CALIFORNIA MANAGEMENT REVIEW

Volume XXIX, Number 3, Spring 1987

1987, The Regents of the University of California

The Emergence of Free

Market Retailing in the
People's Republic of China:
Promises and Consequences
Heidi Vemon-Wortzel Lawrence H. Wortzel

One of the unresolved debates about economic development is whether it

is best accomplished when production and distribution are led by market
forces or when these functions are centrally planned and directed. Propo-
nents of centrally planned, or command, economies seem to place primary
emphasis on equity. They think that production capacity should be used for
those goods considered essential or basic to the health and well-being of
the population: luxury goods should be produced only when the basic needs
of the populace have been fully met. The role of the distribution system is
to insure that goods are allocated according to need and are available to all
who need them.
Proponents of market force led or market-based development empha-
size that equity emerges from an efficient system. They think that a
centrally planned system, no matter how well intentioned, sooner or later
misallocates a country's resources and encourages inefficiencies in produc-
tion and distribution. Without a competitive marketplace, the argument
goes, there are no incentives to produce or distribute efficiently. Propo-
nents of market-based development believe inefficiency is a greater deter-
rent to development than inequity. Consumers are better judges of eir
own needs than government, proponents say, and consumers can de-
termine what will be produced by what they do not buy. Many supporters
of the market-based approach even assert that a change from a centrally
planned to a market-based economic system unleashes forces that lead to a
significant, sustained increase in the rate of economic growth because of
the efficiencies that are introduced.
In this article we look at a situation that might help resolve the debate,
the introduction of free market retailing in the People's Republic of China.

The authors are indebted to Zhu Jingtian who conducted the interviews upon which this article
is based.

59
60 HEIDI VERNON-WORTZEL & LAWRENCE H. WORTZEL

We focus on free market retailing as it has developed in the important

bellweather city, Guangzhou. We describe the free market retail sector
and contrast it with both the State retailing sector it supplements and with
retailing in market-based developing country economies. We then discuss
the potential effects of this new retailing form on China's economic de-
velopment.

Change In China: Moving Toward a Dual System

The initiation of the Four Modernizations program in China brought pro-
found changes in every sector of the Chinese economy. Modernization of
agriculture, industry, national defense, science, and technology carried with
it a fundamental reorganization of the production of all goods and services in
the country. ^ In common with changes in other sectors, the retail distribu-
tion of consumer goods has changed and adapted to meet the priorities set by
Zhou Enlai and advanced and refined by Deng Xiaoping.
It is important to understand the elements of change that have taken place
in retailing in recent years and the trends that are likely to occur in the
future. Changes in the retailing sector can echo far beyond the consumer
goods distribution system. They can profoundly affect the manufacture of
consumer goods as well. An enterprising consumer goods retailing system
provides a strong incentive for the growth of consumer goods manufactur-
ing, offering a ready outlet for its production. A centrally controlled retail
sector, on the other hand, can effectively dampen consumer goods produc-
tion by shutting off access to consumers even if consumer goods manu-
facturing is not controlled centrally.

Background of Free Market Retailing in China

Prior to the Four Modernizations, virtually all retail distribution was carried
out by state-ovmed stores. Merchandise was manufactured by state-owned
factories and food was grown on state-owned communes. A system of
state-ovmed middlemen distributed all goods. Prices were set by govern-
ment and usually did not refiect the actual costs of production or distribution.
Thus, there were no incentives to produce or distribute efficiently. The
primary goal of this system, equity, was reasonable in a merchandise-short,
labor-rich economy. Efficiency was a secondary consideration.^
By the late 1970s, the level of production and distribution of some goods
and agricultural items had reached levels at which government no longer had
to make equity its prime consideration. For example, in December 1978, the
government announced the restoration of free markets and private farming
plots. Now, production in excess of the state quota could be sold to consum-
ers v^thout passing through the state distribution system. ^ The goal of these
changes was to stimulate growth in production still further by providing
incentives to producers while, at the same time, trying to increase efficiency
by using the market to set prices.
 FREE MARKET RETAILING IN CHINA 61

Output in both the industrial and agricultral sectors has risen dramatically
over the last several years. The abandonment of the commune system and
return to townships and collectives has resulted in greatly increased ag-
ricultural production and the proliferation of "side-line industries." The
sidelines enterprises of agricultural townships produce simple consumer
goods from shirts to plywood paneling and employ peasants who would
otherwise drift to the cities.'^ Other changes in industry, exclusive of ag-
riculture, are also far-reaching and their impact is still not entirely clear. ^
Neither the state wholesaling nor the state retailing system was designed
to accommodate a situation in which efficiency and expanded output rather
than equity were paramount. Nor was the state system geared to accept
goods produced by sideline industries. There were few incentives for the
state system to handle more or different goods, to get merchandise to the
consumer as efficiently as possible, or to pass on cost savings to the
consumer. Consequently, the first free market producers had to wholesale
and retail the goods themselves. Many were collectives selling the output of
their sideline industries.
As free market goods became more available, entrepreneurs took ad-
vantage of the increased opportunities of the marketplace and began to
specialize either in manufacturing or distribution. Free market retailers now
include both individual proprietors and collectives. Free market retailing,
though still small in proportion to China's total retail sales, has grown rapidly.
Individual stores have continued to specialize in different categories of goods
and to employ a wider range of retail strategies.

The Emergence of the Free Market

Free market retailing has an official place in China and its substantial growth
in the delivery of food and other products and services will no doubt
continue. Between 1980 and 1985, there has been a 600 percent increase in
retail and service shops, resulting in a total of over 6 million establishments.
These shops can be found in specially designated free market areas. By the
end of 1985, there were about 60,000 of these free markets and all indica-
tions are that China plans to increase the number. ^ But free market retailing
is still an addition or supplement to the state system, rather than a substitute
for it. Moreover, free market retailing has not yet penetrated uniformly
across China. Because change is not proceeding at a uniform rate in all
geographic areas or in all industries, it is a stronger force in some areas than
in others.
The retail free market has concentrated primarily on non-essential goods.
But where the government believes that free market retailing can stimulate
production and efficient distribution of essential goods and where equity is
not an overwhelming consideration, essential goods have also been allowed
to seep into the system. Tacitly, at least, the Chinese government seems to
have decided that equity is paramount for essentials that are not easily
62 HEIDI VERNON-WORTZEL & LAWRENCE H. WORTZEL
1
amenable to significant increases in output as the result of market stimuli,
while efficiency is the key consideration for other goods.
In order to understand and assess the potential impact of free market
retailing on both equity and efficiency, we arranged for extensive personal
interviews to be conducted among a small sample of free market proprietors
in Guangzhou. The composition of our sample is shown in Table 1. As this
table shows, the interviews encompassed a cross-section of retailers includ-
ing "neighborhood" and "downtown" stores offering a variety of merchan-
dise categories. Because free market retailing is in its early stages of
development, our interviews were designed to probe individual retailers in
depth about their enterprises rather than to count numbers. Our analysis,
therefore, is primarily qualitative rather than quantitative. The discussion of
the potential impact of the private sector should be considered to be
hypothesis generation rather than the statement of definitive conclusions.
The development of retailing in China provides the basis for interesting
comparisons of China with other developing countries, for under state
control retailing has developed differently than it would have in a market
economy at the same stage of development. We have found that in addition
to serving household consumers in search of specific merchandise, free
market retailing in Guangzhou is performing two other functions as well.
Both of these additional functions may have significant long-term implica-
tions for the Chinese economy. The first is that some retailers function as
importing and exporting conduits. The other is that retailers carry out
wholesale as well as retail functions, thereby distributing merchandise well
outside the Guangzhou area.

Guangzhou Free Market Retailers as Retailers

The state-owned system that has developed in China since 1949 is signifi-
cantly different from the consumer goods distribution sector found in most
developing countries with market-based economies. In the major cities of
China, the state system uses large department stores and supermarkets to
distribute goods, supplemented by some neighborhood shops offering con-
venience items. There are, in addition, some stores that specialize in
specific kinds of merchandise such as bicycles or fruits and vegetables.
Service is impersonal, no credit is extended, and prices are uniform across
stores. There is no bargaining. The channel is short, since goods go directly
from manufacturers to wholesalers to retailer. Multiple levels of wholesaling
involving physical handling of goods is the exception rather than the rule. In
sum, the structure of China's state-owned retailing system is more like a
structure that would be found in an industrialized country than in a develop-
ing country. In a sense, the state system is managed much like a single chain
of stores with uniform prices, policies, merchandise, and displays.
Typically, retailing in market economy developing countries is character-
ized by very small proprietor-owned and family staffed stores. These estab-
 FREE MARKET RETAILING IN CHINA 63

Table 1. Composition of Sample

diore lype Store Location
Neighborhood Free Market Other*
Restaurant Food Stall 3 4
Building Materials 3
Fruit and Vegetables 2 2
Clothing 2 3
Repair Shop 2
Groceries, Convenience Items 4 1
Meat, Poultry, Fish 1 4
Hotel 1
11 10 11

*Downtown, major thoroughfare

lishments are located in neighborhoods and offer limited lines of merchan-

dise. The average sale is very small and a high degree of personal service is
the norm. These small stores often extend credit. Prices vary from store to
store and bargaining is usually expected.^ Channels of distribution are
usually long and include multiple levels of wholesalers. Where department
stores exist, they serve only a small fraction of the population.
The free market sector in Guangzhou represents a return to forms of
retailing that are more characteristic of other developing countries, but with
some very significant differences. The differences represent both con-
straints and opportunities to the erstwhile retail entrepreneur. The con-
straints are those of both merchandise and location. Goods that are in short
supply are still not available to free market retailers, nor are free market
retailers able to choose their sites freely. Store location is still a government
rather than a storeowner decision.
But there are opportunities related to both merchandise and location.
Even those producers that are state-owned are allowed to sell to the private
sector any merchandise output in excess of their contractual commitments
to the state-owned distribution system. This does not mean, however, that
private sector retailers receive only surplus or over-production. On the
contrary, they may be able to acquire better quality goods than those that go
through the state system if the producer can get a higher price for the better
quality.
For some time, for example, farmers have been sorting their produce by
quality, shipping lower quality to state wholesalers to fulfill their contract
requirements and selling the best quality through the free market at higher
prices. In addition, free market retailers sell unique products or products
produced in too small a scale to go through the state system. Furniture made
in small workshops or by individual craftsmen is much more likely to show up
64 HEIDI VERNON-WORTZEL & LAWRENCE H. WORTZEL
in free market retail establishments than in state-owned retail stores. Often
the constmction of the free market goods is better and the design more
unique; the prices of these goods refiect the differences.
Some free market retailers have managed to obtain advantageous loca-
tions. Many of them are located in areas specifically designated as free
market areas. These locations offer some of the benefits of shopping centers
or bazaars, and while they may not be convenient to peoples' homes, the
larger assortment of goods offered by many free market stores in one place
attracts customers from a larger trading area. A number of free market
retailers have managed to obtain neighborhood locations, mth resultant
advantages similar to those of the convenience store found in the industrial-
ized countries.

The Emergence of Retail Competition

In the People's Republic of China, when the retailing system was wholly
state owned, there was no real competition among stores. To be sure, there
was the occasional case where one store received a shipment of a particular
brand of bicycle or radio and another did not, but these were random
occurrences rather than planned competitive events. With free market
retailing has come competition. The nature of the competition is different,
however, from that of retail competition in other developing countries and
the free market entrants in China have developed different strategies in
response to their unique competitive environment.
Retailers of all types, and in virtually every country, compete by using one
or a combination of three generic strategies:
Merchandise Differentiation: offering products or brands different from
those of competitors.
Service and Personality Augmentation: offering products that are similar
to those of competitors but differentiating themselves on the basis of the
services (e.g., convenience, advice) and/or the decor or atmosphere
(personality) they provide.
Price Leadership: competing only on price; the product line, services,
and personality are the same as competitors.
In most developing countries, the bases of retail competition most offen
observed are price leadership and, secondarily, service augmentation. Per-
sonality augmentation follows when the number of large stores increases to
the point at which they compete with each other. Where competition is
based on service augmentation, the principal components are location con-
venience (near home or work) or personal service. Often prices are not
fixed; price competition takes place on a transaction basis and the price
received depends on each customer's bargaining ability. Retail competition
based on merchandise differentiation is restricted to custom-made goods
such as certain clothing items. Merchandise differentiation or importers are
 FREE MARKET RETAILING IN CHINA 65

vertically integrated either by contract or ovmership; otherwise retailers

carry the same brands.
One universal characteristic of retailing the world over is that it is easy to
enter. As compared with manufacturing, retailing requires little capital and
little skill. In many developing countries, in fact, retailing is a subsistence
level or entry level occupation, and the distribution sector is a dumping
ground for those who cannot find other employment with which to scratch
out a living. Consequently, price competition in developing countries is
intense, especially in small items sold by retailers who are located in very
close proximity to each other.

Competition, Structure, and Strategy

in Free Market Retailing in Guangzhou
Some free market retailers compete primarily against state-owned retail-
ers, while others compete against both state-ovmed and other free market
retailers. The character of the competition faced by an individual free market
retailer depends both on the retailer's product line and on his location.
Chinese free market retailers exhibit a v^der breadth of competitive stra-
tegies than can be observed in many other developing countries. Price
competition is more complex than in other developing countries.
Product Line Determinants of CompetitionThe market shares
accounted for by free market retailers vary considerably by product type.
Retail distribution of goods that are still in short supply, such as television
sets and bicycles, is still through the state system exclusively. The majority
of sales volume in small manufactured goods such as watches, toiletries,
packaged and processed foods is still accounted for by the state system, but
the proportion sold by free market retailers has been increasing significantly.
Free market retailers already account for the majority of sales of fresh fruit
and vegetables. Hundreds of free market retailers in Guangzhou's Qingping
market offer a vast variety of foodstuffs in what is fast becoming a world-
class marketplace.^ Thus, stores selling principally manufactured goods
compete primarily against the state system, while fruit and vegetable stores
compete against state stores and strongly against other free market stores.
Store Location Determinants of CompetitionAs previously noted,
free market retailers are found in two locations. One is a neighborhood
location, where the store is set among a cluster or street of dwellings. The
other is in designated free market areas, set among many other free market
stores and stalls. Both the product lines and the competitive strategies
associated v^th these two store locations are different.
Neighborhood StoresTypically, the neighborhood store is a conveni-
ence store. It is usually located in a residential area and carries small items
such as processed foodstuffs and toiletries that are used by people in the
neighborhood. Unlike the neighborhood convenience store in many develop-
66 HEIDI VERNON-WORTZEL & LAWRENCE H. WORTZEL

ing countries, this type of store is neither the principal retail outlet for the
merchandise classifications it carries, nor one of several competing stores in
the neighborhood. The neighborhood convenience store competes princi-
pally with the more remote and much larger state-owned store. Its competi-
tive strategy is comparable to that of the industrialized country convenience
store that vies with the supermarket for customers. It competes much in the
same way through service augmentation and through providing time and
transaction convenience. Because of the paucity of local, neighborhood
competition, the neighborhood convenience store can and does command a
price premium over the state-owned store. There are not yet so many
neighborhood stores that they must compete with each other using price
leadership strategies.
There are also neighborhood speciality stores. There are several types,
ranging from tiny stalls specializing in perishables (such as fruit) to dress
shops to service businesses (such as barber shops and restaurants). Their
strategies are based on service augmentation and product differentiation.
The fruit stalls and the restaurants base their strategy on offering better
quality or better service than that available in the state store. A dress
shop, for example, may offer alterations in addition to better quality
materials and construction.
Free Market Located RetailersFree market areas attract a ple-
thora of retail merchants. Included in the Guangzhou free market area are
butcher shops,fishand seafood retailers, retailers of preserved foods, folk
medicine hawkers, and jade merchants. Retailers located in these free
market areas compete not only wi the state-owned stores, but very
intensely with each other. They compete with state stores using mer-
chandise differentiation strategies, offering merchandise that is either
unique or of better quality. For example, a store or stall would offer dried
mushrooms that are unobtainable in state stores and might even have been
harvested and dried in another province. The mushroom harvester might
have shipped them or even brought them directly to the store or stall that
sells them at retail.
These retailers compete with each other using both service and person-
ality augmentation and price leadership strategies. Each will try to attract
steady customers by building a personal relationship with them. While the
aggregate price level in the free market may be higher than in state stores,
competition is becoming intense among free market retailers. Prices are
not fixed, bargaining is encouraged, and most retailers will shave prices
where necessary.

Free Market Retailers as Wholesalers

The internal distribution system in China has a very limited capacity. Many
goods available in one province are often unavailable in others. Even where
goods are readily available, there are price differences across provinces.
 FREE MARKET RETAILING IN CHINA 67

When the distribution system was state-owned, individuals could not take
advantage either of differential availability or of the arbitrage opportunities
offered by inter-province price differentials. Now that fi-ee market retailing
is allowed, enterprising retailers travel from province to province in search
of merchandise that is either unavailable at home or can be purchased more
advantageously than at home.
Cigarettes, for example, can be sold for 2 yuan a pack in Chongquing but
cost only 1 yuan per pack in Shanghai. Part-time entrepreneurs from Chong-
quing travel to Shanghai where they buy packs of cigarettes for 1 yuan and
resell them to wholesalers in Chongquing for 1.5 yuan. They claim to earn
200 yuan per month, or twice their salary as factory workers, at this sideline
business.'
The dress shop included in our sample did a substantial proportion of its
business in wholesale sales to retailers from other provinces. Some of the
free market retailers selling dried food, such as mushrooms, also have
substantial inter-provincial wholesale businesses.
The shoppers who buy for resale hand-carry their purchases, travelling
from place to place on the very inexpensive but uncomfortable railroad
system. Their porterage provides a way around the capacity limitations of
the physical distribution system. The quantities they can carry necessarily
are limited, and the goods in which they trade are restricted to items that are
relatively low in bulk but high in value. Interestingly, intra-provincial whole-
saling has already spawned at least one other business in Guangzhou. The
principal customers of the hotel included in our interview sample were
out-of-tovm retailers who had come to Guangzhou in search of merchandise.
In fact, one of the key services provided by the hotel owner is advice on
where to find the best buys; another is providing a safe place to keep money
and goods.
Many of the free market sellers, including those selling fresh meats, fish,
and vegetables and those selling preserved foods, have also developed
substantial local wholesale businesses. Their customers are the privately
owned restaurants. Since these restaurants compete by offering better
quality food or food not obtainable in the state-owned restaurants,
restauranteurs naturally gravitate to free market sources for their needs.
Since free market restaurants can command higher prices for their food,
they pay the higher prices demanded by free market retailers.

Free Market Retailers as Importer/Exporters

Imports of consumer goods into China are controlled by the state trading
companies in each province. Imported goods have been inaccessible to the
average Chinese citizen except when offered for sale in a state store. The
State's efforts to control importing have been reinforced by a dual currency
system, consisting of the local currency, the yuan which can only be used to
buy locally produced products, and the FEC, or Foreign Exchange Certifi-
68 HEIDI VERNON-WORTZEL & LAWRENCE H. WORTZEL

cate. The FEC is issued only to foreign visitors and only in exchange for hard
currency. It is the only currency accepted at tourist hotels, restaurants
catering to foreigners, and Friendship stores (stores set up solely for
tourists).
When state-owned institutions were the only place to use FECs, most
foreign exchange earnings flowed back to the Chinese government because
there was little or no opportunity for local citizens to use FECs if and when
they acquired them. But with the advent of free market retailing, an informal
import/export market has appeared, with free market retailers playing a key
role. A cadre of money changers and middlemen has appeared. The money
changers buy FECs both from local Chinese and foreign visitors. Although
the value of a yuan and the FEC are exactly the same when used to purchase
goods at a state store, money changers will pay a premium in yuan when
buying FECs and will sell them to individuals who want to import. Many of
these importers are free market retailers.
The middleman group is primarily composed of Hong Kong Chinese who
travel to Guangzhou (an easy trip by train or boat) laden with small, high
value consumer products such as watches and tape decks purchased in Hong
Kong. These imports are not limited to goods made in Hong Kong. Japanese
and even Western made goods may be included. The middlemen sell these
items to free market retailers, who in turn sell them to local Chinese. The
free market retailers may accept payment from their customers in FECs at
one price or in joian at a higher price, depending on their own currency
needs. So, in a sense, these retailers are also performing a money-changing
function.
Likewise, the Hong Kong middlemen do not always require pa5niient from
the retailer in FECs. Many of the middlemen are engaged in two-way trade
and will accept yuan, which they then spend in Guangzhou for locally
produced products such as dried mushrooms or traditional medicines. The
middlemen will then bring these back to Hong Kong and sell them at a profit,
using the Hong Kong dollars earned to buy more consumer goods to carry
back to Guangzhou.
The impact of this informal import/export trade extends well beyond
Guangzhou because it also constitutes a key part of the inter-provincial
wholesale trade. The Guangzhou free market retailers who deal in imported
goods wholesale their imports inter-provincially, as well as sell them at
retail. A significant proportion of the retailer/buyers who come to Guang-
zhou come in search of imported goods.
In summary, what has developed in Guangzhou, even at this early stage,
is a retailing system that exhibits diversity in both form and function and that
conducts wholesale trade and import/export trade as well as retailing. The
wholesale component is likely to be found in other parts of China as well. But
the import/export component is likely to be found principally in Guangzhou
and a few other southern cities with easy access to Hong Kong.
 FREE MARKET RETAILING IN CHINA 69
Future of the Free Market Retailer
China is a country of great diversity, and the extent and speed of change
varies significantly by location and by industry. Therefore, generalizations
about the future of free market retailing may not apply uniformly across the
country. Free market retailing is, at present, a very attractive opportunity to
make money. If free market retailing is held to a small proportion of total
retail sales, and if the state system is not radically changed, free market
retailers should continue to prosper. But if free market retailing is either
allowed unbridled growth or if the state system is given more freedom of
action in terms of location, pricing, and strategy, competition will become
much more intense in the free market.
Our expectation is that free market retailing will be allowed to grow.
One reason is that growth will spread the profits more broadly. A second
reason is that continued expansion can stimulate growth in the output of both
manufactured consumer goods and agricultural products by providing acces-
sible distribution channels and the possibility of higher retums to producers.
In addition, unemployment has been increasing in the cities and the free
market distribution system provides jobs for some urban residents who
would otherwise be unemployed.
A shakeout seems most unlikely, unless retums fall to levels that make
free market retailing less attractive than working in a state-provided job.
This does not seem probable because growth in the number of attractive
state-provided jobs will be limited and because economic growth will offer
additional opportunities for new retail entrants without cutting into either the
state or existing free market system to the point at which either is
threatened.
If the Chinese government continues its present policies, evolution in
two directions seems likely. One direction is toward the establishment of
some larger stores, government regulations permitting. The population
density of China's large cities, coupled with rising incomes, mitigates in
favor of bigger retail units. At present, the size limitation appears to be
government imposed. If establishments are to grow, it will be to the extent
that there are adequate supplies of consumer goods and available capital for
expansion.
The second direction will be in the evolution of an infrastmcture to
service free market retailers and to link them more effectively with man-
ufacturers. With the evolution vdll come specialization; some retailers who
are now also doing wholesale business will evolve into dedicated wholesal-
ers. Manufacturers will look for reliable, consistent means for getting their
merchandise to retailers. This will also contribute to the development of
wholesaling. Specialist salespeople, representing manufacturers and
wholesalers, will evolve and so will sectors specializing in transportation,
both intra- and inter-city. The potential effects of these changes in the
70 HEIDI VERNON-WORTZEL & LAWRENCE H. WORTZEL
retail system are many and cumulatively can have an impact on the Chinese
economy that extends well beyond the retailing sector.
It is impossible at this point to identify either the depth or breadth of the
impact because the free market arrangements are too new to be used as
predictors. We can, however, point out some of the likely possibilities and
their potential effects.

Effects of the Private Sector on Employment

In many developing countries, the distribution sector typically represents
disguised unemployment. Many who work as retailers are either peddlers
earning subsistence wages or v^ves and children supplementing the primary
wage earner's income with proceeds from a small store or stall. In China,
however, retailing represents the easiest of the few paths to wealth and it is
an easy path for a collective as well as an individual to take. But it is a path
that is not vdthout risks for individual entrepreneurs. Among individuals,
working in the free market rather than for the state is still for mavericks.
"Generally speaking, we individual laborers are those who dare to go
against the trend of our society. We are those who dare to say, dare to
behave what ordinary people dare not." This observation by Rong Zhiren,
Director of the Guangazhou Individual Laborers Association, gives some
hint of the precarious position of the free marketer in a state system. Before
1978, when Deng Xiaoping took power, those who engaged in private
businesses of any kind were heavily punished. The ideology of the govern-
ment has not changed in rhetoric as much as in substance. Deng continues to
disparage the capitalist system, which he says breeds corruption and greed,
while at the same time he supports and encourages free enterprise. There is
no doubt, however, that a serious debate is continuing within the party about
the proper scope of private enterprise, and that some stillfrovmupon it. The
People's Daily, the official newspaper, urges party officials not to get en-
gaged in business which it calls an "unhealthy tendency (which) undermines
communist ideals and discipline." ^^
Despite some official frovming, in the few years since free enterprise has
been possible, Chinese have taken to it as "sunfiowers to the sun." ^^ Several
economic historians note that no Communist country has encouraged free
enterprise to the same extent, nor had it blossom as quickly. The alacrity
with which the Chinese have taken to free enterprise may be explained by
the fact that there are still many people in China who took part in the free
enterprise system prior to liberation in 1949. Although they were reviled in
the Cultural Revolution, they remember the rewards that were the result of
hard work and an entrepreneurial spirit. For their sons and daughters, the
monetary benefits of free enterprise are considerably more than they can
expect under the State system. Success stores such as that of Han Boting
are legion. According to her story published in China Daily, she invested in
two frying pans, sugar, and 330 pounds of crab apples purchased on the free
 FREE MARKET RETAILING IN CHINA 71

market. Now she makes about $40 a week as a fast food retailer, more than
six times the wage of the average factory worker. '^
The potential problem side of free enterprises is exemplified by govern-
ment engineers who moonlight at the privately owned Shanghai O.K. Infor-
mation & Technology Research & Development Co. Their moonlighting
gives them wages as high as $352 a month, more than twice the salary of
Deng Xiaoping and about seven times that of the wages of government
engineers. ^"^ Now that there are things to buy, the temptations are hard to
resist, even though the engineers risk resentment from those whose op-
portunities are not as great.
There are major issues with which the Chinese are going to have to deal
if they continue to support a system in which a peasant can have a
substantially higher income than a government employee and in which a
government employee can earn much more moonlighting than in his gov-
ernment job. Faculty members of universities, doctors, and other profes-
sionals are finding that the salaries paid them by state put them at an
increasing disadvantage in terms of purchasing goods that make their lives
more pleasant. The result is that the best and brightest may defect from
such occupations.
The situation in Hungary provides a reasonable comparison. Of all the
Eastern European countries, Hungary is the one in which the free market
has prospered (although not to the same extent or in quite the same
direction as in China). The effect, however, is much the same. Govern-
ment workers, highly educated academics, and health care personnel are
paid by the state. They look at a less comfortable, dimmer future in terms
of ability to purchase goods that add to the quality of life. Many are
choosing careers as restaurant owners and shopkeepers rather than as
executives in the large state-owned firms.
Despite the economic disadvantages, some still stay with the state
sector. But those Hungarians who stay have advantages that Chinese state
employees do not. Hungary's proximity to Western Europe and the free-
dom to take vacations outside the Communist bloc siphon off some of the
discontent over earning power. In addition, many professionals are able to
attend meetings abroad and to gain prestige that is not available to their
wealthier, entrepreneurial countrymen. For the Hungarian, there are
other compensations for low wages. To the Chinese businessman or
woman, compensation is overwhelmingly economic. The only reward is
the ability to pay for the Hong Kong-purchased television, refrigerator, or
stereo system.
Choosing the path of economic reward is not without its risks, however.
The private sector entrepreneur must forego many state benefits, includ-
ing free medical care and a pension. In addition, there is always the threat
of a backlash against progress, probably not as severe a backlash as the
Cultural Revolution, but worrisome nevertheless. This concern that en-
72 HEIDI VERNON-WORTZEL & LAWRENCE H. WORTZEL

trepreneurship might corrupt the political purity of the Party was evident in
a People's Daily editorial. The paper warned party members to demon-
strate austerity and not to follow the examples of peasants who used their
money to build impressive homes and to buy Japanese vans. '^ National
leaders are, as prime minister Zhao Ziyang put it, "wading a river by
groping stone by stone for solid footing on the riverbed." If such a backlash
occurs, the entrepreneur might not only lose everything but might also be
prohibited from taking a new position in any state-owned undertaking;
there is the threat of consignment to economic and political limbo.

Effects on Consumers
Free market retailing has the potential of affecting consumers in three ways.
It can introduce inequities in the way goods are distributed, it can change the
mix of goods that are available, and it can affect the efficiency, either
positively or negatively, with which they are distributed.
Equity EffectsEquity can be affected when income distributions change
as they have now with the introduction of free enterprise. Before the Four
Modernizations, incomes in China were relatively equal, regardless of one's
job, and prices were controlled. So far, free market retailing has not affected
the equitable distribution of essentials. This is because the Government has
kept a firm hand on the distribution, and thus the price, of essentials.
However, the potential for inequitable distribution is there, as we can see in
the decrease in grain production. When given the freedom to decide what to
produce, many farmers choose to produce those crops that promise better
economic retum. In this situation, free market retailing of grain could result
in price increases that will, of course, have an impact on the state worker
much more than on the new affiuent class.
But if one wants to apply equity considerations to non-essentials, then the
conclusion is that free market retailing has introduced inequities into the
system. Before free market retailing, for example, the purchase of a televi-
sion required a couponfromthe work unit with no variation in the price of the
set. Since incomes were relatively equal, everyone had relatively equal
access to a set. Now any newly wealthy entrepreneur can manage to acquire
a set imported through Hong Kong, regardless of his (or her) official
entitlement, because he can pay the premium that the availability of the set
commands. As long as the state stores are able to get merchandise, the
consumer can buy at a lower price; but if not, consumers will pay more.
Free market retailers' choices of merchandise are based on what these
merchants think they can profitably sell rather than on a government plan or
on what is equitable. To the extent that they can get a good price for an item,
they are willing to pay a correspondingly high price to obtain it. Manufactur-
ers producing for the free market are motivated to produce whatever gives
the best retum, a circumstance which may not coincide with what the
 FREE MARKET RETAILING IN CHINA 73
economy needs. Given a price-controlled state system operating alongside a
free market, it is likely that manufacturers will realize even more clearly that
they can get better returns by producing those goods demanded by the free
market sector.
Changes in the Mix of Goods AvailableWith access to the free
market, many consumers should find that they have access to a broader
range of products and to broader assortments within product types. The
growth of free market retailing encourages the manufacture of new products
because manufacturers can easily enter a distribution system that reaches
consumers and allows them to get prices for their goods that exceed their
costs. Now that manufacturing enterprises can retain some or all of their
profits, they have an incentive to produce for the free market. Similarly, free
market retailers have an incentive to stock broader assortments because
they profit directly from any increased sales generated by assortment
breadth.
The benefits of a broadened product mix available in Guangzhou extend
beyond Guangzhou. When peddlers come to Guangzhou to purchase prod-
ucts to take back for resale in their native provinces, the customers in
those provinces have access to goods that are not normally available
through the state system. The process of free enterprise in which indi-
vidual entrepreneurs move goods from one area to another may help to
eliminate some of the bottleneck that now exists in China's internal dis-
tribution system without requiring extensive capital investment.
Free market retailing should also increase the flow of better quality
goods. Until recently, under the state system, wholesalers paid growers
the same price for poor tasting or appearing apples as for better quality. In
that system, a more reliable or better-sounding radio did not command a
premium that justified the effort necessary to produce it. Now, factories
that do not produce quality goods are admonished and are not permitted to
retain earnings for bonuses, while the quality producers are allowed to
prosper. Consumers, even under the old state system, became discrimi-
nating as soon as there was some choice in quality. Certain brands of
bicycles would languish unsold in department stores while other brands
would be bought immediately. Consumers would wait for weeks or months
to acquire high quality products.
Since free market retailers can set their own prices, they can pay
manufacturers more for better quality in those cases where consumers are
willing to pay a premium. And they will select only those items that are
well-made and offer good value, since they must bear the economic losses
generated by unsaleable goods. The effect should be to accelerate the
movement to better quality.
In a small way, free market retailing is increasing theflowof imports into
China and broadening the range of goods available without putting pressure
on its balance of payments. Some consumers will benefit as a result, but it
74 HEIDI VERNON-WORTZEL & LAWRENCE H. WORTZEL

is questionable whether consumer benefits from imports will be distributed

either efficiently or equitably using the free market as it now exists. The
inefficiencies occur because imports are hand-carried in small quantities.
Scarce or desirable imported goods are sold by free marketers at artificially
high prices. On the other hand, these imports might dampen infiation by
pulling excess money out of the market. And they may result in more
exports than would have been the case without the informal import-export
market that has grown up.
Free market retailing has also been one of the forces behind the Summer
1986 devaluation of the yuan. The devaluation was, in part, an attempt to
eliminate the difference in value between the yuan and the FEC. As noted
earlier, the FEC commanded a premium over the yuan because it could be
used to purchase imported goods.
Efficiency EffectsThe conventional argument is that moving from a
state-owned to a private enterprise system should increase efficiency for
two reasons: private enterprise offers incentives for efficient operations
that are not present in a state-owned system; private enterprise is ac-
companied by a competitive environment in which prices are set by market
forces rather than by government fiat. Thus, a private enterprise system
encourages efficiency by rewarding the firms who operate efficiently and
punishing those who do not.
Actually, there is nothing inherent in or intrinsic to a state-owned
system that decrees inefficiency. There has been a long standing tradition
of separation of ownership and management among largefirmsin capitalist
countries. Many are efficient because these firms' profit-based incentive
systems reward efficiency. But a system that rewards efficiency need not
be tied to profits. It is possible to design compensation systems that
reward cost-minimizing activity, for example.
As a practical manner, however, it can be extremely difficult to reorient
equity driven state-owned distribution systems to become efficiency
driven. It can be a far more difficult task than increasing efficiency in, say, a
production plant. Typically, production plants often specialize in one or
several products of similar characteristics. Both their costs and the quality
of their output, a tangible product, are measurable and assignable without
too much difficulty. Distribution institutions, both wholesale and retail, are
more complex. It can be difficult to increase efficiency since the focus is on
service rather than product. It is also more difficult to measure the costs of
particular, individual activities than in a factory. The diversity of products
carried by these institutions will usually include both "equity" and "effi-
ciency" products. It is difficult to install any single incentive system in a
wholesale or retail establishment unless the establishment is restricted to
handling only one of the categories of goods. Given these considerations, it
seems that the simplest and most effective thing to do is to create a second
distribution system operating under rules that encourage efficiency maxi-
mization.
 FREE MARKET RETAILING IN CHINA 75

There is, however, another aspect to efficiency besides ovmership and

market forces. That aspect is structure. Increasing distribution efficiency
is invariably achieved by shortening the channels of distribution and in-
creasing the size of retailing, wholesaling, and warehousing units. In the
People's Republic of China, free market retailing has introduced longer
channels and smaller units, at least at the retail level. When specialization
takes hold, the wholesaling units that will emerge are also likely to be
smaller than their state-owned counterparts. Government-imposed con-
straints on the size of privately-owned businesses mitigate against the
growth of large retailers or wholesalers. At present, the maximum allow-
able size of a private enterprise is eleven employees. Thus, the potential of
free market retailing for increasing efficiency may not be fully realized.
This does not rule out, however, the possibility of significant gains in
efficiency from the introduction of free market retailing, especially in small
consumer packaged goods.
Whether the potential gains are realized depends not only on the size of
free market retailing and wholesaling units but on the response of the state
system. As supplies of more and more goods become adequate and as the
free market system sets prices for these goods, it becomes increasingly
tempting and possible to subject state retailers to marketplace discipline,
thus making them responsible for profits and rewarding the management
commensurate with the profits their stores produce. In fact, it may be
necessary to do this in order to keep good managers from defecting to jobs
in the free market. There is some evidence that the state system is ahready
responding and further responses can be expected. State outlets are
responding by improving the quality and range of goods they offer. But the
result, if the free market leads the way, might be higher prices for all.

Conclusion
Probably the most optimistic conclusion that one can come to is that the
introduction of free market retailing has raised some interesting new pos-
sibilities for the accelerated development of the Chinese economy. But free
market retailing will not automatically lead to the realization of these pos-
sibilities. Realization depends on how well and how sensitively the transition
is managed.
The promises and consequences of free market retailing, as they are
being worked out in Guangzhou and elsewhere in China, transcend even the
critical issue of equity and efficiency in this command economy. Free market
retailing is changing the very structure of China's retail distribution and has a
profound impact on the type and quality of goods available to China's one
billion plus citizens. The free market fosters new arrangements in currency
transactions and in import opportunities. Even the internal distribution
system feels the effect of this grov^nng trend.
It is far too early to draw major conclusions about the impact of free
76 HEIDI VERNON-WORTZEL & LAWRENCE H. WORTZEL

market retailing on entrenched institutions. The Chinese government will

have to grope its way over the slippery stones until it reaches the firm
footing of a thriving economy, prosperous population, and stable institutions.
China is unique among developing countries in the mix of state and free
market systems that it uses to deliver goods. If it uses the mix correctly, it
can achieve both equity and efficiency. Even the model adopted by other
command economies is not a predictor for China. If China can achieve its
goals, the lessons for other developing nations will be both useful and
applicable.

References
1. Richard Baum, ed., China's Four Modernizations: The New Technological Revolution
(Boulder, CO: Westview Press, 1980), p. 21.
2. Heidi Vemon-Wortzel, "Equity and Efficiency in the Distribution of Non-Food Consumer
Goods in China: Shanghai as an Example, "Asian Survey (Summer 1983).
3. John A. Reeder, "A Small Study of a Big Market in the People's Republic of ChinaThe
'Free Market' System," The Columbia Jounral of World Business (Winter 1983), p. 74.
4. The New York Times, May 27, 1982, p. 2.
5. Robert Michael Field, "Changes in Chinese Industry Since 1978," The China Quarterly
(December 1984), p. 745.
6. Asiaweek (November 1985), p. 23.
7. Erdener Keynak, Marketing in the Third World (New York, NY: Praeger Publishers,
1982).
8. Lawrence H. Wortzel, "Retailing Strategies for Today's Changing Marketplace, "/(M<r-
nal ofBusiness Strategy (forthcoming).
9. Tom Ashbrook, "A Chinese Cornucopia," The Boston Globe, November 14, 1985, p. 2.
10. Ibid.
11. Ross Terrill, "Capitalism and 'Dancing Fever,' Sichuan Style," The Boston Globe, May
25, 1986, p. 63.
12. The Journal of Commerce, June 11, 1985, p. 5A.
13. The Boston Globe, November 27, 1985, p. Al.
14. The Journal of Commerce, July 9, 1985, p. 5A.
15. The Wall St. Journal, March 11, 1985, p. 32.