Socio-economic implications of economic liberalization: advantages and disadvantages (examples from Russia and China)



The main objective of this paper is to investigate the economic liberalization process in two different countries that used to have similar economic systems: Russia and China. It begins with a discussion of macro-economic factors that preceded both countries’ decision to open-up their economies, the most significant reforms that occurred afterwards, and their impact on the economic development of those countries. The main question that this research paper addressed is: Was the overall result of opening-up beneficial or not? The results indicate that convergence in both countries triggered positive changes in economic growth. Financial and economic liberalization comes with risks, but, in the long run, the net effect of the reforms was likely positive and lead to huge economic benefits. It can be said that economic liberalization is a desirable and beneficial process for developing countries.

Keywords: China and Russia, economic liberalization, privatization, economic development.

Economic liberalization consists of processes, that include state policies and regulations, that promote free trade, deregulation, elimination of subsidies, control over prices and rationing systems, and, usually, the downsizing or complete privatization of state-owned enterprises (SOEs).

The worldwide spread of free-market oriented economic reforms, along with subsequent liberalization of foreign economic policies, privatization and deregulation was one of the defining features of the late twentieth century. Since then, the impact of economic reforms on the global economy was widely discussed by economists all over the world. The main focus of this paper is to identify the overall effects of economic transformation using the example from only two countries: Russia and China. The choice is justified by a number of similarities that those countries used to share, such as protracted development under Stalinist economic model, high level of state interventions in the economy, and, accordingly, lags in the main economic areas. In spite of similar economic situations, China and Russia chose to modernize their economies using gradualist and shock-therapy methods respectively. This research is aimed to identify key advantages and disadvantages of two different transformation models.

Russia (in those days referred to as Soviet Union) and China turned their backs on the capitalist system in 20^th century and adopted communist systems. They both used to have state run socialist economies that followed inward-oriented, state-controlled economic strategies. Those strategies created various economic distortions, such as central planning, state-directed resource allocation and high import protection. The strategies that governments in both countries used held back the private sector and exports, and, as a result, overall economic performance of the countries was poor and inefficient. China and Russia share some common elements in a way, that both countries’ economic systems kept them relatively poor, stagnant, centrally-controlled and isolated from the global economy. However, things started to change and by the end of 1980s, most of the traditionally closed economies in the world, including China and Russia, started liberalization process.

1. Method

This paper incorporated a whole variety of methods used for analyzing economic liberalization related information since it is combine from different books and research papers. Thus, scholars from CSESCE (2008) used transition probability matrices along with Theil’s T statistics, researchers from EACES estimated effects of economic reforms in both countries by using panel data model, whereas others used nonparametric approach, including distribution analysis, quadripartite decomposition and data envelopment analysis to measure the changes in efficiency after the reforms initialization. Both quantitative (descriptive) and qualitative methods were used at the data analysis stage.

2. Initial opening up

Even though China and Russia shared some similarities in the economic systems, the economic conditions were absolutely different. By the late 1980s Soviet Russia was resource rich, mature industrial economy with highly educated labor force. The country was among world’s leaders in science and technology, and it was a military superpower equal to the United States. On the other hand, China was resource poor, predominantly agricultural (80 % peasants, compared to 15 % in Russia), with an insignificant and uncompetitive industrial base and scientific capacity.

Before the free-market oriented reforms, the ruling party in China realized the urge to boost economic development of the country. Central government launched a few governmental programs, such as the Great Leap Forward, that included economic and social policies aimed to enhance economic growth. But all the efforts failed and, moreover, resulted in greater imbalance and deficit in Chinese economy. Moreover, the reforms caused the deficit of food supplies that resulted in famines which killed millions of people across the country.

Things started to change when Deng Xiaoping took power in 1978 and introduced China’s Open Door policy that set the economic transformation of China into motion. Introduced reforms embraced all the aspects of China’s economy, improved agriculture and other industries performance, liberalized financial sector and completely reformed taxation system. Also, country-wide privatization was launched and, for the first time since its founding, the People’s Republic of China finally became open to foreign investment.

In Russia, the actual reforms began only 13 years later, when the Soviet Union collapsed. In the latter years of the Soviet era, top-level officials, headed by then-president Mikhail Gorbachev, tried to reform the Soviet economic system from within Perestroika proposed in 1986. Unfortunately, the reforms were inconsistent, half-hearted and poorly implemented. Few years later, in 1991, after the failed 1991 coup, the Soviet Union ceased to exist. Less than six months after the fall of communist regime, Russia embarked its economic transformation process with “shock therapy” reforms. More than ninety percent of all prices were freed overnight. Within a few subsequent months all centralized operations of the command economy were frozen. Since then, boundless state subsidies, restrictions and ubiquitous state control were replaced by market economic system, that included market institutions and practices, free prices and trade, enterprise autonomy, legalized ownership and bankruptcy. The distinctive feature of Russian reforms is that the country had to face the whole transformation process in just few years.

The Russian “shock therapy”, compared to gradual transformation of China, shows the advantages of the latter. Within 6 years the Russian economy experienced 35 % fall in GDP terms, which is equivalent to the Great Depression of 1930s in the USA, unemployment exceeded 12 % and, eventually, the reforms led to Russia’s financial collapse in 1998. At the same time, China was one of the fastest growing economies with an average growth rate of 10 percent.

Both China and Russia had to turn towards market-oriented reforms to retrieve their failing economies, the only difference is that Russia did so with, and China in the absence of, the constitutional transition.

3. Privatization

The breakdown of the old Soviet monetary and financial system resulted in hyperinflation, that was over 2000 % in 1992, so the government had to urgently come up with a strategy that would stabilize monetary situation in short

time, and at the same time, would lead to a market economy in the long-run. That is when the government decided to privatize state-owned enterprises. In two years 70 % of medium and large enterprises and more than 90 % of small enterprises were given into private hands. The State Committee on the Management of State Property, lately renamed to Ministry of Privatization. divided all the firms into those that would be sold by the local governments and those that would go into the mass privatization program. However, the rapid privatization process has not led to expected results in terms of economic performance. Under the mass privatization program government decided to distribute shares among all citizens. And so, on September 1, 1992, every living citizen received a voucher with a face value of 10,000 rubles. Unfortunately, due to high corruption levels, high inflation and poor management of the whole privatization process, people had no faith in those vouchers, and many just threw them away or sold them. Depending on the time and place of sale, the voucher price fluctuated in the range of 70–120 rubles, enough to buy a toy-car or a couple bottles of vodka. At the same time, some entrepreneurs collected thousands of these “worthless” vouchers and became extremely rich in just few years.

On the other hand, at the course of privatization, a tiny elite and former senior bureaucrats (so-called “red directors”) acquired control of all strategic enterprises, mostly in oil and gas industry, and lately became the Russian oligarchs. Those groups of powerful oligarchs, that emerged out of nowhere, used divide-and-rule strategy and thrived on institutional anomalies and economic policies incompatible with market economy, such as unrestricted monetary emission, low interest rates, multiple exchange rates, myriad regulations, and rigorous licensing of entrepreneurship.

Therefore, privatization in Russia harmed the overall economic situation and resulted in rising inequality and decreasing living standards.

In contrast, the example of privatization from China seems more well-thought and rational. Chinese government realized the need to maintain political power and state capacity, and, therefore, the transition process in China was smooth because the government was always able to correct mistakes and imbalances as they arose. By early 1990s, China had about 300,000 state-owned enterprises that employed almost 80 million people. In 1994, Chinese government gradually started to privatize its SOEs and began with only a few counties and provinces. Only when the privatization program was successfully implement in pioneering provinces, it became spread nationwide. In two years, around 70 % of small and medium SOEs had been privatize. To prevent a small group of wealthy people benefiting from the privatization at the expense of public, the government implemented a set of restrictions on potential buyers.

As a result, within 1990s, China had managed to double its GDP, and has lifted more than 400 million people out of absolute one-dollar-a-day poverty — which is the single increase in world history. Rapid economic growth resulted in a significant rise in China’s global status. In contrast, the Soviet Union lost half of its territory and population, and newly found Russian Federation could never get back its status as a great power. Moreover, failed privatization programs, along with economic recession, has led to an upsurge in lawlessness and crime, a falling birth rate and rising death rate, and the war in Chechnya. That is why China’s transition from state socialism is generally consider a success, whereas the Russian example of market reforms is consider a failure.

4. Overall economic development

Since opening up to foreign investment and trade and implementing free-market oriented reforms, China has been among the world’s fastest-growing economies, with annual GDP growth averaging around 10 % until 2014. Also, the country emerged as a major global economic power and became world’s largest economy on a purchasing power parity basis, manufacturer, holder of foreign exchange reserves and merchandise trader. China’s economic development has substantially raised living standards by lifting hundreds of millions out of poverty and created a flourishing middle class.

Nevertheless, country’s rapid industrialization has brought some serious challenges. One of them is air pollution. China now is the world’s largest source of carbon emission and greenhouse gases, and the air pollution of many Chinese cities fails to meet health standards. Thus, in 2013, on average, the concentration of hazardous particles in the 80 % of China’s cities was forty times the safe level by the World Health Organization (WHO) and prolonged smog was name “apocalypse”. Furthermore, water depletion and pollution, one of the country’s top environmental challenges, was caused by modernization process, for nearly 70 % of the country’s water supplies is dedicated to agriculture and 20 % is being used in the coal industry.

Moreover, the economic boom of China has caused several social issues as well. One of them is child labor. In the past decade, with the fast growth of internet access across China, a topic of child labor has started to gain netizen’s attention. The most vivid examples are cases of child labor in Shanxi’s brick kilns and Dongguan’s sweat shop is 2007 and 2008 respectively.

On the other hand, the economic liberalization process in Russia has had its own pros and cons. The Chinese example shows how a country can grow due to the country’s reliance on foreign capital coupled with cheap labor and well-though economic policies. Russia is quite different in this sense. For its economic recovery, Russia heavily relied on the natural resource sectors that turned the country into a leading supplier of oil, natural gas, coal, and a big range of other raw materials to industrialized countries.

After the failed economic reform program, that created inflation and destabilized the country, Russia has entered a stage of long economic growth that lasted almost 10 years between 1999 and 2008.

During that time the country’s GDP has increased 7 % per year on average, in contrast to an average annual decline of 6.8 % during the previous years. During the first five years after the collapse of the Soviet Union, poverty rates has jumped up to nearly 30 %, but by 2007 the rate had dropped to 13 %. At the same time, Russia’s foreign trade has sharply increased and Russian exports grew by 525 % from $75.5 billion in 1999 to $472 billion in 2008. The developing economy has improved the investment climate in the country. As a result, the annual FDI flows into Russia rose from $3.3 billion in 1999 to $60 billion in 2007. In those years, Russia emerged as the world’s largest exporter of natural gas, second largest oil and coal exporter.

The economic growth has improved the standard of living of the average Russian citizen and has brought economic stability.

However, it has brought certain issues as well. For Russia, the biggest issues that arose are inequality and corruption. The income distribution measurements show how severe is the rising inequality in Russia. Thus, before the collapse of the Soviet Union, the richest 20 % of the Russian population accounted for 30.7 % of the country’s income, while the poorest 20 % accounted for 11.9 %. The situation has changed dramatically, and, by 2006, the richest 20 % held almost 50 % of the income, whereas the poorest 20 %’s share has declined to 5 %.

Also, since the initiation of economic reforms, due to a large number of bureaucrats left after the Soviet regime, Russia has always been among the countries with a high corruption level and the country does not show much improvement in this area.

5. Conclusion

Russia and China have experienced sustained economic growth while integrating with the global economy. As a result of reforms, both countries emerged to global capitalism as more stable and stronger states. Even though, neither of them has fully embraced the values and institutions of the “Washington Consensus”, with its idea that globalization leads to democratization, the development model of China and Russia shows the acceptance of market forces and global integration.

The example of China and Russia has shown that there is no universal solution for all economic hardships. The economic strategy and reforms should consider a country’s individual social, economic and political situation. The changes in rules and regulations should be designed in a way that will benefit the greater number of people and policy makers should prevent cases, like oligarchy in Russia, from happening.

The transition period in Russia had negative effect for the country’s economy and was mostly responsible for the following transformational recession (Popov, 2001). The whole “shock therapy” concept was a mistake. The reforms, that, in theory, were mean to save collapsing economy, worsened the situation and resulted in Russian financial system completely collapsing. It was definitely more shock than therapy (Gerber, 1998). At the implementation stage and over the course of economic growth, the government should have rationally evaluated the resources and time available, as well as political and social conditions of the country.

From the real life examples, it can be conclude that overall effect of the economic liberalization was positive. The side effects, like in the case of Russia’s post-transition difficulties, are not attributed to the liberalization process itself, but were rather caused by poor management, inexperienced top-level government officials and underdeveloped implementation strategy.

As to China, there is still a big room for improvement in inequality reduction, business efficiency, and reduction of environmental effects of growing economy.

Globally, the processes related to the economic liberalization has resulted in a more globalized world, for more and more countries decided to open-up. The globalization process generated complex and deep interdependencies between countries that are driven by a combination of political, socio-cultural, technological, financial and economic factors. As a result, the process known as “flattening of the world” significantly decreased the risks of political and military conflicts, since those are no longer beneficial for any country.

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