Reform Without Losers: An Interpretation of China's Dual-Track Approach to Transition Lawrence J. Lau; Yingyi Qian; Gerard Roland The Journal of Political Economy, Vol. 108, No. 1 (Feb., 2000), 120-143. Stable URL: hup://links. jstor.org/sici sici=0022-3808%28200002%%3A1%3C120%3ARWLAIO%3E2.0.C0%3B2-G The Journal of Political Economy is currently published by The University of Chicago Press. Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/ab g/about/terms.html. JSTOR'S Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles,and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www. jstor.org/journals/ucpress. html. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is an independent not-for-profit organization dedicated to creating and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact support @jstor.org. http: //www.jstor.org/ Fri May2105:57:572004
Reform without Losers: An Interpretation of China's Dual-Track Approach to Transition Lawrence j. lau Yingyi Qian Gerard roland Universite Libre de bruxelles develops a simple model to analyze the dual-track appI to market liberalization as a mechanism for implement ing efficient Pareto-improving economic reform, that is, reform achieving efficiency without creating losers. The approach, based on the continued enforcement of the existing plan while simulta- neously liberalizing the market, can be understood as a method for making implicit lump-sum transfers to compensate potential losers of the reform. The model highlights the critical roles of en forcement of the plan for achieving Pareto improvement and full liberalization of the market track for achieving efficiency. We ex- amine how the dual-track approach has worked in product and abor market liberalization in china au and Qian gratefully acknowledge financial support from the Smith-Richard- on Foundation, and roland thanks the Center for Advanced Studies in the behav- ioral Sciences in Stanford, where he was a fellow in 1998-99 when the revision w completed. We wish to thank Masahiko Aoki, Kenneth Arrow, Coit Blacker, Ronald Findlay, Peter Hammond, Anne Krueger, Paul Krugman, Jean-Jacques Laffont,Da- vid D Li, Ronald McKinnon, Roger Noll, Joh T N Wei, Ho-Mou Wu, and seminar participants ire d'Economie Theorique et Appliquee, the National ureau of econom earch, Stanford University, and th ersity of Michigan for helpful comments and discussions and Shu-Cheng Liu and Li-An Zhou for excel Joumal of Political Econonmy, 2000, voL. 108, no. 1 6 2000 by The University of Chicago. All rights reserved. 0022-3808/2000/10801-0006S0250
REFORM WITHOUT LOSERS 121 Efficiency-enhancing economic reform should potentially allow win- ners to compensate losers, thereby making the reform Pareto- improving. However, in practice, it seems very difficult to find mech- anisms that make economic reform Pareto-improving, and even more difficult for reform to be simultaneously Pareto-improving and efficient, because of distortionary costs of compensation or the lack of credibility of its implementation. We demonstrate in this paper that a simple mechanism of a"dual-track"approach, as used in Chinas economic reform, can serve to implement efficient Pareto- proving economic reform. The basic principle of the dual-track approach is as follows. Under the plan track, economic agents are assigned rights to and obligations for fixed quantities of goods at fixed plan prices as specified in the preexisting plan. In addition,a market track is introduced under which economic agents participate in the market at free-market prices, provided that they fulfill their obligations under the preexisting plan We distinguish two types of market liberalization in this context. We refer to it as"limited market liberalization''if market resales of plan-allocated goods and market purchases by planned suppliers for fulfilling plan-mandated delivery quotas are not permitted. Thus under limited market liberalization, planned suppliers must cally produce all plan-mandated output deliveries and physical all plan-allocated inputs themselves even though it might have cheaper to sell the inputs on the market track and purchase the same output from the market track for redelivery. In contrast,we refer to it as"full market liberalization" if market resales and market purchases for redelivery are all allowed by a planned supplier or a rationed user, as long as its obligations under the plan are all ful- filled Within the conventional supply and demand framework, we ana yze various distributional and efficiency aspects of the dual-track mechanism. We show that, independently of the initial conditions concerning supply and demand, as long as the preexisting feasible plan continues to be enforced appropriately, the dual-track proach to market liberalization is always Pareto-improving. In addi- tion, it also achieves efficiency under full market liberalization and other usual conditions such as profit maximization and perfect com- The idea that the dual-track approach can provide a concrete mechanism for the implementation of efficient Pareto-improving re- See Lau, Qian, and Roland (1997) for a general equilibrium analysis
JOURNAL OF POLITICAL ECONOMY form is both simple and subtle. The introduction of the market track provides the opportunity for economic agents who participate in it to be better off, whereas the maintenance of the plan track provides implicit transfers to compensate potential losers from the market liberalization by protecting the status quo rents under the preex isting plan. Thus the dual-track approach is, by design, Pareto- improving. Moreover, as the compensatory transfers are inframargi nal and thus lump-sum in nature, the dual-track approach can be fficient too. One desirable feature of the dual-track approach is its minimal additional informational and institutional requirements: it utilizes the existing information contained in the original plan and enforces the plan through existing planning institutions. No new information and no new institutions are needed While the"single-track"(or"big-bang")full market liberaliza- tion will lead to efficiency under the usual conditions such as profit maximization and perfect competition, Pareto improvement cannot in general be assured. In contrast, the dual-track full market liberal ization provides a useful way to implement a reform without creating losers while simultaneously achieving efficiency under the same con ditions. In transition economies under both democratic and non democratic systems, there is a need to buy off bureaucrats, govern ment employees, workers, and consumers accustomed to receiving implicit subsidies and to prevent reform reversal being pushed by coalitions hurt by the reform. Because of its Pareto-improving prop erty, the dual-track approach minimizes political opposition to re form ex ante and maximizes political opposition to reversal of re form ex post. Enforcement of the plan track is crucial for preserving the preexisting rents. Sufficient state enforcement power is needed here not to implement an unpopular reform, but to carry out a re- form that creates no losers, only winners An implicit guiding principle underlying Chinas economic re form strategy since 1979 has been that reform should proceed with- out creati ng losers, and the dual-track approach has mechanism to achieve that objective The agricultural market liber- 2 The term um transfers"as used here simply means that the transfers are independent of the actions of the individual nic agents. The values of such transfers may depend on market prices. The principle of reform without losers has been perceived as Wu and Zhao 1987; Zhang and Yi 1995; Lin, Cai, and Li 1996)ar ts on the ide China (e.g, McMillan and Naught 995) have made informal discuss s on the issue, they have not presented form alysis and systematic evidence. The only exceptions are Sicular(1988)and Byrd (1991), who analyzed the dual-track pricing in Chinas agricultural and industrial reforms, respectively
REFORM WITHOUT LOSERS alization illustrates that the dual-track approach can be both Pareto- improving and efficient. The commune(and later the households) assigned the responsibility to sell a fixed quantity of output to the state procurement agency as previously mandated under the plan it predetermined plan prices and to pay a fixed tax(often in kind to the government. It also has the right(and obligation) to receive a fixed quantity of inputs, principally chemical fertilizers, from state owned suppliers at predetermined plan prices Subject to fulfilling hese conditions, the commune is free to produce and sell whatever it considers profitable and retain any profit. Moreover, the com mune can purchase from the market grain(or other) output for resale to the state in fulfillment of its responsibility. There is thus full market liberalization Beyond the Chinese experience, schemes involving various forms of grandfathering"in the West resemble the dual-track approach For example, the two-tier wage system with lower wages for newly hired personnel and higher wages for existing personnel has been used in some industries such as the U.S. airline industry. Discussions of pension reform involving the transition from "pay as you go"to funded pension schemes also feature similar considerations The rest of the paper is organized as follows. We present a theoret- ical analysis of the dual-track liberalization in Section II. In Section Ill, we discuss the conditions for the success of the dual-track ap- proach. In Section IV, we examine to what extent these conditions were fulfilled in China and provide examples of its dual-track experi- ence in product and labor markets. Section V presents concluding remarks I. The Theoretical Analysis In order to understand fully the dual-track mechanism, we consider a variety of possible market situations concerning demand and sup- ply. Since the plan price and quantity are fixed by the state, they need bear no particular relationship to the market equilibrium price and quantity and can be either below or above the market price and quantity, respectively. The plan prices of most normal producer and consumer goods are likely to be below the market prices; however, the preexisting total compensation(wage plus housing, health, and ension benefits) of workers in state-owned enterprises(SOEs)un- der the plan may well be above the market wage rate. Similarly, while high-quality goods are often in short supply under the plan, the plan production of low-quality and unwanted goods may be gr eater than the total demand under full market liberalization furthermore in general, there is no reason to assume that the planned output is