Comments on Rosefielde, Parker/Thornton and Woo.

More than 15 years after the transition began in Europe and Eurasia, the comparison of the experiences of Russia and China and the discussion of their current situation in these three papers provides fresh insight into important issues in comparative institutional economics. From the beginning, the transition from the old system of a bureaucratically managed economy to the new system of a mixed market economy was recognised to require large-scale institutional change, for example Murrell (1992). Two dangers were identified. First, destruction without creation or state desertion of the economy would risk plunging a country into chaos. Second, path dependencies could lead to irreversibilities in sequencing reforms (Barlow and Radulescu, 2005). The possibility of a transition trap in which half-finished reforms transfer power to new affluent elites who employ crony capitalism to stall further reform was identified for several countries, including Russia as Rosefielde discusses. In these cases, the resulting institutional equilibrium does not promote the ongoing institutional change necessary to support sustainable future growth. Woo argues convincingly that more rapid institutional change is required if China is to avoid derailing its growth engine and notes that the current leadership recognises this situation in its call for the establishment of a harmonious society by 2020 at the last plenum.

The comparison of Russia and China is of special interest because the policymakers in each of these large countries have the option to make institutional choices that were not available to the leaders of the smaller European transition economies, all of which were aspiring to join the European Union (EU). For the latter, the path towards an institutional equilibrium was clear - adopt as quickly as possible as much of the acquis communetaire as feasible to hasten accession into the EU. Neither Russia nor China has such aspirations so neither is constrained in this manner; hence, a comparison of institutional choices made in these two countries provides new lessons for comparative institutional economics.

These two large transitioning countries have different development characteristics and different historical legacies that must be taken into account when comparing institutional change. First, during the time period considered in these papers, the countries are at different stages of economic development. From 1978 to 1993, China was at a stage more akin to that of Stalin's USSR as it was transforming rapidly from a mainly agrarian-based economy to one based largely on the industrial sector. Second, the structure of exports is different in the two countries so that growth strategies depend on a different type of participation in the global economy. Russia's exports are predominantly commodity based so that growth in Russia is dependent upon demand and supply conditions in international markets for primary resources. In contrast, China is pursuing a more traditional Asian-type strategy of export-led growth by selling finished products cheaply in the global economy. Third, the industrial structure differs in the two countries due to the legacies of their planning periods. Russian industry is vertically integrated due partly to Stalin's policy of gigantomania whereas China's industry developed with relatively small state-owned enterprises partly due to Mao's policy of bringing industrialisation to the countryside. In addition, the Chinese leaders experimented with new hybrid organisational forms for production units, for example, the regionally based town and village enterprises. Fourth, the supporting planning structure in Russia was organised in a functional manner across republics while planning was implemented regionally across sectors in China. Hence, although the planning and industrial structures were symbiotic in each of these bureaucratically managed economies, different institutional equilibria existed in China and Russia prior to the reform. These resulting institutional differences have important influences on the structure of public finances and on the adjudication of competing claims for fiscal resources as Parker and Thornton make them clear. Moreover, the further institutional change required to support sustainable growth in the evolving mixed market economies is determined to some extent by the different legacies in these two countries.

Rosefielde's paper is an historic tour de force that identifies such long-term hysteresis affecting the institutional equilibrium in the Russian economy. His main point is that the persistence of a Muscovite culture promotes a rent-granting autocracy in Putin's Russia. Yeltsin's oligarchs might have fit the mould of an elite class that would block further reform and plunge the country into a transition trap. However, as Guriev and Rachinsky (2005) argue, many Russian oligarchs favoured further institutional reform in the rule of law and in private property rights to protect their economic rents from the autocratic government. Hence, a combination of cronyism and uncertainty made the struggle to protect rents from an autocratic ruler a typically Russian characteristic of the transition according to Rosefielde.

Related to this hysteresis, Parker and Thornton argue that the biggest threat to fiscal federalism in Russia is the federal government itself because vertical power arrangements eliminate all checks and balances and give the autocrat complete discretion over the allocation of public funds. In their direct comparison of public finances in China and Russia, these authors demonstrate how a period of decentralisation was followed by one of recentralisation in each country. In Russia, the authors conclude that this outcome was an unintended consequence of state desertion of the economy during a period of political centralisation. In contrast, they attribute the same outcome in China to an intentional policy designed to recognise the existing regional autonomy and to separate fiscal systems from other economic activities. The goal of the Chinese policy was to impose hard budget constraints on the regions by using fiscal transfers as a disciplinary instrument. Hence, different pre-reform legacies in the two countries generate a similar outcome in the post-reform institutional evolution of public finances.

In both Russia and China, a regional funding gap arose as a result of the decentralisation policies. Regional expenditures and revenues were essentially balanced in 1992 at about 40% of total government expenditures in Russia. By 1995, regional expenditures had increased to about 50% of the total but regional revenues failed to keep pace with this increase so that a regional funding gap emerged and grew to between 6% and 8% of total government expenditures through 1999. During this entire period, the consolidated government budget in Russia was in deficit with a peak at close to 10% of GDP in 1994. In contrast, from 2000 to 2004, the consolidated budget was in surplus mainly due to a sharp increase in revenues from oil transactions. A struggle over oil rents ensued and the regional funding gap exploded to around 20% of total government expenditures. During this period, the regions levied taxes in kind and attempted to shelter local enterprises from central government taxes. In 2005, the centre responded by monetising subsidised in-kind benefits. This struggle over fiscal revenues in Russia, with its resulting tendency towards recentralisation, illustrates Rosefielde's point that a crucial characteristic of the Russian transition is the persistence of a Muscovite culture in which an autocrat attempts to augment and retain power by allocating rents advantageously.

In China, regional expenditures and revenues were balanced at about 10% of GDP or about 60% of total government expenditures in 1990. From the early 1980s up to the late 1990s, total tax revenues to GDP fell from above 30% to 12% while bank loans to GDP rose from 50% to 120%. This policy of substituting indirect subsidies through the state banking system for direct budget subsidies paid to state-owned enterprises led to a bad-loan problem in the four large state-owned banks. Estimates put non-performing loans at between 25% and 30% of bank loans in China by the end of the 1990s (Bonin and Huang, 2001). Hence, the contingent liabilities of the Chinese government were it to bail out the four large banks would add considerably to the official fiscal debt, which was only about 25% of GDP at the time. Although regional expenditures and revenues remained essentially balanced at about 10% of GDP until 1994, a sizable regional funding gap of about 4% of GDP opened up in that year. By 2004, this regional funding gap had increased to more than 6% of GDP and about 30% of total government expenditures. According to Parker and Thornton, tensions over fiscal receipts led to tendencies towards recentralisation beginning as early as 1995 in China.

These large funding gaps provided the central government in each of these two countries with economic leverage in its bargaining with the regions over the division of fiscal revenues. In Russia, consolidated government revenues to GDP stand at about 36%, which is approximately the OECD average. Hence, the size of the public sector in Russia provides considerable scope for affecting regional economic activity. In addition, as Parker and Thornton document, this situation has a characteristic peculiar to Russia due to the windfall oil revenues accruing to the fiscal budget over the first half of the current century. Since 1999, fiscal surpluses have been used by the authorities to reduce the fiscal debt to GDP ratio to 16.5% in 2005, while transfers to the regions have tended to be procyclical. In China, total government revenues to GDP were about 21% by 2004; this ratio is comparable to its counterpart of 25% in both Japan and Korea. Hence, China's public sector is fast approaching in size and scope the resource strength of the public sectors in developed Asian countries. Although the official fiscal debt burdens were comparable in the two countries in 2000, Russian policy makers used oil-based fiscal revenues to reduce the public debt while Chinese policymakers chose to transfer bad loans from the four state-owned banks to four asset-management companies and, thus, left unresolved the problem of sizable future claims on fiscal resources.

Since future oil-based fiscal revenues are unpredictable and likely to be highly volatile, policymakers in both countries must prioritise objectives and needs in order to adjudicate effectively future competing claims on economic resources. Woo reports that the savings rate in China is currently over 45% of GDP while much of household savings is held in four large, and perhaps insolvent, state-owned banks. In addition, the regional funding gap has its counterpart in the banking system in China due to what Woo identifies as failed financial intermediation. In 2004, incremental bank lending was dominated by smaller regional banks whereas most incremental primary deposits were collected by the big four Chinese banks. Interest rates are being liberalised only slowly and the interbank market that is required to establish the instruments needed to conduct indirect monetary policy is nascent at best. A recent article in The Economist (Black Market Banking, 11 August 2007) reports the uncovering of an illegal bank in Shenzhen that is much larger than the earlier one found in Shanghai. Such illegal banks attract household savings by paying higher deposit rates than allowed and lend to risky ventures that are excluded from legal credit channels. An estimated 3.4% of the broad money supply in China resides in such underground operations; this is particularly troublesome because broad money grew at about 20% last year in China. Obsolete regulation and the dominance of four large state-owned banks leave open the possibility of a banking crisis that would disrupt seriously the harmony required for sustained growth in China. Therefore, capitalising and privatising the four large Chinese banks and deregulating interest rates should be the top institutional priorities for Chinese policymakers. This may be their last chance to use fiscal resources to rationalise the bank-dominated financial sector and address Woo's concern about failed financial intermediation before, to use his metaphor, the left front tire blows.

The financial sector in Russia is considerably different from that in China; stock market capitalisation stands at 72 % of GDP while domestic credit to the private sector is only 26% of GDP and the M2 to GDP ratio is 28%. The relative dominance of capital markets combined with the legacies of an earlier period of demonetisation relieves the Russian authorities of dealing with any considerable contingent liabilities resulting from accumulated non-performing loans in the banking sector. Nonetheless, if history is any guide, oil revenue windfalls will not last forever and commodity markets will be volatile in the future. Such considerations must be taken into account by Russian policymakers preparing to adjudicate future competing claims on resources. The current policy of paying down the public debt by using oil-based revenues provides some distributional flexibility for future fiscal policy. Nonetheless, the central question raised by Rosefielde and Parker/Thornton is whether institutional reforms will progress sufficiently so that the current rent-granting autocracy presided over by Putin, and most likely his successor, will be replaced in the foreseeable future by a more decentralised and predictable fiscal system that mitigates the struggle over future rents between the centre and the regions in Russia.

The task for the current government in China is even more daunting. As Woo argues convincingly, China must become a responsible partner in the international economic system while orchestrating a managed transition to a type of democracy in which the current party retains political power. To achieve this objective, policymakers must both avoid trade wars with the EU and the US and also reduce waste and pollution to become socially responsible global citizens. In addition, the Chinese government must find the appropriate institutional equilibrium to resolve the troublesome issues due to the inequality divides, rural-urban and North-South, which opened up during the last two decades of rapid economic growth. Institutional changes to date in other transition economies provide little guidance for China's leaders as they navigate uncharted waters in search of their harmonious society. Nonetheless, evidence from both developed and developing economies along with the experiences of other transition economies indicates that an important step towards achieving sustainable growth in China is to develop the institutions necessary to support a fully functional banking system that provides effective financial intermediation and efficient resource allocation.

Comparative Economic Studies (2007) 49, 603-608. doi:10.1057/patgrave.ces.8100227

REFERENCES

Barlow, D and Radulescu, R. 2005: The sequencing of reform in transition economies. Journal of Comparative Economics 33: 835-850.

Bonin, JP and Huang, Y. 2001: Dealing with bad loans of Chinese banks. Journal of Asian Economics 12: 197-214.

Guriev, S and Rachinsky, A. 2005: The role of oligarchs in Russian capitalism. Journal of Economic Perspectives 19: 131-150.

Murrell, P. 1992: Evolution in economics and in the economic reform of the centrally planned economies. In: Clague, C and Rausser, GC (eds) The Emergence of Market Economies in Eastern Europe. Blackwell Publishers: Cambridge, MA. pp. 35-53.

JOHN P BONIN

Department of Economics, WesLeyan University, MiddLetown, CT 06459, USA. E-mail: [e-mail]