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Was the gradual approach not possible in the USSR? A critique of the Sachs-Woo 'impossibility hypothesis'.


The disappointing performance of the post-reform Russian economy and the contrasting success of the Chinese reforms have raised anew questions about the efficacy of the shock therapy or the big bang approach to reform that was adopted in Russia. While many earlier enthusiasts of the big bang approach have since modified their views, Jeffrey Sachs, one of the prominent theorists and practitioners of this approach, continues to uphold the decision to prescribe and implement big bang in Russia. In a series of papers, Sachs and his coauthor Wing Thye Woo have put forward the hypothesis that the gradual approach, as implemented in China, was not possible in the (former) USSR because of structural differences between the two economies. In their view, China had a predominantly agricultural economy with surplus labor, so that reforms in China could take the form of mainly growth of new sectors based on surplus labor. The USSR, by contrast, had an over-industrialized economy characterized by full employment, so that reform for her meant mainly restructuring of the existing economy. These structural differences, according to Sachs and Woo, made the gradual approach impossible in the USSR.

To examine the above Sachs-Woo 'Impossibility Hypothesis,' this paper abstracts from the issue of economic structure by focusing on the industrial sector only. As Perkins (1991), Rawski (1995), Nolan and Ash (1995), Popov (2008) and other researchers have pointed out, alongside its agriculture sector, China at the time of reform also had a large industrial sector, whose dimensions in fact exceeded that of the USSR in several respects. In fact, because China's post-revolution industrialization had followed the Soviet model, the industrial sectors of these two countries had many similarities. As a result, SOE (state-owned enterprise) reforms in these two countries faced similar tasks. Furthermore, these two reforms were roughly contemporaneous, both unfolding in the 1980s. In view of these similarities of tasks and timing, a comparative analysis of these two SOE reforms can provide an appropriate test of the Sachs and Woo hypothesis.

The broad outcomes are clear. While the Chinese SOE reform muddled its way through various difficulties and ultimately proved successful, the Soviet SOE reform foundered and ended with the disintegration of the USSR and Russia's plunge into a big bang. These contrasting outcomes already indicate that the main reason for diverging reform paths in Russia and China did not lie in the differences in the economic structure. Two questions however remain. First, how important was the presence of the large agriculture sector with surplus labor for the success of the Chinese SOE reform? Second, if the main reason for differing reform paths did not lie in structural differences of the economy, wherein did it lie?

This paper shows that the process of SOE reform generally has two sides, namely (a) the design and (b) the implementation mechanism. The design, in turn, has two aspects, namely (i) the 'external environment', meaning the arrangement for procurement of input and disposal of output, and (ii) the 'internal incentive structure', meaning the incentives of various stakeholders in the SOE performance. The implementation mechanism also has two sides, namely (i) the 'implementation mechanism at the enterprise level' and (ii) the 'implementation mechanism at the macro level'. The SOE reform process thereby has four interrelated dimensions, which provide the analytical framework necessary for the desired comparison.

The analysis shows that the Chinese and Soviet SOE reforms differed markedly with regard to both design and implementation mechanism. On the external environment side, China adopted the dual-track system, which had a clear delineation between a frozen plan-track and an expanding market-track with freed up prices, so that both the quantitative division and the qualitative distinction between the two tracks were clear. By contrast, the Soviets proved very reluctant to accept the market-track, remaining confined mostly to the plan-track for a long time. Their belated attempt to introduce a non-plan-track through the 1987 Law on State Enterprises (LSE) was too circumscribed and contradictory to be effective. At the same time, by leaving the division between the plan-track (state orders) and the non-plan-track (dogovors) somewhat indeterminate and ill-enforced, the LSE created a situation of uncertainty for the SOEs and led to disruptions and dislocations in the economy.

With respect to the 'internal incentive structure' part of the design, the Chinese moved forward from 'profit retention' to 'profit responsibility' and then to 'tax for profit' system. Moreover, incremental profits of the Chinese SOEs were dependent almost entirely on market prices, so that retained profit could provide an objective measure of their market performance. By contrast, the Soviet reformers remained stuck to the pre-existing khozrashchet funds, tinkering only with their functioning. More importantly, the profit from which these funds were retained was by and large plan profit, so that these funds could not serve as conduit for market influence.

Coming to the implementation mechanism at the enterprise level, the Chinese and Soviets moved in opposite directions. By adopting the 'manager responsibility system', and sidelining the enterprise Party committees, the Chinese moved toward increased authority of managers, who, with collateral and auction, became almost like leaseholders, operating as entrepreneurs in the market. By contrast, the Soviets abandoned their edinonachaleye system and adopted workers' management (WM), with elected directors who became dependent for their tenure on SOE employees and hence vulnerable to their wage pressures. At the same time, efforts by authorities to continue with 'total planning' prevented Soviet SOE directors from responding to market stimuli.

Finally, with regard to the implementation mechanism at the macro level too, the Chinese and Soviets moved in opposite directions. While the Chinese stuck to the Party leadership and retained the implementation capacity in both its restricted and broader sense, the Soviets went for a political reform process that ultimately led to the loss of the implementation capacity.

So far as the role of the agricultural sector in the success of the Chinese SOE reform is concerned, a close analysis shows that the emergence of Township Village Enterprises (TVE) and other non-state enterprises (NSEs) based on rural surplus labor was itself to a large extent a response to the Chinese SOE reform, in particular its dual-track design, which opened up for NSEs the rent opportunities that existed in the plan sector. By contrast, the Soviet reformers, lacking an effective SOE reform design, could not make proper use of the surplus labor that existed in the Soviet economy, hoarded in its SOEs and agricultural farms.

Thus, contrary to the Sachs-Woo hypothesis, differences in the structure of the economy were not the main reason for contrasting reform paths in Russia and China. The main reason lay in the differences in the design and implementation mechanism of SOE reform. It is these differences that led to contrasting reform outcomes in 1980s that in turn led to contrasting reform paths in 1990s.

The differences in design and implementation mechanism of SOE reforms were in turn due to mainly the differences in leadership under which the two countries pursued their reforms. While China under Deng Xiaoping followed a cautious and pragmatic course, Gorbachev proved to be prone to adventurism, rooted in a rather shallow understanding of the economic and socio-political situation. Thus, it cannot be ruled out that under a different leadership, the USSR too, belying Sachs-Woo hypothesis, could have followed the gradual approach to reform.

The issue of the possibility of the gradual approach in the USSR has been discussed in the literature before. A great number of western and Soviet economists expressed caution against the shock therapy even when it was suggested and administered. Needless to say, they generally feel vindicated by subsequent events and have expressed so. Several scholars have offered comparison of the Russian and the Chinese reforms too. What is new in this paper is the detailed comparison of the SOE reform processes in the former USSR and China and thereby a more focused and thorough test of the Sachs-Woo hypothesis.

The discussion of the paper is organized as follows. The section 'Background' provides the background and the section 'Analytical flame-work for studying SOE reforms' provides the analytical framework. Sections 'External environment', 'Internal incentive structure', 'Implementation mechanism at the enterprise level' and 'Implementation at the macro level' present the comparative analysis along the four dimensions, namely (i) external environment, (ii) internal incentive structure, (iii) implementation mechanism at the enterprise level, and (iv) implementation mechanism at the macro level. The section 'Contrasting outcomes of SOE reforms' discusses the contrasting outcomes of the Chinese and the Soviet SOE reforms in the 1980s, and how they led to contrasting reform paths in the 1990s. The section 'The role of differences in economic structure' provides further analysis of the role of agriculture and surplus labor in the SOE reform processes. The section 'Causes for differences in design and implementation mechanism' considers the proximate reasons for the differences in design and implementation of the Chinese and Soviet SOE reforms. The section 'Concluding remarks' concludes.


Contrasting outcomes of reform in Russia and China

The contrasting outcomes of reform in China and Russia can be seen in Figure 1 that plots the two countries' GDP for 1985-2007, taking their respective GDPs of 1985 as 100. It can be seen that while China's GDP increased by almost eightfold during the period, Russia's GDP growth fell into the negative territory from which it has barely come out. The result is a Deep Trough (seen more clearly in Figure 2) that may be compared with the US Great Depression of the 1930s, depicted in Figure 3. A comparison of Figures 2 and 3 shows that while the US per capita GDP fell during the Great Depression by a maximum of about 28%, the Russian GDP decreased during the Great Trough by about 44%. More importantly, while the US per capita GDP bounced back to the pre-crisis level in about 10 years, the Russian GDP took about 20 years to do the same. (1) The welfare loss suffered by Russia as a result of the shock therapy is therefore huge, and is also evident from the sharp fall in life expectancy and rise in mortality rate discussed in Popov (2009a) and shown in Figure 4.

It may be noted that the Russian welfare loss has two components. The first is the loss suffered during the years of the Deep Trough itself. The second, which is probably more significant, is the loss arising from the lower GDP trajectory that Russia now has to follow as compared with what would have been possible if she had not fallen into the Deep Trough. (2) One may argue that Russia will minimize the second component by growing at an accelerated pace and reclaiming its original GDP trajectory. Even if this optimistic scenario is accepted, the fact remains that it will take a long time for Russia to accomplish the necessary catch up, and the accumulated welfare loss incurred meanwhile will be large. Moreover, because of institutional deformities caused by big bang, it is difficult to be sanguine that such a Russian catch-up will occur soon. (3)





The question whether the USSR could have followed the gradual approach is therefore pertinent not only for understanding the past but also for the future, because the answer to this question can provide useful clues to overcoming the big bang-induced distortions and to ensuring a more wholesome socio-economic development of Russia. Furthermore, other countries contemplating, embarking on, or engaging in reform can also learn from the answer to this question.

The Sachs-Woo 'impossibility hypothesis'

The contrasting economic performance of Russia and China has led many scholars to rethink about their support for the big bang approach to reform. However, Jeffrey Sachs, one of the leading theoreticians and practitioners of big bang, and Wing Thye Woo, his frequent co-author, continue to justify big bang, arguing that the gradual approach, though successful in China, was not possible in the USSR because of differences in the economic structure of these two countries. In their view, China had a predominantly agricultural economy with huge surplus labor, while the USSR had an over-industrialized economy with full-employment. Accordingly, in view of these authors, while reform in China could take the form of growth of entirely new sectors of the economy, reform in the USSR involved mainly restructuring of the existing economy and hence was fraught with distributional conflicts that China could avoid. They also contend that job security of the state sector made Soviet workers reluctant to move to NSE. An initial statement of this 'Impossibility Hypothesis' can be found in Sachs and Woo (1994a), where they declare that:

'China's experience does not show that gradual reform is superior to the shock therapy undertaken in Eastern Europe and the Former Soviet Union (EEFSU). Differing performance primarily reflects different economic structures prior to reform: China was a peasant agricultural society, EEFSU was urban and over-industrialized'. (p. 101)

It may he said that in the early 1990s, when the above article was written and published, Russia was just given the shock therapy, so that Sachs and Woo might not yet have the time to absorb and evaluate the results. (4) However, as the quote below shows, even in 2000, when more time had passed, and the effects had become clearer, Sachs and Woo continued to propound the Impossibility Hypothesis, bluntly declaring that,

'China's gradualist strategy is not transferable to Eastern Europe and the former Soviet Union (hereafter EEFSU) because of fundamental differences in economic structure'. (Sachs and Woo, 2000, p. 5) (5)

Other works in which Sachs and Woo reiterate this Impossibility Hypothesis include Sachs and Woo (1994b, c) and Woo (1994, 2001).

A strategy to test Sachs-Woo hypothesis

Many scholars have earlier felt compelled to respond to the Sachs-Woo Impossibility Hypothesis. For example, referring to the attempt by Sachs and Woo to portray China's reform experience as irrelevant for Russia, Rawski (1995, pp. 1168-1169) observes that:

'In their haste to find Chinese experience irrelevant to problems of reform in Eastern Europe and the former Soviet Union, for instance, Sachs and Woo exaggerate the consequences of China's relatively large farm sector.... For them, the chief characteristic of pre-reform China is backwardness, not socialism. A perceptive essay by Dwight Perkins shows the limited validity of this distinction, which in any case brushes aside China's whole apparatus of state control: 83,700 state-run industrial enterprises, 74 million subsidized and tenured workers in the state sector, the automatic priority claim of state entities on funds for investment or research, college graduates, foreign exchange, and scarce materials. Chinese initial conditions are different. They may be so different that Chinese style reform cannot generate favorable outcomes elsewhere. But any such conclusion must rest on sustained comparison between Chinese reform mechanisms and corresponding possibilities elsewhere'.

Unfortunately, Sachs and Woo do not provide the sustained comparison recommended by Rawski, limiting themselves instead to a somewhat superficial analysis in their 1994 article and to sweeping statements in their 2000 paper.

The issue of the possibility of the gradual approach in the USSR has been discussed in the literature before. As noticed above, many western and (ex) Soviet economists expressed caution against the shock therapy even when it was suggested and implemented. (6) Obviously, they feel vindicated by the subsequent events and many have expressed so. (7) Several scholars have offered comparison of the Russian and the Chinese reforms too. In particular, Nolan (1995, 1996) and Nolan and Ash (1995) offer very perceptive comparative analyses showing that, in terms of initial conditions, China was, in certain respects, rather at a disadvantage relative to Russia, and thus China's success has been not because of any initial advantage but in spite of initial disadvantages.

In a sense, works by Nolan and Ash above should have served as a rebuttal of the Sachs-Woo hypothesis. However, that has not been the case, as is evident from restatement of the hypothesis in Sachs and Woo (2000). One reason for this might have been that analyses by Nolan and Ash were more wide ranging and not focused specifically on Sachs-Woo hypothesis. Similarly, Popov (2000, 2007, 2008) provides very informative analyses of Russia's reform, comparing with reform experiences of other transitional countries, and concluding that whether or not a country suffered 'institutional collapse' played the most important role in determining the course and outcome of reform. While Popov's conclusion also goes against Sachs-Woo hypothesis, the analysis is not focused on this hypothesis and hence may not again have the conclusive effect. Thus, a more tightly constructed test of the Sachs-Woo hypothesis is needed. The goal of this paper is to offer such a test. The question is what such a test can be.

Fortunately, some clue in this regard can be found in Rawski's observation above that, alongside a large agricultural sector, China had a large industrial sector, the dimensions of which were in some respects larger than that of the USSR. In fact, Nolan and Ash (1995) express the view that 'over-industrialization may have been a greater burden in China' (p. 987). (8) Moreover, industry's role in the economy cannot be measured just by its share in the GDP. (9) Furthermore, because China's post-revolutionary industrialization followed the Soviet model, the industrial sectors of the two countries had many similarities with respect to organization, management style, technology, intra-sector emphasis, regional distribution, etc. (10) Also of note is that SOE reforms under Deng and Gorbachev were roughly contemporaneous, both unfolding in the 1980s. In view of these similarities in tasks and timing, a comparative analysis of Deng and Gorbachev SOE reforms can provide an appropriate test of the Sachs-Woo Impossibility Hypothesis. (11) However, before proceeding with the test, we first develop in the next section the analytical framework necessary for the test.


Investigation shows that SOE reforms have two sides, namely (a) the design of the reform and (b) the implementation mechanism. The design, in turn, has two aspects, namely (i) the external environment, that is, the arrangement for disposal of output and procurement of input, and (ii) the internal incentive structure that refers to the incentives of various stakeholders in the SOE performance. The implementation mechanism, in turn, also has two aspects, namely (i) the implementation mechanism at the enterprise level, referring to the authority relationships at the enterprise level, and (ii) the implementation mechanism at the macro level, referring to the power relationships in the society under which the SOE reform and the economy as a whole operates.

The above four dimensions of SOE reform are however interrelated, with the internal incentive structure being closely intertwined with the implementation mechanism at the enterprise level. Also, the implementation mechanism at the macro level can be understood in two senses. In a narrow sense, it refers to the mechanism for implementation of SOE reform after a particular design of it has been chosen. However, the actual SOE reform process progresses through a back and forth movement between design and implementation, so that, in a broader sense, formulation of the design is also part of the implementation process. From this broader perspective, the overall implementation mechanism can be thought to encompass both design and implementation (of the narrow sense).

The four dimensions above provide the analytical scheme (shown in Figure 5) for the comparative analysis presented in this paper. Before proceeding, it is useful to have some understanding about the variations that are possible along each of these dimensions.

External environment

An extreme variant of the external environment is provided by the exclusive plan-track, as practiced in the USSR and many other East European countries under 'total planning', as described in meticulous detail by Kornai (1992). Under this arrangement, an enterprise receives all its inputs under the plan, and all its output is also taken over by the plan. Thus, once the plan is formulated, an enterprise has hardly any independence with regard to procurement of input or disposal of output, with regard to both quantity and price. The other extreme case of the external environment is presented by the exclusive market-track, under which an enterprise is free to procure input from and sell output to market in whatever quantities it desires and under whatever prices the market will bear. Between these two extremes however there are many intermediate options.


Internal incentive structure

Unlike that of external environment, the options regarding the incentive structure cannot be put as points in a linear range, because incentives can be of various types, so that different elements of this multi-dimensional space can change in different directions and pace, making a uniform gradation not possible or at least difficult. However, among the different elements of the incentive scheme, profit plays a predominant role, and hence some idea of the possible variation can be obtained by focusing on profit. An extreme variant is provided, again, by the exclusive plan-track, under which all profit earned by an enterprise is taken over by the plan (government or state). From this perspective, it may therefore appear that the exclusive market-track represents the other extreme. However that is not necessarily the case, because distribution of profit is a consequence of ownership relationship, and hence, even if a SOE operates on an exclusive market-track, the state, exercising its ownership role, may take away all or part of the SOE profit. There is therefore no one-to-one correspondence between the degree of market orientation of a SOE and the share of profit it can retain.

Implementation mechanism at the enterprise level

An extreme case of implementation at the enterprise level was provided by the Soviet system of edinonachaleye or sole authority of the manager. Arising during the Russian Civil War (1918-1920), when the exigencies of the war required investiture of sole authority in local military commanders, the edinonachaleye system was carried over by the Soviets after the war to their industrialization drive. The other extreme with regard to implementation mechanism at the enterprise level is probably provided by WM system, under which workers of a SOE govern its affairs through an elected body.

Implementation mechanism at the overall, macro level

One variant of implementation mechanism at the macro level is provided by the Chinese practice of continued party leadership. The Soviet reformers, on the other hand, allowed a multi-party system to emerge, in the process of which they however lost the implementation capacity. Whether or not this Soviet failure implies infeasibility of options other than continued party leadership remains however an open question, because SOEs are found to operate successfully in many countries with multi-party power structure too.

Thus, considerable variations are possible along each of the four dimensions of SOE reform, and the success, as we shall see, depends to a large extent on the choices made, given the prevailing conditions. The discussion of the next four sections shows how the Chinese and the Soviet SOE reforms compared along each of the four dimensions above.


The comparative movements of the Soviet and Chinese SOE reform along the external environment dimension are presented in schematic form in Figure 6.

The Chinese evolution toward the dual track (12)

The Chinese SOE reform experiments of 1979-1980 already included a market-track, allowing SOEs to dispose their above-plan output in the market. However, in doing so, SOEs were required to observe plan prices. As a result, the market-track at this stage remained more a quantitative extension of the plan-track rather than a qualitatively new track of operation. However, when reform resumed in 1984 (following the reversal in 1981-1983), the issue of market-track became more important due to the following two reasons.


The first was the failure to carry out comprehensive price reform both in 1979 and during 1981-1983. When the Chinese reformers began their SOE reform experiments in 1978, their general goal was to make the plan system work more efficiently. They were therefore more focused on rationalizing plan prices following some of the East European countries' reformers, who were in turn inspired by Lange's (1936, 1937) idea of equilibrium plan prices that were claimed to enable the plan economy to emulate the efficiency of the market economy and do even better. To achieve this goal, the Chinese reformers set up in 1979 working groups to formulate a comprehensive reform package including broad alignment of plan prices. However, despite the hard work, these working groups could not arrive at a consensus, in part, because nobody was sure where and how far the reform could and should go.

Despite the above failure and the subsequent reform reversal, the 1979-1980 reform led to the establishment of the Price Research Center in 1981, with the goal of calculating a full set of equilibrium plan prices following the procedures of Czech reformers of 1966-1968. Though the institute worked hard, constructing a 253-sector input-output (IO) table, it could not provide answers to the important questions. Different sets of prices resulted from different assumptions about distribution of 'surplus value', and there was no apparent rationale for choosing one set of prices over the other. Also, no matter which particular variant was chosen, the government was to incur substantial expenses in compensating losers, and before a particular set of prices was computed and implemented, changes on the ground demanded further revision of prices. These failures at rationalizing plan prices led Chinese reformers to take a more positive view of market prices and to see their usefulness, at least as an anchor for revising plan prices.

The second reason why market-track became more important in 1984 was that SOEs themselves with time (ie, during 1980-1983) became more comfortable using the market-track, a process that was facilitated by the overall liberalization leading to setting up of free markets in both rural and urban areas. Moreover, in using the market-track, many SOEs were actually not observing plan prices, a behavior that was particularly true for local government-managed small and medium enterprises for which the supervision was not that strict.

As a result of the above two factors, the Chinese reformers in May 1984 relaxed the restriction, allowing market-track prices to vary within a range of 20% of the corresponding Plan prices. From this relaxation, it was the logical next step, taken in January-February of 1985 to completely free the prices for outside-plan transactions. (13)

While a market-track with free prices provided one component of the Chinese dual-track system, the other was provided by the freezing of the plan in its absolute size beginning January 1984. Again, the Chinese reformers arrived at this step only gradually. Though the failure of price reforms in 1979 and 1981-1983 made Chinese reformers more appreciative of market prices, they were still not fully clear about how to use these prices to make their economic system more effective. The experience of 1979 already led Chinese reformers to a debate about the way to combine plan with market. Of the two competing viewpoints, one was the bankui or 'compartment' view, championed by Chen Yun, the Party elder whom Deng put in charge of economic policy at the 1978 December Plenum. According to this view, plan and market would coexist in different parts (blocks) or compartments of the economy. Proponents of this view thought of market as a concession given to certain (not so important) parts of the economy that were difficult to be brought under planning due to their small scale and dispersed nature of production and/or due to lack of capacity of the planners. Furthermore, this concession was viewed as temporary, to be revoked as the nature of production changed and/or capacity for planning improved. The concrete policy suggestion following from this view was to put agriculture and rural sectors under market while keeping SOEs under the plan.

The alternative view was known as the 'permeating' view, according to which the entire economy was to operate by market principles. This view, though still grounded in the Langean idea of mimicking market through equilibrium plan prices, was the more radical one at the time (1979-1980), since it suggested application of market principles throughout the economy, and not just the rural and agriculture sector. The permeating view therefore provided the theoretical support for market orientation of SOEs, encouraging their engagement in outside-plan, actual market operations. (14)

During the conservative period of 1981-1983, Chen's bankui view got the upper hand. However, in resuming reform in 1984, Zhao Ziyang made a deft use of the bankui view to actually promote the permeating view. He let plan and market to be separate, as recommended by the bankui view, but froze the plan in terms of its absolute size. The move was apparently an acceptance of the bankui view, but in the dynamic context of a growing economy, the freezing meant eventual marginalization of the plan-track.

The freezing of the plan helped to achieve another far reaching goal. Since a frozen (in absolute size) plan was similar to a fixed cost, decisions of SOEs at the margin were now based on the market, so that market prices began to exert decisive influence even when the market-track accounted for a relatively small part of the overall transactions of the SOEs. (15) A frozen plant-rack and a market-track with free prices together constituted the dual-track system, which was quite an innovation on the part of the Chinese reformers, particularly its architect, Zhao Ziyang.

The Soviet reluctance to introduce a genuine market track

While the Chinese moved steadily toward the dual-track, the Soviet reformers proved to be very reluctant to introduce a genuine market-track. Upon assuming power in March 1985, Gorbachev initially engaged himself in a campaign for uskorieneye, which referred to acceleration of GDP growth and scientific-technical progress. To this end, initiatives were taken with regard to retooling of existing plants (instead of building new ones), improvement of quality of products, and perfection of wages and incentives. The campaign however did not reflect any awareness about the necessity for introducing a market-track, and was instead based exclusively on the plan-track. (16)

Unfortunately, it was the inherent weaknesses of the plan-track that had led Soviet Union to stagnation in the first place, and so further efforts along the exclusive plan-track were of no avail. (17) Facing the failure, the leadership was forced to seek changes, and one of the results was the Law on State Enterprises (LSE) adopted on 30 June 1987.

Many commentators have interpreted LSE as introduction of a market- or at least non-plan track. The Article 10 of LSE indeed stipulated that SOEs were themselves to formulate their five-year plan, basing not only on state orders (gos zakaz) but also on direct orders, obtained from or contracted with consumers, other enterprises, and material-technical supply agencies. These direct or non-state orders, often referred to as contracts (dogovor), could then be described as constituting a non-plan track for SOEs.

Unfortunately, instead of elaboration on the dogouor part, Article 10 of LSE almost entirely focused on various specifics of state orders and their fulfillment. In fact, the entire Article 10 is titled 'Planning', leaving no doubt that even the dogovor part is thought to be part of the Plan. Similarly, after mentioning toward the end that contracts are entered for free sale of items in 'wholesale markets', the Article adds that these 'wholesale markets' are themselves 'a base for planning of the assortment, improvement of quality and indices, determining the production and social development of the enterprise' (emphasis added). (18)

The reluctance to accept a genuine non-plan track found clearer expression in the Law's Article 17 titled 'Finance and Prices'. It clearly reflected a tension between the willingness to allow some price freedom on the one hand and an urge to keep everything under the plan as before, on the other. Thus, section 7 of this Article mentions that enterprises earn revenues by selling their output at both centrally fixed (ie, plan) prices and prices either agreed upon in contracts or determined by the enterprises themselves. However, in the immediately following sections 8 and 9, the Article warns severely (with threat of imposing fine, etc) that enterprises are obligated to observe price discipline and are not to raise their prices. Apparently, these warnings and restrictions were aimed at protecting consumers against price gouging. However, in the given context, they basically amounted to nullifying the independence in non-plan price setting that was just granted in section 7. Similarly, in section 10, the article allows SOEs the right to accept contract prices but for a limited range of products. However, this right gets nullified when section 10 also informs that 'state price administration determines the order for determination of all contract prices and controls its implementation'.

Thus the attempt by LSE to introduce a non-plan track was half-hearted, confusing, and replete with contradictory impulses. Though the 1987 June Plenum adopted documents envisaging targets regarding share of dogovors in SOE output, the actual LSE did not specify any such share. By leaving the division between the plan and non-plan parts indeterminate and/or ill enforced, LSE introduced damaging uncertainty (as we shall see further below).


The comparative movements of the Soviet and Chinese SOE reforms along the internal incentive dimension are presented in schematic form in Figure 7.

Three stages of evolution of the incentive structure of the Chinese SOEs Introduction of profit retention schemes and the problems encountered Though the Chinese SOE reform introduced at an experimental level in 1978 and replicated nationwide in 1979-1980 had several elements in it, the most popular proved to be the profit retention component. (19) In implementing this component, the reformers however faced a host of problems, all rooted basically in the price system.

As in other socialist countries, plan prices in China were subjective, determined by planners, often on a cost-plus basis and incorporating various political, ideological, and distributional considerations. (20) In general, prices of industrial inputs were kept low, while prices of consumer goods were set high. The arbitrariness of plan prices of products carried over to prices of capital and to profits, the rates of which therefore differed widely across sectors (Figure 8). For example, profit rates (calculated as the ratio of profits and taxes to total capital) across sectors of the Chinese economy in 1980 varied from 326.9% in the tobacco sector to 6.0% in the coal sector. (21) Profit rates also varied widely across enterprises within the same sector.



This arbitrariness of prices and profits was not a problem under the Plan, because all profits were remitted to the state, so that it did not matter much to the enterprises whether their profits were high or low. However, as soon as profit retention was introduced, the arbitrariness became a problem, because it created an unfair situation, whereby some enterprises could retain higher amounts of profit simply because their prices were set high, while the opposite was the case with enterprises whose prices were set low. Imposition of charges for fixed and working capital was similarly difficult because of the arbitrariness of capital prices.

The obvious solution that came to the mind of Chinese reformers was rationalization of plan prices, and, as described above, they indeed made serious attempts in 1979 and 1981-1983 to achieve that goal. However, to the extent that reaching this goal was not proving easy, reformers tried to implement profit retention schemes using various ad hoc ratios and formulas, postponing the task of comprehensive price reform for the future. (22)

From 'profit retention' to 'profit responsibility'

Meanwhile, profit retention by enterprises, no matter how haphazardly implemented, led to the loss of government revenue and hence caused some concern. To stop excessive revenue loss while creating better incentives for the enterprises, and to bring some uniformity in the marginal retention rates, the Chinese government started replacing the profit retention schemes by profit responsibility systems that stipulated fixed (in absolute terms) profit delivery targets (so as to ensure a guaranteed level of remitted profit received by the government) and high marginal retention rate (often as high as 80%) for above-target profits (so as to provide strong incentive to enterprises for better performance). In 1981 various profit responsibility systems were put in place in more than 30,000 in-budget state industrial enterprises (80% of the total), and similar systems were adopted in 35% of the larger state-run commercial enterprises. (23)

Though the profit responsibility system in principle had more potential to neutralize the unevenness created by distorted plan prices (by taking into consideration the specific circumstances of individual enterprises in setting the profit target and the above-target retention rate), it was difficult to realize this potential in practice, because implementation of the system required one-to-one negotiations that were susceptible to manipulation on the side of both enterprise managers and government bureaucrats. Managers generally had the upper hand in these negotiations, so that the negotiated profit delivery targets generally turned out to be low - an outcome that the government had to accept in order to make the targets binding and ex-post non-negotiable. As a result, contrary to the wishes of the government, the volume of retained profits actually increased during 1981 and 1982 by 23% and 32% respectively, even when the total profit fell, so that the share of retained profits soared from 13% in 1980 to 22% in 1982.

From 'profit responsibility' to 'tax for profit' system

In view of the failure of the profit responsibility system either to prevent revenue decline or to meet the goal of managing the economy through impersonal, universal rules, the Chinese reformers looked for alternatives. Accordingly, when reforms resumed in 1984, they made a final attempt at rationalizing prices and finances of SOEs in the form of the tax-for-profit (ligaishui) initiative.

Enterprise profit in China, as in other centrally planned economies, was a huge undifferentiated sum, amounting to about 2.5 times of the wage bill and representing many different types of income, including natural rent, monopoly rent, interest income, profit, etc. The main idea behind tax-for-profit scheme was to differentiate and classify the accounting profit into these more meaningful economic categories and collect them in the form of various taxes and fees, so that the (residual) profit corresponded to its true economic meaning and reflected more accurately the performance of the enterprises. Also, once classified as taxes and fees, these payments would become legally instituted, non-negotiable financial responsibility of enterprises, so that they could have more autonomy and flexibility with regard to the disposal of the (remaining) profit. The idea was to convert enterprises ultimately into independent business units whose obligation to the state was limited to payment of taxes and fees, with profit being their exclusive domain.

To the extent that one of the taxes or fees could be for use of the capital embodied in the enterprise, the tax-for-profit scheme was also viewed as a way of introducing capital charges, something that the Chinese reformers had failed to do previously. Furthermore, the tax-for-profit scheme was regarded as a solution to the macro-fiscal problem of revenue sharing by the central and local governments. Thus, much was at stake with the tax-for-profit initiative, and Zaho Ziyang and other reformer leaders put much faith in it. (24)

However, when Zhao pushed for the rapid implementation of the tax for profit program in 1984, problems arose even at the stage of concretization of the program. First of all, attempts at comprehensive price reform faced the same problems as they did in 1979 and 1981. (25) Sectors, enterprises, and regions anticipating adverse effects resisted, while the Treasury, being apprehensive of subsidies needed to be paid to those affected negatively, balked, resulting in a stalemate. Similar was the situation with regard to imposition of capital charges, resisted by sectors whose profit levels were already very low (due to arbitrarily set low plan prices). Capital charges were also resisted on the ground that the current capital stock of the enterprises were handed over to them by the state, and not acquired by choice by them, so that it was unfair to hold them now financially responsible for its use.

As a result of these disputes, the final version of the tax-for-profit scheme that arose from the negotiation process did not have much potency. Most of the tax rates and fees were set at very low levels so as not to hurt even the sectors that had very low (accounting) profit rates. Also, in absence of comprehensive price reform, these low rates meant that even after payment of new taxes and fees, profit rates across sectors and enterprises remained very uneven, frustrating thereby the very idea behind the tax-for-profit initiative. A solution to the conundrum was sought through imposition of an additional 'adjustment tax' on sectors and enterprises with high residual profits. However, this meant a return to one-to-one negotiations with enterprises, with all its shortcomings that the tax-for-profit scheme strove to avoid in the first place.

The tax-for-profit initiative was therefore a huge disappointment for the Chinese reformers, who, after struggling with the scheme for two years (1984-1986), came to the conclusion that a different option was needed. They saw this option in the 'long term contract' (chengbao) system, which in turn depended crucially on the Manager Responsibility System (MRS) that meanwhile emerged as the Chinese SOE reform's implementation mechanism at the enterprise level (to be discussed in the next section).

Soviet inertia and 'Khozrashchet' funds

While the Chinese reformers, in their quest for the right incentive structure at the enterprise level, moved from profit-retention to profit-responsibility to tax-for-profit and finally to chengbao, the Soviets appeared to be immobilized. This was ironic in view of the fact that, so far as introduction of material incentives was concerned, they were much ahead of the Chinese. While the Chinese had repudiated material incentives during the Cultural Revolution and were reintroducing profit retention only in 1978, the Soviet SOEs had material incentive funds as part of the 1965 Kosygin reform, under which a part of the profit was retained by enterprises for distribution among three khozrashchet funds meant for (i) material incentives, (ii) production development, and (iii) housing and social development. Unfortunately, despite many tinkering during the subsequent two decades, enterprise incentive structure of the Soviet SOEs did not move much beyond these khozrashchet funds.

Even the 1987 LSE failed to introduce any radical change in this regard. LSE's Article 3, titled 'Distribution and Use of the khozrashchet Funds', merely reiterated the two methods of computing the khozrashchet funds of the enterprise, with one based on the accounting profit and the other based on the net product. The Law then listed the three khozrashchet funds mentioned above into which retained profit was to be allocated and described the purposes of their use, while providing some additional flexibility. Overall, therefore the basic incentive structure of the Soviet SOEs remained unchanged. Moreover, since profits of Soviet SOEs continued to be mostly plan profits, the khozrashchet funds failed to be conduits of market forces. By the same token, the substitution of tax-on-profit for remission of profit fails to have the desired effect when profits are mostly plan profits, based on plan prices.


If the Soviets proved timid with regard to the design of SOE reform, they brought about radical changes in the implementation mechanism, both at the enterprise level and at the macro level. The Chinese, on the other hand, moved cautiously, making sure that the implementation capacity at both the enterprise and macro levels was preserved. The comparative movements of the Soviet and Chinese SOE reform along the implementation mechanism at the enterprises level are shown in Figure 9.

The Chinese evolution towards "Chengabo' with managers as entrepreneurs

Emergence and consolidation of the MRS

If Zhao Ziyang was the main architect of the dual-track design, the main idea regarding implementation mechanism came from Deng Xiaoping. After his third rehabilitation and consolidation of power at the December 1978 CC Plenum, Deng promoted the idea of a Manager Responsibility System (MRS), which made managers responsible for the affairs of enterprises, giving them the authority and incentives to make relevant decisions, and removing enterprise Party committees from day-to-day management role. (26) However during the initial, experimental phase of the reform, Deng's MRS idea competed with ideas favoring WM. In fact, the five documents of September 1980 called for 'factory manager responsibility under the leadership of Workers' Congress', which was similar in spirit to WM, and implementation of this system was actually tried out in a few selected enterprises. However, given his prominence, Deng's idea of MRS, with undiluted authority of the manager, was also implemented. In fact, with time, MRS gained prominence, and was poised for general adoption by 1981.


The conservatives within the Party leadership were however not in favor of either Deng's MRS or the WM system. As a result, during reform reversal years of 1981-1983, there were attempts to backpedal on introduction of both the systems and instead to reestablish the authority of the enterprise party committee. With the resumption of reform in 1984, however, the momentum for MRS revived, with its selective implementation beginning even before the 1984 October Plenum, and the call for its nationwide adoption after the Plenum.

Meanwhile, as a result of revival of the economy from the aftermath of the Cultural Revolution, a new generation of more educated and performance-oriented managers came into place, facilitating the introduction of MRS in 1984. Also, compared with the MRS of the 1979-1980 period, when the authority of managers was still encumbered by enterprise level party and trade union organizations, MRS of 1984 was more emphatic.

Furthermore, while during 1979-1980 enhanced authority of the managers was viewed as a necessary condition for them to respond better to planners' stimuli and to fulfill planners' objectives, the enhanced authority in 1984 was viewed as necessary for enterprises mainly to respond better to market signals, that is, for managers to serve as entrepreneurs operating in the market. Managers were now viewed as an autonomous and independent entity (interest), able to act, if necessary, as a counterweight to workers' pressure to raise wages and bonuses.

However, even in 1984, introduction of MRS was controversial as it went against the views not only of conservatives but also of reformers who were inclined towards WM and were therefore apprehensive of authoritarianism of managers, riding rough shod over workers' interests and thus alienating workers. As a result, resistance to MRS persisted, and in late 1985, conservatives, using the issue of corruption, temporarily halted its implementation and reestablished the principle of collective decision, meaning authority of enterprise party committees.

However, reformers overcame the resistance and in 1986 they were able to formalize MRS in the form of separate regulations defining authority of the manager, party committee, and workers' congress at the enterprise. Following its formalization, the implementation of MRS gained momentum, and in April 1988 a basic law on SOEs accepted MRS as one of the fundamental principles.

From tax-for-profit to long-term contract (chengbao)

Development of the MRS as the mechanism of implementation at the enterprise level provided the Chinese reformers a way out of the impasse they faced in implementing the tax-for-profit scheme, the disappointment with which had led them into a deep debate beginning 1985 about the future direction to take. By this time, the eventual goal of a market-based economy was no longer disputed, so that the debate was mainly on the way to reach that goal.

Two camps emerged in this debate, with one comprised of price-reformers, who continued to believe in the necessity of a price reform as the starting point for enterprise financial reforms. They also wanted to manage the economy through impersonal, universal rules and hence were opposed to reforms that required one-to-one negotiation with enterprises. On the other side were enterprise-reformers who concluded, on the basis of repeated failures at price reform in 1979, 1981, and 1984, that price reform was not feasible, and hence wanted to press ahead with reform without waiting for it. The infeasibility of price reform also made them willing to accept one-to-one negotiations with enterprises and departures from impersonal, universal rules as lesser of the two evils.

While the conclusion about infeasibility of price reform had clear links with the Mises-Lange-Hayek debate regarding equilibrium plan prices, the Chinese enterprise-reformers did not conduct their argumentation at that ratified theoretical level and rather remained grounded to issues of a more practical level. (27) In particular, they based their arguments on the necessity of motivating the managers. (28) They also noted the importance of developing SOE managers as a political constituency in support of the reform and argued that prior price reforms were not possible precisely because they lacked such a political constituency. Although initially not opposed to price reform in principle, enterprise reformers with time became hostile to price reform initiatives, because the talk and prospects of price reform distracted managers away from improving the performance given the plan prices and instead pushed them towards negotiation and liaising with superior bureaucrats to get a good deal on reformed prices.

Indeed, in the course of implementing tax-for-profit, the government, taking advantage of favorable macroeconomic conditions in the spring of 1986, made another attempt at comprehensive price reform. However, the prospects of the reform began to fade in the fall of 1986, despite direct involvement of Zhao Ziyang. The reasons were familiar. Those who would be negatively affected opposed it, while the finance ministry proved reluctant to commit the subsidies that could offset the losses suffered by them. Further, there were numerous competitive estimates about the extent of losses to be suffered and subsidies required. There were also numerous competitive proposals regarding the methodology of price formation.

Faced with another round of disappointment, Zhao, in December 1986, abandoned the approach of price-reformers and accepted the suggestion of enterprise-reformers to adopt long-term contracting with enterprise managers. On 26 December 1986 Zhao formally put forward the policy of chengbao.

The system of chengbao

From one point of view, the chengbao system was the 'profit responsibility system' with extended duration and formalized through contracts signed with managers enjoying enhanced authority under MRS. Previously, the profit responsibility targets were negotiated annually, giving rise to the ratchet effect. Extension of the contract term to longer period (generally five years) was to overcome this effect and provide a more stable atmosphere and stronger incentives for managers to operate. (29)

With time however chengabao acquired additional characteristics that transformed the system. One of these was introduction of collaterals as personal security deposits put up by managers with whom contracts were signed. These collaterals served several purposes. First, they made the contracts more binding, because charges were made against collaterals if profit targets were not met. Second, collaterals helped to stabilize government revenues by ensuring the fulfillment of the profit delivery obligations no matter how much profit was actually earned. Third, by making the profit delivery targets binding, collaterals increased managers' incentives, which were further strengthened by very high rates of retention from above-target profit.

Collaterals in turn made it possible to introduce another chengbao feature, namely auctioning of the managerial position through open bidding process. The switch to long-term contract did not end the necessity of one-to-one negotiation with enterprises. In fact, to the extent that contract periods were longer, the stakes involved in these negotiations were now higher. However, as known from Game theory, one-to-one negotiation does not have any unique, equilibrium solution. Since the negotiation is basically over profit sharing, any point within the profit range can be the solution, depending on the relative bargaining strengths of the negotiators. By contrast, auctioning with open bidding could provide a competitive, transparent, and unique solution to the profit-sharing problem, putting an end to the arbitrariness and manipulation of the one-to-one negotiating process. (30)

The auction of managerial contracts also provided an indirect way of evaluation of the capital stock of the enterprises and of earning a quasi-market return on the capital (in the form of delivered profit). The system thus allowed the state to charge for capital, though the charge was not collected in the form of a fee or at a fixed rate. (31) Finally, the auctioning also helped in developing a market for managerial talent. A professional class of managers developed who could offer their services in return for a share of the residual income of the enterprise. Auctioning actually made managers more like leaseholders of the enterprises.

With chengbao, the evolution of the internal incentive structure and implementation mechanism at the enterprise level reached a point of culmination (albeit interim), and by 1988 most SOEs were already operating under long-term contracts signed in 1987 or earlier.

The Soviet introduction of WM

While the Chinese moved toward increased authority of SOE managers, the Soviet reformers moved in the opposite direction. The Soviet 1987 LSE brought about a radical change in the implementation mechanism at the enterprise level by replacing the traditional edinonachaleye of the director by WM.

As noted earlier, the Soviet economic management at the enterprise level was characterized by edinonachaleye, under which the director had the sole management authority, at least formally. In practice, the director generally shared the power with the party secretary and the chief of the Fabrichno-Zavodskaya-Mestneye-Komitet (FZMK), the local trade union organization, leading to a triumvirate. Many Soviet intellectuals saw a fundamental reason for Soviet economic malaise in the edinonachaleye system, which, according to them, was precluding genuine workers' participation in the management and was thus leading to alienation and low productivity. Accordingly, they viewed democratization of the enterprise-life through introduction of WM as a way of overcoming the malaise. Further, they viewed democratization of the enterprise life as a precondition for or a stepping stone toward democratization and revitalization of the economy and society as a whole. (32)

The Soviet authorities had already taken some steps in response to the above recommendations. For example, the new constitution of the USSR adopted in 1977 included a separate Article 8, proclaiming that labor collectives are to take part in 'discussing and deciding matters pertaining to the management of enterprises and institutions', and the use of khozrashchet funds. However, the Constitution did not specify the ways in which labor collectives would play this role.

The 1983 Law on Labor Collectives was another step in the same direction. It recognized the labor collective, inclusive of all workers and managerial personnel of the enterprise, as a legal body, and termed General Meeting of the collective as the forum through which the rights and obligations of the collective were to be exercised. However, the Law did not provide for any separate standing body representing the labor collective (Article 19). Instead, the right to convene General Meeting/Conference was conferred to the enterprise administration and the trade union (Article 20), who were also to exercise control over implementation of the decisions of the General Meeting/Conference (Article 21). Furthermore, despite the recognition of labor collectives, Article 4 of this Law retained edinonachaleye as the principle of enterprise management, with the qualification that it needs to be implemented 'in combination with broad participation of workers in the management'. Other than that of participation in making decisions concerning the use of the khozrashchet funds (Article 14), most other rights given to labor collectives under this Law were vague (see, eg, Article 6). The Law also appeared to pile more obligations on the labor collective than rights. (33)

The 1983 Law therefore could not satisfy the WM advocates, who therefore saw much hope in Gorbachev. On his part, Gorbachev seemed to be very receptive to the WM idea and spent quite a bit of his initial energy on its promotion. (34) It is therefore not surprising that introduction of WM became the centerpiece of the 1987 LSE, which not only recognized labor collective, but actually made it the main repository of power, and provided it a standing body in the form of a Soviet (Council) to be elected (though secret or open voting and for 2 to 3 years) at the Labor Collective's General Meeting or Conference (as applicable) (Article 7). (35) This Soviet in turn was to elect its Chairman, Deputy Chairman, and Secretary. (36) The task of convening General Meeting (to be held at least twice in a year) was now assigned to this Soviet, which was to exercise the power of the Labor Collective in between two General Meetings, and whose decisions were obligatory for the administration and members of the Labor Collective.

More importantly, LSE subjected SOE directors to the authority of labor collectives and its Soviets by requiring them (and other management personnel) to be elected through competitive elections by members of labor collectives (for a period of five years and through secret ballot or open voting) (Article 6, Section 3). Though the outcome of the election would have to be approved by the higher authority, any rejection would have to be explained. (37) Furthermore, the elected directors were subject to recall at any moment by labor collectives, so that directors could not be sure of their tenure even after getting elected. The LSE thus created a radically different situation of authority relationship and implementation mechanism at the enterprise level. (38) Unfortunately, these changes did not prove helpful for the success of SOE reform, as we shall see.


The Chinese and the Soviet reformers moved in opposite directions with regard to the implementation mechanism at the macro level too. While the Chinese stuck to the principle of party leadership, the Soviets embarked on a political reform process that led to the loss of implementation capacity at the macro level. The comparative movements of the Soviet and Chinese SOE reform with regard to implementation at the macro level are shown in a schematic form in Figure 10.

The Chinese retention of implementation capacity

In contrast to the implementation mechanism at the enterprise level, where local party committees were sidelined to give managers more authority, the Chinese reformers steadfastly maintained the principle of party leadership as the implementation mechanism at the macro level. Though China allowed some elections at the village level, it did not make any move toward loosening of party control and introduction of multi-party system, and did not hesitate to depose leaders who deviated from these policies. Thus the reformist leader Hu Yaobang was allowed to resign in 1987 when his political liberalism appeared to be unacceptable. Even Zhao Ziyang, the architect of China's economic reform, was removed from positions when he appeared to be sympathetic to the political liberalization demands of the students assembled at Tiananmen Square in June 1989.


Furthermore, the role of the party in China's SOE reform was not limited to the macro control. Party methods played an important role in implementation of reform at lower levels too, at least in the early stages of reform. For example, in his account of the reform process, Field (1984) notes that provincial party committees ordered mass meetings, publication of lists of failing managers in order to 'shame' them, signing of military pledges, etc, so as to compel SOEs to improve performance. Similarly, the Chinese reformers very much relied on the party leadership and control in carrying out one-to-one negotiations with enterprises while implementing profit retention and profit responsibility schemes and the chengbao system. (39)

Whether or not the Chinese reluctance to introduce a multi-party system is good for China is an issue that can be and is debated. However, observers generally agree that the continued party leadership helped the Chinese reformers to maintain their overall implementation capacity, avoid breakdown of the vertical chain of command, maintain discipline, enforce plan, and propel the reform process. (40)

The Soviet loss of implementation capacity

The Soviet reformers however took a very different route. Just as he brought about a radical change in the implementation mechanism at the enterprise level by introducing WM through 1987 LSE, so did Gorbachev initiate a radical change in the implementation mechanism at the macro level.

Gorbachev began the process by allowing a campaign of criticism that continued through the 27th Congress of CPSU held in February 1986. Initially it seemed that the criticism was meant for cleansing and rectification so that at the end the party would emerge cleaner and stronger. However, the criticism soon went beyond any such point of redemption. Also, initially it was thought that Gorbachev was moving along two tracks, one being glasnost, meaning openness, democracy, and political liberalization, and the other being perestroika, meaning economic reform. However, at the June 1987 Plenum, Gorbachev put forward the thesis that economic reform was not possible without political reform, thus subsuming perestroika under glasnost, and undermining the importance of economic reform as a separate agenda. (41) As a result of this strategic shift, the Soviet leadership and the society as a whole got caught up and in the end became consumed by a political reform process, with not much time and energy left for economic reform. (42)

To bring the criticism campaign to fruition, Gorbachev convened in June 1988 the 19th Party Conference, for the first time since 1941, where he pushed radical reforms along several dimensions. The first concerned the structure of the highest organ of state power, namely the Supreme Soviet. Gorbachev proposed the replacement of the existing two-chamber Supreme Soviet by a single chamber Congress of Peoples' Deputies (CPD) of very strange composition. (43) The second and more consequential reform concerned electoral rules. As per USSR constitution of 1977 (Article 95), members of the Supreme Soviet and all local Soviets were supposed to be elected on the basis of 'universal, equal, and direct suffrage by secret ballot'. In practice however these elections used to be a single-candidate affair, with the candidate being nominated by the party and its affiliated organizations. Gorbachev introduced new electoral rules allowing multiple candidates per constituency and also allowing voters to cross off unopposed candidates whom they did not like. Third, Gorbachev used the conference also to recommend separation of the government apparatus from party bodies.

Gorbachev went quickly for implementation of these resolutions, first ousting and sidelining conservative elements in the party leadership in the 1988 September Plenum, and then, in the December session of the existing Supreme Soviet, getting the constitutional changes regarding its replacement by CPD and new electoral rules approved, and setting March as the date for election of the new CPD. (44)

Meanwhile, persistent criticisms of the CPSU left its members disoriented and demoralized and the general public further alienated and disaffected, so that when multi-candidate elections for CPD took place in March 1989, many candidates nominated by the party failed to be elected, either losing out to competing candidates or getting crossed off where they ran unopposed. (45) The first CPD session became an arena for further criticisms of CPSU, Soviet state and the government. (46) As a result, though the party held the numerical preponderance, its moral authority was undermined, and the non- and anti-party forces were emboldened way beyond their numerical strength in CPD. Taking opportunity of the CPSU disarray, non- and anti-party members formed in summer 1989 the first CPD opposition bloc, named Interregional Group, with Boris Yeltsin as its leader. (47) Also, loosening of party control let pent up nationalist passions burst in full force, particularly in the Baltic and Transcaucasia republics, and soon engulfing Ukraine and even Russia. The political fissures of the Soviet society found their main expression through the center-republic power-sharing issue, which soon dominated the Soviet political scene.

The main hurdle that the opposition was facing at this stage in advancing further was the Soviet Constitution's Article 6 that gave CPSU effective monopoly over the political system. The opposition therefore demanded its repeal. Gorbachev conceded and made the CPSU CC plenum of February 1990 accept this demand. The CPD session of February-March 1990 formalized the change, opening the way for multi-party elections. At the same CPD session, Gorbachev proposed and secured for himself a new office of an executive President of the Soviet Union, elected by CPD and separate from the chairmanship of the Supreme Soviet. (48)

However, while Gorbachev was arranging his power within CPD and the Supreme Soviet, events overtook him at the republican level, where CPSU organizations, given the general disorientation, started to fracture along the fault lines of nationalism, so that when multi-party elections to republican and other regional Soviets were held in 1990 spring, various nationalist forces made bigger inroads in the (republication) power structure and put up a serious challenge to the center. (49) Gorbachev's power edifice began to crumble, vertical chain of command started to collapse, and the overall implementation capacity of reformers started to vanish. With no implementation capacity left, there was also no chance for the Soviet SOE reform to progress further.


Figures 11 and 12 combine the movements along different dimensions and present the anatomy of SOE reforms in China and the USSR. These show clearly that SOE reforms of China and the USSR carried out in the 1980s were more dissimilar than similar. No wonder therefore these reforms produced very different outcomes.

Outcome of SOE reform in China

With dual-track determining the external environment, chengabo providing the incentive structure and implementation mechanism at the enterprise level, and continued party leadership as the implementation mechanism at the macro level, the Chinese SOE reform process attained a coherent shape and achieved success. This success has been recorded and analyzed in detail by previous researchers, so that its repetition here is not necessary. (50) Suffice it to say that, instead of suffering any collapse (or transformational recession), the output of China's state sector increased by an average annual rate of 7.8% between 1980 and 1992 (Jefferson and Rawski, 1994, p. 48, Table 1). The dynamism of the Chinese state sector also helped the vigorous growth of China's non-state sectors (as we shall see in more detail in the next subsection).

Of particular interest here is the effect of the reform on sectoral profit rate differences that had propelled much of the Chinese SOE reform process. Figure 13 presents the Chinese sectoral profit rates in 1989. Comparing it with Figure 8, we see that competition among SOEs themselves and with NSEs over time whittled away the rents created by arbitrary plan prices, and adjusted sectoral prices in a way that sectoral profit rates were equalized to a large extent, as would be expected in a well-functioning market economy. The standard deviation of profit rates across sectors decreased from 19.7 in 1980 to 7.4 in 1989, with corresponding coefficient of variation decreasing from 0.78 in 1980 to 0.44 in 1989. (51) Thus what the price reformers could not achieve 'from above' through their repeated attempts (with elaborate IO tables and complicated formulas for price calculation, etc), the dual-track system achieved it 'from below' as the outcome of an almost spontaneous process.




In the end, the frozen plan got dissolved in the expanding sea of market through further reduction of its absolute size, shrinkage of its relative size, and substitution of plan prices by market prices. The Chinese plan-based SOEs became by and large market-based SOEs, and China, as Naughton (1995) put it, 'grew out of plan'.

Consequences of Gorbachev's economic reforms

By contrast, the combination of limitations of the design and misdirected changes in the implementation mechanism at the enterprise and macro levels produced very disappointing outcomes of the Soviet SOE reform. The concrete dimensions of this outcome include: (i) spurious SOE profit, (ii) spurious wage growth, (iii) increased budget deficit and government debt, (iv) repressed inflation and monetary overhang, (v) deteriorating external economic position, (vi) and a general breakdown of economic relationships and chaos. (52)

Spurious SOE profit

Taking advantage of the more flexible way in which state orders were formulated in the LSE, SOEs skewed their output structure toward more high priced and hence more profitable items, thereby increasing their profits. As a result, SOE pre-tax profit increased in 1988 by 16% compared with that of the previous year, and the gross operating surplus of the enterprises (ie, profits before payment of turnover taxes and receipt of subsidies) increased by 2 percentage points of GDP. Unfortunately, these profits neither reflected any productivity growth nor were they always derived from production of products that were actually in demand, so that they mostly led to increased inventory. (53)

The swollen SOE profits also exacerbated the problem of profit rate differentials across sectors and SOEs, and the branch ministries tried to deal with the situation by confiscating profits in order to cross-subsidize the less profitable ones, causing the ex-post tax rates to vary enormously, ranging from 0% to 90%. Despite the confiscations, SOEs could use LSE to retain more of the profit, so that the total profit remittance to the budget actually fell in nominal terms in 1988, and after-tax profit as ratio of GDP increased by 4 percentage points. The confiscations, low or negative real interest rates on bank deposits, and general uncertainty pressured SOEs to use up their retained profits in the form accumulation of inventory, and launching of new investment projects that led to unfinished construction. In fact, 'change in inventory' became a significant component of 1988 NMP, (54) and change in unfinished construction almost tripled as a percentage of gross fixed investment (to 9.8%) and of GDP (to 2.2%) (for data cited in this entire section, see IMF et al., 1991, pp. 26-27).

Spurious wage growth

A companion process was unjustified wage growth, resulting from the following factors. The first is the spurious growth of SOE profit, so that more could be allocated to khozrashchet funds. Second, LSE allowed more flexibility with regard to both imputation to and use of khozrashchet funds, making it easier for SOEs to use them for granting wage increase and bonus.

Third, for worker-elected directors it became almost a compulsion to appease employees by raising their compensation. Fourth, prospects of confiscation encouraged SOEs to use up retained profits in the form of wage increases and

bonuses. As a result, wages soared in 1988, with payments from wages and material incentive funds rising by nearly 7.5% and 'Other remuneration' by 13%. (55) The wage growth accelerated in 1989, with wages increasing by 8% (the average wage in the material sphere increased by almost 10% and 'other remuneration' increased by close to 14%). The authorities made many attempts to control wage growth, but to no avail. (56) Unfortunately, as was the case with profit growth, wage growth was not a result of productivity growth, nor was it always related to production of goods and services that were actually in demand, and hence it led to inventory increase.

Rising budget deficit and debt

The counterpart of profit and wage growth was growth of government's budget deficit and debt. The budget suffered on several accounts. First, to the extent that enterprises made use of LSE to increase their share of the profit, the volume of profit repatriated to the state fell. Second, since LSE's non-plan track remained confusing, the budget constraint faced by SOEs remained soft. The government, therefore, found itself in the unenviable situation whereby profitable SOEs retained more of their profit, and unprofitable SOEs passed on their losses to the government budget. Third, the government had to continue financing the consumer subsidies. Fourth, the rising center-republic tension, with more republics asserting their sovereignty and proving reluctant to pass on revenues, exacerbated the budgetary crisis.

The government tried to confront the situation by reducing credit to SOEs and instead borrowing for itself. As a result, official domestic debt as percent of GDP increased from 11.3% in 1986 to 39.6% in 1989. (57) The government also chose the easy way of external borrowing, so that between 1985 and 1989, the external debt grew from virtually zero to 120 billion dollars. When borrowing was not enough, the government started to sell assets, so that the gold stock of the country decreased from 2000 to 200 tons between 1985 and 1989. (58)

Repressed inflation and monetary overhang

The spurious wage and profit growth and increased government borrowing from domestic and external sources, all combined to create the much discussed problem of monetary overhang. To the extent that prices were still mostly under state control, the official inflation rate remained low, so that price increases could not soak up the rise in effective demand. Instead a vast amount of money started chasing few goods that were available and were in demand. (59) The hoarding behavior on the part of consumers and enterprises only exacerbated the situation through self-fulfilling expectations, whereby more hoarding in anticipation of shortage ended up creating more shortage. Responding to the situation, the government reintroduced (first time since the end of the World War II) rationing, that is, distribution through food cards that limited each citizen amount of product per month. To Soviet citizens, who were looking for a change for the better, reintroduction of rationing, something that was not necessary even during the Brezhnev period of stagnation, proved very disappointing and distressing.

Uncertainty, disruption, and dislocation

A particularly damaging consequence of 1987 LSE was the introduction of pervasive uncertainty. In China, under dual track, the plan part was kept intact, and enterprises were allowed to expand along the market track. Thus uncertainty was confined only to the incremental part of a SOE's operation, thus minimizing dislocation. The Soviet LSE, on the other hand, did not specify how much dogovor an SOE had to procure, so that the whole operation of an SOE suddenly became subject to uncertainty. Instead of being incremental, the change had an all-at-once flair, even though, ironically, the market (dogovor) track itself was ill-defined. Furthermore, though the June 1987 Plenum did suggest some quantitative targets about production under dogovor, these were often arbitrary and not based on an inter-sectoral consistency check on the requirements of the plan part. Finally, in the general atmosphere of a collapse of the implementation mechanism, even the proposed targets lost the necessary force behind them. Thus, while the Chinese dual track had, so to speak, the best of both (ie, plan and market), the Soviet LSE and SOE reform had the worst of both: it gave up the certainty of plan, without introducing a genuine market track. (60)

The result was disruption and dislocation in the production and supply chains, aggravated by the collapse of the vertical chain of command and recalcitrant behavior of the republics. The dislocations and disruptions exacerbated the general situation of shortage, hoarding, rationing, tunneling, and created a situation of panic. Instead of a positive turnaround in the economy, Gorbachev's SOE reform led to a crisis.

Russia's plunge into big bang

Crisis plans of 1990

By the summer of 1990, Gorbachev was beset with crisis from all sides. His political crisis aggravated, because his power started to slip away just as when he seemed to have consolidated it in the form of an executive presidency. Following the multi-party elections of the republican soviets in the spring of 1990, the Baltic republics declared their independence. (61) On 29 May 1990 Boris Yeltsin became the President of the Russian Supreme Soviet, a position he now used skillfully as a counterweight to Gorbachev's power. In fact, on 12 June 1990, Russia itself declared its sovereignty. Yeltsin quit the CPSU at its 28th Congress held in July 1990, and started accusing Gorbachev of not respecting Russian sovereignty. With the republics leaving the Union, the elaborate presidential power structure that Gorbachev constructed for himself started to become an empty shell.

Meanwhile, the economic crisis eroded public faith in Gorbachev's policy and competence and in the hope of revival of the planned economy through reform. The previous resistance to market evaporated quickly in the face of the panic, and the Gorbachev government suddenly became ready for a whole scale replacement of plan by market. However, by that time the political initiative had shifted to Yeltsin, who accused Gorbachev of foot dragging on market reform and announced his own plan of introducing market economy within 500 days, instead of following the more conservative plan of Gorbachev's Prime Minister, Ryzhkov.

To regain initiative, Gorbachev tried to strike a deal with Yeltsin, suggesting (on 2 August) formation of a joint committee with advisers from both his and Yeltsin's governments, to be entrusted with the task of combining Ryzhkov and Yeltsin plans. The result was the Shatalin Plan, named after the economist Stanislav Shatalin, the chair of the committee. Gorbachev however could not endorse the Shatalin Plan (Shatalin 1990), not so much because it proposed a faster transition to market (than was proposed in the Ryzhkov plan), as because it made republics the main repository of

power, with a center having only such powers as republics would concede. The tussle over the economic plan continued through the autumn of 1990, while Gorbachev, despite his rejection of the Shatalin Plan, tried to implement this Plan's economic recommendations through presidential decrees. (62)

Not happy with Gorbachev's course of action, Yeltsin pushed ahead with republican sovereignty, going to the point of stopping payment of revenues to the central government, and also implementing Shatalin's ideas of destatization, thus leading to a complete chaos not only at the union-republican nexus, but also at the enterprise level.

Dissolution of CPSU and the USSR

To save the USSR in face of the rebellion by republics, Gorbachev proposed a new Union Treaty, and put the issue of continuation of the Union to a March 1991 referendum. Though the continuation proposal won an approval of 76.4% of the vote (with 80% turnout), the referendum was implemented in only nine of the 15 republics. Following the referendum, the April 1991 meeting at Novo-Ogarevo between Gorbachev and the heads of the nine republics issued a statement on speeding up the creation of a new Union Treaty.

However, on 12 June 1991, Yeltsin got elected as President of the independent Russian republic through direct popular vote, bolstering his bargaining position vis-a-vis Gorbachev, who owed his position only to CPD members and not to popular vote. (63) Following the August 1991 coup, Gorbachev had no power left, while Yeltsin, citing the coup, banned CPSU throughout RSFSR on 6 November 1991. (64)

In early December 1991, Ukraine voted for independence from the Soviet Union, and a week later on 8 December 1991, Yeltsin met with Ukrainian leader Leonid Kravchuk and the Belarus leader Stanislav Shushkevich, in Belovezhskaya Pushcha, where the three presidents announced the dissolution of the USSR by annulling the 1922 agreement that had formed the Union. Both the CPSU and the USSR were lost, and Gorbachev was left with neither a Party nor a country.

Adoption of big bang

With the disintegration of the USSR and dissolution of the CPSU, there was no force left to propel the SOE reform process, and Russia, partly as a result of the inner dynamics and partly as a result of foreign advice, plunged into big bang, with liberalization of prices in 1992 and privatization in 1993, followed by a second round of privatization in 1996. (65)


Thus, it were the stark differences in the design and implementation mechanism of the Chinese and Soviet SOE reforms that led to the contrasting outcomes in 1980s, which in turn led to contrasting reform paths in the 1990s: Russia fell for big bang while China continued along the gradual path. Contrary to the Sachs-Woo contention, differences in the structure of the economy did not have the direct determining role in this outcome. This conclusion conforms to the conclusion reached earlier by Nolan and Ash that the main reason for different reform outcomes in Russia and China lay in 'differences in policy choice'. (66) It also agrees with Popov's conclusion that the main reason for contrasting reform outcomes lay in institutional collapse. However, to remove any lingering suspicion about this conclusion, we provide below a more direct analysis of the role of agriculture and surplus labor in the SOE reform processes in these two countries.

Relationship between SOE reform and NSE growth in China

There is no denying that the presence of a large agriculture sector with surplus labor helped China to develop her NSEs, and competition from NSEs played an important role in improving the performance of China's SOEs. (67) What is however important to note is that China's NSE growth itself was to a large extent a consequence of her SOE reform, in particular of its dual-track feature that opened up to NSEs the rent opportunities created by distorted prices of the plan sector. (68) The best evidence of the role of SOEs in spawning NSEs can be seen in the latter's geographical distribution. In fact, close to 80% of rural industrial output was generated by NSEs located in cities (meaning rural peripheries that were administratively considered part of the cities) and subordinated areas of cities. (69)

This geographical concentration of TVEs in and around cities is not surprising, because many of them were sponsored by SOEs directly, under various arrangements, such as subcontracting, joint production, joint marketing, etc. (70) There are many reasons why SOEs sponsored or entered into contractual relationships with TVEs. One is to diversify supply. An example is provided by the growth of textile producing TVEs in the countryside around Shanghai as part of the effort by Shanghai-based SOEs to diversify textile supplied for export, even though both procurement of raw materials and export of the finished product continued to be in the hand of government monopolies. Second, by reducing costs, particularly labor costs, sub-contracting and other cooperative arrangements with TVEs were helpful in increasing SOE profits, of which more could now be retained. The labor cost saving incentive was particularly true for textiles and other labor intensive industries. Third, cooperative arrangements with TVEs allowed SOEs the flexibility necessary to escape the tight constraints (with regard to construction, land procurement, and hiring, etc) when they tried to expand their operations using the opportunity of outside-plan activities under dual-track. Fourth, cooperation with TVEs allowed SOE managers to have control over funds in the collective sector, where accounting standards and supervision were less strict than in the state sector. Partnership with TVEs allowed SOEs to enjoy more autonomy and independence than what state was prepared to give SOEs even under the reform. Thus, the Chinese NSE growth was in a large measure a response to or 'spillover effect' of urban SOE reform process, and needs to be analyzed, in Naughton's (1995, p. 155) words, 'as part of the broader process of metropolitan industrial growth'.

It is clear that the mere presence of large agriculture sector with surplus labor was not enough, because otherwise NSE growth could have taken place in the pre-reform period too. Thus, the presence of a large agriculture sector with surplus labor was not a sufficient condition for success of SOE reform. Further, within the interactive process of SOE reform and TVE growth, both the historical and causal precedence lay with the SOE reform, showing that the presence of a large agriculture sector with surplus labor was not a necessary condition for the success in SOE reform, either.

A corollary of this finding is that, instead of being a unique phenomenon for China, NSE growth could be an accompaniment of SOE reform process in other transitional economies too. In fact, Naughton (1993, p. 169) notes that the Chinese urban peripheries, where TVE growth was concentrated, were in many respects similar to the countryside of East European countries. Thus, even though China had an advantage in having a much larger rural area, a combination of SOE reform and NSE growth, as witnessed in China, should have been possible in East European transitional countries, including the USSR, too.

Surplus labor in the Soviet economy

Unrealized potential of labor hoarded in Soviet SOEs

Unfortunately, Soviet reformers could not create a mutually reinforcing process of SOE reform and NSE growth, even though the Soviet economy too, despite its apparent full employment, had a large amount of surplus labor, hoarded, in part, in its industrial SOEs. (71) The exact estimate of this surplus labor is difficult to obtain. However, according to IMF et al. (1991, pp. 141-142), surveys of managers of SOEs in the first of half of 1980s suggest that they usually retained about 15 to 20% more labor than was necessary to fulfill their production plans. For some branches, this figure was even higher, reaching 25%. The study further notes that decades of the practice of labor hoarding might have affected the very perception of Soviet managers about the amount of labor required. More objective measures of labor requirement, based on comparison of Western-built plants in the USSR with matched plants in the West, showed that Soviet plants employed 50% to 150% more labor. The total amount of hoarded labor in Soviet SOEs was therefore large. (72) However, as Kornai (1992) shows in detail, hoarding of labor was a 'structural necessity' for SOEs operating under conditions of 'general shortage' endemic of a plan economy. Hence, in considering withdrawal and redeployment of this surplus labor, offsetting changes in the external environment were necessary in order to avoid disruption in production and supply.

Also, contrary to Sachs-Woo assertion, Soviet SOE employees were not unwilling to move out of SOEs if alternative opportunities were lucrative enough. This is evidenced by the presence during even pre-Gorbachev times of shabashnikis or independent contractors, whose activities generally fell in the economy's grey areas, often bordering on illegality. Though many shabashnikis used to retain their SOE jobs and the security that comes with them, others would indeed leave their SOE jobs.

Some evidence of the willingness of Soviet workers to move out of the state sector was seen during the brief period of implementation of the Soviet 'Law on Cooperatives (LoC)' enacted in 1988. (73) Cooperatives were, of course, not new to the Soviet Union, because formally kolkhozes were also cooperatives. However, LoC intended to introduce cooperatives in other sectors, including manufacturing and, in particular, services. Under this law, cooperatives were recognized to be an important part of the economy (Article 1), and cooperative property was assured of state protection (Articles 8 and 29) and given equal status to that of the state property in most respects.

Cooperatives were allowed not only to enter into contracts (dogovors) with other enterprises, including SOEs, suppliers, agencies, and consumers (Article 17), but also to compete with SOEs for state orders (Article 18). That the Soviet reformers saw an important role of cooperatives in absorbing surplus SOE labor was evident from the fact that laid-off SOE employees were given preference in joining cooperatives and working for them under contract (Article 40, Section 2). Apart from its own members, cooperatives were allowed to engage non-members to work for them under contract, so that the formal restriction on use of hired labor by cooperatives did not make much of a difference in practice. Furthermore, SOE employees were allowed to become members of cooperatives or work for them under contract during their flee time, so that people did not have to leave SOEs in order to become a part of the cooperative sector, rendering the Sachs-Woo claim of Soviet workers' reluctance to leave state sector job as an argument for their Impossibility Hypothesis even more tenuous.

LoC also provided certain advantages to cooperatives. For example, with regard to prices, despite the LSE-like confusion and vacillation (see, eg, Article 18, Section 3, and Article 19, Section 1 and even Section 2), LoC on balance gave cooperatives more freedom in price setting than what SOEs enjoyed under LSE. (74) Cooperatives were also given considerable freedom with regard to wage setting (Article 25, Section 2). (75) In addition, cooperatives were given the right to export and import, retain and use the foreign currency earned (after payment of taxes), enter into joint ventures with foreign enterprises, either inside the country or even abroad (Article 28).

In order to increase their incentives to care for the cooperative sector, LoC put cooperatives under the financial jurisdiction of local Soviets, making them recipient of all taxes from the income of cooperatives, its members, and those working for cooperatives. It also authorized local Soviets to provide cooperatives tax concessions (Article 21, Section 2). (76) Article 22, Section 2 stipulated that in certain situations the state could provide cooperatives budgetary support for construction purposes. There were many other such advantages granted to cooperatives under the LoC.

Many Soviet citizens did make use of LoC, so that the new cooperative sector expanded rapidly. The total number of people engaged in these cooperatives increased from 1.4 million in 1988 to 6.1 million in 1990, accounting for 1% and 4.4% of total employment, respectively. Similarly, the output produced by these cooperatives rose from 6.3 billion in 1988 to 67.3 billion rubles in 1990, accounting for 0.7% and 6.1% of the country's GNP. In some particular sectors, cooperatives became quite important. For example, by 1990, cooperatives accounted for 17.7% of 'personal services' and 17.4% of 'construction' sector. (77) This rapid rise in the cooperative sector shows that the Sachs-Woo claim about Soviet workers' reluctance to leave the state sector was unfounded, and there was a significant scope for growth of NSEs even in the USSR using the surplus labor hoarded in its SOEs.

Unfortunately, for several reasons, the process of NSE growth (in the form of cooperatives) in the USSR could not proceed much further. Unlike in China, where the NSE growth and SOE reform proved mutually reinforcing, in the USSR, due to design problems, the two processes often proved conflicting. One main reason for this conflict was the absence of a proper SOE market-track, which could serve as the docking point for the SOE and NSE sectors, as was the case in China. Second, unlike in China, where plan, though frozen, remained the exclusive domain of SOEs, so that the Chinese SOEs and NSEs competed only in the incremental arena of the market, Soviet reformers ignited a premature turf war between SOEs and cooperatives by allowing the latter to compete for state orders. Third, the hostility between the two was exacerbated by the fact that SOEs could not share the advantages granted to cooperatives under LoC, because they were not allowed to engage in subcontracting and other joint operations with cooperatives. (78) As a result, the SOE sector felt further threatened and disadvantaged. The envy and hostility eventually led to a political backlash, with the authorities trying to rein in the growth of cooperatives by imposing various restrictions, thus adding to the confusion and chaos.

Thus, while in China a well-defined dual track allowed both SOEs and NSEs to develop in a complementary fashion, in the USSR a confusing LSE in combination with LoC put SOEs and NSEs on to a path of conflict, hindering both SOE reform and NSE growth.

Unrealized potential of surplus labor of the Soviet agricultural sector

The lack of a proper design also prevented Soviet reformers from utilizing the surplus labor hoarded in kolkhozes and soukhozes. Compared to that in the industrial sector, the productivity gap between the West and the Soviet Union was about three times greater in the agriculture sector, making it obvious that there was a considerable amount of surplus labor in this sector.

It is true that in much of the European part of the former USSR, the agricultural labor force comprised disproportionately of elderly women, with less education and skills. It is only in the Asian republics of the USSR that a sizable number of young males still worked in the agricultural sector. However, the fact remains that there was much scope for better utilization of this labor, at least to raise agricultural output, if not to create new enterprises in industry and service sectors. This scope was evidenced by the fact that kolkhoz and Soukhoz members' private plots, comprising only about 1% of the agricultural land, were producing about 20% of the total Soviet agricultural output. The Soviet failure to make use of this scope, and reap the benefits of agricultural reform as a springboard for or accompaniment of industrial reform is particularly telling in view of Gorbachev's own background in and initial politburo portfolio of agriculture. (79)

In order to overcome the inefficiency of the agriculture sector, the Soviet leadership in the early 1980s attempted to introduce the brigade or zueno (link) system as a way of carrying out the production operations within kolkhozes and soukhozes. Zuenos in Soviet agriculture have a long history, with their introduction in the 1930s, criticism and suppression in 1950, revival in mid1960s, and again receding from attention in the 1970s. (80) Under the zueno system, a small number of workers/families would form a zueno, which would then be assigned land and equipment in return for obligatory supply of output. During its checkered history, zuenos have seen various types and forms, with regard to size, duration, attachment of crop cycle, land, and equipment, specific areas of operation, place in the organizational hierarchy, rights and obligations vis-a-vis higher levels of organization (brigade or the kolkhozes and soukhozes), etc. In general and over time, zuenos evolved toward being durable, with attached land and equipment, and responsible for entire crop cycles.

Clearly, the move toward zuenos was similar in spirit to the Chinese household responsibility system, though the zueno-system applied not to individual households but groups of them, so that it had a collective character and hence was more acceptable to the Soviet establishment. However, operation and spread of zuenos under the Soviet system faced formidable challenges. Some of these were of techno-economic nature. For example, the flexibility inherent with the zueno system did not fit well with the total-planning strivings of the Soviet system. To the extent that the Soviet agriculture depended heavily on industrial inputs (machinery, chemical fertilizer and pesticides, etc), reform in the agriculture sector required some synchronization with changes in the industrial sector management. Other challenges were socio-political and ideological in nature. For example, the differentiation in income that zueno system gave (or could potentially give) rise to was not acceptable to many. Similarly, many saw in the attachment of land to zuenos a slippery process towards private ownership of land, and hence not acceptable, etc.

In his capacity as the first secretary of the regional party committee (talcum) of the agriculture-dominated Stavropol region, Gorbachev was expected to be familiar with the zueno reform. In fact, many thought that it was because of his expertise and accomplishment in this area that he was brought to the politburo and put in charge of agriculture. Whatever the case may be, Gorbachev failed to make use of his background (as a leader coming from an agriculture-dominated region) to bring about a positive transformation in the Soviet agriculture. Instead of working patiently on the challenges faced by the zueno system and making it successful, Gorbachev, after assuming power, started calling for family farms.

Yet as Goldman (1991, p. 280) informs, after almost three years of trying, there were only 900 family farms in the Russian Republic and a mere 12 farms in the Ukraine. Similarly, Zaslavskaya's poll in 1990 showed that only 4% of the soukhoz and kolkhoz members were willing to embark on family farming, making it clear how unprepared Soviet farm workers themselves were in 1985 to the idea of family farms. Gorbachev's call for family farms was therefore not only pre-mature but counter-productive, because, to a large extent, it scuttled the zueno reform process by making people, particularly those within the Soviet establishment, apprehensive. (81)

Thus it was again appropriate design and implementation mechanism of SOE reform why China could make use of her surplus labor of the agricultural sector, and it was lack of good design and implementation mechanism why the Soviets failed to use the surplus labor hoarded in their SOEs and agricultural farms.


The question that arises is: What caused the differences in design and implementation mechanism of SOE reforms in China and the USSR? A full investigation of this question is beyond the scope of this paper. Introspection however shows that there were both deep-seated and proximate causes. In the following, we offer only an exploratory discussion of some of the proximate causes, leaving their fuller discussion for the future.

Proximate causes of contrasting performance with regard to the reform design

Varying degree of ideological opposition to market prices

One main reason why the Soviets failed to arrive at an effective reform design in time was their ideological opposition to market and market prices. The Chinese were opposed to market too, but their opposition was not as deep and ingrained as was the case with the Soviets.

The discussion in the sections 'External environment', 'Internal incentive structure' and 'Implementation mechanism at the enterprise level' shows that the Chinese leaders arrived at dual-track and chengbao through an evolutionary, learning process that involved back and forth movements, twists and turns, bold initiatives, retreats and compromises. The Chinese did not have a fully developed blueprint in hand when they embarked on reform in 1978. The dual-track system was as much a discovery to the Chinese reformist leaders, in particular to Zhao Ziyang, as it was to the general public. The coherence of the Chinese design was therefore 'ex-post coherence'. (82)

It was also noticed that one main reason why the Chinese reformers were successful in reaching their coherent reform design was their (begrudging, though) willingness to accept market and market prices. Their initial intention was to make the Plan system work better, and they embarked on price reform with that intention. However, facing repeated failures at comprehensive price reform, the Chinese reformers proved willing to consider and ultimately accept market prices as objective, equilibrium prices, and market as the coordination mechanism in general. Ideological considerations did not prove to be an insurmountable barrier to their acceptance of the market.

By contrast, the Soviet reformers found it very hard to accept market and market prices. Their khozrashchet reform, beginning in mid-1960s, all along remained confined to the plan-track. Even in the 1980s, when the Soviet economy's stagnation was officially recognized, there was no recognition in the leadership of the necessity of switching from plan to market. As noticed above, Gorbachev himself spent his valuable initial years in power on championing exclusively plan-track based campaigns, such as uskorineye, Stakhanou movement, 'brigade' system of labor, etc.

It is instructive that the Soviet reformers did not consider seriously even the Lange idea of equilibrium plan prices, even though reformers in some of the East European countries wrestled with this idea and its implementation, as did the Chinese reformers following them. To the contrary, Soviet leaders associated the Langean idea with 'deviations' of Hungary in 1956 and Czechoslovakia in 1968, and accordingly viewed it with considerable suspicion. During the late 1970s and early 1980s there was some interest in Soviet academic circles in 'optimal' prices, meaning the dual (or shadow) prices emerging from linear programming exercises. However, as is known, the practical usefulness of shadow prices is limited. (83)

Soviets theoreticians generally thought that the amount of 'socially necessary labor' to produce a product (the Marxian definition of value) could be determined from-above, in a subjective manner, by planners, acting on behalf of the society. They failed to see the role of market in determining the socially necessary labor in an objective manner, through a bottom-up process, with actual and direct participation of the multitudes of sellers (producers) and buyers (consumers). Instead, they associated market only with spontaneity (in its negative sense) and anarchy.

Kontorovich (1988) argues that Soviet planners developed a phobia towards market because of their obligation to achieve 'material balance', which was difficult to construct for a large economy having numerous sectors. Examining the experience of Khruschev and Kosygin reforms, Kontorovich shows that those components of reform that could potentially make construction of material balance difficult did not survive. Thus, apart from (perhaps more than) deep theoretical arguments regarding value and price formation, the practical necessity of construction of 'material balance' made Soviet planners averse toward introduction of market and acceptance of market prices. (84)

Yet, price formation from above by planners was also the root cause of the soft budget constraint. By not addressing the price issue, the Soviet reformers therefore could not address the soft budget issue. Without objective prices, other efforts at improving efficiency were not to be successful, and they were not, as the Soviet experience of two decades (1965-1985) of khozrashchet reform proved. (85)

The khozrashchet reform had the potentiality of evolving toward a dual-track system, replacing plan prices by market prices gradually, as in China. However, for this to happen, the Soviet reformers needed to face the question of price formation in a more fundamental way. Unfortunately, that did not happen. Suggestions by Soviet economists to open a market-track were not accepted. As noticed in the section 'External environment', even in the 1987 LSE, Soviet reformers remained very reluctant to free up prices for the non-plan track. As a result, the market-track remained half-baked, while the integrity of the plan track was destroyed, leading the whole system to chaos.

Different perceptions of the contradiction between labor and management

Alongside the failure to see the usefulness of market to provide objective prices, the Soviet reformers also failed to appreciate the potential contradiction between management and labor (or between profit and wages) and thereby to anticipate the consequences of introduction of the WM system, particularly when prices were still subjective and SOEs were still basically under soft budgets. The conflict between wage and profit is a real one, and it does not go away even when the enterprise is under state ownership. The Chinese reformers, on the other hand, displayed a keen appreciation of this conflict and, by providing SOE managers necessary authority and incentives, converted them into a counterweight to possible unwarranted wage demands by workers.

Varying depth of understanding of economic issues

Gorbachev and his associates not only failed to identify the root cause of the Soviet economic malaise (namely continuation with subjective Plan prices), they also displayed a remarkable shallowness of understanding of economic problems in general. One example of this superficiality was Gorbachev's futile anti-alcohol program. Instead of seeing alcoholism as primarily an effect of socio-economic problems, he saw in it mostly a cause of ills, and tried to fight it in a quixotic manner. The result was a failure, with significant economic and other costs. The shallowness of understanding also found manifestation in his frequent switches from one campaign to another, calling for family farms, on the one hand, and promoting Stakhanou movement on the other, being oblivious to the fact that the two represented completely different philosophies. (86)

The problems of the Soviet economy were deep, and their solution required deep strategic thinking. Unfortunately, the Soviet leaders failed to live up to the task. By contrast, the Chinese reformers displayed a keen sense of what would work in practice, even though they could not always theorize what they were doing.

Mercurial versus collegial leadership

Another notable difference between the Chinese and the Soviet reform processes is that, while the former proved to be a more collaborative effort, the latter was more dependent on one person, namely Gorbachev. As noted earlier, at the very 1978 December Plenum, Deng delegated economic decision making to Chen, who in turn brought Zhao from Sichuan province and delegated authority to him. It was also noted that while the dual-track design was primarily an outcome led to by Zhao, the key idea of the MRS came from Deng. (87) Apart from Deng, Zhao, and Chen, there were other leaders of independent strength who contributed to the reform process. (88)

In case of the USSR, almost everything seemed to depend on the mercurial personality of Gorbachev, who unfortunately, as noticed above, had a shallow understanding of economics and also politics. To make matters worse, the other major personality of the Soviet reform drama, namely Boris Yeltsin, for various reasons, became an adversary and ultimately the preeminent enemy of Gorbachev as the leader, CPSU as the party, and the USSR as the state.

Regional decentralization

Another factor that worked in favor of evolution of the Chinese reform design is regional autonomy and decentralization, allowing Chinese reformers to experiment more freely and then choose for replication at the national level reform measures that proved successful at the province level. Thus, Zhao could initiate and test out SOE reform experiments in Sichuan province, before these were promoted for adoption at the national level. (89) By contrast, the USSR, though formally a union of sovereign republics, was much more centralized, both economically and politically, so that the scope for regional experimentation was paradoxically more limited. True, the idea of experimentation was not unknown to Soviets, and they sometimes did experiment at sectoral and enterprise levels. However, the 1987 LSE, with its momentous switch from edinonachaleye to WM, was introduced without much experimentation. Soviet leaders failed to direct nationalist passions of constituent Soviet republics towards economic reform and experimentation, rather than towards political separatism.

The Soviet failure to learn from the Chinese example

The Soviet failure at successful designing of the SOE reform is striking in view of the fact that they had the opportunity of learning from the Chinese experience. Though the Soviet and the Chinese SOE reforms analyzed in this paper were contemporary, the SOE reform under Deng actually preceded that under Gorbachev. By 1985, when Gorbachev came to power, the Chinese had already arrived at their dual-track system and were moving toward chengbao, which they adopted in 1986. Several Soviet scholars actually urged Soviet leaders to take note and learn from the Chinese experience. (90) Unfortunately, Soviet leaders did not pay much attention to such pleadings. (91)

Proximate reasons for contrasting performance with regard to the implementation mechanism

With regard to the implementation mechanism, it may first be noted that the Chinese reformers needed seven years, from 1978 to 1985, to arrive at the dual-track system and another year to arrive in 1986 at chengbao. By contrast, between 1985 and 1989, Gorbachev had only four years in power before things crashed down on him from all sides. It may therefore be argued that Soviet reformers would also have arrived at an effective design and implementation mechanism if they had more time for learning. Thus, it was the loss of implementation capacity that proved fatal for the Soviet SOE reform process.

Yet, when Gorbachev came to power, there was no sign of any instability of the Soviet power. As Popov (1991, p. 308) notes, but for Gorbachev's initiatives, 'the old system could have easily survived another 10 or 20 years'. The question that arises is: Why did Soviet leaders lose their implementation capacity so soon?

The Soviet reduction of economic reform to political reform

It was noted in the section 'Implementation at the Macro Level' that the Soviet reform effort took a pivotal turn in June 1987, when Gorbachev put forward the thesis that economic reform was not possible without political reform, thus subsuming the former under the latter. It is the acceptance of this thesis that led to the Soviet political reform process which at the end led to the loss of implementation capacity. So an important question in judging the contrasting performance with regard to the implementation mechanism is to determine whether the 1987 thesis was valid or not.

The first fact of note in this regard is that, until the adoption of LSE (in the same June 1987), Gorbachev did not actually take any major economic reform initiative, limiting himself instead to steps that were very much a continuation of the past (such as campaigns for uskoreneye, Stakhanov movement, Brigade system of labor, implementation of the 1983 Law on Labor Collectives, etc). (92) It therefore seems very illogical to complain about resistance to economic reform when reform itself was yet to be initiated. Second, as noticed earlier, the centerpiece of the 1987 LSE and the single most important economic reform initiative of Gorbachev was introduction of WM that implied erosion of power of the SOE directors, party secretaries, and trade union chiefs, who were among the most important members of the Soviet power structure. The fact that Gorbachev could get such a law approved showed that whatever resistance there was in the party toward economic reform was not strong enough to thwart Gorbachev's initiative. These two facts together suggest that the 1987 thesis that economic reform was not progressing due to political resistance did not have much basis. (93)

Success and failure in identifying the strategic link of the chain

Even if it were granted that there was resistance within the party to economic reform, it was the job of the leadership to steer the reform skillfully despite the resistance. As noted in the sections 'External environment', 'Internal incentive structure', 'Implementation mechanism at the enterprise level' and 'Implementation at the macro level', the Chinese reformers also faced considerable resistance, which was at times so strong that it forced into retreat even Deng, not to speak of Zhao. A particular example is provided by the abandonment during 1981-1983 of Deng's idea of MRS that was under implementation during 1979-1980. (94) Similarly, Zhao had to see many of his steps toward dual-track reversed during 1981-1983. However, Chinese reformers persevered, promoting reform as much as possible under the circumstance, letting time work in their favor, and making deft use of opportunities when these arose, as Zhao did in 1984 to freeze plan in an apparent concession to plan, knowing well that the step would lead to eventual shrinkage and eclipse of the plan. Similarly, following 1988 Tiananmen events, when the future of the Chinese reform again became uncertain (in face of strong resistance of conservative elements, who gained upper hand at the center), Deng made deft use of his historic Southern Tour in 1992 to rally support for his reforms, particularly from southern provinces, which benefited the most from these reforms, and thus to turn the tide. The whole Chinese reform process is full of such skillful use of opportunities by the leadership in order to overcome resistance and push the reform process forward.

There is in fact a parallel between the contrast between the big bang and gradual approaches to reform and the contrast between the big-push and 'unbalanced growth' approaches to development. In expounding his theory of unbalanced growth, Hirschman (1958) noticed that it was often not possible to engage in an across-the-board effort, so that one has to identify particular tasks that are feasible under the circumstance but are also of strategic nature, so that their implementation has cascade and ripple effects, bringing about other changes that taken together lead to a qualitative transformation of the overall situation. Thus one needs to identify the strategic link of the chain, and concentrate effort on that link. Introspection shows that this idea is applicable to the task of reform and transition too.

The Chinese reformers indeed succeeded in identifying such a strategic move in the form of introduction of the dual-track system. Obviously, in the Chinese political context of 1978 or even 1984, the proposition of a general switch from plan to market was not acceptable, and actually did not occur even in the mind of the reformers themselves. However, introduction of a market-track alongside the plan-track was then acceptable and feasible. Yet, this apparently small step let market influence the entire SOE behavior even when the actual share of the market track in the total SOE production remained small. It changed the entire dynamics of the SOE sector and ultimately led to the transition from plan to market. The Soviets, unfortunately failed to identify such a strategic move in the economic front. Instead of introduction of the market-track, they introduced WM, seeing great potentiality in it to improve the performance of SOEs and to bring about a renewal of the economy as a whole. Unfortunately, it proved to be a wrong move.

Gorbachev's failure at identifying strategic moves in the economic front contrasts sharply with what he ended up doing in the political front. Surely, removal from power and dissolution of the CPSU would have been an unacceptable and absurd proposition in 1988. However, the proposition of introduction of multi-candidate election was feasible, and Gorbachev therefore managed to get it accepted. Yet this apparently small step triggered a process that ultimately led to the removal from power of CPSU and its dissolution. (95) The small opening that was created through the electoral rule change in 1988, in a matter of just three years, led to the takeover of the Soviet power structure by non- and anti-Party forces. The process was parallel to what happened in the economic sphere in China, where a small opening in the form of introduction of the market-track within dual track, in the course of couple of years, allowed market forces to take over the world of plan. Unfortunately, whereas the Chinese move worked in favor of the SOE reform, the Soviet move led to its failure.

Adventurism versus pragmatism

The proximate cause of the contrasting reform outcomes and paths in China and the USSR therefore lay in the realm of politics. The Soviet leadership (Gorbachev and his associates) proved to be prone to adventurism, rooted in a shallow understanding of the economic and socio-political situation. So far as SOE reform is concerned, this adventurism found manifestation in, inter alia, (i) subjecting the entire SOE production plans to uncertainty by making the demarcation between the plan and dogovor parts arbitrary, unclear, and poorly enforced, (ii) rash introduction of the worker management system without adequate prior experimentation and without any anticipation of possible worker-management conflict, (iii) introduction of LoC without adequate complementariness with the LSE, etc and without consideration to the possibility of a premature turf war between SOEs and newly formed cooperatives, (iv) prematurely calling for family farms instead of patiently implementing the feasible zueno reform, etc. Gorbachev displayed a rather cavalier attitude by plunging into political reforms before making any headway with economic reform, and being oblivious to the necessity of the party to provide the implementation capacity to carry out economic reform. (96)

The Chinese leadership, by contrast, displayed remarkable pragmatism. (97) Just coming out of the Cultural Revolution and having experienced the previous Maoist adventure of Great Leap Forward, the Chinese leadership represented by Deng was loath to adventure. (98) They were also intent on seeing economic progress, because they had had enough of political adventure during the 10 years of Cultural Revolution. (99) Furthermore, they were aware of the tremendous economic progress that neighboring Asian states, including economies populated by their own ethnic counterparts (eg Taiwan, Hong Kong, and Singapore), have achieved. They wanted to emulate that achievement and were prepared to try almost anything that would help them to attain that goal. (100) At the same time, they were aware that it was CPC that liberated China from several centuries of semi-colonial subjugation, and it was CPC that can ensure China's territorial unity and political integrity, at least at the present stage, and lead the Chinese society to whatever the goal is. Hence they did not want to put the leadership role of the party to any risk. Thus the political leaderships of the two countries differed in a fundamental way, and it is this difference that proved more important in its immediate sense than differences in the economic structure.


The comparative analysis presented in this paper shows that SOE reform processes in China and the former USSR in the 1980s differed markedly in terms of both design and implementation mechanism. These differences led to very different outcomes, which in turn set Russia and China on to contrasting reform paths in the 1990s. The structure of the economies of the two countries differed, and these differences did influence the course of their reforms. However, these structural differences were not the main immediate reason why Russia plunged into big bang in 1992, while China continued along the gradual path. The proximate causes of the differences in the design and implementation mechanism lay in the realm of politics, namely in the failure of the CPSU to come up in time with an effective reform design and implementation mechanism and in the success of the CPC to do both. Therefore, it cannot be ruled out that under a more astute leadership even the USSR could have followed the gradual approach to transition from plan to market.

Of course, the Chinese SOE reform did not end in 1988. After the political turmoil of 1989, the SOE reform reached a new stage when reforms resumed in 1992 following Deng's southern tour. Whereas the SOE reform during 1978-1988 remained confined primarily to changes in management (without changes in ownership), reforms beginning in 1992 started to involve ownership transformation through corporatization, equitization, listing in stock exchanges, and sale of shares. The process has led to the conversion of many SOEs into State Controlled Enterprises (SCE), whose controlling share belongs to the state. A large part of non-state share of many SCE was actually owned by other SOEs or SCEs, local governments, etc, so that, despite the pluralization, the ownership to a large extent still belongs to the public sector. For a long time, the state's share of SECs was non-tradable, guaranteeing continued state control over these enterprises. Since 2005, the state share has been made tradable, setting off a process of further transformation of ownership.

However, the retreat of market fundamentalism in the face of the 2008 financial crisis and the accompanying recession seems to have made the Chinese leadership more cautious with regard to further transformation of the ownership of SCEs. In fact, according to some press reports, the Chinese government recently has renationalized some enterprises. Thus, where the Chinese SOE reform (for that matter the overall reform) process will finally end stills remains an intriguing question.

Many have propounded the notion of internal evolution of China into a run-of-the-mill capitalist economy. Others have put out the hope of China blazing the way towards a different type of post-capitalist society. The Chinese leadership itself continues to profess its goal to be 'socialism with Chinese characteristics', without providing the concrete specifics. However, even if this professed goal proves to be a mirage, and the Chinese economy evolves into a regular capitalist country (of the OECD variety), CPC will deserve the credit for guiding the huge Chinese society through the transformation orderly and successfully, ensuring about 10% GDP growth rate for more than three decades now, rather than letting the economy and the country into a free fall, as CPSU has done. Why CPSU, the older and apparently more sophisticated party, failed where CPC, a younger and apparently less sophisticated party, succeeded is a fascinating question, the exploration of which however remains beyond the scope of this paper.


The author would like to thank three anonymous referees and the editor, Josef Brada, for their comments that helped to improve the paper. Earlier versions of the paper were presented at the annual conference of Western Economic Association International (WEAI) held in Hawaii in July 2008, and at the 9th Pacific Rim conference of the WEAI held at Ryokoku University, Kyoto, Japan, in March 2009. The author is thankful to the participants of these conferences who commented on the paper. The author is particularly grateful to Vladimir Popov, whose considerable previous research on the subject provided a useful point of departure for the current paper. In addition, he helped the author through helpful discussions, providing data and information, and assisting in preparing several graphs. The author is also grateful to Andrei Klepach, Margarita Prokofiev, Dimitry Prokofiev, and Andrei Yakovlev for helpful discussions and support. The author alone is responsible for remaining errors and shortcomings. The views expressed in this paper are author's own and may not be ascribed to organizations with which he is associated.


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(1) For earlier comparison of the Russian Big Trough with the US Great Depression, see Campos and Coricelli (2002, pp. 793-794), who acknowledge that the Russian output fall was unexpected, and quotes from both Blanchard (1997) and Kornai (2000) to support this view.

(2) Some authors, such as Shleifer and Treisman (2003), try to discount the impact of the Deep Trough on Russia, claiming that Russia has now become a 'normal country'. Many observers however do not agree with this view, made all the more suspect, in their view, because of Shleifer's personal involvement in administering shock therapy to Russia. See, for discussion, Popov (2009b), Rosefielde (2005) and Zhuravskaya (2007).

(3) First, the recent Russian GDP recovery has been to a great extent due to high oil prices, and hence may not be very robust. Second, the way privatization was carried out in 1993 and 1995 has left Russia with a capitalist class that still lacks social legitimacy, so that Russian capital and capitalists tend to flee to Western countries. On the other hand, those parts of the Russian economy that remain under the state ownership lack many pre-conditions necessary for efficient market functioning. See, for example, Goldman (2003) for discussion of these issues.

(4) Indeed, commenting on the Sachs and Woo (1994a) article, Stanley Fischer (1994, p. 146) note that 'We should not forget that these are very early days to judge gradualist versus big bang reforms in EEFSU'.

(5) It may he noted here that Sachs suffers from some vacillation and contradiction with regard to characterization of China's approach to reform. On the one hand, he cannot deny that China followed the gradual approach. On the other hand, in order to discount the gradual approach and

buttress his claim of superiority of the big bang approach, he sometimes attributes even China's success to the big bang approach. See Islam (2008a) for discussion of Sachs' vacillation and the reasons behind it.

(6) See, for example, Goldman (1992, 1994) and Popov (1991).

(7) See, for example, Goldman (2003).

(8) They add that 'industrial reform might have posed a more difficult task in China due to the presence of many small scale facilities in addition to the usual large ones that were common in all centrally planned economies' (Nolan and Ash, 1995, p. 994).

(9) As Naughton (1995, p. 7) notes, despite the large agricultural sector, 'industry is the main character in the (Chinese) reform drama'. Similarly, Jefferson and Rawski (1994, p. 47) note that 'industry stands at the core of China's reform problem'.

(10) See Nolan and Ash (1995) for discussion of similarities and differences of the industry sector in the former USSR and China. In general, as Naughton (1995, p. 26) notes, 'Command economies share certain fundamental characteristics, and thus the problem of transition from a command to a market economy poses similar challenges, whether carried out in Eastern Europe or China'.

(11) As Nolan and Ash (1995, p. 996) note, 'a comparative analysis of China and the former USSR indicates that the two countries shared important similarities at the start of their reform programmes'.

(12) The discussion of the Chinese SOE reform in this and the remaining sections reform draws upon the excellent works of Naughton (1994, 1995), who provides probably the most insightful analysis (in English) of the Chinese SOE reform. See also Byrd (1987), Field (1984, 1992), Jackson (1986), Lau et al. (1997, 2000).

(13) As Naughton (1995) informs, although the step was taken without any fanfare, it was very significant since differentials between plan and market prices were generally quite large.

(14) See Naughton (1995) for details.

(15) See Byrd (1987) for more detailed discussion of this issue. Byrd actually thought that with the introduction of the dual track, the reform of plan prices had become a redundant issue. As he put it 'At a fundamental level, the issues of market allocation and to a lesser extent price reform have become a passe, and they no longer need to be the prime concern for reformers' (p. 307).

(16) For discussions about Gorbachev's initial steps in the economic sphere and their inadequacies, see, for example, Battle (1988), Gagnon (1987), Popov (1991), Shmelev (1988), and Shmelev and Popov (1989).

(17) As IMF et al. (1991, p. 23) note, Gorbachev's attempts to revive the economy 'faltered at a disappointingly early stage'. See also Fischer (1993).

(18) The Law uses the Russian word "yarmark' which is different from 'rinok', the more straightforward Russian counterpart of the English word 'market'. This particular usage also reflects the reluctance on the part of the drafters of the Law to accept the option of market.

(19) Other components of the proposed reform package included payment of fees to the budget for fixed capital and to banks for working capital and gradual transformation of budgetary investment grants into repayable interest bearing loans. But these were largely ignored.

(20) As a result of the cost-plus method, the world of plan prices was like a hall of mirrors, with each price reflected on prices of others, and any change in one of them having cascading effects on prices of all others.

(21) See Naughton (1995, p. 239) for details. The arbitrary price and profit structure also acquired certain regional dimensions, because, for example, the coal producing western provinces had more enterprises earning low profits while eastern, coastal provinces had more enterprises producing consumer goods and hence enjoying higher profit rates.

(22) See Naughton (1995, pp. 99-103) for details.

(23) See Naughton (1995, pp. 122-123),

(24) Interestingly, the origin of the 'tax-for-profit' system can actually be traced to the initial reform of 1979-1980, when, in trying to go beyond the 'profit retention' system, the 'tax for profit' system was introduced to a very limited number of SOEs in January 1980. Under this system, SOEs paid 'four taxes and two fees', among which were capital charges, resource taxes, sales taxes, and income tax. However, the experiment could not go further due to the reversal of reform as a whole in 1981.

(25) It is important to note that though the taxes and fees were supposed to whittle away rent components of the accounting profit, the 'tax-for-profit' scheme was supposed to he preceded by a comprehensive reform of plan prices so as to create a level playing field for the enterprises (leading to equalization of profit rates}. Thus the 'tax-for-profit" scheme per se was not an alternative to the goal of comprehensive price reform. See Naughton (1995) for details.

(26) In a sense, the idea of 'Manager Responsibility System (MRS)' goes back to early 1960s when Deng, as General Secretary of CPC-CC, found himself in charge of reviving the economy following the disaster of the Maoist Great Leap Forward. Confronted with the task, Deng presided over formulation in 1961 of the '70 articles on State Industrial Enterprise Work' that emphasized clear delineation of personal responsibility, authority, and incentives. Deng returned to this theme when in 1973 he was once more put in charge of rehabilitating the economy following the disaster of the Cultural Revolution and supervised drafting of the State Planning Commission document, 'On Several Questions of Accelerating Industrial Development'. See Naughton (1995) for details. See also Lee (1986) and Walder (1989, 1995).

(27) See Mises (1935), Lange (1936, 1937), and Hayek et al. (1935) for this debate.

(28) They noted that managers still lacked the incentives to become 'true profit maximizers', and hence saw much benefit in dual-track, because it allowed managers to become accustomed to operating in actual market environment and pick up the necessary managerial skills.

(29) First round contracts signed during 1986 and 1987 were mostly with individual managers, though in some cases contracts were signed with management groups or the work force as a whole too. See Naughton (1995, pp. 217-218) for details.

(30) In practice, many different concrete forms of the auction and bidding process arose, and the government tried to ensure that the auctions were genuine and not stage-managed. Some evidence of government's success can be seen in the survey in Hebei province showing that about half of the enterprises had their managers changed as a result of the auction. By 1988 most SOEs were operating under long-term contracts signed in 1987 or earlier. See Naughton (1995, pp. 216-218) for details.

(31) As Naughton (1995, p. 214) notes, in such a system, the state, instead of earning revenues from its assets as collector of capital fees and taxes, earns a quasi-market return on assets in its role as the owner of those assets. The return is determined by competition for the right to manage instead of accruing as fixed interest payments as would be the case if capital fees were charged.

(32) The idea was advanced mainly by the IGPAN (Institute of State and Rights) of AN-USSR (Academy of Sciences of the USSR) through its journal SGiP (Soviet State and Rights), edited by Kurashvili, and also the Novosibirsk Division of the USSR Academy of Sciences (led by Aganbegyan and Zaslavskaya) through its journal Eko. However, there were differences of opinion among advocates of workers' council regarding its exact jurisdiction. While these intellectuals advocated the right to the selection of the manager, others had a more limited view of the jurisdiction. According to some Soviet scholars, setting up of workers' councils was to be complemented by creation of independent labor courts. See, for example, Moses (1987) for further details.

(33) The same was the case with the Soviet 1977 Constitution, Article 8 of which enjoined that 'Work collectives promote socialist emulation, the spread of progressive methods of work, and the strengthening of production discipline, educate their members in the spirit of communist morality, and strive to enhance their political consciousness and raise their cultural level and skills and qualifications'.

(34) For example, soon after Gorbachev became the General Secretary, the CPSU Central Committee adopted a resolution on 28 June 1985 expressing support for the idea, criticizing several Belorussian enterprises for failing to implement the intent of the 1983 Law on Labor Collectives. See Moses (1987, p. 220) for further discussion.

(35) Apart from brigade leaders, members of party, trade union, komsomol organizations, and members of the administration could also be elected to the Soviet, though their number was not to exceed one-fourth of the total number of members of the Soviet. Also at least one-third of Soviet members were to be new in each election cycle.

(36) Meetings of the Soviet were to be held as necessary, but at least once every quarter. The members of the Soviet were to serve on a voluntary, social work basis.

(37) The Law further stipulated that this principle of election will apply to leadership at all levels, down to that of the brigade leaders.

(38) Although Article 6 of LSE mentions edinonachaleye, it is now the edinonachaleye of a director, who in turn depends on the labor collective and its soviet to be elected and remain in the post.

(39) Naughton (1995, p. 504) notes that Deng was 'constantly exhorting the Party' and relying on party mobilization to carry out economic policies. For Deng, CCP was the 'major actor'.

(40) Naughton (1995, p. 511), for example, notices that, as a result of the continued party leadership, 'the chain of command within the state sector has been maintained intact'.

(41) This thesis absolutized political reform, reducing economic reform itself to political reform. At a conference held in 1987, Leonid Abalkin, a Gorbachev's economic adviser, concluded that 'deep transformations in the management of the economy cannot be realized without corresponding changes in the political system'.

(42) For discussion of Gorbachev's steps toward introducing democracy in the USSR, see, for example, Gooding (1990), Popov (2000, 2007), Shlapentokh (1988), and White (1990).

(43) The existing Supreme Soviet consisted of two chambers, one based on popular representation and the other based on representation of nationalities. In its place, Gorbachev suggested a single chamber Congress of People's Deputies, comprised of three parts, with the first based on popular representation, the second based on national representation, and a third based on representation from CPSU and mass organizations. This 2,250-member body was however to elect a 542-member smaller body of permanent standing, called (again!) Supreme Soviet. Thus the new State body would effectively have two chambers too.

(44) At this time he also got himself elected as Chairman of the Presidium of the Supreme Soviet, thus combining the positions of the head of the state and the chief of the Party. The existing Supreme Soviet dissolved itself after approving these constitutional and electoral rule changes.

(45) Nevertheless, 87% of the newly elected CPD were CPSU members, including party stalwarts. Even Boris Yeltsin could find a berth on the Supreme Soviet when another member relinquished his position in favor of Yeltsin. Gorbachev got elected unopposed as Chairman of the Supreme Soviet. However, as a commentator observed, 'The first CPD was the last moment of real control for Gorbachev over the political life in the Soviet Union'.

(46) It ran for two weeks and was televised in its entirety. As one commentator noted, 'Deputies from all around the country railed against every scandal and shortcoming of the Soviet system that could be identified without sparing Gorbachev, KGB, or even the military'.

(47) How Boris Yeltsin metamorphosed from a CPSU leader into the leader of the Opposition is of itself a fascinating and crucially important story, which is however beyond the scope of this paper.

(48) Apparently he did this to insulate himself from removal from power by CPSU conservatives. This was the third time in 18 months that Gorbachev assumed the office of the head of the state of the USSR. Anatoly Lukyanov became the Supreme Soviet Chairman, a post which was no longer (for the first time in Soviet history) equivalent to that of the head of the state, and now became closer to that of the Speaker of the parliament.

(49) As Popov (1991, p. 323) notes, 'By the time of the 28th CPSU Congress in July 1990, the CPSU was regarded by liberals and nationalists of the constituent republics as anachronistic and unable to lead the country. The CPSU branches in many of the fifteen republics began to split into large pro-sovereignty and pro-union factions, further weakening central party control'.

(50) In particular, Jefferson and Singh (ed). (1999) provide detailed analysis of productivity improvement of Chinese SOEs under reform. See also Jefferson and Rawski (1994), Jefferson et al. (1996), Jefferson and Xu (1991), and Lau et al. (1997, 2000). For a critical view, see Woo et al. (1994).

(51) See Naughton (1995, pp. 236-239) for further details. This also explains the apparent puzzle of productivity improvement of Chinese SOEs while at the same time their profit rates declined.

(52) See, for example, IMF et al. (1991) and Popov (1991, 2000, 2007) for discussion of consequences of Gorbachev's economic reforms.

(53) In a sense, SOEs were reaping the rent opportunities created by distorted Plan prices.

(54) NMP stands for Net Material Product, which was the measure of economy's output used by the former USSR and many other socialist countries. The main difference between NMP and the conventional GDP is that the former generally excluded services.

(55) The average monthly wage increased by about 9% in the material sector as a whole.

(56) For further details, see IMF et al. (1991, pp. 27-28).

(57) Domestic debt was 20.5% in 1987 and 30.3% of GDP in 1988. In absolute terms, the state deficit grew from 0 to 109 billion rubles between 1985 and 1989. As Gorbachev himself acknowledged in October 1990, 'we lost control over the financial situation in the country. That was our most serious mistake in the three years of perestroika' (The New York Times, 20 October 1990, quoted in Marshall Goldman (1991a, b)).

(58) As Popov (1991, p. 307) notes, different ways to reduce budget deficit were discussed, but the so called 'radical' economists preferred the easy way out, namely printing money and external borrowing.

(59) According to Hewett (1990/1991, p. 147), the 'hot money" amounted to about 165 billion rubles (equal to about a half-year's consumption expenditures). See also Pipes (1990/1991).

(60) Since the Soviet SOEs never had to find customers and suppliers on their own, many of them found it difficult to cope with the new responsibility under LSE of procuring dogovors. See IMF et al. (1991, pp. 26-27).

(61) Lithuania declared independence on 11 March 1990; Estonia followed suit on 30 March 1990. Latvia also followed the same path on 4 May 1990.

(62) Among these are the Land Act, approved by the Supreme Soviet in February 1990, effective from 15 March, allowing farmers to lease land with lifetime tenure (thus going farther than the Chinese Household Responsibility System, which allowed 15-year tenure), though not ownership, and the possibility of inheritance. The Act however, prohibited sale and purchase of plots of land and use of them as collateral. The Law of Property of March 1990, effective from 1 July, allowed private ownership of small enterprises for family members and 'other persons, jointly operating labor based business'. In July 1990, however, the government issued a decree allowing small private businesses, with up to 200 employees. In June 1990, a government decree allowed the transformation of state enterprises into shareholding companies with possible buyout of part of the shares by individuals and other companies. See Popov (1991, p. 313) for details.

(63) Yeltsin received 57% of the vote, defeating Gorbachev's candidate Ryzhkov, who received only 16% of the vote.

(64) RSFSR stands for Russian Soviet Federated Socialist Republic, the formal name that current Russia had within the USSR.

(65) For discussion of the Russian privatization and its aftereffects, see, for example, Black et al. (2000), Blasi et al. (1997), Brainerd (1998), Friedman et al. (2003), Frydman et al. (1996), Hoff and Stiglitz (2004), Hoffman (2002), Klebnikov (2000), and Prakash and Mauro (2001).

(66) 'If our analysis is correct, the main source of the contrasting outcome under system reform in China and Russia must be difference in policy choice' (Nolan and Ash, 1995, p. 997). See also Buck et al. (2000).

(67) See Islam (2008b) for a general discussion of the role of surplus labor in China's industrialization.

(68) As Naughton noted, the rent-opportunities associated with the distorted Plan prices created a 'hot house' for the development of NSEs. See Islam (2008a), Naughton (1995), Sachs and Woo (2000) for a discussion of the various factors that led to the development of TVEs in China.

(69) In 1987, cities and their subordinated areas comprised 58% of the population, 91% of state industrial production, 87% of non-state industrial output, and 77% of rural industrial output (meaning output of village collectives and below-village cooperatives and private businesses). Thus even rural industry was concentrated in peripheries of cities and not in the remote hinterland. Rural industries were also concentrated in coastal areas. Thus Jiangsu, Zhejian, and Shandong (which had only 17% of China's population) accounted for 43% of rural industry. See Naughton (1995, p. 147) for further details.

(70) For example, in the province level municipalities of Beijing, Shanghai, and Tianjin, about 60 to 80% of rural industrial output was produced by NSEs under sub-contract with SOEs. This share was higher in the neighboring provinces of Jiangsu and Zhejiang, for which links with Shanghai SOEs played a decisive role. In the southern Jiangsu town of Wangshi, each of the 93 TVEs in 1985 had some form of sub-contracting or joint venture relationship with SOEs of Shanghai area. Similarly, in the Changsu district under Suzhou city, of the 3,400 TVEs, over 1,500 had horizontal links with Shanghai, and in Wuxi municipal district, 2,055 NSEs were linked with urban SOEs. See Naughton (1993, p. 155) for further details.

(71) The phenomena of labor hoarding in centrally planned economies and the reasons behind it have been analyzed earlier by scholars, including Kornai (1992), who has provided a particularly detailed treatment of the issue.

(72) See Nolan and Ash (1995) for useful discussion about the presence and potential use of surplus labor in the USSR for reform.

(73) The LoC was very detailed, as was the case generally with other Soviet Laws, having 54 Articles and running through 22 pages of small print, specifying in detail different aspects of functioning of cooperatives. Earlier in 1986, the Soviets also introduced the 'Law on Individual Labor' to bring some order to the area of work by individuals outside their formal jobs.

(74) According to Article 19, Section 2, cooperatives could set their prices either in agreement with consumers or on their own. This right was however laced with many restrictions. For example, it also stipulated that the Soviets of People's Deputies may set limits to prices (and rates) of basic consumer goods produced and sold by cooperatives. Similarly, cooperatives were required to follow state prices in carrying out state orders, in producing output using state supplied inputs, and in retailing out products procured from the state, etc (see Article 19, Sections 3 and 4). Overall, despite many confusing statements, cooperatives were allowed to set their prices, as long as they were not producing under state orders, not using raw materials supplied at state prices, and are not distributing products procured at state prices from state and other marketing agencies. Thus, compared with SOEs, cooperatives had more independence over price setting.

(75) Article 25, Section 2 announced that cooperatives could determine on their own the form and system of wage payments.

(76) Having stipulated that tax rates for cooperatives will remain fixed for at least five years, LoC (Article 21, Section 2) authorized local Soviets to provide cooperatives tax concessions (in order to encourage production of items enjoying popular demand and in accordance to the Laws of the USSR).

(77) See IMF et al. (1991, p. 30), Narodneye Khozyatsvo SSSR 1991, and Economika and Zhiz'n, 1991 No. 20.

(78) Recall that in China there were no such restrictions, and sub-contracting by SOEs played an important role in spawning NSEs.

(79) As Blasi et al. (1997, p. 175) concludes, 'We believe that Gorbachev lost an important opportunity to use agricultural reform and a rapidly growing small business sector to stimulate the Soviet economy'. See, for example, Islam (2008a) and McKinnon (1994) for discussion of the role of agricultural surplus for the overall reform process in China.

(80) See Pospielovsky (1970) and Hedlund and Lundahl (1982) for discussion of the history and experience of Zuenos in Soviet agriculture.

(81) This situation in the USSR may be contrasted with that of China where it was the Commune members themselves who, practically in defiance of higher authorities, took the initiative to switch from communal farming to family farming.

(82) Naughton (1995, pp. 201-202) for example notes that 'There was no programmatic document that can serve as a guide to reforms in this period. In a sense, then, reform continued to develop in an evolutionary manner, without a single blueprint. Reformers continued to "cross the river by groping for stepping stones" and the different measures added up to a distinctive Chinese approach to economic reform'.

(83) The receipt of the Nobel Prize by the Soviet economist, Leonid V. Kantorovich for his work on linear programming was an evidence of the Soviet interest in this line of search for optimal prices.

(84) By contrast, planning in China was never really as comprehensive and tight, so that parts of the economy always operated outside the Plan, making it easier for the Chinese to accept formally the market track and market prices. See Naughton (1995) for details.

(85) An interesting question that arises in this connection is how the Soviets dealt with profit retention for their khozrashchet funds in face of differential profit rates caused by arbitrary Plan prices. As noticed, it was this problem that propelled much of the Chinese SOE reform. See Kushnirsky (1989) and Shmelev and Popov (1989) for discussions of this issue.

(86) While proposition for family farms embodied an extreme form of material incentive, Stakhanov movement basically meant repudiation of material incentive.

(87) See, for example, Naughton (1993), Pye (1993), Shambaugh (1993), and Yang (1993) for discussion on Deng's role in the Chinese reform process.

(88) Mention may be made of Hu Yaobang, the Party Secretary during 1981-1987, who took initiatives with regard to liberalization of thinking and expression of views. See Merle Goldman (1991) for a discussion on Hu Yaobang's role in the reform process.

(89) See, for example, Li Jingjie (1994), Li Linda Chelan (1997), Liu (1992), and Parris (1993) for discussion of examples and importance of experimentation at regional level for the Chinese SOE reform process.

(90) See for example, Palei and Radzivanovich (1990).

(91) Interestingly, Gorbachev visited China in 1989, coincidentally in the midst of the Tiananmen unrest. It is a matter of conjecture whether the Tiananmen unrest had any impact on the Soviet leaders with regard to their willingness to study and learn from the Chinese experience.

(92) See Slider (1987) for discussions about the brigade system of labor that was introduced in Soviet SOEs as a way to improve their performance.

(93) The very fact that people like Gorbachev and Yeltsin could rise to the top leadership of CPSU and the ease with which Gorbachev removed and sidelined many leaders in September 1988 Plenum also shows that whatever resistance to reform there was in the CPSU was not insurmountable.

(94) The opposition was so strident and the retreat of Deng was so clear that when his collected works were published in 1983, the passage advocating MRS was expunged from his speech that was included in the volume.

(95) Popov (2007) notes that one of the main reasons for institutional collapse in the USSR was that 'competitive elections were introduced before the rule of law was established'. Perhaps removal from power and dissolution of the CPSU were unanticipated outcomes of introduction of multi-candidate election, but that only shows the potency and the strategic nature of the move.

(96) It may therefore be said that Gorbachev's shallowness in economics found its match in his recklessness in politics. Unfortunately, adventure feels good only as long as it lasts, but it cannot last too long, as Gorbachev himself found out very soon. According to many observers, the subsequent descent of Gorbachev into advertizing for Pizza Hut, Louis Vuitton, etc, shows that he was probably too lightweight to be the CPSU General Secretary and to shoulder the great responsibility of transforming the Soviet economy and society.

(97) See, for example, Pye (1986) for a discussion on Chinese pragmatism in the 1980s. Also, see Goldstein (1995).

(98) It is well known that Deng suffered many personal losses due to Cultural Revolution and previous adventurist steps of Mao.

(99) By contrast, the half-century long political stability probably led to some boredom and ennui, making it easier for Soviet citizenry to accept the adventurist steps of Gorbachev.

(100) This explains Deng's dictum that 'It does not matter whether the cat is black or white. What is important is whether it can catch mice!" It also explains why Deng reportedly recommended postponement of discussion of ideology for 100 years, so that all attention can be focused on achievement of economic progress. Whether such postponement is possible or not is another matter. See Islam (2009, p. 44) for a discussion of the latter issue.


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Title Annotation:Regular Article
Author:Islam, Nazrul
Publication:Comparative Economic Studies
Article Type:Report
Geographic Code:9CHIN
Date:Mar 1, 2011
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