When Deng Xiaoping unveiled his vision of economic reform to the Third Plenum of the 11th Central Committee of the Chinese Communist Party in December 1978, the Chinese economy was faltering. Reeling from a decade of stagnation during the Cultural Revolution and already falling short of the projections set forth in the 1976 l0-year plan, China needed more than a new plan and the Soviet-style economic vision of Deng's political rival, Hua Guofeng, to improve the economy. Deng's plan was to lead the country down a road of gradual and incremental economic reform, leaving the state apparatus intact, while slowly unleashing market forces. Since that time, the most common image of China, promulgated by members of the US Congress and media, is of an unbending authoritarian regime that has grown economically but seen little substantive change.
There is often a sense that China remains an entrenched and decaying authoritarian government run by corrupt Party officials; extreme accounts depict it as an economy on the verge of collapse. However, this vision simply does not square with reality. While it is true that China remains an authoritarian one-party system, it is also the most successful case of economic reform among communist planned economy in the 20th century. Today, it is fast emerging as one of the most dynamic market economies and has grown to be the world's sixth largest. Understanding how this change has come about requires an examination of three broad changes that have come together to shape China's transition to capitalism: the state's gradual recession from control over the economy, which caused a shift in economic control without privatization; the steady growth of foreign investment; and the gradual emergence of a legal-rational system to support these economic changes.
Reform Without Privatization
During the 1980s and 1990s, economists and institutional advisors from the West advocated a rapid transition to market institutions as the necessary medicine for transforming communist societies. Scholars argued that private property provides the institutional foundation of a market economy and that, therefore, communist societies making the transition to a market economy must privatize industry and other public goods. The radical members of this school argued that rapid privatization--the so--called "shock therapy" or "big bang" approach to economic reforms--was the only way to avoid costly abuses in these transitional systems.
The Chinese path has been very different. While countries like Russia have followed Western advice, such as rapidly constructing market institutions, immediately removing the state from control over the economy, and hastily privatizing property, China has taken its time in implementing institutional change. The state has gradually receded from control over the economy, cautiously experimenting with new institutions and implementing them incrementally within existing institutional arrangements. Through this gradual process of reform, China has achieved in 20 years what many developing states have taken over 50 to accomplish.
The success of gradual reform in China can be attributed to two factors. First, the gradual reforms allowed the government to retain its role as a stabilizing force in the midst of the turbulence accompanying the transition from a planned to a market economy. Institutions such as the "dual-track" system kept large state-owned enterprises partially on the plan and gave them incentives to generate extra income by selling what they could produce above the plan in China's nascent markets. Over time, as market economic practices became more successftil, the "plan" part of an enterprise's portfolio was reduced and the "market" part grew. Enterprises were thus given the stability of a continued but gradually diminishing planned economy system as well as the time to learn to set prices, compete for contracts, and produce efficiently. Second, the government has gradually promoted ownership-like control down the government administrative hierarchy to the localities. …