China and Political Realignment Jude Wanniski January 26, 1979

Executive Summary: Peking has altered the global political landscape in a fundamental way. Breaking loose from ideological communism, China is experimenting with Western democratic forms, moving toward a system of incentives at the center of economic life. Peking has become de facto leader of the Titoist bloc among socialist nations. The rejected Soviet model is now under greater pressure from western values, Romania and Poland already tugging away. The global impulse toward economic growth and human rights (democracy) now elevates the People's Republic of China as a pro-Western laboratory for the Third World, pushing Maoist egalitarianism off the agenda. A central political fact is the age (74) of Deputy Prime Minister Teng Hsiao-ping, for Teng must live long enough to imbed Western values in China, yet must not rush industrialization in a way that produces corruption, waste and debt — which would invite counter-reformation back toward Eastern oligarchic forms. As his negative model, Teng now has Iran under the Shah. As a positive model, he looks to Japan.

China and Political Realignment

Beginning in late November and into early December of 1978, the walls of Peking, Shanghai and other key mainland cities of China exploded in poster appeals for freedom, human rights, economic growth and democracy. The outburst of seemingly free and spontaneous expression — which included admiration for the economic development of Taiwan — gathered an earthshaking momentum felt in capitals around the globe. The events marked a thrilling, historic passage in the life of the world political economy, with the People's Republic of China all but formally announcing the end of its experiment with ideological communism.

When President Carter on Dec. 15 announced normalization of relations with the PRC, it was clear enough that the dazzling poster campaign of the previous week had been orchestrated to some degree by Peking and Washington. The aim, of course, was to soften U.S. public opinion for the news that U.S. diplomatic relations with Taiwan would be severed. The transparency of the poster campaign, though, did not detract from its importance and validity. The poster campaign could not have taken place a year ago; one could not even be orchestrated in Moscow today. It takes more than a genuine measure of belief to open the Pandora's Box of democratic experimentation in the way Teng has done. It also takes confidence in the likelihood of the outcome. In the several weeks since the Carter announcement, every report coming out of Peking adds to the probability that a political revolution has occurred and out of it a truly pro-Western government has emerged.

The revolution has been underway at least since the death of Mao Tse-tung in September 1976 and is thus not a great surprise. In the period since then, even casual China-watchers have seen Peking gather the necessary critical mass to make this passage. In September 1977, I observed:

In China, the passing of Mao Tse-tung has given that vast electorate of 900 million an opportunity to "vote" in new leadership, through internal consensus-shaping. The result has been a relatively rapid drift in the direction of classical economic forms. Peking has openly embraced the idea of using individual incentives as a means of expanding production, going so far as to twist a Marxist slogan into one more appropriate to Adam Smith: Instead of Marx's idea of communism, "From each according to his abilities, to each according to his needs," Peking proposes, "From each according to his abilities, to each according to his work." If China can find a way to unlock the nation's intellectual capital through incentive systems, for industry as it has for agriculture, rapid growth can follow. Unity with Taiwan is historically inevitable, as is unification of North and South Korea. But it is now not outlandish to consider the possibility that the completed results will mean a China and Korea that more closely resemble Taiwan and South Korea than Marxist models, which has been the conventional assumption by both liberal and conservative intellectuals in the West.1

To understand the events unfolding in China today, it is crucial to remember that the revolution in China after World War II was an agricultural revolution, not — as in Russia — an uprising of the urban proletariat.

In the Soviet Union, Stalin attempted rapid industrialization on the backs of the Russian peasantry. His 1929 supertax on grain production was designed to provide the capital resources for urban industrialization, instead meeting a peasant resistance that resulted in the deaths of 3 million kulaks during the early 1930s. The Soviets have had severe difficulties with agricultural development ever since.

In China, even during the economic turmoil that accompanied the worst days of the Cultural Revolution (1966-69), farm output was sufficient to feed several hundred million Chinese. The secret has been a system of agricultural taxation that maximizes incentives to produce. As in the Soviet Union, Chinese peasants are permitted private plots to work, the fruits of which are not subject to tax. Unlike the Soviet Union, communal production is not subject to progressive duties. Instead, high output is rewarded through regressive taxation.

In other words, the state sets a base year against which grain duties are calculated. Each production team of about 100 people in the 50,000 communes is required to deliver 5% of that base year production to the state, plus a slice of the next 13% of the base according to a variable price formula. There is thus no tax on any grain above 18% of the base year. The team could double production against the base year and keep or sell all the surplus. To the outside world, the Chinese peasants have thus appeared to be "blue ants," somehow motivated to work feverishly for the state. In reality, they are organized entrepreneurially to maximize individual benefits, the teams being small enough to link effort and rewards.

In addition, all non-farm work inside the communes is rewarded with "work points," a form of currency that permits effort and reward to be linked across populations of 50,000 or 100,000. In this system, no marginal tax rates are faced, with the result that the communes are self-contained beehives of individual effort seeking individual gain, the state's presence felt only as a framework.

This framework has been critical, though, in preventing larger economies of scale as well as imposing structural barriers to freedom. In the non-farm sector of the communes, for example, work points cannot be traded from commune to commune. There are 50,000 separate, nonconvertible currencies, then, which have no value outside the currency area. Wealth cannot be transferred because work points cannot be traded, so migration is blocked as well as commerce in this private plateau of the Chinese economy. Most individuals are born and die in the same area of several square miles.

In the farm sector, the tax-free output incentive has its limitations too. The state periodically adjusts the base year to reflect increased productivity. Thus, a gung-ho production team that honestly reports its output invites higher taxes. Mao was a hero to the peasantry by his willingness to wink at underreporting: "Dig tunnels deep, store grain everywhere, and never seek hegemony," he advised as the surest way to avoid the wrath of the tax collector.

After Mao's death, the "Gang of Four" that included Mao's wife seemed to align with the tax collector. Effective taxes were boosted by lowering the state grain price, and when the grain went into the tunnels to escape taxation, China was forced to import to feed the urban populations. With the Gang of Four smashed and Teng in the saddle, the policy was reversed and since then there has been a great leap forward in grain production. The 1978 grain production of 295 million metric tons was the greatest ever despite an unusual drought.

Leading from strength, Teng will attempt to use farm output to produce a surplus that can earn foreign exchange, to be used to purchase Western technology. But instead of raising taxes to build a surplus, he will lower them again — essentially going down the Laffer Curve. The Communist Party Central Committee in late December pledged to increase the state's grain purchase price by 20% on compulsory procurement and by 50% on any additional voluntary procurements. It also pledged that it wouldn't increase the grain duty "for a fairly long period to come," nor will it raise the base year against which the duty is calculated. We can expect the effort to be successful.

Nevertheless, Teng's problem in the years ahead will be to translate the incentive systems working in rural China to the towns and cities. While rural capitalism has enabled China to produce bountiful harvests, even without advanced farm technology or elaborate road networks, industrial productivity has languished somewhere in the 19th century. By one account, automobile productivity in China is one-fiftieth that of Japan. There simply is no system to reward management for productivity increases, nor is there an effective system to allocate industrial capital. We have no way of knowing what Teng has in mind, but his conceptual approach is correct. Here is a quote from the Party's Central Committee report of December 23:

It is necessary to act firmly in line with economic law, attach importance to the role of the law of value, consciously combine ideological and political work with economic methods and give full play to the enthusiasm of cadres and workers for production.

It is necessary, under the centralized leadership of the party, to tackle conscientiously the failure to make a distinction between the party, the Government and the enterprise and to put a stop to the substitution of party for government and the substitution of government for enterprise administration, to institute a division of responsibilities among different levels, types of work and individuals, increase the authority and responsibility of administrative bodies and managerial personnel, reduce the number of meetings and amount of paperwork to raise work efficiency, and conscientiously adopt the practices of examination, reward and punishment, promotion and demotion. These measures will bring into play the initiative, enthusiasm and creativeness of four levels — the central departments, the local authorities, the enterprises and the workers — and invigorate all branches and links of the socialist economy.

This policy statement, which could have been written by Peter Drucker, is almost breathtaking in its abandonment of ideological communism and Maoist egalitarianism. It puts incentive at the very center of economic life, and if the mechanisms can be found to elaborate the concepts, China will indeed be on the capitalist road.

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The smoke has not yet cleared, but we are clearly in the midst of a major global realignment of powers. It is suddenly clear that the Soviet Union has seen this coming all along, and has been building its military arsenal not because of the military threat from China, but because of this ideological threat. China submerged in Maoism was no threat at all. But a Taiwan of 1 billion people on the doorstep of the Soviet Union is indeed the kind of threat the Soviets could not withstand. Soviet communism would have to be abandoned too, which the aging ideologs in the Kremlin have understood all along.

There is now no longer Tito standing alone in Yugoslavia as a socialist maverick; the PRC has emerged as the de facto leader of what might now be properly called the "Tito bloc." Only tiny Albania remains as a lonely Maoist outpost, now that Cambodia has fallen to the neo-Stalinist, pro-Soviet Vietnamese. The Soviets are bristling, sending out word and command to their "neo-Stalinist bloc" to boost military spending. But already they have to deal with a recalcitrant Romania, which is openly bidding Moscow to throw in the towel and recognize that the competition in the 1980s will be in economic growth, not military might. Poland, likewise, indicates it will not expand military spending, gingerly testing the Brezhnev Doctrine.

These ideological convulsions are surely being felt throughout the capitals of the Third World, especially among those intellectuals who have looked upon Communist China as a social laboratory, a Third World leader ever since the Bandung Conference of 1955.2 Is this what it's all about? Incentives? With Peking pushing manic egalitarianism off its agenda, elevating social experiments in democratic capitalism, it is no wonder that Soviets are working overtime to gobble up Afghanistan, South Yemen, Cambodia, taking greater risks than they ever have to extend and consolidate their bloc. In a year's time, the forces of human rights and economic growth may be visibly entrenched in most unexpected places, following Peking's lead.

What can go wrong? Teng can die. The central political fact in global politics today is Teng's age, 74. He vows to live another decade at least, but if he does not, will a successor be tough enough to push ahead with these experiments in the face of Soviet threats and the inevitable foulups that will occur in the experiments themselves. Given the right kind of help from the West and a good stretch of years, Teng will be able to imbed China so thoroughly with Western freedoms and systems and values that the inevitable move to counter-reformation will fail. If Teng dies or if he is thwarted by the West in the kind of help he needs, counter-reformation can succeed.

Fortunately, he has and the West has before it exactly the development model that China should not follow: Iran. The Shah had more or less the same problem Teng now faces: personal mortality. He desired to bring Iran out of the East into the West in the span of years his insurance actuaries allowed him. To get from here to there meant not only spending the oil receipts of Iran on a breakneck industrialization program. It meant spending future oil receipts via debt finance. It also meant total dictation of the Iranian economic landscape, as if the nation were the Shah's personal Erector Set. The West, the United States especially, happily obliged because it meant tens of billions of dollars worth of cost-plus contracts to American business and industry. No American of note is on record as having warned the Shah against his plan, or suggested that he might consult the people of Iran, whose future he was mortgaging.

Teng, though, seems to have been watching and learning. In the Central Committee's December 23 report we find: "We must make concentrated efforts within the limits of our capabilities to carry out capital construction actively and steadily and not rush things, wasting manpower and material."

We also find: "In ideological and political life among the ranks of the people, only democracy is permissible, and not suppression or persecution . .. Leadership at all levels should be good at concentrating the correct ideas of the masses and using explanation and persuasion in dealing with incorrect ideas." That is at least within shouting distance of Thomas Jefferson who said: "I know of no safe depository of the ultimate powers of society but the people themselves; and if we think them not enlightened enough to exercise their control with a wholesome direction, the remedy is not to take it from them, but to inform their discretion."

What kind of help will Teng need?

For one thing, he will need to buy from the West, not only through credit but through the sale of goods to the West. The tendency of American business and labor will be to play the Iranian game, selling to China but buying only oil. Teng, though, will be in a position to export grain and labor-intensive consumer goods if he can get both his agricultural and industrial act together. Inevitably, there will be a protectionist wave in the United States as a result, directly or indirectly. To the degree Japan becomes a buyer of Chinese grain, it will reduce imports from the United States, and the United States will feel increased pressure from world farm products. On January 15, the leading Republican presidential contender in 1980, Ronald Reagan, vowed to protect American farmers against cheap foreign imports. And George Meany for years has fretted about the possibility of mainland China becoming a productive industrial power, to compete against U.S. goods. Somehow, the United States and the other Western industrial powers will have to make the economic adjustments within a free-trade framework. The biggest adjustments, though, will have to be made by Japan. But then Japan will be the biggest beneficiary of an expanding China, and is already the No. 1 exporter of intellectual and financial capital to the PRC.

Teng also will need better assurances from the United States than is indicated by Secretary of State Vance that America is more concerned than not by Soviet expansionism. The Soviets are threatening and the Chinese are not. The State Department is acting as if it were just the reverse.

Teng needs time and assurances that there is some military security value in this new relationship with the U.S. A series of Soviet initiated border skirmishes would place a huge burden on the Chinese economy, undermining its potential for economic growth and threatening Chinese political stability. Instead of folding the umbrella that once protected Taiwan and South Korea from Communist Chinese aggression, the U.S. needs to extend that umbrella of military security to shelter the incipient "capitalist" system on the mainland from Soviet aggression. Approval of the Salt accords as they now are reported would be discouraging to Peking. Further erosion of U.S. strategic power vis-a-vis the Soviets would be a major setback.

Such assurances will not be easy to provide at this time. The Kremlin is amplifying the message to U.S. allies that, with the fall of the Shah of Iran, America's word alone is no longer enough to insure meaningful security. Pravda, the Communist Party newspaper, on January 21, said Iran proves that the U.S. cz not be trusted, that American assurances of support for the Shah had come to nothing. "The Iranian crisis", Pravda said from Moscow, "gives food for thought to those statesmen and regimes who neglect their national interests for the sake of a dirty and risky political game in which they can at any moment fall victim to the short-sighted recklessness of their own partners."3

Given the texture of optimism in the observations of this report, it is self-evident I believe that the developments in China are bullish for the U.S. economy and financial markets too. The Dow Jones average on the Tokyo exchange broke through 6000 early this year, this new high ground reflecting in part the rising level of wealth that will accrue to Japan with economic expansion in China. The tide, though, will not stop at Japan, but will ripple throughout the world, bringing great gains to those who do not try to turn it back.

Efforts to isolate domestic markets from China's entry into world commerce only will shift these gains to those economies willing to trade openly with China, with little benefit to domestic labor or business. Reagan's vow to protect American farmers is an empty promise. World prices will adjust to reflect the reality of China's comparative advantages, and only cessation of all trade can isolate domestic markets from these changes.

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1 Jude Wanniski, The Way the World Works, How Economies Fail and Succeed, Basic Books, Inc., New York: 1977, page 299.

2 One of the first large scale gatherings of "third-world" nations to discuss economic cooperation and peaceful goals. Jawaharal Nehru of India and Chou Enlai of the People's Republic of China were the most notable of the 2,000 delegates from 29 African and Asian countries.

3 New York Times, "Pravda Says Iran Proves U.S. Cannot be Trusted", January 22, 1979: page A9.