Prisoner of the State: The Secret Journal of Premier Zhao Ziyang (17 page)

H
ow did China come to adopt an approach of gradualism?

In my ten years running the economy for the Central Committee—until the time that I stepped down—we pursued a gradual transition. There were two major aspects. The first was the emergence of a new, market economy that gradually matured beyond the realm of the planned system. For example, as rural reform got under way, state quotas for mandatory procurement were reduced; as the mandated quantities were reduced, agricultural production increased, so the proportion of the state quotas dropped year after year. There was an increasing quantity of products making it to market.

In 1985, taking things a step further, we eliminated the mandatory procurement program in agriculture, and basically became market oriented, freed from the planned economy, with the exception of a few products like cotton.

The emergence of township and village enterprises, private manufacturing and commercial enterprises, joint ventures and solely owned foreign enterprises—all of these were set up outside the planned economy. Together they formed an economic sector that responded only to market forces. This sector started from nothing, and has experienced vigorous development in recent years, growing at levels far exceeding the state-owned or collectively owned sectors. It has brought prosperity to the Chinese economy and a new economic system: the market economy.

As the market sector grew day by day, China’s economic system eventually experienced a qualitative change, even without fundamental reforms of the original economic model of state planning. This is the principal reason that economic reform in China has not only promoted prosperity, but also maintained political stability.

The other important aspect was the reduction of the planned economic sector. The change was not instantaneous. Instead it began with a small number of minor changes, but it gradually involved bigger changes.

Policies and measures were introduced to shift more power to lower levels of administration and expand the autonomy of enterprises. To reform economic planning, there was a gradual reduction of direct planning, an expansion of indirect planning, a reduction in material resources allocated by the state, and an expansion of the types and quantities of products that were traded by state-owned enterprises themselves. Trading was permitted for key material resources beyond the fulfillment of state-allocated quotas, and even within the quota, a portion could be directly traded as well. In addition, we also introduced a contract scheme for enterprises and pricing reform. All of these measures played strong ancillary roles while the market sector continued to grow.

At the time, the major components of the market sector were agriculture, rural products, light industries, textiles, and consumer products. Products involved with the means of production were mostly still controlled by state-owned enterprises.

There have been criticisms of the transitional approach: “no overall strategy,” “taking one step and waiting to see what happened,” “no foresight,” “blind,” etc. There are fewer such criticisms these days.

However, there have been shortcomings resulting from the coexistence of the two systems that should not be underestimated. When the negative impacts exceed what society can endure, problems will erupt. Only by achieving further economic and political reforms can such problems be resolved. It was correct to adopt gradualism in the early stages, but that cannot continue over the long term.

T
he economic readjustments made in 1981 reduced the growth rate for agricultural and industrial output to 4 percent. The next year, the economy started to grow faster and eventually got on a healthy track. Economic development in 1983 and 1984 was very good; not only did the economy grow rapidly, but demand and supply were relatively in sync. Various indicators were healthier; economic efficiency had noticeably improved and people’s living standards had risen a great deal.

However, starting from the fourth quarter of 1984, the growth rate became excessively high, credit was overextended, and the scale of national infrastructure construction was too great. As a result, prices rose even faster.

In the beginning of 1985, as these signs of overheating emerged, the Central Economic and Financial Leading Group and the State Council tried to cool the economy by strengthening macroeconomic control, reining in credit and lending and reducing infrastructure construction. However, since the banking system had not yet been reformed, control over credit and lending had to be done through administrative means, assigning credit quotas to lower levels.

Reactions from all sides were strong and caused considerable difficulties for the smooth running of the economy. Credit quotas were passed down from the State Council through the Central Bank to provincial and district level branches. As a result, local governments filled their credit quotas with preferred projects, especially special construction projects, and had nothing left for projects that could not afford to be ignored. This forced the central government to raise the credit quota.

For example, as soon as credit controls were imposed, many local governments complained they lacked funds for the annual grain procurement, though they used the assigned credit elsewhere. The credit limits were tightened only to be relaxed soon thereafter.

So in 1985, the growth rate was still exceedingly high, even though macro controls had been implemented in the beginning of the year. The overheating got worse.

How could we handle the situation? Two approaches were considered. We could use the traditional method: repeat the readjustments of 1981 by again putting the brakes on the economy and cutting infrastructure construction.

The other way was to address the problem gradually. The first method would result in great losses all around; and it wasn’t practical, since many infrastructure projects had just been resumed after being delayed by the 1981 readjustment. Cutting them again would have caused considerable domestic and international damage. That’s why I decided to take measures for a “soft landing,” that is, to make gradual adjustments over several years rather than in only one.

A decision was made to continue relatively tight control over credit and financial policies for two more years. Infrastructure construction was to remain at 1985 levels with adjustments made to the priority and timing of specific projects. If the growth rate remained the same for two years, the situation could ease back to normal. With the execution of this plan, overall conditions were good in 1986.

The positive results continued. In 1987, GNP and GDP each expanded by more than 10 percent. Industrial output grew more than 17 percent. Agriculture grew nearly 6 percent. Retail prices rose by 7.3 percent. The situation with fixed-asset investments and infrastructure construction was basically good.

Overall, after two years of the “soft landing” approach, the situation improved. The overall economic environment was no longer tense. When the Central Committee and the State Council reviewed the situation at year’s end, they acknowledged that instead of taking abrupt adjustment measures, the “soft landing” method could work.

That was originally the strategy for 1988 as well. When we were discussing plans for 1988 at the national planning work congress in September 1987, I made a speech on behalf of the Central Committee. I pointed out that in order to implement policies for stabilizing the economy—especially the rise in prices—finances and credit needed to be tightened, infrastructure construction needed to be reduced, consumption funds needed to be controlled, and at the same time steady production growth needed to be maintained. The strategy for the economy in 1988 can be summarized in two points: further stabilizing of the economy and deepening of reform.

With the strategy set, why was inflation in 1988 so high, with the retail price index rising 18.5 percent? Since the beginning of reform, this had never happened.

The inflation resulted from a combination of factors. I mentioned then, and I still believe today, that the primary cause was the inappropriate response taken in 1988 to reform the pricing system.

Price reform—the gradual adjustment of the pricing mechanism—is an extremely important issue in economic reform. We had always believed that if pricing were not sorted out, then economic reform could not be accomplished.

After two years of the “soft landing” approach, in 1986 and 1987, the conditions were in place in 1988 for taking a bigger step in reforming the pricing system. However, the proposed reform—“making a breakthrough in the pricing system difficulties”—was all wrong in its guiding principles and in its implementation. The result was a grave error that caused a serious setback for the economy.

How did this occur? As I mentioned before, the “soft landing” policy had originally been expected to continue. But in the spring of 1988, there was a strong reaction to the rise in prices and to the two-track pricing system, which encouraged corruption. Also, Deng Xiaoping had repeatedly urged us to be decisive in price reform, which he believed required a breakthrough, saying, “a quick sharp pain is better than prolonged pain.”

With all this in mind, I started to be swayed away from incremental steps and toward the all-at-once idea. Though fixed prices had risen, the situation with incorrect pricing had not changed, so perhaps it was better to make a major adjustment all at once. Over a period of time, say two to three years, we could increase prices at a certain rate, for example 30–50 percent, to bring prices of commodities to reasonable levels and thereby eliminate the twisted and unreasonable pricing system.

After my proposal was passed in principle at the enlarged Politburo Standing Committee meeting in spring of 1988, Yao Yilin was assigned to lead the State Planning Commission in a study of the specifics of implementation. In the summer of 1988, the proposed plan by Yao Yilin and the State Planning Commission was passed, after back-and-forth discussions at an enlarged Politburo Standing Committee meeting in Beidaihe [the beach resort where Party leaders convene each summer]. The implementation was set to begin in the fourth quarter of 1988 or in early 1989, but it was canceled because of high inflation.

Since the Third Plenum of the 12th Central Committee, our strategy for pricing reform had combined readjustments with a relaxation of controls. Some prices were adjusted by the government in a top-down fashion, while others were allowed to adjust according to market forces. The same commodity whose price was set by the government within the planned sector’s quota might then be sold in the market at an open price. This was the two-track pricing system.

The intent was to respond to the market and gradually relax price controls, to let the market take over. However, the proposed pricing reform was not in line with the gradual reform strategy but relied on large-scale government-administered price adjustments. This reflected the sentiments of the time: to rush through price reforms, and to eliminate the two-track pricing system in order to unify or at least reduce the gap between set prices and market prices.

This was not the correct way to carry out price reform, because ultimately it was not a shift from price controls to market mechanisms. It was using planning methods to adjust prices. It was still the old way of planned pricing. It is clear now that if high inflation had not occurred, and this price reform plan had been carried out, it would not have resolved the problem and could have set back price reform.

The most direct cause of the high inflation of 1988 was that before plans for price reform had even been drawn up, the media campaign started. All of a sudden, rumors were widespread: “prices will rise by 50 percent, wages will double.” The rumors caused a public panic, greatly affecting people’s anticipation of rising prices. “Psychological anticipation” was an issue that we did not understand at that time. However, nations with market economies paid a lot of attention to this issue when they needed to control inflation. They tried to find ways to avoid causing an overreaction through “psychological anticipation”; we on the contrary had encouraged and stimulated it.

In the end nothing happened, but people believed that prices were going to rise, and we could not provide reassurances to the contrary by, for example, raising interest rates for bank savings, which would have meant a pledge to people that their bank savings would grow at a rate exceeding inflation; or providing value-guaranteed deposits. While people were anticipating that a big price hike was coming, there were no reassurances given about the interest on their savings, so everyone worried that the rising prices would devalue the years of savings they’d deposited in the bank. Since the Third Plenum of the 11th Central Committee [1978], people who had been living frugally had deposited more than 100 billion yuan into the bank. When they anticipated that their hard-earned savings would be devalued by inflation, they rushed to withdraw their savings from the bank and purchased commodities. This caused bank runs and panic buying in the summer of 1988.

Panic buying for certain supplies had occurred many times in the past, so it was not unfamiliar to us. But this time it was different. In the past, panic buying had been caused by shortages; people were worried about the future availability of soap, table salt, flour. But this time, the purpose of purchasing was not for personal use, but value saving, so the situation was more prevalent and serious than ever before.

Many shops and enterprises raised their prices, and bank savings dropped 40 billion yuan more than anticipated. Banks had to print money to cover withdrawals, resulting in a big increase in currency in circulation.

As soon as the panic buying started, we should have immediately and decisively taken measures to raise deposit interest rates, or announce value-guaranteed deposits. If we had, the situation could have been better and the losses suffered would have been less.

At the time, the Central Economic and Financial Leading Group had proposed the measure to the State Council, but Li Peng and Yao Yilin were worried that raising interest rates on deposits would have resulted in higher interest rates on bank loans to enterprises beyond what enterprises could afford, thereby affecting production. They did not take immediate measures and, as a result, losses that could have been reduced instead continued to grow.

Ultimately, though, they were left with no choice but to take action. After the announcement of value-guaranteed deposits, bank deposits quickly stabilized and gradually bounced back. This proved that when faced with bank runs and panic buying, if we had provided guarantees on savings, we could have greatly reduced the losses.

The high inflation of 1988 saw prices rise by 18.5 percent. The problem was not a loss of control over credits and loans, nor was it overspending on infrastructure. These two factors had not exceeded the limits set under the policy for “soft landing.”

The main problem was the drop in savings deposits caused by the mistakes in price reform. In hindsight, if we had continued the policy of mixing readjustments and relaxation of controls, or even if we had moved faster to relax price controls while raising interest rates beyond the level of the price increases to guarantee the value of deposits, then 1988’s high inflation might have been avoided.

Facing high inflation and bank runs and panic buying, to quickly stabilize the situation we announced the cancellation of price reform and shifted economic policy to “adjustment and reorganization.” These proposals were initiated by me and passed by the Politburo meeting and plenum of the Central Committee. In retrospect, I believe that canceling the price reform package was correct but shifting from the original policy of “stabilizing the economy and deepening reform” to “adjustment and reorganization” was inappropriate.

Even though the proposed “adjustment and reorganization” did help to quickly stabilize the economy, it caused yet another setback to reform.

First of all, in order to slow the rise in prices, almost all of the administrative measures for controlling prices had been restored. Officials at all levels of government were made responsible for the implementation. This meant that years of revitalization had been retracted in favor of the old ways of price controls.

In the name of “adjustment and reorganization,” Li Peng and others at the State Council took back power that previously had been handed down to lower levels and put controls back on measures that had been freed. Everything was going in the opposite direction set by reform, setting back what had already been reformed in the economic system. Precisely for this reason, in less than a year there was an economic recession and market slump, and other serious economic problems continued until Comrade Xiaoping’s speech during his tour to the south [in 1992].

In summary, we made one mistake after another. I learned a very profound lesson from this.

In the spring of 1988, I sent Comrade An Zhiwen [deputy director of the State Commission for Economic Reform] and other comrades to Hong Kong and invited some economists to discuss China’s problems. Six economists participated, all members of the Taiwan Academia Sinica. They included the chief of the Chung-Hwa Institution for Economic Research, Tsiang Sho-Chieh, who had tremendous influence in Taiwan.