China began the 20th century with a serious effort to modernize its economy and ended the century with a successful economic modernization. It was a success story but it took China one century to achieve what could have been achieved in about forty years. On the way there were political instability, wars and mistaken development strategies. I will elaborate on these statements below. Much of the material is based on my book China's Economic Transformation to be published by Blackwell Publishers, January 2002.

I. End of the Qing Dynasty, 1901-1911

The century began with the humiliating Treaty of 1901 after the defeat of the Boxers who had entered foreign embassies and killed foreigners. The Qing government surrendered to the military forces of eight foreign nations who invaded Beijing in July the year before in response to the Boxer Uprising. Ever since the Treaty of Nanking signed in 1942 after China's defeat in the Opium War to the British, other countries including France, Germany and Japan had forced China to sign unequal treaties to obtain concessions of territorial and other rights from China. The Treaty of 1901 was the climax of these unequal treaties. The feeling of humiliation has generated a sense of nationalism that remains to be an important social force in China today.

Foreign imperialism is criticized in China, but it has some positive effects on China's economic development. Deng Xiaoping's open door policy is credited with helping China's economic modernization. The foreign imperial powers forced an open-door policy to China, although in their terms. Even in their terms China had the benefit of learning modern technology, modern ways to operate business and a modern education system from the foreigners. The development in of Shanghai up to 1949 and of Hong Kong up to 1997 illustrates this fact. Also the foreign imperial nations forced China to modernize. In 1898 Beijing University was founded. In 1901, China introduced the modern system of primary schools and middle schools to supplement the traditional system of education. In 1903 economics was included as one of the subjects in imperial examinations for selecting government officials. The government was reorganized. A foreign ministry was established in the Qing government in 1901, and a Department of Commerce in 1903. Railroads were being built, connecting northern provinces in 1901 and between Guangzhou and Hankou in 1903. In 1904, the Bank of Communications was founded. In short foreign nations helped China modernize its economy through foreign investment and by forcing the Qing government to modernize.

II. The Republic of China, 1911-1949

In the first decade of the 20th century the Chinese people, a majority being Han people, were unhappy with the government mainly because the country was weak. There were at least three options to make it strong. The first is through internal reform. The second is through a revolution to establish a new dynasty with an emperor under some form of constitutional monarchy. The third is the establishment of a republic. That the conditions at the time were not ready for the third alternative was demonstrated by the political instability, chaos and lack of national unity between 1911 and 1937, when the war with Japan formally started. In the early years of the Republic of China, the government in Beijing was not able to govern the entire country and was itself unstable. There was a government in the South and many provincial governments often declaring independence. The Presidency in Beijing changed hands several times between 1916 and 1927, with premiers and associated cabinet members being changed more often. The parliament was dissolved and reconstituted at the will of a strong President. That was a republic in form but it was not functioning.

1. State of the Economy

In the first half of the 20th Century while China was going through revolutions, political instability and wars, the economy continued to function and develop. It was essentially a market economy as it had been since at least the Han dynasty. Most of national output consisted of agricultural products produced by family farms and the majority of the population were peasants.

An excellent study Chinese Farm Economy (the University of Chicago Press, 1930) by professor John L. Buck of the University of Nanking is based on surveying 2866 farms in seventeen localities of China in the 1920s. The survey includes a total farm area of 21,000 acres and a rural population of approximately 17,000 persons. It provides information on the economics of the farm business, including capital investment, receipts, expenses and profits, farm ownership and tenancy, labor cost and efficiency, demographic characteristics of farm families, food consumption and the standard of living.

According to Buck (pp. 423-425), "farm land is [was] generally worked by owners, although approximately one-fifth is farmed by tenants and another one-fifth by part owners, ... The production from the farm business in China and in the United States is remarkably equal in quantity per unit of land… In the United States the chief means has been the use of capital as well as labor; in China it has been the use of labor, for the most part human labor, and with very little capital…The Chinese farmer has by the trial and error method arrived at many sound and practicable conclusions for his situation. His crops are often suited to the soil, and his cropping systems follow the general principle of rotation remarkably well…The small size of business and the crowded population led necessarily to a standard of living that is low when compared to the standard of the western farmer… Diet, while remarkable in containing many of the elements needed for health and strength, lacks variety mainly in fruits and vegetables, particular in North China. The direct utilization of grains and to a certain extent of soybeans, however, is probably a more economical procedure than the western way of using so much food largely through animals."

Along with agriculture, handicraft industry and trade were parts of the traditional Chinese market economy. After the Western impact, modern industries and financial institutions began to emerge. Factories producing consumer goods such as textile, wool and leather products, toys, tobacco and paper products were operating by 1920 if not before, especially in Shanghai, Tianjin and other coastal cities. The governments in power did succeed to some extent in building infrastructure, including railroads, highways and seaports. Telephone lines and telegraph network were built. Electric power supplies became available in major cities. In addition to the old-fashioned banks, new commercial banks were established and functioned as modern banks in taking deposits and extending loans for business working capital and investment. By 1920, the Bank of China and the Bank of Communications were the two largest banks which issued currency, while numerous commercial banks existed in various cities. A stock market in Shanghai was trading actively in the 1930s. Private life insurance companies were operating. The education system improved, through government effort and private initiative, with help from foreign friends, including missionaries. Private universities coexisted with state universities sponsored by the central government and provincial governments.

2. Economic Lesson from the Period 1911-1949

What important economic lesson can be learned from reviewing briefly the history of the first three decades of the Republic of China? In spite of political instability economic activities were carried on and economic development took place between 1911 and 1937. Modern economic institutions evolved naturally in a market economy. The resourcefulness of the Chinese people and their desire and energy to make a better living were sufficient to improve the economy once they were given some freedom and opportunity to do so. In short modernization was taking place. China had a well-functioning market economy, although it was still a poor country except for some coastal cities. The important economic lesson is that market economic institutions combined with Chinese human capital are sufficient for rapid economic development provided that there is sufficient political stability.

Economic progress would have been more rapid if there had been internal political stability and no war with Japan. Some observers have remarked that Japan attacked China in 1937 because it was witnessing the progress made in China and could not wait any longer. This explains why China was capable of returning to a market economy after economic reform started in 1978 and why, once the Chinese people were given some economic freedom, economic development was so rapid since 1978. In some respects, including the institutional structure and functioning of the commercial banks and of many industrial enterprises, the current state as of 2000 has not yet reached the high point achieved in the 1930's because it is difficult to abolish the economic institutions and change bureaucratic behavior established under central planning.

III. The People's Republic of China, 1949-2000

1. Experiments with Planning and Economic Disruptions, 1949-1978

After the establishment of the People's Republic of China in 1949, the economy began to recover after years of wars. In 1953, the government adopted the Soviet-style central planning in the form of the first Five-Year Plan of 1953-1957. Private enterprises and enterprises formally controlled by the government of the Republic of China were reorganized into state enterprises. In agriculture, the farmers were first given land after the land-owners as a class were brutally destroyed. They were then organized into cooperatives, more advanced form of cooperatives and into Communes in 1958 as a part of Chairman Mao's Great Leap Forward Movement. The Great Leap led to the death of over 25 million people from 1959 to 1962, as can be calculated by officially published death rates. The death rate was about 11 per thousand in 1957 and 1963, but went up to 17 per thousand in 1962. China had the most severe famine in its history.

In this short essay, I do not have space to discuss the economics of central planning, a subject of chapter 2 of my new book. The shortcomings of the planning system were well recognized by Chinese economic officials before economic reform started in 1978. The planning system with limited foreign trade and investment, together with the two political movements, the Great Leap and the Cultural Revolution, accounted for the failure of the Chinese Economy up to 1978.

2. Economic Reform

A. Why reform started

1978 was the year when Deng Xiaoping took over control of the Communist Party. He was responsible for initiating reform of the planned economy towards a more market-oriented economy. There were four reasons why the time was ripe for reform. First, the Cultural Revolution was very unpopular and the Party and the government had to distance themselves from the old regime and make changes to get the support of the people. Second, after years of experience in economic planning government officials understood the shortcomings of the planning system and the need to change. Third, successful economic development in other parts of Asia including Taiwan, Hong Kong, Singapore and South Korea, known as the four Tigers, demonstrated to the Chinese government officials and the Chinese people that a market economy works better than a planned economy. This lesson was reinforced by the contrasts between the different rates of economic development in North and South Korea, and in countries in Eastern and Western Europe. Fourth, for the same reasons as stated above, the Chinese people were ready for and would support economic reform.

Given the above four reasons was economic reform in 1978 inevitable? My answer is the positive. The first two reasons alone were sufficient for the government to initiate reform. The Cultural Revolution had made the government so unpopular that both the government and the people wanted to change eagerly. The direction of change was clear because economic planning was recognized to be a failure. Given such a situation there was no other way for China to go. The urgency of the case was such that it had to occur as soon as the political leadership was ready after Chairman Mao's death. Chinese economic reform in 1978 is an example of the possibility of predicting a major social change by examining the prevailing conditions. Such prediction is easy to do by hindsight but more difficult to do before it occurs.

In Chapter 3 of my book I survey six major components of economic reform beginning with agriculture. The remaining areas are state-owned enterprises, price reform, the banking sector, foreign trade and investment, the non-state sectors and institutional infrastructure. I point out that the reform process has been a combination of the effort of the central government and the natural desire of the Chinese people and lower level government units to improve the economic institutions for their own benefits. For example it was a combination of the efforts of the farmers and the government which changed the Commune System. As far as the role of the central government is concerned, the process has been a gradual and experimental one and has proceeded in steps.

Reform of Chinese state-owned enterprises is an example of a gradual approach to economic reform through experimentation. In this case, the following concepts were accepted and carried out step by step. The first was to give state enterprises some autonomy in production decisions rather than simply carrying out the production targets under a system of central planning. The second was to make them financially independent, allowing them to keep the earnings as their own profits after paying taxes to the state, rather than as revenue belonging to the government. The third was to introduce a contract responsibility system, first to selected parts of the enterprise under the important reform decision of October 1984, and later to an enterprise in 1987. Under the contract responsibility system, a part of an enterprise or the entire enterprise was allowed to keep all the gain (such as output produced) or profit after surrendering a fixed amount of it to the enterprise controlling the part, or to the government controlling the enterprise. The fourth was the reform of the price system that gradually allowed prices to be determined by the market forces of demand and supply. In the mean time a two-tear price system was introduced to allocate scarce resources formerly under the control of central planning, including material inputs to state enterprises and foreign exchange. Under such a system, the government continued to distribute the scarce resource to designated users at an official, below market price. At the same time a second market was allowed to trade the scarce resource at market price. The fifth, introduced in 1997, was to restructure the state enterprises into share-holding companies. It will be useful to keep this general picture in mind when studying China's reform process in general or in a particular sector.

To summarize China's economic reform process, we note that agricultural reform was initiated from grassroots and succeeded rapidly in returning to private farming. Reform of state-owned enterprises went through different stages and are not completed. Reasons are provided for the difficulty in reforming state enterprises in contrast with the agricultural sector. Efforts to transform the People's Bank and the specialized banks were outlined briefly but reform is far from being completed. Under the open-door policy, foreign investment and foreign trade rapidly increased, both contributing to China's rapid development. In the mean time the non-state sectors experienced dynamic growth, with the collective sector surpassing the state sector in industrial output. China's reform policies are similar to those of Taiwan two and half decades earlier in the promotion of market forces, the reliance on the agricultural sector in the initial stage, the encouragement of exports, the emphasis on price stability and the gradual decontrol of foreign exchange. An interesting phenomenon was the blossoming of township and village enterprises operating without clear property rights and the protection of a well-functioning modern legal system. The study of this phenomenon provides a challenge to economists accustomed to observing the functioning of private enterprises in Western market economies. Institutional infrastructure including the education and legal systems was also improved in the process of economic reform.

B. Why reform succeeded.

First, the Chinese leaders are pragmatic and not subject to ideological restraints. The author was working with the Commission for Restructuring the Economic System of the State Council that had the responsibility to design strategies for reform in the 1980s. At meetings with the top officials of the Commission, any proposals could be discussed. One member made the following remark, "there is nothing of value in the capitalist economic system that we cannot consider and adapt for China." Of course some policies were not proposed because Communist Party members were not ready to accept them at the time. On pragmatism, Deng Xiaoping said that one should not care whether a cat is black or white as long as it catches mice.

Second, there was no blueprint for the economic institutions to model after and policies were adopted through experimentation. This is a process of learning by doing, or as Deng put it, of "crossing the river while feeling the rocks." The responsibility system was adopted because it had worked well. Reform of state enterprises started by introducing partial autonomy to a small number of them. A larger number and more autonomy were tried later as the experiment proceeded. Another example of experimentation was the policy to allow the Province of Guangdong in 1979 and the special economic zone of Shenzhen in 1982 to adopt more capitalist policies first. The advantages of experiments are two. First, they were used to find out what works. Second, by successful experiments Party members indoctrinated with old ideology could be convinced of the new ways and to give their support for the reform program. As the wise leader Deng advised, "Seek truth from facts." He understood these two points well. In this statement he asked the Party members not to let ideology prevent them from accepting new policies that were shown to be good experimentally. Because of the lack of a predetermined blueprint and the use of experimentation, reforms took place gradually and step by step. This process has been characterized as "gradualism" in contrast with "shock therapy." Shock theraphy was adopted by some Eastern European countries that desired to change immediately to a market economy.

Third, the reform had the support of the Chinese people and of the government officials who had discovered and experienced the failure of economic planning. They desired to change course from central economic planning. They also desired a new system after the excesses of the Cultural Revolution. They were ready for the change. As Premier Zhao Ziyang once remarked to the author, "the Cultural Revolution had done great harm to China, but it had helped us get rid of many ideological restrictions."

Fourth, there was political stability while the reform took place. The Communist Party remained in power and was able to exercise leadership during the reform process.

Fifth, much credit had to be given to the Chinese leaders themselves. Deng in particular should take most of the credit in sitting behind the scene to oversee the overall direction of the reform. He had the ideas of pragmatism and the use of experimentation. He had to get the support of the high-level members of the Communist Party. Some top leaders were not willing to let China deviate from its traditional course. There was a difficult political balancing act at the top level of the Communist Party. It is difficult to imagine another leader who could have done as well in leading China during the first two decades of reform. Without Deng, the reform would not have been so successful even if it had taken a market-oriented direction in the first place. There were also Zhao Ziyang, a brilliant economic thinker who served as the Premier and later Party General Secretary who designed and carried out economic reform, and Hu Yaobang, the humane and highly respected Party Secretary. The current Premier Zhu Rongji is also very skillful in managing the economy while General Secretary Jiang Zemin kept the country and the Party in order. There have been numerous able officials in the Chinese government whose contributions cannot be enumerated here. It should be pointed out that the political process practiced in China has been capable of selecting and promoting able and especially college educated people in the government, but the process has not been perfect and the economic system itself has bred corruption.

The above positive features of China's economic reform process need to be balanced by some qualifications. Political stability and the ability of the government to manage the economy were not perfect. In the late 1980's the banking reform and monetary policy allowed the rapid increase of money supply, by 50 percent in 1984 and over 30 percent per year in 1986-1988, leading to inflation at an annual rate of 30 percent in the fall of 1988. In the mean time, reform provided opportunities for government officials to extract bribes through control of state assets and the rights to issue permits required to perform economic transactions. Corruption became a serious problem. Inflation and corruption in the late 1980's created much discontent among the urban population. Student demonstration started in April 1989 at the memorial of the death of Party Secretary Hu Yaopang and lasted until June. Tiananman Square was occupied by thousands of students during the entire two-month period, with new groups of students coming from other parts of China continuously. There seemed to be no end to the student occupation as money was distributed to them from sources in Hong Kong and Taiwan, and perhaps from America as well. The government lost control of the situation and anarchy was likely to result. Failing to end the demonstration by other means, Deng Xiaoping decided to send tanks to disperse the students in Tienanman Square.

Critical reactions all over the world of this Tiananman incident came immediately, probably to an extent unexpected by Deng. Government officials and business men of many foreign countries refused to go to China. Foreign investment and tourism declined. The government suffered a big shock from internal disagreements on how to handle the demonstrations, the disorder of the demonstrations which became wide spread in several major cities and from the negative reactions in many parts of the world. However the policy of reform toward a market economy continued its course, contrary to the expectations of some foreign observers. During his visit to Shenzhen in February 1992, Deng reaffirmed and in fact pushed further domestic economic liberalization and the open-door policy. Later in the year, the Party Congress declared that China's economy is a socialist market economy. China's economy by the end of 1992 had resumed its rapid growth path after the disruption of the Tiananman incident. The incident served as a test of the stability of China's political system and the able leadership of Deng who managed to regain his support after so much external and internal criticism.

In discussing the reasons for the success of the reform process I have mentioned the contribution of millions of resourceful Chinese entrepreneurs and skillful and hard-working Chinese workers to economic growth. It is the Chinese human capital that contributed to growth once the reformed institutions permitted the Chinese people to utilize it effectively. Growth itself provides the momentum for more reform. In addition to domestic Chinese human capital, both human and financial capital were supplied by thousands of overseas Chinese, in Hong Kong and elsewhere in the world, and by foreign investors. The important contribution of Chinese human capital should not be surprising if one recalls that China was experiencing economic development in the 1920's and 1930's because of the resourcefulness and energy of its people even when there was political turmoil.

The degree of institution reform achieved can be measured by the contributions of the market institutions to national output at the beginning of the 21st Century. China Statistical Yearbook 1997, p. 42, provides the following breakdown of 1996 GDP of 6859.4 billion yuan: primary industry, 1388.4; secondary industry, 3361.3 ( 0.87 industry and 0.13 construction),; tertiary industry, 2109.7 (0.26 trade, 0.17 transportation and communication). If all primary industry, namely agriculture, 75 percent of industry (since state enterprises account for less than 30 percent of gross industrial output and some of them are profit-oriented) and 50 percent of tertiary industry (since much of retail trade is private) are considered output of profit-maximizing producers, then 1388.4 plus 2521.0 plus 1054.9 or a total of 4964.3 of the 6859.4 billion yuan is so produced. This amounts to 72.4 percent as a measure of the degree to which China's economy is market driven, and of the stage which market economic reforms have reached. This 72 percent of gross domestic product produced by market-driven productive units happens to coincide with the 28 percent of gross industrial output value produced by state-owned enterprises reported in official statistics.

The successful experience of China' reform may or may not be relevant for other former Communist economies, depending on the circumstances of each country. I will mention two factors which contributed to the success of China's reform process and were absent for the former Soviet Union. One is the support of numerous overseas Chinese, including those living in Hong Kong and other parts of the world. These people contributed large amounts of financial and human capital for both the reform and the development of the Chinese economy. The second is the human capital retained by Chinese farmers who still remembered how to operate as private farmers in 1978, whereas it has been suggested that the Soviet farmers in the early 1990s were all trained as collective farmers and did not know how to run a private farm. I will also mention two favorable factors for China which Russia could have adopted. These are the maintenance of a stable political system under the Communist Party and the use of gradualism and experimentation rather than rapid privatization for the reform of state enterprises. Economists and historians can debate whether Russia's economic reform would have been much more successful if these alternative courses had been taken.

C. Was the Success of China's Economic Reform Inevitable?

My answer is the positive. Given the pragmatic attitude and the ability of the Chinese leaders and government officials, the use of experimentation and the support of the Chinese people, there was no way for the reform in China toward a market economy to fail unless a market economic system does not work better than a planned economy (which no economist believes). Why almost no one in 1979 forecasted the rapid transformation and growth of the Chinese economy that followed? First, very few people understood these sufficient conditions for success of the economic reform at the time. Perhaps most of the able Chinese leaders themselves did not understand all the conditions. They might have confidence in their own ability but might not know that the market economy could work so well. They might not know how much support they would get from the people. Second, note the "in China" part of the above statement of inevitability. The high degree of success of the reform process was partly due to the accompanying rapid growth of GDP to which the able Chinese laborers and entrepreneurs contributed. At a given stage of reform, the human capital of the Chinese people made the economy grow fast, and the rapid growth itself push the reform forward. The success of the economic reform is judged mainly by the rapid economic growth, and not merely by the extent to which the economy has been transformed to a market economy. Even if institutional changes were limited when judged by the latter criterion, the reform would be considered successful if there were substantial growth. The able Chinese laborers and entrepreneurs might not have contributed much to the reform process directly but have contributed to it indirectly through their contribution to the rate of economic growth.

Is continued future development inevitable? Not many people in 1979 recognized the quality of China's human capital and its role in promoting economic reform indirectly through increasing China's national output. Without high quality human capital, economic institutions and market incentives alone cannot produce rapid economic growth. The important contributions of the Chinese population to the economic performance of Indonesia, Malaysia, Thailand and Vietnam (before the Vietnam War) suffice to demonstrate this proposition.

D. Will China's Economy Continue to Growth Rapidly until 2020?

Yes, because of the combination of existing market institutions and the high quality Chinese human capital is sufficient to produce rapid growth in the future with the understanding that the rapid growth will slow down as the economy matures. That is why I used the term "successful" at the beginning of this essay to describe the process of China's economic modernization in the 20th century. In Chapter 5 of my book I provide an econometric model to forecast China's real GDP up to 2010. In Chapter 22 I discuss three sets of forces at work to push China's economy forward. These forces are the government's attempt to modernize the country under an open-door policy, the energy of the Chinese people and the inertia of bureaucracy and existing economic institutions, some left over from the period of economic planning. The first two are positive while the third slows down the process of growth. The combination of these forces will lead to a substantial rate of growth, as they have in the last two decades of the 20th century. Some institutional weaknesses of the Chinese state enterprises and the banking system are discussed in the book but these are not serious problems that can affect the positive forces driving future economic growth.

When will China catch up with the US? The World Bank, in its 1997 publication China 2020 also provided a fairly optimistic forecast of China's real GNP up to the year 2020. The projected annual rate of growth was 8.4% for 1996-2000, 6.9% for 2001-2010 and 5.5% for 2010-2020, showing a decline in the growth rate as the economy becomes more developed. As it is shown at the end of Chapter 5 of my book, beginning from the level of its GNP in 1998, the United States will have to grow at a annual rate of 2.95 percent up to 2020 in order to achieve the same level of real GDP as China's level as forecasted by the World Bank. Allowing for error of these forecasts, one can definitely say that around 2020 China will have caught up with the United States in total real GDP. Of course China's GDP per capita will still be much lower, but many parts of China will enjoy a high standard of living, as we can even witness in Shanghai today.

Thus China's economic development in the 20th century has a happy ending, in spite of the suffering and turmoil that the people went through. The Chinese people can look forward to a happy and prosperous future.

(The author is a professor of economics at Princeton University.)