They assumed that the institutions required to enable this new market system to function efficiently would appear more or less automatically — if they thought about them at all.

The reality is that there are a wide variety of institutions that must be created — often from scratch — when a country transitions from a command system to a market system. The managers of these new institutions must also learn to operate in a very different way than in the old system, and that can take time.

During the first period of China’s economic reform from 1978 to 1992, there was no agreement among China’s elite on the long-term objective of reform so the process was mostly ad hoc. Agricultural products were the first to be sold on markets in large volumes at market prices, and the agricultural sector was in effect privatised by shifting production from communes to household units.

In industry, ownership remained in state hands and a dual-pricing system was created whereby state-owned enterprises continued to receive inputs through planned administrative allocation, while other industrial inputs were sold at market prices. This two-price system disappeared over the ensuing years because producers preferred to sell at the higher market prices.

At the 14th Party Congress in 1992, the Chinese Communist Party decided for the first time that the goal of reform was to create a ‘socialist market economy’. That decision was followed by the creation of a range of tax and other laws to allow foreign direct investment (FDI). The result was a boom in FDI from large multinational corporations, which contrasted with China’s first phase of FDI through the 1980s where most investors were Hong Kongers and overseas Chinese who secured their smaller investments through personal ties rather than formal legal avenues.

China also began to reform its financial system in the 1990s by moving towards a modern, market-oriented banking system. On paper China had established a modern banking system in the 1980s by breaking up the centrally planned mono-bank into a separate central bank and several major commercial banks. But this new system behaved in much the same way as the old system: state-owned enterprises determined when they needed credit, the commercial banks provided this credit more-or-less automatically and the central bank made sure that the commercial banks had sufficient funds to do so.

This system worked in reverse of how a banking system should work in a market economy, where it is the central bank, not the enterprise or the central planners, who decide what the money supply should be. This reverse banking system led to major bouts of inflation in China in the late 1980s and mid-1990s. As market prices replaced state-set prices, it also became apparent that most state-owned enterprises were making losses and swamping the banking system with non-performing loans.

The Chinese government’s reaction to this situation was — for the first time — to appoint a politically powerful individual, then deputy prime minister Zhu Rongji, as head of the central bank. Zhu not only cut back lending but more importantly reined in state-owned enterprises by forcing them to either become profitable or go out of business. China’s banking system has in general become steadily more efficient since then, though newer financial institutions such as insurance and the stock markets are still a work in progress.

China’s next major market reform was to privatise housing and free up urban land for real estate development. This started in the late 1990s and led to the creation of a large, private real estate sector that operates mostly on market principles. But rural land remains subject to various restrictions, and though China’s labour market was substantially freed up in the 1980s it continues to be distorted by the restrictions of the household registration (hukou) system.

At the Third Plenum of the 18th Party Congress in 2012, the Party developed a list of the 60 or so areas where further reform was required. Over half of these were related to completing the move to a full market system. Notably, the Third Plenum emphasised the need for further reform of the legal system to achieve goals such as securing private property rights.

But the Third Plenum of the 18th Party Congress was the high tide of market reform to date. At the 19th Party Congress in October 2017 the Party re-emphasised the strengthening of the state-owned sector and of the role of private sector Party committees in what would appear to be a step backward from market reform. Only time will tell whether China will deliver the reforms that the Party promised in 2012 and that its markets need.

Dwight H Perkins is the H H Burbank Professor of Political Economy, Emeritus, Harvard University.

This article is abridged from Dwight H Perkins, ‘The complex task of evaluating China’s economic reforms’ in Ligang Song and Ross Garnaut (eds.), Forty Years of Chinese Reform, China Update, ANU Press, 2018.10