Market formation in China from 1978

Abstract

This paper studies the formation of market economy in China from 1978 to 1992, a period in which market economy was introduced and developed alongside planned government procurement for agricultural goods. Under the “dual track system” (DTS), rural farmers were obligated to fulfill government procurement before selling to the market, whereas urban consumers enjoyed de facto subsidies to agricultural products. Using a neoclassical general equilibrium model with heterogeneous firms and workers and input-output linkage, this paper exploits historical data and analyzes allocation, prices, and the formation of markets in China during this DTS period. Theoretically, while DTS will distort the resources allocation between rural and urban (misallocation effect), it selects workers and farmers in the rural (selection effect). What is more, comparing to the economy under Soviet-style big bang reform, DTS activates industrialization by providing intermediate goods with lower-than-market price (activation effect). Quantitatively, directly switching to market economy in 1978 would decrease total output by 4.5% as the activation effect dominates. On the intensive margin, reform on DTS (procurement price was getting closer to market price) had contributed to total output by 4.4% from 1978 to 1992.