CEWSEI (Centre for East and West Studies and European Integration)
University of Verona
Russia versus China: How to Compare Success in Economic Transformation to the Market?
Paper presented at the CREES Annual Conference - 6-8 June 2008
Cumberland Lodge, Windsor Great Park
China is considered to be more successful than Russia in her path to market reforms and growth.
While institutional progress has been slow in China compared to Russia, Chinese performance has
been more brilliant. While China benefited from increased competition and openness to the world
economy in the nineties, Russia suffered from output fall. From 2000, however, both countries have
enjoyed robust growth.
This presentation challenges some widespread views on the pros and cons of a different sequencing
of reforms in the light of evidence. The paper also discussed whether growth at current rates is
sustainable in the light of persisting institutional and policy weaknesses and the ambitious
development agenda each country wants to pursue.
It is a short version of a longer paper that can be made available on request.
GDP growth and projections
According to official China‟s statistics during 23 years between 1978 and 2001, the average annual
growth rate of China‟s GDP was 9.4% (Han Wenxiu 2004, p.9). But sub-periods performance is
marred by statistical failures. Pre-1995 statistics overestimated growth by some 2.4 percentage
points according to Angus Maddison (1998, first Chapter). Afterwards the likelihood of effectively
higher than official growth rates has gathered consensus since the incentives for enterprises to
report true revenues have changed: tax avoidance replacing the former planning incentives to
overstate production. Different firm behaviour has prompted a revision of official GDP data.
Following new GDP estimates in 2006, based on revised data for the tertiary sector, China‟s
average GDP growth 1979-2004 was finally estimated at 9.6% (The Economic Times, 16.02.2006).
At this rate of growth it would take China little longer than 7 years to double total output.
In comparison, Russia‟s economic records appear to be less successful. While the average GDP
growth 2000-2007 is estimated at 7.025 (that would imply about ten years to double GDP), the
earlier years of transformation recorded negative output from 1990 (apart the ephemeral recovery in
1997) onwards, if Gorbachev‟s years are also included. There are some caveats on statistics for
Russia, as well. The size of GDP fall in Russia has been seriously questioned taking into account,
among other things, the negative value added of a large part of the Soviet-type economy and the rise
in informal businesses particularly after 1992, (Aslund, Anders 2002, pp. 121-141)
Is GDP growth in China exceptional?
Many Asian economies have experienced high rates of growth for a rather long time span. Comparing
performance of Japan 1950-1973 to that of China 1978-1999 shows that Japan‟s GDP and GDP p.c.
increased 7.7 and 5.9 times respectively, while China „s GDP increased 4.4 times and GDP p.c. 3.3
times (Maddiso, Angus 2001, p. 298, 304). Other comparisons are also revealing. Japan‟s GDP
quadrupled from 1970 to 1985. Between the eighties and nineties Thailand, Malaysia, Indonesia,
Philippines, Singapore and South Korea rates of growth were between 8-12%. That was interrupted by
the 1997 Asian financial crisis largely due to structural/institutional weaknesses. There is no reason to
believe, as Chinese authorities do, that the current rate of growth is sustainable in the long run, given the
costs of structural reforms that will be needed to address social and environmental problems (see below).
There are no strong reasons to believe, either, that Chinese comparative performance is primarily due to
better policies: i.e. gradualism versus shock therapy.
Gradualism versus the big bang
There is renewed debate in the literature as to the advantage of gradualism versus the big bang and
the sequencing of reforms. The so-called Washington consensus blamed for being at the origin of
the big bang ( despite its recommendations were originally addressed to Latin American countries,
Williamson, John 2004) has been increasingly challenged. According to Dani Rodrik (2006) the
Washington Consensus was deterministic and hopelessly ambitious in both its earlier version and
the second generation reforms blueprint. In his views, there is need, on the contrary, for a practical
agenda that would be based, first, on a diagnostic analysis of constraints to growth; second, on
imaginative policy design, and, third only, institutionalisation designed to maintain productive
dynamism while ensuring conflict management. Gary Jefferson (2008) argues in favour of a
sequencing of reforms that would start from competition and give rise to institutions in time. Both
authors find evidence for their approach in the process of formation of Town and Village
Enterprises (TVEs) in China that went along with agricultural prices liberalisation at the beginning
of the eighties. The alternative to the big bang should have been to let each country develop its own
institutions after singling out what is crucial for growth. In China, Rodrik argues, property rights
were effectively more secure under direct local government ownership than under formal property
rights legislation. In Russia they were introduced earlier, but, in the absence of an effective
judiciary, they did not work.
There are three flaws in these approaches. One stems out of a cursory reading of the TVEs
development in China that was far from straight and did not give rise to institutional developments.
At the end of the eighties, exactly because TVEs had been successful and started challenging state
enterprises, they were crushed. The success of TVEs, where employment had risen to 95.5 million
people in 1988 from 32.4 million in 1984, provoked a policy backlash. Suspicion as to the causes of
success, fear that private property concealed under collectively owned firms was growing, and
political controversies caused a policy reversal. Between 1989 and 1991 many TVEs were closed
down leading to a fall in TVEs‟ output of 8% and the return of millions of people to their villages.
Another flaw comes from letting out of the picture of transformation to the market 1985-1991
Gorbachev‟s trial and failure in piecemeal reforms aimed at introducing elements of market in the
state administered economy (Aslund, Anders 2007). That experiment ended in the collapse of
output in 1991, burgeoning fiscal deficit and foreign debt. In 1991 the FSU National Income fell by
20% y-o-y, the budget deficit increased to 20% of GDP, shortages increased and prices tripled. The
net foreign debt increased from 14.1 billion USD at the end of 1984 to an impressive figure of USD
67 billion (roughly 560 per cent of rouble GDP at the market exchange rate at the end of 1991 while
foreign reserves fell to USD 60 million, around 10 hours‟ import cover ( Ahrend, Rudiger and
Tompson, William 2005). Finally, together with the collapse of the CMEA trade, there was default
on international debts and collapse of the rouble. The Soviet system ended in bankruptcy.
The third flaw, in my view, is that there is no evidence that there was in either country a gradual
approach to transformation to the market. China was unable to cope from above with the disaster
produced by the cultural revolution in the rural areas; agriculture, employing about 60% of the
population, being the most important sector in the economy. Soviet Russia was unable to compete
with the west on high technology that required fast and massive capital investment, while suffering
from increasingly severe labour shortage and wage pushed inflation. Market incentives were
introduced cautiously and suspiciously, the leadership being afraid of their negative economy-wide
and political consequences and ready to pull back. There were political backlashes in both
Effective market reforms were introduced in the nineties. In Russia they led to the overhaul of an
institutional system that had already collapse under the incapacity to reform from within. In China,
price liberalisation was extended to industry after the 1989 Tiananmen revolts showing that partial
liberalisation was unsustainable. Official data show that, following the policy reversal against
TVEs, the (overestimated) real annual rate of growth fell from 11.3% in 1988, to 4.1% in 1989 and
to 3.8% (almost stagnation for China) in 1990 (National Bureau of Statistics S of the People‟s
Republic of China). In both countries the leadership learned from past errors.
The nineties: systemic change in Russia versus muddling through in China. Different outcomes
Reforms in the nineties were undertaken under different constraints and opportunities. Russia had
inherited from her Soviet past an oversized and market unfriendly industrial structure dominated by
large scale enterprises. Small entrepreneurship was nihil. Russia also inherited the huge foreign debt
accumulated by the Soviet Union. There was no room in the federal budget to finance industrial
restructuring. China had quite a few small-medium scale state enterprises, the bulk of large scale
enterprises (SOEs) being concentrated in heavy industry and energy resources and was open to FDI
in the coastal areas where special economic zones had been formed under the Open Door Policy of
the eighties to attract capital and know how from the Chinese diaspora.
The stage of development was different. Russia was an industrialised country and a resource-based
economy. China was still an overwhelming agriculture-dependent economy. There was
comparatively more room in China for catching up. Vast underemployment in the countryside
contrasted with labour shortage in Russia. Little or no state security for millions of people was
strong inducement to find and accept any job. A large poster that I noted at the entrance of a small
factory in western China in one of my earlier visits to the country warned (as proudly explained by
the manager): “Better you like your job, otherwise you will loose it”.
With few exceptions Russia liberalised the bulk of prices and foreign trade early in 1992. China
went on with price and trade liberalisation and opened further to FDI. Russia transformed state
enterprise into corporatised companies the shares of which were sold under a voucher scheme to the
population. Mass scale privatisation of industry was over in two years (1992-1994), while the state
retained some of the most valuable assets. China abolished state control over the SMEs under the
slogan “retain the big, let the small go”. Though the process was different, in both countries the
state economy retained an important role counting to date for about one third of the total economy
There were two important differences. First, Russia introduced earlier individual property rights to
capital: this has allowed the ownership structure to change over time from insiders to outsiders
interested in productivity increase and profit-making (Bennet, John and al. 2006). China divested
state management but not property rights. SMEs in China were turned over to their (formerly state)
managers as non-state enterprises: a curious institution from a legal point of view. De facto, this
process allowed for quasi-property rights that were useful in boosting growth, but still remained on
check and open to abuse by state authorities and CPC officials. A large informal economy has
developed where labour rights are missing and the room for the enterprise to grow in scale and
scope is subject to legal uncertainties. It is unclear how quasi- private property changes hands.
Uncertainty about collateral under quasi-property rights also hampers the development of bank
lending to SMEs.
Second, earlier adoption in Russia of the main provisions in support of market contracts and
obligations to the state (the Civil Code, the Commercial Code, the Labour Code, the Land Code,
together with tax and customs laws), despite well-known problems in implementation, has helped
the upgrading of syllabi and curricula of the Schools of Law and provided the grounds for new
habits of thinking and new expertise in legal matters that are crucial for the working of a market
economy. There are abuses, but they are exposed and debated in the press. Insufficient attention to
individual property rights in China, even after some favourable, but incomplete, amendments to
property rights provisions in the Constitution since 2004 and further in 2007, is causing unrest in
the rural areas exposed to urbanisation that is becoming potentially explosive.
Outcomes of the transition process in Russia and China in a snapshot
First stage: the nineties
The cost of the big bag in Russia was the output fall, except the aborted turnaround in 1997, until
1998 that wa marked by the August financial crisis. A thorough discussion of the actual size of the
output fall in post-soviet economies is in Aslund (2002, 121-151). A serious estimate of the output
fall in Russia is difficult, but few would disagree that there was output fall. Installed and unsuitable
capacity, slow adaptation of supply to demand, disorganisation and lack of market support
(distribution, marketing logistics, etc.) all conspired to depress output. High inflation rates and lack
of financing helped to depress investments. There was apparently fiscal stimulus, given the high
budget deficits, but this was out of policy failures rather than intentions. Anti-western feelings
developed both on the score of tight, and perhaps too demanding, policy recommendations issued
by the international financial organisations, pressure for the repayment of foreign debt contracted to
western countries and, finally, the IMF‟s reticence to provide the necessary financial facilities to
stem the 1998 financial crisis (in contrast with the prompt and huge intervention in support of Brazil
few months later). The inward-looking approach that Russia developed in the turn of the century
coincides with the Presidency of Putin, but it is not entirely his fault.
Prima facie, China‟s performance compares favourably to Russia. In comparison with shrinking
Russia, the average annual rate of growth in China in the nineties was above than 9%. Price
liberalisation and the “let the small go policy” released energies and entrepreneurial spirits.
Nonetheless, progress in China was costly. This has been documented by the IMF, the World Bank
and the OECD. The investment to GDP ratio has remained high throughout the period, at 44%,
while the capital/output ratio kept increasing and total factor productivity rising but at a slowing
pace. Recurrent peaks in non performing loans (NPLs) issued to state-owned enterprises (SOEs) by
the state-owned banks (SOBs) were financed by the state through banks‟ recapitalisation. Poor
credit risk management by the SOBs produced adverse selection. Excess capacity accumulated in
the provinces, each competing for self-sufficiency. Growth was driven by excessive investment and
net exports, while consumption remained subdue. Institutional change was slow and uncertain.
While informal institutions, such as quasi-property rights and informal credit survived, China was
unable to work out own institutions. It resorted to institutional cosmetics borrowing from advanced
market economies the blueprint for corporate governance, capital market regulations, monetary
transmission mechanisms and tax arrangements without really being able (or willing) to make them
The second stage: from 2000 onwards
There were benefits from the first stage of reforms to both countries. They were of different nature
In Russia, the market institutional and policy framework put in place earlier was important in
helping GDP growth to recover and consolidate after the rouble devaluation in August 1998.
Increasing oil/commodity prices contributed to the good performance of the external and fiscal
balances. Sound macroeconomic policy was crucial for the repayment of the foreign debt owed to
the Paris Club on which Russia had declared the moratorium in August 1998 while debt to the
London Club was restructured and rescheduled on favourable terms. The peak of inflation in 1998
(84%) was rapidly tamed. The number of SMEs that had been stagnant until the end of the nineties
increased by 37% from 800,000 to 1,100,000: still a small number compared to advanced
economies, but perhaps the sign that entrepreneurial skills are developing. The rate of fixed capital
investment (18% of GDP) started increasing bringing about a fall in unemployment. Wages and
income p.c. increased bringing about higher demand for housing and consumer credit.
China has benefited from increasing competitiveness and openness to the world economy after
entry into the WTO (2001). From about 40% foreign trade openness in the early nineties, China has
attained more than 65%: an astonishing level for a large economy. The expanding non state
industrial sector has been able to absorb the workforce released by the SOEs undergoing
restructuring and millions of farmers leaving agriculture. Early concerns about rising
unemployment have not materialised. The poverty level has considerably diminished at well below
20% of the population. China has approved a Labour Code in 2007 and constitutional amendments
upgrading the status of private property. The profit tax has been revised to bring about in few years
equal rates of taxation for all enterprises (25%), thus ending privileges for FDI.
There has not been a reversal in market policy reforms since 1992. In my view this should be taken
as the main criterion for success in transition economies. It is to the credit of the respective
leadership to have been able to move forward in spite of political resistance concentrated in the
unreformed parliament in Russia and within the ruling communist party in China. A plus for China:
-- to a large extent related to the structure of the economy based on manufacturing, rather than
natural resources as in Russia -- has been the decision to open to FDI and enter WTO. Russia failed
in this area probably because of excessive pride in her own human capital and potential, as well as
greed and rent-seeking attached to wealth in natural resources.
From 2000, GDP growth in China has almost reached an annual average rate of 10%. Russia‟s
growth has been robust at around 7% in the average. The problem is whether these rates of growth
are sustainable in the light of persistent policy and institutional weaknesses in both countries
compared to the image they have, or wish to portray, of themselves.
Persisting weaknesses in the process of transformation to the market
State control and rent-seeking on the part of state officials are still important, and somewhat on the
rise in Russia. China‟s state authorities, despite the wave of corporatisation and listing of state
enterprises, retain control of key sectors: foreign investors are welcome to the extent they contribute
to capitalisation as minority shareholders. Most company boards are still answering to the
Communist Party (Holstein, W. 2008). High profile cases of state interference in the energy sector
(Gazprom, Rosneft and other companies) in Russia hint to similar behaviour on the part of the
authorities in power (Tompson, W. 2008) and raise questions about the economic soundness of state
controlled companies‟ strategy versus their pivotal role in foreign policy (Kalotay, K. 2007). The
role of the financial sector is weak in both countries, and in China the State Owned Banks s‟ non
performing loans (NPLs) to SOEs, that officially are down to 7% of the total could start building
up once again in, following the unabated investment drive and on-going excess capacity in the
provinces under a protracted slow-down of the world economy.. Unsurprisingly, corporate
governance is opaque in both countries and leaves room for mismanagement and corruption.
Both countries rely on an undervalued nominal exchange rate to protect their economy. This policy
causes inflationary pressures and misallocation of resources. As a result, domestic savings are used
to finance world advanced economies rather than social needs of the less privileged. Policy
adjustment is also needed, particularly in China, not to aggravate global imbalances further (Rogoff,
Fiscal federalism has not contributed to reduce regional income disparities and improve
accountability in either country. In Russia ad hoc negotiated agreements between the centre and the
regions account for the larger transfers (Parker, E. and Thornton, J. 2007). Fiscal engineering in
China‟s provinces that finance 70% of public social spending, is still a problem, while fiscal risks
stemming from local government borrowing are an increasing concern. The majority of local debt is
unrecorded and not subject to regulation (World Bank, 2006).
Decision-making at the top level is less than transparent and there is no clear mechanism of policy
coordination between government agencies. Compared to Russia in this area, the situation in China
is perhaps more problematic, since, due to low tax revenues, public expenditure is a drag on human
development. There is need for more public spending to improve education, health, sanitation and
the environment (OECD, 2006).
Self-image and deception
Underscoring economic developments since 2000, there are grand self-perceptions in Russia and
China as to the role each country is to play in the world. In both cases, this clashes with their
outside image. Both Russia and China are characterised by surging nationalism and strong
Russia‟s vision is that of a Great Power. “A great, powerful and mighty state” was how Putin
described his vision for Russia when he first took office in May 2000 (http://newsvote.bbc.co.uk
06.05. 2008). China‟s vision is that of a Harmonious Socialist Society (6th Plenum of the 16th CPC
CC, China Daily, 10.12.2006). Elitist culture of the Tsarist and Soviet Union empires, on the one
side, and Confucianism, in its evolving, but intrinsically consistent, interpretations through
centuries, on the other side explain a great deal of self-image. There are also emotional and political
aspects. After years of frustration and distress, strong growth and disintegration of former societal
structures communities call for an anchor in the own self, for an identity to re-discover, re-affirm
and flag. Boosting national pride helps restore social consensus and legitimise the leadership.
While such sentiments are common to both countries, there are different nuances stemming from
each country‟s history. The problems each country faces in the effort to achieve rapidly world
power status also differ.
Russia, as a New Independent State, strives for sovereignty and commanding of respect from the
outside world. At the inauguration ceremony of the new President of Russia Dmitry Medvedev,
Putin said:” Today we are setting goals and objectives not just for the next month or two, but for the
next 20-30 years. We are setting ambitious goals…” (www.Kremlin.ru/ May 7, 2008).
Strong visions help shaping policies and may offer a clue on the possible trajectories of growth and
development. Under Putin‟s second mandate, Russia‟s self-perception as Great Power has been
rising fast on the score of robust growth and growing incomes p.c. while Russia‟s ranking was
falling behind on a number of indicators of social and institutional performance.
Russia is not a Great Power. Almost at par with Brazil, personal wealth is far below many countries
including Poland as shown by the World Bank‟s estimates.
In USD Exchange Rates the US economy and the French economy are respectively 18 and 3 times
as large as the Russian economy. Russia is below India, South Korea and Mexico. With a GDP per
capita (PPP) of 14,600 in 2007, Russia‟s welfare is one third of that of the US and ½ that of the
European Union (Table 1).
Table 1: Ranking of countries by GDP in USD Exchange Rate, 2007 estimates.
1 World $46,660,000,000,000
2 European Union $13,620,000,000,000
3 United States $13,220,000,000,000
4 Japan $4,911,000,000,000
5 Germany $2,858,000,000,000
6 China $2,512,000,000,000
7 United Kingdom $2,341,000,000,000
8 France $2,154,000,000,000
9 Italy $1,780,000,000,000
10 Canada $1,089,000,000,000
11 Spain $1,081,000,000,000
12 India $796,100,000,000
13 Korea, South $768,500,000,000
14 Mexico $741,500,000,000
15 Russia $733,000,000,000
16 Australia $645,300,000,000
17 Brazil $620,700,000,000
18 Netherlands $612,700,000,000
Source, CIA, The World Fact Book, 2007.
There are two main challenges to sustainable growth in Russia: one is demography, the other is
large exposure to international price shocks.
The Russian population is decreasing at an alarming rate through a perverse combination of low
fertility and high mortality that makes the country rather unique among countries at similar level of
economic development. Extrapolating from current trends, population could decline to 122-125
million by 2025. Compared to similar countries the lag in life expectancy is 3-11 years for men and
1-5 for women. The workforce is estimated to fall by 8 million by 2015 and by 18.19 million by
2025. The worst of the decline is estimated to occur in 2010-2014 when the working age group is
expected to fall by 1.3 million a year (United Nations in the Russian Federation, 2008).
Growth dependence on raw materials and energy exposes Russia to sudden external shocks. About
80% of exports consist of energy, ferrous and non-ferrous metals. Interestingly, the World Bank
(WB, 2005, Economic Memorandum) challenged the official data on supply components in GDP
that give an increasing percentage to services, noting that this is due to underestimation of energy
prices in the country. If the contribution of sectors to GDP is re-estimated on the basis of effective
prices, the contribution of industry is about equal to that of services (Table 2) and relatively closer
to that of China. Since extractive industry is the major component of this sector, growth is, indeed,
still much dependent on resources. Budget performance similarly owes much to levies and royalties
applying to natural resources. Russia remains a natural resource-based economy where
domestic/foreign incentives to industrial diversification are not sufficient (Ahrend, R. 2005).
Table 2. GDP by sectors in percent, 2005
Sector on GDP Russia* China**
Agriculture 5 (5.6) 13
Industry 35 (47.3) 46
Services 60 (47.1) 41
Source. National data 2004-2005 and World Bank 2002.
* WB data in brackets ** After the GDP estimates 2006.
Russian authorities are aware of the main challenges to growth, but perhaps not fully aware of the
complexity of measures that will have to be introduced in trying to make them mutually consistent.
In his political programme on the eve of presidential elections, Dmitry Medvedev focused on
institutions, innovation, infrastructure and investment as the key elements for sustainable growth.
Imitation was missing as noted by Pekka Sutela (Focus/Opinion, Expert view 1/2008, 27.02). The
World Bank observes that Russia, owing to comparatively higher labour costs, should rapidly try to
specialise in high value added industry (World Bank, 2006, Russian Economic Report, no.13, p.14 )
but this would need a better economic environment and less state interference in the economy.
Russia is falling behind other EMEs in technological achievements (Cooper, Julian. 2006, pp. 255-
84). One should also add that the economies that quickly benefited from imitation were those that,
like China, opened earlier to FDI. Russia has long resisted FDI, trying, on the one side, to control
foreign penetration in strategic sectors, and, on the other side, channelling since 2005 FDI to
Special Economic Zones. Imitation, particularly in high value added industry, also needs adequate
human capital: this has long been an asset in Russia compared to other emerging economies.
Nonetheless, problems are emerging also in this area. The last OECD PISA (Programme for
International Students Assessment) ranks Russia 35th in sciences and 34th in mathematics, compared
to Macao respective 17th and 8th rankings and Taiwan‟s ranking first for mathematics (BOFIT 51-
52, 21.12.2007). Thus, measures needed to upgrade the economy and increase labour productivity
range from improving education and stimulate labour and capital mobility to changing the
demographic patterns while adjusting the pension fund to the existing and foreseeable dependency
Being in charge of the government from May 2008, Putin listed quite a few areas in his programme
of work, from taming inflation and cutting tax to improving infrastructure, defence spending and
minimum wages. At his inaugural speech as a President of the Russian Federation, Medvedev
insisted on the rule of law and institutional upgrading, some of the themes that he already discussed
while touring the country before being appointed President. In one of his first meeting with
government officials, he discussed, indeed, changes in legislation that would be needed in support
of small businesses, such as reducing control from state bodies and police (http://www.prime-
tass.ru, 14.05.08). However, the division of power between the prime minister and the President is
not yet clear while a number of changes in ministerial responsibilities have been approved
apparently strengthening the functions of the Prime Minister and enhancing the status of some
siloviki, like Igor Sechin ( the Chairman of the Board of Directors of JSC Rosneft, which swallowed
up the assets of jailed oligarch Khodorkovsky's Yukos to become the biggest oil company in the
world, promoted to vice-prime minister) who formerly worked in the shadows of the Presidential
Administration (The Moscow Times 13 May 2008): perhaps an astute move that would help expose
their policies to criticism, but most likely a sign of the importance of the oil sector in the new
government‟s political agenda. All in all, the current changes show the attempt to create a balance
between conservatives and reformers, the most prominent of which retain their status.1 While in
principle a division of power that would give to the President pre-eminence on institutional matters
and foreign policy, and to the Premier responsibility for an economic policy agenda ranging from
stabilisation policy to housing and infrastructure could work, it is not clear that a neat division of
responsibilities has been agreed upon. At times, Medvedev has expressed his views on issues that
one would qualify as micro-management (small business, privatisation, etc.), while Putin is
unlikely, after two presidential mandates, to narrow to current economic policy issues his scope for
Finally, there is no clear understanding in either Madvedev or Putin of the profound causes of the
low level of competitiveness of the Russian economy. In 2007, the ranking of Russia fell from 43 to
47 among 55 leading economies in the world (World Competitiveness Yearbook 2008) largely out
of worsening indicators for infrastructure, including ITC (Vedomosti, 15.05, 2008) while other
countries made progress. M.E. Porter and al. (2008) point to low level of productivity, capital stock
obsolescence and lack of financing to firms as some of the main obstacles in this area. But they also
point to another area of concern which the authorities do not seem to grasp: the negative influence
that a larger scope for state command over resources and rent seeking exerts on competitiveness. In
coping with the host of challenges that becoming a great power implies, Russia will have to choose
on whether to integrate in the world economy through competition (WTO) 2 and exposure to peer
pressure (OECD) or to pursue an inward-looking path that would exacerbates her inner obstacles to
The resolution to commit the CPC to establish a Harmonious Society by 2020 approved by the
Plenum of the CC on 11 October 2006 reflects the concerns of the authorities about the current state
of the economy and society (China.org.cn 26 October 2006, and Wing Thye Woo, 2007, pp.572-
602). The goal of harmonious society includes improving the democratic legal system and human
rights protection, narrowing the wealth gap, increasing employment, improving the public services,
Some, perhaps too hastily, note that nothing has really changed compared to the past Presidential Mandate, there is no
economic vision, and the matter is just how to distribute wealth and budget revenues to please people in power (see
Milov, Vladimir, “Globalist: Kabinet Raskhodov”, Vedomosti, no.86, May 14, 2008).
According to William J. Burns the U.S. Ambassador to Moscow about to leave his mandate, membership in the
World Trade Organization should be achieved this year, Moscow Times May 13, 2008. Noticeably, Ukraine entered
WTO on May 16, 2008.
promoting moral standards, securing public order and protecting the environment. The ambitious
agenda came out after discussions that focused on existing conflicts in society and CPC concerns:
“We must always remain clear-headed and be vigilant even in tranquil times” (China Daily,
10.12.2006). Income inequality, underemployment and environment degradation are the most
immediate problems for China. They can become explosive in time.
China is to challenge in a few years the US‟ top ranking among large economies, but her distance
from advanced and many emerging market economies in development is large. China is clearly
distant from any possible idea of harmony. While moving up fast on economic growth, China is
lagging on development: 81st versus Russia‟s 67th in the last HDI of the United Nations. China‟s
Gini coefficient climbed from 0.4074 in 1993 to 0.4725 in 2004, second only to Nepal, overtaking
countries like Malaysia (63rd in HDI) that in the meantime had made visible progress towards lower
income differentiation. Income inequality is high between provinces (1:14 comparing Shanghai to
Guizhou) and in general between rural and urban areas, where p.c. incomes are three times the
former. The issue is not only one of income disparity, but more comprehensively one of wealth and
welfare disparities that are huge. In rural areas almost 18% of the population is poor compared to
0.4% in the urban areas. And, just to mention one aspect of living standard, only 7% of rural
households are equipped with piped water facilities (OECD 2002, pp.682-684).
While these problems are common to most developing countries, in China there are political
implications that will need to be addressed in a proper arena. Rapid urbanisation occurs in a context
in which individual property rights to land do not exist and expropriation for residential building is
a matter of deals between public agencies run by CPC officials at each level of administration.
Compensation to dispossessed farmers is low, or even inexistent. In comparison, India protects the
dispossessed farmers by buying their land at a 40% mark-up of market price and ensuring that at
least one in the household finds a job in the urbanised zones (OECD Economic Surveys, India,
2007). The 2007 amendments to private property rights in China have not yet addressed the issue of
agricultural land ownership.
The most immediate environmental problems concerns water availability and quality and air
pollution (OECD, 2002, Chapter 17). There is looming water crisis due to desertification over the
years. In some 25 years the overall existing water availability will be below demand. About two
third of China‟s 640 cities face water shortages, of which 100 severe shortages. The number is
increasing. There is also inefficient use of water for industrial purposes: China uses 5-10 times more
water per unit of output than OECD countries. The re-use rate of industrial water is half that of
OECD countries. About three-quarters of drinking water does not meet Chinese standards, that are
low compared to the WHO international standards. The water quality in the main river basins has
sharply deteriorated over the years; 25% of all lakes in China are adversely affected by
eutrophication due to heavy organic pollution and pollution by nutrients (nitrogen and phosphorus).
Carbon dioxide emissions are higher than in the US. Chinese cities are among the most polluted
cities in the world. Beijing is the third most polluted city in the world (Long Life to the Olympics‟
Fans!) Air pollution has been estimated to cause premature death of 750.000 people a year in
China‟s cities. According to the WB, 7% of all deaths in urban areas are due to air pollution.
There are less immediate, but also severe, challenges that concern society as a whole. Rapidly aging
population will require increasing social spending for pensions and health care. Fiscal policy at the
central and provincial level will need deep adjustments to face this challenge. One point can be
easily made, though: the re-orientation of policies towards balanced growth will be costly. The main
drivers of recent growth in China have been rapid investment and rising trade surplus. Due to slow
rise in consumption capacity created by investment has been in part absorbed by rising net exports.
Overcapacity, however, has also accumulated in the provinces. An IMF study points to possible
disruptions caused by falling prices in overcapacity sectors, limits to export market growth and, as a
result, building up of large new loan defaults (Aziz, Jahangir 2006). To better balance growth,
domestic consumption should increase and domestic investment abate, but this would require
improved efficiency in the allocation of resources in order to sustain, at the same time, high growth
rates, lesser state control over banks and capital markets, and utilities and land prices adjustments.
It is not clear that the CPC is ready to speed up reforms in these areas where government rent-
seeking is high.
But, more importantly, shifting public spending towards social needs, reform pension and
healthcare will require tax reforms and a new fiscal federalist approach that can spur tensions in the
country. China will need some forms of democracy to solve social conflicts. The main challenge for
China will be, indeed, how to transform to democracy.
Taking into account initial conditions, the stage of development and different constraints to growth,
China‟s success in transforming to market compared to Russia‟s appears to be less exceptional than
macroeconomic indicators alone would portray. Like Russia‟s, China‟s transition has been marred
by political controversies and stop and go in reforms that have slowed down the pace of change.
Both countries have moved more decisively to market reforms in the nineties, China gaining rapidly
due to her lower stage of development and economic structure that left larger room for catching up,
while Russia suffered from the legacies of planned economy and market unfriendly large industrial
capacity. The huge foreign debt inherited from the Soviet Union was also a significant impediment
to macroeconomic stabilisation and was crucial in igniting the 1998 financial crisis. In comparison,
China‟s macroeconomic balances all along were sound, though largely due to institutional
cosmetics that helped transfer the costs of transformation to large state owned banks (SOBs).
The main criterion of success in transformation to market is no reversal in systemic change. Both
countries succeeded in their resolution to transform to market in the nineties and oppose counter-
reform pressures and revolts. China muddled through informal arrangements that did not hamper
growth, but constrained social spending out of poor tax revenues. China has still a way to go in
transforming quasi property rights of the so-called non-state enterprises into formal rights that are
needed to allow companies to grow in scope and scale. Institutional adaptation to market has also
been more comprehensive in Russia; a great deal of it implemented in 2000-2204 under Putin‟s first
In both countries, the size of state economy is still large, about one third of total output. In both
countries state-owned enterprises are less efficient than privately owned. In China they are financed
by SOBs that bear the losses, while in Russia large state corporations have easy access to foreign
banks‟ loans. In both cases this reflects weak financial markets and political interference: the
underlying contingent liabilities from underperforming state companies and/or banks to public
finances may materialise abruptly in the likelihood of a sharp downturn in the world economy.
Both countries have benefited from globalisation: Russia through positive terms of trade for energy
and commodities and China from competitive manufacturing exports. Underlying such
developments, however, there are competitive exchange rate policies that translate into excessive
liquidity, less than successful sterilisation policies and inflationary pressures. Undervalued
exchange rates impact negatively on the allocation of resources: a development that may become
rather costly in time.
The problems each country will have to face in the near future to make growth sustainable are of
different nature and scope, and depend to a large extent on the image each country wants to portray
to the outside word. Russia is striving to (re)gain the status of a Great Power through ambitious
programmes of modernisation targeted to institutions, innovation, infrastructure and investment.
China wants to be admired as a Harmonious Socialist Society where human development will be at
par with economic growth. The leadership in both countries believes that current rates of growth
will be sustainable while undertaking a wide range of structural reforms.
This will be a great challenge for Russia where growing focus on the role of goskorporatsiia in
speeding up modernisation contrasts with the comparative lower efficiency of such structures and
the rent-seeking attached to them. The challenge to China is also formidable to the extent that fast
rates of growth sustained by excessive investment have led to growing social inequalities and
tremendous damage to the environment. Rebalancing growth will need a broad re-allocation of
resources out of productive investment to damaged groups and sectors, improved fiscal-federal
relations and effective tax administration. It will entail redistribution of wealth, and, possibly of
power. This is unlikely to occur unless democratic institutions are put in place.
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