1949–1952: ‘Land Reform Dividend’—Old Crisis Plus New Crisis

Abstract

The First Crisis 1949–1950: This chapter describes how China in 1949–1950 dealt with the decade-long hyperinflation crisis that had crumbled the old regime. The crux was how to keep the speculative economy at bay by consolidating a real economy.

How the rural sector under the new communist regime contributed to resolve the crisis lasting from the old republic; the transition of the New Democracy (national capitalism) to socialism; geopolitical environment and the rapid industralization of China.

1 Overview

The economic fluctuation in the early years (1949–1952) of the People’s Republic of China was the culmination of new problems breaking out on top of old ones. On the one hand, China had had to deal with persistent hyperinflation since the old republic; on the other hand, a new crisis had to be tackled, namely, the contradiction innate to primitive capital accumulation for the development of ‘national capitalism’.

The enormous institutional cost of modernization and its derivative, the urban crisis unfolding as hyperinflation in the age of the Republic of China, could not be resolved by adopting the same old economic means by the new regime whose success of revolution was marked by the occupation of cities.

The new republic resolved this chronic crisis (as a result of a half-a-century pursuit of modernization since the late Qing dynasty) by fully restoring the traditional peasant economy through agrarian reform, thus gaining the ‘land reform dividend’.¹ Colloquially, this was expressed as, ‘Nine peasants are capable of supporting one urban citizen.’²

Agrarian reform is not only about relieving the crisis of modernization through the restoration of a traditional institution. It also involved the extension of revolution experience (the military strategy of encircling cities from villages) to economic realm in peaceful times. Moreover, it lays the foundation of the sannong (三农)³ as a means to resolve the urban industrial capital crisis under a persistent dual urban–rural structure.

The substance of the land revolution in China is ‘even distribution of land and tax exemption’, which was the goal of all peasants supporting the founding emperors during dynasty change. History shows that as long as rulers maintained the basic economic institution of land to the tillers, Chinese rural society, characterized as a ‘sponge society’, could secure about 200 years of stability in the dynastic cycle.⁴ Apparently, this has been the historical experience of Asian agrarian societies with populations that are mostly aboriginal (unlike for example Latin America where most of the aboriginal population were exterminated and replaced by European immigrants). In this regard, we borrow from Marx’s Asiatic Mode of Production hypothesis to propose the concept of East Asian Stable Society. We submit that China, Japan, North and South Koreas, as well as Vietnam all belong to the East Asian Confucian Cultural Sphere. No matter the political and ideological system they claim to adopt, they all strive to build a sponge society through the even distribution of agrarian land among peasants. They are therefore more stable than the developing societies of Latin America and Africa, for example.

This historical experience was once again demonstrable in mainland China in the twentieth century. The land revolution, which had been disrupted by the Second World War and then resumed during 1946–1949, can therefore be called the Third Land Revolutionary War.⁵ Since China regained its sovereignty through this war after having been partitioned by imperialist powers, it is also known as the independence war that granted it political autonomy from its semi-colonial status.

The new government that emerged from the revolutionary war implemented agrarian reform in the entire country, achieving an even distribution of land for nearly 90% of the population. Nevertheless, in order to extract agricultural surplus to support industrialization, the central government deliberately procrastinated on tax exemption, which most new dynasties would immediately implement along with land distribution.

As a consequence, this fundamental institutional transition in property relationship by means of revolutionary war achieved three results. First, a vast and diversified physical economy was created by letting about a 100 million rural households return to their traditional mode of production and to delink from the process of modernization so that the subsistence of urban residents (about 10% of the total population) could be secured. The hyperinflation in cities since the last years of the old republic was then greatly ameliorated. Second, as long as peasants could be mobilized by the ideology of land reform, sufficient amount of material products could be collected and transported to the cities. This represented the first triumph of state capital over private capital through revolutionary mobilization. Third, the state established its fiscal and financial system, which was necessary for economic regulation of the real economy. The experiences gained from the process became the foundation on which the state constructed its basic economic institutions.

Achieving these three results by means of a single policy involved a transplantation of the military strategy learnt during the revolution (encircling cities from villages) into the realm of economy. The institutional heritage of so-called rural socialism with Chinese characteristics therefore took shape long before the final victory and involved the development of the real economy by self-reliance in the ‘liberated’ regions. We will return to discuss this further.

After the regime change, China faced a new economic crisis. The old crisis of developing national capitalism as led by the Nationalist Party (Kuomintang, KMT) was yet to be overcome when the new government led by the Communist Party faced a new crisis in its effort to develop its own version of national capitalism. It was a case of old wine in new bottles, leading to the same problems.

The constant threat of imperialist invasion would have prompted any modern Chinese government to pursue modernization regardless of the ideology it officially identified with. Nevertheless, as long as the institutional cost of primitive capital accumulation necessary for industrialization could not be transferred outwards, internal crisis would break out.

The political-economic structure of New Democracy (新民主主义), as promulgated by the new regime, was represented by the national flag of the People’s Republic of China. The large star represented the leadership of the Communist Party (including the state capital controlled by the party). The other four stars represented the working class (less than 5% of the population), the peasant class (petit landowners or rural petit property owners, 88%), urban petit bourgeois and national capitalists. State capital, private capital and petit property owners constituted the major political sectors of the country. Workers and the urban proletariat, which according to classical Marxism should have the consciousness of a class revolution, represented less than 7% of the total population.

In short, China had long been an agricultural country composed mainly of geographically scattered peasants. What took place in 1949 then was a pre-capitalist peasant revolution, asserted both by the Communist International headed by the Soviet Union and the Chinese Communist Party. Both agreed that China should develop national capitalism (which means capitalism of and for the nation as opposed to domination by foreign capital). Only after establishing mass industrial production could China be transformed into a socialist country.

Accordingly, the new government, which was midwifed by a violent revolution to overthrow the oppressive old system in 1949, not only openly advocated market capitalism (as Mao said, ‘New Democracy is national capitalism under the leadership of the Communist Party’) but also took for granted the swift accomplishment of industrialization (pursuing modernization had become the preference since the late Qing dynasty). As a consequence, China inevitably had to face the internal contradiction of a peasant country striving for primitive capital accumulation despite its scarcity of resources. This was the reality no matter how the national predicament resulting from this was presented ideologically.

As a matter of fact, the new republic managed to resolve the crisis through three institutional arrangements, along with the interaction of three sectors: politics, economy and society. First, the overall land reform allowed peasants (88% of the population) to delink themselves from the urban crisis of modernization and return to the traditional peasant economy. An extensive and vastly diversified physical economy took shape in rural regions. In the process, China managed to resolve the hyperinflation crisis. From then on, rural sector served as a vehicle for the ‘soft-landing’ of urban sector in case of crisis. Second, a national fiscal-financial system was built upon the rural economy, which was centred on real physical goods/production. This system was connected directly with the policy of physical goods and supplies distribution, enabling the government to perform counter-cycle economic regulation.⁶ Third, the government used military means, with the aid of a political campaign, to forcibly put down the speculative behaviour of urban private capital at the lowest cost. It successfully put out the economic crisis instigated by private enterprises, which would have followed the trend of economic cycle out of individualistic economic rationality.

To summarize, right after the success of the revolution (which was marked by the occupation of cities), China faced severe crises in cities where capital was concentrated. It was a great challenge to the new regime whose political subjects comprised peasantry moving into cities. At the same time, the government had political problems like bureaucratization and cadre corruption, which could be viewed as the internal crisis of peasantry politics. That’s why we define the economic fluctuations during the early years of the new republic as the first crisis.

The subsequent political campaigns were derived from this. The hyperinflation (as a result of budget deficits and monetary oversupply) was quickly suppressed, partly due to the fact that about one-third of the oversupplied money was absorbed by the peasant household economy like a sponge. However, as a result, the rural economy was monetized and polarized, which led to problems within the cooperative movement.

Considering that many developing countries might be confronted with crises right after becoming independent, sovereign states, the experience of China’s first crisis may be of universal significance (Image 1).

Image 1

The land reform staff publicizing the Land Reform Law to peasants in 1950

2 An Interpretation of the Crisis in the Three Years of National Economic Restoration

According to the official narrative, the three years (1949–1952) before the first Five-Year Plan were never described as undergoing cyclic economic crisis. Instead, they were known as the Three Years of National Economic Restoration (Gu 1992: 151). Researchers of historical studies would usually compare the statistical data of these three years with the initial days (1949) of the republic, and the best days of the previous republic (around 1936).

We must agree with this comparison when we interpret these three years as being in crisis. This is because the Chinese leadership at that time openly admitted that in this period China followed the strategy of developing national capitalism known as New Democracy (Ren 2011: 104–106). This means that at the beginning of the new republic, the economy operated mainly according to the laws of market capitalism as dominated by capital expressed both in their state and private forms. The function of the government was to perform counter-cycle regulation during economic recession. Therefore, the nature of its economic base was comparable with the old republic.

It’s well known that the development of capitalism in its initial phase entails the enormous cost of the primitive accumulation of capital. This general law was also embodied in 1949–1952. The author has suggested that the traditional peasant economy resolved the crisis of modernization, which we believe is once again proven by the 1949–1952 crisis.

It should be understood that the definition of New Democracy, with private capital as main catalyst, is not contradictory to the ideological discourse of national economic restoration. However, we wish to highlight two important questions that seem to have been neglected. First, how did the new republic get out of the chronic hyperinflation crisis that had been persisting since 1937? Resolving hyperinflation allowed the new republic to avoid the development trap and to proceed towards the establishment of national capitalism. Second, if the new regime had really committed itself to developing national capitalism, why did it later launch highly charged political campaigns that have generally been generally regarded as targeting private capital?

We believe that clarifying these two questions are of significance to China and other developing countries in the new millennium.

First, let’s address the question of how China got out of hyperinflation. What concerns us is that hyperinflation is a common phenomenon in developing countries, no matter which ideology they officially declare adherence to. China has to a certain extent succeeded in resolving the crisis of urban inflation by transferring the costs of development to rural society. However, many developing countries without a land revolution still appear caught in the development trap.⁷

Once a country gains political independence after de-colonization, it often finds itself in an economic predicament. One of the key factors is that when a developing country achieves independence through non-violent or non-revolutionary de-colonization, it generally has to reach a deal with its former colonial master or the hegemonic power through negotiations that involve conceding a part of its economic right (sovereignty). Usually, what transpires alongside the declaration of independence is the signing of an economic agreement or treatise with its former colonial master. Although a developing country aspires to achieve modernization as quickly as possible, the continuation of a colonial mono-economic structure often makes it impossible to de-colonize the economy.

We may call this the colonial ‘original sin’ of developing countries. No matter what kind of ideology their political leaders subscribe to, they have to face the problem of what we call the negative externality of sovereignty.

Through comparative studies, we come to the theory that any developing nation gaining sovereignty through non-violent negotiations has to go through a transaction process (in terms of institutional economics) with its former master state. Sovereignty gained by this kind of transaction would lead to a structural imbalance of interests due to informational and power asymmetries between the two parties. Accordingly, most developing nations with political sovereignty gained through negotiations have to face the problem of negative externality of sovereignty. After independence, the nation must concede to its former suzerain (or transnational corporations) a part of its right to gains in economic resources and/or fiscal-financial aspects. As a result, it must continue to depend on its former master state economically or politically. Such is the ‘original sin’ causing the developing countries falling into the development trap.

We find that the fundamental difference between the general state of developing country dependence (according to Samir Amin’s Dependence Theory) and China’s success in delinking resides in whether a country manages to resolve the general negative externality of sovereignty independence negotiations usually result at. People are familiar with the wisdom that we must clean our house before inviting guests. The problem is whether it is possible to have a non-violent revolution that sees the guests off if they occupy the house by their comparative advantage due to colonization and outward-bound cost transfer. Hence, research into how China cleaned the hyperinflation in its house of semi-colonization may contribute to development economics. It can also serve as an instructive experience of the practice of delinking to many developing countries.

The second problem is about the nature of the first political campaign in the new republic: San Fan Wu Fan (三反五反, literally struggle against three harms [corruption, wastefulness and bureaucratization] and five venoms [bribery, theft of state property, tax evasion, shoddiness and economic spying]).

While the economic achievement of 1949–1952 is generally praised, the initiation of socialist transformation in 1953 remains contentious. It was a widely-held belief that as long as the Chinese kept to the path of New Democracy in the initial years, economic fluctuation and hence political turmoil would then be avoidable. Yet one must remember that this belief is sustained by historical de-contextualization and selective memory. While the development of national capitalism in these three years was admirable, the political campaign that was going on simultaneously was widely considered reprimandable. Moreover, the counter-cycle economic regulation effort by the government had almost completely sunk into oblivion. In the general criticism, these three issues (economic development, political campaign and economic regulation) seem to have taken place in different times and spaces as if they were totally unrelated.

Therefore, an attempt to explore the nature of San Fan Wu Fan must take three factors into consideration. First, the consistency of background with the first question (how China resolved the crisis of hyperinflation?). According to the chronology of the mainstream narrative, 1956 was the end of New Democracy after the completion of the socialist reform of private capital. However, according to our analysis, the market economy with private capital as major economic agent lasted for less than three years. During these years, under the strategy of New Democracy, China had cautiously gone through the minefield of inflation, economic imposture (especially in supplies to government) and recession.

The correlation between these three problems could be summarized as follows: all Chinese governments since the late Qing dynasty have promoted the concentration of capital in cities, which proportionately also incurs the concentration of risk. As a consequence, cities become the place where institutional cost accumulates.⁸ Furthermore, under the pressure of high inflation, the real economy becomes less profitable. Private capital, driven by economic rationality, tends to turn away from the physical economy and towards speculation. Therefore, the phrase following inflation is always recession. The narrow escape out of hyperinflation with a resulting deflation is necessarily followed by the misfortune of industrial and commercial recession.⁹ Without governmental intervention or a strong counter-cycle regulation, this pro-cyclical economic roller coaster in an unstable economy would lead to a drastic collapse. For this reason, the new regime implemented the first counter-cycle regulation by tackling the economic anarchism of private capital, which is regarded as the first industrial and commercial regulation.

Second, the essences of the first and second questions are in common. We must accept the fact that aiming at modernization through industrialization requires primitive capital accumulation for the formation, expansion and constant upgrading of industries, no matter the ideology adhered to, or political system in place. The negative externality generated by capital pursuing profits is inevitable. National capitalism composed of Chinese private enterprises is not an exception. The downstream consumption end of the real economy must endure indirect exploitation by accepting overpriced, low-quality products as a way to contribute surplus value to primitive capital accumulation as much and as fast as possible.¹⁰ Hence, the key question becomes: who is going to play the role of the consumption end in order to bear the institutional cost of primitive capital accumulation?

A well-known viewpoint is that China could push forward industrialization only by extracting surplus from the rural sector. However after land reforms, the peasant economy became ‘unembedded’ from the urban economy.¹¹ Capital therefore could not accomplish its “precipitous leap” to complete its movement. Since the rural sector could not play this role spontaneously, the government had to take it up. The government applied a loose fiscal and monetary policy in 1950, performing a counter-cyclical regulation by placing orders and purchasing, and so on. Nevertheless, it implied that the government directly absorbed the institutional cost of primitive capital accumulation without changing the innate characteristics of private capital. Attempts to accelerate capital accumulation through collusion with government officers, counterfeiting, poor quality, and tax evasion prevailed, which not only exacerbated fiscal difficulty but also harmed the new regime’s political credibility.

Hence, whereas the new government aiming to develop national capitalist industry and commerce had to concede to private capital under conditions of capital scarcity, its tolerance for the institutional cost of accumulation and expansion of private capital had to be limited because of fiscal constraints and the consideration of its own legitimacy. Besides, there was no room for poor quality and counterfeit products in the provision of supplies to the Korean War which China got involved in beginning in June 1950.

For a regime born out of revolution, still self-conscious and self-disciplined, San Fan Wu Fan was a self-cleansing political movement. It was an effort to solve economic problems by political means after the land reform and an attempt to block the path of institutional cost transfer by capital in urban and government sectors.

Therefore, this political movement was quite significant in suppressing the over-concentration of capital risk in cities.

The collusion between officers and merchants during the government’s effort to save the economy could be viewed as the impact of the economic base mainly comprised of private capital upon the new superstructure constructed out of a violent revolution. In this sense, San Fan Wu Fan was the active reaction of the superstructure to the economic base, representing a dialectical movement driven by the contradiction between them. This political movement was an effort to lessen the accumulated institutional cost of primitive accumulation of capital. However, as it did not touch upon the fundamental contradiction of how capital accomplished primitive accumulation in urban sector, a recession took place after San Fan Wu Fan in cities where capital was concentrated.

As a response, the central government made the second effort to resuscitate industry and commerce by policy adjustment (Zhu 1999: 104–107).

During 1949–1952, the government acted as a purchaser to relieve recession. At the same time, it played the role of a commercial negotiator to regulate and limit the profits of manufacturing while acting as a political agent to crush misbehaviours and collusion. If we take the previous efforts to suppress hyperinflation and accommodate old civil servants into consideration, the policy of the New Democracy during 1949–1952 could be viewed as a consistent combination of reservation, constraint and suppression.

In view of this complicated history, we endeavour to generalize two concepts.

The first of these is ‘land reform dividend’. In a traditionally agricultural country with a large population, land is the most important property for peasants. The even distribution of land—or the principle of land to the tillers—is of vital political and economic significance for national mobilization. The internal mobilization thus achieved becomes an important tool for developing countries to delink from dependency and realize absolute sovereignty among the nations of the world. In circumstances of negative externalities of (or incomplete) sovereignty, the ability to internalize cost based on common landownership offers an institutional advantage.

The second concept is of ‘government rationality’. An economic agent who is seeking profit guided by individualistic economic rationality usually has a shorter investment time-frame. He or she will go along with the economic cycle. When the economy is booming investors will jump into the market, adding oil to a maybe already over-heated carnival. While the market is turning down, they may turn to short-selling. However, a government which is non profit-seeking should not be bound by this narrow rationality. On the contrary, a government should take counter-cycle measures for the greater benefit of the society as a whole. We call it “government rationality,” an expanded form of rationality with much longer time-frame and larger inclusive concern of interests.

As long as a nation pursues developmentalism, it incurs various kinds of negative externalities, no matter its political system.¹² The government can act as an economic agent, directly taking counter-cyclical policies in the market to mitigate the cost of such externalities. Moreover, the experience of this period can supplement the deficiency in the theory of the separation of government and enterprises, which has been emphasized as an orthodoxy by economics and political science since the late 1990s. These experiences of government rationality learnt during the economic development of China provide rich content to be explored for the general theory of government behaviour (He 2014). Thirty years later in the age of Reform, local governments actively took part into economic activities and competed with each other, a condition known as local government corporatism.¹³ The rendering of political momentum into economic advantage by the government’s involvement in the economy has been constantly replicated and reinvented.

3 Resolving the Modern Financial Crisis of the Old Republic

Analysing the crisis of stagflation confronting the new republic in 1949 is a challenging task. Stagflation involved the simultaneous occurrence of inflation and rising unemployment, which is an inversion of conventional economic wisdom. It was a situation China was forced to bear as a semi-colony, the result of the negative externality of sovereignty. To fully understand it, we must put aside the cold war ideology which still informs value judgement in social sciences. We must trace its origin to the general crisis of overproduction during 1929–1933 in the West, which was followed by the Second World War. Only by doing so can we hope to understand how China managed to resolve this exogenous crisis by a land revolution, which brought to fruition the millennium-long appeal of land to the tillers by the traditional peasant economy. Therefore, we must start with the monetary reform of establishing a modern financial system in the old Republic of China.

3.1 From Silver Crisis to Paper Currency Crisis

In the initial period, the Republic of China did have a golden decade. During 1920–1930, China recorded high economic growth under the capitalist economy (Faribank 1992). However, it ended due to internal conflict and exogenous crisis.

The republic experienced a silver crisis in 1935 and chronic inflation after 1937. We believe that it was an after-effect of the West transferring cost outwards in order to get out of the crisis of 1929–1933. It was another lesson the Chinese had to learn while aspiring to modernize in the footsteps of the West since the late Qing dynasty.

First, let us look into the Silver Purchase Act of 1934 as a response to the Great Depression in the USA and its consequent influence on China.

President Franklin D. Roosevelt put forth the Silver Purchase Act of 1934 due to the lobbying and pressure of seven silver-producing states and related interest blocs. Accordingly, the treasury purchased silver till the end of 1961. The act was eventually abolished in 1963. During 1934–1949, the US government had spent US$ 1.5 billion to purchase silver, more than the New Deal’s subsidy to agriculture (see Box 1).¹⁴

Box 1: United State’s Silver Purchase Act of 1934

The United States of America is traditionally a major silver producing country. In the 1930s, US capital controlled 66% of silver production and 77% of silver smelting of the world. Yet the silver industry did not have an important position in the US economy. According to 1934 data, the total value of silver production was only US$ 32 million, lower than that of peanuts and potatoes, and much lower than that of wheat and cotton. Nevertheless, for the seven western states where silver production was concentrated (Utah, Idaho, Arizona, Montana, Nevada, Colorado and New Mexico) it was highly important, and the senators from these seven silver-producing states had control of one-seventh of the votes in the Senate. These senators, the Democrat senators in particular, along with the producers of copper, lead and zinc that had silver as a by-product, formed the so-called silver bloc. The US government and politicians found that only by pleasing the silver bloc could they smoothly implement their policies or pass legislations.

The Great Depression in 1929 brought serious setbacks to the silver producers. The price of silver dropped drastically, from US$ 0.58 per ounce in 1928 to US$ 0.38 in 1930. By the second half of 1932 it had dropped even more to US$ 0.25 per ounce. In that situation, the silver bloc immediately launched lobbying activities to prop up the price of silver, such as convening international conferences, requesting the government to purchase and reserve silver at higher than market price, to mint and issue silver coinage, and so on. However, these lobbying actions did not have much effect during the administration of President Hoover. In November 1932, not only was Roosevelt, a Democrat, elected president of the United States, but the Democrats also won a major victory in the Congress. At the same time close allies of the silver bloc—Democrat senators from agricultural states—also saw their force strengthened. As a result, the space for and the impact of lobbying actions by the silver bloc rose to an unprecedented height. President Roosevelt needed the support of the silver bloc in order to pass a series of legislations related to the New Deal, and thus had to indulge the silver bloc’s activities. The famous silver senator Pittman, chairman of the Senate’s Foreign Relations Committee, had said that if President Roosevelt did not raise the subsidy on silver production, he would request the Senate not to put the Neutrality Act to vote. The Silver Purchase Act that was passed in June 1934 signified the apex of the silver bloc’s lobbying activities.

The main content of the Silver Purchase Act was to authorize the Department of Treasury to purchase silver in the overseas market until the silver price reached US$ 1.29 per ounce or until the value of silver in the US Treasury reserve reached one-third of the value of the gold reserve. During the process of purchasing, the Department of Treasury had widespread discretionary power.

Key measures included:

• The Department of Treasury decided the timing and terms for purchasing silver in the overseas market based on whether or not it would be beneficial to US public interest.

• When silver price reached US$ 1.29 per ounce or when the value of silver in the currency reserve reached one-third of the value of gold in the currency reserve, silver purchase should stop.

• On 1 May 1934, the domestic silver price in the US should not be lower than US$ 0.50 per ounce.

• When the value of silver in the currency reserve exceeded one-third of the gold in the reserve, the treasury should sell silver.

• The face value of the silver certificate should not be lower than the cost of the silver content.

• The Department of Treasury was authorized to control import and export, as well as other trading activities in relation to silver.

• The president announced the nationalization of silver.

• Profit tax of 50% would be imposed on trading gains relating to the purchase and sale of silver.

• Source: Liu Yunzhong ‘Impact and Implications to the Chinese Economy Of the U.S. “Silver Purchase Act” in 1934’, State Council Development Research Center, Research Report, 28 November, 2005, Issue 200.

At the beginning of the Great Depression, for about two to three years, most of the nations trading with China adopted the gold standard. The demand for gold was higher than silver. The general commodity prices in these countries, including silver, were falling after 1929, though the silver price fell by a greater extent than the general price. Based on the value of gold, the value of silver fell by 40% in the international market during 1929–1931, while the US wholesale price index declined by 26%. Therefore, the high economic growth during 1920–1930 in China was at the mercy of the West before the wave of financial globalization. China avoided the immediate impact of the crisis in the West due to its adoption of a different currency system. Thanks to the silver standard, China enjoyed a golden decade. Pegged to silver, the Chinese currency devalued in the world market, which greatly mitigated the conductive effect of the international economic crisis.

Even though China also recorded a decline in export, it was relatively less serious compared to the fall in import and compared to global export. In 1930–1931, when the crisis in the West was at its peak, China recorded a trade surplus. In 1931, China imported 45.45 million taels of silver. While other nations were hit hard by deflation, China on the contrary recorded mild inflation.

However, in 1931, the UK, Japan and India abandoned the gold standard in succession. Still on the silver standard, China’s currency appreciated against other major currencies and it faced an international payment deficit. In 1932, the net export of silver was 7.35 million taels due to the trade deficit. The domestic price index started to decline. When the US abandoned the gold standard in 1933, the Chinese currency started to appreciate against the dollar, from US$ 0.19 in 1932 to US$ 0.33. The export in 1932 was merely 58% of 1930. The trade deficit had to be balanced by exporting precious metals such as gold and silver.

Now when the world economy and trade began to recover, China stumbled into recession.

Generally, a colonized or semi-colonized country in dependency would pursue modernization according to the model of its master state, unaware of the fact that modernization was achieved in the latter by external colonization. Similarly, when China suffered from the exogenous crisis that originated in the master state, its modern economy was hit hard in the 1930s.

The most serious impact on China was the Silver Purchase Act. From its implementation in June 1934 to 30 June 1935, the US government purchased 294 million ounces of silver. The silver price was rocketing to US$ 0.81 by April 1935. The rise in the international silver price was higher than the domestic price in China. By mid-October 1934, the difference between international and domestic prices was greater than 25%. By the spring of 1935, it became greater than 50%. A profit of US$ 300–400 could be made by exporting US$ 1,000 worth of silver. Tax on silver export failed to curb the draining of silver (Liu 2005). From April 1934 to November 1935, the silver reserve in China dropped from 6.02 to 2.88 trillion yuan¹⁵ (part of which was exported to Japan and then smuggled aboard) (Xu 2010: 73).

The consequence of silver draining was an exogenous deflation. A chain reaction led to a vicious circle, which can be represented with the following flow Chart 1.

Chart 1

The economic crisis in China caused by the Silver Purchase Act

When silver started to drain out of China in 1932, the physical economy rapidly went into recession, while private capital in the urban sector flowed from industry towards speculation. In this way, statistics still showed the national economy as booming.¹⁶ Therefore, the period 1927–1937 is generally known as the Golden Decade of the Republic of China.

Rural regions suffered most from the impact of deflation and asset depreciation. Agricultural product price dropped by 6.9% in 1934 and 3.7% in 1935. As price dropped and demand for agricultural products declined, together with the impact of drought, agricultural production amounted to merely 13.1 billion yuan, a drop of 46% compared with 1931. A member of the Nationalist Party (KMT) Li Tianni conducted a survey in Shandong in 1934 and reported:

Shandong East is traditionally a rich region. However, land price which used to be a hundred yuan per mu is now worth only about 40–50 yuan. In the western and southern poorer regions, land price that used to be 50 yuan is now as low as 20 or even 10 yuan per mu, yet nobody wants to purchase land. Peasant bankruptcy is prevailing. The agony is unprecedented. (Li 1934)¹⁷

At the same time, the interest rate was rocketing. In July 1934, the market rate was 5%. In September it became 12%. Many enterprises closed down. In 1935 alone, 1,065 enterprises went bankrupt in Shanghai, and 20 banks closed down or halted business in the whole country. The production of yarn, the largest industry of China was cut by 60%. (The whole situation is similar to the impact of the policy of US Federal Reserve since 2008, which cut then raised the interest rate.)¹⁸

Under such severe economic pressure, the government had to abandon the silver standard and establish the modern paper currency system. The financial reform of shifting towards a modern fiat currency is somehow similar to contemporary ‘deep reform’ as strongly advocated by liberal and neo-liberal economists, both as a response to an exogenous crisis.

In fact, China had long been perplexed by the fluctuation of the international silver supply since it took the silver standard in the mid-sixteenth century (Han 2009). The fiat currency reform not only ended the silver currency system that was in function since the Ming dynasty but also skipped the gold standard prevalent in the West after the silver standard. China moved directly into paper currency. Many view this as the beginning of modernization of China’s currency system. (The mentality of advocating swift and radical modernization is similar to those who nowadays advocate radical financial reform.) Yet, the effect of this reform was underestimated and China soon ran into a free fall of hyperinflation. The crisis as a result of the malicious cost of modernization continued till 1950 after a new regime was established (Liu 2005).

China at that time had a fiat currency system that was based on foreign exchange reserve (the US dollar). It was not a sovereign currency system based on the credit of the state’s political power, as China had a semi-colonial relationship with major Western powers. Any currency system based on foreign reserve implies a high level of dependency, which may erode a nation’s currency sovereignty.

The lesson should be learnt nowadays. If exports do not weigh much in a nation’s economy, when the ratio of foreign exchange reserves and domestic currency value corresponding with the circulation of goods and services is lower than a certain level, the monetary policy may fail when foreign reserves are inadequate to regulate domestic money supply. In another case, when exports constitute a large part of a nation’s economy, the hard earned wealth is given to the master nation of foreign reserve as a form of seigniorage. Furthermore, the domestic economy may be constrained by external factors like external demand and foreign exchange rate. Before 1949, China was in the former situation whereas today it is in the latter. Worse still, military expenditure due to chronic wars (invasion and civil war) put great pressure on the fiscal balance. Arms purchase led to a drop in foreign reserve. The KMT government was powerless in monetary regulation. As a consequence, a booming speculative economy and hyperinflation went into a vicious circle.

The reason China managed to maintain a relatively good economy during the 1929–1933 crisis in the West is because it did not adopt the gold standard. And because the silver standard had become obsolete in the West, it helped China to avoid currency competition with the rest of the world (Li 2005). The Chinese took this precious chance to develop heavy and chemical industries, which lay the foundation of resistance against the Japanese invasion. State capital was formed in the process and continued to become a dominant force in China’s economic construction after 1949.

But for all that, the financial reform in 1936 ushered China into the international paper currency club and at the same time the international parade of economic crisis.

3.2 Currency War and Hyperinflation in the Republic of China

Prior to military defeat, the failure of modern financial reform became the major factor in the KMT regime’s downfall. In 1935, the KMT government, confronted with the problems of silver draining and deflation, put forth an important reform in the financial system. The traditional silver standard was replaced by the modern paper currency system. On the one hand, it was an important step in the modernization of the economy. On the other, it began the collapse of the modern financial system because of consequent hyperinflation and other complications.

When a developing country pushes forth paper currency reform without cutting its connection with foreign finance (which was impossible for China at that time), it has to rely on foreign support in terms of capital and policy. Otherwise, it cannot establish the credit foundation of its currency. At that time, the USA, UK and Japan all wanted China to peg its fiat currency with theirs since doing so would put China into their sphere of influence. Eventually, the KMT government opted for the US dollar (Chen 2015). It became one of the factors triggered Japan to accelerate its invasion of China. Japan, which aspired to monopolize interests in China, invaded North China in 1935 when the KMT government put forth the fiat currency reform. In 1937, the invasion began in earnest. Military expenditure put great pressure on the KMT government’s fiscal budget as overseas arms purchase cut into its foreign reserve and it became difficult to sustain a stable exchange rate. The war was also conducted in the field of currency. Japan issued a huge amount of counterfeit currency in the occupied regions in order to transfer the cost of its domestic fiscal deficit (see Box 2).

The KMT failed to resolve its internal contradictions even after the victory in 1945. Monetary regulation and anti-regulation became means of struggle by different partisan sects. The fiscal budget was further burdened by civil war. Hyperinflation, born together with the fiat currency, became uncontrollable after 1945, till the beginning of the new republic.

Box 2: Legal Currency, Resistance Currency and Puppet-Regime Currency in Shandong Liberated Regions During the Sino-Japanese War

In addition to military battles during the years of the Sino-Japanese War, there were also battles between the legal currency (issued by the KMT government), the resistance currency (issued by the anti-Japanese democratic government) and the puppet-regime currency (issued by the puppet regime, set up and controlled by the Japanese imperialists).

The currency battles among the antagonists during the war could generally be divided into two phases:

• Before the eruption of the Pacific War in 1941, legal currency was freely circulated both in the liberated and occupied regions, and had a preferred status in the latter. At that time, with support from countries like the USA and the UK, its value had not declined significantly. Japan then issued a large amount of currency under the puppet regime in the occupied areas in exchange for legal currency. The collected legal money was then taken to American and British banks in places such as Shanghai to exchange for foreign currencies (US dollar and British pound) to purchase various needed materials from the international market. Because of that, they still allowed free circulation of legal currency and did not wish to see it depreciating rapidly.

• During the Pacific War, Japan plundered billions of legal currency from areas like Shanghai and took over foreign banks in these regions. The channel to convert legal currency into dollars and pounds was therefore disrupted. Following that, Japan changed its strategy. In deciding to eliminate the KMT legal currency, it sent billions of it to KMT’s regions for the acquisition of large quantities of supplies. At the same time, Japan also issued large amounts of currency under the puppet regime to replace the legal currency in order to cover fiscal deficits. As a result, legal currency rapidly depreciated in value. Yet, since the KMT government had the support of the USA, UK and others, the value of legal currency could still be stabilized from time to time. Besides, given that the Japanese invaders had issued the puppet currency recklessly, the latter’s value started to decline sharply from 1944, even more seriously than the legal currency.

• Source: Xue (2006).

The first complete fiscal year after the fiat currency reform was 1936. The fiscal deficit in that year was 33%, which was serious enough by today’s standard. (During 1987–1989, China’s overall fiscal deficit reached 25%; in 1988 the inflation rate was 18.5%.) However, in 1940, fiscal deficit reached 87%. In 1945, the year of victory, it was 81%. That was only one year during 1940–1945 that recorded a figure lower than 70%. In the following two years during the civil war, the deficit stayed above 60%.¹⁹

During the Sino-Japanese War, fiscal budget was out at the elbows. The discount rate of the national bond was up to 45–50%. Increasing the money supply became the only source of revenue (Coble 1987: 43). Consequently, the value of paper currency in circulation expanded from 1.3 billion yuan in January 1937 to 556.9 billion in August 1945, just before Japan surrendered. At the end of 1948, it rocketed to 24,558,999 billion yuan. The subsequent inflation rate became one of the highest recorded in history. Take the general price in 1936–1937 as the base of 1. In June 1945, it became 2,133. In August 1948, before the currency reform (yuan being backed by US dollar reserve the government held at hand), it became 7.25 million. Before liberation, it was 316.67 million. While the purchasing power of 100 yuan in 1937 was two cows, in 1941 it was a pig, in 1943 a chicken, in 1945 a fish, in 1946 an egg, and in May 1949 0.00245 grain of rice.²⁰ The period 1937–1945 was of relatively mild inflation. During 1945–1948, prices increased by 30% every month. After 1948, money supply and inflation went out of control. From August 1948 to April 1949, the money supply expanded 4,524 times, which was twice the increment that took place during the eight years of the resistance war. The price index in Shanghai at that time was 13,574,200% (Xu 2008: 515). Such was the historical background when East China was liberated and the renminbi entered into Shanghai in 1949.

3.3 The Birth of Renminbi: The Continuation or End of the Crisis?

Since its foundation, the Communist Party of China (CPC) was identified as a ‘peasant party’ by the Soviet Communist Party. The former accepted the theory proposed by the latter that China had to develop national capitalism first. In the 1940s, national capitalism was formulated as the strategy of New Democracy. However, after the new regime occupied the cities, it immediately found itself in a predicament. It was almost impossible to achieve industrialization on a shabby economic foundation by private capital under conditions of hyperinflation. The peasant economy accounted for the major part of the Chinese economy at the time, which consisted of geographically scattered peasants with little surplus to offer. To push forth industrialization under this condition, the state had to face the problem of an excessively high transaction cost between urban capital and rural peasants. It was a fundamental contradiction regardless of how this new regime, which was born out of a peasant revolution, defined itself.

The condition of the new republic was like that of many poor developing countries nowadays. In 1949, the total industrial and agricultural production in China was 45.6 billion yuan, 84.18 yuan per capita; the total social production was worth 54.8 billion yuan, 101.17 yuan per capita; and the gross national income was 35.8 billion yuan, 66 yuan per capita.²¹ The industrial foundation was weak, and agriculture constituted the predominant mode of production of the national economy. However, most of the agricultural production was conducted by traditional means. In the same year, the average production of staple grain in China was 142 catties per mu, while the world’s average was 154 (Zhang 1997: 35–37). Total foodstuffs production was 225 billion catties. A historical comparison shows that industrial production had been cut by half, heavy industry by 70% and light industry by 30%. National per capita income was merely US$ 27, about two-thirds of the average of Asian countries (Zhou 2005). Total unemployment, including workers and intellectuals, amounted to about 1.5 million, besides which there was also a huge semi-employed population (Zhen 2001).

In short, even if the new government had decided to stay on the path of national capitalism that the old regime failed to make a success of, it would not have had the required economic foundation to get out of the lasting hyperinflation.

While the civil war was still raging on, the new regime found itself caught in the same dilemma as its predecessor: serious fiscal deficit required an expanding money supply, which in turn increased the pressure of currency devaluation. According to Chen Yun (陈云), then deputy premier and director of the Financial and Economic Committee, the fiscal revenue in 1949 was equivalent to 30.3 billion catties of foodstuffs, whereas the fiscal expenditure was 56.7, with a deficit of 26.4 catty or 46.56%. Excluding Northeast China, which was the major grain-producing region, the fiscal deficit would have gone up to 65.97%. In other words, beyond the Northeast, only one-third of the expenditure was covered by revenues. The other two-thirds had to rely on money issuance. Since its circulation from December 1948 onwards, the supply of RMB increased by 160 times in a year and 270 times by February 1950 (He 2008) (see Box 3).

Box 3: The Pressure of Fiscal Deficits During the Early Establishment of New China

When the civil war was still raging in October 1949, direct military expenses alone had taken over 60% of the total fiscal expenditure of the new government. Moreover, the new government had adopted the policy of retaining the former regime’s military and government personnel who were willing to submit to the new government. In addition, the number of military, government and administrative personnel in the liberation areas had also increased from 6 million in August to 7 million in November. Such an enormous expenditure had mainly been sustained by the issuance of paper currency.

Chen Yun, in his speech on 8 August 1949 to the Shanghai Financial and Economics Conference, mentioned that:

The total amount of paper money issued up to the end of July 1949 was 280 billion yuan, which constituted the monetary base. To ensure disbursements for military battles, subsidies on grain and food in new liberated regions, repairs of the railroad, as well as funds for investment in shipping and transportation, in postal & telecommunication, and mining, for operation of state-owned enterprises, purchase of cotton yarn and so on, it would be necessary to issue 163.3 billion yuan every month between August to October. That is before taking into account industrial investment and the purchase of agricultural produce. In November and December, there would be the need to purchase cotton and other material supplies on top of military expense. Taking all into account, the monthly issuance necessary would be 169.2 billion yuan.

In fact, the actual amount far exceeded the plan. On 13 November, in the draft report on inflation to be presented to the State Council Fiscal and Economics Committee, Chen Yun had mentioned that the total amount of currency issued at the end of September and October was 810 billion and 1.1 trillion yuan respectively, and that on 13 November it had reached 1.6 trillion yuan.

The new money supply was mainly to make up for the fiscal deficit. According to Chen Yun’s estimate, from August to November fiscal expenditure had reached 5.43 trillion yuan while fiscal revenue was only 1.88 trillion yuan, with a deficit of 3.55 trillion yuan.^* Total revenue could only cover 34.6% of the total expenditure. For every 3 yuan of expenditure, revenue accrued was 1 yuan, leading to a 2 yuan deficit. The total expenditure for three months, December 1949 to February 1950, was over 3.14 trillion yuan, while revenue was estimated to be 0.64 trillion yuan, with a deficit of 2.5 trillion yuan.

• Sources: Jin and Chen (2005: 642–656) and Chen (1995a: 1–8).

• Note: ^*In the original article, these figures were 543 million, 188 million and 355 million yuan respectively, and have been converted into trillion taking into consideration other materials and the need to keep data logical.

Furthermore, the economy had to be rebuilt from scratch. The money issued by the new government corresponded even less to real economic wealth than under the previous regime.

Due to years of wars and natural disasters, the number of livestock was reduced by one-third and major farming tools were reduced by 30%. Rural labour decreased remarkably too; in north China alone, it was cut by one-third. The amount of land affected by disasters was 12.795 million mu, which constituted about 8.71% of the total arable land. Total foodstuff production decreased from the pre-war historical height of 150 million tonnes to 112.18 tonnes in 1949. Cotton production dropped from 849,000 tonnes in 1936 to 444,000 in 1949. Edible oil production dropped from 5,078,000 tonnes in 1933 and 1,934,000 to 2,564,000 in 1949. The number of large livestock decreased from 71.57 million in 1935 to 60.02 million in 1949.²² There were 40 million people affected by natural disaster and 7 million by famine. In the flood and drought-stricken East and North China, according to conservative estimates, there were less than 2,900 million catties of grain (Jin and Chen 2005: 669).

By 1949, enormous amount of materials for industrial production had been destroyed in war. Post-war industrial capacity was remarkably low. The general price difference between industrial and agricultural products expanded by 45.3%. Total industrial production value, especially of heavy industry, decreased by half compared with 1936; steel production dropped by 90% compared with 1943; and coal production decreased by 50% compared with 1942. At the birth of the new republic, the whole steel industry in China was equipped with only 7 open hearth furnaces and 22 small electric furnaces. Total electricity capacity was merely about 1,146,000 kilowatt. Total industrial fixed assets of the nation were worth only 12.4 billion yuan.²³

Moreover, the KMT government had transferred a substantial part of its faculties and materials to Hong Kong, of which there were 29 state-owned monopoly enterprises, including China Airlines and Central Airlines; China Merchants Steam Navigation Company (Hong Kong); the largest ocean shipping companies in old China; the bodies of minerals export; and nine banks and offices in its financial system. The total assets amounted to 243 million Hong Kong dollars.²⁴

Moreover, a great part of the infrastructure was destroyed by the war. Transportation became difficult, which aggravated regional scarcity. In 1949, railways in China covered merely 26,878 km, including 913.7 km in Taiwan (Wu and Dong 2001: 442). Motorways were in a poor condition and total mileage was short. According to statistics, total motorways were 149,000 km, of which 86,000 km were accessible.²⁵ On average, there were only 1.6 kms of motorway in every 100 square kilometre stretch. Only 30% of motorways were paved, mostly with low quality gravel or cobbles. Over 60% was unpaved road (ibid: 454). As for shipping, in the liberated regions (not including Southwest and South China), there were 2,357 vessels of 38,100 total tonnage, whereas in Hong Kong, Taiwan and overseas there were 448 vessels of 78,200 tonnes. Aviation was at its initial stage. Therefore, the total traffic mileage of modern goods transportation was 229.6 tonne-km, merely 52.7% of 1936 (Li and Zou 1993: 215) (Table 1).

Table 1 Transportation route length of China in 1949 (unit: 10,000 km)

Additionally, the KMT government transferred all of the country’s gold reserves when retreating to Taiwan. There were no hard currency reserves in the Central Bank. The new regime had no means to withdraw currency from circulation. According to a report by Renmin Daily, KMT took 2.775 million taels of gold and 15.2 million silver yuan to Taiwan.²⁶ At the end of 1948, Chiang Kai-shek ordered all the gold, silver yuan and foreign reserves of about 500 million US dollars transferred to Taiwan.²⁷ After liberation, the Central Bank was taken over. There remained 6,180 taels of gold, 1,546,643 silver coins and a little foreign exchange reserve (Li 1993: 7; Shanghai CPC History Research Office 1993: 1086).

The consequence of issuing a large amount of paper money due to the deficiency of materials and hard currency was severe. General prices marked by RMB rocketed from the very beginning. From April 1949 to February 1950, four rounds of substantial price fluctuations were recorded (see Box 4). From December 1948 to December 1949, the wholesale price index in 13 cities including Beijing was up to 7,384%. On every occasion, the price spike started in the cities, and then spread to the whole nation. Two essential consumer goods, staple food and cotton gauze, were always leading the rise (He 2008). As money supply accumulated, the inflation rate accelerated.

Box 4: The Four Instances of Renminbi Devaluation During the Early Years of the PRC^#

• 1. The first instance of devaluation

In 1949 there was a severe spring drought in North China and the harvest fell short. A wave of price fluctuations occurred in April in North and Northwest China, impacting Shandong, north Suzhou, Beijing, Tianjin and so on. In April and May, the areas mentioned above recorded a general price hike of around 50%. Using the wholesale price index (WPI) in 13 major cities in the country, including Beijing and Shanghai as example, and with December 1948 as the base index of 100, in March 1949, WPI had inflated to 234.3, in April 287.0, and to 494.8 in May. For month-over-month comparison, April was 122.5 and May had risen to 172.4.^*

• 2. The second instance of devaluation

This time, the wave of price fluctuations occurred in Shanghai soon after liberation. It started with silver coin speculation, and then led to attacks on other major commodities such as grain and cotton yarn, causing price levels in Shanghai to spike. During the 13 days between 17 May 1949 and 9 June 1949, the general price index rose by more than 2.7 times. The gold price rose by 2.11 times, silver by 1.98 times, rice 2.24 times and yarn 1.49 times. The status of paper currency was almost completely supplanted by gold and silver coins. From 23 June to 21 July, within the course of a month, the price of yarn rose from 325,000 to 615,000, increased by 89%.^## The hike was even worse for grain. From 23 June to 16 July, the price of rice rose from 11,700 per Chinese stone [1 Chinese stone = 100 catties] to 59,000, an increase of 404%. The extent of price inflation was high overall. The price index in July was 204.6, higher than June by 104.6. All major commodities had a price increase of 50–200% in July as compared to June. Price levels in Beijing and Tianjin also spiked. The wave of inflation spread precipitously like wildfire across the country.

• 3. The third instance of devaluation

This was the most severe and most widespread price inflation after the establishment of New China. It also lasted the longest. On 1 October 1949, the People’s Republic of China was established. From 15 October, with Shanghai and Tianjin in the lead, followed by Central and Northwest China, the price of imported industrial material such as metal and chemicals steadily rose. After that the price of yarn and grain jumped, leading to a rapid increase in the overall prices. The daily increase was between 10 and 30%. The renminbi declined in value drastically. The wholesale price index, which was 100 in June 1949, rose to 302.5 by October, 720.9 in November and 998.3 by December. The 13 major cities including Beijing and Tianjin had the wholesale price index going up from 1,667.5 in September to 2,179.4 in October, then to an unprecedented 5,376.6 in November, rising further to 7,484.2 in December.^** With the July price level as base, in the four cities of Shanghai, Tianjin, Hankou and Xian, the price level on 10 December rose by an average of more than 3.2 times. The peak of the price fluctuation was seen on 24 November, when it was 3.7 times more than it was at the end of July.

• 4. The fourth instance of devaluation

Around the Chinese New Year in early 1950, speculators in Shanghai got the chance to exploit the old pattern of favourable market openings as well as opportunities in consumer commodity due to a shortage in supplies to meet increased demand. This shortage was caused by the disruption in operations of factories and electric plants that had suffered serious damage during the air bombing of Shanghai by the KMT, prompting another assault on the prices of grain and yarn. This had once again led to countrywide inflation. The wholesale price index of 25 commodities in 15 large- and medium-sized cities, with December 1949 as a base, had risen to 126.6 in January 1950, 203.3 in February and 226.3 in March. On a regional basis, Chongqing had an increase of 186%, Xian 132%, Guangzhou 73%, Tianjin 83%, Wuhan 68% and Shenyang 57%. At the later stage, the rate of increase of the price level had far exceeded the increase in the money supply.

• Notes:

• ^#Apart from specified quotes, other data is taken from He (2008).

• ^##The unit of weight for yarn has not been specified in the original article.

• Sources:

• ^*1949–1952 中华人民共和国经济档案资料选编·综合卷 (Selection from People’s Republic of China Economic Archives 1949–1952: General). Beijing: China Urban Economy & Society Press, 1990, p. 111.

• **Ibid.

In summary, the newborn RMB was the sovereign currency of the People’s Republic of China. In order to consolidate its credit foundation as a sovereign currency, the government had to increase its credibility by solving fundamental economic difficulties. If the national currency could not establish its credibility, then the political power of the state would be seriously diminished and incomplete.²⁸

How could an economic foundation for political sovereignty be built upon a wasteland of recession and speculation? This problem remained unsolved for the KMT government, because of which they lost the battle. How could the new government manage to achieve this goal? We will attempt to offer an explanation below. The mechanisms at work could then help shed light on the ever-changing difficulties people face nowadays.

Here, we emphasize two theses. First, inflation always takes place in cities where capital is concentrated. Second, in situations of crises, private capital always veers away from the physical economy towards speculation according to its economic rationality. These were apparent at the very beginning of the new republic.

3.4 Stabilizing the RMB: ‘Material Supplies Standard’ Resolved the Crisis of Paper Currency

It is well known that the communist regime in China completely eradicated the decade-long problem of hyperinflation in one year, to the surprise of many.

The new republic was in a state of destitution. It was a yet-to-be-unified nation embroiled in the Korean War, on top of being confronted by armies from 16 countries and completely blockaded by the West. Troubled by domestic problems and external aggression, how did it achieve the political and economic goal of an independent nation with its sovereignty intact?

The actions of going to war while trying to maintain people’s livelihoods are somewhat contradictory. Securing supplies for war required the expansion of the money supply, which naturally led to inflation. Under these conditions, the economy could not function well.

Accordingly, citing inflation as a reason, Dong Biwu (董必武) and Bo Yibo (薄一波) suggested in April 1949 that the new government should not expand the money supply. In other words, they suggested going along with the cycle by ‘selling short’ when the market was heading downward. However, the CPC leaders finally adopted Chen Yun’s point of view, which involved the counter-cycle measure of ‘going long’. He thought that in the long term, as the regime consolidated its footing in the whole country and resumed production, the government could act proactively in the economy. Then the expansion in the money supply would not run out of control. Besides, the government’s purchase of supplies did require expanding the money supply.

In other words, an economic agent who is seeking profit in the market and guided by economic rationality with a shorter time-frame will go along with the cycle by selling while the market is turning down. However, a government which is non profit-seeking and guided by “government rationality” with much longer time-frame and larger inclusive concern of interests should take counter-cycle measures.

What followed has proven that the government’s move to carry out counter-cycle regulation by directly ‘going long’ is a practical way to resolve an economic crisis.

However, counter-regulation based on government rationality requires certain rather specific conditions, otherwise different results could ensue. After many experiences of crises, and especially after the 2008 credit crunch when the US, Japan and China one after the other successively adopted a quantitative easing policy, people started to understand that Chen Yun’s proposal was actually an expression of government rationality in the face of crisis. It is only on the condition that a government directly confers credit upon paper money (fiat currency) using its political power that it can perform counter-cycle regulation.

In comparison, the KMT had failed in counter-cycle regulation through the enormous expansion of the money supply. We propose this is because full and intact national sovereignty is a necessary and sufficient condition for effective counter-cyclical regulation. The new government succeeded because it viewed itself as a people’s government, having its footing in national mobilization through revolution and taking unlimited responsibility for the welfare of the people. It is owing to such background political factors that it could achieve such an effective and desirable result.

The major mechanisms of the RMB currency battle at the birth of the new republic included, in the short term, a dependence on military-political authority. The state took military control over cities where capital was concentrated, appropriating all state capital and transnational capital. A state-owned system based on capital was therefore developed at the least cost and enabled it to concentrate its power. Second, the government directly organized large-scale material supplies throughout the entire nation. It was a direct battle against the hard currency control of speculators, enabling the government to modify the foundation of the value of material supplies controlled by speculative capital. Besides, the long-term problem of regional compartmentalization by local powers and vested interests was also an issue. Almost all the big cities occupied by different field armies suffered from hyperinflation and speculation. Were it not for this condition, the central government could not have successfully adopted a counter-cyclical regulation policy when the country was permeated by a byzantine network of complicated local and partisan interests.

In the mid-term, the key was the economic regulative tools established by the central government. The government anchored the value with physical commodities essential to daily life in three domains: public bonds, savings and salaries (see below). The RMB was then linked with material supplies in the urban distribution of goods as well as with fiscal and financial systems. Its credit foundation to function as a currency was thereby consolidated.

Furthermore, there were two essential factors. First was the expansion of production. The new government emphasized agricultural production. People were mobilized to build large-scale agricultural infrastructure. Water conservation and irrigation facilities were constructed on rivers that used to be plagued by floods. This made thousands of acres of fields stable for producing crops. During 1949–1952, total arable land area increased by 10.25% and grain production increased by 46.1%.²⁹ It is noteworthy that in many cases funds for irrigation facilities were delivered as loans. Without the extensive mobilization of peasants, local governments would generally have found it difficult to overcome the high transaction cost of dealing with peasants individually and had to take up all the cost of irrigation. That would have eventually been rendered a fiscal burden to the national budget.

The second factor was frugality. Production expansion went hand in hand with frugality. Together with the San Fan Wu Fan movement, the efficiency of the fiscal fund was remarkably improved. Despite the continuation of the war, China had recorded a fiscal budget surplus consecutively in 1951 and 1952.

Because value was anchored, the floating interest rate was expected to stabilize. The RMB therefore became accepted by the people and became a source of savings in the People’s Bank of China. Increasing social savings bestowed on the new banking sector the capability of credit creation for investment. It was an institutional innovation of material supplies-based currency (see following introduction),³⁰ different from precious metal standard or foreign exchange-based currency. According to this experience, we may propose a hypothesis on the correlation between the value discount of material supplies and currency credibility:

The core concept of the economics of development, namely Saving = Investment³¹ could only be validated under the condition of 3P + 3S.³²

In 1953, China started to launch large-scale industrialization projects with the aid of the Soviet Union. The state accordingly began to implement the united purchasing and selling system. The RMB, which had just begun circulating smoothly, lost the status of an independently functioning currency. Otherwise, the supplies-based currency would become an important experience of constructing currency sovereignty, the core of economic sovereignty, for developing countries hoping to get out of a financial crisis.

In summary, we elaborate on two concepts put forward so far, namely, the revolution dividend and government rationality. Land revolution has paid the institutional cost of total mobilization, which can be regarded as a bonus of revolution. The government, guided by the interests of sustaining its institutional gain, instead of profit-seeking economic rationality, forms a ‘comprehensive rationality’ in which different aspects such as politics and economy, the physical economy and finance, short-term and long-term profits coordinate and balance themselves.

We start with the stabilization of the financial order in a short period.

3.4.1 The Great Currency Defence Battle

Confronted with the four instances of ‘short selling’ against the RMB at the beginning of the republic, as mentioned in Box 4, the new government started to fight the currency defence battle in the second instance and was successful in the third. The two battles took place in Shanghai, where speculative capital was concentrated.

In the Silver Yuan Battle during the second instance, the major means used by the new regime was a combination of military and political power. The Communist Party deployed military force to close down the silver coins market, politically declaring trading in silver coins as illegal. The RMB became the only legal currency. However, this did not fundamentally repress inflation. Then the government realized that the chief enemy of the RMB was no longer KMT’s Jinyuanjuan³³ (bank note based on US dollar reserve), which had lost their credit base as the old regime collapsed, but the silver coins, which had a long history of circulation and potential of appreciation under inflation.³⁴ The credit foundation of silver coins remained robust (see Box 5).

Box 5: The Shanghai Silver Yuan Battle

Shanghai was liberated on 27 May 1949. On the following day, the Shanghai Military Control Commission announced the regulations for using renminbi and the abolition of Jinyuanjuan, the old republic currency. One RMB (old) was equivalent to 10,000 Jinyuanjuan. After 5 June, the latter was strictly prohibited from being circulated in the market. Given that the latter’s credibility was already close to zero, the conversion was conducted very smoothly. In seven days a total of 35.9 trillion Jinyuanjuan was collected, approximately 53% of the total amount issued by the KMT government.

Yet, the newly issued 200 million RMB existed only superficially in the market and did not enter into actual circulation—in reality, without equivalent commodities the conversion of the currency had simply amounted to taking over the depreciation pressure of the Jinyuanjuan.

Given that silver still functioned as currency, while the RMB could only have a supplementary role in low-value transactions, silver became the target of speculation. To start with, one silver yuan was equivalent to 100 RMB. By 3 June it had appreciated to 720 RMB. On 4 June, it suddenly spiked to 1,100 RMB and the trend went on. On 5 June, the Eastern China Financial Commission and Shanghai Municipal Committee released 100,000 silver yuan in an attempt to suppress speculation on silver coins, but it was like a drop in the ocean. On 7 June, the value of a silver coin had even gone up to 1,800 RMB.

The failure of market-based measures was too much and it was a big lesson for the new government. It was not until 10 June, when the Shanghai Military Control Committee sent troops to close down the securities exchange building and arrested a number of speculators, that a heavy blow was dealt to speculation. At the same time, the government announced ‘Measures for Management of Gold, Silver and Foreign Currency in Eastern China’, prohibiting the free circulation and private trading of gold, silver and foreign currencies. Then, starting 14 June, the banks launched value-anchored deposits. Using these kinds of low-cost, direct intervention measures, the government was able to mitigate price inflation for the time being.

• Source: Jin and Chen (2005: 569).

After the failure of silver coins speculation, private capital turned to speculation on staple grain and cotton. Through hoarding and market manipulation, speculators aspired to make windfall profits. It turned out to be the ‘Battle of Rice and Cotton’ (see Box 6).

The victory in the battle during the third instance of speculation was decisive in consolidating the status of the RMB. The key was not to rely on the communist government having more hard currency, the silver yuan or foreign reserve, but rather more hard commodities, the essential supplies of livelihood. As Chen Yun put it, ‘people’s confidence relies on staple grain in cities, on cotton gauzes in rural regions…. how much we were able to get hold of determined our capacity to regulate market’ (Chen 1995a: 118–120).

This battle against the selling short of the RMB can be presented as the best manoeuvre of government rationality combining political power and economic operation. It was the first muscle-flexing of the Communist Party of China in the economy. Henceforth, people understood that what stood behind the RMB was more than the state’s political power, but also an enormous reserve of material supplies stocked by the mobilization of the whole nation in the land revolution.

Therefore, the success of this battle not only established the RMB’s status in the currency system but also facilitated the policy of anchoring value to essential commodities for consolidating the RMB’s credibility in the middle term. When the credibility of the RMB was still weak, people would accept it only when its credit was backed up by essential supplies. And the success of this policy was guaranteed by the CPC’s power to secure material supplies through popular mobilization across the whole nation. Therefore, Mao Zedong praised it highly, comparing it with one of CPC’s most decisive military victories, the Huaihai Campaign.

Box 6: The Battle of Rice and Cotton: Dealing with the Third Wave of RMB Devaluation

From mid-June to late July 1949, in Shanghai, where there was the highest concentration of Chinese private sector capital, a wave of speculative activity took place targeting essential commodities. They took advantage of the KMT’s military blockade against the CPC government and the disorders caused by the agents of the former, as well as natural disasters like flooding and storms in certain areas to trigger speculation on grain, cottons and so on, deploying enormous sums of money. Led by the price of rice, followed by the price of yarn, an across-the-board inflation emerged. The price of rice in Shanghai increased drastically by four times, while that of yarn doubled. At the same time, it also affected the entire Eastern and Northern China, as well as regions in Central and South China. The average price level in July rose by 1.8 times as compared to June.

Faced with the onslaught of the third wave of inflation, the person in charge of the fiscal faculty of the central government, Chen Yun, noticed that speculators in Shanghai were hoarding mainly yarn, while in Northern China speculators focused on grain. To avoid being attacked simultaneously on two fronts, he first turned his attention to the north. Starting from 15 November, a daily shipment of 10 million catties [1 catty = 600 gm] of grain was sent from the northeast to supply the Beijing and Tianjin regions. At the same time, 16 traders speculating on grain were arrested and punished. These measures overwhelmed the speculators and pacified the people. After sorting this problem, Chen Yun focused all his efforts towards suppressing the inflation trend in Shanghai.

To deal with this issue, he convened a financial conference from 27 July to 15 August concerning the five major regions—Eastern China, Northern China, Central, Northeast and Northwest—to discuss solutions for the severe economic situation facing Shanghai and the entire country. Chen Yun suggested that the key to solving the problem in Shanghai and stabilizing the price level nationwide was to take control of the ‘two white, one black’ (i.e., rice, yarn and coal). And within the ‘two white, one black’, the crucial ones were rice and cotton gauze. ‘The extent of control we had on these would determine the control over the market…. The key to maintaining calmness in cities is staple grain and in rural regions it is cotton yarn.’

After analysing the sources of supplies and the conditions for transportation, Chen Yun believed it was completely possible to deploy supplies to Shanghai to ensure price stability there. The population in Shanghai at the end of 1948 was 5.05 million, and by May 1949 it had reached 5.5 million. Of this, urban population was 4.4 million. There were around 400,000 people who were staying there temporarily after liberation, which meant that the permanent urban population was 4 million. Based on a monthly supply of around 11 kg per person, the daily need in Shanghai would be around 1.5 million catties, which could be deployed from the old liberated regions (Xu and Li 2003: 9–11).

Therefore, even though Chen Yun accepted that the increased money supply by the CPC was the main reason for the inflation, he believed that through deployment of goods (from the old CPC bases to big cities) the inflation would be controllable.

Before November, the CPC fully exerted its well-organized system to raise material supplies from around the country. With grain, for example, the plan was to deploy 400 million catties from Sichuan and 10 million catties from Northeast China to Shanghai on a daily basis (for a duration of half a month). Furthermore, liberated areas in Northern and Central China, in Shandong, and so on also supplied grain to various big cities on an ongoing basis. The scale of this deployment, in terms of vastness and quantity, far exceeded that of the Huaihai Campaign. By the end of November, the quantity of grain mobilized by the CPC was no less than 5 billion catties, while the Huaihai Campaign had mobilized only 1 billion catties. The quantity of cotton yarn and cotton cloth controlled by the state-owned China Textile Company reached half of the total nationwide production.

Through a series of successive small price level increases to attract investors to purchase the commodities, the People’s Bank of China had absorbed 800 billion liquid funds in the society.

On 24 November, the general price level was 2.2 times compared to that at the end of July. At this level, the quantity of goods under the central government’s control was equivalent to the amount of monetary circulation in the market.

On 25 November, the central government directed a unified action in big cities across the nation to sell commodities. In addition to large-scale selling off, other coordinating measures in terms of taxation, credit and so on put tremendous pressure on speculative capital. The Central Committee of Finance and Economy stipulated that funds of all state-owned enterprises must be deposited in state-owned banks, and must not be loaned to private banks or private enterprises; private-owned factories were not permitted to close down operations and had to pay normal wages to workers; tax collection was intensified and no delays were permitted; at the same time, underground banks were banned to block sources of funds to speculators.

The speculators had acquired commodities in large quantities, even borrowing to do so. Yet from that day on, price levels did not increase further; rather they declined, to the shock of speculators. After 10 days of continuous selling off by the government, the speculators could no longer hold their positions and had to sell at a low price. Because of this, price levels dropped by 30–40%. By then, the inflation storm that had lasted for 50 days finally came to an end under the CPC’s command and coordinated actions. That was known as the “Battle of Rice and Cotton”.

• Sources: Bo Yibo (1991), Jin and Chen (2005: 642–645), and “中共当年金融战之霸气” (‘The CPC’s Domineering Financial War in Years Back’) https://www.360doc.com/content/16/0302/12/1941668_538784910.shtml.

In adhering to individual economic rationality under a market economy, private capital tends to withdraw from the physical economy and turn towards speculation under pressure of long-term inflation. The economic failure of China before 1949 was due to the fact that the KMT government, having limited stock of foreign exchange, precious metals and staple grain and cotton, had been incapable of carrying out counter-cyclical regulation against speculation. The government selling to suppress price rises had amounted to subsidizing speculative merchants. Capital related with the government had also sneaked into speculation through different means, leading to corruption. Eventually, the official credit system had collapsed.

We can see the difference between the two governments in dealing with crisis.

Notably, in the two instances of inflation, the opponent of the RMB was no longer the old fiat money which had lost its credibility, but rather silver yuan which was hard currency generally welcomed by the people. That meant the new paper money (the credit of which was conferred by the state) had to compete with the credibility of silver coins. Under that condition, the credit of the RMB could only be backed by material supplies. In order to win this defence battle in one effective strike, the government had to concentrate staples and cotton in overwhelming quantity in a short period of time. It was impossible to suppress speculation by selling a limited amount of supplies in the market.

For example, on 5 June, the government sold 100,000 silver yuan to the market to suppress silver coin speculation. However it was to no avail. On the contrary, the price of silver yuan rose from 100 RMB (before short-selling up to 1,100 RMB) to 1,800 RMB on 7 June. On 10 October, the government started a new round selling off staples and cotton. In one month, 30 billion yuan of currency were withdrawn from circulation by selling cotton gauzes, staple grain, sugar, etc. However, these supplies were hoarded by speculative merchants in different cities. Material supplies failed to reach consumers. Speculators even made profits by purchasing supplies in a city and then hoarding them in another.

Against such circumstances of market failure, the CPC was forced to change its strategy. It moved from counter-market regulation to temporarily and strategically going along with the trend. Market prices were gradually pushed up, attracting speculators towards buying material supplies. Then at the end of November, the state started to sell supplies in major cities at the same time. Compared with the currency that was in circulation, the value of supplies held by the CPC had exceeded the total value of capital in society. State-owned facilities stocked more than half of the nation’s total production of cotton gauze. Therefore, the government could give a decisive blow to speculation in a short period.

After the victory, the stock of staple grain and cotton in Shanghai far exceeded demand for more than half a year, which served as a precaution against speculation making a comeback. As Chen Yun stated, these supplies were not necessary to be put on the market; however, they had to be ready. Furthermore, in Beijing and Tianjin regions, a large amount of backup reserve was prepared. Chen said, ‘We must be determined to stock up about 400 million catties of rice in Shanghai around Chinese New Year. ‘400 million catties of reserve should be maintained’ until autumn harvest (Jin and Chen 2005: 671).

It was not until the beginning of 1950 when the CPC suppressed the fourth inflation by an unbeatable amount of material supplies that the RMB began to earn its credibility and the people started accepting the RMB as a saving currency. Before this, a vital policy involved anchoring the value of savings to essential supplies.

3.4.2 The State-Conferred Credibility on RMB by Supplies-Based Value System in Three Domains

The Silver Yuan Battle and the Battle of Rice and Cotton were both strategic responses to speculation and they were executed by a state under the military’s control. Anchored value in three domains was to secure the value of surplus money held in common people’s hands: (i) salaries of civil servants; (ii) savings in banks; and (iii) public bonds. The credit base of national financial capital was thereby consolidated.³⁵

It is unimaginable today that in 1949 the accounting unit of the national fiscal budget was millets instead of the RMB. But this was in fact a long tradition in the liberated regions before 1949. Xue Muqiao, later director of the National Bureau of Statistics, recalled that despite diversity in species and supply volume, the total quantity of money in liberated regions was generally maintained around the average of 30 catty of millet per capita. Money would devalue if supply exceeded this amount; otherwise, money supply would be insufficient and peasants would be harmed by deflation.

As the CPC entered the cities, the value of the RMB was still unstable. Therefore, millet remained to serve as the accounting unit in the whole state system. For example, during the age of Soviet Aid, the annual salary of an expert from the Soviet Union working in China was 18,000–20,000 catty of millet, whereas the chairman and vice chairman were paid 3,400 catty, a minister 2,400 catty and a bureau director 1,800 catty of millet.

Taking millet instead of money as a unit of pricing was actually a way of anchoring value. The new regime anchored the value of money to essential supplies in three domains. The market was stabilized in this way to facilitate withdrawing newly issued money from circulation.

Despite differences in the domains, the strategy was basically anchoring value to material supplies. The RMB served not only as a medium of exchange but also as a unit of account and a store of value, which are the classical functions of money. What secured its value were in fact essential supplies, including staple grain, cotton and coal.

The following is an introduction to the practices in the three domains.

1. Public Bonds. Public bonds were sold at a price based on a basket of essential supplies (like rice, millet and flour), then redeemed at the current price of the same amount of supplies according to different maturities. The purchasing power of the money invested was thus guaranteed. Here, public bonds as a means of saving were similar to its equivalent products in other countries. What was really creative was the credibility of bonds secured by essential supplies (Jin and Chen 2005: 652). See Box 7 for the process of public bonds offering.

Box 7: China’s First Public Bonds Offering

The offering of public bonds had been under consideration well before the establishment of the state. Yet, within a short span of five months, between initial planning to final implementation, the scale of the public bonds offering had increased by five times.

• 1. Proposed plan on public bonds offering of RMB 240 billion yuan

To stabilize finance and price, and to resolve fiscal difficulty, the plan for the first public bonds offering was drawn up under the direction of Chen Yun in July–August 1949.

Based on Chen Yun’s report in the planning meeting as well as subsequent supplementary explanations, the scale of this offering was to be 240 billion yuan, about a quarter of the fiscal deficit of the time.

The rationale put forward by Chen Yun was that the liberated zone had been expanding continuously and the liberated population increasing steadily. In addition, with railroad repairs, battles and so on, fiscal disbursements had consistently grown, while revenue could not go up in that short span. Between August and December, the nationwide fiscal deficit was estimated to be at 580 billion yuan. Moreover, to ensure ongoing production of textile and agricultural produce, funds for acquiring materials could not be spared. After autumn, the purchase of cotton wool and other materials would require 350 billion yuan worth of cash. The two items totalled 930 billion yuan.

If all of these disbursements were to be resolved by issuing currency, it would be difficult to sustain a stable price level. In Southern China and small towns, the use of rice for exchange of goods had already led to an abnormal price level for rice. The plan was to issue public debt of 240 billion yuan. Although it was only a quarter of the issued currency, it could still exert a major impact on finance. Besides making up the deficit and reducing price fluctuations, it could also facilitate the purchase of local produce and currency circulation in rural regions.

The value of public bonds would be anchored to essential commodities. The amounts to be issued would be 120 billion yuan in Eastern China, 70 billion in Central China and 40 billion in Northern China. The targets would mainly be urban industrial and commercial entrepreneurs, as well as landowners in new regions that had not yet experienced land reform. The regulations for the debt would have to be worked on urgently and announced as early as possible in August. The offer period would end in October, with September as the focal point for collecting funds. The terms were to repay the debt by a third every year and to fully repay it in three years. Interest and principal repayments would start in the following year (1950) in November, and the annual interest rate would be fixed at 4% (equivalent to the half-year fixed interest rate for anchored value savings deposit) (Chi 2003).

However, due to disagreements with the national capitalist class, the central government decided to delay the issuance (Bo 1991: 76).

• 2. Issuance of the People’s Victory Bond

The first public debt plan had not been implemented due to opposition from national capitalists. Yet it was at the initiation of national capitalists that public debt offering was put on the agenda for a second time.

To date the reason for this given in various literatures was that price-level inflation had had a major impact on industry and commerce, hence the request for public debt from all sides. Yet, based on the historical background, one could see that inflation had already continued for 13 years since 1937. Further, at the discussions that took place only three to four months ago on public debt offering to alleviate price fluctuation, the national capitalists had been against the proposition. Why would they turn around just after three or four months?

The view in this book is that, in late November, the CPC was able to succeed in combating the violent onslaught of price inflation, relying on nationwide mobilization to deploy physical goods and material (see the Battle of Rice and Cotton described earlier), hence taking away the abnormal speculative profit margins by private capital. That had been a significant turn in China’s modern history of paper money. Therefore, the agents of capital turned around and requested the government to use public debt to compensate for the deficit, ‘to maintain a stable currency environment’.

To put it precisely, between September and November, the CPC purchased and transported grain as well as other goods around the country. On 25 November, these were put up for unified sale in various big cities, and the price level began to decline from that day on. Three days later, the CPC began to discuss issuance of public debt pursuant to requests from all sides. It was presided over by the top leaders of the country: on 28 November 1949, Mao Zedong chaired the Chinese Central Politburo meeting to work on the estimates for the 1950 revenue and expenditure, as well as the issuance of the People’s Victory Bond. On 2 December, Mao Zedong convened the fourth meeting of the Central People’s Government Committee, passed the ‘Draft Report on 1950 National Fiscal Budget Estimation’ as well as the plan to issue public debt.

Based on Bo Yibo’s explanation of the ‘Draft Report on 1950 National Fiscal Budget Estimation’ as well as the report by Chen Yun and Bo Yibo to the CPC Central, ‘The Plan for Issuing Bank Notes and Bonds’, the 1950 budget deficit was estimated to be 7 billion catty of millet, accounting for 18.7% of the total disbursement. The two ways to resolve the deficit were: first to issue bonds to cover 38.4% of the deficit; and second to expand money supply to cover the remaining 61.6%.

The public offering of People’s Victory Bond was planned to be 200 million shares, to be phased in during 1950. The first offering would be between January and March. The collection of funds and repayments of principal and interests would be computed based on the prices of a basket of physical goods. The unit was ‘share’. The price of each share would be computed based on the average total wholesale price of 6 catty of rice, 1.5 catty of flour, 4 Chinese feet (=1.33 m) of white fine cloth and 16 catty of coal in six big cities (Shanghai, Tianjin, Hankou, Xian, Guangzhou and Chongqing). This average market price would be announced by the People’s Bank of China once every 10 days. The debt would be repaid in 5 years, 10% in the first year then increased by 5% every successive year.^# On every annual maturity, the principal would be repaid once by drawing lots. The annual interest rate would be 5%, also to be computed based on a basket of physical goods, payable once a year after completion of one full year counting from the cut-off date. Upon issuance of the debt, there would be appropriate expansion of the money supply so that liquidity would not become too tight. That would facilitate the sale of debts and the withdrawal of currency, as well as avert a price-level decline that would depress industry and commerce.

On 16 December, the state council passed the regulations for the first phase of issuing 100 million shares, to be launched on 5 January.

Based on the price level at the time, every share of debt was equivalent to approximately RMB 12,000 yuan. With the first phase of 100 million shares, the public debt plan had amounted to 1.2 trillion yuan.

The completion of the first phase of debt issuance was better than expected. As for the second phase, given that the national fiscal economic situation had already improved it was no longer issued (Jin and Chen 2005: 654–655).

• Note:

• ^#This meant that the repayment from year 1 to year 5 would be 10, 15, 20, 25 and 30%, respectively).

As mentioned in Box 7, the value-anchored bond was put on the agenda when the CPC was dealing with the silver yuan impact in Shanghai during July–August 1949. However, after consulting economists, Mao thought that the timing was not right for issuing public bonds as New China was yet to be born. It was only after the victory of the Battle of Rice and Cotton, by which time the new government had succeeded in defending the RMB by state capital three times, that value-anchored bonds were ready.

On 4 December 1949, the Renmin Daily announced the decision of offering value-anchored bonds. The unit of value-anchored bonds was based on the values of a basket of essential supplies. It included the sum of average retail prices of 6 catty of rice (millet in Tianjin), 1.5 catty of flour, 4 feet of white fine cloth and 16 catty of coal in six major cities: Shanghai, Tianjin, Hankou, Xian, Guangzhou and Chongqing. The prices were announced by the People’s Bank every 10 days. The annual interest rate was 5%, which was also marked at the values of the above supplies (Jin and Chen 2005: 654–655). Since the issuance of the bonds on 5 January 1950, the total sale amount was 9.15 million units, 91.6% of the target. The budget deficit was thereby reduced by 40% (Wu and Dong 2001: 345).³⁶

2. Salary. After liberation, the value of the RMB was very unstable. Public and private enterprises generally applied the method of supplies-based value. There were many ways of determining supplies-based value. Units of salary were different even in the same city. The new government employed a large number of employees and workers in the public sector (see Box 8). In order to secure their basic livelihood, the Department of Labour and the Central Committee of Finance and Economy successively proposed solutions and suggestions for salary reform. After 1952, salary reform was implemented in major regions in North China, East China, South Central China, Southwest China and Northwest China. Taking ‘salary point’ as the unit of salary was the main content of the reform.

The salary point was set by five major supplies essential to livelihood: staple grain, edible oil, cloth, salt and coal. Every salary point included 0.8 catty of staple food, 0.2 feet of white cloth, 0.05 catty of edible oil, 0.02 catty of salt and 2 catties of coal. The amount was constant in the whole country. However, content could vary in different places. For example, in the south of the Yangtze River, rice was the staple, while in North China the staple was composed of 40% white flour and 60% coarse grain. In Northeast China it was 20 and 80%, respectively. The types and brands of cloth, oil, salt and coal varied from place to place. Workers at the same skill level were paid at the same salary point; however, the equivalent amount of RMB in cash could be different.

Box 8: Background of the ‘Taking On’ Policy

In comparison with many policy adjustments executed since the 1980s of contracting out that were in essence the shrugging off of fiscal burdens, the new government that took over in 1949 had adopted a ‘taking on’ policy towards former public service personnel and bureaucratic capital enterprise personnel

On the eve of the establishment of the state, following successive liberations of large and medium cities, the question of how to handle former public service personnel in the KMT government as well as personnel in bureaucratic capital enterprises that had been taken over became a tricky problem that the CPC faced. A comprehensive acceptance would most certainly lead to a heavy burden on the new government, while unrestricted dismissals would increase unemployment and social instability. Based on the experience of taking over cities in the north-eastern region during early liberation, the conclusion was to take them on as is in order to facilitate the establishment of new governance as quickly as possible. After the liberation of Beijing and the Tianjin region, the CPC Central accepted this policy after weighing the pros and cons. As such, the Party and the People’s government kept 6 million people employed

On 24 September 1949, the CPC Central issued guidelines on handling former personnel, putting forward that:

• (i) Except for a small number of war criminals, spies and malicious persons among former personnel, most of the others have generally pinned their hopes on us. Their basic requirement was simply to be fed. After the liberation of Nanjing, Shanghai and Hangzhou, the dismissal of over 27,000 former personnel had led to high instability. With the peaceful liberation of Beijing, the 17,000 former military personnel being laid off had mostly fled to Suiyuan, full of bitterness and grievances, and now we still have the responsibility of resolving it. All such experiences indicate that former personnel should not be handled by means of dismissals and lay-offs. They must be given a way out in terms of work and livelihood.

• (ii) The Party and the People’s government have the responsibility to reform and feed these people through providing work. We are prepared, within a specific period after nationwide liberation, to retain 9 to 10 million people, including new and former military and administrative personnel. It most certainly would be difficult for the fiscal budget, but it is solvable, and politically it is essential

• Source: Wu and Dong (2001: 314).

A third of the supplies-based salary corresponded to the levy of public staples in real grain. This levy and payment in material supplies without the medium of money helped to greatly suppress the room for speculation in essential supplies. Therefore, salary point as an accounting unit was an important and effective measure in stabilizing employees’ livelihood (Wu and Dong 2001: 906).

3. Savings. Value-anchored savings catered to people’s preference for material supplies over money. This way of saving had been first tried by Huabei Bank in North China. The RMB was rendered into a unit of essential supplies and the value of the savings was secured by the amount of this unit. When money was deposited into a bank account, the value was rendered into certain units of essential supplies. In case the unit price rose, the difference in the value of money would be subsidized by the bank (the state) (see Box 9).

Box 9: The Implementation of Value-Anchored Savings^*

In order to implement the value-anchored business, the People’s Bank of China (PBC) announced temporary rules on fixed-term savings deposits on 20 April 1949. This was done to regulate the four types of value-anchored savings—lump sum deposit and withdrawal, deposit by instalment and lump sum withdrawal, lump sum deposit and withdrawal by instalment, as well as principal deposit with interest payments. Each equivalent unit of essential goods would be the total price of one catty of flour, one catty of maize or millet noodle and one Chinese foot (= 0.33 m) of cloth. The price would be based on price levels published in local newspaper, calculated as the average price over the previous five days before the deposit or withdrawal.^**

Since there would be a big differential in the unit price between deposits and withdrawals during the inflation period, current and term deposits less than one month would only be offered to workers, teachers and so on during its early implementation to prevent speculation by businessmen. Deposits for more than 3 months would be offered to all.

On 18 March 1950, the PBC established unified terms for value-anchored deposits, stipulating that the equivalent unit would be constituted based on appropriate goods to be selected by the local PBC in each region. In addition to the four types of common value-anchored deposits, there were also fixed term deposits and special deposits for organizations, joint enterprises and cooperatives. Compared to 1949, there was no longer a limit on target depositors based on the duration of the deposit. In rural regions, single item deposit was implemented. This type of deposit was based on one single item, using the retail price announced by the local trading organization as the standard for computing the equivalent unit. Upon maturity, withdrawals would reflect the rise but not the fall in price. There were three types of deposits for rural regions: (i) Production and Livelihood: deposit by instalment and withdrawal in lump sum; (ii) Patriotic Savings: deposit with reward; and (iii) Rural Fixed Sum Savings.

• Sources:

• ^*Wu and Dong (2001: 779–780).

• ^**Selection from People’s Republic of China Economic Archives 1949–1952: Finance (1996: 286–287).

Apart from value-anchored savings, there were also loans denominated in real supplies, or loan and repayment denominated by real supplies. This was as a way to stabilize prices. These supplies included staple grain, cotton, cotton cloth and oil. This type of loan was more prevalent in the liberated regions in North China. Usually the loan was specific to agricultural investment. For example, in the northern liberated regions, the monthly interest for a general agricultural loan in cash was 10–100%, 50–100% for industry and 70–100% for commerce. On the other hand, the monthly interest rate for real supplies savings was much lower at 5–10%.³⁷

As inflation subsided and savings in cash increased, value-anchored savings were eventually cancelled at the end of 1950. All in all, anchoring value to essential supplies in finance, banking and salary afforded the state a standard method of fighting inflation by firmly standing on the heavily agriculturally-based physical economy.

Agricultural tax in the form of grain levies corresponded with the payment of civil servants’ salaries by rationing supplies. Under a tight fiscal budget, the pressure of inflation due to expanding demand in the cities was relieved. Thanks to value-anchored savings, the wealth effect of holding money became positive again for the first time after a long period. The price of a commodity is determined by the volume of money in circulation and the amount of that commodity in the market. The more supplies the government held in stock, the easier it was to withdraw money from circulation. Similarly, supplies-based bonds also played an important role in relieving the fiscal budget tension, withdrawing money and suppressing inflation.

Supplies-based value system was applied with modification in three domains. It was practical and easy to operate. The new government applied it to effectively regulate economy.

In 1952, the general prices of essential and industrial materials became stable and gradually declined. That meant China succeeded in eradicating inflation due to speculation by private capital. General prices in important resource commodities such as food, fuels and industrial materials recorded deflation in December 1952, an unprecedented situation since the Sino-Japanese War, which marked the decisive victory of the People’s Republic of China over inflation.³⁸ The CPC already had a strong footing in the cities where capital interest blocs colluded to seek speculative profits. From now on, it could focus on solving the problem of depression in the real economy.

3.4.3 ‘Supplies Standard’ Currency System in Practice in Liberated Regions

The concept of taking essential supplies as the credit base of currency was not invented in 1949 when the new regime was born. It had been successfully put into practice in the liberated regions during the Sino-Japanese War. An analysis of these practices should be included in the experience of the strategy of ‘encircling cities from villages’ in the Chinese revolution.

In the liberated regions of Shandong, Xue Muqiao had suggested the idea of a supplies standard and confidently believed in the efficacy of using essential supplies of livelihood as the basis of monetary issuance. Xue argues that it is much better than silver and gold which you cannot not eat or wear for warmth: “People in our base areas welcome this currency system. They don’t need gold, much less dollars or pounds.” (Xue 1992: 153) (see Box 10).

Box 10: ‘Supplies Standard’ Currency in Shandong Liberated Regions

During the Sino-Japanese War the Shandong base region adopted measures of lowering rent and tax, which resulted in a significant increase in peasants’ productivity. Agricultural production led to good harvests year after year. Food grain, cotton and oil were in abundance, and in some regions there were even surpluses that could be exported. The coastline of Shandong was long and thus rich in salt production. On both sides of the Jin-Pu Railway and Jiao-Ji Railway, there were more than 10 million Japanese soldiers and people in the occupied zones who needed salt. The resistance government implemented a monopoly on salt, making use of salt export to earn large amounts of legal currency and puppet-regime currency, then exchange them for all kinds of supplies and materials from the occupied zones, to suppress the relative value of both these currencies. Daily necessities like food grain and cotton yarn that were controlled by the resistance government were the most reliable for the resistance government’s currency. There was no need for gold backing. The people who held the resistance government’s currency were not concerned with how much gold or silver—and even less how many US dollars or British pounds—they could exchange the money for. Rather they were more focused on what quantity of daily necessities they could get from the money.

During the Liberation War, a US journalist who came to the Shandong liberated regions noted that the resistance currency had neither legal gold content, nor gold or silver reserves, nor the backing of the US dollar and British pound. Yet it was able to maintain its value as well as price stability. He thought it was an enigmatic miracle. He asked Xue Muqiao who was in charge of monetary policy in Shandong what the standard was for the resistance currency. The latter told him that it was the material supplies standard. He said:

The resistance government regulates the amount of money supply so it does not exceed the amount needed for market circulation. Out of every 10,000 yuan of currency, at least 5,000 is used to purchase essential goods such as grain, cotton wool, cotton cloth, peanuts, etc. If prices go up, we sell these goods to withdraw money and depress the price level. On the other hand if prices decline, we issue more currency to buy the goods. We use daily necessities as reserves for currency issuance, and it is much better than using gold or silver which cannot be eaten as food when hungry or worn as clothes for warmth. The people in the base regions welcome our currency system. They do not want gold, and even less US dollars or British pounds.

Practice had shown that although Shandong did not have gold or foreign exchange reserves to back the money supply, yet their currency value as well as general prices in the market were very stable. This was because the industrial and commercial bureaus in the base region held enormous quantities of material supplies. If general prices were found to rise, it indicated that the quantity of goods in circulation was lower while of the circulating currency was higher, and there was a danger of inflation. The bureau then sold off large quantities of the supplies at hand, like rice, cotton wool, cotton cloth, salt, peanut and peanut oil, to withdraw the currency. And if the price level declined, it indicated that there were more goods in the market when money in circulation decreased. This carried the risk of depressing the price of produce and hurting the peasants. The government then increased monetary supply and printed more money to buy up goods and supplies, filling up the stockpile. With the innovative monetary policy that relied on large quantities of material goods reserve and control over currency circulation, the currency of the government in the Shandong base had achieved the same level of stability as the US dollar backed by gold.

As a result, Shandong money started to circulate in the occupied areas surrounding the Shandong liberation base. From businessmen to common folk, everyone in the occupied areas wanted to sell their goods to the Shandong base in exchange for Shandong money which they would then save up to buy salt, peanut oil and so on from Shandong. Even those people who did not need to buy salt and peanut right away wanted to convert large amounts of Shandong money and save it for the preservation of its value. In this way, the predecessor of the renminbi—shandongbi—became the reserve currency of the surrounding regions, and because of that, even though shandongbi did not have any gold or foreign currency reserves, it was able to achieve relative stability in value.

• Sources: Xue (2006: 166–172; 1992: 151–159).

In the border regions of Shaanxi, Ganxu and Ningxia, Zhu Lizhi (朱理治) and Chen Yun had made remarkable achievement in restoring and developing the economy and consolidating currency credit, while avoiding a repeat of the bankruptcy of the Chinese Soviet government in Jinggangshan in the early 1930s.³⁹

The establishment of a new currency system in the aforementioned base areas was achieved under extremely difficult fiscal circumstances condition. The fiscal background was similar to the whole of China in 1949 (see Box 11).

Box 11: Fiscal Difficulties in the Border Regions of Shaanxi, Gansu and Ningxia After 1940

Shaanxi, Gansu and Ningxia in the loess plateau of the north-western border regions were rich in natural resources like salt, coal, oil, ores, forests, medicinal plants, etc. and also suitable for agriculture and husbandry. Yet the population there was low and habitation was scattered. The economy and technology were also backward. If the economy could not be developed, the CPC could not gain a footing there and turn the regions into the rear headquarters for resisting the Japanese.

In the first few years of the resistance war, the main fiscal sources for the border regions had been part of the funds given to the Eighth Route Army by the KMT government, as well as monetary and material subsidies from progressive people both overseas and domestic. In 1937 and 1938, the only levies had been of 10,000 Chinese stones (1 stone = 100 catties) of grain each year. Taxation was also low. In 1940, the KMT government stopped military funding to the Eighth Route Army and blocked all donations (domestic and overseas) to the border regions. In 1941, after the Wannan Incident (the attack on the New Fourth Army by the KMT army in southern Anhui) channels of external assistance to the border regions were completely cut off. The economic and fiscal situation fell into severe difficulty. Mao Zedong said, ‘The biggest hardship had been in 1940 and 1941—both incidents of KMT’s anti-Communist campaign had occurred in this period. Our situation had become so bad that there were almost no clothing, no edible oil, no paper and no vegetables. Soldiers had no boots and socks. Staff had no quilts for winter.’

Under these circumstances the border government started production for subsistence, tightened expenses and increased taxation. The grain levy in 1940 was 90,000 Chinese stones and, in 1941, it increased to 200,000. This was too burdensome for the people and some of them were upset. In that year, when a county mayor died after he was struck by lightning, the common folk said, ‘Why didn’t it strike Mao Zedong?’

After several years of all-out production efforts, the scarcity of food grain was resolved, which led to better self-sufficiency. However, the fiscal situation was becoming increasingly problematic for various reasons. The trade deficit with other regions, investment of large amounts of funds in production, and increase in military spending for the deployment of the army, all added to the problem.

In May 1940, Cao Juru, the president of the Bank of Border Regions pointed out, ‘We should have a self-sufficient fiscal budget but we still have deficits. We need 170,000 yuan every month. The shortfall is over 40,000 yuan.’ The fiscal situation was difficult. Bank loans became an important way for the government to cover the deficit in public finance. In 1940, loans to support fiscal budget accounted for 69.2% of the total loans taken by the bank (in 1938 and 1939 it was 21.6 and 18% respectively). Out of that, the loan to directly support public finance was as high as 93.1%. In November 1940, the central authority of the border region requested the bank to increase money issuance by 4 million yuan to subsidize the Office of Finance’s production fund and operating costs.

In the first half of 1941, due to the demands of fiscal expenditure and investments in government-operated production, the bank expanded the money supply. As recorded in 陕甘宁边区社会经济史 (Social Economic History of Shaanxi, Gansu and Ningxia Border Regions) by Wang Zhenglin, from March to June 1941, the border currency issued each month was 3,095,410 yuan, 2,760,500 yuan, 2,780,000 yuan and 2,373,600 yuan respectively; the average monthly increase rate was 31.9%. From July to December, the issuance each month was 1,076,625 yuan, 1,413,900 yuan, 2,438,600 yuan, 2,688,015 yuan, 1,051,725 yuan and 3,344,975 yuan; the average monthly increase rate was below 10%. At the same time, the price equivalence between the price of commodities and the border currency also went up. For example, in Yan’an the rate of increase in the price level went from 12.9% in March to 26.7% in June, while the price equivalence went up from 6.6 to 14.6%. In this regard, the bank adopted a tightening policy in July and August. The rate was 7% in July and 8.5% in August. In September and October, due to investment in salt production, the money supply again went up, with the rate of increase at 16.9 and 13.2% respectively. In December, because of the need to compete for the purchase of goods, launch agricultural loans and for fiscal turnover, the rate of increase in money supply again went up sharply from 4.5% in November to 13.9% in December.

• Sources: Jin and Chen (2005: 351–401), Geng (2015: 6).

Under the new leadership of Zhu Lizhi, the Bank of Border Regions emphasized the real productivity of loans, and increased their disbursal for agricultural production and trading. Loans adopted a variety of forms to anchor value to essential supplies. In 1942, the bank decided to conduct lending through real supplies. Industrial lending was done through purchasing orders and payments were made in goods. Commercial lending, except relief aid loan, also took the form of goods purchasing order. Take agricultural loan as an example. A peasant wanted a loan from the bank to buy farm cattle and tools. The loan was valued at the market price of material supplies (such as staples or cotton). After the harvest, the peasant repaid the loan in the form of real goods of equivalent value. Different regions adopted variations to this template of loan finance. Some banks lent physical farming tools and then received repayment in the form of agricultural products. Some allowed borrowing and repayment both in terms of millet. This form of lending ‘solved the difficulty of peasants and promoted production. The value of the loan was secured. The turnover of the agricultural loan was maintained in this way. The policy was reasonable both for the government and peasants’ (Geng 2015).

In 1943, the issuance of currency and trading again fell into difficulty. The problems of trade, finance and the fiscal budget became increasingly serious (Jin and Chen 2005: 351–401).

In order to tackle the fiscal difficulty in these border regions, Chen Yun implemented a series of measures in 1944, including trade management, import substitution and issuing the ‘salt note’ (formally known as the Commercial Circulation Note). All of these became important experiences in inflation management later through circulating supplies and increasing production (see Box 12).

Box 12: How the Border Regions of Shaanxi, Gansu and Ningxia Stabilized the Currency in 1944–1945

External trade surplus was the main channel for building up the reserve for the border bank’s currency. In regional trade at the time, the largest export was salt, accounting for two-thirds of the total export of the border regions. Cotton and cloth were the largest import commodities, taking care of 65% of the total import into the border regions. Therefore, salt, cotton and cloth played a key role in balancing imports and exports, as well as in stabilizing price levels. In 1944, the border region won a glorious salt hoarding battle. On 18 April, the battle of Henan, Hunan and Guangxi erupted as the Japanese army attacked Henan. This led to the disruption of the channel for salt distribution by the border region. Yet, the Northwest Financial Office decided to stock additional quantities of salt. Along with the initial loan of 300 million yuan to the Salt Sales and Transportation Cooperative, a further 300 million was allotted to launch the salt hoarding battle, which led to more than 10 million catties of salt being stocked up. In the beginning, traders from the KMT territories did not come to the border regions to buy salt. But the territories in Shaanxi could only hold on for about two weeks and other north-western regions for two months before they had to come to the border regions for salt. The price of salt went from the loss-making 12,000 yuan (legal currency) per 100 catties to the break-even price of 13,000 yuan, travelling further up to the profitable 16,000 yuan. Afterwards, because of changes in the war situation, the source of sea salt to the KMT territories was completely cut off. The border salt price rose further. Salt from Xihuachi rose to 18,000–19,000 yuan per 100 catties, while in Liulin it went up to 36,000–37,000 yuan. When it came to the import of cotton wool and cloth, on the one hand, the border regions during harvest time offered a price 1.5 times higher than the KMT authority to buy cotton wool before the latter did. On the other hand, they actively developed production, planting cotton and weaving cloth during idle time in winter. In September and October, when new cotton wool from the Guanzhong Plain went on the market, the price of cotton wool in the KMT territories was 11,000 yuan per 100 catties, while the purchase price offered by the border regions was 28,000 yuan per 100 catties, higher than the former by 17,000 yuan. As a result, not only were merchants selling cotton to the borders, even the Kuomintang army blockading the border regions sold cotton wool to seek profit. KMT platoon commanders would bring their entire platoons to carry cotton wool over. Some would make even more than three trips in one night. The border regions achieved an import of over a million catty of high-quality new cotton wool within two months, collecting sufficient raw material in preparation for developing the textile industry to produce clothes and linen. The border regions further produced 3 million catty of cotton wool: common folk weaved gauze during winter so that the need to buy from outside was reduced. ‘Without planting cotton wool and having to buy cloth completely from outside, there would be a need to spend 225 million yuan (border currency), amounting to 26–27 million yuan in legal currency.’

Given that the price ratio was well controlled for import and export of cotton and salt, in 1944, the border regions were able to realize a trade surplus of 1.9 billion in terms of border currency. In 1945, they continued to have surplus, turning around the disadvantaged trade deficit situation. They then formed the basis for stabilizing the border currency.

To stabilize the border currency, Chen Yun, after much consideration, came up with the solution of the ‘salt coupon’:

In order to bring the exchange rate of the border currency at par with the legal currency without disrupting financial transactions in the market, there has to be a ‘replacement’ method. Is it possible to have the salt company issue a kind of circulation coupon, with a price at par with the legal currency and at a fixed rate of exchange of 1:9 with the border currency? Then it can be circulated in the border regions while gradually withdrawing the border currency. When it reaches the intended level the border currency can be raised to be at par with the legal currency in one go, and then the issuance of salt coupons can be stopped by using the border currency to replace and withdraw the salt coupons. In this way, the goal of raising the border currency to be at par with the legal currency can be reached and financial activity in the market would not be affected. Moreover it would expel the legal currency so that the border regions are not disadvantaged.

Based on this line of thinking, on 23 May 1944, the Northwest Financial Office met and decided to issue the Border Trading Company Commercial Circulation Coupon, pointing out that although it had been nominally issued by the trading company, in reality it had been issued by the border bank. Every circulation coupon converted to 20 yuan in border currency; the latter was to be withdrawn gradually. In future, all business trading and debt clearance in the border regions were to be conducted based on the circulation coupon. The face value of the commercial circulation coupon was 50 yuan, which could be exchanged with the border currency (Jin and Chen 2005: 369).

Pursuant to the effect of the various aspects described earlier, the exchange rate between the border currency and the legal currency declined from the initial 12:1 and 10:1 down to 8.5:1 after June 1944, at which level it basically stabilized. After December, the circulation coupon as the chief medium for specialized loans and trade investments to purchase salt and local produce effectively supported external trade. Moreover, it supported the liquidity of funds in banks, maintaining outflows and inflows in an orderly manner. By being used to exchange old border currency notes of smaller value, the coupon also improved convenience for people in their daily life.

In 1961, this was Zhou Enlai’s assessment of the border region’s achievement:

The peak period of production engagement in the Shaanxi, Gansu and Ningxia border regions had only lasted three years from 1943 to 1945. At the time we put forward the goal of saving up one year’s crop out of three years’ yield... that goal was indeed achieved. In March 1947 when Hu Zongnan attacked Yan’an, we retreated from Yan’an to fight guerrilla battles in north Shaanxi. Wherever we went, even in the mountain region of Hengshan where conditions were the hardest, grain reserves in peasants’ homes were full. That was the support based upon which we were able to fight the 3 years’ liberation war. The troops of Hu Zongnan could not do anything about it.

• Source: Jin and Chen (2005: 351–401).

3.5 RMB Put on a Firm Footing by the Organization of Rural Regions After Land Reform

This book analyses the experience of the new regime’s resolution of crisis through the revolution dividend. To take it a step further, we must emphasize that as a newly independent nation, the earlier discussed measures could not be implemented in isolation, despite the curbing of hyperinflation in a short time period or the setting up of the fiscal and financial system by value-anchoring. In fact, the strategy was an extension of Mao’s revolutionary strategy of encircling cities from villages being implemented in the economy during peaceful times.

First, peasants who had land distributed to them returned to work in the traditional self-sufficient economy. That meant that 88% of the population was immune to modern economic crises in cities and that the government could focus their attention only on the cities to deal with them. The case of the previous republic was different. The major agents of industrial capital were absentee landlords controlling commerce and industry. They had a high demand for agricultural raw materials. Cash cropping therefore became a big part of peasant production. The result was greater commercialization of peasant livelihoods and monetization of peasant incomes. Peasant livelihoods were in turn hit hard by the devaluation of the legal tender (Wen and Feng 1999). Second, due to the accomplishment of the land revolution, the state succeeded in politically mobilizing almost all peasants, which supported the policy of supply-based value-anchoring of the fiscal and financial system. That is to say, a historically unprecedented yet rigorous rural organizational system comprising 88% of the total population became the means by which inflation in cities was stabilized.

During 1949–1950, the government focused on dealing with hyperinflation. Even though the state had yet to announce the land reform law, the reform had been implemented in the liberated regions of Northeast and North China since 1947. The combination of land reform and peasant mobilization was a basic principle formulated by the CPC during revolutionary struggle. Total mobilization of the population enabled middle-class and poor peasants, which comprised a majority of the peasant population, to sunder their dependence on the landlord class. For the first time in history, peasants gained the consciousness of political subjects playing an active part in the nation’s polity and new forms of rural political practice began to take shape.

But how was the political subjectivity of peasants being expressed? This was determined by whether it was necessary to mobilize peasants in the state’s strategies and, accordingly, which group of peasants (rich, middle-income, poor or tenant) needed to be mobilized. Through selective mobilization, the new regime extended state power into natural villages for the first time in Chinese history (Wen 1993; Wang 2015).⁴⁰ Properties inside villages, such as land, houses and livestock, were redistributed by way of revolutionary politics. A form of incomplete property rights compared to individualized private property rights took shape. Thereby, the state later found an institutional breach to intervene to reshape property relationship.

Afterwards, the state faced little resistance from local interest blocs in implementing its will in villages, for example when establishing a state-monopolized purchasing and selling system in the name of state-owned unit or cooperatives, as well as the cooperative movement in the 1950s. It was a sort of revolution dividend. The state’s supreme political power was based on its right to regulate the collective interests of all social groups.

The most important function of land reform lay in the reduction of transaction costs when collecting surplus staple grain from self-sufficient and geographically scattered peasants. In the name of revolution, it became relatively easy for the state in taxing and purchasing supplies from villages.

Whether the state managed to collect enough staple grain and supplies was vital to its success in curbing speculation and hyperinflation. After speculation and hyperinflation were stamped out, the staples and supplies stocked by the state were redistributed to peasants through wage payment as a form of aid and investment into irrigation infrastructure, etc. On the one hand, agricultural production could be greatly improved and, on the other, surplus workforce could be prevented from flowing out of the villages during famines. In this way, a crisis could be quickly resolved before it resulted in social turmoil.

So, can the countryside continue to bear the costs of urban crises? It depends on whether the property relationship in villages is equitable and to what extent the peasants can organize themselves. With these two factors realised, the vast rural areas can insulate against the crisis of inflation by providing basic supplies to cities.

3.5.1 Redistribution of Property Relationship and Organization of Peasants Reduced the Cost of Levying Staple Grain

After land reform, poor peasants (52.2% of the total population) owned 47.1% of arable land, 2.93 mu per capita on average; middle-income peasants (39.9%) owned 44.3%, 3.67 mu per capita; rich peasants (5.3%) owned 6.4%, 3.8 mu per capita; and landlords (2.6%) owned 2.2%, 2.52 mu per capita (Xu 2007: 10). According to some studies, the level of unevenness was not as serious as expected (Wen and Feng 1998).⁴¹ Nevertheless, after land reform, the fairness of landownership had indeed improved. The institutional cost of land reform was a certain loss in terms of the economy of scale. The institutional benefit was the state’s capacity for political mobilization of over half of the rural population.

Regarding support by rural areas, after land reform, peasants in the liberated regions still had a relatively heavy tax and levy burden of about 20%. During the Sino-Japanese War, the average grain levy per capita was about 32 catty of rice. In some areas it was as low as 18–19 catty per capita. In 1948, the average grain levy was 40 catty per capita. In 1949, it became 56 catty, about 18.2% of the total agricultural production. During the Sino-Japanese War, besides grain levy, peasants had to pay some money without other additional charges. In 1949, the burden on the peasants increased. In some provinces, it was 5–15% more. Then the average total tax per capita was 58–64 catty of fine grains, about 20.6–22.7% of the total agricultural production in that year. Additionally, peasants had to bear a salt tax, a custom tax, civilian war service and the invisible loss of currency depreciation.

The burden imposed on peasants after liberation was due to the pressure of the fiscal budget. In November 1949, non-productive personnel paid by fiscal revenues numbered more than nine million. As the war raged on, fiscal expenditure increased.⁴² China’s participation in the Korean War in October 1950 only made the economic situation more difficult.

As industry and commerce were just recovering from war, revenues from these sectors were not substantial. In consideration of the nation as a whole, the new government had to continue burdening peasants (Tables 2 and 3).

Table 2 1950–1952 Agricultural Taxes and Other Levies (RMB 10,000)

Table 3 1949–1952 Agricultural taxes

Although the CPC decided to reduce the tax burden on peasants in 1950, the policy was not implemented because of the Korean War. In general, due to the need for fiscal revenues, the tax burden on peasants became relatively heavy in the liberated regions till the restoration of the national economy.

Historically, tax below tithe was bearable for peasants, and an incidence of 20% tax would definitely have amounted to an imposition. Were it not for peasant mobilization and the successful deployment of appropriate ideology associated with the land revolution, it seems unlikely that they would have acquiesced to such a tax burden so readily and peacefully.

We could examine this situation with some cases in Southwest China, which was liberated relatively late. Although the total amount of grain levy was not particularly large, the levy did increase. By that time land reform was yet to be implemented and local grassroots organization was absent. As a result, a large number of hungry peasants became bandits or violently resisted the grain levy. Banditry was quite rampant after liberation in the southwest (Box 13).

Box 13: Banditry and Grain Levy in the South-Western Region in the Early Years of the PRC

Since the liberation war progressed rapidly, when the troops entered the newly liberated regions the democratic government was not in place or perhaps had just been put in place. As a result the conditions were poor for implementing certain necessary policies. Rural land reform could not be done in time, hence the agricultural taxation system could not be put in place temporarily. To ensure grain supply to the troops, in addition to seizing it from the reserves of the local KMT government in battles, the CPC adopted the approach of levying on-site, and announced ‘Regulations Regarding the Collection of Grain’ on 21 March 1949. The main targets to levy and borrow from were first landlords and wealthy peasants, and then middle-class peasants. The levying and borrowing was based on the total grain harvest: landlord 40–50 per cent, wealthy peasants 25–35 per cent, wealthy tenant peasants 20 per cent, and middle-class peasants 10–15 per cent. Poor peasants had to lend very little or not at all. Hay for horses was requested in proportion to the grain levy. Former Bao Jia Head [the team head of the local rural administration and security system] monitored and executed the implementing of the policy. For regions that were liberated a little earlier, even though they had already started the agricultural taxation system, yet many places had still not been able to set up a formal system nor announced comprehensive regulations in that regard. Without a set of comprehensive rules, different places had different approaches (totally over 30). Certain places had situations in which the burden was placed on limited portion of people or the marginal levying rate too high or too much to the extremes at both ends.^*

From 17 November 1949 to 25 March 1950 there were 29 incidents of grain robbing in the mid-southern regions. Also in the southwestern regions, due to ‘bandits in Sichuan disturbing and blockading the region, the scope of grain levying was not wide’, and all the major cities had insufficient food grain.^** According to statistics, in 1950 there was a loss of agricultural tax of 1.46 billion catty, of which over 65 million catty was grabbed or burnt by bandits. Moreover, in the process of levying over 3,000 cadres had sacrificed their lives.^***

• Sources:

• ^*Wu and Dong (2001: 327–328).

• ^**1949–1952 中华人民共和国经济档案资料选编·综合卷 (Selection from People’s Republic of China Economic Archives 1949–1952: General). Beijing: China Supplies Publishing House, (1996: 340); quoted from Wu and Dong (2001: 308).

• ^***1949–1952 中华人民共和国经济档案资料选编·商业卷 (Selection from People’s Republic of China Economic Archives 1949–1952: Commerce). Beijing: China Supplies Publishing House, 1996, 18; quoted from: Wu and Dong (2001: 308).

Judged on the basis of numbers alone, the cost of transferring staple grain from Yunnan to other regions was much lower than the cost of transporting them from Central and Northeast China, even if the cost of transportation was double that of production. However, as the Northeast was liberated earlier and land reform completed, publicly-run commerce and cooperatives developed rapidly. Therefore, in the region the capacity to sell commodities and transportation became strong, which substantially contributed towards stabilizing supply–demand and price in the market (see Box 14). For example, in early 1950 the Central Committee of Finance and Economy planned to transfer two billion catty of staple grain from Central and Northeast China to famine-stricken regions, much higher than the 400 million catty from the Southwest.

Box 14: Development of Government-Operated Commerce in the North-Eastern Regions

Before 1947, in the north-eastern liberated regions only the bases in Northern Manchuria and Western Manchuria (now Heilongjiang) had a relatively large government-operated business. In late April 1946, the city of Harbin started to conduct government-operated business centring on the purchase of grain and sale of cloth and salt. In the same year, Harbin established the Northern Manchuria Trading Company and Dongxin Company. Trading companies were also established by various provinces (back then the north-eastern base was divided into five provinces, Songjiang, Heilongjiang, Nenjiang, Kejiang and Mudanjiang, and the special municipality of Harbin). In August 1947, the Northeast Trading Management Bureau was set up to coordinate the operation. Harbin Department Store, set up in August 1948, was the first large-scale shop during the history of the base region. By 1948, the north-eastern liberated region government had government-operated shops set up in over 80% of cities and towns.

• Source: Wu and Dong (2001: 100).

A major function of the rural cooperative at the beginning of the PRC was to purchase supplies for the state. It showed that a cooperative could cut transaction costs of collecting supplies from peasants (see Table 4). It is clear that in regions that were liberated earlier and where land reform was implemented, cooperatives developed better, which may be regarded as an institutional benefit.

Table 4 Rural cooperatives purchase products for the state as ratio of total state purchasing

In summary, the central government collected staple grain from the whole nation in order to suppress inflation in cities. The state regime that was based in cities therefore enjoyed the institutional benefit of social stability. However, in rural areas which were yet to be organized, the institutional cost in terms of social instability increased. The above analysis demonstrates that fair distribution of properties and grassroots organizing were pivotal to the villages’ capacity to bear institutional costs.

3.5.2 Irrigation Infrastructure Construction Through State-Mobilized Labour to Secure Food Production

The building of irrigation infrastructure proved remarkably effective in increasing food production. This was closely related to the organization and mobilization of peasants during land reform.

In the early years of the republic, under conditions of material scarcity, the most effective way to increase food production in a short period of time was through mobilization of the workforce, which was a way to earn labour rent at a relatively low cost. During the restoration of the national economy, irrigation was a crucial component of infrastructural investment, second only to transportation and communication (Table 5).

Table 5 Irrigation infrastructure in China 1949–1952

During 1949–1952, the total investment in agriculture, forestry and irrigation was 1.03 billion RMB, 13.14% of the total infrastructure investment, most of which was used in irrigation construction.

In 1950, the value of loans for irrigation investment was equivalent to 500 million catty of rice, which was allocated to 21 million mu of arable land; and 320,000 soldiers were organized by the state to participate in irrigation construction (see Box 15).

Box 15: Mobilization of Labour to Construct Irrigation Infrastructure in New China (Examples of Several Large-Scale Irrigation Projects)

In dealing with the problem of flooding of River Huai, the state mobilized 220,000 workers to build dams. It was a large-scale irrigation construction rarely seen in the history of China. In 1951, before the expected start of flooding season, a preliminary regulation of River Huai was achieved. Except for certain parts that faced mountain torrents or waterlogging, most rivers in the region went through the flooding season safely. The result was an unprecedentedly rich harvest in the River Huai basin. Compared with 1950, flooded area was reduced by 65%, while irrigated area increased by 21%.

In October 1951, construction work started on the Guanting Reservoir located in upper Yongding River. More than 40,000 workers and peasants participated in the construction of the project. It was essentially completed before floods came in 1953. No sooner was the main dam completed than it blocked a particularly bad flood, the second largest on record.

As for the pre-1952 project to channel the flood water of the Jingjiang, on the one hand, it strengthened the Jiangjiang dam that was 114 km from the left shore of the Changjiang (Yangtze River), and on the other hand, it secured the flood channelling region, that is, the low-lying areas to the right shore of the Changjiang, east of Hudu River, west of the dam on the right shore of the Jingjiang, and north of Anxiang River, a total area of 921 sq. km. A water entrance gate that was 1,054.3 m long as well as a 336.6 m control gate were built to control and manage the water flow. In the two-and-a-half-month period from 5 April to 20 June 1952, the project had mobilized 300,000 labourers, including troops, workers and engineers, supplied on a timely basis close to 1 million tonnes of engines, equipment and material, and invested 5 million on the construction project as well as 10.5 million on relocation. The water entrance gate with 54 holes and water control gate with 32 holes were built in accordance with the plan. At the same time, the project of constructing a dam for the flood channelling area to take in up to 5–6 billion m³ of water, as well as the project on strengthening the 133 km dam along the Jingjiang were also completed. These had the effect of safeguarding the lives and properties of eight million people on either sides of the Jingjiang, ensuring rich harvests in that vast region, and facilitating transportation for the country along the Changjiang. Given that such an enormous project was completed within such a short duration, it was referred to by some international friends as a ‘world wonder’ of the time.

• Source: Wu and Dong (2001: 479–483).

During 1950–1952, 420,000 km of embankments along rivers across China were repaired and reinforced. In the three years, 20 million people directly took part in irrigation infrastructural construction. The earthwork was estimated to be over 1.7 billion cu. m, equivalent to the construction of 10 Panama Canals or 23 Suez Canals. Up to 107 projects involved land over 10,000 mu. Collective construction work was being undertaken in 2.08 million places. Irrigation areas were extended by 32.4 million mu, 24 million of which reaped the benefits in the same year.

Flood-stricken areas rapidly decreased in the country. In 1949, there were over 100 million mu of them, about 60 million in 1950, 21 in 1952, and down to 16 in 1952. Meanwhile, extended irrigated areas were 49.5 million mu. A rough estimate had it that food production increased by a few million tonnes due to flood prevention and increased irrigation facilities (Wu and Dong 2001: 479–483).

Irrigation infrastructural construction became another tool for extensive mobilization in rural regions after land reform.

The experience of the low-cost mobilization of labour force was formed in having soldiers build the railway, which was Sun Yat-sen’s idea that was not realized during his time. At the eve of the new republic, the task of railway restoration was heavy. Peng Dehuai (彭德怀) suggested having sappers to do earthwork and cave digging to build the Tianshui–Lanzhou railway line. The Central Committee of Finance and Economy also suggested using surplus troops for roadbed work and cave digging. Earlier, the CPC had mobilized people in the liberated regions to build railway lines. Before leaving for Moscow in December 1949, Mao Zedong called Chen Yun and Bo Yibo to say: ‘It is imperative to deploy troops to build Tianshui–Lanzhou, Tianshui–Chengdu, Chengdu–Chongqing, Yibin–Kunming, Yunnan–Guizhou, Guizhou–Guangxi, Hunan–Guangxi railway connections. Please work on it immediately.’ Consequently, despite a very tight fiscal budget, the state invested as much as possible in building railway lines in the early years of new China. With limited funds and heavy tasks, sappers were irreplaceable in this undertaking. In 1950, 286,546 people were mobilized for the construction of Baoji–Tianshui, Tianshui–Lanzhou, Tianshui–Chengdu, Chengdu–Chongqing lines. The fund was equivalent to 997,475,095 catty of millet. The cost of dynamite was equivalent to 27,725,000 catties of millet, most of which was taken from captured ammunition. The salary budget was originally 379,147,426 catties of millet. It was later cut substantially. The total cost was reduced almost by half because of the participation of sappers.⁴³

Labour force mobilization was also applied in other domains, for example, ‘disaster relief through work’, which helped to achieve part of the government’s relief task and also prevented famine-stricken people from flocking towards cities. In 1950, 1,532 million catties of staple grain were used for refugee relief. Out of this, 545.64 million catties was relief in the form of remuneration to pay the peasants working in irrigation construction and other projects, 37% of total aid (Jin and Chen 2005: 672). According to incomplete statistics, 123,854 people worked for relief allowance in 1950, 59,639 in 1951 and 85,128 in September 1952 (Wu and Dong 2001: 873).

The rural economy in China has always been diversified. The peasant household economy has long been comprised of different businesses besides farming. After land reform, sideline production in the rural sector developed, which became an effective way to absorb surplus labour force in disaster-stricken times. This has been a feature of the village as a ‘sponge society’ capable of resolving disasters and crises.

In order to relieve the impact of extensive natural disasters, the government implemented a series of supportive policies and measures to revitalize and develop sideline production and the handicrafts industry in rural regions. In the winter of 1949 and spring of 1950, a great part of the 766 million catties of relief grain were used to support peasants in developing sideline production and the handicrafts industry. Rural sideline production increased from 1.16 billion RMB in 1949 to 1.83 RMB in 1952, an increment of 57.8%, annual growth of 16.4% on average, which was a little higher than the average growth of gross agricultural production (see Box 16).⁴⁴

Box 16: The Implementation of Relief Through Work in Various Regions, 1949–1952^*

To resolve the difficulty of transporting food grain from producing regions to stations, piers and transportation lines, people were actively mobilized. This approach of providing relief through work allowed peasants to earn a certain portion of their subsistence by delivering grain.

For example, in the Changde region of Hunan, where flooding was severe, the organization of peasants to deliver food grain enabled over 880,000 of them to receive income through labour, thereby securing their livelihood.^**

In the process of organizing grain transportation in the central and southern regions, the fiscal disbursement on shipping charge was equivalent to around 250 million catties of grain, and the amount paid out by the Bureau of Trade was equivalent to around 200 million catties. These transportation charges could provide for one month’s consumption for 10 million people.

The supplementary production arising from disaster aids achieved notable results everywhere. For example, in Wen’an and Wuqing counties in Hebei, 90,000 peasants were mobilized into fishing and mattress weaving, with a monthly income of 600,000 catties of millet. In addition, over 60,000 people were organized to weave willow baskets, knit sacks, operate mills and so on, with income sufficient to sustain the livelihood for 200,000. In the Anqing region of Anhui, 100,000 victims were organized to self-help, engaging in such activities as gathering wood, fishing and delivering goods. The basic livelihood for 500,000 people was thus secured.^*** Victims numbering 300,000 in the coastal regions of Shandong and 450,000 in Hauiyin region of northern Suzhou relied on supplementary production to live through the spring famine.^**** The Duyang Lake area in the mid-southern region had actively organized peasants to engage in supplementary production and transportation activities, and 500,000 people were able to earn their living.^***** Such practices have shown that wherever there was effective organization, the results of self-help among victims were good.

• Notes:

• ^*1949–1952 中华人民共和国经济档案资料选编·商业卷 (Selection of People’s Republic of China Economic Archives 1949–1952: Commerce). Beijing: China Supplies Publishing House, 1995, 126–127; quoted in Wu and Dong (2001: 310).

• ^**Xinhua News Agency, ‘全国调粮任务接近全部完成’ (Country-wide Mission on Deployment of Food grain Close to Full Completion); 1942–1952 中华人民共和国经济档案资料选编·商业卷 (Selection of People’s Republic of China Economic Archives 1942–1952: Commerce). Beijing: China Supplies Publishing House, 1995, p. 126; quoted in Wu and Dong (2001: 319).

• ^***1949–1952 中华人民共和国经济档案资料选编·农业卷 (Selection of People’s Republic of China Economic Archive 1949–1952: Agriculture). Beijing: Social Sciences Literature Press, 1991, p. 54; quoted in Wu and Dong (2001: 54).

• ^****Sun Encheng, 与空前严重的灾荒奋斗中的华东人民 (People of Eastern China Struggling with Unprecedentedly Severe Famine); 1949–1952 中华人民共和国经济档案资料选编·农业卷 (Selection of People’s Republic of China Economic Archives 1949–1952: Agriculture). Beijing: Social Sciences Literature Press, 1991, p. 77; quoted in Wu and Dong (2001: 319).

• ^*****1949–1952 中华人民共和国经济档案资料选编·农业卷 (Selection of People’s Republic of China Economic Archive 1949–1952: Agriculture). Beijing: Social Sciences Literature Press, 1991, p. 54; quoted in Wu and Dong (2001: 54).

3.5.3 Preliminary Completion of State Regime Building

The central government’s strong capacity for supplies allocation, on the one hand, profited from its experience mobilizing people in the base areas. Grassroots organizations that came into existence during land reform became the pillar of mobilization. On the other hand, it was the consequence of a highly centralized system, which was built by the CPC during the war for military command and unified local construction of the base areas (see Box 17). Confronting the pervasive challenge of inflation, the Central Committee of Finance and Economy was sanctioned by the top military authority to work across regions and departments. It was therefore capable of collecting incredible amounts of supplies from different parts of the country.

The political and economic authority of the central government was rebuilt in a short time, which was an anomaly in the history of the centre–local relationship, particularly, the lack of control of the central government over local regions since the late Qing dynasty.

Box 17: Focusing Power on Large-Scale Tasks—The Formation of a Unified System of Nationwide Financial-Economic Work

During the war, various liberated areas had been situated in isolation from one another, each taking care of their respective fiscal and economic works, and issuing their respective currencies. After Mao Zedong, Zhou Enlai and Ren Bizhi came to Xibaipo. Zhou Enlai suggested that finance and economy in the liberated areas should no longer work on the basis of ‘united’ governments, but a ‘unified’ government. He wanted to eliminate agency offices, establish Central Ministry of Finance and Economics, and set up People’s Bank of China to issue currency on a unified basis (Jin and Chen 2005: 595–596).

Yet the financial and economic tasks in the various liberated areas were far from coordinated. For example, in October, after Jinan was liberated, the northern and eastern liberated areas united. Given that price levels in the two regions differed quite substantially, in the town of Linqing (located on the border of the two liberated areas, it was a major trading post before the liberation of Jinan) there emerged a major bidding battle for cotton material between the trading units of Northern China and Eastern China. More than 20 government-owned shops took part in the bidding for over 1.5 million catty of cotton material, with the result that the price level surged abruptly and private businessmen were able to make use of the opportunity and profit through dishonest practices. It was estimated that the cotton material purchased by government-owned businesses was on average 10% soaked, causing serious losses to the government (Wu and Dong 2001: 102).

On 4 June 1949, in the inauguration ceremony of the Central Committee of Finance and Economy, Liu Shaoqi clearly indicated that a highly centralized management on finance and economy was needed. Chen Yun also pointed out that with the liberation battle continuously gaining ground, the problems of finance and economy had increased. Moreover the problems were often nationwide, thereby requiring one organization to handle these problems (Jin and Chen 2005: 609–611).

The Central Committee of Finance and Economy had been set up just before the establishment of the PRC, led by the Central Military Committee. Under this committee, in each local region, a Committee of Finance was set up. In this way, the institutional structure of focusing power on large-scale tasks was formed.

This institutional advantage of centralization with Chinese characteristics facilitated the enormous supplies allocation and mobilization in the whole nation. In a work meeting in Shanghai, Chen Yun emphasized the coordination within and among regions:

On the matter of finance and economy, local governments would have their own agendas. However, if each local government has its own plan, our force will be too diffused to deal with the present situation. It is now impossible to concentrate all the reserve power. However, major reserve power must be used in a unified and systematic way. (Jin and Chen 2005: 624)

In the meeting, a decision was made to form unified enterprises for purchasing. The allocation of supplies in different regions, which used to be under the command of the field army, was now centralized. Large amounts of supplies allocation were to be made through the Central Committee of Finance and Economy (ibid.: 625–626).

In order to make up for a shortage of 2.9 billion catties of staple grain due to a natural disaster at the end of 1949, the Central Committee of Finance and Economy decided to allocate grain from Central, Northeast and Southwest China to East and North China. Out of this, 1.5 billion catties was from Northeast China and 1.1 billion catties from Central China. To secure the supply of food and cotton in major cities, grain were transferred from Sichuan regardless of cost. At that time, the grain reserve in Shanghai was less than 100 million catties. In order to prevent speculative merchants from making trouble, a stock of 400 million catties was needed. Grain were transported to Shanghai from different regions. Furthermore, 600–800 million catties of reserve was ready between Suzhou and Nanjing. After liberation, Shanghai had merely 20 million catties of staple grain. In the first half of 1950, the state managed to mobilize 1.7 billion catties of grain, enough for one-and-a-half years (Jin and Chen 2005: 669–673). The scale of supplies allocation for this purpose was enormous. Till the end of July 1950, 6 billion catties of staple grain were allocated in the whole nation.⁴⁵

Furthermore, through land reform with extensive rural grassroots mobilization, the CPC managed a feat unparalleled in Chinese history: a complete arable land survey.

Land was the foundation of tax for every dynasty throughout China’s history. However, the total area of arable land was unknown to the rulers. Measurement of land was always a difficult task for politicians and reformers who hoped to suppress ownership concentration by landlords and land appropriation by powerful families. In history only the founding emperor could have successfully implemented even distribution of land and tax exemption based on relatively transparent information. In comparison, poll tax was much easier to operate. For example, Zhang Juzheng (张居正), the chancellor of the Ming Emperor Wanli,⁴⁶ took on the task of putting the tax problem in order. In 1580, measurement of land in the whole country was promulgated in the name of the emperor. The goal was to survey the total amount of farmland. However, the task had not even started when Zhang passed away in 1582. In some counties and districts, no land survey had ever been done for centuries (Huang 1997: 33).

In the new republic, land reform through total mobilization achieved an outcome that exceeded expectations. From statistics, the ratio of agricultural tax on real production decreased in 1950, then rose up in 1951 and declined substantially in 1952. In 1951, the real agricultural tax (including formal tax and additions by local governments) was more than 36 billion catties, an increase of 34% compared to 1950. Besides the additional tax prepared for the Korean War, one of the reasons was an addition of 60 million mu of ‘invisible’ farmland found in the survey. The taxable production was therefore increased by more than 20 billion catty (Wu and Dong 2001: 752). In 1951, an extra few billion catties of real agricultural tax was gained on top of the expected budget.

These were the mechanisms of how the state, based on the urban–rural dual structure, made use of internal power to resolve urban crises by way of agricultural policy and investment, making villages the institutional facilitators and bearers of soft-landing.

Obviously, with a very tight fiscal budget, the key to the effectiveness of the various policies—whether concerning grassroots mobilization by land reform, irrigation infrastructure building, or sideline agricultural production—was the mobilization of the labour force, a resource very rich in China.

The reason the state benefited from it was that these workforces that answered the state’s call to take part in building national infrastructure were paid according to the cost of rural labour reproduction under an urban–rural dual structure, which was obviously lower than the cost of urban labour. Therefore, China became the only developing country able to rely on a low-cost labour force for a long period of time.

4 New Crisis: Government Regulation Under a Weak Market and Political Movement

Very few have looked into the experience of dealing with a market crisis under private capital. Not many have understood the pattern of an economic crisis turning into a political contradiction, and taken the opportunity it affords to analyse the strategic adjustments a government has to make in such matters implicating national security.

The developmental strategy of New Democracy was set up by the state before the republic was born. This strategy approved market economics and encouraged private capital. However, urban hyperinflation and the subsequent speculation by private capital, which is inevitable under a free market economy, would generally lead to the collapse of the real economy in developing countries and the modernization trap.⁴⁷

Earlier in the chapter, the new government’s measures such as increasing market liquidity and creating demand by government purchasing were discussed. Admittedly, these market rescue policies were an effective counter-regulation to save urban private industry and commerce. However, the management and moral risk of urban private capital soon spread to the government. Numerous cases of corruption demonstrating the collusion between enterprises and officials occurred.

As Einstein said, ‘Problems cannot be solved with the same mindset that created them.’ In the same vein, we say that urban private capital crisis cannot be solved by strengthening urban capital. Therefore, China undertook socialist reform in 1953, which was a major strategic adjustment. That a new regime emerging from the Chinese peasant revolution could overcome the crisis may be attributed to two basic conditions of the rural regions.

First, the government suppressed inflation and speculation mainly by putting enormous amounts of essential supplies (mostly agricultural products) into the market. At the same time, these supplies were produced by a great number of peasants mobilized by land revolution.⁴⁸

Second, official commercial institutes could collect enormous amounts of supplies from geographically highly scattered peasant households only because of the extensive mobilization of peasants by a powerful regime formed during a violent revolution.⁴⁹

In the name of land revolution, the government as a political practice distributed land to 400 million of peasants based on the natural boundary of villages. On the one hand, the three agrarian sectors (sannong; peasants, villages and agriculture) became delinked from the high-risk urban economy, which lay a solid foundation for stabilizing the financial order. Hence, Mao repeatedly emphasized the political and economic function of land reform, which secured the victory of the financial struggle in cities (Bo 1991). On the other hand, this became a serious institutional path dependency, first on the traditional land system in villages (afterwards, any distribution of land must delineate boundary of property right within the natural village, latter transformed into production squad and economic cooperative), and second on the institutional cost transfer from urban capital to the sannong, which subsequently became the bearer of soft-landing in every economic crisis.

4.1 Background: Sluggish Urban and Rural Economies After Curbing Hyperinflation

It is a general law of cyclical crises that depression follows after the suppression of hyperinflation. Officially, it has been explained that the Chinese national economy was in a difficult period of transitioning from the old to the new order. However, the real reason was the law of cyclical crisis emphasized in this book. Under high inflation, the physical economy will decline and private capital will rush towards the speculative economy. A laissez-faire approach, as advocated by interest blocs, would eventually lead to the bursting of the bubble. However, harshly putting down speculation will inevitably lead to recession.

At that time, the new regime had yet to be influenced by interest blocs. It therefore took forceful measures to suppress speculation, which was then followed by recession. That is the reason we put the hyperinflation in 1949 and the recession after 1950 in the same economic cycle. A complete economic cycle usually consists of four phases: boom, recession, depression and recovery. The feature of the Chinese economic cycle was a bipolar oscillation between boom and depression, even if it was with relatively little government regulation. It had nothing to do with ideology. In the so-called free market economy, an economic trend is correlated with the form in which the cost of crisis is transferred outwards.

We may also look into other explanations. For example, some studies believe that apart from the destructive factor of the KMT regime retreating, there were problems with transforming a part of the old economic foundation, for instance, luxury goods, services sector, speculative sector, comprador import–export sector, etc. Further, some overreacting behaviours of squeezing out private industry and commerce also led to a certain increase in unemployment.

We believe that the trend towards regression after 1950 in urban industry and commerce was obviously related to the speculation on essential supplies in the phase of high inflation. As prices stabilized and declined, the opportunities or speculation and value protection shrank greatly. Industrial products started to overstock. Market turnover was much lower than commodities available.

In the second half of March 1950, 70 million catties of staple food was available in the market, only 14% of which (10 million) was sold. Of 280,000 sacks of flour, only 7% (20,000) was sold. In Chongqing, some of the major commodities transacted in private commerce decreased in April compared with March: edible oil and coal by 50%, cloth by 70%, cotton yarn by 92.5% and cotton by 93.5%. As for the wholesale market in Shanghai, taking the transaction volume in January as 100, in April, the transaction of cotton yarn was 53%, rice 17%, flour 56%, rolled tobacco only 5%. The sales turnover of six large departmental stores in Shanghai decreased by 50% in March compared with January, and by 90% in smaller stores.

As the market was weak and sales declined, production of private enterprises dropped drastically. The most difficult sectors were flour manufacturing and spinning, where speculation was previously most intensive.

In May 1950, compared with January, the production of cotton cloth decreased by 38%, silk fabric by 47%, wool by 20%, rolled tobacco by 59%, caustic soda by 41%, and paper by 31%. In eastern and coastal regions, where private industry and commerce were concentrated, the situation was more difficult. In Shanghai, the production of matches decreased in April compared with January by five-sixths, and flour, rolled tobacco, wool yarn, chemical glue, glass, etc. by 60–80%. Many factories were run at half capacity and many were closed down. The situation developed in stages. From January to February 1950, the number of private industry and commerce business start-ups was still higher than close-downs. Since March, however, the number of close-downs increased while start-ups dropped drastically. From January to April in Beijing, 1,043 shops were applying for starting a business, while 1,573 were shutting down, many of which were shops selling rice and flour, cloth and coal, as well as departmental stores. From January to April 1950, in 14 large cities, 2,945 factories went out of business. Urban private industry and commerce ran into trouble. In 16 big cities, 9,347 shops shut down (Wu and Dong 2001: 357–358). In April 1950, 2,600 employees in Tianjin were about to lose their jobs, most of whom were working in staple foods, coal and money exchange stores (Wu and Dong 2001: 654–655). The situation was bad in Shanghai, where industry and commerce were concentrated. In the second half of April, 1,000 factories closed down and 2,000 shops went out of business. The number of unemployed workers was more than 200,000 (Wu and Dong 2001: 866).

When spring was turning to summer in 1950, a 20% unemployment rate was recorded for the first time in the new republic. According to incomplete statistics, by the end of September 1950, the number of jobless workers in the nation amounted to 1,220,231 and unemployed intellectuals numbered 188,261, resulting in a total of 1,408,492. Moreover, semi-unemployed workers were 255,769, out of which 120,472 were about to lose their jobs. The unemployment rate peaked in July 1950. Registered unemployed persons were alone 1,664,288, which was about 21% of the total urban employees. The number would have been higher if it included unregistered unemployed persons (Wu and Dong 2001: 865–866). The increased unemployed population during the price stabilization was about 380,000–400,000.⁵⁰

The crowding out effect of inflation-induced speculation over the real economy and depression following the curbing of speculation took place more than once after 1949. It is still relevant today.

4.2 Efforts in Promoting Urban–Rural Market Exchange and Their Limits

It is noteworthy that the economic difficulties mentioned earlier took place in modern cities where capital was concentrated, whereas villages, which were delinked from the modern urban economy after land reform, were more insulated. Under the dual urban–rural structure representing modernity and tradition respectively, the effect of depression over the cities and the villages showed remarkable difference. In the cities, it was general recession, while in the villages it was expressed as underdevelopment of agricultural sideline production, unmarketable local products, tax overburden, etc. In some grain-producing regions, the sale of staple grain was also a problem.

Confronted with depression, the government took two different types of measures. First, it acted as the regulator and conductor of the market economy, a policy of New Democracy. Second, it acted as an economic agent to transform private capitalism into state capitalism, also known as socialist reform.

In the actual process, the government was constantly adjusting its measures and policies. Fortunately, the leadership and management had yet to construct interest complementarity with domestic and foreign capital at the time. Therefore, the policy adjustment was a practical one of amending errors and diversification, confined neither to the revolutionary discourse nor bound by urban interest blocs. However, the enormous institutional benefit and the political energy gained by the extensive mobilization of peasants started to express itself as an institutional cost in relation to urban capital.

Agrarian reform had a dual impact on the urban–rural relationship. On the one hand, the political distance between rural areas and governments was reduced. On the other, the economic connection between rural sector and urban industry–commerce was severed.

Apropos the first aspect, land reform made peasants (at that time 88% of the population) highly dependent and loyal to the People’s Republic of China under the leadership of the CPC, just as peasants in history were loyal to any dynasty that had realized land distribution and tax exemption. That means the new Chinese government had succeeded in the most extensive national mobilization in state building through land reform, which in terms of fundamental institutional condition was essentially different from many developing countries without complete land reform.

However, with regard to the second aspect, land reform involved even distribution of land to rural households according to the number of family members. As a result, what were simultaneously eliminated were two important traditional economic agents extracting surplus value from rural China at low cost for the accumulation of urban capital. First, rich and middle-income peasants, the agents of production of scale, who could rent land on a large scale, were gone. Second, landlords, the agents of commodity circulation of scale, who could turn agricultural products into commodities at low cost merely by real rent, were also gone.⁵¹

Along with the elimination of the two agents of the economy of scale, the previous economic setting was also altered. That is, gone too also was the phenomenon of industrial and commercial capital descending into rural areas with financial capital, while landlords running industry and commerce acted as loan sharks.

As agrarian reform was not favourable to capital, what arose as a result was the confrontation between the geographically scattered peasant economy and urban capital concentrated in cities. Henceforth, private capital would find it difficult to extract surplus value from the peasants for the sake of primitive accumulation.

It is as true today as it was then. So it was for China in the 1950s and for developing countries now as well.

Although land reform substantially reduced the degree of exploitation of peasants by external agents, it led to a contradiction between urban and rural sectors due to the economic disparity in the phase of New Democracy. In order to develop national capitalist industry in cities, rural surplus had to be extracted from a peasant economy comprised of geographically scattered peasants who also operated sideline production. The concern was that the transaction cost between the two sectors would become very high. Furthermore, the peasant economy had been under the impact of hyperinflation for more than a decade. It was expected that peasants would be risk-averse and opt for demonetarized behaviour. In other words, under market fluctuations, the peasants would generally save staple grain and cut their consumption of urban products.

4.2.1 The Achievement of Promoting Urban–Rural Market Exchange and Its Limit

From the point of view of managing the urban–rural market after hyperinflation, industrial and commercial capital, whose chance of speculation had been curbed, had to leave cities to get out of the doldrums. The market had to be expanded to rural regions where 88% of the population lived so as to complete the primitive accumulation of capital. Therefore, as the first step towards dealing with post-inflation depression, it was logical and practical for the government to promote urban–rural exchange.

In November 1950, Chen Yun, who was in charge of economic and financial issues, pointed out in a speech on the Second National Conference on Finance and Economy: ‘The expansion of marketing of agricultural products is not only a rural issue but also a key to vitalizing China’s economy. It is the first priority in the Chinese economy at present.’⁵²

However, the contradictions of matching urban–rural markets under a dual structure started to unfold when the exchange between the two sectors was being promoted. As the issue of insufficient urban–rural exchange was raised, it was understood that the first step would have to involve the government paying peasants in advance by purchasing agricultural products. As money went into villages, the commodity exchange between urban industry commerce and peasants would be kick-started. After traditional urban–rural trade was banned or limited during and after the government’s dealing with hyperinflation, there was still active demand in villages to exchange with cities and other regions.

According to surveys by local product companies, the value of special local products as well as handicrafts was 36% of the total staple food production in East China in 1950, about 1,500 billion yuan (in old RMB). In North China, local products except major cash crops were worth about 25% of the total production. In Central and South China, the value of local and special products accounted for about 30% of peasants’ incomes. In Southwest China, it was about 30–40% of peasants’ incomes. More than ten million people made a living through special local products. In Northeast China, the value of local products amounted to 26.2% of the total agricultural production in 1950. In Northwest China, it accounted for 30% of the total income. In Inner Mongolia, the value of special and local products was almost equal to other agricultural income. In Guizhou, the value of 46 major local products was equivalent to 2.7 billion catty of rice, about the same as the income from staple foods (Wu and Dong 2001: 388) (see Box 18).

Box 18: Economic Difficulties in Various Regions After Hyperinflation Was Controlled

In Northeast China, because of stagnation in the flow of goods between urban and rural regions, various provinces, cooperatives and peasants together had a grain inventory of around 540,000 tonnes. Out of this, the provinces had no more than 100,000 tonnes, cooperatives had around 80,000 tonnes, and the remaining 360,000 tonnes were in the hands of the people. In the north-western region, the economic crisis that had been hiding behind artificial prosperity was fully exposed. Speculators not only refrained from buying anything, they even sent their hoard of commodities to the market. With more supply than demand, the sale of commodities became difficult. In the southwest, ‘local produce had no market so the countryside had no money. Therefore industrial goods in turn found it hard to go to the countryside. The three had exerted impact on one another resulting in the stagnation of the rural economy.’ In the northern region, peasants had urgent need to sell agricultural produce in exchange for production material and daily life goods. Based on Chahaer Province’s statistics on 14 kinds of agricultural produce, the quantity waiting to be traded out valued over 28 million yuan. For this winter, Shanxi needed to transport out 400 million catties of surplus grain, over 45 million catties of cotton wool, and 100 million catties of various items such as oil, hemp, herbal medicines etc.

In the central and southern regions, local produce valued more than 1 billion yuan, accounting for 20% of peasants’ income. Yet, due to the blockade by the United States and the ongoing land reform among peasants, sales and delivery of local produce were significantly affected.

• Source: Wu and Dong (2001: 384–385).

Faced with depressed urban industry and commerce, leaders in the central government who were experienced in rural issues came up with policies to expand commodities exchange among regions and promote industrial products in villages. These measures included restoring and developing transportation capacity, encouraging private merchants to take part in purchasing and transporting between cities, encouraging state-owned cooperatives to promote selling of special local products, holding supplies exchange fairs, developing rural market trades, increasing commercial loans, developing remittance and mortgage services, enlarging the remittance network, bringing currency into villages by purchasing agricultural and sideline products, etc.

These measures of bringing currency into villages were effective. Statistics show that the value of agricultural and sideline products’ purchasing increased to 129,730 billion yuan (in old RMB) in 1952 from 80,000 billion in 1950, a growth of 62.16%.⁵³

However, taking a further look at this data, it is not hard to see that these improvements in fact owed largely to the rehabilitation of traditional local market exchange between peasants, irrespective of region. The commodification rate of peasant household production was only 30–40%. A self-sufficient peasant economy appeared to continue in this mode. It was unlikely that it would spontaneously become the market of urban industrial products. Even in the market of agricultural tools and means of production, where the expansion rate of the market scale was much higher than the growth rate of the peasant income, the deepening of capital was still inhibited (see Box 19).

Box 19: Industrial Goods in Support of Agriculture Found It Difficult to Go to the Countryside

Based on statistics, following an increase in peasants’ income, the supply of agricultural production material nationwide increased from a total value of 7,300 billion yuan in 1950 to 14,100 billion in 1952, an increase of 93.15%. This was higher than the increase in peasants’ purchasing power by 11 percentage points.^*

After 1949, there was a story in China about an iron plough finding it difficult to go to the countryside, which demonstrated the contradiction in the dual urban–rural structure. Following the Soviet Union’s advanced farming approach that relied on horse-drawn ploughs to raise the level of agricultural production facilities, the revived urban industry produced a type of two-wheel, two-spade plough whose power was double that of the wooden plough. It could dig two parallel ditches deeper than any common plough was able to. It was referred to by the rural folks as an iron plough in contrast to the wooden plough that was commonly used. The cost of the iron plough was only 29 yuan and the selling price was 39 yuan (new post-1955 monetary value).

For the city, it was supposed to be a major event marking the beginning of agriculture-supporting goods production by the national industry. A lot of newspapers publicized it. Many urban cadres excitedly named their newborns that year after the iron plough. However, in the countryside, no matter how much the government publicized it and pushed it, hardly any peasants bought the plough.

That was because the traditional peasant economy that was revived after land reform was still a type of ‘lightly capitalized’ economy: for one thing, a plough could simply be constructed with the help of a village carpenter who could build a frame and a blacksmith who could hammer out a spade and plough. After that, all it needed was an animal yoked to it to make it ready for the field. There was no need to go and purchase an iron plough. The other thing was that within the rural community many types of operations in industry and commerce did not use cash, hence, rural people were not in the habit of buying urban industrial goods.

Afterwards, this type of two-wheel, two-spade plough was distributed on a semi-mandatory basis and pushed into the countryside. However, this kind of one-size-fits-all command did not consider the vastly diverse geographical and geological characteristics of different places. While productivity had clearly increased in some places, in others the allotted ploughs were simply put aside unused since they were not appropriate for the local fields and animals. This outcome regarding the iron plough subsequent to the cooperative movement in the countryside also demonstrated that it was only with the establishment of the peasant cooperative system that urban industrial goods could be received by the countryside.

• Note:

• ^*Agricultural means of production data from State Statistics Bureau, 商业统计资料汇编 (1950–1957) (Commercial Statistics Compilation 1950–1957, General Volume 1), 1958; Peasants Purchasing Power data from: State Statistics Bureau, 中国商业历史资料汇编 (Compilation of Historical Data of Commerce in China), 1963; quoted in Wu and Dong (2001: 401, 403).

• Source: This box has been compiled by the author based on personal experiences and materials.

• Top photo: The two-wheel, two-spade plough being manufactured.

• Bottom photo: Mao Zedong inspecting the two-wheel, two-spade plough; 人民画报 (People Pictorial), Issue 11, 1955.

• Photo source: https://www.wzrb.com.cn/article299816show.html.

What has been discussed so far shows that whenever a developing country modernizes, it faces the difficulty of high-transaction-cost trading with geographically dispersed peasants and the problem of primitive accumulation of capital. This phenomenon of high-transactions cost is the institutional cost of modernization and is implicated irrespective of the official ideology a country maintains. In our case, regardless of the classic Marxist theory imported from the Soviet Union in the late 1940s or New Democracy by the CPC, China fell prey to the development trap as early as 1950. As it was difficult to promote exchange between industry and the rural sector by market transaction, the primitive accumulation of private capital necessary for industrialization became impossible.

We may look into statistics to understand the overall situation. The value of agricultural and sideline products purchasing increased to 129,730 billion yuan (old RMB) in 1952 from 80,000 billion in 1950, a growth of 62.16%. From 1949 to 1952, peasants’ net money income increased to 127,900 billion yuan from 68,500 billion, a growth of 86.7%. The purchasing power of peasants was increased by 80%. The total volume of retail sales in cities and villages was 170,560, 208,840 and 246,880 billion yuan in 1950, 1951 and 1952 respectively.⁵⁴

In 1951, the increment in value of agricultural and sideline products purchasing was 19,100 billion yuan. Meanwhile, the rise in expenditure of peasants buying industrial products due to price rise was 9,200 billion yuan. The benefits peasants gained were therefore 9,900 billion yuan. In 1952, the increment in the value of agricultural purchasing was 27,700 billion yuan, a slight drop but still higher than 1950. The benefits peasants gained were 18,000 billion yuan. In two years, it was 27,900 billion yuan.⁵⁵

The supply of agricultural means of production increased to 14,100 billion yuan in 1952 from 7,300 in 1950, a growth of 91.15%.⁵⁶

At the end of 1952, RMB held by peasants because of habits of saving, ready for purchasing livestock or land, etc., was up to 11,000 billion yuan, about 40.4% of the total volume of currency in circulation.⁵⁷

Admittedly, the above data was often quoted to represent the achievement of the government in increasing the income of peasants. Nevertheless, if viewed in the context of Chinese industrialization and from the perspective of the difficulty of industrial products going into the countryside, we can provide a new reading of this data.

First, the increment in the total amount of agricultural and sideline products was a result of raising the purchasing price. Peasant production showed no trend towards a higher extent of commodification. The total value of the increment was RMB 19,500 and 27,700 billion in 1951 and 1952, respectively. The sum was 47,200 billion yuan, about the same as the total amount of purchasing which was 49,700 billion (129,700 minus 80,000). Therefore, only RMB 2,500 billion (49,700 minus 47,200), about 5% of the increment, was gained because of the increase in the purchase volume of agricultural products.

Second, peasant production in general did not show a trend of capital deepening. In 1952, the commercial sector’s supply of agricultural means of production to the countryside was RMB 14,100 billion, merely 10.87% of the total value of agricultural and sideline products, which was RMB 129,700 billion. If the RMB 110,000 billion held by peasants was deducted from this RMB 129,700, then the expenditure of peasants in rural and urban sectors was about RMB 118,700 billion in 1952, of which merely 11.88% was demand for agricultural means of production.

Third, the demand for industrial products by geographically scattered peasants did not change in proportion to the income level and relative price. The income and price elasticity of demand for industrial products by geographically dispersed peasant households were extremely low. In 1951, peasant income increased by 19,500 billion yuan after raising purchasing prices. However, less than half (47%, 9,200 billion) was rendered into increased demand for industrial products. In 1952, the value of purchasing was increased by RMB 277,000 billion. Still, only RMB 9,500 billion was rendered into increased demand for industrial products, the ratio further dropped to 34.3%. Therefore, as the price scissors between industrial and agricultural products was decreasing and peasant income was increasing at a higher rate than expenditure, the currency going into the countryside stayed there. Only a relatively small portion of it circulated back into the cities.

It is apparent that peasants held a large amount of cash, mainly for internal circulation within the traditional rural economy, including a small section of the rich peasants who saved money for buying houses and land. On the one hand, it helped to absorb the expansion in the money supply by the government and relieve the pressure of inflation. On the other hand, it showed that urban–rural economic exchange was difficult to establish. In managing inflation, the former aspect was positive. However, after inflation was curbed, its negative impact started to emerge. Though it did not represent a long-term trend, nevertheless, as industrial production was totally revived, the market of industrial products was hard to expand if the purchasing power of peasants did not release itself through buying urban industrial products.

The situation of different industrial sectors matched well with the above analysis. Industrial overproduction occurred mainly in light industries related with daily life, for example, in the sectors producing matches, rolled tobacco, soap, flour, silk fabric and soy sauce (Wu and Dong 2001: 361).

4.2.2 Primitive Accumulation of Capital and the Policy Paradox of Price Scissors

It is generally thought that primitive accumulation of capital came from the extraction of rural surplus. Only by enlarging the price gap between industrial and agricultural products could the industrial sector extract surplus from the agricultural. Many scholars in China have conducted research on how much surplus the urban industrial sector has extracted from the rural sector through the price gap between them (Cui 1988; Han 1993; Jiangsu 2003; Li and Li 2008; State Council 2006; Su 2006; Wen 2000; Yan et al. 1990). However, we argue that it was when the state coercively pushed rural collectivization that urban industrial capital was capable of extracting surplus from the rural sector, hence the importance of the state. Before that, it was almost impossible for the geographically scattered and mixed-business running peasants to accept industrial products produced on a large scale in cities.

We would like to point out that the self-sufficiency of the peasant economy is typical of peasant economic behaviour of deploying internal/domestic labour to diminish its exposure to external risk. This peasant household rationality sustained by the internalization of risk is the vital mechanism by which traditional peasant sponge society can remain self-sufficient and stable (Wen 2011). However, in modern society, where industry is prioritized in development, this mechanism becomes an obstacle for industrial products going into the rural market. This binary contradiction has nothing to do with ideology. It is common to all developing countries.

The difficulty and experience of China achieving primitive accumulation for industrialization in a prevailing peasant economy may help us to understand the difference between the development path of the West and the East. Macfarlane (1978) suggests that as early as 800 years ago in England, rural organization typical of traditional peasant society had disappeared. Economic activities and social relationships were highly individualized. England achieved primitive accumulation of capital through colonization. The colonies afforded England with the demand for industrial products. Therefore, we are not able to find similar mechanism internalizing external risk through a family portfolio of allocating labour force as in rural China. In other words, China has achieved primitive accumulation of capital through rural households internalizing the cost by self-exploitation while England achieved so through colonization.

It is well known that the textile industry was a pioneer of modern industry and an important sector of light industry. In the early 1950s, the volume of the urban market was limited. Unlike developed countries in the West, which had access to markets overseas, China could only rely on its rural regions as market outlets for its modern industrial products such as textiles. According to a survey in April 1951 of 18 cloth shops in Beijing, there was an increment in sales turnover. Sales to the countryside was increased by 120–130%, whereas merely 65% to Beijing. The former was two times the latter.⁵⁸ The problem was that in traditional rural society, weaving had long been the work of women. As land reform restored the long history of weaving, the competition faced by the Chinese urban textile industry was not the dumping of foreign products but rather the looms spinning in every house in villages.

Therefore, we had the policy paradox of price scissors between industrial and agricultural products.

The reality of the practice of New Democracy during 1949–1952 was as follows. The traditional peasant household in China had long been a mini composite economic cell in which production and consumption were highly internalized. When peasants’ income did not increase substantially and the price scissors was too large, household weaving replaced machinery production. It became difficult to sell industrial products to the countryside. At the same time, faced with low grain prices, peasants would rather consume more grains than sell them. It became difficult to gather grain to supply the cities. Therefore, besides the transaction cost of peasants trading with the external market, peasant incomes also became an important factor for the textile industry to expand into the rural market. And until the 1980s, the textile industry remained China’s major export sector capable of earning foreign exchange. In essence, there was a conflict of interest between urban and rural sectors, and also between industrial and agricultural sectors. It was not easy to come up with a balanced decision.

Even though peasants benefited from the urban–rural exchange as described earlier and peasant incomes did show a remarkable increase during 1949–1952, the income rate was still lagging behind that of industrial and commercial sectors.

During 1949–1952, total arable land was increased by 10.25% and grain production by 46.1%. However, the value of agricultural production only increased by 41.4%. The increment in value lagged behind the increment in volume. In terms of division within agriculture, the greatest increase in production and income took place in cotton cultivation. However, the total farming area of cotton was small in ratio. It helped little in increasing peasant incomes (see Box 20). The largest income growth of peasants was recorded in production of local special products and sideline products based on a traditional mixed business mode, which is a feature of peasant livelihood diversity. As the traditional peasant economy was not monetized and commercialized to a great extent, the influence of cotton planting in increasing peasant income was limited.

Box 20: Revival and Growth of Agricultural Production After Land Reform

According to available data, total cultivated land area and total grain production quantity did not increase significantly after land reform.

China has always had the pressure of more people and less arable land. The population in the late Qing period already exceeded 300 million. Without any significant technological breakthrough, there was limited room for development and utilization of land. After the establishment of the PRC, with policies that encouraged the development of barren land, cultivated land area countrywide increased from 1.47 billion mu (15 mu = 1 hectare) in 1949 to 1.62 billion in 1952, an increase of 150.5 million or 10.25% (Wu and Dong 2001: 506).

In the early period of the PRC, the production of key agricultural produce had realized a large-scale increase. Comparing 1952 to 1949, total grain production increased from 112.18 million tonnes to 163.92 million tonnes, a growth of 46.1% (Wu and Dong 2001: 246). Given that the production in 1949 had been more seriously affected by natural disasters, a significant portion of the growth reflected the natural revival of production. Nevertheless, compared to the production of 150 million tonnes in 1936 (Wu and Dong 2010: 50), there was still an increase of 9.28%.

The highest growth was recorded in the cash crop, cotton. Total production of cotton increased from 444,000 tonnes in 1949 to 1.3 million tonnes in 1952, an increase of 193.69% in three years, and 153.6% of the historic high. The average per capita production increased from 1.6 catties in 1949 to 4.6 catties in 1952. The main reason was that in order to meet the demand in industrial raw material, the government had raised the purchase price of cotton. In April 1950, the Central Committee of Finance and Economy had set the price equivalent between cotton and grain as 1 catty of 7/8-inch medium grade ginned cotton for 8 catties of millet or 7 catties of wheat or 6.5 catties of rice. In March 1951, it was raised to 1 catty of 7/8-inch medium grade ginned cotton for 8.5–9 catties of millet, 8 catties of wheat or 8.5 catties of rice. By 1952, it was 1 catty of cotton for 8–9 catties or 8.5–9.5 catties of millet, 7.5–8.5 catties of wheat or 8–9 catties of rice (Wu and Dong 2001: 673). It should be noted that the increase of cotton purchase price subsequent to 1951 was implemented after the announcement of the government policy of unified purchase and marketing by the state on cotton yarn and material. That did not lend support to the general view that the state policy of unified purchase and marketing was for the purpose of procuring material from peasants at a low price. On the contrary, from the perspective of handling hyperinflation, that policy did have an obvious effect in curtailing speculation as well as hoarding by intermediaries.

Although ‘to get rich, grow cotton’ became the slogan of many peasants, yet given that the proportion of cotton relative to the total agricultural produce was insignificant, its contribution towards improving peasant income was limited. Furthermore, since cotton was using up land used to cultivate grain, the former could not be allowed to expand unchecked. From the table below it can be seen that in 1949, the cultivated area for cotton was about 2.2% that for grain. By 1952, it had gone up by 104.7% compared with 1949, yet as a percentage of cultivated area for grain it was still only 4.7%. Therefore, the impact of cotton on driving peasant income was generally limited.

1949–1952 Cultivated Land Area, Grain Cultivation Area and Cotton Cultivation

Area by Region (in million mu)

• Source: Wu and Dong (2001: 588–624).

Even though the new government sought to develop national capitalism as a state strategy, it failed to solve the problem of transaction cost between urban enterprises and the peasant economy. Limited by its dual feature of natural reproduction and economic reproduction, the development of the peasant economy usually lagged behind second and tertiary industries. It was the same for the New Democracy under the leadership of the CPC during 1949–1952. Compared with modern economic sectors such as industry, construction, transportation and commerce, agriculture recorded the lowest growth rate. Peasant income growth rate was also the lowest. Even including all incomes due to the sideline businesses, the purchasing power of peasants increased merely by 80% during the period, whereas national incomes in other sectors at least doubled. Commerce grew by 60%, which was 22.3% higher than agriculture (See Table 6).

Table 6 Production value growth rate in different sectors and national income growth index, 1950–1952 (Value in 1949 = 100)

Aside from the low-price characteristics of agricultural products, policy has been decisive in determining peasant income.

For instance, the even distribution of land and tax exemption was a common practice at the beginning of most dynasties in history. In new China, however, the policy entailed the even distribution of land but without tax exemption.⁵⁹

The way the CPC dealt with inflation at the beginning of the new republic was based on extracting agricultural surplus through the mobilization of peasants. At that time, peasants’ burdens were not relieved but actually increased. Tax relief was supposed to have been implemented in 1951, but such planned tax exemption was rescinded due to the Korean War.

Second, the commercial gains in the countryside were taken by state-owned cooperatives as a result of the government collecting agricultural products to fight speculation in cities.

The major consequence of land reform was the redistribution of wealth inside villages. However, during the process, the landlord, the agent of the circulation of scale, was also eliminated. Commercial organizations and businesses of different components were developed in the urban–rural exchange. Nevertheless, the gains of rapid growth in urban–rural trade were appropriated by state-owned commercial bodies and cooperatives.

From 1950 to 1952, state-owned commercial enterprises increased from 7,638 to 31,444, a growth of 312%. Profits and tax increased by 302%. Domestic commodities’ sales volume increased from RMB 34,420 to 155,080 billion yuan, a growth of 350%. The number of supply and marketing cooperatives increased from 22,817 in 1949 to 335,096 in 1952. The value of purchase by cooperatives increased from 12,290 billion yuan in 1950 to 86,840 billion in 1952, a growth of 610%. In comparison, the number of private commerce and catering enterprises increased from 4,770,000 in 1950 to 5,150,000 in 1952, a growth of 8%. The total volume of retail sales by private commerce increased from 100,890 billion yuan in 1950 to 120,400 billion in 1952, a growth of 19.3%.⁶⁰

Third, the short-term measure of repressing inflation by price control over agricultural products in cities became a long-term policy.

The purchase prices of staple grain as essential commodities were maintained at a low level until the end of 1951. The prices of most of the other agricultural products were hard to increase as the prices of staple grain were low. As a result, the growth of agricultural production value lagged behind the growth of volumes. The rate of peasant income growth was accordingly low.

Apropos the problem of price scissors, the state had in fact tried many times to adjust policy. However, the difficulty can be summarized as two contradictions. The first was the opposition in the urban–rural dual economic structure. When the government attempted to enlarge the price scissors in the second half of 1950 and 1951, it faced the unconscious soft resistance of the peasant household economy of mixed business, which did not take labour cost into consideration. Then industrial products and consumer goods found it hard to get into the rural market.

The second contradiction was the fundamental change in China’s development strategy in a sudden shift in the geopolitical setting. When the government started to narrow the price scissors between industrial and agricultural products and pushed industrial products going into villages, the condition of rural market exchange was improved. Nevertheless, the Korean War armistice in 1953 had fundamentally changed China’s international situation. China started to receive strategic aid from the USSR. The aid of military-heavy industry from the USSR was rendered into state capital. Within a short period, state capitalism controlled by the central government became dominant.

Facing internal and external contradictions, China pushed for socialist transformation beginning in 1953, the substance of which was the reconstruction of private capital by state capitalism. The New Democracy strategy of promoting private capital by market economy became history. The process of expanding and narrowing of the price scissors by government policy can be summarized as occurring in three stages.

The first stage took place at the beginning of the new republic. Due to the destruction caused by war, industry recovered at a slower pace than agriculture. As industrial products were scarce, peasants could exchange lesser industrial products with the same amounts of grain and cotton. The price gap in 1950 increased by 31.8% compared with 1930–1936, and 45.3% compared with 1936. At the beginning of the regime, the priority was to stabilize prices and control inflation, the price-setting of industrial and agricultural products was subject to this task before any other considerations. As staple grain and cotton were the primary commodities of inflation and the policy in 1950 was to stabilize prices, the price scissors continued.

The second stage started in early 1951. The government attempted to develop urban industry and commerce by enlarging the price scissors between industrial and agricultural products so as to accelerate the primitive accumulation of capital by extracting surplus from the rural sector. However, in less than a year, this policy faced rural market resistance. As the prices of yarn and cotton were relatively high, the peasants increased local weaving. Cotton flowed into villages and the state found it hard to purchase. Besides, as the official staple grain price was relatively low, urban and rural consumption increased and the market price became higher than the list price. State-owned companies found it difficult to purchase grain from the peasants.

The third stage was the narrowing of the price scissors. To deal with the problem in the second stage, the state gradually increased grain prices in November 1951, and in February, September and December 1952. The prices of yarn and industrial products were lowered. Although the relative prices of industrial products were higher than agricultural products, the price scissors was narrowing. Compared with 1950, the purchase price of staple grain in 1952 increased by 7.4% and of cotton by 8.9%. The prices of other agricultural products also rose. The purchase price index of agricultural products rose at a higher rate than industrial products in the countryside (see Box 21 for details).⁶¹

Box 21: Adjustments in Comparative Prices Policy of Industrial and Agricultural Products in the Early Years of the PRC

In the early period of the PRC, the national economy was severely impaired by war. Since the revival of industry was slower than the rural economy under the peasant rural community system, industrial products were relatively scarce. Therefore, industrial products that peasants could barter with were fewer than in the pre-war period with the same quantity of grain and cotton. In 1950, the rate increased by 31.8% compared to the average level in the pre-war years of 1930–1936, and by 45.3% compared with the year 1936. At that time, the first priority of the CPC was to stabilize the price level and control inflation. Given that cotton yarn and grain were the key commodities of inflation, the policies in 1950 were mainly for maintaining price stability, which had the effect of extending the scissor differential in prices at the early days of the PRC.

In the second half of 1950, grain prices declined, while prices of industrial goods and cotton gauze rose. The peasants were very upset about it. The central government’s policy was: to prevent grain price from going down and allow appropriate rise; stabilize cotton gauze prices to prevent its further rise and to make suitable adjustments on the premise of ensuring a certain profit for producers and distributors.

In September 1950, the Central Committee of Finance and Economy suggested that the key task in preventing or reducing damage to peasants due to low grain price was not so much reducing the price of industrial goods but maintaining a certain level of grain price, hence the plan to procure grain in large quantities to establish a reserve of five billion catty. Yet, since the state had limited funds for procurement, some regions were forced to reduce or stop it, and the effect of that price stabilization was unfavourable.

In January 1951, in order to supplement revenue and to balance income and expense, the Central Committee of Finance and Economy agreed with the suggestion from the mid-southern regions to widen the price scissors and redirect it to other regions, with the thinking that it was necessary to plan and expand the differential to stabilize the price of local produce while suitably raising the price of industrial goods. In April, it was suggested by the second national price level working session that consideration must be given to ground reality; a simple-minded emphasis on reducing the scissors differential, while well-intended, would not work in practice; it would hurt the peasants while also affect industrial production. In terms of policy, during 1951, the state adjusted the price of cotton yarn upwards twice, in January and April. Simultaneously, it adjusted the prices of grain downwards, partially each time. On 4 January, the price of rice in Shanghai and in the urban areas of rice-producing regions in Eastern China was reduced by 5%. On 12 April, the price of coarse grain was reduced all around. The procurement price of millet was changed to become the selling price. In July, the Central Committee of Finance and Economy felt that according to the rising trend in prices over the recent two months of 1% daily, and further, given that the state’s control over cotton yarn was not yet adequate, the purchasing power of peasants after the cotton harvest would increase by an estimated 40% compared to the previous year. The liquid fund in the hands of capitalists would increase over the previous year. Therefore, price levels were potentially at risk of massive fluctuations in the lead-up to autumn. Furthermore, with financial needs arising from the Korean War, starting 1 August, at the time of raising the price of yarn, grain price was reduced. Starting from the mid-southern regions, the procurement price of new grain harvest was reduced by 10–15% relative to the current price for rice. The price of flour was also appropriately reduced everywhere.

These several price adjustments led to the widening of the price ratio between industrial and agricultural products. Therefore, while the short-term problem was resolved, it created new unreasonable relative prices. The relative prices of cotton gauze and cotton wool were too high, resulting in the expansion of local yarn weaving in rural regions. Cotton flowed to rural areas and the state had difficulty procuring it. Moreover, with the price of grain at a relatively low level, not only did it increase both urban and rural consumption, but it also resulted in a higher market price than the official price, making it difficult for the state to procure. The state was forced to gradually raise the price of grain and cotton while reducing the price of cotton gauze and industrial goods in November 1951 as well as in February, September and December in 1952. The impact of this was that although the prices ratio between industrial and agricultural goods was higher than the pre-war period, the price scissors became narrower.

Comparing 1952 to 1950, grain price rose by 7.4% and cotton by 8.9%. The price of other agricultural produce also increased. Further, with the return of higher prices in trading markets for agricultural produce, the overall price index for agricultural produce procurement exceeded that of the retail price of industrial goods in rural regions. With 1950 as base, the overall agricultural produce procurement price index for 1951 and 1952 was 119.6 and 121.6, respectively, while the general price index of industrial goods in rural regions was 110.2 and 109.7, respectively. The quantity of industrial goods that peasants could barter for with the same quantity of agricultural produce grew. The average index of industrial and agricultural products price ratio, with 1950 as base, was 90.3 in 1952. Out of this, the narrowing was less significant in coastal regions, and more in inland and remote regions. The net gain for peasants through bartering increased, from 0.99 billion yuan in 1951 to 1.8 billion in 1952.

• Source: 1949–1952 中华人民共和国经济档案资料选编·商业卷 (Selection of People’s Republic of China Economic Archives 1949–1952: Commerce). Beijing: China Supplies Publishing House, 1995, pp. 549–636; quoted from Wu and Dong (2001: 670–672).

The price scissors between industrial and agricultural products during 1950–1952 are shown in Table 7.

Table 7 Purchase price index of industrial and agricultural products and price ratio index, 1950–1952

The purchase price index of agricultural products was higher than the rural retail price index of industrial products in 1951. However, as the price scissors was relatively larger in the early period of the republic, the rural retail price index of industrial products had a comparatively high base figure. The rural sector was in a less favourable condition in the market exchange with the urban sector.

In short, the predicament of limited rural market capacity for industrial products was yet to be solved during 1950–1952. Therefore, the government intervened directly in the market during depression.

4.2.3 Dealing with the Crisis: Counter-Cycle Regulation and Political Movement

After the repression of hyperinflation during 1949–1950 and the construction of the national fiscal and financial foundation, the physical economy with private capital as its chief agent was supposed to be in a relatively more stable condition for development. Accordingly, the primitive accumulation of capital for industry and commerce should have accelerated in China.

Nevertheless, apart from the problem of depression after crushing speculation, there was another seldom discussed problem. Developing national capitalism with private industry and commerce had been an urgent strategy of the state. However, primitive capital accumulation for industry and commerce is a process of exploitation everywhere in the world. No official Marxian theorist in China has ever openly discussed this problem. Even if it was represented as New Democracy, internal exploitation was the real process of this development model.

Private capital tended to maximize its gains on capitalizing resources. During this process, risks would accumulate. When this enormous institutional cost could not be directly transferred to urban and rural workers after revolution, internal economic disorder in cities where industrial and commercial capital was concentrated would become inevitable, implying that a hard economic landing would become a persistent occurrence. Even if the government directly intervened by taking counter-cycle regulation measures, it was impossible to reverse the deterioration of the business environment and economic behaviours. Furthermore, disorder spread to the government through market-saving measures such as government purchasing and orders, breeding corruption among some officials.

This situation, which was unexpected in the idea of New Democracy, was the background of political movements sanfan and wufan. During the primitive accumulation of national capital in 1949–1952 (also known as national economy rehabilitation), counterfeiting, speculation as well as corruption and favouritism among officials occurred in almost every major city. The contradiction became acute as the requirement of securing military supplies for the Korean War was imperative. Then the central government under the leadership and revolutionary authority of Mao Zedong ordered local governments, which had yet to take firm footing in cities but still controlled the distribution of supplies, to launch popular movements such as sanfan and wufan within the governments and against certain industrial and commercial capitalists.

The institutional transition experiment in Northeast China is more noteworthy. In the northeast regions, the outbreak of the Korean War and the strategic aid from the USSR elevated state capital, which justified its taking of more surplus than private capital. State and private capital were caught in opposition and competition, and a choice had to be made between them. Then the institutional transition of unified purchasing and selling by the state was implemented. After 1953, when aid from the USSR was at its peak, unified purchasing and selling was also implemented in the whole nation.⁶²

4.2.3.1 The First Counter-Cycle Regulation

Faced with the problem of a weak market after price repression, the Central Government Committee used the Seventh Conference on 8 April 1950 to discuss the economic difficulties and find solutions. Mao pointed out that ‘in the following months, the government should focus its fiscal and economic policy on adjusting public enterprises and private enterprises as well as the relationship between different sectors among public and private enterprises, and overcoming economic anarchy’.⁶³ It was the guiding principle of policy adjustment in the development of private capital in the New Democracy.

In April, after the value-anchored public bonds were issued and general prices were stabilized, the Central Committee of Finance and Economy decided to shift its focus from fiscal problems to revitalizing and developing the economy. The plan was to support the development of private industry and commerce by providing loans, a favourable tax policy, supply of raw materials, improving transportation, etc. In early May, the committee proposed concrete measures such as easing money supply, enlarging government order and purchase of agricultural products, increasing the purchasing power of peasants, facilitating the export of industrial products, increasing the turnover of industrial fund, unemployment relief and reducing the blindness of private industry only seeking profit.

In June, at the third plenary session of the Seventh Party Central Committee, Mao continued to emphasize developing capitalism:

To improve our fiscal and economic situation, we need three conditions: first, the completion of land reform; second, reasonable adjustment of the present industry and commerce; third, heavy cuts in the budget of public institutions… Someone believes we can eliminate capitalism ahead of time and realize socialism. This is wrong and not suitable for the concrete situation of our country.⁶⁴

This guiding principle was the foundation of the government’s first counter-cycle policy adjustment in developing private industry and commerce.

There are three noteworthy points. First was the lack of a market economic agent. As discussed earlier, promoting urban–rural market exchange was the government’s major measure of counter-cycle regulation. However, we also pointed out that as land was distributed evenly, the existing agents of production of scale as well as the agents of circulation of scale in villages were eliminated, whereas a new agent of the agricultural economy of scale was yet to emerge. The rural sector had limited demand for the agricultural tools that the industrial sector was producing. Therefore, the result of promoting industrial products in the countryside was not as expected by policy makers. The effect of this measure was limited to rehabilitating urban industry and commerce in 1952. In comparison, expanding fiscal expenditure to boost domestic demand was more effective.

Second, the government implemented ‘targeted going-long’ measures as opposed to general selling-short during economic downturns.⁶⁵ Only after successfully resolving hyperinflation and having complete financial sovereignty did the new government gain the legitimacy of counter-cycle regulation. Until 1998, fiscal and financial systems were unified in China. The new government could coordinate loose fiscal and monetary policies in counter-cyclical regulation. Apart from general monetary tools, such as increasing bank loans, a greater amount of money supply was targeted towards a specific sector. A large part of increased money supply was invested in the target sector through a direct financial tool. After the Korean War, the government became even more dominant in supplies distribution.

Third, political movements went hand in hand with economic regulation. Not long after the initiation of the first policy adjustment, the government had to face the challenge of a geopolitical shift. The demand for fiscal expansion for economic recovery and the rigid fiscal expenditure of war had exerted double pressure on the fiscal budget. It was the background of the production expansion and frugality movement, and the sanfan and wufan political movements. As politics is the focused expression of the economy, they were not contradictory. The greatest political issue was China’s involvement in the Korean War. War had created great demand for industrial production and agricultural products. However, at the same time, these industrial and agricultural products were requested to be clear of the ‘original sin’ of primitive capital accumulation. Clearly, it conflicted with the spontaneous tendency of private capitalism.

Here, let us analyse the second point and move the third into the next section.

In 1950, the government started to expand expenditure. Practices such as commissioned production and unified purchase and selling had effectively changed, in Mao’s words, ‘the anarchy of private industry and commerce’.

Government purchasing began in December 1949 with the saving of Shanghai’s industry and commerce that was in dire straits (see Box 22).

Box 22: Helping Shanghai’s Industry and Commerce, Setting a Precedent of Processing Order and Purchase by the Government

During the severe nationwide price fluctuations between 15 October and 25 November 1949, the Shanghai industrial and commercial sector, based on years of experience, overestimated the extent of the price fluctuation and believed that the renminbi would devalue continuously to a large extent. They thought the rise in interest rate would fall behind the price increase. Therefore, speculators borrowed to buy goods. Factory owners also preferred to borrow to pay for expenses (such as wages) than sell inventory. The interest on borrowing rose to a monthly rate of two yuan for every one yuan of loan. As it turned out, the situation was not what had been expected. Beginning on 25 November, the price level stabilized and then went on a decline, forcing the disposal of goods to repay loans. The outcome was increasing difficulties in selling goods even as prices fell. More and more people raised new debts in order to repay old ones. As a result, even though prices had dropped, liquidity was still tight and the interest rate remained high. Many factory owners suffered from liquidity problems.

On 3 December, the Shanghai Municipal Party Committee wired CPC Central and informed the latter that many large and medium-sized factories in Shanghai were in debt and could not maintain operations. They requested loans from the government to avoid a large-scale closing down. On 8 December, the Central Committee of Finance and Economy allotted RMB 50 billion to Eastern China. The larger portion of this was for procuring goods from factories in Shanghai and a smaller portion for lending to alleviate the imminent difficulty of industrialists and business people in the private sector.

During the time of his visit to the Soviet Union, Mao Zedong read the wire from the Shanghai Municipal Party Committee and asked Chen Yun: ‘Do the factory owners in Shanghai actually have such serious difficulties? Has the government agreed to give a loan and how much? Is the outcry of the capitalists based on true circumstances or just on the intent to boycott the public debt offering?’ Chen Yun reply was an analysis based on why Shanghai’s factory owners were having such difficulties. He was of the view that ‘the outcry… did in part reflect the intent to avoid buying the public debt. Still, tight liquidity and difficulty in financing were in fact the main reasons.’ Chen Yun further told Mao Zedong that the 50 billion yuan allotted to Eastern China by the Central Committee of Finance and Economy on 8 December had already alleviated the crisis faced by the Shanghai industrial and commercial sector. After that, the plan was to provide a further 100 billion yuan to resolve their difficulties.

This resolution in the Shanghai business sector, while only within the scope of one city, set a precedent for the subsequent approach of processing order and purchase, whereby the state bought goods from factory owners.

• Source: Jin and Chen (2005: 688–689).

The importance of demand from the government can be illustrated in the cotton yarn textile industry, which accounted for nearly one-third of the total production value of private industry in 1949. In the second half of 1950, the state’s order amounted to 70% of the industry’s production capacity (Wu and Dong 2001: 367). In 1949, the value of order, sale, and purchasing by and processing for the state accounted for 11.88% of the total value of private industry. In 1952, the figure rose to 56.04%. Accordingly, the ratio of independent production and sale declined from 88.12 to 43.96%. In 1950, the industrial value of the private sector grew merely by 6.59%, whereas order, sale and purchasing by and processing for the state increased by 158.6%, a 17% growth in total production value, up to 28.83%. The value of independent production and sale was decreased by 13.91%, a drop of 71.17%. The year 1951 was a boom year for the private sector. However, the government was still the dominant contributor to economic growth. Order, sale, and purchase by and processing for the state increased by 106%, representing 42.71% of the total production value. In comparison, independent production and sale increased by merely 11.9%, 57.29% of total value. In 1952, the value of order, sale, and purchase by and processing for the state increased by 36.49%. It went over 50% for the first time, whereas the absolute figure of independent production and sale dropped by 20.17% (See Table 8).⁶⁶

Table 8 Composition of production value of private industry sector 1949–1952 (1,000 yuan [old RMB])

Under the government’s policy adjustment, national capitalism underwent substantial development. In less than half a year, the business environment improved. In 10 big cities (Shanghai, Beijing, Tianjin, Wuhan, Guangzhou, Chongqing, Xian, Jinan, Wuxi and Zhangjiakou), the number of enterprises starting business was 32,674, whereas 7,451 went out of business. In the third and fourth quarters of 1950, tax revenues from private industry and commerce increased by 90 and 80%, respectively, compared with the first quarter. In August, September and October 1950, applications for business permit in industry increased 28 times compared with April, and 17 times in commerce. In that period, business closures were merely 12% of the number in April (Wu and Dong 2001: 371). See Table 9 for the variation of production index of major industrial products.

Table 9 Variation of production index of major industrial products during April to December 1950 in Shanghai (production in January 1950 = 100)

The statistics in Table 9 show that primary forms of state intervention, such as placing orders and purchasing were significant in resolving structural overproduction and the weak economy of national capitalism, especially when structural transformation was required and industrial products were hard to sell in the rural market because of the restoration of the traditional peasant economy in the early years of the republic.

The statistics also show that the new government was consolidating its understanding of the economic system and the ability of economic regulation when dealing with old and new crises. Therefore, the strategic shift during the beginning of the republic (socialist transition from New Democracy of private capital under trouble to state capitalism) was the final result of constant adaptive adjustments in the face of changing politico-economic circumstances. It was certainly not the product of a subjective wish based on a particular ideology of a particular leader. Accordingly, we can understand what Mao said in 1953 elaborating the general route of socialist transition: ‘the socialist transformation in New China has been under way since 1949’.

4.2.3.2 The Korean War, and Sanfan Wufan

As described earlier, the counter-cyclical economic regulation by the government resolved the contradiction of primitive capital accumulation into economic growth. It is a general principle of development economics.

However, while the government was implementing counter-cyclical regulation, the Korean War broke out. In October, when industry and commerce had just stabilized, China decided to participate in the war. The fiscal and economic system that was getting rid of the burden of war returned once again to a state of war. Domestic resources and capital were concentrated into heavy and military industry necessary for war. The fiscal budget therefore became tight again. Resources supposed to be used for building the economy, culture and other sectors were transferred to national defence. And the budget for building the economy was reallocated to military expenditure. According to a rough estimate in the autumn of 1951, fiscal expenditure exceeded the original budget by 75%, 55% of which was military expenditure (Wu 2014: 24–25) (See Table 10).

Table 10 Expenditure for economic building and national defence, and Ratios in Total Fiscal Expenditure 1950–1952

Due to greatly increased military expenditure, and the need for heavy and military industry investment, the state had to take a series of measures to increase revenues and cut social expenditures in urban and rural sectors.

The measures to increase revenues in the countryside included: (i) cotton yarn sale tax and tax on cotton yarn and cotton cloth stock, both at 6%; (ii) agricultural tax revenues increased by one-tenth (the lowest tax rate rose from 3 to 5%; proportional tax system was maintained in the old liberated regions); and (iii) staple grain prices were suppressed to enlarge the price scissors between industrial and agricultural products. However, as stated earlier, the tax burden on villages was heavy enough. The space for extracting more rural surplus by increasing tax and purchase volume was limited. As for cutting expenditure, since the base was already small and villages were mostly self-sufficient, it did not work at all. Furthermore, these measures in fact constituted an institutional barrier for industrial products entering the rural market. The growth rate of peasants’ income in cash was slower than the industrial production rate. The purchasing power of peasants lagged behind. Urban industrial and commercial products after structural adjustment found it hard to go into rural regions.⁶⁷

In cities, as the war was marching on, the central government promoted the Patriotic Production Expansion and Frugality Movement to the whole nation, requesting the suppression of cost and increase in efficiency and production in different sectors. The main measure was to suppress and set a limit on expenditure. The cost of purchasing military supplies and materials for infrastructure had to be strictly controlled to suppress the profits of merchants. As the name given to the movement suggests, it was a full-scale national mobilization in the name of patriotism.

As the movement went on, some merchants thought that they were unfairly treated, as the difference between government purchasing and market prices were substantial. They had been under pressure due to the government’s effort to suppress inflation (for example, it was hard to get loans and there was a limit on purchasing), and therefore had to bear high production costs. Then they had to face the double difficulty of pushing products into the countryside along with strict state price controls.

Experiences have shown that when enterprises face high business risks, they tend to engage in morally dubious activities. This tends to be the case irrespective of whether the enterprise is private or state-owned. If it were not content with government policy, the likelihood of such enterprises engaging in morally questionable activities would increase even further. Private enterprises did show a tendency towards misbehaviour. They were more prone to profit seeking by improper means. As a consequence, the institutional cost of primitive capital accumulation would intensify in cities. Commercial misbehaviour such as counterfeiting, adulteration and tax evasion prevailed, which converged with rent-seeking of some officials, leading to a negative impact on the conduct of the war.

Under general dispersive market demand, private industry and commerce could transfer their cost by various ways, for example, by suppressing customer rights or with bad money driving out good money. The institutional cost was thereby borne by society as a whole. The negative impact would not express itself immediately. Even if it were the government purchasing, the institutional cost would be spread among the people through government distribution. However, in the case of war, it was a different story. What the government purchased and ordered were industrial products to fulfil the needs of national defence. The information of quality was concentrated and transparent, and could be traced back to every single supplier. Counterfeiting and adulteration was instantly reported from the frontline to logistics departments.

When the institutional cost of primitive accumulation in national capitalism unfolded in national defence, its contradiction with national security became inevitable. That explains why even those top CPC leaders who were in favour of developing national capitalism also advocated the sanfan (literally “three-antis”) and wufan (literally “five-antis”) campaigns.

Although from the logic of capital, the targeted problems of sanfan and wufan emerged simultaneously, these movements took place one after another.

The sanfan movement began first, at the end of 1951. According to existing historical materials, during the Patriotic Production Expansion and Frugality Movement, there were many reports about misconducts such as corruption, lavishness and bureaucracy in local governments, state-owned enterprises and faculties. For this, Mao decided to launch the sanfan movement. On 1 December 1951, the CPC Central Committee announced the decision of mobilization.

Then, in early 1952, the wufan movement began. It was reported that during the investigation into corruption in the sanfan movement, many cases of misconduct were found to be related to unlawful capitalists. As early as on 1 November 1951, a report by the Northeast Bureau to the Central Committee pointed out that a common feature of many serious cases of corruption was collusion between merchants and corrupt officials to usurp state properties. Therefore, just after the sanfan campaign was launched, the CPC Central Committee initiated the wufan movement to eliminate misconduct in the economy (Wu and Dong 2001: 407–427). An instruction drafted by Mao announced the wufan movement on 26 January 1952 (see Box 23).

Box 23: The Sanfan and Wufan Movements

• Sanfan: A Struggle against Misconducts Known as the Three Kinds of Harm

The sanfan movement had arisen directly out of the Patriotic Production Expansion movement that was launched nationwide during the Korean War. In this movement, shocking problems of corruption, lavishness and bureaucracy were exposed everywhere. On 1 November 1951, the Chief Secretary Gao Gang of the CPC Northeast Bureau submitted a report to CPC Central titled ‘A Report on Launching the Production Expansion and Frugality Movement, and Further Deepening of the Struggle against Corruption, Lavishness and Bureaucracy’. It captured the attention of Mao Zedong: ‘The CPC Central upheld this report and requested all of you to pay attention to the various experiences described in this report to launch a determined fight against corruption, lavishness and bureaucracy during this nationwide movement on production expansion and frugality….’ On 29 November, Bo Yibo, Liu Lantao and others submitted a written report to Mao Zedong and the CPC with regard to the severe corruption and lavishness of the Tianjin Party Committee leader. This report attracted even more attention from Mao Zedong and the CPC, and on the following day it was redirected to the various regional bureaus. Mao Zedong had pointed out in his comments that ‘it is essential to pay attention to the reality of party cadres being eroded by the bourgeoisie and engaging in severely corrupt behaviour. We should pay special attention to expose and punish the corrupt, and handle it as a major battle campaign.’ On 1 December, the CPC presented the ‘Decision on Implementation of Military Downsizing, Government Streamlining, Production Expansion, Frugality, Anti-corruption, Anti-lavishness and Anti-bureaucracy’. The curtain was officially drawn on the sanfan movement.

In January 1952, the focus on the sanfan movement was placed on investigating and striking seriously corrupt persons, known as the stage of fighting tigers. Those who had taken bribes of over RMB 100 million (old currency) were referred to as big tigers, while those between 10 and 100 million were small tigers.

After that, the sanfan movements roughly went through three stages: between January and February, it was the stage of reporting and exposing; between March and April, it was the stage of cases investigation; and in June, with the finalizing of cases, it went into the closing stage. On 25 October 1952, the CPC approved the Central Political Research Office’s ‘A Report on Terminating the Sanfan Movement’.

Based on relevant statistics, the number of people that were involved nationwide in the sanfan movement, from party and government organizations at the county level and above, were more than 3.83 million (not including the military). Over 100,000 people had received bribes of over 10 million, around 2.7% of the total involved. Of these, 9,942 people were given prison sentences and another 67 faced life imprisonment. Another 42 were given death sentences and 9 death sentences were suspended.

• Wufan: A Struggle Against Misconducts Known as the Five Kinds of Venom

On 31 December 1951, Bo Yibo reported to Mao Zedong on the situation of sanfan. When he said that capitalists usually seek collusion with procuring personnel by giving rebates, Mao Zedong interrupted: ‘This should be investigated not only in governmental organizations but also among business people. In the past during land reform, we had protected industries and commerce. Now we should differentiate between good and unlawful businessmen and fight with the latter.’ On 26 January, Mao Zedong drafted on behalf of the CPC Central the ‘Instructions Regarding the Launch of a Large-Scale, Determined and Thorough Wufan Movement in Cities within the Given Time-Frame’. The document requested:

It is essential and timely now to launch in all cities nationwide, first in large- and medium-sized ones, a large-scale, determined and thorough movement against unlawful bourgeoisie to combat bribery, tax cheating and evasion, frauds on state assets, adulteration and poor quality, and stealing information about the economy (together referred to as the ‘five venoms’), by relying on the proletariat and allying with the law-abiding bourgeoisie and citizens, and to collaborate with the internal struggle within the party, government and army against corruption, lavishness and bureaucratisation.

With that, the wufan movement was launched on all fronts. In early February, it was first launched in all the big cities, and soon after that spread to various medium and small cities, reaching the peak in fighting the five kinds of venom of capitalists.

Shanghai was the city where the national capitalists were concentrated, and the wufan movement there had been important to the overall situation. On 25 February 1952, before Bo Yibo arrived in Shanghai to preside over the Eastern Regional Bureau, the wufan movement had in fact already begun, with more than 200 people arrested. There were 48 attempted suicides and 34 deaths of capitalists. Given such radical actions, the CPC pushed back on launching the movement in Shanghai. In fact, besides Shanghai, other cities where commerce was relatively concentrated, such as Shenyang, Beijing, Tianjin, Chongqing, Wuhan and Guangzhou, also saw suicide incidents. In particular, the famous patriotic industrialist Lu Zuofu, who had recently led a fleet of ships returning to China, could not live with the insult and had taken sleeping pills to commit suicide in his home in Chongqing. It was a shock to the senior level in the CPC Central. On 5 March, Mao Zedong redirected the document ‘Beijing Municipal Party Committee’s Means and Standards for Classifying and Handling Industrialists and Merchants in the Wufan Movement’ to various places, increasing the categories of private industrialists and merchants to five, the first three taking up about 95% (law-abiding, basically law-abiding and semi-law-abiding) and the latter two about 5% (seriously unlawful, completely unlawful) of the businessmen. The inspection of industrialists and merchants were tightly controlled at the municipal level. Other organizations did not have discretion to send inspectors and no authority to arrest people for trial. After revisiting the preparation work, the wufan movement was eventually launched on an official basis in Shanghai on 25 March.

On 25 October, the CPC Central circulated the report by the Political Research Office on the issue of ending the wufan movement. The report pointed out that: based on statistics from 67 cities in the five major regions of North China, Northeast, East, Northwest and Mid-South, as well as from the overall Southwest region, the number of industrialists and merchants involved in the wufan movement totalled 999,707 enterprises. Criminal sentences were given to 1,509 persons and 19 people got death or suspended death sentences.

• Sources:

• He Yunghong, ‘五反’运动研究 (Research on the Wufan Movement). Chinese Communist Party History Publishing House, 2006.

• Wang Shunseng, Li Jun, ‘三反’运动研究 (Research on the Sanfan Movement). Chinese Communist Party History Publishing House, 2006.

The misconduct of capitalists—also known as the ‘five types of venom’—revealed during the wufan movement were as follows: bribery, tax evasion, usurpation of state properties, shoddiness and spying on economic intelligence. Apropos of tax evasion, according to a survey, 99% of the 3,510 business taxpayers in Shanghai were involved. It was 82% among 1,807 business taxpayers in Tianjin. According to a survey in 1952, about 13,087 enterprises (26%) in Beijing were involved in bribery. In the first half of 1952, reports of wufan showed that in nine big cities (including Beijing, Tianjin and Shanghai) 340,000 among 450,000 private enterprises were involved to some extent (Wu and Dong 2010: 312) (see Box 24 for case examples).

The number of criminal penalties imposed on capitalists was much less than on officials. However, the crimes by the former were more serious.

Box 24: Major Expressions of the Institutional Cost of Primitive Accumulation for National Capital Prior to the Sanfan and Wufan Movements

• 1. Frauds and shoddiness in contracting state projects as well as in the manufacture and purchase for the government

For example, in the irrigation project for River Huai, the contracting companies disregarded the quality standard, using old or defective material in place of new and good material. In doing so, they stole large amounts of national wealth and assets that were meant for the project. In 1952, the total disbursement incurred by the Henan Province in Shanghai in procuring labour and equipment for the River Huai project amounted to over 50 billion yuan (old RMB). Of this, the amount cheated and stolen by vicious merchants in Shanghai had been up to a dozen billions yuan.^*

In another example, after the start of the Korean War, the battlefront had urgent need for first-aid kits. The government assigned a large part of first-aid kit production to private merchants. The unlawful businessmen in Shanghai disregarded the life and death of the voluntary army and cadres, and put used cotton wool in the kits without even disinfecting it.

• 2. Widespread practice of tax cheating and evasion

Based on material provided in a typical survey conducted by the State Taxation Bureau in 1950, after the submission and first payment of business tax, out of the 3,510 business taxpayers in Shanghai, 99% showed tax evasion practices, while out of the 1,807 in Tianjin, 82% did so. Further, based on investigations in 1952 by Beijing, about 13,087 or 26% of industrial and commercial taxpayers showed bribery practices to varying extents.^**

• 3. Exceptionally serious bribery and collusion between businesses and officers

In Wuhan, 109 business operations had been involved in bribing cadres to acquire over 130 billion yuan (old RMB) of state assets. Of these, 27 had used 400 million yuan to bribe more than 430 cadres. Of the latter, 22 became their insider informants. In Beijing, investigations in 1952 showed that more than 13,000 business operations in the city had had bribery actions, accounting for more than 26% of the total. Among them, there were 169 operations involved in bribery of over 100 million yuan. The unlawful capitalists in Tianjin had formulated a set of bribery experiences, which were: those who ask the time, give them watches; those who ask for a light, give them lighters; those who are interested in card games, give them the winnings and settle their losses; those who care about their image, give them gifts in secret; give wedding rings, clothes for children, eggs to celebrate a newborn, and even coffin material for parents of cadres; pay for prostitutes, dance girls, and even offer daughters and wives. Li Tinglin, the chief of bureau of medical affairs under the Ministry of Health in Northeast People’s Government, colluded with Cong Zhifeng, manager of Guangming Pharmacy in the private sector, to cheat the government by selling at a high price to and buying at a low price from the latter. The cheating also occurred in speculations, forging checks, evading tax, faking accounting records and so on, resulting in a loss to the state of around 6.1 billion yuan (old RMB) (He 2006: 56–57).

• Sources:

• ^*新华月报 (Xinhua Monthly) March, 1952, pp. 34, 39; quoted from Wu and Dong (2001: 428).

• ^**新华月报 (Xinhua Monthly) April, 1952, p. 20; quoted from Wu and Dong (2001: 428).

Not only did sanfan and wufan purge businesses involved in misconduct and official rent-seeking, it also had a remarkable effect on cutting lavishness and shoddiness.

Chen Yun affirmed the necessity of the sanfan and wufan movements by concrete examples when reporting to the Central People’s Government Committee in April 1952. He concluded that ‘after the movements, expenditure was cut by 20% in various departments, with the same task fulfilment’. He continued,

In the first season, the Ministry of Finance repaid 3,100 billion of old debt to banks. We still have 7,000 billion yuan, an increment of 1,000 billion. This is something big. Since the establishment of the Central People’s Government two years ago, the Ministry of Finance has always had higher expenditure than revenue. We have spent too much last year. The Central Committee of Finance and Economy has reported this to Chairman Mao and Premier Zhou. If we continue like this, price stability would become impossible in March. However, now March is over. The situation is looking good. If you ask, ‘Do you sleep well?’ Yes, I sleep well because the Ministry of Finance has 7,000 billion yuan in hand. Therefore, sanfan and wufan have had a very positive effect on fiscal wellness.

There was a report about improvement in enterprise management in the movement. It was reported that an assistant of Tangshan Steel Factory invented a new way to decrease the consumption rate of pig iron, which saved 20.38 billion yuan annually.⁶⁸

According to a report by the Central Committee of Finance and Economy on 29 November 1952, the direct benefits of the movements in 1952 were as follows. The total gains were 31,778.9 billion yuan (13,676.9 billion yuan of increased sale by the Ministry of Commerce not included), of which 11,660.8 billion yuan was increased production, with a profit of 2195.6 billion yuan (profit from the Mid-south and Inner Mongolia not included). Production costs saved were about 11,257.6 billion RMB. Infrastructure costs saved were about 2,454.4 billion RMB. They totalled 13,712 billion RMB. Saved capital flow due to an increased turnover rate and less excessive reserve amounted to 6,406.1 billion yuan. The result of the movement was proportionate to the scale of state-owned enterprises. In the north-eastern regions where state-owned enterprises were stronger, benefits contributed to 51.9% of the total gains (Wu and Dong 2001: 433–436).

Nevertheless, we should take note of the complication of social contradictions.

Admittedly, China at that time lacked the condition of class politics dominated by proletarians having a class consciousness. That made it impossible to achieve socialism defined by classic Marxism. A part of what rose along with these movements was the expression of partisanship formed in the war. A great part of what the movements unleashed was discontent among general urban citizens and enterprise staff, who were mostly petit bourgeois. Internal grudges that had accumulated among the people became over-aggression, which might be inevitable in any political system.⁶⁹

From the perspective of social class features, the target groups were quite homogeneous in rural land reform and urban sanfan and wufan movements. They were elite groups relative to general people.

Whether in rural or urban society, over-aggression or even violence was commonly perpetrated by petit bourgeois in official political movements. This is the reason that one would not simply and uncritically approve a political movement. The experiences of popular involvement in politics show that in ‘an ocean of petit bourgeois’ (Mao Zedong), any petit bourgeois revolution transplanted from Western ideology would turn violent. Unfortunately, the subsequent political movements have proven this point of view.

However, the most regrettable aspects of these political movements, which were later heavily criticized, have never been discussed by castigators until it was too late. The problem the politicians and entrepreneurs failed to foresee was that it is impossible to absorb the institutional cost of primitive accumulation for national capitalism in the urban economy by way of an urban popular movement alone. That is the crux of why most developing countries have failed to achieve primitive accumulation for urban industrialization and have gone through one turmoil after another. Accordingly, it is no wonder that China fell into an economic depression again after the wufan movement.

The various measures the government took as a response can be called the second economic adjustment, which included providing reasonable profits for government orders and purchases, specifying the standard, adjusting interest rate and bank loans, adjusting tax and regulating the. At the end of 1952 and the beginning of 1953, the second adjustment became quite effective (Wu and Dong 2001).

We will not go into the details of the second counter-cycle adjustment as shortly after this, the socialist transformation followed, which commanded the attention of the world.

We would like to take this opportunity to remind the readers that the loop of a planned economy (‘regulation results at stagnation and de-regulation lead to chaos’), much criticized since the economic reform in the 1980s, had actually come in a full circle during the rehabilitation of the national economy (1949–1952), which then mainly comprised the market economy and private capital. An experience the government learnt in this process was counter-cyclical regulation. These two occasions of counter-cyclical regulation laid the foundation of socialist transformation in 1953, and it was applied again and again later in economic regulation.

4.2.4 Re-understanding the Shift from New Democracy to ‘Socialist Transition’

We conceive that the determining major contradiction expressed in the transformation of urban economic institution in 1949–1952 was the institutional cost of primitive capital accumulation in two forms: state and private.

The bureaucratic monopoly capital in the old republic was directly transformed into state capital after the occupation of cities by the CPC. In addition, the Soviet strategic investment during the Korean War could only be rendered into state capital. During 1949–1952, what was growing the fastest in the national economy was state capital. The weight of industrial production in the state-owned sector rose from 34.7 to 56%, mixed ownership from 2 to 5%, whereas the private sector declined from 63 to 39% (Hu 1991: 339) (See Table 11).

Table 11 Industrial production variation in different sectors 1949–1952

During the period of Soviet aid after the Korean War, the divergence in trend between different sectors was obvious. However, these sectors were still complementary to a certain extent in the industrial structure. In 1949, industrial production in the private sector was 63% of the total value, which was mainly light industry producing daily consumer goods. During 1949–1952, state-owned heavy industry was further consolidated. The transformation of private capital in 1953 took the path of ‘acquisition’, which allowed private capital to share benefits in the long term rather than revolutionary confiscation.

The weight of private and state-owned industry in various sectors is shown in Table 12 and Fig. 1.

Table 12 Weight of industrial production in the state-owned Sector, 1949–1952 (%)

Fig. 1

(Source: Wu and Dong 2010: 265)

Weight of the private sector in industrial production 1949 (%)

Unlike the sanfan and wufan movements, which were launched by the government against the institutional cost of primitive accumulation of private capital, the structural expansion of state capitalism at its initial stage had a relatively low institutional cost. The cost of institutional transition it dominated was also relatively lower. There were five reasons for this:

• 1. The revolution had covered the institutional cost. After October 1949, the new regime confiscated the old bureaucratic capital and transnational enterprises in China, which became state capital. The sacrifice in the revolutionary war was not counted in the cost accounting of state capital. No payment to interest blocs or other sectors was required.

• 2. The land reform had covered the organization cost. Agrarian reform and the Korean War achieved total mobilization of the population through the ‘reorganization’ of society. This sort of organized mobilization hid the fact of state capital appropriating benefits behind the state’s grand narratives. The transaction cost between the state and scattered individuals was thereby effectively reduced.

• 3. Financial gains were generated from restoration at a lower cost than building new infrastructure. Infrastructure was merely partially damaged, and the state had only to pay a part of the construction cost to gain all the benefits of the facilities. Lower cost contributed to fast growth of returns in economic accounting.

• 4. Heavy and chemical industries had lower transaction cost. State capital was concentrated in heavy and chemical industries, which manufactured intermediate products rather than consumer goods. Therefore, it did not have to pay the high transaction cost in trading with the rural market.

• 5. State-owned enterprises offered better wage and welfare. Employees in state-owned enterprises enjoyed better benefits than employees in the private sector. Conflicts between labour and employer (the state) were therefore milder.

In general, the primitive accumulation of state capital appeared to be milder than private capital. These factors can help us understand the socialist transformation of replacing private capital with state capital.

5 Conclusion: The Relevance of China’s Experience to Developing Countries

At the early years of the new republic, the new government made use of various means (economic, political and even military) to curb the vicious circle of hyperinflation and speculation. This experience is relevant to present day situation where money supply expansion leads to speculation while very little money created by Quantitative Easing is eventually channelled into the physical economy.⁷⁰

Mao Zedong said that we should take heed of historical experiences. The 13-year hyperinflation in China before 1950 was exogenous, a derivative that originated in the economic depression in the West which attempted to transfer the cost of crisis to other parts of the world. Under the pressure of war and inflation, the KMT government had to increase its dependency on the US dollar. The new regime born with the land revolution received no foreign aid and cut the nation’s dependency on the US dollar. However it succeeded in controlling inflation by the power of the rural real economy. It can be seen as a significant victory of a sovereign nation in the long struggle of delinking from dependency.

Under long-term inflation, capital tends to leave the real economy and rush into the speculative sector, which is the invariable behaviour of private capital under a free market economy. Since 1947 the new regime advocated the development of a system of national capitalism with private capital as the major agent. It pushed the development strategy of New Democracy after crushing down speculation as a way to curb hyperinflation. As a result, recession in the real economy became inevitable.

At that time, the state was still not in the shackles of the interest bloc and could choose to ‘go long’ as a form of counter-cyclical regulation to tackle recession. The foundation of regulation was a combination of two apparently opposite elements: a dispersive peasant economy and a centralized state capital. The relevance of this experience of curbing the crisis of urban capitalism for other developing countries can never be overestimated.

Furthermore, the historical significance of China’s victory over hyperinflation lay in the establishment of a sovereign currency system, a success finally achieved after the efforts of two regimes over decades. The UK, USA and Japan had given up the gold standard in a short period of time. On the other hand, China under the double pressure of an exogenous crisis (originating from the West) and war, eventually succeeded in paper money reform.

This brought to an end the 500-year-old silver standard in China since the Ming dynasty. In a global economic system, where the history of currency is a history of devaluation, perhaps only by giving up the precious metal standard can a currency be competitive with others. This is not a simple matter of right or wrong.

The author has long emphasized that we should look into the development path of China objectively without using the lens of ideology. Institutions and thoughts taking shape in the modernization of advanced Western countries should not be regarded as absolutely correct standards that less developed countries must follow. If we are willing to put aside this lens, then we might understand that China in 1949 actually resolved the crisis of modernization by de-modernization. And we might be able to explain how China cured the plague of hyperinflation by a high degree of organization in villages. Accordingly, we might generalize some points in development economics.

First, the real economy with independent sovereignty is the foundation of currency sovereignty. For a sovereign nation facing sanctions and a blockade but with a traditional peasant economy as its major mode of production, the key to securing the fruit of the revolution lies in the state taking staple grain (the most important factor for livelihood) as the major standard of currency value. Sovereign currency is correlated with staple grain. Thus, a stable expectation of floating interest rate is also formed. From there, a steady growth in the rural real economy and a value anchored to basic agricultural products can prevent hyperinflation. Fiscal budget and finance are closely related with the distribution of supplies for livelihood. Given these factors, RMB became a widely accepted state credit tool both in cities and villages. All of these consolidated new China as an independent nation with its sovereignty fully intact.

Second, only by changing the mono-economic structure can developing countries get out of the colonial development trap. Many developing countries in the world are confined to being export zones of primary products. And they lose the power of pricing as logistics, trading and financial clearing are controlled by transnational corporations from (former) suzerains or master states. As a result, they do not have the foundation to correlate agricultural products with currency. Many developing countries born during the de-colonization movement after the Second World War have failed to achieve self-sufficiency with basic consumer goods (including industrial and traditional products) because of the mono-economic structure of agriculture. If they want to import these goods, regardless of factors like trade sanction or blockade, market prices at the destination is necessarily higher than in the place of origin. What is more, the goods have to be paid for with hard currency, which is generally scarce in developing countries. These countries might on some occasions take a ride on booming international trade to enjoy handsome short-term benefits. However, the boom is often ephemeral. If the countries fail to mobilize domestic production and initiate import substitution, they will repeatedly face a scarcity of staple grain and hard currency under the convention of the market economy.

Third, only under the dual rural–urban system can organized labour substitute capital in scarcity. Here, we come to the Gordian Knot of developing countries. Under conditions of capital scarcity, developing countries generally find it hard to effectively mobilize labour as a way of factor substitution for capital (Gerschenkron 2009).

The prelude to modernization in the West was colonization, which transplanted slavery prevalent in Ancient Greece and Rome to other continents. The primitive capital accumulation for industrialization in the West was achieved by drowning the colonies in blood and tears. Developing countries do not enjoy the same conditions for industrialization. Many development economists in the West, especially classical economists like W. Arthur Lewis, John C.H. Fei and Gustav Ranis, have attempted to elaborate on the industrialization of developing countries by the hypothesis of labour creating capital. For example, Lewis and others believe that under resource scarcity and when the foundation of capital accumulation is weak, people can mobilize their creativity as a way to substitute capital. For instance, people can be mobilized to build irrigation systems or dams with low or no payment.⁷¹

However, the foundation of these Western theories applies only to the history of colonization. These theorists hypothesize that under very hard conditions labour can take part in creating capital in the most primitive manner, which contributes to capital accumulation. But they do not give a reasonable explanation about how labour investment can be rendered into capital accumulation necessary for industrialization under scarcity of capital. In reality, Lewis’ Labour Surplus Model under Dual Sector cannot be applied to the initial stage of industrialization where capital is scarce, nor to China in 1949 under hyperinflation.

In short, these models have yet to find success in developing countries. This is because if a country relies on importing basic goods for subsistence, then the price of labour in this country determined by the cost of labour reproduction must be higher than in the place of production of these goods. This implies that it is impossible to mobilize the labour force in this country at a low cost. Moreover, any way to organize the labour force through money will only lead to greater scarcity of capital.

Nevertheless, long before the birth of these Western models, China effectively mitigated the problem of capital scarcity by mobilizing a large amount of labour at a low cost into the construction of state projects. This is possible to do only in an urban–rural dual system where rural labour is priced according to agricultural factors.

To sum up, the agrarian reform in China created a mechanism of labour mobilization at low cost, which effectively helped to suppress hyperinflation. Furthermore, it greatly contributed to China’s successful industrialization through substituting capital with labour when capital was in extreme scarcity (Dong et al. 2011).

Apart from China, it is rare to find another developing economy in which one or two generations of people are willing to sacrifice themselves for the primitive accumulation of state capital. Moreover, for the millions of peasants mobilized during the land revolution, this sacrifice was not unconscious. Accordingly, to understand the subsequent institutional transition of state capital we must take large-scale labour force investment as a basic principle.