Gradual versus Rapid Liberalization in Socialist Economies: The Problem of Macroeconomic Control

From 1978 to 1992 China experienced gradual liberalization with a fairly stable price level. The more rapid liberalizations attempted after 1989 in Eastern Europe and the former U.S.S.R. generated much higher inflation. Yet both regions' fiscal policies were similar. As in formerly socialist Europe, in China the share of government revenue in gross national product (GNP) has fallen sharply. Nevertheless, China avoided resorting to the inflation tax. The resulting enormous growth in saving and in stocks of financial assets allowed the liberalized sector to finance itself, the Chinese government, and the deficits of the slowly reforming state enterprises. Important aspects of China's dualistic banking and pricing policies could well be adopted in other transitional socialist economies. But such incredibly high real financial growth is not feasible in Russia or in formerly socialist Europe. Thus, to prevent inflation, fiscal reforms should come much earlier in their transitions than they did in China's.