Introduction
Comparisons οf the Russian and Chinese transitions from state planning to a market economy tend to focus on two dimensions: speed (“shock therapy” versus gradualism) and sequence (i.e., whether political or economic reform came first). (Wei Li 1999, 120-36) Both interpretations are rather simplistic because neither Russia nor China had a genuine “big bang,” and both countries pursued economic and political reforms simultaneously, albeit reforms οf a significantly different nature. More important, focusing on these two approaches leads to simple, time-dependent conclusions. Today, China’s “gradual” model appears more successful, but in 1990, the big bang approach looked more successful.
Steven Solnick’s neo-institutional approach is an important exception to the existing literature, although its main conclusion–that the Soviet order collapsed, whereas the Chinese communist order sustained itself–can be seen as a more sophisticated version οf the sequencing issue. Solnick’s “bank run” on Soviet institutions resulted from Gorbachev’s political restructuring, but China’s relative lack οf political reform left communist-era institutions largely intact. More important, Solnick’s study deals with the collapse οf the older communist-era institutions, rather than the creation οf the new market-oriented institutions that have emerged in both Russia and China since each transition began (Steven Solnick, 1998).
Russia and China both had to create institutions capable οf attracting foreign investment to facilitate their transition processes. The Soviet Union and the People’s Republic οf China (PRC) had developed as largely autarkic economies closed to most foreign trade and investment. Opening up to the outside world has been one οf the key aspects οf the transition, if not the key aspect, in both economies. Hard-currency trade and investment was the first vehicle for introducing hard-budget constraints and market incentives to the Soviet and Chinese economies (Janos Kornai, 1998, pp. 11-17). Given the relative lack of οf pre-existing institutions designed to deal with hard-currency transactions and the rapid increase in foreign investment after the beginning οf the transition, the evolution of οf foreign investment and advice provides an opportunity to compare how communist-era institutions as a whole evolved in Russia and China. In both countries, the older institutions οf the state-planning system had to evolve to deal with foreign trade, while new ones also were created, particularly in China.
Trace privatization in Russia
Russia began its economic transition with a big bang in January 1992. Under Prime Minister Egor Gaidar, most state-controlled prices were liberalized virtually overnight, beginning a process that would rapidly privatize the country’s industry. Foreign economic advisers, such as Harvard’s Jeffrey Sachs and the Swedish economist Anders Aslund, were instrumental in launching Russia’s shock-therapy program.
Aside from government debt instruments, there were very few vehicles available to foreign investors for actually investing in the Russian economy in the early 1990s. Corporate debt and equity markets were as yet under-developed, and direct investment was hampered by the lack οf clearly defined property rights, which persisted despite the advertised success οf “spontaneous” privatization, Gross domestic investment in fixed capital in Russia declined by 24.3 percent in 1994 and again by 13 percent in 1995 even as privatization progressed (PlanEcon, 1999, p.29) The transfer οf ownership from the state to the private sector did not lead to an increase in domestic investment or growth, contrary to what foreign economic advisers touting shock therapy had predicted. The foreign investment did not replace or supplement the drop in domestic investment, and the drop in domestic investment itself deterred foreign investors from considering Russia as a target market.
In 1996, Russia began to attract foreign investors to the domestic government debt market as well as the domestic equities market, particularly oil, gas, and telecommunications. The new governor οf the Russian Central Bank, Sergei Dubinin, had started to finance the country’s persistently high fiscal deficits with short-term government bonds (known as “GKOs” in Russian) rather than the hyper-inflation οf his predecessor, Viktor Geraschenko (who was reinstated as governor following the crash οf 1998). Initially, the GKO market was restricted to domestic investors. In fact, the Central Bank and the state-owned Savings Bank (Sberbank) dominated the domestic debt market at the beginning. Yields on GKOs were in the triple digits, which obviously caught the eye οf foreign investors, particularly as Russia’s economy and currency were beginning to show signs οf recovery.
In November 1996, Russia also went directly to international capital markets, launching its first post-Soviet Eurobond. Having secured a fairly high rating (just below investment-grade), demand for the Russian issue was strong enough that the government doubled the offering amount from $500 million to $1 billion at the last minute, yet it was still over-subscribed. The IMF loan package, improving the macro-economic situation, the relatively high credit rating, and the appearance οf political stability following President Boris Yeltsin’s reelection in July 1996 encouraged foreign investors to move into Russian equities. Templeton and other mutual funds began to include Russia in their emerging-market funds and even launched exclusively Russian funds. In 1997, Russia had the world’s hottest stock market, having grown 105 percent (Moscow Times 50 index), due in no small part to the $3.6 billion in net inflows foreign portfolio and direct investment. At this point, foreign investors were also allowed to participate in the domestic debt market directly. Significantly, Russia recorded its only year οf positive economic growth in 1997, albeit a meager and presumably exaggerated 0.7 percent.
The foreign investment came to an abrupt end in August 1998 following the devaluation οf the ruble and the effective default οf domestic government bonds, the GKOs. At the time οf the default, foreign investors directly held nearly a third οf GKOs (about $20 billion). The reasons for the devaluation and default are clear in hindsight and had actually been predicted by Russian economists beforehand. The continuing deterioration in the government’s fiscal position caused a liquidity crisis where it could no longer afford to roll over the interest payments on its GKO obligations. Direct foreign participation in the GKO market had brought yields down from triple digits to low double digits in 1997. After the Asian crisis, however, both foreign and domestic investors saw an increased risk premium in all emerging markets, including Russia. Yields on GKOs began to creep higher: from under 20 percent to over 60 percent in early 1998. At the same time, the Asian crisis depressed international demand–and hence prices–for Russia’s primary exports, oil, and gas, further strapping the government’s finances. Renewed high-interest rates in the GKO market effectively demonetized the Russian economy so that no amount οf IMF funding or preaching about the need to increase fiscal revenues could have resuscitated the government’s finances. Significantly, the emergency IMF package οf July 1998, negotiated just weeks before the devaluation and default, failed to restore foreign-investor confidence in Russia. The default effectively ended foreign investment in Russia’s transition and thoroughly discredited the foreign advice offered since 1992. Subsequent IMF loans to Russia have been extended simply to prevent the country from formally defaulting on its payments to the IMF. In other words, the IMF is no longer transferring funds to Russia but merely extending new credits to service its existing exposure, thus maintaining the pretense that Russia is not in default on its IMF loans.
Contrast οf Russia approach with that οf China
China began its economic transition much earlier than Russia. Starting in 1978, China decollectivized agriculture and began to introduce market incentives into other areas οf the economy. China’s four special economic zones (SEZs) were the first in a series οf efforts to attract foreign investment. The reform program stalled in the aftermath οf the 1989 Tiananmen Square massacre. Three years later, in October 1992, Deng Xiaoping took his famous “southern tour” to the first SEZs and effectively re-ignited the reform effort. The foreign investment came to play a more important role as the earlier SEZ experiments, having been deemed a success, were expanded to the rest οf the country. The major industrial and urban centers in coastal China, such as Shanghai, were opened to the type οf foreign investment previously restricted to the SEZs. While the earlier reforms obviously provided a framework for the subsequent expansion, the discussion here will focus on the foreign investment and advice that China attracted from 1992 through the end οf 1998 in comparison to Russia during the same period.
China adopted a dual-track reform package. According to Barry Naughton, market incentives created a parallel economic structure that promoted growth to supplement–not destroy–the planned economy (Barry Naughton, 1993). Initially, the special economic zones operated as a parallel economy, open to foreign trade and investment, while the rest οf the mainland economy remained autarkic. Eventually, just as market incentives gradually expanded from agricultural production to the rest οf the economy, the foreign trade and investment policies οf the SEZs spread to the rest οf China. As a result, the level οf foreign trade as a percentage οf GDP gradually increased, foreign investment began to expand, and China became increasingly integrated into the world economy.
As an institution for generating foreign currency, the special economic zones conformed precisely to Western neo-classical economic models οf the sort that drove the advice οf Jeffrey Sachs, Anders Aslund, and the IMF in the Russian case, although there was no formal institutionalization οf such advice in China. In essence, the SEZs generated hard-currency earnings by marketing China’s comparative advantage in labor to foreign investors by establishing duty-free export-processing zones in coastal cities near the established market economies οf Hong Kong, Macau, and Taiwan. Like Russia, China had traditionally generated a trade surplus through the export οf natural resources, primarily oil. As oil resources became depleted or diverted to domestic consumption, China’s balance οf trade started to move toward a deficit. From 1990 on, the foreign investment and trade generated by the low-value-added, export-oriented industries created large trade surpluses, eventually reaching $45 billion in 1998.
More impressive than the trade and current account surpluses generated by the foreign-invested sector οf the economy was the amount and nature οf the foreign investment. Contrary to the pattern in Russia or even the successful export-oriented economies οf Southeast Asia, China attracted large amounts οf foreign direct investment (FDI) as opposed to foreign debt or portfolio investment in the second stage οf its economic reforms. Net FDI inflows into China were, for example, $7.2 billion in 1992, increasing to nearly $42 billion in 1997 and almost $43 billion in 1998, ranking China second only to the United States in net FDI inflows.
Foreign direct investment has the obvious benefit οf being more stable than portfolio investment or short-term debt, the financing and subsequent withdrawal οf which was a primary cause οf the financial crises in Thailand, South Korea, and eventually Russia in 1997–98. More important, FDI became a vehicle for transferring foreign economic advice to China. In Russia, economic advisers from Harvard, the U.S. Agency for International Development, and the IMF offered macroeconomic advice based on Western neo-classical theory and development models, whereas the foreign investors who brought FDI into China inherently brought along micro-economic and business management practices that they physically implemented in the Chinese operating environment. World Bank development programs brought a similar sort οf micro-economic advice to China, as opposed to the IMF-designed, macro-economic models that Russia adopted. Theory and practice were more coordinated and suited to local circumstances in the Chinese case.
A second source οf foreign economic advice in China’s transition was the return οf foreign-educated Chinese economists beginning in the mid-1990s. While Russia imported Western advisers at the government level, China attracted Western-educated Chinese scholars to return to universities and research institutes. These research centers effectively translated and imported Western economic debates into the evolving debate on the course οf China’s economic transition. Western-educated economists like Fan Gang, Hu Angang, and Lin Yifu began to conduct major debates with Chinese scholars while also advising the government on specific economic policies. Western texts were translated into Chinese and used in university courses. Chinese scholars brought home economic debates, while Russia tried to implement Western neo-classical dogma, largely without input even from Russian economists familiar with Western economics. The Western economic advisers enlisted to support Russia’s big bang ignored both Russian and Western critics who noted that Western theories were ill-suited for Russia’s peculiar post-Soviet economic environment (Bela Greskovits, 1998, pp. 33-34).
In addition to the special economic zones, township and village enterprises (TVEs) was another new Chinese economic institution that proved instrumental in attracting and advancing foreign investment. The TVEs developed in the mid-1980s after the success οf China’s initial agricultural reforms. Decollectivization had led to agricultural surpluses and surplus labor in the countryside. The TVEs developed as local governments sought to develop the rural industry to absorb this surplus labor and profit from the decentralization that accompanied economic reforms. Initially, these rural industrial enterprises were financed locally and focused on production for domestic consumption. As they developed, and particularly after Deng Xiaoping’s southern tour in 1992, the township and village enterprises themselves began to attract foreign direct investment and expanded production for foreign trade. Overseas Chinese investors, particularly from Hong Kong, Taiwan, and Southeast Asia, were the principal sources οf foreign direct investment that started to flow into the TVEs.
Russia and China – Conclusion
Most comparisons οf the Russian and Chinese economic transitions have classified the former as shock therapy that focused primarily on political reforms and the latter as more gradual and economically focused. In terms οf foreign investment, arguably the most import initial sector to be reformed in a transition economy as it provides the initial hard currency and hard-budget constraints, neither Russia nor China experienced a particularly rapid transition. The Russian institutions, such as energy, natural monopolies, and finance, that had access to foreign investment inflows were not reformed in Russia’s big bang. More to the point, these institutions exported capital out οf Russia rather than attracting foreign investment. And while China’s foreign investment policies have indeed been implemented on a gradual basis, building upon the initial experiments in the special economic zones, China has witnessed the creation οf innovative non-state vehicles for absorbing both foreign investment and advice, most notably the township and village enterprises, but also private banks like Minsheng and a range οf independent economic think tanks.
In terms οf political versus economic reforms, foreign investment policies in Russia and China demonstrated the overall lack οf substantive reform in either country. Reports οf political and economic “revolutions” and the creation οf real market economies have been greatly exaggerated in both cases. Reform has been evolutionary, not revolutionary. The winners in the post-Soviet reform οf the foreign investment regime were the very same institutional functionaries who had access to hard currency in the Soviet era. Similarly, the winner in China was the Chinese Communist Party (CCP), simply recast in practice as the Chinese Capitalist Party, as one Chinese economist put it. And as with the big bang in Russia versus gradualism in China dichotomy, political reform in the foreign investment regime has, if anything, been more extensive in China than in Russia. The CCP extended the right to access foreign capital first to the special economic zones, then to the coastal cities, then to the township and village enterprises, and finally lifted the Ministry οf Foreign Trade and Economic Cooperation’s restrictions on foreign trading rights. On the other hand, Russia’s presumably more liberalized foreign investment regime, in fact, left more than 80 percent οf the country’s financial resources, including foreign capital, concentrated in Moscow.
Thus the key difference between Russian and Chinese use οf foreign dollars and sense in the transition does not pertain either to the pace οf reform, institutional change, or a revolution in terms οf the political actors in charge οf foreign investment. It was instead a difference in the policy preferences οf the established political institutions and actors as reflected by their foreign investment policies and practices. The disparate nature οf the types οf foreign investment attracted to the two economies indicates the difference in policy preferences. The Chinese central state apparatus designed policies to attract foreign direct investment, indicating a long-term commitment to the development οf the domestic economy on the part οf the state as well as the foreign investor in addition to a preference for practical, micro-economic advice. Russia, on the other hand, relied on foreign debt, reflecting a willingness to mortgage the country’s future while transferring the capital necessary for financing that future overseas. Russian institutions with access to foreign capital exempted themselves from the institutional bank run with a sort οf bank deposit insurance scheme that paid claims into foreign bank accounts. Institutionalized capital flight was also present in China. (Terry Sicular 1998, 589-602) The state apparatus, however, developed institutions to encourage its effective return in the famous “round-tripping” οf capital in and out οf Hong Kong, just as it created institutions to attract genuinely foreign sources οf capital to finance China’s transition. An “amnesty” for investors who illegally transferred funds abroad has been proposed in Russia but is unlikely to succeed even if adopted until the state apparatus or key political actors within it adopt a more long-term commitment to financing Russia’s transition.
References
Barry Naughton, Growing out οf the Plan: Chinese Economic Reform, 1978-1993 (New York: Cambridge University Press, 1993).
Bela Greskovits, The Political Economy οf Protest and Patience (Budapest: Central European University Press, 1998), pp. 33—34
Janos Kornai, “The Place οf the Soft Budget Constraint Syndrome in Economic Theory,” Journal οf Comparative Economics 26, no. 1 (1998): 11—17
PlanEcon, Review and Outlook (Russia) (1999): 29.
Steven Solnick, Stealing the State: Control and Collapse in Soviet Institutions (Cambridge: Harvard University Press, 1998).
Terry Sicular, “Capital Flight and Foreign Investment: Two Tales from China and Russia,” World Economy 21, no. 5 (1998): 589—602
Wei Li, “A Tale οf Two Reforms, Rand Journal οf Economics 30, no. 1 (1999): 120–36.