Surplus and capital formation
By Henry CK Liu

This is the fifth article in a multi-part series.
Part 1: In the beginning was Tiananmen
Part 2: Revolutionary lessons
Part 3: Lessons of the Soviet experience
Part 4: Mao's legacy lives on

For an underdeveloped feudal economy transitioning towards a modern industrial growth path, one that is not isolated by hostile forces such as foreign embargos, the problem is not that economic surplus being too small, but that the way the economic surplus is produced and appropriated is not conducive to capital formation.

In feudal economies, the main forms of economic surplus are land rent, usury interest rates and middleman profit. Only a small part of the surplus is capitalist profit in feudal economies - because land assets have not found ways to become monetized capital, which remained trapped in land that was not commercially traded.

Participants in the feudal economy, its agrarian sector in particular, were predominantly landlords, moneylenders and commodity traders, while capitalists played no major role. The participants in a feudal economy produced their surpluses from narrow direct financial margins by rack-renting tenant farmers, squeezing debtors through usurious interest rates, hoarding to manipulate prices, and so forth, but the surplus was not invested to increase productivity or output.

This type of surplus were merely income transfers from the property-less class to the class that monopolized property in the form of land or money, and who had little incentive to improving productivity. Landlords in feudal societies were generally conservatives who felt threatened by changes, even changes towards productivity. They consumed their surplus through non-agricultural construction such as luxurious goods and grand estates. Traders by definition were not interested in increasing production, only in high profit margins. Usurers were interested only in transferring to themselves, from distressed debtors, ownership of collateralized assets that required no further capital investment.

At the time of the founding of the People's Republic in 1949, China's feudal economy was producing surpluses that were mostly socio-economically unproductive. The developmental problem then was:

how to transform these structural socio-economic unproductive forms of surplus into new productive forms, leading to a rise in capital formation and hence in national income.

Conservative Method:

Under capitalism, the approach to transformation was a conservative, socially elitist and narrowly based one of reforming but preserving the system of landed private property. Land reform took the path of paying financial compensation to landlords, and redistributing the land thus acquired through the market by selling to those who had money to buy. [Our 'eminent domain'. -FNC] This method structurally limited land redistribution to a minority with money, or with access to money, and excluded the majority of the peasants who worked on the land and who needed land most. Thus, capitalism of the landed elite was promoted at the expense of a broad-based peasant socialization of capital.

Revolutionary Method:

By contrast, the revolutionary socialist path was a socio-economically broad-based one of abolishing private ownership and the associated system of rent and interest on debt. This was achieved by seizing the landed property of rentiers without compensation, namely confiscating it in the name of the people, followed by a free and egalitarian redistribution to peasants who actually worked on the land, and writing off all outstanding confiscatory mortgages. Given their improved economic status, the peasants then would evolve capitalist efficiency production "from below".

Example, Japan:

In Japan, the conservative path was exemplified by the Meiji land reform during 1869 to 1873, which abolished the feudal right to rent-cum-tax of the nobility (daimyo and the samurai) only by paying them compensation, namely, the capitalized value of their rents as cash and bonds; and then taxed the farmers heavily to finance the compensation.

After World War II, US occupation regime in Japan under General Douglas MacArthur, whom historian William Manchester labeled an American Caesar, instituted land reform in 1945, under which all land with resident lords in excess of one cho (2.45 acres) was acquired and redistributed to the tenants on it at a nominal payment, while absentee landlords were not allowed to keep even one cho, but had to surrender all their land for redistribution.

The insistence of the US occupation regime in Japan in the post-war period on land reform, up to that time the most comprehensive ever in Asia, arose from US perception that the twin pillars of Japanese militarism had rested on the zaibatsu, monopolistic conglomerate, and the prevalence of petty tenancy as opposed to owner-occupied land.

Example, Soviet Union:

In contrast, the revolutionary path was exemplified by the confiscation and free distribution of land in the Soviet Union after 1917, and by the land reform in China after 1949. In this revolutionary approach, the egalitarian and free distribution of land to peasant households was thought of as the successful completion of an essentially capitalist task of doing away with feudal property, and as a transitional phase to the eventual establishment of production cooperatives and collectives, in which individual ownership of the material means of production would be replaced by cooperative and collective ownership in enlarged units.

Example, China:

Prior to land reform in China in 1952, the total of landlord net income in rural areas by way of land rent, usury interest and profit amounted to 16.9% of the value added in agriculture. Adding a 2.1% tax paid by land owners, a total of 19% of value added in agriculture (9.39 billion yuan at 1952 prices) was taken from the farming peasants. Of this total, some 4.5 billion yuan was retained by farming peasants after land reform and 4.9 billion went to the government in new taxes.

Thus the peasants benefited, and at the same time the new socialist state had access to resources released by land reform to support socialist construction which included road building, hydroelectricity development, free education and health care. This transfer of surplus from the agrarian sector to the state budget, expressed as a percentage of total gross and net domestic investment in the economy in 1952, amounted to 34.7% and 44.8%. Land reform thus contributed significantly to needed development finance.

Yet further capital formation for socialist development needed to come from development planning since the increased income of peasants after land reform, while in theory could provide more saving for investment, was too low and given the residual abysmally low standard of living of the peasants before land reform, all the additional income from land reform was immediately consumed, for on a per family basis it worked out only to about 55 yuan in 1952.

Thus egalitarian land reform, while eliminating a parasitic landlord and taxation system, did not in itself generate a rapid rise in productive investment needed for output growth. In effect, poverty was being equitably shared by egalitarian land reform unsupported by wealth creation government measures.

Yet egalitarianism by itself is never the cause of poverty or prosperity. It is just that egalitarianism can enhance prosperity more effectively when effective wealth creation policies are functioning.

A case in point in history is that of the founding Civil Emperor of the Sui dynasty (518-618), who, after his coronation, took 5,000 buffalos from government lots and distributed them free to impoverished farmers, helping to restore farm production. He also opened state land reserves to the landless, forbade the military to draft men under the age of 21, reduced the annual tax burden by as much as 80%, shared with the people revenues from state monopolies on wine and salt, exempted the elderly, those over 50, from taxes and reduced the state's take from farm harvests by one third. A central bureaucracy was established and staffed with literati selected on merit through public examinations. As a result, within a few years of his socialist reign, the economy recovered totally from three centuries of war and destruction and grew with unprecedented prosperity. By the final year of his 15-year reign, the state grain reserve was so large that it was sufficient to feed the nation for the next 60 years, albeit the population was only 50 million in size.

In recent centuries, both as a result of population growth and shrinkage of territory from persistent Western imperialist encroachments, China has become an agricultural economy deficient in cultivatable land for the size of its population. Thus China, like England in earlier centuries, must either adopt an industrial policy to support agricultural imports, or an emigration policy, or a population policy.

In the socialist perspective, land reform in itself is a bourgeois measure taking socioeconomic evolution no further than the French Revolution had over two centuries ago. Land reform constituted a necessary condition for further institutional change towards a cooperative society.

The urgent need to amalgamate peasant efforts for the purpose of socialist investment is underscored by the accelerating level of environmental degradation and deforestation in China before 1949 and after 1979. Countering the massive problems of large-scale deforestation, soil erosion and land degradation could not be realistically done on an individual basis or through the market mechanism. It requires the socialization of hundreds of millions of individual households on a network of local projects, not driven by individual profit incentives but by a unified sense of national purpose.

In 1949, abysmally low standards of public sanitation and health care and the prevalence of epidemic diseases from snail-infested canals and mosquito-infested water called for a massive collective investment effort towards cleaning up the environment and initiating a health care system to provide service to those who needed it regardless of their purchasing power. Since 1979, public social infrastructure in education, health and pension has been allowed by policy to regress towards pre-1949 levels.

Latent economic surplus trapped by unemployment and underemployment
Marx observed that the internal contradiction of capitalism is not the competition it fosters or its indifference to inequality. Rather, it is the structural problem of surplus labor which, under the labor theory of value, translates into surplus value. To Marx, capitalism is a self-terminating system because it structurally deprives the worker of a significant portion of the value of his work. Capitalism is built on the concept that value is a function of marginal utility which justifies the exploitation of many by a few.

For Marxists, it follows that latent surplus value can be mobilized for the purpose of capital formation by the reduction of unemployment and underemployment of labor. In China, this is particularly true for rural labor. Neoclassical economics, based on the concept of scarcity, invented the concept of surplus labor, deriving from the concept of surplus people as those who are economically unnecessary. Market fundamentalism creates in market economies the phenomenon of labor with zero marginal utility. This views flies in the face of reality that nations with large populations are economic powerhouses if full employment is ensured by policy. (See Scarcity economics and overcapacity Asia Times Online, July 28, 2005. )

The fallacy comes from treating labor as a commodity to be traded in the market, a residual mentality of the slave society. Economics exists for the benefit of people. People exist as a matter of nature, not for making any economic system more efficient. The very idea of surplus people in an economy is obscene.

Market operations cannot deal effectively with the employment problem as long as employment is restricted to boosting narrow economic efficiency through a market mechanism. Full employment must be a goal in all economic systems, not structural unemployment, as in the concept of non-accelerating inflation rate of unemployment (NAIRU), defined as the rate of unemployment at which i) there is neither upward pressure on inflation (from producers taking advantage of the market power given them by bottlenecks, and from workers using the market power provided by a tight labor market to try to realize wage growth aspirations higher than the rate of productivity growth); nor ii) downward pressure on inflation (from customers taking advantage of the market power given them by excess capacity, and from firms using the market power provided by high unemployment to try to decrease the rate of wage growth).

Market capitalism thus falls short because it must use unemployment as a device to restrain inflation. Excess capital formation derived from unemployment and underemployment leads structurally to overcapacity due to demand rising at a slower rate than productivity from overinvestment.

Capital formation can also be achieved with a system of voluntary deferred wages, wherein every worker agrees to work longer hours without corresponding increases in pay in order to accumulate capital with which to increase productivity, so that less labor can command higher wages in the future.

However, such a system will only work if the capital so accumulated is collectively owned and the benefits of additional productivity are equitably shared among workers who made the temporary sacrifice. Thus mobilizing voluntary economic surplus towards capital formation can only take place in a socialist system. Under a capitalist system of private ownership of the means of production, only oppression of workers can produce capital formation.

In China in the 1950s, cooperatives with 300 households and people's communes with 3,500 households played a key role in voluntary mobilization of economic surplus toward productive capital formation to increase productivity.

During the crucial period of the transition to advanced cooperatives, an awareness of the potential of cooperatives to mobilize surplus labor was recorded in Mao's writings.

The Transition to Advanced Cooperatives

In 1954, Mao wrote: "Under present conditions of production, there is already a surplus of roughly one-third of labor power. What required three people in the past can be done by two after cooperative transformation, an indication of the superiority of socialism. Where can an outlet be found for this surplus labor power of one-third or more? For the most part, still in the countryside. ... The masses have unlimited creative power. They can organize themselves to take on all spheres and branches of work where they can give full play to their energy, tackle production more intensively and extensively, and initiate more and more undertaking for their own well being." (Mao Zedong, Selected Works, Beijing, Foreign Languages Press, 1978, p269.)

Local adaptations and variations were to take place within a broad national policy of promoting undertakings in the following sectors: physical capital formation via land reclamation, hill terracing, reforestation and irrigation; infrastructure (roads, bridges and buildings); hydroelectric energy; rural businesses and industries; and human capital formation (public sanitation, health clinics and schools).

The possibilities were certainly nearly limitless at this time, given the existing abysmally low levels of material, educational and health development in the countryside. On land reclamation and reforestation, Mao Zedong stressed the need for "state organized land reclamation by settlers, the plan being to bring 400 to 500 m. mu [3 million hectares] of wasteland under cultivation in the course of three five-year plans".

He went on to say: "I think the barren mountains in the north in particular should be afforested, and they undoubtedly can be. Do you comrades from the north have courage enough for this? Many places in the south need reforestation too. It will be fine if in a number of years we can see various places in the south and north clothed with greenery."

Mao Zedong confidently expected, even within the advanced cooperatives and before full collectivization, that the annual labor days employed per worker would rise substantially and that female participation rates would also rise as more rural undertakings were established, existing labor surplus thereby mobilized and increasing supply elicited:

"Before the cooperative transformation of agriculture, surplus labor-power was a problem in many parts of the country. Since then, many cooperatives have felt the pinch of a labor shortage and need to mobilize the masses of the women, who did not work in the fields before, to take their place on the labor front ... For many places, the labor shortage becomes evident as production grows in scale, the number of undertakings increases, the efforts to remake nature become more extensive and intensive, and the work is done more thoroughly."

Further, he goes on to say: "Things in this country also show us that an outlet can be found in the villages for rural labor power. As management improves and the scope of production expands, every able-bodied man and woman can put in more work-days in the year. Instead of over 100 workdays for a man and a few score for a woman as described in this article, the former can put in well over 200 workdays and the latter well over 100 or more."

The timing of the shift to the large-scale communes was not a happy one; it coincided with a run of very poor harvests, complicated by floods in some parts of the country and attacks of pests in others. There was a very substantial downward deviation of output from the trend during 1959 to 1963, and this has complicated the evaluation of the shift ever since.

There is a severe problem of causal identification here: it is arguable that even without the institutional change to communes, output would have fallen anyway, for agricultural output is subject to cyclical patterns of movement. Many Western scholars who are disposed to criticize the idea of large-scale collective production have, however, tended incorrectly to place the main burden of the output decline on the shift to the communes. What is probably true is first, that the decline which would have taken place anyway, was exacerbated by the initial severe management problems entailed in the shift.

The geopolitics of the Sino-Soviet split was a key factor. In 1960, the Soviet Government unilaterally broke up 600 aid contracts with China, and notified the Chinese government that it would withdrew all its 1,390 experts and stop sending the agreed upon 900 new experts. The Soviet experts left with all their blueprints, plans and materials. The Soviet government also stopped delivering urgently needed equipment and parts to China. As result, the construction and operation of over 250 large industrial enterprises had to be suspended. This put a halt to heavy industrial development and greatly exacerbated China's economic difficulties in the following decade.

Since 1979, average income in rural areas has lagged far behind the average in cities, giving China one of the highest income disparity measures in the world. Many farmers still work on tiny, state-allocated plots of land for a small fraction of the year, investing little in agriculture. While they are entitled to 30-year land-use contracts, the state retains ownership of rural land, and local authorities sometimes seize or reallocate farm land to suit their non-agricultural development priorities.

Rural land disputes are perhaps the biggest source of social unrest in China. Protests and riots in rural areas number in the thousands each year, according to national police estimates. They are often incited by allegations of corruption and illegal land seizures.

Many farmers leave the land to seek work in cities, but they are still classified as farmers under the country's population control policies and tend to work in low-wage factory or construction jobs on a seasonal basis.

Advocates for land reform say the proposed changes would create more asset wealth for farmers and strengthen land security, which would in turn encourage peasants to invest in farming and increase productivity.

A law enacted in 2002 allows limited land-use trades between individual farmers but does not permit unrestricted trade between farmers and companies, straight sales of land-use rights, or the option to use the land as collateral to obtain a loan.

The major state news organizations reported in October 2008 that rural land reform was at the top of the agenda for a meeting at the time of communist party leaders. China Daily, the country's official English-language newspaper, reported, "The meeting is expected to make it easier for farmers to lease or transfer the management rights of their land, measures that have become necessary as many farmers move to cities as migrant workers."

As the New York Times reported in October 2008, "Private ownership of land is not allowed under the constitution, and rural land is still effectively controlled by township- and village-level leaders. Officials characterize the proposed policy changes as allowing the farmers to lease or trade their 30-year land-use contracts to individuals or companies.

"The issue remains a delicate one. Many party traditionalists strongly favor collective land ownership. They have argued that China's economy is still not robust enough to absorb hundreds of millions of rural laborers full time. They also defend the system of allocating small plots of land to all rural families as guaranteeing farmers at least a subsistence income.

"But repeated efforts to enliven the rural economy without freeing up land have failed, and proponents of moving toward partial privatization appear to have the upper hand. One point under discussion is whether land contracts should be extended to 70 years from 30 years, scholars say, a move that would give farmers more security and presumably increase the value of their land-use rights."

In the Soviet Union, the percentage of planned output achieved by important industries at the end of successive five-year plans, in "value-added" terms, was impressive. The first five-year plan (1928-32) achieved 75% of its target, the second (1932-37), 76%. The plan ending in 1950 achieved 94% and 1955 achieved 99%. Yet the area of trouble in Soviet planning was in agriculture, not so much in the state farms but in the collective farms made of small farmers. The knotty problem of reward and incentive in collective enterprise has yet to be solved by human ingenuity. The same was also true in China. When China abandoned collective farming, the agricultural problem also eased, but it was not solved, even today. In the US, free-market principles never touched agriculture, which has remained a fortress of government subsidy.

On June 27, 1981, the sixth plenary session of the 11th Central Committee Congress of Communist Party of China adopted unanimously an official resolution on certain question related to the Founding of the Nation: Concerning economic development during the Mao Zedong era:
"The accomplishment we have achieved over the past 32 years is still significant. To neglect or denied our accomplishment, and to neglect or deny the successful experience we gained from these achievements, would be a serious mistake.

"From 1953 to 1956, the nation's gross value of industrial output on average increased progressively every year by 19.6%. The total agricultural output value on average increased progressively every year by 4.8%. The economic development was relatively rapid, the economic effect relatively good and the proportional balance between the major sectors of the economy relative well coordinated. The market was prosperous with price stability. The livelihood of the people improved remarkably.

"In April, 1956, Comrade Mao Zedong summarized in his speech 'Discusses Ten Big Relations' our country's initial socialist construction experience, and proposed the task of exploring a path towards socialist construction that would suit our national conditions.

"After the completion of basic socialist transformation, our party leads all of the nation's various nationalities to start to change over to the comprehensive large-scale socialist construction. Until the eve of the decade-long Great Cultural Revolution, despite having encountered serious setbacks, we still achieved the very great accomplishments.

"A very major part of the material and technical foundation we now depend on to carry on the program of modernization had been built during that period. The backbone strength behind the effort for national economic cultural construction and their work experience had also been mostly cultivated and accumulated in this period. This had been the Party's main task in this period."

On top of rising income, farmers during the Cultural Revolution decade enjoyed free education and free rudimentary health care, which they never enjoyed before or after. In 1965, with the launch of the Cultural Revolution, Mao expanded the idea of health for the masses beyond infectious disease. Mao proclaimed: "In health and medical work, put the stress on rural areas." With that, China's cadre of "barefoot doctors" was born. These health care programs were called "rural cooperative medical systems" and strove to include community participation with the rural provision of health services. It became a model health care program much admired and copied by the world's developing countries.

A peasant medical force
Hundred of thousand of peasants, young men and women mostly in their 20s with some general education, were selected for an intensive three- to six-month course in medical training. They were instructed in anatomy, bacteriology, diagnosing disease, acupuncture, prescribing traditional and Western medicines, birth control and maternal and infant care. They came to be known as barefoot doctors because some of them were not even equipped with shoes.

The barefoot doctors continued their farming work in the commune fields, working alongside their comrades. Their proximity also made them readily available to help those in need. They provided basic health care: first aid, immunizations against diseases such as diphtheria, whooping cough and measles. They provided health education. They taught hygiene as basic as washing hands before eating and after using latrines. Illnesses beyond their training, the barefoot doctors referred on to physicians at commune health centers.

Ten years after the Cultural Revolution, there were an estimated 1 million barefoot doctors in China. In the 1970s, the World Health Organization and leaders in some developing countries - even the Soviet Union - began to consider China's program as an alternate model to Western-style health care. They were looking for inexpensive ways to deliver health care to rural populations; China had seemed to set up a successful model.

But the barefoot doctors program largely fell apart after 1979. The central government provided less financial support for the program, and the country's emerging free-market system began forcing farmers to pay for their health care. The World Health Organization recently ranked China as fourth-worst out of 190 countries for equality of health care. To correct the regression, the government recently adopted an universal medical insurance program.

Yet 40 years after the program began, the program still holds allure and lessons for health officials around the world looking for a solution for inadequate rural health care. There is also recognition outside of China that the country did go much further than other countries of comparable wealth in reducing infectious diseases, such as polio, smallpox and schistosomiasis during this period,

On a visit in 1972, American doctor Victor Sidel praised the program for supplying health care where previously there had been none; he also singled out the barefoot doctors themselves for their role as patient advocates.

Next: The Great Proletariat Cultural Revolution

Henry C K Liu is chairman of a New York-based private investment group. His website is at http://www.henryckliu.com.