University of California Institute on Global Conflict and Cooperation

How has China achieved its spectacular economic growth under reform, despite having no commercial law, no financial market, prices that are only partially freed, and no privatization? I argue that the fundamental reasons for China’s success are not unique to China. China succeeded because it unleashed the forces of competition. China shows the power of incentives; but it also shows that, in a transition economy, workable incentives can take surprisingly nonstandard forms. Novel institutional forms evolved to solve the unprecedented problems of transition. Entry of new firms, albeit with an unusual ownership structure, produced a competitive non-state industrial sector. New state-imposed incentives induced the state-owned firms to improve their efficiency. The discipline on managers that comes from product-market competition helped compensate for the missing financial-market discipline. Reputation incentives substituted for formal legal enforcement of contracts.