This speech was presented at the fifth symposium: The Market Economy in China on April 3, 2008. The original speech was made in Chinese.

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China's era of reform and opening up began in 1976 with the end of the Great Proletarian Cultural Revolution.

A Life-and-Death Struggle: "Crossing the River by Feeling the Stones" (1978-83)

In the mid-1950s China attempted to make itself a rich, strong nation in a short time by modeling its economic and political system on the "Stalin style." This system was taken to extremes in the late 1950s, triggering the great famine of 1960-62, in which over 30 million people died. A few years later, the Cultural Revolution of 1966-76 drove Chinese society as a whole to the brink of collapse. Having experienced these massive social catastrophes, the vast majority of people despaired at the systems and policies that had been implemented until that point. Not only did workers, farmers, and intellectuals--yearning to break free from the status quo--demand a path to survival, but even high-ranking Communist Party of China and government officials, the backbone of the old system, learned from the persecution they suffered during the Cultural Revolution and recognized that the situation must not be allowed to continue.

In the early years of economic reform, China's leaders did not set specific reform goals or models. Instead they adopted the approach of "crossing the river by feeling the stones" (that is, through trial and error), in which any method could be used as an emergency measure, providing that it helped the economy to recover and develop. Freed from the ideological constraints that had bound them for so long, the Chinese people produced an explosion of new thinking in which a wide range of visions were expounded. The government dispatched numerous observer missions to other countries, including Britain, the United States, France, Japan, and Germany, to learn how industrialized countries had developed their economies. Then in the late 1970s and early 1980s--a period when the command economy still held sway--a flexible system was created that would prove highly significant in the subsequent formation of a market economy in China.

-- The responsibility system of production in agriculture
In response to requests from farmers, the government revived the practice of farm management in the form of the "household responsibility system," through which land remained under collective ownership but farming families were given responsibility for production and distribution on individual plots.

-- Administrative decentralization
Some of the central government's resource distribution powers were delegated to local governments, and regional authorities gained more say over policies regarding how resources and fiscal revenues were distributed. In the old planned economy system, the power to make economic policy decisions lay almost exclusively with the central government, making for a basically unitary structure. In 1980 China implemented self-support accounting in the fiscal system, creating an economic structure that gave provinces, prefectures, counties, and other local units ownership of economic profits. The Chinese economy went from being a single system to a multi-division system with numerous independent susbsystems. Under this setup, local governments gained a certain level of economic control, which they used to develop their economies by protecting and supporting entrepreneurs in their respective regions. This increased the income both of regional governments and of individual regional bureaucrats.

-- The dual-track system of resource distribution and pricing
In the era of the centralized planned economy, all production and capital resources were concentrated in the hands of the state and allocated by administrative decree. At the end of the 1970s, however, the Chinese government reformed some state enterprises with the aim of promoting self-management and transferring power and profits to individual firms. The reforms gave these enterprises autonomy over production and sales and permitted them to sell their goods outside of the planned production system at prices negotiated by the seller and the buyer. This created a "second track"--effectively a market track--for allocating production materials and setting prices of finished products. The government established this dual-track structure as an official system in 1985 and fixed at 1983 levels the volume of production materials that were allocated to state enterprises according to central government plans. The dual-track system put in place the basic conditions for market-based production activity, with private companies able to purchase production materials and sell finished products through the market track.

-- Special Economic Zones
The fourth systemic reform was the establishment of Special Economic Zones. China had lifted its policy of seclusion and begun trade with developed countries in 1972, when the Cultural Revolution was still ongoing. After the Cultural Revolution ended, trade with developed countries progressed rapidly, and the Chinese government officially declared it would implement an open door policy. It absorbed and introduced technology from overseas and encouraged the establishment of corporations on the Chinese mainland using foreign direct investment, especially capital from Hong Kong, Macau, and Taiwan. In 1980 China implemented a special open door policy in Guangdong and Fujian Provinces and decided to establish Special Economic Zones operating principally by the market mechanism in Shenzhen and three other locations.

The favorable economic environment created by these flexible systems triggered the development from scratch of private economic activity. Whereas China had only 1.83 million private companies in 1981, by 1985 this had risen to 11.71 million, an average annual growth rate of almost 60%. The open door policy also triggered a sharp rise in China's total imports and exports and foreign direct investment. Since the government was still playing a leading role in these flexible systems, however, they provided fertile ground for rent seeking, fomenting corruption.

Clarification of Market-Oriented Reform Goals (1984-93)

The measures described above spurred a rapid recovery of the Chinese economy in the early 1980s. By the middle of the decade, however, it became clear that the economy could not be put on a growth trajectory simply through an unsystematic assortment of incentives. Meanwhile, the coexistence of a command economy and a market economy under the dual-track system caused much conflict and confusion. This raised the question of what model China's economic reforms were aimed at achieving.

Based on China's experiences in the late 1970s to early 1980s, four possible models were taking shape: (1) an improvement on the Soviet model, (2) a market socialism (East European) model founded on state ownership and a planned economy, (3) a government-led market economy (East Asian) model, and (4) a free-market (Western) model.

By the mid-1980s the influence of the former two models was waning, and the latter two had gained the upper hand. The East Asian model was favored by senior reformists in the government, while the Western model was welcomed by intellectuals who had been influenced by Western ideas.

A joint effort by advocates of the East Asian and Western models led to the adoption of the reform goal of a "planned commodity economy" at the third plenary session of the Twelfth Central Committee of the Communist Party of China in 1984. This, as was later further clarified, consisted of three elements: financially independent companies, a competitive market system, and a macroeconomic adjustment system.

At the Thirteenth CPC National Congress in 1987, the mechanism of China's commodity economy was defined as one in which the state regulates markets and markets guide enterprises. This clarified the reform goal as being one of switching to a market economy.

In 1986 the Chinese government decided to commence the comprehensive implementation of economic reforms in 1987 and to construct the framework of a socialist commodity economy in the 1990s. It was also in 1986 that Deng Xiaoping made a renewed attempt to launch reforms centering on the separation of the CPC and the government and to adapt China's political system to the market economy. Although Deng was unable to follow either of these reforms through, the government restarted comprehensive reforms in the mid-1990s aimed at realizing a socialist market economy.

Establishing a New System and Discovering Flaws (1994-)

In 1993 the third plenary session of the Fourteenth Central Committee of the CPC adopted the "Decision on Some Issues Concerning the Establishment of a Socialist Market Economic Structure." Based on this decision, comprehensive economic reforms were carried out, including the following measures.

• Reform of the fiscal and tax system, the banking system, and the foreign exchange management system beginning in 1994
• Vitalization of state-owned enterprises (including the Southern Jiangsu Model and township and village enterprises) and development of the private-sector economy beginning in the mid-1990s
• Reforms to privatize state-owned enterprises beginning in the late 1990s
• Structural adjustment by granting freedom of market entry and exit for the state-owned sector at the end of the 1990s and promotion of private business, based on a decision by the Fifteenth CPC National Congress

As a result of these reforms, the late 1990s and early 2000s witnessed the development of an economy featuring diverse ownership systems, and the private sector greatly increased its share of the national economy. (It now accounts for three-fifths of the economy as a whole, although this figure is higher in coastal regions.)

These initial steps in establishing a market economy spurred rapid growth. The Chinese economy has maintained high growth averaging 10% a year for 15 years since 1993, and standards of living have also improved considerably. China is now recognized as an important presence in the global economy.

On the downside, however, the current economic system established through the above reforms still has some major defects. These flaws are apparent in the various regulations imposed on economic development by the government and include the state monopoly of key sectors, which prevents the market from fulfilling its proper role in the allocation of resources, and the universal presence of conditions conducive to rent seeking, which foments and encourages corruption.

Ever since the idea of a socialist market economy was first proposed, there have been divergent views as to what the term actually means. Some people assume that strong government involvement in economic activity means that the mercantilism and rent seeking during the initial phases of East Asian development are normal for a modern market economy, and those who benefit from such rent-seeking activity make no attempt to move toward a modern market economy. These people use every means at their disposal to block market-oriented reforms to prevent any reduction in their own power while twisting reforms to increase rent seeking and get their hands on more wealth.

This situation has been present throughout the three decades of reform and opening. The public has overwhelmingly expressed happiness whenever corruption has been reined in through the implementation of market-oriented reforms--for example, when commodity price controls were lifted at the beginning of the 1990s, greatly reducing the potential for commodity rent seeking. By contrast, people have expressed dissatisfaction at the exacerbation of corruption in cases where justified reforms have been adopted but then distorted, such as when reforms styled after those of Russian Prime Minister Pyotr Stolypin (1862-1911) resulted in more power being concentrated in private hands, or where reforms, such as to state-owned monopolies, were brought to a standstill.

There have been times when attempts like these to block change have come to the fore and caused the reform drive to slow down or retreat. After the Fifteenth CPC National Congress and the fourth plenary session of the Fifteenth Central Committee of the CPC decided to structurally adjust the state economy and turn state-owned enterprises into joint-stock companies, for example, substantial progress was made in reforming the state economy, yet the reforms to giant state-owned monopolies made little headway. Some sectors even experienced a reversal of reform, with state-owned enterprises gaining ground while private companies slipped back.

Even discounting delays in economic reform, there was widespread intervention by every level of government, including at the microeconomic level, at the end of the 1990s and the beginning of the 2000s. Some bureaucrats abused their considerable powers regarding land and credit facilities to implement grand projects whose sole purpose was to improve their own image or achieve political results; others abused their powers to approve construction projects and ratify companies' initial public offerings, making massive profits for officials and the wealthy merchants who cozied up to them.

Another major problem is the delay in the implementation of political reform. Deng Xiaoping twice launched political reform drives, in 1980 and 1986, but neither was sustained. The Fifteenth CPC National Congress put forward the task of building a legal system in 1997, while the Sixteenth CPC National Congress proposed establishing a socialist democracy in 2002, but regrettably these reforms are progressing very slowly. This is extremely detrimental to the effort to build a market economy. Without a fair and just legal system and an independent and equitable judiciary, fulfillment of contracts in a modern market economy dominated by depersonalized transactions cannot be guaranteed. Under these circumstances, economic entities wishing to keep their assets safe have no choice but to link up with the government and bureaucrats. In an environment where the lack of clear public rights means that companies' success or failure depends on the whim of individual bureaucrats, the unrestrained power of officials becomes a highly marketable commodity, fueling widespread corruption that includes even the buying and selling of government jobs.

Finding a Way Out and Charting the Future

As detailed above, the rampant corruption of recent years has its roots in the failure to drive home economic and political reforms. Yet some supporters of the old, pre-reform systems and policies have twisted the truth about the negative aspects of modern society to claim that "mainstream neoliberalist economics" is to blame for the various social and economic problems we face, including widespread corruption, unfair income distribution, the high cost of healthcare, and the difficulty of entering schools. These problems occurred, they insist, because China adopted policies aimed at establishing a market economy and opening up to the outside world.

These assertions provoked a major argument over reform between 2004 and 2006. In this controversy, supporters of the old system and the old ways took the legitimate grievances of some vulnerable groups regarding the corruption and income disparities that exist in modern Chinese society and channeled them in a mistaken direction, exploiting them to advocate a rejection of the policies of reform and opening up pursued since 1978 and a return to "continuous revolution under the dictatorship of the proletariat" under such banners as "class struggle is the key" and "total political control over the bourgeoisie." These elements want to reverse the 1978 reforms and carry the Great Proletarian Cultural Revolution through to its conclusion.

The CPC and the government have taken a clear stance against these regressive elements. At the Seventeenth CPC National Congress held in October 2007, even the work report of the Central Committee roundly criticized the assertions of the regressives, tackling head-on the issue of what banners should be raised and what path should be followed. The report stated: "Reform and opening up . . . accord with the aspirations of the Party membership and the people and keep up with the trend of the times. The orientation and path of reform and opening up are entirely correct, and their merits and achievements can never be negated. To stop or reverse reform and opening up would only lead to a blind alley." Before this, President Hu Jintao used a speech to the Shanghai delegation to the National People's Congress to declare unequivocally that the party would firmly maintain its reform orientation in order to complete the establishment of a socialist market economy and allow the market to fulfill its proper role in the allocation of resources.

A new ideological liberation movement is currently stirring in some regions, as people shake off the constraints of old ideas and forge new economic, social, and political thinking. I hope that China will pursue economic and political reforms based on a clear understanding of the way forward.

In my opinion, the government itself holds the key to whether reform can be pursued successfully. Under the planned economy, the government controlled everything from the macroeconomic to the microeconomic level and even the people's domestic lives. It must now reform itself into a service-style government that provides only public goods, to which end government bureaucrats must be guided in everything they do by a spirit of public service and must relinquish of their own accord any powers that do not belong in the hands of public servants. The task of reforming the government is not simply a matter of enabling the market mechanism to fulfill its rightful role by reducing or eliminating bureaucratic involvement in resource allocation and price setting; the bigger task is to build an institutional platform that enables the market to function properly. Without such an institutional platform, it will be difficult to escape the current situation characterized by rule bending, disorder, and kickbacks.

As China has little tradition of constitutional government, we should accept that the effort to implement the rule of law will inevitably meet hurdles and resistance. In the new phase of reform that has just begun, we will have to overcome a variety of obstacles in pursuing our quest to build a prosperous, culturally rich, democratic, and harmonious China.