Free Market Economy in China and Russia - Case Study Example

The transaction from a centrally planned economy to a free market or mixed economy involves owned enterprises being privatised. But economists debate as to whether this is actually beneficial to the countrys economy. Discuss this statement from the experience of China and Russia. Introduction Virtually, there are no areas in which globalization has failed to bring revolutionary changes. In business and economics, the changes caused by the globalization are phenomenal. Many of the established economic systems in this world have undergone tremendous changes as part of globalization. For example, socialist economy was prevailing in China and Russia like communist countries before the introduction of globalization. In fact these countries visualized globalization as a weapon in the hands of capitalist economic countries such as America to loot the resources of other countries. However, these perceptions and beliefs were changed quickly. At present, China is the number one exploiter of globalization. China has currently no problems in accepting foreign direct investment or private capital. In fact, China is doing everything possible to attract foreign companies to invest in their soil. The case of Russia is also not different. In short, socialist economies in these countries have undergone huge changes as part of globalization. Even though socialist economy is still prevailing in these countries in principle, free market or mixed economic systems are there now in practice. Many of the state owned enterprises in these countries were privatized recently. Only the critical sectors are still preserved under the public agencies at present in these countries. Some economists believe that privatization or free market economy in China and Russia may create problems for them in the long run whereas others argue in the opposite direction. This paper critically analyses the benefits and drawbacks of privatization and free market economy, taking China and Russia as examples. Economic theory A centrally planned economic system is an economic system in which the state or the government is responsible for taking economic decisions (Investopedia, 2014). Consumers and business have nothing to do to influence such decisions taken by the government or the state. Moreover, in a centrally planned economic system, production and distribution oriented decisions are taken by the state or the government. On the other hand, in a mixed or free market economic system, both private and public entities have equal roles in taking economic decisions. In this type of economic system, production and distribution decisions are taken by the public and private agencies or organizations. An important characteristic of a centrally planned economic system is the pricing mechanisms. Prices in this type of economic systems are purely formal in nature. Both the monopolist producer and the monopolist buyer are the same and the objective of the pricing mechanism is to enhance the movement of funds for further production in this type of economic system. The market plays only a vestigial role in a centrally planned economic system (Jonas, p. 49). From the above observations, it is evident that a centrally planned economic system has greater difficulties in creating wealth. It should be noted that the wealth creation is necessary to increase the standard of living of the people. Everybody wants to increase their standard of living; however, in a centrally planned economy, the state has full control over economic activities and the living standards of the people. Production and distribution of goods in a centralized economic system is fully controlled by the government or governmental agencies. The instructions for the production and the distribution are given by the central agencies to the producers or the distributors. As a result of that, competition does not exist in a centrally planned economy. Moreover, in this type of economic system, “the work force was assumed to be fully employed and wages were somewhat arbitrarily predetermined” (Greenspan, 1997, p. 1). In short, avoidance of inequality in income distribution is one of the core objectives of a centrally planned economic system. Theoretically, in a free market economy, production and distribution of goods being done based on their supply and the demand in the market. It is not necessary that the demand for certain commodity is always remaining stationary. It may increase and decrease time to time because of various reasons. For example, demand for ordinary mobile phones was huge until a decade before. At present, demand for ordinary mobile phones is less compared to that of Smartphones or touchscreen phones. Therefore, supply of ordinary phones in the market is currently reduced, whereas the supply of Smartphones has been increased a lot. From the above observations, it is evident that the manufacturers of ordinary mobile phones at present are earning less compared to the Smartphone manufacturers. In other words, inequality of income distribution is one of the key characteristics of free market economy. “That some gain more profit than others has been regarded as usual in the free market economy” (Kantarci and Karacan, 2013, p. 35) State Ownership and Privatization in China Until 1992, China did not allow any economic activities without state control. However, at the 14th National Congress of the communist party of China in 1992, “building up the socialist market economy was officially proposed, which was a milestone economic reform in the Chinese history” (OECD, 2009, p. 4). As part of the new policy, or economic system, privatization started to enter Chinese territory. It should be noted that state enterprises were enjoying a monopoly in China until 1992. But the new economic policy initiatives helped foreign companies to invest heavily in China. Being the cheapest labor oriented country in the world, China offers tremendous production potentials to foreign companies. In order to survive in the heavily competitive global market, it is necessary for the companies to reduce the prices of their products as much as possible. Cheap production facilities in China helped them to do so. The increased entry of private companies has turned the Chinese market from a monopoly (monopoly of public agencies) to a perfect competition. The following diagrams illustrate the structure of a perfectly competitive and a monopolistic market. Perfectly Competitive Market Structure Long run equilibrium in the market and firm-price takers Allocative and productive efficiency at P=MR=MC=min ATC Pure Monopoly (Essential Graphs for Microeconomics, n.d., p. 3) From the above diagrams, it is evident that free market increases competition, whereas monopolistic market denies it. Until the introduction of globalization, the majority of the organizations in China was operated under state ownership. In other words, state sponsored monopoly was prevailing in China until recent times. It is a situation in which the government enjoys the freedom of sole provider of goods or service to the public and competition is prohibited by law in these areas. For example, electric power distribution system and the telecommunication systems in China were operated under governmental control until recent times. Private participation was not allowed in these sectors until a couple of decades before. At present, plenty of private companies are operating in these sectors and hence the competition is increasing. State Ownership and Privatization in Russia Before the collapse of former Soviet Union, centrally planned economy prevailed in Russia. The collapse of the Soviet Union and the introduction of globalization have changed the Russian economy from a centrally planned economy to a free market economy. Even though Russian economy is still a centrally planned one in principle, in practice, it shows all the characteristics of a free market economy at present. Many public organizations in Russia were privatized in recent times as part of the Government’s effort to attract more FDI. According to Russian President, Vladimir Putin, “the government should lead the way providing privatization deals for the Russian exchange under national jurisdiction. Currently, about nine out of ten deals being struck are not controlled by the state law” (Russia needs a free market economy, rather than cowboy capitalism – Putin, 2012). Uncontrolled privatization is causing big threats to Russia at present. It is a fact that Russia is one among the most rapidly emerging economic group; BRICS (Brazil, Russia, India, China and South Africa). It is necessary for Russia to attract FDI as much as possible to sustain its growth. At the same time, uncontrolled privatization may cause huge problems in Russia for its security and sovereignty in the future. Moreover, these companies are causing big damages to the environment. It should be noted that private companies always keen on exploiting natural resources for making profits. That is why Putin is stressing the importance of increased governmental control of privatization activities. Conclusion In a centrally planned economy, government has full control over production and distribution, whereas in a free market, the government has little control over these things. Moreover, competition is less in a centrally planned economy, whereas in a free market, competition is stiff. A kind of monopoly exists in a centrally planned economy, whereas in a free market, monopoly has no role. In a perfectly competitive free market, people get many benefits in terms of cheap price, best purchasing options and quality goods. It would be impossible for firms fix prices in such markets. On the other hand, in a monopolistic market, people will not get such flexibility in prices or products. In other words, in a monopolistic market, companies or the sellers are dictating whereas in a free market, buyers are dictating. At the same time, in a free market, sellers or the companies try to exploit the natural resources as much as possible. As a result of that, people may face problems in the long run even though they get short term benefits. In short, free market economy has many benefits compared to a centrally planned economy. At the same time, it has some drawbacks also. Therefore, it is necessary to increase the governmental control on free market as a measure to reduce the drawbacks as much as possible. References Essential Graphs for Microeconomics. N.d. [Online] Available at: http://ungerecon.weebly.com/uploads/2/0/8/8/2088048/essentialgraphsformicroeconomics.pdf[Accessed 29 Jan. 2014] Greenspan, 1997. Mr. Greenspan examines the process by which former centrally planned economies are embracing free markets. Central Bank Articles and Speeches, 10 Jun 97. [Online] Available at: http://www.bis.org/review/r970626c.pdf[Accessed 29 Jan. 2014] Investopedia, 2014. Centrally Planned Economy. [Online] Available at: http://www.investopedia.com/terms/c/centrally-planned-economy.asp [Accessed 29 Jan. 2014] Jonas, P. 1968. The redistribution of the product-mix in a centrally planned economy. Southern economic journal. Jul68, vol. 35 issue 1. Kantarci, H. B. and Karacan, R. 2013. The Misusage of Free Market Economy and Turkey Example. Journal of Marketing & Management. Nov2013, Vol. 4 Issue 2, p35-45.  OECD, 2009. State Owned Enterprises In China: Reviewing The Evidence [Online] Available at: http://www.oecd.org/daf/ca/corporategovernanceofstate-ownedenterprises/42095493.pdf [Accessed 29 Jan. 2014] Russia needs a free market economy, rather than cowboy capitalism – Putin, 2012. [Online] Available at: http://rt.com/business/russia-economy-putin-address-872/ [Accessed 29 Jan. 2014] Read More