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From 1978 to 1992, China's liberalization was gradual with a fairly stable price level. Since 1989, more rapid liberalizations attempted in Eastern Europe and the former Soviet Union generated much higher inflation. Yet, both regions' fiscal policies were similar. And, like its socialist counterparts in Europe, the Chinese government's revenue share in GNP has fallen sharply; in 1991-92, its consolidated fiscal deficit may be approaching 10 percent of GNP. China avoided resorting to the inflation tax in four ways. It first liberalized in areas like agriculture where subsequent productivity growth was rapid. It imposed very hard budget constraints on, and gave little bank credit to, the newly liberalized "nonstaten sectors in industry or agriculture. But it did retain price controls on, and (constrained) financial support for, traditional soft-budget state enterprises. Last, it set positive real interest rates on savings deposits. The resulting enormous growth in saving and stocks of financial assets allowed the liberalized sector to finance itself, the Chinese government, and the deficits of the slowly reforming state enterprises. Important aspects of these dualistic Chinese banking and pricing policies could well be adopted in other transitional socialist economies. But such incredibly high real financial growth is not feasible in Russia and formerly socialist Europe. (Indeed, high financial growth may not be sustainable for much longer in China itself!) Thus, to prevent inflation, fiscal reforms should come much earlier in their transitions than in China's.


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