Academic journal article
By Liew, Leong H.
Journal of Economic Issues , Vol. 29, No. 3
The fortunes of states pursuing a program of economic reform have been varied. While the economies of the former communist countries of Eastern Europe have shrunk in size, the growth of the Chinese economy, apart from a minor biccup in 1989-90, has been phenomenal. In purchasing power, the Chinese economy is now 45 percent as large as that of the United States and larger than either Japan or Germany [Summers 1992, 7].
Reform in China began in agriculture and was soon followed by modifications in industry. The major achievement in industrial reform has been the development of village and rural township enterprises. Their development has been achieved with overseas Chinese entrepreneurs providing much of the needed capital and management expertise. The presence of crucial support from state and party bureaucracies for village and township enterprises has been due to the underlying strategy of economic reform adopted by the Chinese authorities. The aim of this paper is to discuss that strategy, its gradual approach, and its implications for the role of a strong central state.(1)
The Two-Track Price System and Gradual Reform
As part of its gradual approach to reform, China introduced the two-track price system in February 1985. Under this system, a fixed price for products allocated by the central plan coexists with a free market price for out-of-plan output. State enterprises, once they have fulfilled their plan-allocated production quota, are allowed to sell any excess at the free market price. They are also allowed to purchase inputs in quantities above the plan quota at free market prices. This policy complements the state policy of encouraging the development of non-state (collective and private) enterprises, which was initially introduced with the sole purpose of absorbing the large numbers of young people who returned to the cities from the countryside at the end of the Cultural Revolution.(2)
Whether the architects of the two-track price system were fully aware of the implications of the system they were setting up or not, in hindsight it was a clever method of transforming the Chinese economy from being centrally planned to being one in which markets play a major role. The value of this system can be supported by both conventional and institutionalist arguments. To most conventional economists, the two-track price system, by allowing marginal decisions on output and input choice to be based on market prices, would improve allocative efficiency and increase output. For example, Terry Sicular's  study of the two-track price system in agriculture demonstrated this conclusively by showing that the system could be viewed as a lump-sum tax on producers and a lump-sum subsidy for consumers and hence, it does not distort economic efficiency. I [Liew 1993] was able to show that less rents are available for corrupt officials under a two-track price system than under central planning. Increased corruption in the reform era has less to do with the two-track price system than with a weakened state. This point is important because one of the criticisms of the two-track price system by many Chinese and foreign economists is that it encourages official corruption. In the aftermath of June 1989, the CCP (Chinese Communist Party) had in fact labelled the two-track price system as a hot bed for the breeding of corruption" [CCP Central Committee 1990].
From an institutionalist perspective, the two-track price system can be described as facilitating the building of a constituency in favor of reform. The two-track price system is an intermediate system between a centrally planned and a market system. By retaining the original centrally planned system, the impact of the market on industries in the state sector is cushioned and at least a minimum standard of living for workers in that sector is maintained. The main and most important advantage of this gradual strategy, as opposed to the "big bang" or "shock therapy," is the impact of this strategy on the nomenklatura. …