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Piecemeal reform creates tensions: the rigidity of the old planning system is pitted against the resiliency of the market. In China, old institutions are giving way to new ones, but not fast enough to eliminate ‘‘institutional incompatibility.’’ As Lin et al. (1996: 226) point out,

The overall performance of China’s gradual approach to transition is remarkable, but China has paid a price. Because the reform of the macro-policy environment, especially interest-rate policy, has lagged behind reforms of the micro-management institution and resource allocation mechanism, institutional arrangements in the economic system have become internally inconsistent. As a result of the institutional incompatibility, rent seeking, investment rush, and inflation have become internalized in the transition process. To mitigate those problems, the government often resorts to traditional administrative measures that cause the economy’s dynamic growth to come to a halt and retard institutional development.9

If China wishes to continue its rapid economic growth into the next century and end corruption, it must strive for institutions that are consistent with free-market principles and the rule of law. That is why Lin et al. (1996: 226) argue, ‘‘It is essential for the continuous growth of the Chinese economy to establish a transparent legal system that protects property rights so as to encourage innovations, technolog- ical progress, and domestic as well as foreign investments in China.’’

The Soviet system failed because it disregarded reality—namely, the reality that the way of the market, not the plan, is most consistent with human nature and, thus, with individual rights to life, liberty, and property. Soviet-style planning destroyed the institutions of prop- erty and contract that underpin the free private market and created a rigid economic system that finally collapsed of its own weight. What Soviet citizens witnessed during perestroika and glasnost was ‘‘not the organic revitalization of socialism but the withering away of forcibly imposed economic and political structures’’ (Tsypko 1991: 290). Today, China is also witnessing the ‘‘withering away’’ of the state-controlled economy, but its ‘‘political structures’’ still await fundamental reform.

Ultimately, economic and political reform are inseparable. To depo- liticize economic life, China needs constitutional change and new

9In 1984, China decentralized the allocation of credit by allowing local branches of the central bank to extend credit directly to SOEs. But interest rates were kept artificially low and the banks simply extended new credits, which led to rapid money growth and inflation. Instead of deregulating interest rates, the government reimposed central rationing of credit and directly controlled investment projects. Thus, the ‘‘planned system’’ returned. China’s ‘‘boom-and-bust cycle’’ is a result of not going all the way to a market economy and failing to insulate the banking system from political manipulation. Because interest rates are set at below-market levels, nonprice rationing and rent seeking are rampant in the allocation of credit in China. For a discussion of these points, see Lin et al. (1996: 219–20).


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