Superfusion : How China and America Became One Economy and Why the World's Prosperity Depends on It

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  • Edition: Reprint
  • Format: Paperback
  • Copyright: 2010-10-19
  • Publisher: Simon & Schuster

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Zachary Karabell argues that the intertwined economic relationship between China and the United States will affect our long-term prosperity more than any other contemporary issue.As the world continues the slow work of repairing the damage of the financial crisis, it is crucial that the United States understands that it cannot go it alone. Its fusion with China is powerful, essential, and defining. Zachary Karabell's brilliant book lays out this complex and important economic story.

Author Biography

Zachary Karabell is president of River Twice Research and River Twice Capital and a senior adviser for Business for Social Responsibility. He is the author of A Visionary Nation, The Last Campaign: How Harry Truman Won the 1948 Election, and Peace Be Upon You: The Story of Muslim, Christian, and Jewish Coexistence. A regular commentator on CNBC, CNN, and MSNBC, he is also a contributor to the Wall Street Journal, the Los Angeles Times, the Atlantic Online, and the New York Times.

Table of Contents

Introduction: Superfusionp. 1
Black Cat, White Catp. 15
The New Economy and the Not-So-New Economyp. 37
So Good, You Suck Your Fingersp. 57
Avon Comes Callingp. 77
Up, Up, and Awayp. 97
Free Trade and Its Discontentsp. 115
Data Dupedp. 137
Still Waters, Running Deepp. 153
Wow, Yaop. 173
The Great Wall and the Gold Rushp. 193
Benedict Arnold Goes to Mississippip. 213
A Not-So-Harmonious Risep. 235
The (In)Glorious Olympicsp. 259
An Idea Whose Time Has Comep. 283
Codap. 301
Acknowledgmentsp. 309
Notesp. 313
Indexp. 325
Table of Contents provided by Ingram. All Rights Reserved.


Black Cat, White Cat

THE CONVERGENCE OF CHINA and the United States began when the two were worlds apart. There was nothing inevitable about what took place. It didn’t have to happen, yet it did.

At the end of the 1970s, few societies were more distinct and distant. China was a predominantly agricultural nation mired in poverty and cut off from the world after the excesses of the dictatorship of Chairman Mao. By the 1970s, trade accounted for only 5 percent of China’s gross domestic product, an astonishing low figure for a country of China’s size and scale. In fact, China in the waning years of Mao had become significantly more isolated and detached from the international system than it had been either before the Communist victory in 1949 or during the initial years of the revolution in the 1950s.

The United States, by contrast, was the dominant power in the world in the late 1970s, even though its self-perception was mired in malaise and doubt. The experience of the Vietnam War, the stagflation of the domestic economy, the Watergate imbroglio, and a sense that it was no longer perceived as a champion of freedom all contributed to a crisis of confidence and self-image. The 1970s also saw the beginning of a long and permanent decline in U.S. manufacturing employment, as other parts of world began to produce an ever-larger share of consumer goods for sale in U.S. and European markets. But in both military and economic terms, the United States remained the central force on the globe, even factoring in the military challenge of the Soviet Union and the growing economic strength of Japan and West Germany.

The United States and China had a dramatic and surprising rekindling of relations in 1972, when Richard Nixon traveled to Beijing to meet with Mao in the Great Hall of the People off of Tiananmen Square. It was an extraordinary meeting, made possible by the assiduous back-channel diplomacy of National Security Advisor Henry Kissinger, his Chinese interlocutors in general, and Premier Zhou Enlai above all. Of course, there was also Ping-Pong. China extended an invitation to the U.S. table tennis team as a gesture of goodwill in 1971, setting the stage for the political rapprochement a year later. It was perhaps the most important moment for the game, ever, save the occasional family bonding experience that still takes place in garages, dens, and fluorescent-lit basements throughout the world.

But neither Ping-Pong nor elaborate banquets in Beijing radically altered the cold peace between China and the world. The opening between China and the United States was largely confined to politics. While there was a lessening of tension and an increase in diplomacy, that was the extent of it. Until Mao’s death in 1976 and the resulting turmoil in the two years after, China remained as cut off from its neighbors and the world at large as it had been at any point in its long and complicated history. Relations with the Soviet Union, nominally a cousin and an ally in the global Communism-versus-capitalism battle, were at best frosty. Within the ruling elite of the Chinese Communist Party, there was substantial resistance to closer ties with the West or even the East. The first decades of Communist rule, coming on the heels of more than a century of pressure and encroachments by the West, were devoted to making China autonomous, independent, and self-sufficient. That ran contrary to integration with the world at large, even as the economic policies of the ruling party failed to improve the material conditions of hundreds of millions of Chinese people.

In 1978 Deng Xiaoping consolidated his hold on the party and the country, and he pushed through an agenda of reform and modernization. Too many of China’s people were mired in poverty, and Deng wisely understood that unless that changed, the tenuous compact between the party and the people would disintegrate. Deng was an unlikely visionary. He had survived purges, internecine battles within the Communist Party, bouts of internal exile and disfavor, the animosity of the Red Guards of the Cultural Revolution, and what could best be described as an up-and-down relationship with Mao. Already seventy-two years old when Mao died, Deng was at an age when most people look back at their lives. But he had no intention of going gently into that good night, wizened and gnomelike that he was. He had the grudging respect of many of the older party cadres and the utter loyalty of a younger generation that venerated his long service to the party and marveled at his ability to escape death—political and actual—for so long.

Deng intended to remake the way that the party governed the economy. To that end, he first undertook agricultural reform and began to abolish the collective farming system. Then he allowed for the creation of a few select special economic zones along the southern coast. These zones were allowed to design their tax regimes to be more hospitable to private industry and foreign business ventures, and to give individuals more latitude to do business separate from the mandate of the state. In spite of the Communist Party’s hostility to the West, the main criteria for the zones were that they were proximate to centers of Western commerce and trade—namely, Hong Kong, Macau, and in related fashion, Taiwan.

This limited opening was meant to be a laboratory, but the hunger of people for more autonomy and for raising their standard of living led to a rush of activity. Trade spiked dramatically, as did industry in formerly sleepy regions such as the Pearl River Delta north of Hong Kong. That did not please many in the party, who would not speak out directly against Deng but who could fall back on deep-seated and widely shared ambivalence about trade and too much entanglement with the West. Many old-time party members held fast to the belief that fewer exports were better than more, and that no imports were better than some. There was also resistance to welcoming foreign capital into the closed loop that was China’s economy in the 1970s and early 1980s. Many feared—rightly, as it turned out—that once foreign capital began to flow into China, the days of Maoism and even Chinese Communism would be numbered.1

But there was no going back. Throughout the 1980s, while the pace of reform sometimes accelerated and sometimes sputtered, it never ceased. The results were impressive. Economic growth averaged nearly 10 percent during the 1980s, while inflation was moderate. Some years growth was 7 percent, some years it neared 15 percent, but the overall trend was up. That said, the starting point was so low that even such rapid growth still left China a poor country compared to the rest of the world. It would need many more years of growth before it would even enter the ranks of a “middle-class” nation. And the big-picture statistics masked huge regional variations. While the new economic zones thrived and expanded rapidly, many parts of the country, in the interior and in the western provinces, grew not at all.

During these years, Deng championed an approach of “crossing the river by touching stones,” which meant being flexible, nimble, and heterodox. There was also a concept of “one country, two systems,” which meant a socialist system governed by the absolute authority of the state and the party for the bulk of China, while for the special economic zones and eventually for Hong Kong (once it was unified with the mainland) market forces would be predominant. There would be one state and one government, but there would be two distinct approaches. These ad hoc, somewhat confusing policies had wider implications for China’s development. While Deng may have been clear in his own mind about the differentiation, he was at heart a pragmatist who shifted plans, labels, and slogans to fit the needs of the moment. It was left to others to debate and flesh out the implications of his ideas.

The result was a system in flux. Some resisted the move toward more openness with the world and fought the very idea that market rules should have a place in China. Others wanted the opening to go faster and extend more broadly throughout Chinese society. Most of the discussions occurred behind a veneer of party unity, but soon the debate began to seep out in public. Intellectuals and poets joined the discussions, while millions in the special economic zones set up small business enterprises and cast off the bland ideological straightjacket that had stifled change and growth for the past decades. Of course, the fact that the government relaxed its restrictions and was less prone to the indiscriminate use of force as a tool of control allowed for that loosening.

Part of the debate was purely about the best path to modernization and economic growth. But with that came the more radical debate about democracy and political openness. Inside the party, there had long been discussions about democracy within the framework of Communist Party rule, but now there were rumblings about democracy as a separate reform that could jeopardize party rule. By the end of the 1980s, some of the defenders of democracy were making their claims in public. While they were assailed as “bourgeois liberals” bent on undermining the revolution, the fact that they were even able to publish and discuss their views in public without being arrested and jailed was more notable than the acrimony they generated. Of course, they did face harassment, and when certain invisible lines were crossed, they could be stripped of their posts, confined, and in other ways silenced. The rising volume of these debates was the direct precursor to the democracy movement that culminated in the Tiananmen Square protest during the spring of 1989.

These developments were largely invisible to the outside world. There was an increase in the number of foreign tourists in China (though given the complete absence of tourists previously, any number would have represented a significant increase), and there was a sharp rise in the number of Chinese students studying abroad. But the internal dynamics of Chinese society were watched only by academics and to some extent intelligence agencies. The former did a relatively good job tracking the changes and the debates but tended to see China’s evolution through a prism of “Communism and the party, bad; democracy and the market, good.” Intelligence agencies were mostly focused on counting men in uniform and numbers of missiles, and on predicting whether China would take action against Taiwan.

Though the party was always on guard against internal challenges, the central leadership, including Deng, was surprised by what happened at Tiananmen. While the square had been the scene of protests in the past, including just after Mao’s death, what made the spring of 1989 different was that students from other parts of the country journeyed to Beijing to join the movement. That in turn spawned other protests throughout the country, which united a hodgepodge of dissidents, factory workers, peasants, and students, each of whom had their own grievances and shared only a common anger at the party and the central government.

The swift and brutal end to the movement did lead to a period of repression and fear. Many thousands were arrested and jailed, and more were detained and beaten as the government used its considerable powers to end any possibility of a revival. But like the general in his labyrinth, Deng retreated and recouped. He knew that something had not gone according to plan, and he was determined to set a future course that would not see a repeat of the protests on the one hand, or the chaos that he saw as endemic in China’s past on the other. China over the previous 150 years had been buffeted by a never-ending series of civil wars, invasions, and self-imposed crises, and Deng was determined not to perpetuate a destructive cycle that had left the country on the sidelines of history.

First he had to protect his own flank. There was a risk after June 1989 that he would be ousted by younger hard-line factions who would hold him accountable and use the protests as an excuse to clamp down on reform and shut China off from the world once again. Deng believed that would be tantamount to digging the collective grave of the party and the future of China. As a result, he renewed his commitment to reform and decided that the pace needed to be accelerated, the scope expanded, and the results magnified. Unless more people saw material improvement in their lives, and quickly, there would be nothing but trouble ahead. Always armed with an aphorism, Deng remarked, “We certainly must not stop eating for fear of choking.”2 Continuing on the path of the 1980s remained an imperative, Tiananmen notwithstanding.

Deng’s willingness to embrace a market economy and adopt an open door approach to the world at large was anything but ideological. Years earlier, observing party members anguishing over some proposed policy, Deng had remarked, “Black cat, white cat, what does it matter as long it catches mice?” The ends above all mattered for Deng, and both before and after Tiananmen, the goal was the continuation of the Chinese state led by the party for the betterment of all of China. The material prosperity of the masses was an integral component to that end, and he had the foresight to understand that the rising affluence of neighboring Asian countries such as Japan, Singapore, South Korea, and Thailand was making it impossible for the party to maintain legitimacy unless it delivered on the promise of prosperity.

Looking back, we now know that China embarked on a path of economic modernization that managed to transform the country more quickly and more effectively than anyone could have imagined. At each stage along the way, of course, other paths were available, many of which might have led to very different outcomes—including the collapse of the government, much as the ossified government of the Soviet Union fell apart in the early 1990s. Historians and scholars tend not to narrate the past in light of future outcomes. That can lead to selective memory and to emphasizing details and decisions that were understood to be more important only because of what happened subsequently, even if other things were more important at the time. In China of the 1980s and early 1990s, it was far from apparent that the outcome would be a dynamic market economy that would end the Communist experiment and leave in its wake something new and unprecedented. Most people at the time believed that Deng’s policies would result in a modern, more open, and more prosperous Communist China, not the fusion of China and America. But in charting the evolution of Chimerica, the paths that were taken matter more than those that weren’t.

In 1992 the pace of reform accelerated again, due once more to Deng’s initiative. China had suffered a recession in 1990–91, and the reform agenda had come under attack. To shore up support, Deng took what would become a symbolic trip to the south. Touring the special economic zones, Deng proclaimed his enthusiasm for more change, and everywhere he went, he celebrated the notion that getting rich was consistent with the goals of the party and the state. In Shenzhen, which would soon become a metropolis of millions of people and would be one of the anchors of the industrial boom of the Pearl River region, he announced that there was no inherent conflict between a market economy and a state-planned economy. Deng’s ability to hold simultaneously to contradictory ideas was either the mark of a genius or a madman, but he had a better read of the pulse of his society than anyone else. He was willing to embrace contained turmoil and his tour was taken—rightly so—as a green light to plunge into the untested waters of the markets without fear and without inhibition.

The 1980s had seen the first tentative steps of foreign companies coming to China to set up production. That had already been happening in Taiwan and greater Hong Kong for decades, so it was not completely alien for foreign companies to look to the Pacific Rim for business and manufacturing opportunities. But the reforms of the 1980s, even with the dispensations granted to the special economic zones, still left it difficult for foreigners to conduct business. Private property laws were ill-defined, and all initiatives had to be structured as joint ventures with domestic Chinese counterparts. While foreign companies could invest in China, they faced a variety of hurdles if they wanted to get their money out of the country.

What happened in the 1990s removed many of the restrictions on both foreign and domestic companies. Before, domestic Chinese who wanted to set up anything larger than a cottage industry had to go through elaborate and at times bizarre steps to function legally. Banks could not lend to private, nonstateowned entities, and private organizations could legally employ only a handful of people. While tens of thousands of small businesses existed, the limited scale created barriers to growth. Some party members were able to circumvent the restrictions by setting up entities underneath the umbrella of the Communist Party; these wryly became known as “red hat capitalists.” By affiliating with party entities, red-hat entrepreneurs were able to set up companies without being shut down for being “capitalist.” That was still a dirty word. Until the early 1990s and in spite of the energetic support of reform emanating from Beijing, it was still forbidden to be a capitalist, however loosely and arbitrarily that was defined. You could be involved in profit and industry; you could strive to get rich; but you had to do so in a manner that seemed consistent with the rule of the party and the people. The lines were vague, but crossing them was dangerous.

In 1992 the United States was about to plunge into the Internet revolution, and the European Union was celebrating its giddy first days. But in China, the economy—for all the ferment of the past decade—was still barely in the twentieth century. The north, in the heartland of what had been Manchuria, was a decrepit industrial Rust Belt. Steel, cement, guns, aluminum cans, bicycles, and other daily commodities of Chinese life were made by vast state-owned companies that employed tens of millions of workers without reference to quality, demand, or need. The production quotas were set in arcane and arbitrary fashion, in theory referencing the five-year plans that were drawn up by the central governors of the party. In practice, quotas and goals often fell short or overshot—usually the former where quality was concerned. Cars were a rarity; there were fewer than nine million in the early 1990s in a country with a population of more than 1 billion. Not surprisingly, there was a dearth of paved road for a country China’s size, and rail lines were inadequate. That made getting anything from point A to point B in China arduous, time consuming, and expensive. Energy, then as now, was supplied primarily by coal. The oil fields of Daqing in the northeast, which had provided enough oil both for China’s domestic consumption and for exports, were rapidly being drained.

When Deng reignited economic development in 1992, no one could have possibly envisioned that within 15 years, society would be radically altered. It was as if Deng had sprinkled high-growth pixie dust everywhere he went, and the results were skyscrapers, roads, factories, ships, airports, and the entire phantasmagoric spectrum of the modern world—along with dystopian pollution, steroidal urbanization, and social ferment.

Recounting what has happened in China since the early 1990s always carries the risk of sounding hyperbolic. Books and articles list in mind-blowing and mind-numbing detail the statistics that demonstrate China’s growth, from its prodigious consumption of metals and raw materials such as copper, iron ore, cement, steel, and aluminum, to its gigawatts of new power plants, its new roads, new airplanes, new cities, new world of 400 million cell phone users, and 100 million Internet users, and on and on. The problem is that no language can adequately capture the magnitude of the changes and the speed at which they happened. It may sound hyperbolic, but in fact, language offers a pale guide to what took place. Time-lapsed photography might offer a better gauge, though even that would sanitize the lived experience.

Take the case of Pudong, across the river from central Shanghai. In the late 1980s, before it was declared a special economic zone, Pudong—as so many fondly recount—was composed of scrappy fields, rudimentary factories, and apartment blocks. Today Pudong is an icon and a clichÉ, epitomized by the looming Oriental Pearl transmission tower, thrusting a third of a mile into the sky, with its bulbous middle perched on massive tripod legs, lit at night against a backdrop of 100-story buildings and miles of high-tech factories that stretch beyond, hovering over the river with the colonial buildings of the Bund illuminated by neon, the aging historic Peace Hotel lost in the fray, and barges flashing liquid crystal billboards in some real-world replication of a Blade Runner fantasy.

For China to make a decisive and definitive great leap forward, there were two imperatives. The population had to become urban, and the grip of the state-owned enterprises (SOEs) had to be broken. Until the 1990s, these SOEs dominated the Chinese economy and accounted for more than three-quarters of all industrial production. They were the classic expression of the command economy, and of state ownership of all vital aspects of production. These enterprises were often so vast that they were ministates unto themselves, responsible for the housing, feeding, educating, and health and elder care of their hundreds of thousands of workers.

One of the pillars of the reforms initiated by Deng was that the SOEs had to be overhauled. You could promote and spur private enterprises all you wanted, but unless the behemoths changed, critical mass would be impossible. The state enterprises were used to operating in a tight web of party, local cadres, provincial officials, and the central government in Beijing, which collectively arrived at targets, quotas, and, of course, prices. Quality was often abysmal—and in the case of certain types of goods such as food or mechanical goods, fatal when defective. Death sometimes drew official attention and forced changes at a particular plant. But on the whole, the state enterprises were inseparable from the system that had evolved since 1949. There were entrenched interests, bureaucratic inertia, and hundreds of millions of people whose lives, literally, depended on their employment by these organizations.

That said, it is easy to make a bit too much of the “old system.” It had emerged in the 1950s, but in between the stops and starts of Mao, the dislocations of the Great Leap Forward in the 1950s, and then the wrenching disruptions of the Cultural Revolution of the late 1960s, it had been buffeted by shifting and contradictory laws, varying mores, and rotating leadership. It is vital to recognize that while the changes of the past decades in China have been dramatic, Chinese society has been in constant flux since the late nineteenth century, with rarely a period of calm, peace, or security. First there were the encroachments by the powers of the West starting in the 1840s; then wars and internal revolts that left millions dead, and led to the fall of the Manchu dynasty in the early part of the twentieth century; then violent rebellions that lasted years and took the lives of millions more. While Shanghai between the wars was a miniversion of Europe, the rest of the country in the 1920s and 1930s was dominated by warlords who broke alliances as impulsively as they made them and put down arms less often than they took them up. There was also the civil war between Communists led by Mao and the Nationalist government of Chiang Kai-shek and his American supporters, and a Japanese invasion and occupation that began in 1933 and lasted until the end of World War II in 1945, with a death toll that will never be precisely known but must have been in the tens of millions.

The war with Japan would have been enough to unhinge any society, but the civil war between the Communists and the Nationalists continued after the defeat of the Japanese and flummoxed the American expeditionary forces in central China, even with their tough, ornery, and thoroughly upright general, “Vinegar Joe” Stilwell. That conflict ended, of course, with the Communist takeover in 1949, followed by a complete refashioning of the agricultural system, years of famine, state-led industrialization, and then a self-inflicted ideological frenzy during the Cultural Revolution that sent millions of urban, educated people to the countryside and led to the indiscriminate purging, persecution, and often death of those seen by student cadres as disloyal to the vision of Mao.

So when the post-Mao period saw yet another turn of the wheel, this time away from reliance on state industry and the command economy, it was hardly the most unsettling development that hundreds of millions of Chinese had faced in the past decades. In fact, it was a more benign upheaval, and one that at least promised a better outcome. In that sense, the blood of Tiananmen, real and ugly though it was, hardly compared to the violence of China’s twentieth century, and that may be why it left fewer scars in China itself than in the public imagination throughout the world. Yes, internal censorship in China has all but erased what happened at Tiananmen, and that also explains the lack of greater internal shock waves. But decades of turmoil, death, and violence may have inured Chinese society to being shocked that an authoritarian government might actually use lethal force and kill people in order to maintain control and defend itself against those who questioned its legitimacy.

Intending to revitalize the state enterprise system was one thing. Doing it was another. The reforms included setting new targets, holding senior managers and local party officials accountable for meeting them, and allowing individuals in positions of authority greater latitude in determining how best to meet those targets. While these measures all looked good on paper, in practice they had little effect. Many state-owned companies were industrial giants, makers of steel or generators of power, but they also included the major financial institutions, especially the four primary national banks and their thousands upon thousands of branches. That meant that even when targets weren’t met, or when desired profit margins weren’t achieved, if there was insufficient income to meet payrolls or procure new materials, these enterprises invariably turned to the state-owned banks, controlled by local officials who were as beholden to the regional party cadres as the officials running the factories or the power plants. The result was that loans were given, more money flowed, and, barring some special case, nothing consequential happened when managers failed and plans fell short.3

After 1992, the central government took more aggressive steps to curtail bad loans to nonperforming companies and to further encourage both urban entrepreneurs and innovative village and town enterprises. The result was that select rural areas became manufacturing centers. One of the more lauded of these was the town of Wenzhou and its satellite settlement Qiaotou, which in short order came to dominate the global button manufacturing industry, producing more than 60 percent of the world’s buttons by the end of the 1990s. Wenzhou also cornered the market for cigarette lighters, with a consortium of several thousand small manufacturers eventually producing nearly three-quarters of all the lighters sold globally. Another mass-market product that became a regional specialty drew more prurient interest: sex toys. While some criticized local entrepreneurs for producing them, to the residents of the city, it didn’t much matter whether the product was lighters or dildos, as long as there were global buyers.4

Farther south, many of the factories of the Pearl River Delta also began as “town and village enterprises,” which weren’t saddled with the moribund legacy of the state enterprises, nor with the massive payrolls of underemployed workers. As the number of those so-called TVEs mushroomed, the role of the state-owned companies started to diminish as a percentage of overall activity.

At the time of his southern tour in 1992, Deng was already 88 years old. His one-time protÉgÉ Zhao Ziyang was under house arrest, having taken the brunt of the blame for Tiananmen, and the factions opposed to further economic opening had come close to seizing the momentum before Deng undercut them. Somehow, Deng managed to find coteries loyal to him and, more important, loyal to his vision and his urgency. He could lead the orchestra, but he was getting too old to play all the instruments. While Deng himself was extraordinary—and whether one likes what he did, that much is hard to deny—it would have been little surprise if his immediate successors had stumbled. Instead, led by the dual characters of Jiang Zemin and the more junior Zhu Rongji, they not only continued what he had started but magnified it, sharpened it, and perfected it.5

Jiang’s political career was made in Shanghai, which had been the center of commerce and modern China before the revolution, as well as a melting pot of Western and Chinese business interests. Because of that, Shanghai had earned the distrust of Mao and the party, and that never fully eased during the chairman’s lifetime. Only in the 1980s did the central government begin to allow Shanghai to breathe. As party secretary of the city, Jiang had been integral to the revitalization of the region and the birth of Pudong as a new industrial city. At the same time, he also supported the suppression of the protests in June 1989, and his combined profile as both economic modernizer and party loyalist was a key element in his elevation to the presidency just underneath Deng in the early 1990s.

While Jiang was credited with the rebirth of Shanghai, his lieutenant and slightly younger comrade Zhu was also instrumental in reversing Shanghai’s decline. Zhu’s career had in many ways been as speckled as Deng’s, with periods when he was purged from the ranks and in danger of worse, and times when he found favor with his superiors and demonstrated an unusual combination of grit, creativity, and foresight. Foreign diplomats confessed amazement at Zhu’s acumen and his steeltrap memory. He also had little tolerance for corruption and incompetence, which mitigated the cronyism and favoritism that is a chronic weakness of bureaucratic states and authoritarian regimes. Transferred to Beijing as Jiang’s star rose, Zhu soon had a prominent role in moving along reform at the People’s Bank of China and from there rose to the premiership under Jiang.

Steered by the two men, the Beijing government became not just an advocate of reform but a driver. Jiang and Zhu were strong proponents of more regional experimentation. The privileges that had been confined to a small number of special regions were extended much more widely and aggressively throughout the country in the 1990s, though not so quickly that the old order would collapse before a new one could be established. As the number of private enterprises ballooned, the state-owned enterprise system, already challenged by Deng, began to change rapidly and permanently.

Perhaps most significant was that by the late 1990s, state-owned enterprises were allowed to lay off workers; select banks were allowed to pursue state companies for payment on loans and to take punitive actions for nonrepayment; and many restrictions on the size and scope of private companies were lifted. As many as 50 million workers lost their jobs. That was a profound shock to millions who had long been accustomed to the “iron rice bowl” that had provided cradle-to-grave care—not very good care, but better than nothing. Other state enterprises simply folded, which would have been unthinkable well into the 1980s. For most of the previous decades, it was no more likely for a state company to go bankrupt than it was for a government agency to close.

State-owned companies had become a weight holding back future growth. They consumed capital without reference to productive output; they held on to workers both capable and inept; and for the most part, they produced subpar products and delivered mediocre service. There were, of course, exceptions, but the reforms promised to allow productive state enterprises to survive and thrive while letting the others expire. The surge in unemployment was a shock, but also an opportunity, as some of those workers were then able—and willing—to find new employment in vibrant private enterprises. That often entailed moving, which tens of millions each year were now able to do as the government lifted the once-stringent restrictions on internal travel and migration.

The disintegration of the state enterprise matrix was the proverbial case of pulling one thread and seeing the entire tapestry unravel. The vacuum created by closing thousands of old factories and businesses had to be filled, and was. Millions of workers had to find new employment, and while many lacked the skills to enter the new workforce, millions more did. The movement of workers from old industrial regions and rural areas that were shifting away from the state collective system meant an urban influx that was in itself an essential ingredient to the new economy. The urban population went from 25 percent in 1990 to nearly 40 percent at the end of the decade, which meant that as many as 200 million people relocated. Urbanization in turn sparked a different approach to owning property. Many of those who relocated at first worked for factories and were housed in dormitories or units owned by the employer. But the influx into places such as Shanghai, Guangdong, Shenzhen, and Beijing led to a dramatic shift in attitudes and laws. People clamored for their own apartments, and in a move that would have astonished and dismayed the party traditionalists of an earlier era, the government allowed people to have title to their own homes. As the state enterprises shed workers, they also were permitted to sell off assets, including housing units, and these were eagerly bought. Later in the decade, the urban housing market became a prime area of financial speculation, which was one of the unintended consequences of China’s embrace of the free market.

It is hard to overemphasize the importance of urbanization to what has taken place in China over the past 20 years. In the United Kingdom in the nineteenth century and the United States in the early twentieth century, urbanization was a key ingredient to industrialization and rapid growth. The same was true of China in the 1990s. Cities with burgeoning populations had to spend increasingly large sums of money on new infrastructure, which included roads, water and sewage systems, buildings, public transportation, bridges and tunnels, power plants and power grids, and then the whole gamut of consumer infrastructure such as shopping centers, schools, and homes. Initially that activity was most notable in the Shanghai region and southern coastal regions, but by the end of the decade, more and more was happening in other coastal areas and also farther inland, in areas such as Chengdu, Chongqing, and Wuxi.

For all the reform, it wasn’t as if the state enterprises disappeared. The banking system—dominated by four large banks; steel, coal, oil, gas, and power companies; telecommunications, both for fixed lines and for wireless; and much of the health care system remained state owned. The difference was that managers of these companies were increasingly held to performance standards, were given more latitude to improve operations, and were rewarded for optimal performance and penalized for subpar results. Much has been made of the endemic corruption that was a logical outcome of a system that married public and private with little visibility into the inner workings of party and government elites. But the focus on corruption is misplaced. What changed in China in the 1990s is more significant than what remained the same. Yes, local party officials could instruct a bank to grant a loan to a construction project run by another official, whether or not the project was economically viable or whether the loan would ever see any payments. Yet some of those projects needed to be built regardless of short-term viability. Take, for instance, a road connecting a new city to a port before there was enough traffic to merit it. One road may have been a waste; thousands meant that China built a modern infrastructure that gave it the capacity to grow even faster.

Another development, which would have ramifications later on, was the beginning of a domestic stock market, one in Shanghai and another in the southern Pearl River city of Shenzhen, in the early 1990s. All of the initial listings were state enterprises, and purchase of the shares largely benefited the companies, not the shareholders. The markets were one way to inject money into moribund companies, and once the initial offerings were complete, the exchanges had difficulty attracting investor interest. The markets were also closed to foreign capital, including Hong Kong, which made them that much more illiquid. Some of the larger, more established state companies were allowed to list shares in Hong Kong, and that gave foreign investors their first opportunity to “own” a piece of mainland China’s growth. Most of the trading, however, was dominated by speculators and not until more than a decade later would these equity markets become a more significant aspect of China’s transformation and Chimerica’s rise.

The final piece of an immensely complicated puzzle was a quiet yet radical decision made by Jiang Zemin and Zhu Rongji. After Deng died in 1997, the two new leaders not only pushed ahead, they pushed beyond. Deng had focused on opening China to the world and overhauling its internal means of production. That had led to increased contacts with the world at large, but those relationships were still a fraction of overall economic activity in the early 1990s. Jiang and Zhu understood, or at least their actions suggested that they understood, that the next step was to weave China into the global economy. Rather than simply opening the sluice gates in select regions and allowing foreign capital and foreign business to participate, they planned to make China a full participant in the global economy. And the one way to do that was to join the primary driver of the global economic system, the World Trade Organization.

Deng had set the precedent, going so far as to sign the General Agreement on Tariffs and Trade that was the precursor to the WTO. But Zhu went further. It was not enough to reform the bureaucracy, alter the culture of the state enterprises, and push ahead with urbanization. Rather, Zhu declared that “China’s economy had reached the point where it could not further develop without being restructured.” Instead of directly managing the economy, the party and the central government would move China evermore toward a market economy, whose success would be determined not just by internal yardsticks but by China’s ability to attract global capital and produce goods that were competitive in global markets.6

That said, Jiang and Zhu were also highly attuned to the risks of changing too much too fast. They had watched, as the world had watched, the evolution of the economic reforms in the former Soviet Union. They had observed with dismay and alarm the Soviet collapse, and they were even more troubled by what took place in Russia soon after. With the Russian economy in shambles and production sinking rapidly, the leaders of Russia in the early 1990s took dictation from the United States and financial institutions such as the World Bank and the International Monetary Fund. That led to the sudden opening of the Russian economy to the world, and especially to foreign capital. But the Russian system could not withstand the influx, nor could it change quickly enough to be competitive in a global marketplace. China’s leaders learned several lessons watching Russia unravel: reform, but do so in a controlled way; change, but set your own pace; globalize, but in stages; attract foreign investment, but on your own terms.

From one perspective, the evolution of China’s reforms took place without much reference to the world at large. Party leaders vied for power; factions jockeyed for position around Deng and then Jiang; and academics and intellectuals debated with party officials about the pace, nature, and scope of reform and what amount was consistent with Communism, what was not, and how much in fact needed to be. Most accounts of these years—in China itself, in contemporary Western media, and in books written largely by Western academics and journalists—treat China as a closed nation involved in a major internal transition. And it was. But although that internal reconfiguration was necessary for the economic fusion of China and America, it was not sufficient.

By the time China entered the WTO in December 2001, it had already been fundamentally altered not just by the reforms discussed so far but by the expanding presence of foreign companies doing business throughout China. We will get to the story of how China joined the world market and how the market changed China, but for now, there is still a missing element. Tentatively in the late 1980s and more boldly and aggressively in the 1990s, Western companies started to probe the China market. With stops, starts, and considerable growing pains, they established a foothold and began to see results from their efforts and their investments. These companies, many of them American, were integral to the transformation of China, but that would be only half the equation. China also transformed them. In the United States, and in the Europe of the first days of the European Union as well, the 1990s were a heady period of optimism and giddy belief that anything was possible. Underneath that veneer, however, all was not quite so rosy. The free-market model was running into headwinds, and growth was beginning to peak. Groping for answers and for solutions, corporate leaders tried almost everything. Few of them believed that China was the answer. As it turned out, it was.

© 2009 Zachary Karabell

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