How Deng’s Drama Unfolded (Part 1)
Aug. 22 is the 115th anniversary of the birth of former Chinese leader Deng Xiaoping, who is remembered for helping China emerge from the devastation of the Cultural Revolution (1966-76) and introducing market reforms to a country that once deemed capitalism evil. Zhou Qiren, now a professor of economics at Peking University, was one of the first young people to return to university after the Cultural Revolution. Starting with rural studies, Zhou witnessed the reforms that boosted farming productivity in the 1980s and allowed people to lift themselves out of poverty. The following article, to be published in two installments, is based on a transcript of Zhou’s speech at a seminar held in Chicago in 2008 to mark the 30th anniversary of the start of the reform and opening-up that has profoundly changed China’s economic and social landscape. Zhou shared with international scholars what he believes to be Deng’s accomplishments and what he has left undone that is still being pursued by Chinese people.
I had written a different paper for this conference before Lennon Choy sent me an email on June 3, in which he conveyed Professor R. Coase’s opinion that “the conference would be incomplete without a paper on Deng” and that “you are probably the best person in China to work on it.” This is an honor that I would not have been able to live up to, but I convinced myself to take the risk and try to finish this task assigned by Professor Coase.
I first encountered the name of Professor Coase from a pirated edition of a small book. It was the summer of 1985, and a friend in Beijing’s Stone Company handed me two books secretly. I opened them and discovered that they were “China’s Future” and “More on China’s Future” by Steven Cheung, published by the Hong Kong-based Newspaper Press. It was obvious that the two copies I was given were pirated since they had no cover, the quality of the paper was extremely poor, and one could clearly see that they were printed from photo images.
I did not know who Steven Cheung was, but I could not put his books down after opening them. Steven said “Coase had a deep understanding of how economic institutions operate and he is deeply concerned with the future of China.” The book also mentions two important articles by Coase, which try to explain economic institutions and institutional change from the point of view of property rights and transaction cost. As I recall, I had very little first-hand experience of market transactions, and therefore the concept of “transaction cost” was obtuse for me. I had difficulty understanding the “Coase theorem” that seems to assume zero transaction costs. However, I had an immediate understanding of the “delineation of rights” and thought that this concept had a great explanatory power.
Why is it that I could understand “delineation of rights” right away? Let me provide my background. I entered a university in Beijing in 1978 directly from rural Heilongjiang province, where I had been working as a farmer since 1968. For someone like me, the first act of Deng’s drama was to reopen the college entrance exam, a change that would rewrite the fate of an entire generation.
In October 1978, Beijing was the epicenter of some of the great transformations China was undergoing at that time. Although we should have seized this regained opportunity and studied hard, Beijing was hardly a quiet place for students. We enthusiastically circulated all kinds of information about the modernizations in Japan, the U.S., Europe, Hong Kong and South Korea. We gathered together to listen to the news reports of the Third Plenary Session of the 11th Central Committee of the Chinese Communist Party and the Italian journalist Oriana Fallaci’s interview with Deng. We spent many sleepless nights discussing all this fresh information in our study groups.
However, the most memorable story we learnt from these group meetings was how the Household Responsibility System came into practice in rural Anhui province. Some people who went there themselves came back and told us that when facing drought and the increasing risk of famine, local peasants secretly distributed collective land among individual households, and as a result, agricultural output increased significantly. Since it was against the law to de-collectivize the land, this practice could only be conducted underground. This story was exciting since it made us realize that there were still ways to improve peasants’ life even in helpless rural China. But we were also puzzled about why these organizational patterns that were proven to stimulate productivity and help peasants solve the problems of starvation and poverty could not be legitimized by the “superstructure” of China.
In 1980, some university students organized the “Research Group for Rural China Development” to study various issues in rural reform and development. Since many of these students had experience of being farmers during the Cultural Revolution (some were actually from peasant families), we shared a common passion and goal, and we willingly went back to rural China to observe, inquire, and conduct research in order to increase our understanding of the real world. We were lucky to get support from Mr. Du Runsheng, a very senior and highly-regarded expert on rural China. He not only gave us guidance and support, but also actively involved me, a non-party member, in the preparation, drafting, and revision of several documents stating the central government’s countryside reform policies. These documents were not to be read by people who were not party members! Quite unexpectedly, we became witnesses to history being made — the first act of Deng’s drama of reform was none other than the Household Responsibility System.
Delineation of rights
The practice of the Household Responsibility System (HRS) was not a new thing initiated in the Deng era. As early as 1956, Yongjia county in Zhejiang province already allotted collective land to individual households in order to rectify the lack of incentives and to encourage members of the collectives to work harder. I got acquainted with the head of this county Mr. Li Yunhe. Because he had supported the practice of distributing land to individual households, he was demoted and sent back to his hometown for twenty-one years. Between 1959 and 1961, the HRS was a common practice in all provinces hit by the Great Famine. As many as 40% of the production teams in Anhui alone had this practice. Farmers there called the land that was under their responsibility to cultivate as “the land that saved lives.” Now a problem arises: if the HRS was not an invention of Deng, why did people consider it the first act of Deng’s drama?
The answer to this question needs to be found in this practice itself. The nature of HRS is a household-based contractual responsibility system. In this kind of setup, collective land is allotted by a contract to individual households, each in principle assuming a certain amount of responsibility. In the beginning, this responsibility is tied to output: farmers promise to give a certain percentage of their gains back to the state or the collectives based on a calculation of how much a piece of land can produce on average. The promise is made in exchange of management rights of a particular piece of land. It is obvious that this is a contract that allows peasants to keep additional gains for themselves and that its effect on the stimulation of productivity is beyond doubt. At the same time, the contract does not change its ownership — land still belongs to the collective; peasants only have user rights over their allocated land under certain contractual terms.
The fact that peasants invented the household contractual responsibility system proves that this practice could effectively increase productivity and alleviate the impact of famine. However, peasants did not have the right to determine the legitimacy of this system by themselves. A byproduct of the Soviet-style centralization system is that any change in economic institution is viewed upon as something significantly impacting the model of socialism, and it can be approved only by the highest authorities. In China, from “a three-donkey-leg cooperation unit” to a supercommune with hundreds and even thousands of households, decisions from whether one should have a collective cafeteria to whether members of a commune can be allowed to raise female pigs that belong to the collective, are all made by the Central Party Committee and its chairman. It is unfortunate that Chairman Mao had deep prejudice against the HRS. Records indicate that only in some severe conditions of famine, Chairman Mao acquiesced to adopting this system, but only as a temporary solution. Whenever the situation got a little better, he would hold up the banner of class struggle and launch a severe campaign against this practice. Hence, during the Mao era, the HRS experienced several ups and downs.
The lack of legal recognition and contract protections had a negative impact on the behavior and expectations of the people involved in the contracts. We saw that self-initiated attempts to allocate land to individual households could let peasants taste the fruit of greater output and a better life, but would these benefits last? What changes would be made to the conditions of a future contract, and when would the contracted responsibility system be criticized again? All of these uncertainties affected peasants’ decisions around production and investment. Some of these difficulties have to do with the nature of contractual behavior: when it comes to a set of promises yet to be realized, uncertainties about the future inevitably increase the enforcement cost for a contract. The contribution of Deng Xiaoping is that he provided legitimate recognition and protection to self-initiated contracts which had been proven to stimulate productivity. This was not a random decision. According to the recollection of Du Yunsheng, Deng Xiaoping stated in 1962 that “when it comes to the question of which production relation is better, we should adopt the attitude of endorsing whichever form that can enable agricultural production to recover and grow in a particular locality, and which the masses are willing to adopt. If this production mode is illegal, we can make it legal.”
This statement shows that he was well aware of the importance of legitimization for a specific mode of production. When history pushed Deng to power, he adopted exactly such an “attitude” towards the household contractual responsibility system which was invented by peasants themselves.
Thus, following Deng’s guidelines, peasants’ household contracted responsibility system experienced significant expansion. The range of this practice extended from remote and underdeveloped regions to centrally located and well-developed areas. Almost all the production teams adopted this system. The terms of land lease grew from one, three, fifteen or thirty years to “long term without any change.” The responsibility of the contract was initially tied to productivity; gradually it was tied to the property value of the land. Thus, the household contracted responsibility system was gradually recognized by the higher level of the governments: from a secret practice of the grassroots to a system recognized by the local governments and then endorsed by the central government. In 2002, the People’s Congress passed the “Law of the People's Republic of China on Land Contract in Rural Areas.” According to this law, the rights of usage, income and transfer of farm land are contracted long-term to peasant households. Although the “collectivity” is still the legal owner of the land, its economic function only goes as far as subcontracting farm land to peasants at the end of a term. Since contractors have priority when it comes to renewing the lease, it is not difficult to transform “long-term invariability” to “permanent invariability.”
This reminds us of Coase’s idea: “The delineation of right is an essential prelude to market transactions.” Based on this statement, we can argue that a clear delineation of rights is the basis of a contract. If two or more parties do not have well defined property rights, how can they make a contract? However, the experience in China shows that it is only through the contracted responsibility system that peasants’ rights to the land are defined. Peasants’ rights to collective land are ambiguous until a contract agreement is made. Shall we then argue that property rights of peasants are defined through contract and that a clear delineation of property rights and the signing of a contract are but one and the same thing?
A contract can be adjusted through re-contracting. Property rights that are continuously defined through a contract will find their economic content gradually clarified and the intensity of the rights increased. Those private property rights that are now protected by the constitution initially grew out of responsibility contracts established in the conditions of the collective economy. The exclusive rights of usage of public resources obtained through responsibility contracts are no less than private property rights. According to the responsibility contracts, the output exceeding the amount specified by the contractual obligation belongs to the contractor. Isn’t this the same process by which private property is created? Private property is gained by farmers through legal contracts by accumulating the surplus output exceeding the contractual requirement. As this surplus output gained volume and intensity, members of the collective economy gradually enlarged the range of their contracts, accumulated more and more private rights, and entered into a network of market contractual relationships of a greater and greater variety.
When I came to Chicago to attend this conference, it happened to be the spring wheat harvesting season in China. One witnesses a magnificent sight of thousands of tractors and harvesters following the path of wheat maturation and traversing villages, counties, and provinces to collect harvests along the way. These tractors and harvesting equipment belong either to one individual or several individuals who have formed a corporation, or they could be leased to individuals by a “corporation.” The range of this operation goes beyond the limited sphere of individual “collectives.” There would have to be a complex market contractual network in order to establish the connection between those with machinery and those with the harvesting needs including peasant households, cooperation units, corporation-style farms of an even greater number. Sometimes even the government is involved in this process. Emergency legal documents issued one after another have ordered highway authorities to not only waive toll fees to the harvesters, but also provide better service to them. This is a microcosmic reflection of China’s economy: property rights and contractual relationships lay a systemic foundation for vibrant productive activities.
Deng Xiaoping himself may not have grasped the true essence of the idea of “delineation of rights.” However, Deng’s path of reform never swerved away from the principle of “delineation of rights.” Deng’s notion of delineation of rights received criticism from all directions: some say that Deng’s reform went over the line of collective economy and moved away from classical socialism; others say that the reform of property rights based on contracted responsibility is not as thorough and stimulating as “outright privatization.” These critical voices may be right in one way or another; however, there is a blind spot in all of them, that is: the delineation of property rights and the choices of institutions do not happen without a cost. The first line of criticism ignores the huge cost required by a system that sustains an expensive organizational structure. We can get a clear idea of this by observing the differences between China, that welcomes reform, and North Korea, that rejects it. The second criticism underestimates the cost of a structural transformation: as long as enough people are still bound by what seem to be “outdated” ideas and guaranteed benefits, then “radical and thorough reform” cannot be realized in actuality. Even the “ultimate goal” is dependent on transaction costs. For instance, to come to University of Chicago, we have to rely on the roads provided by Chicago municipality. Why can’t the roads be privatized? The answer is cost. It would be way too expensive for each individual to have his own exclusive road, so society makes a compromise. While it makes roads public, it also regulates people’s behavior on the road.
Deng Xiaoping was not easily persuaded by any critical voice. He believed up until the end that the Chinese should be allowed to explore and experiment with different institutional and structural choices within the constraints of reality. As long as a particular form of property rights, structural or contractual relationship is proven to increase productivity and improve people’s lives, as long as it can be recognized and accepted by the relative interest groups involved, Deng Xiaoping was willing to use his political authority to mobilize the state mechanism to support it, and provide it with legitimate recognition under the banner of “socialism in Chinese style.” Whereas this may seem to be a highly pragmatic approach, economic theory since Coase seems to suggest that the actual experience of China’s reform had a great deal of universal value, that is, transaction costs, broadly defined, determine the status and transformation of an economic institution.
II. Bringing entrepreneurship back into China
In 2006, I interviewed the owner of a private company in the town of Songmen in Daizhou, Zhejiang province. Her name was Jiang Guilan — a former peasant who came to the city to work 10 years before. She started a factory manufacturing plastic products in 1991, using a private loan of 200,000 yuan. Four years later, taking advantage of one-sixth of an exhibition platform that she rented from someone else at the China Import and Export Fair in Guangzhou, Jiang obtained the first order from a foreign businessman. Ten years later, her company became the main provider of plastic dinnerware to KFC’s restaurants around the world. When I visited her company, it already had over 1,000 employees and exported as many as 600 containers worth of plastic products annually.
Jiang’s story is very common in China today. Compared to other star entrepreneurs such as Ren Zhengfei of Huawei, Ma Yun of Alibaba, Li Shufu of Geely Automobile, and Niu Gensheng of Mengniu Dairy, Jiang Guilan’s story may be a lot less legendary. However, in the pre-economic reform era, Jiang’s company would have made a name for itself even if it had been a hundred times smaller. At that time, as the head of a company that had its own employment system, Jiang would have been notorious for setting a bad example of capitalism. Whereas a private company would have been considered to be a capitalist monster in the past, less than 30 years later, the same company became a laudable model of “a privately owned enterprise.” What has happened in China in the past 30 years?
People often mention the pressures of everyday economic life in answer to this question. An “economy of shortage” produced the lack of products and services, resulting in the inability to meet the daily needs of people living in the city and the countryside. At the same time, a singular public ownership economy could not create enough employment opportunities whose demand was increasing day by day; it particularly could not accommodate the great amount of surplus labor from the countryside after household responsibility system was started there. Pressures coming from both directions forced China to adopt a more flexible pattern to organize its economic activities.
So private owned businesses grew like wild grass side by side with the collective ownership economy. A significant event in the 1980s is the “big tea bowl” stalls set up by young people who had just returned to the city from the countryside. Relying on self-employment or employing other family members, these people used their small capital and tried to seize any little opportunity there was on the market. Some private businesses became successful, and rising market demands required that they expand their operation; consequently, “individual businesses” started to grow out of the pattern of “family labor plus two or three helpers” and moved in the direction of “private businesses” with a work force of a bigger size. At this point, they faced a challenge: how can socialist China allow the return of capitalist exploitation?
According to the conventional thinking, individually owned companies that control some means of production and employ over seven workers can be considered as engaging in “capitalist exploitation.” Their operation is completely incongruent with socialism. China in fact never transgressed this hard boundary created by Marx and the economic model of the former Soviet Union ever since it completed “the Socialist reforms of industry and business” in 1956. Now the new reform challenged these conventional taboos. The anxiety of whether China was becoming capitalist loomed large over the entire country.
Deng Xiaoping who held up the two banners of economic reform and socialism at the same time solved this problem by seizing onto a watermelon seed. In the beginning of the 1980s, a private businessman Nian Changjiu from Wuhu in Anhui Province invented the “Dummy Watermelon Seed” (a snack) that quickly became a popular product. His business expanded. Within two years of September 1991, the company grew from a size of a father and two sons plus four helpers to a business with 140 employees and an annual income of 7.2 million yuan. As the “dummy” became the boss, controversies arose in Wuhu and went all the way up to Beijing. How could one tell right from wrong in a small watermelon seed?
The research institute on rural policies where I worked at that time was led by Du Runsheng. He organized a research group that carefully investigated the background of the “Dummy Watermelon Seed” and sent a report to Deng Xiaoping’s office. I remember the reply we got from Deng only contains five words: “Do not touch him yet.” Of these five words, the most important one is “touch,” which implies “to use compulsory measures of the state mechanism to ban and suppress.” “Do not touch him” means that the government is not allowed to use the power of the state to suppress Nian Guangjiu. What about the word “yet”? This word conveys a gesture of compromise to Deng’s angry colleagues both inside and outside the Party. It means “Let’s wait and see. If he turns out to be a dangerous flood or fierce monster, we would still have time to ‘touch’ him.”
Deng Xiaoping allowed experimentation and encouraged on-the-ground observation and analysis. If one takes a detached perspective toward this watermelon seed, it is not hard to figure out what can be gained from it: the 140 workers Nian employed did not have an opportunity to work in state owned companies to begin with. The salary Nian paid them was higher than other workers employed by the state-owned enterprises in this locality. If these workers had not been hired by Nian, they would be either unemployed or self-employed in a business whose earnings would not be as much as the salaries they would be getting from Nian. The important thing is that the market success of the “Dummy Watermelon Seeds” stimulated competition among other producers of watermelon seeds. This was good news not only for customers but also for the workers. But how should one determine whether this was a case of capitalist exploitation?
No one pointed out at the time that the basis of Marx’s theory of surplus value is the assumption that transaction cost is zero. Marx insists that when capital employs labor in the “realm of circulation,” both sides follow a principle of exchange on the basis of equivalence in value. At this stage, all commodities including labor have a price that is equivalent of their value, so there is no exploitation of capital toward labor. The trick happens afterwards: when capitalists take the workers into the factory, they can organize, control, and force workers to produce products whose value is higher than the price of labor. Then owners of the factories take these commodities back to the realm of circulation and realize their surplus value through another round of exchange based on equivalence of value.
It is clear that all these analyses do not take into consideration any transaction cost. It seems as though capitalists find out who their customers are and what their needs are quite effortlessly and make decisions about what to produce and how much to produce based on this knowledge. It also seems as though it did not take any efforts for capitalists to discover employable labor and other key ingredients of production and decide at what price and in what matter to hire these labor. It seems as though it did not take any efforts of supervision and management and the product of the team would automatically be worth more than the total sum of the products of individual members of the team. Only when we accept these scenarios can we agree to Marx’s view that surplus value is not only surplus but immoral since it comes from unfair exploitation.
The problem is that in the real world, transaction costs can never be zero. Whether it is the general relation between provider and buyer of commodities and services, or the specific relationship between capitalist and worker, their mutual discovery, the signing and carrying out of a contract with each other is an expensive cost. Since the transaction cost is not zero, there cannot be automatic “equal exchange” or economic organization without supervision. From this perspective, operations such as the discovery of the market, the coordination of demand and supply, and the organization of production cannot be considered “surplus.” The profit gained by a capitalist comes partly from the interest of the financial capital invested in a particular business, and partly from the return for the service of an entrepreneur’s human capital. The actual amount of these incomes is dependent on market competition between entrepreneurs, workers, buyers and providers of a particular commodity or service.
Of course, the capitalist will maximize his relative scarcity and translate that into greater profit. Like everyone else participating in market exchange, it is possible that a capitalist will violate and hurt the interested parties involved in a transaction, such as other investors, credit holders, workers, upstream and downstream suppliers, retailers, and even customers. We can use the term “exploitation” to describe all of these acts of violation. However, “exploitation” is not the only function of the capitalist, in the same way that counterfeiting is not the only function of merchants. In the real world, people’s acts to save or increase transaction costs are often mixed together. Which act takes priority in a particular economy depends on certain regulatory conditions, including customs, morality, law and the practice of law.
So how should we deal with the capitalist in real life? The revolutionary principle that the former Soviet Union and pre-economic reform China adhered to is to “eliminate exploitation by eliminating capitalists.” This also means the elimination of the capitalist’s function of saving transaction costs and organizational costs. However, transaction costs do not disappear with the elimination of capitalists. A socialist economy still has the problem of production cost, institutional cost, and organizational cost. What results from the elimination of capitalists is that the socialist nation-state has to play the role of the “mega-capitalist,” who manages the economy by using “capitalistic privilege without capitalists” (Lenin). The experience of several decades in the past has shown that not only is the cost of running a central planning system extremely high, but it does not eliminate “exploitation” completely. As a hierarchical system replaces a system of property rights and market contracts, bureaucratic privilege takes the place of capitalist exploitation.
The consequence is beyond the expectation of many revolutionaries and demands reflection. Deng Xiaoping did not want to smash the newly emerged private businesses right on the head because he wanted to experiment and observe more. He tried to separate out entangled problems and find different solutions for each of them. I don’t believe that Deng’s generation of revolutionaries could tolerate any “exploitative” behavior. However, the historical experience of the former Soviet Union and China itself repeatedly raises the question to decision-makers: “Why does a socialist economy have to eliminate the creativity, judgment of the market and the ability to organize and coordinate production along with capitalists?”
Deng Xiaoping brought entrepreneurs back to China. After he gained power, he strongly approved of the work of the representative of the “nationalist capitalists,” Rong Yiren, and boldly allocated an amount of state-owned capital for him to manage. This was the beginning of the new economic model of “state capital plus entrepreneurs.” Deng Xiaoping also voiced his opinions from a position of political power on similar controversies to the one involving the “Dummy Watermelon Seed.” He disallowed the use of state power to bluntly crush private businessmen. This senior revolutionary repeatedly asked the same question again and again: Is it really going to hurt socialism to allow these entrepreneurs to exist?
More and more people have reached an answer to this question based on their experience and observations. As the existence of entrepreneurs began to be viewed upon as a “right” thing, starting a business and becoming an entrepreneur once again gradually became one of the “rights” of the Chinese. Since the beginning of the economic reform era, China has issued many policy documents, passed many laws, and revised its constitution several times to gradually give recognition to and protection of the freedom of signing contracts, the right of setting up various businesses and to allocate profit according to the percentage of investment. According to an authoritative report, by the end of 2007, private businesses took up 50% of the total GNP (gross national product), accounted for 70% of nonagricultural employment, amounted to 30% to 40% of tax revenue. This would be an unimaginable picture in the pre-economic reform era.
To be continued in second installment.
Zhou Qiren is a professor with Peking University’s National School of Development. He specializes in studies of China’s reform and development.
Contact editor Wu Gang (email@example.com)
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