Introduction
The graph above shows the astounding growth of the Chinese and Russian economies in the last 30 years. The graph shows the Gross Domestic Product (GDP) of both countries from 1990 to 2012 and it clearly shows that the Chinese economy has over paced Russia. In fact, the online web resource “The Guardian” reported that China‘s GDP slowed down at a rate of 7.6 percent in 2012 . This “slowdown” is already considered a remarkable growth rate for other countries but the Chinese economy sees it already as a contraction.
Russia is also growing impressively and has become the largest economy in Europe. According to Lisina Russia has managed to overtake all of the European nations becoming the largest in Europe and the fifth largest economy in the world . There is also no sign of a slow-down for Russia, whose continued growth is fuelled by more favourable oil prices and greater productivity.
Success stories are common place but what makes China and Russia astounding, compared with other emerging global superpowers such as India and South Korea, is the fact that China and Russia were once centrally-planned economies that were built around socialist political regimes. Is the obvious wealth coming from economic growth, clear proof that a free-market economy is the correct economic framework to implement?
The transition from a centrally planned economy to a free market economy involves changing the prevalent ownership form from public ownership to private ownership and in the process, establishes an enterprising and competitive environment. The transition is desired but it is rarely an easy and smooth process. The transformation from one to another normally causes a fall in the country’s GDP since trade is disrupted. Even in centrally planned economies, production is halted and economic uncertainty becomes a larger risk. This results in unemployment and a rise in inflation which is driven by the scarcity of the supply of goods to the public. The requirements for reform encompass not just the business ownership of former state assets but a rehabilitation of the various support systems within the economy, including tax, health care, education and other reforms.
Economic Theory
China and Russia were once centrally planned economies (also known as “Command Economies”). In a centrally planned economy, the State (also referred to as “the Public”) is the owner of all economic activity and the government “manages” these activities for the public. These activities include production of good and services, the amount of which is assigned and controlled to conform to the allocation of raw materials. Production is a political decision rather than an economic decision based on demand and supply. Because production is a political decision, the allocation of goods and services are based on political decisions as well. A centrally planned economy is inefficient and causes surpluses and shortages for goods and services for the public and creates a lot of bureaucratic red-tape and corruption practices. It also limits creativity and competitiveness and does not allow consumers the freedom to choose, instead dictating to them their choices based on their very limited options . Prices are set by the planners as well and in centrally planned economies, prices do not correspond with market movements.
On the other hand, a free market economy is one wherein the forces of supply and demand dictate the levels of production of goods and services. Moffat describes a free market economy as a theoretical concept for a country where resource allocation is determined purely by market forces. The description is appropriate since no country in the world puts any restriction on the use and ownership of its resources or the commodities (goods and services) that it produces. There is always some form of regulation thus making an absolute free-market economy a hypothetical construct .
However, existing free-market economies today behave in a regulated state, usually managed by the State (acting in the interest of the Public) but participated principally by private sector players. In the pure form of a free-market, the government acts in a neutral fashion and does not create any legislative nor administrative action that would limit or promote market interaction. Again, this type of free-market does not exist because regulations are required for reasons of sustainability and equity. Prices are indicative of market movements and as such, inform sellers and buyers to behave and act in accordance with their individual objectives. Buyers and sellers of course, behave independently (i.e. not in coercion) and consent to trade to improve their position under the belief that what they are trading would provide them better value .
China opened its doors to economic reform starting in 1979 . One of the first steps that China’s government took was the utilization of present-day corporate management principles to “liberate” and manage China’s numerous state-owned enterprises (SOEs). Prior to 1979, China’s government kept a very tight control over all activities related to SOEs, including allocation of financial resources, the purchase and use of raw materials, the selection of personnel, the allocation of produced goods and services, among others. The government controls these activities but pursues them not because of any profit motivation but as an execution of the overall plans designed by the central government. By the 1980s, China has started working on its management reforms which started with the use of production contract responsibility systems . Also, China instituted the use of self-supporting accounting systems which was an adoption of prevailing accounting practices used by private entities outside China. There was no reform on ownership of the SOEs and the Chinese central government kept a tight grip over other SOE activities.
The privatization of SOEs contributed to China’s economic development. However, China’s management of its SOEs are not fully liberated, compared with its free-market economy contemporaries and are still linked to the centrally-planned approach of China’s socialist political party. A good example of this is the inability of these SOEs to provide sufficient and transparent information to the public. For example, Dr Liu Yuting, the Director-General of the Accounting Regulatory Department of the Ministry of Finance of China, stated that the need for useful financial reports is important. He believes that China’s system for accounting and audit is in good shape and that no problems are found with the use of principle-based standards as opposed to a standardized methodology such as that of IFRS. The “protectionist” stance of China’s MOF indicates the continued use of China’s accounting standards which are very much unlike what the rest of the world uses . This is a fundamental issue because Chinese finance reporting systems are less than satisfactory by western standards. There are no generally accepted accounting principles (GAAP) in China, with their accounting based on “principle” rather than convention. The Ministry of Finance has a subcommittee which handles Accounting Standards but remains largely dormant.
In addition, scholarly research on the control of the Chinese government on the privatization programs concluded that China retained control over some of the SOEs that pursued privatization efforts. These corporations were reported to have weaker gains than those that have no retained management control relationships with the Chinese central government. The results further highlight the fact that political factors still influence economic institutions in China despite the clear privatization policies and programs that the country has implemented .
Russia’s privatization efforts started later than China. Under the leadership of Mikhail Gorbachev, Russia began transforming its SOEs to private entities in 1988 . Russia’s reform began with the transfer of some controlling rights over the SOE to the SOE’s management and employees (originally held by the State). This enabled these SOEs to form associations that later led to spontaneous privatization of industrial assets that were acquired by the SOEs managers and employees. The privatization movement between 1988 to 1991 involved several thousand SOEs but this number was considered small in relation to the numerous SOEs owned by the central government of Russia.
After 1991, Russia scaled its privatization further. The Russian government established a goal to sell its resource assets to the Russian public. This was an important step in the abolition of the Soviet Union and the establishment of the Russian Federation, a move that clearly transitioned the government from that which is centrally-planned to a more liberal, free-market driven government philosophy. However, the Russian Federation inherited a largely inefficient enterprise sector and the natural progression was to begin the disposal of assets to the private sector.
Seeking to turn the SOEs into profit-seeking enterprises, the State Committee for State Property Management (the assigned organization), began selecting SOEs that could be disposed to private sector players as assets from those SOEs that would continue to require government subsidies for its survival. The mechanism used by the State Committee for State Property Management is the “Free Voucher Privatization”, a mechanism of sale of the SOE that would prevent the concentration of ownership of the SOE to some individuals only. While it was clearly not overly successful in that some SOEs ended up being owned by the political and industrial elite of the previous regime, the mechanism still resulted in the transfer of SOEs to some new industry players and more importantly, wide public support for the program. The vouchers are distributed equally to the Russian population and when the SOEs are privatized, these vouchers could be used to acquire shares of the privatized SOEs. Unfortunately, some of the people that received the vouchers ended up selling them thus failing to curb the problem that the voucher system was principally trying to address. The public’s perception changed and what was once a widely popular and supported mechanism, ended up as a deceitful mechanism for most of the Russian population .
In Russia, the effect of transitioning to a free-market economy is more positive. Research indicates that the change in ownership has significant positive economic effects, despite the setbacks caused by the voucher privatization approach. The positive results came from the inclusion of outside management personnel into Russia’s industrial sector, thus professionalizing the industry .
Conclusion
A country’s ability to manage its economic issues through the use of polices and legislative frameworks will equip that country to compete and perform against various economic scenarios. While two countries are never identical in resources and capabilities, it is still an advantage to learn from the approach and experience of other economic managers in determining the best and most effective combination of policies to use. In the case of China and Russia, two previously centrally-controlled markets, the transition to a free-market economy proved to be arduous, risky, bumpy but by all intents and purposes, successful. The growth of China and Russia today as two of the five largest economies of the world, with growth prospects that continue to improve despite the global economic slowdown is nothing short of astounding, as it highlights the effectiveness of the free-market concept and provides tangible proof of the free-market’s effectiveness and wealth-creation capabilities. China and Russia’s once individualistic view of the world has now changed and its new outward perspective has created a new wave of economic possibilities. It is now inconceivable to think of world trade without products from China or oil from Russia. It is also inconceivable to think that privatization has not worked in these countries. Truly the experience of both China and Russia provide an economic model for the rest of the centrally-planned economies for establishing their economic ground.
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