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Free Economic Transition in China and Russia Essay Sample

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Russia and China are large state socialist nations that embarked on market transition in 1991 and 1978 respectively. Irrespective of their similarities as socialist states, their transition strategies extremely differed. Nevertheless, macroeconomic evidence of Chinese and Russian are at opposite ends of the spectrum, suggesting that China’s transition strategy was more than effective than Russian transition strategy (Chow, 2002). The aims of this paper are twofold: to identify the key differences in their approaches to the transition, basing on reform policies, and assessing the effectiveness of these approaches. This paper answers Q1, 3 and Q2: a, b, and c.

Q-1 Identify the Key Differences in Their Approaches to the Transition

Q1, 3

Russia’s transition strategy relied on neoliberal transition strategy, an economic model, established by Western neoclassical economists, who advocated for minimal government participation in the transition process. Russia’s strategy depended mostly on state-interested initiatives for economic transition (Kynge, 2006). On the other hand, China’s economic transition towards a capitalist market relied mostly on state-directed transition strategy, which varies considerably with Russian’s neoliberal transition strategy. China’s transition strategy involved the state playing an active role in managing the economic transition. It is apparent that China’s transition economy has lasted more than Russian’s transition. It is a fact that performance of China’s transition economy is dramatically superior to Russia’s transition; China has witnessed a rapid economic growth during the transition, whereas Russia’s economy fell dramatically. The key differences in approaches relate to speed of transition and the nature of reforms, adopted to facilitate the transition (Kynge, 2006).

Neoliberal transition strategy, sometimes referred to as shock therapy, advocates for rapid transition from state socialism to capitalism. Shock therapy depends on three primary policies including liberalization, privatization and stabilization (Rogoff, 2002). Liberalization mainly entails the elimination of state restrictions in relation to price regulation and market control. Stabilization has the main objectives of controlling inflation by cutting government expenditure and a tight monetary policy (Wu, 2005). Privatization advocates for the transition from state ownership towards private ownership of enterprises. Further, shock therapy calls for rapid termination of state allocation of resources and elimination of barriers to global trade and investment. In sum, market reforms in shock therapy aim at transforming state socialism to capitalist market by removing state-ownership of firms and state regulation of the economy (Rogoff, 2002). This transition draws on the anticipation that market forces and self-interested initiatives will initiate and coordinate economic activity; roles, previously played by the state. The Russian government adopted the shock therapy in January 1992 after the elimination of central planning and allocation of resources. The reform policies, adopted by Russia, based on liberalization and stabilization, with the implementation of privatization coming later. For instance, price liberalization took place in January 1992, with prices of consumer and intermediate goods, determined freely by the market. The second goal of Russian economic reform was stabilization, aimed at ensuring low inflation rates. Attaining low inflation rates involved lowering the growth rate of currency supply, which posed the need to cut government expenditures (Rogoff, 2002). Almost all prices were devoid of state regulation since the onset of transition. There was a sharp reduction in government expenditure from 47.9% of GDP in 1991 to 26.9% in 1995. The country adopted tight monetary policies with currency supply falling sharply during the early years of transition; currency supply declined from 100% to 16% of nominal GDP during 1990-1994 (World Bank, 2007). Privatization increased at a faster rate, with non-state firms accounting for 78.5% of 1994 industrial output. In addition, Russian market reforms encouraged free imports, global capital flows and currency exchange (World Bank, 2007).

On the other hand, the state-interested transition strategy (gradualism) entails a gradual liberalization of prices by maintaining a dual system of prices (Wu, 2005). China adopted this transition policy by maintaining a dual system of prices, whereby state-owned firms had to offer specified output levels at a lower price plan, while outputs above the specified level sold at the market price. The experimental approach adopted by china implies that it was not fully gradual; there are some instances where workable reforms were implemented instantly. The state controlled prices of retail commodities through 1991, which was 13 years after the inception of the transition. China combined direct administrative measures with brief durations of tight monetary policies to regulate inflation rates. China did not reduce government expenditure as in the case of Russia; instead, it adopted extensive infrastructural investments to enhance economic growth (Qyian, 2003). Instead of tight monetary policies, China offered room for credit expansion, while, at the same time, forwarding credit towards productive sectors of the economy, using government control through bank lending and setting up interest rates. The control and ownership of banks were under the state. In contrary with the sharp monetary contraction policy, adopted by Russia, the monetary supply of China increased from 25% to 89% of GDP during the period 1978-1994 (World Bank, 2007). Instead of embarking on the privatization of state-owned firms, the government encouraged the establishment of non-state firms by various economic agents such as townships and villages, private individuals and worker unions. The government continued supplying investment funds to the state-owned firms controlled by the state. There was no immediate dismantling of central planning, although the public sector retained central planning and loosened as time progressed (Weil, 2009). The newly established non-state economic sector witnessed rapid economic growth, accounting for approximately 55% of GDP in 1995. China embraced foreign investment but remained protective of its domestic market (Kynge, 2006).

Even though gradualism is a typical attribute of China’s transition strategy, the differences between shock therapy and gradualism extend beyond the pace of transition. Instead of aiming direct transition of planned economy and state-owned firms to the market-based economy and privatization, China used its existing state-owned and planned economy as a foundation for introducing the new non-state and market-based economy. China’s transition strategy involved two simultaneous sectors, which is contrary to Russia’s “one-sector” strategy. China aimed at encouraging the growing non-state sector, while retaining and improving its state sector. Russia’s transition was a complete overhaul, typified with speedy transition (Kynge, 2006).

Q2 Assess the Effectiveness of These Approaches

Q2: a

Measuring the effectiveness of the transition strategies require a comparative analysis of their outcomes. This draws on the predisposition that there is a positive correlation between economic outcomes and the effectiveness of transition strategies (Pomer, 2001). It is a fact that the primary objective of economic transitions is economic improvement. As such, an improvement in economic performance in post-reform periods implies that the transition strategy was effective in meeting its goals. On the contrary, a decline in economic performance, when in comparison to pre-reform period, implies that the transition strategy failed to achieve its goals; hence, considered ineffective. In light of this view, the chosen criterion for measuring the effectiveness of the approaches is economic performance of the transition economies. The variables, used in ascertaining the effectiveness basing on economic performance, include macroeconomic indices such as Real GDP, economic growth rates, living standards and any other macroeconomic variable that indicates economic performance (Pomer, 2001).

Q2: b

The use of economic performance to evaluate the effectiveness of the approaches draws on the assumption that economic transition has the primary goal of improving economic performance. Therefore, this criterion uses a goal-oriented approach to measure the effectiveness of transition strategies in the sense that their aftermath indicates their appropriateness (Pomer, 2001). In addition, transition strategies have a direct impact on the variables that affect economic performance, such as inflation rate, monetary policies and market opening; implying that it is the most appropriate method for measuring the success of the transition strategies. This requires a comparative analysis of empirical evidence in relation to the economic performance of Russian and Chinese transition economies.

Q2: c

It is evident that the performance of Chinese transition economy in terms of macroeconomic indices is one of the best globally since 1978 (World Bank, 2007). China witnessed a Real GDP annual growth rate of 9.4 percent during 1978-1995. China’s GDP did not fall during those years. After 1995, economic growth of China has been rapid, with a GDP of 8.9% in 1997. There was an increase in agricultural output at an annual growth rate of 6.2% in the decade, following the inception of transition. Such rapid growth rates impose significant inflammatory pressures, but China has managed to handle them without resorting to tight fiscal and monetary policies as outlined in the shock therapy transition strategies (Weil, 2009). During 1978-1995, the mean consumer price inflation was 8.4 percent annually, compared to Russia’s inflation rate of 513% annually during the period 1991-1995 (World Bank, 2007). Since the introduction of transition, China has witnessed an increase in living standards. Despite the fact that inequality increased, the level of income inequality in China is relatively lower than Russia’s income inequality. This is evident in China’s gini coefficient of 38 compared to Russia’s gini coefficient of 48 during the period 1992-1993. The rapid economic growth in China extended beyond the non-state sector. For instance, the real output for state-owned enterprises increased at an annual growth rate of 7.7% (World Bank, 2007).  It is apparent that using macroeconomic indices, China’s gradualism strategy is a remarkable success. The following tables indicate China’s mean annual growth rate of GDP and GDP per capita during 1978-2005.

It is evident that China’s annual GDP growth rate of approximately 10% doubled the size of its economy for every seven years, translating to increased living standards. The following table 2 indicates the purchasing power parity GDP per capita.

Numerous scholars and economists argue that the success of China’s transition economy was because of distinctive initial conditions such as decentralized economy, large agricultural workforce, low subsidies to its citizens, and rich Chinese citizens overseas. The Chinese transition experiences point out the superiority of evolutionary, experimental and bottom-up economic reforms to the rapid, comprehensive, top-down approach. China’s transition strategy was gradual and evolutional since the beginning of the reforms in 1978 (Kynge, 2006). The gradual approach provided room for the government to adopt measures to increase profit sharing and fractional managerial autonomy. These measures ensure that the economy moves towards the production frontier. The gradualness of the transition is a key success factor in the case of China because it offered the reformers with an opportunity to experiment in order to determine the effective reforms. The adoption of reform policies drew on experimentation; the reformers implemented economic reforms that seemed to work and discarded others (Qyian, 2003). For instance, openness to FDI commenced with permitting certain provinces to use extreme capitalist policies before expansion to other provinces. The fundamental argument is that the gradual transition is responsible for the remarkable success in China’s economic performance over the last three decades as affirmed by the above macroeconomic indices (Pomer, 2001).

In the case of Russian transition, it is evident from table 3 that the reforms imposed significant drawbacks on Russian economy. The growth rates of Russian economy have been falling continuously since the inception of economic reforms.

During the economic transition, it is apparent that life for the ordinary Russian was extremely difficult. This is due to declining production and income levels, and price increases that reduced the living standards. The living standards were worse than the pre-reform period under communism. The Russian reforms are exclusively responsible for the deteriorating economic performance in Russia during the early periods of shock therapy. The early years of reform were problematic for the case of Russia. For instance, in the period 1991-1996, industrial production and real GDP declined by approximately 50 percent, investment declined by 70%, while agricultural output declined by 33% (World Bank, 2007). The mean real pay also declined by at least 50 percent by late 1995. The Russian production sector collapsed, as evident by the contraction of output of fuels, metals and raw materials sector. By 1999, there were prospects of reversing the deteriorating economic performance. In addition, the state and non-state institutions were not able to pay their employees timely even under reduced pay grades. Unpaid wages totaled $ 6.8 billion in 1996, approximately 64% of Russia’s monthly wage bill (World Bank, 2007). The situation worsened by the fact that the government was not able to pay its foreign debts during 1998, leading to a collapse of its financial system. It is apparent that economic outcomes of Russian transitions were worse than Chinese economic performance after the transition.

Using macroeconomic indices as measures of economic performance, it is apparent that China’s gradual strategy for economic transition was more effective than Russian’s shock therapy approach to transition (Chow, 2002). Deteriorating economic performance in Russia during the early years of transition and the following hardships that Russians faced is in contrary with China’s experience with gradualism. In the case of China, there were no periods, associated with declining production output. Perhaps, Russian transition could have been effective under gradualism. The experimental and incremental reforms were effective in China because it allowed for the determination of reforms that worked, and their later expansion. Comparative analyses of the economic outcomes in Russia and China are an adequate evidence to affirm that gradualism is more effective than shock therapy transition. The evidence, presented in the paper, indicates that the sharp therapy approach, used in Russia, is not feasible, when converting socialist economy to a capitalist market economy, whereas gradualism is a feasible transition strategy (Kynge, 2006).

Conclusion

This paper has discussed the differences between Russian shock therapy strategy and China’s gradualism and their respective effectiveness in converting socialist economy to a capitalist market economy. It is evident that the differences between the approaches extend beyond the pace of implementation. Gradualism entails a slow transition, while sharp therapy entails a speedy adoption of neoliberal strategies during transitions. Russia’s strategy depended mostly on state-interested initiatives for economic transition. On the other hand, China’s economic transition towards a capitalist market relied mostly on state-directed transition strategy, which varies considerably with Russian’s neoliberal transition strategy. The reform policies, adopted by Russia, based on liberalization and stabilization, with the implementation of privatization coming later. When measuring the effectiveness of the strategies, this paper used economic performance as a criterion, with microeconomic indices serving as measures for determining their effectiveness. It is apparent that using macroeconomic indices, China’s gradualism strategy is a remarkable success. The evidence, outlined in the paper, illustrates that the sharp therapy approach, used in Russia, is not feasible when converting socialist economy to a capitalist market economy, whereas gradualism is a feasible transition strategy. There is the likelihood that Russian transition could have been effective under gradualism. 

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