China transformed from a peasant society to the world’s second largest global economy within a single generation. With the opening of the economy and market reforms, entrepreneurial spirit has flourished: State-Owned Enterprises (SOEs) have been privatized, millions of Chinese have started new ventures, and China has taken advantage of its large labor force through low-cost manufacturing. But the PRC has come to a crucial juncture in its economic and social development. The current growth model is unbalanced towards exports and not sustainable in an environment of rising input costs. Thus, China’s growth in the next decade will depend on the country’s ability to move to the next stage of production through innovation and enhanced productivity and higher consumption through social stability.

Reform via a step-by-step approach

In order to maintain close control over this economic development, Chinese leadership first invoked a step-by-step approach to reforms, or as often summarized by the famous expression, “cross the river by feeling the stones”. On a trial and error basis, special regions were chosen for reform. If the reforms worked, they would be applied to new areas; if they failed they would be abandoned. This approach continues to this day.

The first economic changes, begun in the late 1970s, consisted of agricultural decollectivization by dismantling rural communes and giving entrepreneurs permission to start up businesses. Shortly thereafter, the area around Shenzhen (Guangdong province) was granted the status of a Special Economic Zone (SEZ) and thereby given favorable policies allowing for foreign trade and investments.

These reform approaches were almost instantly successful: China’s agricultural production soared, and Shenzhen became an economic powerhouse. Consequently,…