Initial Conditions as the Determinate Factor in Russia and China’s Transition Outcome

It is widely acknowledged that China has been vastly more successful than Russia in her transition from a planned socialist economy to a market-based economy.  The literature on the subject focuses on two major themes to explain the explosive growth in the Chinese economy and the precipitous fall in the economies of the Former Soviet Union (FSU). 

The first major position asserts that the primary cause of the outcome was the policy choice taken by the respective governments.  On the other hand, the other position, taken by most orthodox western economists, is that the initial conditions rather than the policies the governments of these countries chose, was the primary cause of the different outcomes. 
This is not to say that policies did not affect the outcome of the economy; rather, they assert that initial conditions played a larger role than policies or, even at times, constrained the possible outcomes of the policies. 

Though the policy choice did contribute to the relative success of the economies, I will argue that the initial conditions were the determining factor in the relative success of China and relative failure of Russia. 

I take this position for a number of reasons.  First, it is difficult to reach a firm conclusion about the relative advantage of gradual over radical reform or vice versa, as the variables involved are as complex as those involved in planning the Soviet economy.  Furthermore, it is difficult to separate the initial conditions of the country from the policy choice because, often, the policy choice was the consequence of the initial conditions.  By applying the rational choice framework to the analysis of political and economic behavior, we may arrive at an interesting explanation for the economic and political policy choice of the countries. 

The individuals with economic and political power, power that was often intertwined under the communist system, maximized their welfare within the constraints created by the initial political and economic conditions by choosing the policies that led to the collapse of the Russian economy and the boom of the Chinese economy.  Even if we discount the admittedly overly deterministic view of policy choice, the initial political and economic constraints and incentives each country faced were such that China was highly favored over Russia to succeed.  

Transition Policies, Transition Results    

It may be argued that Russia undertook both radical and gradual reforms.  During the end of the Soviet Union, Gorbachev tried to push through gradual reforms.  Unfortunately, the Soviet Economy was already too diseased to be fixed.  When the Soviet government collapsed, the new regime had to decide whether to continue gradual reforms by maintaining state control over a large portion of the economy or whether to follow the advice of Western economists and undertake radical reform.  The regime chose the latter options, first undergoing rapid liberalization of prices and then privatization of most of the economy. 

In practice however, Russia achieved less than full liberalization because of political constraints. Radical reforms entailed a centralization of fiscal policy, tightened monetary policies, deregulation of prices, liberalized domestic trade, freely convertible currency, free trade, privatization, and a new social safety net for groups in need.  (Åslund 2000, 77)  While these reforms were pushed through during the first years of the transition, many of these reforms were later eroded by political compromises.

China on the other hand chose the gradualist path.  This model favored step-by-step price liberalization and increased openness to the outside world, while the political regime maintained a strong grip on its power.  (Åslund 2000, 93)  Thus, they chose to first reform only foreign trade and agriculture, while maintaining control over other parts of the economy.  Then, the government opened the economy more and more to market-based incentives while maintaining control of certain state owned industries.  More about how the Chinese reformed their government will be explored later in this paper.  

The difference between the results of the Russian and Chinese transition has been enormous.  China’s economy has grown tremendously since its reform while Russia has had a difficult transition period, only recently stabilizing.  The economic success of China is clear, as the GNP grew an average of 8.5% per year until 1994 since the start of reforms in 1978. (Perkins 177)  (Figure 1) This is not merely economic growth, but also economic development that benefited a large portion of the population.  Housing condition and food supplies greatly improved; even television sets became accessible to the poor during this period of expansion.  (Perkins 179)  The Russian Federation on the other hand has not fared nearly as well. 

The real GDP of Russia contracted over 35% during the first years of reform from 1989 to 1993; from 1993 until 1997 the GDP decreased at a more gradual rate.  (OECD 29) Russia’s standard of living has also fallen during the transition years.  In sharp contrast to the improving living standards in China, the Russian people have faced deteriorating qualities of life with a lower life expectancy, a phasing out of housing subsidies, and a marked decrease in consumption.  (OECD 236)  The results of Russian reform have led to worsening shortages, decline in output, increases in income inequality, and an increase in corruption.  (Kizilyalli 309) 

The Policy Choices

The dramatic difference in outcomes has sparked an enormous debate focusing on whether it was the policy choices taken by the governments that produced this outcome, or whether the difference was caused by the initial conditions of the country.  In regards to policy choice, there are three general perspectives, though the individual arguments of each member of the groups are distinct and by no means limited by their grouping. 

The first group argues, without many caveats, that the “Big Bang” method of radical reform is the most effective transition policy.  For example, Woo (1994) argues that gradualism was not the optimal strategy for economic transition, even for China. Instead, initial conditions led to China’s growth, while the initial conditions of Russia made even radical reform fall short of its goal, though the results would have been worse had Russia taken more gradual reforms.  On the other extreme, the advocates of gradualism claim that the “Big Bang” approach is disastrous for transition.  Peter Nolan argues that though the initial conditions of China and Russia were significantly different, these differences cannot explain the disparate outcomes. 

Russian officials could have chosen the correct policies, as their compatriots in China had, to achieve better results. (Nolan 3) Finally those who take the intermediate position argue that the initial conditions of a country affected the best policy the country should follow.  Poznanski calls this the evolutionary interpretation of transition.  (Poznanski 3) Barry Naughton argues that though China’s initial conditions help to explain China’s success, the strategy of reform was also important.  (Naughton 150)  Others such as Ronald I. McKinnon and Josef Brada also take this position.  

When these positions are examined in the comparative context between China and Russia, they boil down to two main explanations: policy choice and initial conditions. This paper focuses primarily on these two fundamental concerns, rather than focusing on the policy choices themselves, though it will spend time showing the difficulty of using policy choice to explain the contrast between the countries. 

Because Russia’s policy had a period of unsuccessful results while China’s policy choice resulted in an explosion in growth, it must be shown that the constrains and incentives created by policy choice had more influence than the constraints and incentives created by the initial conditions; China’s gradualism must be shown to be superior than Russia’s radicalism.  The evidence fails to support this condition. 

While policy choice of the two countries did result in significant effects on the transition economies, it is difficult to support the argument that the choice was the determining variable that separated the FSU and China.  Depending on the variables emphasized in the theoretic framework of radical and gradual reforms, both arguments make strong points.  For example, if we emphasize the growth of corruption as the primary factor, then the Big Bang approach would be the better path toward reform.  However radical reformers argue that gradualism encourages corruption.  (Åslund 110-112)  Indeed, by 1989 in China, corruption was perceived to be a major problem stemming partly from the reforms. (Perkings 180)

However, Russia ranks higher than China in a corruption index.  (Figure 3) This gives support to the argument that neither the Big Bang approach, nor gradualism could prevent the underlying flaws of the system from arising, as corruption arose regardless of the reform path taken, in fact growing more where in theory it should have grown less.

On the other hand, if we emphasize stability as the vital condition for economic growth, then gradualism would be the correct path to choose. Radical reformers argue that the gradualist approach leads to greater inefficiencies as it promotes speculation for storable goods while giving little incentive for firms to operate with a hard budget constraint, as losses may be the result of inefficiency or price controls. 

(Woo 1994, 278)  Vigilant coordination is necessary to enforce quotas in dual price systems effectively.  (Murphy 900) There seems to be a general consensus among the various sides of the debate that a strong central government is beneficial to administer the transition.  Though a shift to a more efficient market economy may provide enough gains to a country to justify the potential lose to those whose positions are damaged by this structural change, the cost of compensating affected workers may be higher for the new government because of its limited information.  In certain cases where the government has power to indicate future reforms and execute its directive, the cost of attaining efficiency may be lowered through gradual reforms.  (Dewatripont, 292) Even Åslund, who argues vehemently against the gradualist perspective, concedes that strong government is advantageous to implement reform. (Åslund 1995, 15) In order to achieve a successful transition, the government should have the authority to control corruption in the enterprise as well as public office, regulate monopolies to ensure competition, control market institutions, collect taxes efficiently, and finally make forecasts for future reforms measures.  (Kizilyalli 121)  Radical reforms undermined the government’s ability to fulfill these conditions.

Gradualists argue that the policy choice to radically reform the political system as well as the economic system was the primary cause of the chaos of Russia.  Nolan argues that the cause of the Soviet economic collapse was due to the destruction of the administrative apparatus. (Nolan 309) This in turn was caused by Gorbachev’s push for radical political reform while also initiating economic reform.  (Linden 71) This chaos created skewed incentives.  For example, in the early stages of the reform during perestroika, whole pieces of firms were separated from the main firm to benefit only the managers.  Skewed profit incentives encouraged this behavior, as this initial round of privatizations did not result in more efficiency. (Poznanski 8) Furthermore, because of the thorough level of government collapse, most people lost confidence in the authorities. Layard argues that this caused high levels of inflation in addition to retarded output growth.  (Layard 4)  

Theoretically, this seems to argue for the gradualist approach.  Radical reform can undermine the government, which in turnundermines the government’s ability to reform. However, despite the consensus that a strong government is necessary to implement effective economic transition policies, the important issue to keep in mind is whether Gorbachev’s government would have had enough strength to implement economic reform without also pursuing political reform.  The evidence does not support the gradualist’s assertion that the Soviet government had enough strength to fulfill the conditions outlined by Kizilyalli.  (Åslund 1995, 15) The leadership was already crippled by the system, and anti-reform interests were already too entrenched. 

Even if the stability imposed by the Soviet regime had remained intact, the system probably would not have allowed effective reforms to occur. Evidence for this assertion can be found in the history of early attempts at gradual reform where reforms consistently failed. (Gregory 223) Neither the growth of the non-state sector, nor the liberalization of the state sector during the Soviet era brought economic success.  (Sachs and Woo 122) Thus, neither policy choice provides strong evidence to support that either choice was the best choice for the country. 

The empirical evidence is also too inconclusive to unambiguously support either argument.  In fact, studies have found a greater statistical correlation between initial conditions and successful transition than policy choice and successful transition.  (Heybey and Murrell 1999) If the policy choice had primary importance in the outcome of a transition economy, then the superiority of the gradualist approach should be clear in the data.  This is far from the case: though China is considered a successful example of the gradualist approach, (Woo 1994, 277) Vietnam failed to transform its ailing economy into a success story when it implemented gradualist policies, instead suffering a recession; however, Vietnam met with a successful transition after it changed its gradualist policy to radical economic liberalization.  (Woo 1994, 305)

To account for this fact, it may be argued that only China and Hungry effectively implemented the gradualist approach while the other countries that tried failed because of misadministration; however, those who support “Big Bang” take a similar argument, asserting that Russia’s radicalism was also incomplete. 

The radical reformers have a data set in the FSU and Eastern Europe where many countries undergoing their recommended course have unequivocally failed to grow, even if adjusting factors such as the duration of reform, are taken into account.  The Baltic States are a notable exception where they successfully implemented reforms; however, their success may have been due to the flight of the Russian oligarchy, or to enthusiastic western financial support, though this support may in turn have been influenced by their policy choice.  This highlights the difficulty in assigning a firm weight to the impact of policy choice.

The Hungarian experience with gradualism also hurts the radical reform position.  In order to justify this lack of empirical evidence, the radical reformers have made adjustments to the data.  One assertion by Woo, as well as many others, is that radical reforms were never fully carried out in Russia or most of the states of the FSU.  (Woo 1994, 277) Åslund (2000) argues that in general, the more radical the reforms, the more successful the economy; if this is true, this gives support for the initial conditions argument, as Russia’s reforms were then the superior choice being more radical than China’s reforms. 

The collapse of trade between the countries of the Council for Mutual Economic Assistance (CMEA) also played a vital role in the GDP fall after the reforms.  (Gomulka 21)  Åslund concludes after calculating his adjustment figure that output decline was much smaller than perceived.  Part of the reason is that the Soviet economy was in much worse shape than was commonly known.  (Åslund 2000, 121)  However, despite these mitigating factors, China still grew at a much faster pace than Russia, either in spite or because of its policy choices, and so we cannot yet discount the possibility that China’s policies were better.

The Economic and Political Foundation of Policy Choice

The constraints and incentives created by the initial economic and political conditions in each country may have helped to create the ambiguity of the superiority of either policy choice.  These conditions confounded the policy choice variable with many other factors.  It seems probable that, as Åslund argues, the policy choice taken by the FSU was a direct result of the initial political conditions in the FSU.  (Åslund 1995, 15)  Similarly, Stanley Fischer arguers that gradualism was irrelevant in Russia’s case because of large macroeconomic imbalances.  (Fischer 154) 

Initial condition of China’s political structure played a large role in China’s policy choice.  In spite of the relatively strong leadership exhibited by Deng Xiaoping during the start of reforms, each individual reform policy had to be implemented by consensus that resulted in the gradual introduction of reforms.  (Shirk 128)  “Deng Xiaoping and his reformist lieutenants were extremely cautious, ‘taking one step forward and looking around before taking another.’” (Shirk 129) In order to pass a reform policy, deep compromises had to be made that left important individuals on at least the same indifference curve. 

For example, in 1983 when the Ministry of Finance recommended new taxes, a compromised was reached with the heavy industrial ministries and inland provinces to reduce their tax burden, with the fiscal gap filled by an adjustment tax on profitable medium and large state enterprise on an individual basis.  (Shirk 139) In this way, the industrial ministries did not lose, while profitable enterprises were allowed to remain independent.

The path taken by each country was largely influenced by the elites of each country; these elites maximized their welfare gain within the political and economic constraints, and capitalized on structural incentives. In the Soviet Union, much of the actual power was concentrated in the heads of ministries.  Thus, the structure of power in the Soviet Union can be characterized as a centralized oligarchy.  It was to the advantage of these elites to spur the collapse of the system that was the sole obstacle against full-blown rent seeking behavior.  They controlled valuable resources that had the potential to provide them with much private wealth outside of the confines of the system.  In addition, the rising political elites needed to seek allies within this oligarchy to overthrow the dying leadership of the Communist Party.  Furthermore, because the new political elite did not have enough support from Western government, they had to turn to domestic elites to buttress their power, creating an “underreform trap” that could not be broken until after a financial crash shook the oligarch’s positions.  (Åslund 2000, 382) 

After the collapse of the old system, proponents of gradualism were often elites who wanted to make money during the transition; these were the same elites who the radical reforms had to turn to for support. (Åslund 1996)  Thus, after effecting the collapse of the system, the elites maximized their welfare by reestablishing advantageous price supports.  In addition to these anti-reforming incentives for the elites, reform was also against the interest of the workers.  The population of the FSU “was covered by an extensive social welfare system, with many of the benefits linked to the place of employment.”  (Sachs and Woo 104)

China, on the other hand, faced very different political and economic constraints.  The political power at the time of the start of her transition was still firmly in the hands of the top leadership.  However, the
grassroots population some of the power, as central control had not been extended to the rural areas to the same extent as it had been in the Soviet Union.  (Sachs and Woo 1994, 110)  These peasants were eager to increase their production, only hoping that the heavy governmental bounds were loosened. After the Cultural Revolution, which was catastrophic for the legitimacy of the Communist Party, the top leadership was eager to reestablish legitimacy; their only recourse was economic growth.  (Wang 65-72)  The political and economic constraints created by China’s initial conditions resulted in an incentive to pursue a successful transition policy for most of the significant parties involved.  Local officials stood to gain from successful growth with increased economic success in their locally controlled enterprises.  The top leadership would re-legitimize their power, and the rural laborers could increase their economic welfare.  Russia on the other hand did not have such well-aligned incentives to drive those with power to contribute toward the good of the country. 

During the transition, “managers enjoyed quasi-property rights over ‘their’ enterprises without accountability.”  (Åslund 2000, 287) Decentralization would result in loss of political and economic welfare for the elite managers.  Furthermore, workers were heavily subsidized; thus, their economic welfare was threatened by market reforms.  Finally, though the new Russian politicians initially stood to gain by pursuing economic reform, as successful reform would attract foreign investment and affirm their legitimacy, the lack of foreign investment forced them to seek support from the economic elite and political conservatives, thus partially aligning their incentives with this anti-reformist group. Yeltsin tried to mitigate criticism of the Gaidar [reformist] team by granting concessions to four groups: the parliament, state enterprise managers, the old-line bureaucracy, and his close friends.”  (Åslund 1995, 94)

The reform of agriculture in China further demonstrates the incentives and constraints created by initial conditions on the effectiveness of the policy choice. Agriculture was reformed with land leasing despite government bans on these practices.  Ninety-four percent of cultivated land was under household control, though the leadership did not sanction this until 1985 (Woo 1994, 282) Therefore, it seems that the gradualist “choice” of the Chinese government was not a choice at all, but was rather dictated by their initial conditions.

Admittedly, it may be argued that the government chose to ignore the flouting of its decrees because it saw it was advantageous.  Yusef argues that the private household’s unsanctioned rights had several advantages, allowing the community to uphold official ideology while still experimenting with novel techniques. (Yusef 76)  However, it is likely that the policy was not truly a free choice, as the option was simply acknowledged after the fact.  

The most important point to bring out of the discussion thus far, regardless of the relative merits and drawbacks of each theory, is that neither theoretical considerations nor empirical evidence can conclusively support the argument that policy choice is the deciding factor in the economic performance of transition countries.  While gradualists point to the massive failures of the Shock Therapy countries, they do not consider that gradualist policies might have been impossible to pursue in Russia given the political constraints.  Similarly, radical reforms often make the same mistake in asserting that full radical reform would have benefited China more without strong enough evidence to outweigh the weight of the influence of the initial conditions. 

While some evidence shows that more radical reforms would have increased production in some Chinese sectors, complete radicalization could also have many unwanted results such as the loss in public confidence experienced by the Russian government.  The Soviet Union was already in a frozen state of economic stagnation that could not be solved without significant measures (Gregory 238), while the political situation in China was such that only a gradualist approach to reform was acceptable to the political elites. (Shirk 131) Therefore, to a significant extent, the initial conditions created the acceptable terms of the policy choice.

Initial Conditions

The other end of the debate focuses on the different initial conditions of the countries.  Up to this point, the paper has only discussed the implications that initial conditions had on the policy choice of Russia and China.  However, the incentives and constraints created by the conditions had a direct effect on economic growth that if not determined, then overshadowed the changes caused by policy change.  The situation created by these initial conditions are almost unambiguously favorable to China, providing strong, clear evidence in support of this side of the argument. These initial conditions of the country may be divided into four general categories of differences: the economic structure, the political conditions, foreign influences, and domestic finances and savings. 

The structure of the economies contributed significantly to the results of the transition.  Qian and Xu (1993) characterize the structure of centralized economies as M-form and U-form.  The M-form structure of organization brings complementary jobs together while the U-form organizes similar jobs into a central entity.  China’s economy had an M-form organization with regional government control, while the Soviet Union had a U-form organization with large central ministries; the industries with a state sector legacy in Russia are still affected by this U-form organization.  (Xu and Zhuang 186) This may provide an explanation for why enterprise managers in Russia accumulated enough power to overshadow the central leadership while the Chinese leadership remained strong.  Because of this organization, industry in the FSU faced soft-budget constraints that promoted inefficiency.  China on the other hand had established Township Village Enterprises (TVE), which were collectives under local control that faced hard-budget constraints and thus had a strong incentive to maximize efficiency.  (Sachs and Woo 1994, 121)  

Therefore, power was centralized in ministry managers in the FSU while relatively decentralized in China.  In addition to the TVEs, the State Owned Enterprise sector was small allowing the state to effectively monitor performance.  The maintenance of State Owned Enterprises within the system was one of the policies of gradualism; however, this policy has supported one of the worst performing sectors of the Chinese economy, giving some evidence that gradualism may not be the optimal strategy. Nine-tenths of the 5 trillion Yuan ($600 billion) of bank loans outstanding in China, equivalent to about 70% of GDP, is financing loss-making state owned enterprise. (“The End of Gradualism”)

In addition to the structure of the economy, the production basket also affected the success of reform.  The proportion of agriculture and heavy industry in the economy played a significant role in the policies the leadership chose and in the effectiveness of theses reform policies.  Seventy-one percent of the Chinese worked in agriculture, compared with only 14% in Russia.  (Åslund, 1995, 14) Soviet agriculture was heavily centralized and inefficient, characterized by costly giant state farms and tiny peasant plots. (Hunter 353)  (Table 1) Brada (1995) argues that productivity gain was much easier to achieve in agriculture, especially in Chinese agriculture, because this sector was less dependent on inputs from industry than the industrialized farming of the Communist Block in Europe.  Furthermore, because of the heavily industrialized structure of the Soviet economy, labor was overly specialized and difficult to reorganize; China’s rural labor force on the other hand did not face this problem.  (Sachs and Woo 1994, 105) 

The initial political conditions between the two countries were vastly different.  Though the Communist Parties of both the FSU and China were similarly structured with centralized bureaucratic rule, a large Party apparatus, and a close nit state/party administration (Nolan 154), there were important differences in the systems.  The Cultural Revolution was an event that created a large difference between the two countries, devastating the economy and bringing terror to the party bureaucracy (Åslund 2000, 93); this event left much of the administrative capacity of China in shambles. (Woo 1994, 304) 

Sixty percent of the bureaucracy was purged (Sachs and Woo 1994, 111), leaving the power in the hands of the central leadership.  (Oksenberg 18) After a struggle of a few years, the party placed Deng, a dedicated reformer, and his followers securely in the position of power. (Hunter 38) This strong leadership was necessary to carry out reforms as it helped to prevent the short-circuiting of reforms by the party bureaucracy as they seek to advance their own interests. (Shirk 86)  Unlike the FSU, where power was centrally decentralized in the hands of a few middle ranked party bureaucrats, the middle ranks of the Chinese Communist Party were governed by parallel rule, a method also known as “police patrol,” first developed by Soviet Communist Party leaders in 1919, where government officials are supervised by party committees.  (Shirk 58)

  However, China took this practice to another level, establishing “Party groups,” that actually took over the job of administering the government, directly supervising enterprise managers.  (Shirk 59)  This practice helped to prevent the enterprise managers from hijacking reforms to their advantage, as the party groups supervised their actions and reported their conclusions to the top leadership.    

In addition to the political impact the Cultural Revolution had on China, it also altered the Chinese economy to be more amenable to slow economic reform.  The number of enterprises under direct central control after the Cultural Revolution in 1971-3 was less than the number under control near the beginning of the Chinese Communist state.  This figure rose to a maximum of 10,000 in 1963.  Similarly, the number of materials that were distributed by the center was 217 in 1971-3 compared to 227 in 1953, peaking at 532 in 1957.  (Nolan 47): (Table 2)

Furthermore, the state only had to worry about twelve official prices because of the reduced role of the state, allowing the regime to better focus its limited attention.  (Woo 1994, 306)  Therefore, because the current economic transition began a few years after the Cultural Revolution, Chinese Communism was at a uniquely decentralized and weakened condition.  Without as many entrenched interests in the economy, reform may have been easier to take. 

The initial political conditions in Russia were not conducive to successful reform.  As mentioned earlier, neither the Soviet Union nor the succeeding Russian state could enforce the dual pricing system that was a central aspect of the successful reforms in China.  In the FSU, power was spread through the top bureaucracy with too little power in the hands of the top leadership to make effective reforms. Much of the economic power rested primarily in the enterprise managers who had enough room to act autonomously. (Åslund 2000, 44)  Leonid Brezhnev delegated much of the political power down to the industrial ministries and regional party secretaries, leaving Gorbachev to contend with powerfully entrenched bureaucratic bosses.  (Åslund 1994, 15)  Thus, much of the real political power rested in the hands of the nomenklatura rather than in the leadership. 

When Russia first tried piecemeal reforms, such as the cooperative, many of the enterprise managers took the opportunity to perform rent-seeking activities through arbitrage opportunities. (Åslund 2000, 3Further Soviet attempts at partial reform, through programs that allowed quasi-private firms to decide what to produce and to whom to sell their products, failed, resulting in a GNP decline of 8% in the first quarter of 1991.  (Murphy 889)  This was due to the misallocation of resources, as private firms had an incentive to enter sectors with shortages in order to purchase from price controlled public outlets and redistribute to higher priced private markets. 

(Murphy 890)  Speculation on storable goods was rampant, and shortages at the state level became common.  (Woo 1994, 277)  The private firms diverted raw materials such as timber and oil away from the public sector into the private domestic and international markets.  (Murphy 897)  The result of the partial reform was the breakdown of economic coordination.  (Murphy 896)  China on the other hand  avoided the breakdown of economic coordination because of its strong government, which had the power to enforce strict quotas to avoid the diversion of materials away from vital industries and small state owned enterprises. The government also provided industries an incentive to produce above the quota supplies by allowing an open market for these goods.  (Murphy 889) 

When the Soviet Union collapsed, the new central government did not have much choice in the policy it could pursue.  The workable gradualism, which China executed, could not be applied to the newly formed Russia.  The Russian leadership after the fall was highly limited in its powers, even more so than the Soviet leadership. (Fischer 142) Thus, the old rules of the enterprise sector no longer held true.  (Fischer 155)  Another major impediment to the success of the Russian transition was the constitutional crisis that led to political deadlock in many of the issues of reform.  (Kizilyali 309) Boone and Hörder argue that the initial levels of inflation were also a result of the chaotic political conditions that were pervasive in Russia after the fall of the Soviet Union.  (Boone, 43) 

The uncertainty that ran throughout the Russian political sphere affected foreign investment and aid, stemming their flow into the country.  In contrast to the Western response to the Baltic States, the West did not provide enough aid to ensure that full liberalization stood on a firm financial foundation.  (Åslund 2000, 406-407) Political collapse also led to a collapse in trade.  Russia traded largely with the CMEA countries at disadvantageous conditions, which collapsed at the beginning of transition in 1991 (Åslund 1995, 111); furthermore, the country was deeply in debt at the time of transition growing from 10% of GDP in 1990 to 33% of GDP in 1995 to 95% of GDP in 2000.  (Gregory 358)

Foreign investment in China was important in the success of its development.  In contrast to Russia and the FSU, which did not attract much foreign investment when it first initiated reforms (Table 4), China had a large Diaspora situated in countries such as Taiwan, Hong Kong, and Macao who contributed both financial capital as well as human capital (production skills, knowledge of quality control, and exporting skills). In addition to the investment role these territories played in China development, they also opened the way for special economic zones in the regions near Taiwan and Hong Kong.  The success of these zones may have helped make China’s reforms successful.  “Roughly 70% of China’s overall trade leaves through Hong Kong.”  (Sachs and Woo 1994, 112) 

Capital from Japan and the United States also helped develop skills in transportation, electronics, and tourism. (Yusef 81,82)  Foreign investment in 1993 rose to $25.76 billion, (Yusef 82) a substantial amount considering investment was only $7 billions dollars in 1991.  China also had a small foreign debt at the time of transition.  (Nolan 184)  While some may argue that it was China’s careful macroeconomic and trade policies that led to this aspect of its economic success, the policies were formulated based on knowledge of a potential opportunity.  When Russia sought foreign investment with similar policies, foreign investors were not so eager to help. 

The fiscal conditions of these countries after the initial reforms profoundly affected the success of reform.  When reforms were first implemented, macroeconomic instability arose (Sachs and Woo, 126) causing both governments’ GNP shares declined significantly. (McKinnon 97)  (Table 4) However, China still managed to avoid fiscal collapse in part because of the particular condition of their banking system. 

During the 1980s, rural households saved at a remarkably high rate with the household deposits to GNP ration rising from 5.85% in 1978 to 45.88% in 1991.  (McKinnon 111) In addition to avoiding fiscal collapse, this high savings rate has also contributed significantly to China’s high investment rate and has allowed the country to absorb outside shocks.  (Yusef 1994)  However, even this seems to be a result of initial conditions of China as there are few other places to store money when the agricultural boom began: “just a tiny stock market, plus some wild-west markets for, say, PVC or mung-bean futures.”  (The Death of Gradualism)

Savings in Russia on the other hand were already high and so could not be further tapped for government investment since it had already been injected into the capital system. (Brada 194) The initial conditions played a vital role in creating this situation as the shortages of consumer goods created unsatisfied demand and thus resulted in a degree of forced savings.  (Denton 170)  Furthermore, because of macroeconomic misadministration, Russia’s dual track system collapsed with spiraling non-state sector prices creating opportunity for arbitrage.  (Sachs and Woo 1994, 112)  China on the other hand, carefully managed macroeconomic policy to maintain stability.  However, it must be remembered that China’s initial political conditions allowed the country to have enough power to maintain this stability.  Russia’s conditions were not conducive to effective management. 

Limitations of this Analysis

Though these conditions differed greatly, was this difference large enough to explain such a dramatic divergence in outcome?  Nolan argues that the Cultural Revolution paralleled Gorbachev’s glasnost, and thus, China and Russia began at similar initial conditions, leaving policy choice as the only factor that could explain their outcomes  (Nolan 238) However, there were differences that were large enough to change the state of the delicately balanced system.  The Soviet economy was already in a state of stagnation and decline, thus making the cause of economic regression difficult to pinpoint.  (Åslund 1995, 26)  In addition the reforms did not affect the bureaucracy’s power until the entire power structure collapsed. 

The Cultural Revolution left the central government in China intact.  While both events brought in new leadership, China’s leadership maintained a strong hold on the political apparatus while the Russian leadership did not.  (Aslund 2000, 93) In Russia, as stated earlier in this paper, much of the power devolved to the enterprise bosses and communist Party leaders who no longer had a stake in the government.  Furthermore, he implies that China’s agriculture could have been a hindrance on China grown relative to Russia.  (Nolan 114)  However, the evidence does not support this claim.  When China liberalized agriculture, the sector grew at a rate of 7% a year.  (Perkins 184)  On the other hand, reforms in agriculture did not have a significant impact on the economy of Russia.  (Woo 1998, 29)  China’s reform was easier because it involved moving “surplus agricultural labor into industries,” while Russia had to move “labor from uncompetitive industries to newly emerging efficient industries.”  (Woo 1994, 305) Though both countries had the potential to catch up, this potential was inhibited by the economic structure of Russia. 

Nolan argues that Russia’s initial economic conditions did not preclude a successful transition because both countries had “catch up” potential because of their large economies.  (Nolan 115) It may be argued that policy choice created the initial political and economic condition.  Certain aspects of the initial conditions in China and Russia gave Russia the advantage.  For example, in education, in 1970, the adult literacy rate percent was 66 in china while it was 100 in the USSR.  (Nolan 117)

Paradoxically, the Arable area per capital in China was only .10 hectors while it was .89 hectors in the USSR.  (Nolan 139)  This is ironic because China’s most successful reforms were in agriculture, despite its small resource base.  However, these statistics may be misleading as China’s population is vastly greater than Russia’s.  Furthermore, the quality of production on this arable land is affected by the economic structure of the country, which seems to be the more important factor. 

Poznanski (1995) argues that though these piecemeal reforms were the inevitable results of political compromise, they were still the correct choice for reform.  In addition to this initial assertion, Poznanski also proposes that gradualism is the correct approach to reform in all cases because of the lower level of institutional chaos and social cost. The second half of this argument is difficult to support The Baltic States are an example of a radical success, where one of the major reasons that the transitions of these states were largely successful was because the radical policies attracted foreign investment and foreign aid into the country. (Åslund 2000, 199)  Undoubtedly, the specific policy choice made within the range of political constraints affected the outcome of the transition.  However, ambiguity remains in both sides of the argument as the success of the radical policies may have had more to do with the Western enthusiasm and support that prevents erosion of these early reforms. If the focus goes back far enough, the cause and effect become inextricably blurred.  Similarly, Poznanski’s first point that they were the correct choice is confusing as it implies that the leadership of China actually chose the specific reforms that were successful. Instead, as already stated above, the leadership in China took the least costly
steps to reform, these steps were dictated by the structure of the system.


Though policy choice affected the outcome of the transition experiences of China and Russia, the evidence strongly supports the argument that the determining factor was the initial conditions of the countries.  The relative costs and benefits of gradualism and radicalism are very ambiguous as both sides make strong arguments and neither policy is conclusively beneficial.  However, because initial conditions constrain the outcome of policy choices, this detracts from the strength of the gradualists’ argument that policy choice was the determinant factor.  In addition, almost all the initial conditions of China and Russia, in addition to those that directly constrain policy choice, favored China’s success.  Out of the four conditions mentioned in this paper, the large Chinese Diaspora and the devastation of the Cultural Revolution are unique to China’s case; the economic structure and the political conditions also favored China, though Russia could have conceivably reproduced some of these conditions, such as the high savings rate, with proper policies. 

One of the only conditions that may have favored Russia was its highly educated work force; unfortunately, because of other conditions, Russia could not capitalize on this advantage.  However, this is not to say that China produced these conditions with its policies; rather, China was blessed with these conditions at the time of its reform, while Russia was limited by its conditions.  Thus, the applicable lessons that China’s case could have provided for Russia’s transition were relatively few.  Eventually, China’s successful transition policies may run out of the fuel provided by its initial conditions.

Perhaps it is time for the United States to heed the lessons of China and the Former Soviet Union.