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lending practices more on political factors than on sound economic criteria (Yoon 1998). Preferential loans to Korea’s large conglomerates, the chaebols, at below-market interest rates may have maintained the cozy relations among business leaders, bankers, and politicians, but they also laid the basis for a boom-and-bust business cycle. Creating Korean-style conglomerates in China would be a costly error. Letting natural market forces weed out inefficient firms would be a step in the right direction.1

China’s state-owned enterprises (SOEs) and banks do not need partial reform; they need to be divorced from the state and subjected to the full force of market competition. Turning to the half-measure of market socialism will only prolong the costs of transition to a real market system and continue to politicize economic life. What China needs are ‘‘free private markets,’’ not regulated socialist markets (Friedman 1990: 5). Privatization of SOEs would create real owners who were responsible for their firms’ performance and had an incen- tive to maximize profits by hiring efficient managers and producing what consumers wanted.

The absence of a hard budget constraint for SOEs means that bankruptcy is a hollow threat for most of China’s 305,000 state enter- prises. And the absence of that threat means SOEs have little incentive to change their inefficient ways. As a result, 50 percent of China’s 118,000 state industrial enterprises reported net losses in 1996 (World Bank 1997: 28).2

Although China’s leaders have been willing to sell off smaller SOEs, they have not embraced the idea of large-scale privatization, for obvi- ous political reasons. Selling off all SOEs would relieve China’s massive headache due to the financial drain on the state budget of having to subsidize SOEs, but it would also jeopardize the authority of the Chinese Communist Party. With socialism being the dominant ideol- ogy in China, there remain serious obstacles to fostering the market component of market socialism. Turning SOEs into ‘‘public’’ corpora- tions, with the state retaining a controlling interest and restricting the marketability of shares, may be appealing at first sight, but on closer examination can never replicate real markets. As economist G. Warren Nutter (1968: 144) noted 30 years ago when he examined the theoreti- cal case for market socialism, ‘‘Markets without divisible and transfer-

1As Nicholas Lardy points out, China ‘‘ought to be relying on a much more competitive market to drive out inefficient firms and allow some natural consolidation to take place’’ (quoted in Restall 1997: A22).

2The actual state of SOEs could be much worse. Hugo Restall (1997: A22) reported in the Wall Street Journal, ‘‘State firms are desperately sick: as many as 70 percent are losing money.’’


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