se.” Alt is correct that democracy is not the sole route to growth, nor a sufficient route. But what generates sustainable growth? What prevents predatory or incompetent rulers from stifling economies? Limited government is the only path to sustainable balanced growth. It may be achieved by an enlightened despot (therefore dependent on the individual in power who may or may not remain enlightened and may or may not be succeeded by someone enlightened), a balance between competing forces (subject to imbalances over time), or by democracy (based on institutions that may endure if defended). Democracy may promote equality and be sustained, though neither of these outcomes is guaranteed. 

Precisely because the system lacks institutional safeguards, China’s success now is threatened by a “Xi change.” Along with a serious campaign against corruption, Xi Jinping has sought to increase CCP involvement in many areas of Chinese life and exert greater control. These policies, while ostensibly aimed at providing more balance and equity, entail the risk of stifling the bottom-up and private initiative that have been responsible for most of China’s success. 

China’s economy is now 70-75% private (Lardy 2016). Even this understates the importance of the private sector. With the exception of a few profitable monopolies, China’s state-owned enterprises (SOEs) are poor economic performers (Hong and Nong 2013: xxi-xxiii). In 2009, ten firms accounted for 70% of SOE net profits. Of these just two firms, China National Petroleum Company and China Mobile provided more than one-third of the total. The average return on equity for China’s SOEs in 2001-09 was 8.16%. In the same period, non-SOEs returned on average 50% more (12.9%). In 2009 SOEs returned 8.18%; non-SOEs nearly double that (15.59%). 

The poor performance by SOEs remains heavily subsidized. Chinese SOEs have a lesser tax burden and receive fiscal subsidies from the central government. Banks provide credit at below-market interest rates. Land and resource rents are subsidized. Hong and Nong calculate that if all of the benefits are taken into consideration, the average real return for Chinese SOEs in 2001-09 was minus 6.29%. Despite this weak performance, managers and workers in state enterprises often receive higher pay than those in the private sector. 

Hong and Nong (2013: xxiii) describe an accelerating phenomenon of guo jin min tui (state advance and private retreat). While this has been visible for well over a decade, the process has intensified since Xi came to power in 2012. As in Putin’s Russia, policies include stricter media controls; curtailing the independent activity of civil society; reaffirming the role of the ruling party, with party cells playing a role in private enterprises; renewed emphasis on ideology; favoring Chinese firms while limiting foreign business competition; and a more aggressive foreign policy. 

It appears that rather than Russia learning from China’s economic successes, China is adopting Putin’s tightening of domestic political life. Putin views globalization as a threat. Xi has either misunderstood or rejected the pragmatic interaction with the global economy that made China’s economic miracle possible. Given that both countries’ economic models are in need of serious overhaul (Kudrin & Gurvich 2014; He 1999; Naughton 2015), it is plausible that Xi and Putin will end up resembling Thelma and Louise, driving their economies over the cliff. That leaders in Hungary, Poland and elsewhere are implementing similar policies suggests that the transition may not be over. 

Harley Balzer retired in June from his full-time positions in the Department of Government, School of Foreign Service and Department of History at Georgetown University. In 1982-83 he served as a Congressional Fellow, with responsibilities including helping to secure passage of Title VIII. In 1992-93 he served as Executive Director of the International Science Foundation, and then worked with the MacArthur Foundation and Carnegie Corporation to design the Basic Research and Higher Education Program for Russia. He will speak on two panels on Russia and China at the 2016 ASEEES Convention in NovemberL for more info see here and here..

Full citations of the resources used in this piece can be found on the ASEEES website.