I. Proposition of the Problem

By far, China is a developing country and a transitional country. This determines that the general theories on stages of economic development [1] do not apply to China. Therefore, we need to extract and develop a new theory to investigate and summarize the stages of China’s economic development.

Now we limit the object to the economic stages since 1949. Several severe transformations have been witnessed since 1949 in regards to the society and economy of China, and the economic developments went hand in hand with these transformations. The problem we need to ask is whether there are characteristic stages. If the answer is affirmative, then, the questions lies in how these stages evolve, and how these stages are interconnected.

The explanatory theory of economic development always come from investigation and analysis of the historic facts, and the criterion to test whether the theory stands is its predictability. Therefore, a hypothesis or theory on the economic development stages should be able to review the past and foresee the future. In fact, the understanding of the history and its value lie more on its influence on the solution to the present problems and its forecast of the future.

In this article, what I’d like to address is the three stages of factor formation, optimization of factor allocation, and the innovations of factors of the evolution of national economy since 1949. China has passed the stage of factor formation(which is 1949-1978), and now China is almost approaching the end of the second stage of optimization of factor allocation. And now, China has come to a critical point before entering the new stage of factor innovation. The three stages are proposed in order to indicate the main intrinsic features of the different periods of economic development. This does not mean in certain stages(for example, the stage of factor formation) features of other stages (for example, stage of the optimization of factor allocation, and stage of factor innovation) will not exist. The features of different stages of economic development are not mutually exclusive. On the other hand, in certain stage of economic development in some countries(for example, the US in the turn of the 20th century), the features of the three stages coexisted and were all significant. And in some other countries and regions(for example, South Korea and Taiwan in the 1950s to 1970s), the formation of factors took an incremental path in the condition of the optimization of factor allocation. This difference is the concretely shown by the time sequence, dynamics, and evolutionary nature of historic development.

The unique feature of the different development stages in China is fundamentally attributed to certain historic conditions and the subjective choices people made under these conditions. If we take a dynamic evolutionary point of view, we would find: the current results of the choices under the given condition will be the factors and conditions that influence of the choices of the next stage. To be specific, as the administration after 1949 made certain choices to make “the socialist ownership of productivity materials the sole economic basis for the state and the society”, it led to the formation of a planned economy that featured with optimized ability to mobilize resources, which established the feature of the factor formation stage for China’s economic development. As the total amount of factors increased over time, the national economy- as a “big factory”- and its scale effective of economy(i.e., the marginal efficiency of the factor formation) will decrease. And when it decreased to a certain point from a marginal perspective, the efficiency of productivity factors optimized allocation will overtake the efficiency of factor formation in general. At that point, “the reform and opening-up”- in nature as the stage of “optimization of factor allocation” that follows the stage of “factor formation”- will come naturally. Therefore, the design of China’s early economic development path determined the features of the different stages of “factor formation” and the “optimization of factor allocation”. [Page]

II. The Separation between the Stages of Factor Formation and the Optimization of Factor Allocation

The founding of People’s Republic of China marked that the idealist and elitist Chinese Communist party officially obtained the decision-making power for China’s economic development path. “National industrialisation” meant the dual objective of industrialisation and nationalisation, which has become a consensus within the leadership of the Party. This choice was under the condition of low productivity level and uncertainty of the international environment, the unknown specific method and path for nationalisation, and a 15-year long “new democratic society” which allowed the co-existence of private capitalist industries and commerce. The corresponding “superstructure” was the Common Program that acted as the temporary constitution, and the “National Committee of the Chinese People’s Political Consultative Conference”(CPPCC) that was different from that of the Kuomintang (the Chinese Nationalist Party). Even so, the strategy of “exploitation” and “containment” of the non-socialist factors in the social production shifted the focus to containment and anti-containment, and a basic method of limiting the wage, tax, and market, which was included in written form in the programatic documents before 1949.  Therefore, the transitional characteristics of the new democratic economy, at least for the leadership of the Chinese Communist Party, were apparent. Mao Zedong once made it very explicit that the transition to a socialist society had already begun since 1949.

The path for industrialisation, i.e., to “transform the less developed agricultural China into a developed industrialised China”, was a main strategy for many less developed countries in the mid-20th century. Besides, it was not rare to see under the market economic structure, there was government intervention and guidance, especially in the areas of heavy and chemical industries where state-owned economy dominated investment and management, even in self-claimed capitalist developing countries. Therefore, the aim of nationalisation in the industrialisation strategy proposed by the Chinese Communist Party was the real unique feature of the choice of development path for China(and the former member states of Soviet Union). Fundamentally, this choice is

As the basic framework for China’s development path was determined, the choice of the time frame, detailed methods, and methodology were then determined by the objective conditions and the practice of the Chinese Communist Party. The eruption, development, and the outcome of the Korean War had a major influence on the development and the transformation of China’s economy and the political system. Firstly, China sent army into North Korea and fought the United Nations Forces led by the US. This act helped China win support from the former Soviet Union as it showcased China’s position in politics and economics with great sacrifices and unexpected results. This also resulted in the enhancement of China’s state-owned enterprises; [2] Secondly, the result of this war completely shattered the illusions of other political clans for a similar polity like the US and UK in China. They were, then, aware of the capability of the CPC to mobilise and organise political and military resources, and the tremendous influence of the Soviet Union system on maintaining state sovereignty and national security. Thirdly, the Korean War stimulated the demand of domestic heavy industries, which further drove the development of other industries. It also helped to form the strategy of the CPC to drive civic industries by promoting military industries. Lastly, as there were some speculators who provided under-qualified products to the armies in the front line, the CPC then enhanced its propaganda against capitalist industries and businesses, and brought about the three-anti/five-anti campaigns, which upheld state-owned industries as the main body of the national economy.

The struggle of the two forces in politics and economics provided opportunity and conditions for the institutional evolution of nationalisation. As the trials and errors went on during the recovery of national economy, one institutional reform path got clearer: from mutually benefiting groups to cooperative societies, which led to the collectivization of agriculture; in the form of national capitalism, reform of capitalist industries and commerces was undertaken; and by employing cooperative societies, handicraft industry was integrated into the socialist road. This solution of the “Three Great Transformation” was later entitled a total road for the transitional period and recognised during the months-long summer meeting on fiscal and economics in 1953 by the CPC.

Even though the aim of “peaceful transformation” was met as the “socialist ownership of productivity materials” was completed by the “Three Great Transformation”, this transformation was still a compulsory and coercive case of institutional evolution. Seemingly, coercion can be considered the antonym of “voluntary contract” and it mostly has something to do with violence and threatening. However, coercion can also be deemed as a contract, that is, a special contract that encloses a clause stipulating “punishment will be taken should this contract was not to be made”. Therefore, as long as there is a third party(or the contracting party itself) changes the original “pay off function” of the contracting party under a context of different options in a certain way, a contracting relation of a peculiar kind which seems to be voluntary but actually is compulsory can be made. Obviously, compared to the voluntary contract in a society of rule of law, this form of contract is neither just nor efficient. Hence, compulsory institutional evolution can be completed nonviolently with the attempt of interest. Difference (in the comparison between this contract form to attempt-driven institutional evolution) lies in the fact that the government(or the organisation that’s in charge of governance ), in the broad sense, as the their party(or the contracting party itself), directly pushes the evolution of property right institution by influencing the new type contract, instead of fulfilling its role in the recognition and implementation of the new type institutional arrangements(when the contracting party chooses the changed conditions).

After the land reform, many Chinese farmers acquired the most important productivity material that they needed the most: land. Before long, gap between the rich and the poor began to emerge. Some professionals, with the tenancy system abolished, were able to accumulate some agricultural surplus which was used to buy other productivity materials including oxen, horses, and waterwheels. In order to fully exploit the productivity materials, new forms of cooperation came into being. These forms of cooperation were established on a voluntary basis and their premise was the Pareto optimisation that generally improves the interest of all the collaborators even though the distribution of newly acquired interest is not equal. If the cooperation went well, some cross-vocation collaboration could shift from seasonal to year-long projects.

However, as the CPC entities of all levels promoted and advocated, cross-vocation collaboration developed well as human beings were positioned against individual economy and the positive side of the collaboration was exaggerated. And it was clearly stated that such collaboration was built upon the collective labor of individual economy(the basis of farmers’ private property), and its perspective was the collectivisation of agriculture and socialism[3]. It was not hard to imagine that the CPC entities adopted differentiated and clearly favourable policies and handling towards collaborations instead of individual labor(Bo Yibo, 1991, P196) in terms of credit and loans, provision of new agricultural instruments, awards of examples, and organisation disciplines. By doing so, some individuals were attempted to join the collaboration group because of the “interest” , that is the opportunity cost. If the award of cooperation was enough to attract some of the capable farmers, for those poor and intermediate level farmers with ordinary capabilities, it was obviously not reasonable to turn down the contract.

After the master road of the transformation period, the collectivisation of agriculture developed by leaps and bounds. The types of collaborative organisations were also shifting from cross-vocational entities to more collectivised elementary society and advanced cooperatives. With this process, the CPC turned the activity of two respects, namely, the activity of individual economy and the mutual aid, to a demonstration of the dual nature of the identity of farmer who were the labourer and the private owner. Besides, “the incentive to cooperate developed from the nature of farmers who are also labourers, and this incentive could lead farmers to socialism; while the incentive of individual economy developed from the nature of farmers as private owners and the vendors of produces shows that the natural trend of farmers is capitalism. This fact inevitably lead to the struggle of the two paths which are the socialist and the capitalist paths of development. With the recovery and development of agriculture, the struggle of these two paths becomes more and more apparent and difficult to ignore.” [4]

The process of China’s agricultural collectives developing from rudimentary level to advanced level is, in fact, a process where individual decision-making was interrupted as the private ownership was lost, in the meanwhile, it is also a process where public decision-making, by corroding private ownership, gained momentum and expanded. From elementary aiding organisations to elementary society, members could obtain benefits based on the land they owned, and compensation for the farming equipment they had. Individual decision making underpinned by incomplete private ownership still was in effect. In the process of elementary society to advanced collectives, all the production resources was put together without compensation, and the benefit of the land was exploited. By doing so, the individual decision making was extinguished and replaced by collective public decision making.(ZHANG Shuguang, ZHAO Nong, 2002). Therefore, what’s difficult to believe is, under the condition of mutual imposition of externalities, the agricultural collectivism could be achieved by unanimous agreement of true voluntariness. As the cooperatives went on, the distinguished treatment featuring bonuses seemed uneconomical and impossible. Hence, another path with direct punishment being a main way of treatment took place, that is by adopting the “struggle of the two roads”.

The cooperatives, born of a movement of cooperation developed by discrimination, coercion and the high trust and gratitude of the general poor farmers towards the Party, found it difficult to be advantageous over individual labor and mutual aids based on voluntary and mutual benefit, even though it did possess some advantage in fronts of construction of agricultural and aggregation facilities and the promotion of new technologies. However, this simple fact was never spoken of or considered by the decision makers. Many local organisations chased a motive of more produce in the national competition of cooperatives and these organisations abandoned other sideline industries so that they could investment more labor and materials into productivity. Yet the cooked up books of the production motivated the decision makers to make bigger plans. In fact, “the more developed the cooperatives are, the better” is more of a faith than a fact. It was the new dress of the emperor. Therefore, “to ensure private ownership” in order to maintain the motivation of agricultural productivity was demeaned as “misunderstanding of the decision and an act of bribing the people by giving small favours”. In terms of slowing down the development of cooperatives by investigating and correcting the behaviours of cooperatives was scored as a “small-feet woman” with “too much judgement, improper complaints, and numerous disciplines and codes”. The easement within the Party always meant that life-long faith prevailed. It was not difficult to tell why collectivisation developed so fast and “successful” by taking a brief look at the environment of the villages and the proportion of the different ranks of farmers.

 “To implement the nationalisation of private industries” was one of the preset goals.[5] It located the end of China’s private industry and commerce. It was only at the beginning when the conditions were not mature that there was still a short “honeymoon” for the so-called“ mutual benefit for the labourers and the capitalists”. Even so, the “New Man” of the People’s Republic of China was surrounded by the “Alarms” of “exploitation” and “limitation”. Since the beginning of the founding of the PRC, the Party acquired the monopoly over international trade and a series of powers to constrain capitalist industry and commerce by taxation, credit, and the relation between the labourers and the capitalists. After the three-anti/five-anti campaigns, the social status and reputation of domestic capitalists had deteriorated. In the meantime, the integrity of the internal authoritativeness of private commercial enterprise was lost by “disclosure of capital ” and “democratic evaluation”. As the state-run industry and commerce and the agricultural cooperation took momentum, “the socialisation of capitalist industry and commerce” was undertaken in the form of “state capitalism” by manufacturing, ordering, collective purchase, guaranteed sales, and public-private partnership. It was also taken under the national planning, which was a plausible approach for “nationalisation”. [6]

It must be pointed out that the so-called “redemption” and “peaceful transition” was, just like the agricultural cooperation, coercive and compulsive institutional transition. In the early 1950s, the country was in a bad condition. The “low level state capitalism” that adopted manufacturing, ordering, collective purchase and guaranteed sales, and the “advanced” public-private partnership forms, compared to capitalist industry and commerce, were beneficial. With stable sources for commodities, sales channels, and the specially designed relation between labourers and capitalists and the support of credit, the risk for investment and management was greatly decreased, which enabled capitalists to have a comparatively stable inflow of profits. This de facto beneficial contractual relation also had content that stipulated punishment for non-compliance. After the master road of the transformation period was proposed, the establishment of the collective purchase and sales and the agricultural cooperatives, alongside with the exclusion of the private wholesalers, the room for private capitalist industry and commerce was further squeezed. Therefore, just the “four horse split the feed” [7] and the competition of being the “advanced capitalist”[8] had pushed the public-private partnership to a certain monumental stage. [9] After the peak of the agricultural cooperation, the capitalist class of China had been totally isolated. Another round of pan-industry public-private partnership commenced as the prospect of socialism and the future of capitalists were pointed out by “conviction” and “education”. [10] At last, the Party decided to “redeem” the power of control which was possessed by the capitalists completely by a way of paying with fixed interest. This act in fact marked the completion of the socialisation of the capitalist industry and commerce (i.e., the transition from decentralised individual decision making to collective public decision making.).

Even though from strict economic terms, it cannot be deemed redemption by paying with fixed interest rate on a ten year term and by giving away the profit as the paying party, we have to give some credit to the Party as it took a strategic and incremental way to force the private capital in China to be “transformed”, along with the socialisation of agriculture and handicraft industry.  It was a miracle that such short-term drastic social transformation did not cause large scale economic recession or social unrest. The good will of the three transformations which aimed to eradicate capitalism and even small scale private productivity was based on a belief that public-ownership would absolutely facilitate higher efficiency. Should this preposition stand, then, by “social revolution”(i.e., agricultural cooperation) and “technical revolution”(i.e., achieving other technical advancement by using machines in agriculture), the aim of “making more general public rapidly step on a road to abundance and the country have more consumer food and other industrial materials with higher purchasing power of the people and bigger market for the industrial products” would have nothing but logical. Similarly, the road to “peaceful transition” by “redemption” would have been the best path to national industrialisation with minimal social cost.

However, this preposition may not stand on solid ground.[11] When the productivity and management under singular public ownership has to be finished by a layered totalitarian system by public decision making, it is meant to deviate from an optimised distribution system of elements of productivity. Due tot he fact that the optimisation of productivity elements has to be based on decentralised individual decision making, the three transformation, therefore, led to the deviation from “factor formation under optimised factor allocation” as it scattered the private ownership which underpinned individual decision making. In other words, China was developing and pushing forward its industrialisation under market economy system which guaranteed private ownership. In this sense, this artificial gap between factor allocation and factor formation, which was also the development path of China, happens to be the reason for this article’s focal issue of the different development stages of “factor formation” and “factor optimisation”.

To be sure, just like any other country, China was faced with the so called development shortage issue in the beginning of the industrialisation period. The shortage was indicated by the shortage of money capital, skilled workers, industrial materials and land, machinery and equipment, technology, and infrastructures such as energy and transportation. In this condition, especially after China was suffering from loss of land after war, economic deprivation, and years of warfare, it was more likely to fall into the “vicious cycle of poverty”, i.e.: low savings due to low interest rate, and low investment due to low savings, therefore, it was not able to join the racks of industrial countries. Hence, the formation of factors was a key to the economic development. In singular ownership conditions, it seemed a practical option to allocation and mobilise to the biggest extent the people, capital and materials to form large quantity of factors in a short period in order to avoid the “vicious cycle of poverty” and solve the shortage issue. In fact, the various industry system was built up on the basis of agricultural cooperation and collective purchase and sales, which helped by the formation of national capital and its development. [12] In this way, the stage of “factor formation” in the development of China’s economy was completed and indicated by the the accumulation of capital in the form of national capital, which had a sense of original accumulation of capital.

The question goes back to this, as the national capital plays a big role in the economic development, especially under the condition of singular public ownership and side by side with the formation of factors, which could be advantageous in certain period: at that time, was it necessary to eradicate completely the private economy by the three transformations when the state-owned economy was developing? In order to assess properly the establishment of the “factor formation” in the economic development of China, one has to objectively make a list of social profit and social cost. This article hereby reminds the readers that the social cost does not only include the payment at the time,(such as the efficiency loss due to the fact that element of productivity was not allocated in an optimised manner), but also include the future cost- the historic cost. In fact, China till this day is still paying the tremendous “interest” due to the damage made to humanism, rule of law and the spirit of contract. 

III. The Stage of Factor Formation: The Planned Economy and Its Disadvantages

Under the master road for the transitional period, and with the “first five-year plan” implemented, from 1952 to 1957, the proportion of the industrial added value in the total turnout of the industrial and agricultural sectors rose from 41.5% to 56.5%; the ratio of state-owned and public-private owned industry in the total turnout of the industrial sector rose respectively from 54.1% and 5.7% in 1953 to 64.8% and 31.7% in 1957; the ratio of households that enlisted in agricultural mutual aids rose from 40% to 97.5%, among which the households of advance societies rose from 0.1% to 96.2%(LUO Gengmo, 1981). So far, the industrial and agricultural sectors were integrated into public decision making areas, and the collective purchase and sales also enable the state to dominate the major sales channels of main agricultural products. Thus, a planned economic system with powerful mobilising abilities was established.

For any layered organisations, political totalitarian systems included for sure, there is a problem of striking the balance between control and activity.(Aghion and Tirole，1997) For the top decision makers, the increase of control over its inferiors usually means a decrease of the activity of the inferiors; and vice versa. So, how to strike the balance? This depends on the goal, coherence of the different layers, and the expectation of(confidence in) the control, and the cost of searching and processing information of the top decision makers. Apparently, the higher the organisational “output” is, the more coherent the layers are, the more confident of the decision makers in its control, the lower the information cost is, and the balance was stricken more towards the activity side, and vice versa.

For any complete organisation, there is a tendency or willingness to run full power. Especially for the Party that strove to surpass the developed capitalist countries such as the UK and the US. Therefore, it is not acceptable to the top leaders of the Party if something was not done which “could have been done with some efforts”. In fact, when the the information was not complete, it was a rather difficult thing to draw a clear line between full power and overload. Thus, when there was symptoms of “overheat” such as shortage of materials, transportation and inflation where macro adjustment measure needed to be taken, a delay was seen as these measure might pose a threat to the activity of the people. What's more important, the willingness to avoid “overheat” in fact bred a sense of “doing something impossible with endeavours” in “conditions that are not realistic”.

In the willingness of going full power, the output target set by the Party was already too high. In November 1957, Mao Zedong led a delegation to visit the former Soviet Union for the second time, which served for his over estimation for the future output of China. Thanks to the sense of equality and the recognition won by “Declaration of Moscow”, China won great support from the eastern clan while Mao was generally respected. From talks Mao had with representatives of the communist parties of Italy and Britain, he gained more understanding of the developed capitalist countries. And he was also amazed by the parade on the Red Square of Moscow. In order to step out of the “pressure” and “containment” from the eastern clan for the Party and himself, Mao considered “surpassing the UK in the output of industrial products within the next 15 years” not only as his mission, but as his responsibility. As for the Great Leap which was a result of Mao’s expectation to do this in, not 15 years, but a mere two years, was purely his fault.

After the anti-rightist movement(including anti-subjectivism, anti-bureaucracy, and anti-sectarianism within the Party), the top decision makers of the Party was convinced that: in the struggle between the proletariat and the capitalists, between the socialist path and the capitalist path, the “East wind” has overtaken the “West wind”; the whole party was more unified in thinking and in organisation; and the relation between the party and the people was closer. Therefore, putting together the optimistic estimation of the domestic coherence and control abilities of the Party, and the overestimation of the output of production[13], the top decision makers went for the other end of the spectrum and chose to be over optimistic than objective. A spiritual weapon of “struggling for the upstream with lots of endeavours” in order to “build up the socialist country in a low-cost, rapid and economical manner” was employed to mobilise the whole society.  

Besides propaganda, the efficient and practical way to mobilise different layers of the system is by decentralisation and empowerment to the inferiors. For this, the Party had deeper considerations.How to avoid copycat behaviours was a key issue when the Party was learning from the former Soviet Union. It was established that the Soviet Union as controlling so much that the activity was hurt. Therefore, a management system which features blocs as power was entrusted to different layers of the system was built up as an attempt to avoid the mistakes made by the former Soviet Union[14]. If the achievement of the first five-year plan was mainly due to the 156 projects supported by the former Soviet Union, then during the second five-year plan period, more efforts were put to the development of the provincial and county level industrialisation.   The “three priorities” declared on the second session of the eighth CPC central committee(i.e., in the condition of heavy industry development, industry and agriculture are two priorities; In the condition of centralised leadership, comprehensive planning, and division of labor, the central industries and local industries are two priorities, and the large enterprises and medium and small size enterprises are two priorities. ) was an indicator of this. Therefore, as stipulated by the documents passed on the Chengdu meeting on fiscal and finance, industry and commerce(management) systematic reforms, many enterprises were given to be run by local authorities, and there was an enlargement of the fiscal power of local authorities (including off-budget funds, the usage of revenues, arrangement of local personnel, and the handling of turnovers) as well as the rights of the enterprises.

However, the problems with the layered management system featuring “blocs” were more serious in implementation than expected by the top decision makers. Firstly, the “opportunistic behaviours” of the local government hindered the coherency between the central government and the local government along with the goals the former set. Secondly, the control of the central government over the local ones was undertaken by the due duties of the departments under the central government(such as the planning commission, the economic department, and the financial ministry, etc.) to a certain extent. Due to the fact that the “amended tax system” in 1953 and the “anti-rash advance” were criticised, under the request of the local governments and enterprises, many regulations and institutions of the departments were abolished and some of the essential legislation power was given to the local authorities(such as the legislation of certain clauses of the tax management system) in the name of “based on certain circumstances”. Therefore, the enlargement of the fiscal power and legislative power showcased the tendency of “federalisation”[15]. Thirdly, tempted by the bonus of profit, there was a willingness to expand the productivity size, especially in the condition where important regulations were abolished. Many enterprise even enlarged their size of production by mobilising off-budget funds and in the form of expanding infrastructures. At last, the information cost of such a big organisation is impossible to estimate. Due to the various personal goals and in the condition of incomplete information, the information on output and profit was distorted. Mao even complained that the information on foreign countries was even clearer than that about domestic situations. In a certain sense, the disadvantage of the unified system of production was in formation cost one had to pay due to the transition from a decentralised system to a unified one.

The above mentioned problems- collectively shown as a loss of control- were enlarged by the “Great Leap” and the movement of people's commune, which led to unprecedented disaster for China. Regardless of randomness and exigence, another critical factor that led to the mistakes in the economic development was the overestimation of agricultural development. The draft of the national economic development plan followed a principle of “a combination of top-down and bottom-up approaches”: the central government proposed the basic control benchmark and breaks it down to local levels; and the local governments, according to the real situation, adjusts the numbers and reports to the central government before the central government makes the final decision. With a sense of “exaggeration”, the planned food production of 1959 reached 500 million tons, three times of the actual production of the year[16]. A roadmap based on such benchmarks would inevitably led the ship of the country into troubled waters. In fact, China’s agriculture was not doing well after the agricultural cooperation movement, which can be seen in the difficulties in the collective purchase of produces and the fluctuations of the stocks. It’s not hard to tell if we take a brief theoretical analysis of the advanced agricultural society and people’s communes.

One of the basic characteristics of the people’s commune is the combination of politics and the communes. The comprising “cells” of people’s commune can be considered advanced societies that take orders from its superiors in terms of production management[17]. From the perspective of distribution, the members of the communes get credits according to their physical conditions and performances, and the value of the credit units are totally determined by the total output of the whole labour unit. Hence, the labor units are a theoretical contractual team depicted by Holmstrom (Holmstrom,1982): every team member gets a share from the total output of the team, and the total output of the team is determined by the contribution of every team member. In this situation, the optimal choice of the labor contribution of the team members(Nash equilibrium) should fulfil that “the marginal negative utility equals the marginal output of the part he is entitled to”, instead of the conditions of a Pareto optimisation condition at which “the marginal negative utility equals the marginal output of the whole team”. In this condition, the labor contribution of the team members is undersupply. This theoretical analysis can be put into simpler words: if a team member works hard, then other team members share his working outputs; yet if he does not, other team members will have to bear the outcome of his laziness. In this overlaying effect of “externalities”, the total output of the whole team cannot reach a satisfying level. This is the root reason for the low efficiency of the advanced societies and the people’s communes[18]. Building on this, the efficiency was even lower when we take into consideration the “70% by population and 30% by labor credits”ratio of distribution, non-exit for members, incomplete management and decision making power for the labor units, the opportunistic behaviours of the unit cadres, the improper redistribution within the people’s communes, and the egalitarian adjustment of debts beyond the communes, and the overly high proportion of collective purchase of agricultural products, etc.. Hence, it was only plausible to shift the road from “development of the heavy industries as a priority” to “agriculture as a basis and industries as a leading front”.

Without doubt, there were apparent mistakes with the choice of development path for the “factor formation” stage. This is not to say that the choice did not make any sense. (For instance, taking 1952 as the constant price level, the total volume of state-owned capital rose from RMB 14.7 billion in 1952 to RMB 354.6 billion in 1978, an increase of 24.1 times.[19]) The mobilising abilities of the public decision making system under the public ownership, which attempted to achieve ultimate accumulation of capital in terms of the ratio of consumption and accumulation, played a major role in the process of China’s overcoming the development shortages. This effect was predominant especially in the beginning of the “factor formation” stage. Firstly, though there was a general shortage of factors, the natural resources were of abundance and the raw materials for industries were of rich supply. Meanwhile, there was a huge demand for output products, which guaranteed the full utilisation, even over utilisation, of productivity capacities with high product exchange rates[20]. Secondly, in the beginning of the factor formation stage, as the industry categories were not complete and the there was a lack of infrastructures, the room for the choice of investment areas and projects was comparatively large. In other words, as China needed much investment, investment into any area or project would have equal weight, therefore, the investment efficiency was high. At last, similar to the utilitarianism in the early years of traditional capitalism, the Party advocated the combination of collectivism, a sense of handwork and endeavours, industriousness and thriftiness, and the the thoughts of Confucius, which effectively facilitated the formation of state capital.

As the formation of factors came into being and the development shortage was mitigated, the flaws and disadvantages of a planned economy emerged. The flaws and disadvantages were shown in two aspects, i.e., the imbalance of the national economy structure and the lack of incentives.  They were caused by the twisted signal of prices (of the product and factors)[21]. When the development shortage is mitigated, the abuse of capacities usually leads to the decrease of product exchange rate, which triggers the excess supply of products. Besides, as the development shortage is mitigated, the value of the choice of investment ascends; when there is a lack of proper price signals, “planned investment” will lead to bad investment, which results in the decrease of the investment efficiency. The two points made above, and the soft constraint as a characteristics of the plans system(Cornel, 1986), will lead to an imbalance that is indicated by a combination of systematic shortage and general over supply of products. Besides, along with the growth of the total volume of the economy, this structural imbalance will also show a cyclic fluctuation: in a given period, as time goes by, the structural imbalance is worsening to the extent that during the macro-adjustment period, the planning authorities will have to take measures such as “closing, halting, combining, transferring, and moving” as well as keeping the overall volume growth down in order to correct the imbalanced economic structure. And this situation will come about again with the next economic cycle[22]. If the corrective measures fail to shift the situation to the initial conditions when the cycle starts, an accumulative effect of the structural imbalance will take place: the cycles will be shortened, and there will be more and more frequent adjustment, and the national economy will come to a halt(ZHAO Nong, 1996). In the meantime, the long term distortion of the factor prices and the deprivation of the right of workers to choose between positions and enterprises will result in the decrease of workers’ incentives. In the long term, the sense of working ethics will be the only discipline that guide the behaviours of workers, which is against the principle of benefit and hardly sustainable.

To sum up, as the factors come into formation, and there is a lack of optimal allocation for factors, the  marginal efficiency will decrease[23]. Then the national economy- as a “mega factory”, will be in a non-scale economy state due to the large size of the economy. In other words, the decisive importance of the factor formation on the overall output(especially for social net welfare) is shaken, and the development of the economy will depend more on the optimised allocation of factors. When the uniq cost for factor optimisation, in general, surpasses that of the factor formation, China embraced the era of opening-up and reform, and it was also an era of optimised factor allocation. 

IV. From Factor Formation to Optimised Factor Allocation: The End of Planned Economy

The issue of optimised factor allocation caught the attention of the leadership before the three great transformations were completed. In regard to the downgrade of quality due to the unified sales, the decrease of supply of industrial raw materials due to the monopolistic sales by supply and demand cooperatives, and the increase of cost due to the lack of competition, Chen Yun, a high-level Party leader, proposed the “three main tasks and three complementary measures”[24], in the hope that a “free market” would still exist within a certain scope under the basic planned economy structure in order to improve the allocation of factors and raise the efficiency. However, this proposal, especially right after China stepped into “socialism”, seemed incoherent. The social atmosphere at that time seemed not to allow the existence of such a “capitalist tail”. In the purely planned economy, one can only suppose that the “coordination” between regions and enterprises would substitute the free flow and competition of factors. After the “Great Leap Forward”, in order to eradicate poverty and famine, the people’s communes adopted the contract-production on the basis of labour units, some regions even on the basis of households, which fostered an active free market. However, once the situation got better, the spontaneous forces that “bred capitalism all the time” became the prosecuted force of the “rule of the proletariat class”.

By mid 1960s, even though the national economy recovered to normal after multiple adjustments, the function of the planned system and the factor formation was seceding. This was best shown in the phenomenon of “copycatting the antiques”(that is peripheral expanded reproduction), the internal cycle of heavy industries, and the rise of urban unemployment(and the later movement of “ Educated Urban Youth Going and Working in the Countryside and Mountain Areas”). Besides, the function of the market power in optimised allocation of resources was recognised. Apparently, China did not improve the resource allocation method according to the Soviet model which featured the establishment of large trust enterprise, but China managed to achieve economic development and social progress by reforming the people and improving the incentive mechanism in the form of class struggle and political movements. Indeed, it was impossible to shift the route by the decision maker of the original system. Especially under the totalitarian system at the time, doing so was no different from “committing suicide”. From the perspective of modern game theory, a “cultural revolution” that aimed to eradicate the “bedside Kruschev” and get back the control was a priority(they both held many distinguished opinions on many critical issues), and a delicate Nash equilibrium[26]. The ten years of chaos witnessed great social cost, which to a certain extent was a result of the encompassing public decision making system that included almost all areas of the society.

It has been proven by theory and practice that: the prerequisite of the optimised resource allocation is individual decision making. To be specific, it requires: (1) there are many independent economic entities that are free to choose and act to maximise their own interest under the law; (2) a market system that allows various factors to flow; and (3) a just environment of rule of law. When the above mentioned conditions are existing, institutional reforms must be undertaken. By the 1970s, the conditions for reforms were mature. Firstly, relation between China and the former Soviet Union was broken, which posed China out of the “eastern clan”. And the constraint of the international ideology disappeared, China shifted from “conflict between the east and the west” to “a conflict between the south and the north”. Secondly, China’s relationship with the US and Japan was mitigated, which marked the “icebreaking” act that ended the stand-off between China and the west for over 20 years. This ushered in a better international environment for future reforms. At last, the ten years of chaos led to the reconsideration of the second generation of leadership, which laid the background for the future blueprint that eventually broke the planned economy structure.

For any reformist, the benefit and cost of the reform have to be taken into serious consideration. The cost of China’s systematic reforms includes: (1) the endeavours made to achieve the shift of ideology; (2) the obstacles for the adjustment of interest structure; and (3) the cost for compensating for the loss of interest. The benefit of the reform mainly lies in the raise of efficiency due to the optimised allocation of factors. The public discussion on the standard of truth in the 1970s within the Party, as a prelude of the reform, greatly lowered the cost for the shift of ideology; the emergence of the “literature of scars” and related art forms helped facilitate the enlightenment of the citizens. Fortunately, the high level leadership of the Party was in line with the people and the times. 

It is not a surprise that China’s systematic reforms began in rural areas. It is  a mistake if we take Xiaogangcun Village in Anhui Province as the conception for rural household contract responsibility system（家庭联产责任承包制）. In fact, in the planned system, “contract production to the household” was already practiced. It was even popular for a while during the “low living standard” periods. The comparatively high efficiency of this arrangement was a major threat to the whole planned economy based on people’s communes. Therefore, this arrangement was mostly suppressed by the authorities. It can be said that the multiple political movements initiated by the Party was a countermeasure against this arrangement. Therefore, the forcefully promoted rural collective economy was a path dependence and as result of the frequent “movements” and “struggles” in China. However, it was totally agains the will of the people to hold an leftist extremist point of view that claimed to “rather hold on to the grass of socialism than the crop of capitalism” in the times when the real income of urban workers decreased by an average of 0.1% from 1958 to 1978(Research Team on China’s Important Rural Problems, 1987) and widespread undersupply of food was witnessed and coupons were used for urban consumptions.

V. Conclusions

This article reviewed the formation and evolution of China’s planned economic system. Combining the history and comments, this article reveals that the planned economy based on public ownership divided the formation of factors and the allocation of factors, which formed unique economic development stages. There are no evidence that this development path is a must. It is only that China chose such a path. In fact, when the planned economy based on public ownership became a goal for the decision makers, the social status and international environment subsided as mere stages and backgrounds for the historical events. In regard to the creation of this ideology, despite concerns of mass communication, studies should be taken on China’s traditional culture. Of course, that will make the topic of another article.

Even though mass factors were created during the planned economy period, which have a lot to do with the resurgence of China’s economy, we should keep a cool mind on this. The reasons lie in that such a development path requires high social cost. Due to the lack of optimised factor allocation, the efficiency is low and there is a waste of resources, which offsets the practical utility of the mobilising capacity of a planned economy. What’s more important, is the formation and operation of a planned economy asks for anti-humanism measures(such as discrimination, coercion and public diminishment), it then cannot be justified. Of course, those who uphold the state may disagree.

This article does not discuss the stage of factor innovation, which was not entirely a result of the consideration of the length but that more and strict considerations need to be taken for this stage. Only with a just and fair competition order, shall the dream of free creation be realised. This needs initiatives and endeavours of the Chinese.

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Note:

[1] According to Rostovian take-off model, there are five basic economic stages, namely, traditional society, preconditions for take-off, take-off, drive to maturity, age of high mass consumption.

[2] A treat that sealed the alliance of China and the former Soviet Union was signed after days of hard negotiation when Mao Zedong visited the former Soviet Union at the end of 1949; other events included that China retrieved the operation right over some railways, the establishment of three joint ventures, and a loan of 300 million roubles. China seemed not to have obtained something that “not only looks good but also tastes good”. At that time, Stalin had doubt about Mao Zedong. Mao was considered as “half of Tito”. Mao also expressed on his second visit to the former Soviet Union in November 1957 that: I have visited the Moscow twice and the first time was not so pleasant.

[3] Please refer to The Decision on the Mutual Aid and Cooperation of Agricultural Production by the Central Committee of the Chinese Communist Party(Draft) (December 15th, 1951).

[4] See The Decision on the Cooperatives of Agricultural Production by the Central Committee of the Chinese Communist Party(December 16th, 1953), Selected Important Documents Since 1949, Vol. 4, Zhongyang Wenxian Press, 1993 July, pp. 662-663.

[5] See the closing speech on the second session of the first CPPPC, June 23rd, 1950, Selected Works of Mao Zedong, vol. 6, People’s Publishing House, 1999 June, p.80.

[6] Article 31 of the Common Program stipulates: “The cooperation between the state capital and the private capital is the state capitalistic economy. If the conditions allow and if it is possible, private capital should be encouraged to develop towards state capitalism, for example, manufacturing for state-owned enterprises, or joint venture between private and state-owned capital, or in the form of leasing to operate the state-owned enterprises, and develop the resources of the country.” At that time, it was not recognised that the state capitalism was one way to transform the private capitalist industries and commerce.

[7] September 7th, 1953, Mao Zedong invited Mr. Chen Shutong and another nine non-party figures for a talk at Yidetang.  According to the record of the talk, the “four horse split the feed” means: in the distribution of profit of the state capitalist enterprises(i.e., the joint ventures), the income tax accounts for 34.5%, welfare fees accounts for 15%,  public accumulation funds account for 30% and the profit of the funding party accounts for 20.5%.

[8] On the convention of China Chamber of Commerce from October to November, 1953, many felt that “socialism was the trend that had to be chosen”. Some proposed that they should “actively operate, try to implement, avoid the five poisonous behaviours, enhance studies, and welcome transformation”.  See Biography of Mao Zedong(1949-1976), Zhongyang Wenxian Press, 1st edition, December 2003, p. 435.

[9] 1954, the cooperation form of the so-called “apple eating”  which integrated 793 industrial enterprises that were of big size and important to the livelihood and the country, and the total output of the year reached RMB 2.56 billion, higher than the sum of all the joint ventures in the previous years. See Biography of Mao Zedong(1949-1976), Zhongyang Wenxian Press, 1st edition, December 2003, p.437.

[10] Decision on the Issue of Transformation of the Capitalist Industries and Commerce (February 24th, 1956) stipulates: To deal with the capitalist class, there are three things we need to consider. Firstly, redemption and the method of state capitalism should be undertaken, compensations should be made, an incremental path should be adopted to change the ownership of the capitalist class; Secondly, we need to make certain arrangement for them to have jobs while transformation; Thirdly, the suffrage of the capitalist class should not be deprived, and for those who uphold and support the socialist transformation and who make contributions, certain political arrangements should be made. 

[11] On the 5% household land, an agricultural output of 25% of the total national agricultural output was witnessed(Xin Yi, 2000).  This overturns the above mentioned presumptions.

[12] The main origins of the state capital of the People’s Republic of China are: (1) confiscated “bureaucratic capital”; (2) transformed “capitalist industry and commerce”; (3) the “difference of scissors” of the price of industrial and agricultural products; (4) the self accumulation and expansion of state capital; and (5) foreign aid by the former Soviet Union.

[13] “Three Books” were made for the output goal, that is: the preset number published by the central government, while the internal number of the central government was the expected number: the expected number of the central government is the  preset number of the local governments who also had their own expected numbers. The goal of steel output of 1958 was 6.248 million tons, an increase of 17% over the actual output of 5.35 million tons of 1957. This number was later raised to a goal of over 11.50 million tons [Please refer to Bo Yibo: Reflection on Some Critical Decisions and Events (second volume), Central Party School of the Central Committee of the CPC Press, 1st edition, 1993 June, p. 704.]

[14] During China's War of Liberation (1945-1949), some achievements in terms of “competition” of authority building and killing enemies among the liberated regions were made which may be helpful for the decentralisation of the local governments.

[15] An indicator for the existence of federation is the comparatively independent power of legislation and fiscal affairs. 

[16] This goal was not achieved until 1996.

[17] It does not matter whether the basis was a labour unit or a villager unit(a more independent calculation unit).

[18] Chen Yun once pointed out that “The activity of the farmers should be put first. Without this, tractors won’t run by themselves. ” See Nine Instructions on the Issue of the Market by Comrade Chen Yun.

[19] The total volume of the state capital comprised of the net fixed asset and fixed floating capital of the independently audited public ownership industries. Calculated according to China’s Statistics Yearbook(1987), p.177, p. 314, and National Income Statistics Documents(1986) p. 37, and p.40.

[20] The abuse of production capacities refers to over capacity on the basis of designed capacity by the overuse of human resources by working overtime and the equipment and machines.

[21] At that time, the price of industrial products was determined by adding on the cost, i.e.,, according to the average cost, adding a certain amount of profit to the average profit ratio to form the price. However, the producing price- in Marx’s Capital, can only be determined when there is a free flow of factors across different competitive departments. Apparently, in the planned economy, as factors can hardly move across departments, the producing price will send off distorted price signals. Besides, with the soft budget control, most of the stock data is distorted. 

[22] As long as we suppose the investment shows an horizontal expansion across departments, as the marginal output of different departments differs, there will be an imbalance in terms of the structure of the economy, and the degree of imbalance will keep rising(the degree can be measured by the substitutional elasticity of the stock against shortage, and the raise of imbalance means with the same degree of shortage, there will be less stock.). In fact, after the development shortage takes place, the competition between departments will easily lead to the horizontal expansion of investment. 

[23] According to calculation(of the independently audited industrial enterprise of public ownership), during the first five-year plan period(1953 to 1957), the growth rate of total factor productivity(TFP) accounted for over 40.7% of the net value growth; during 1958 to 1978, this ratio was only 2.5%(Zhao Nong, 1990). This means, the growth of the latter period was mainly dependent on the growth of the input of factors.

[24] Chen Yun pointed out that “the socialist economy should be like this: in the operation of industries and commerce, the main body should be the state-owned and collectively owned enterprise, with a certain number of private-owned enterprises. These private-owned enterprises should be the supplement of the former. In terms of planning of production, the main part of the national industrial and agricultural products should be produced according to the plan while some products should be freely produced within a certain scope allowed by the national plan. The latter part should be the supplement of the former….  In the unified socialist market, the national market is its main body with some free market. This free market, under the supervision of the government, was a supplement to the national market, therefore, it is a component of the unified socialist market.” (See Chen Yun, New Problems After the Basic Socialist Transformation, September 20, 1956; Selected Important Documents Since 1949, Vol. 9, Zhongyang Wenxian Press, 1993 July, p.287.)

[25] At that time, long distance sales was considered “speculation”, and the goal was set at 5%.

[26] For himself, if the choice of a socialist path was correct, then it was beneficial to stick to the principles and eradicate opportunism. However, if this choice was incorrect, then to obtain absolute political control by a “coup d'état”  would only seem plausible.

Reference

Bo Yibo, 1991: Reflection on Some Critical Decisions and Events (first volume), Central Party School of the Central Committee of the CPC Press.

Luo Gengmo, 1981: “Analysis on the Process of the Formation and Development of China’s Planned Economy- Several Issues that Need to Be Clarified on China’s Socialist Planned Economy, II”， Economics Studies, Issue2.

Xin Yi, 2000: “On the Sidelines of Rural People’s Communes ”, Journal of the History of CCP, Issue 5.

Research Team on China’s Rural Development, 1987: The New Growth Stage of National Economy and the Rural Development, Zhejiang People’s Publishing House.

Zhang Shuguang, Zhao Nong, 2002: The Allocation of Decision Making Power and the Evolution of Decision Making Methods- Systematic Thinking on China’s Rural Issues, Chinese Social Sciences Review (Hong Kong), Issue 1, vol.1.

Zhao Nong, 1996: On the Structural Imbalance and Its Micro Basis, Nankai Economic Studies, Issue 5.

Zhao Nong, 1990: Analysis of China’s Macroeconomics Benefits(1979- 1987), Master Degree thesis(self-printed).

János Kornai(Hungary), 1986: Economics of Shortage, Economic Science Press.

Aghion, Philippe, and Jean Tirole, 1997, “Formal and Real Authority in Organization”, Journal of Political Economy, vol. 105 (1), pp. 1–29.

Bengt Holmstrom, 1982, “Moral Hazard in Teams”,BellJournal of Economics, vol. 13 (2), pp. 324–340.

Zhao Nong, Researcher from Institute of Economics, CASS, Vice Chairman of Unirule Academic Committee. This article was first published by Academics, 2014, vol. 9.