December 1978 was a political, economic and social turning point for China. As the balance of power within the top leadership shifted, a search for new policies began that deepened into what came to be called “reform and opening” and culminated decades later in a multistranded transition to a market-based economy. This new policy orientation was accompanied by a shift in development strategy that permitted China to take advantage of its factor endowments and structural conditions and dramatically accelerate economic growth. Thus 1978 marks not only the beginning of “reform,” but also the start of the Chinese “economic miracle,” a remarkable thirty-two-year period, through 2010, during which GDP grew at an annual rate of 10 percent. Chinese economic structure and Chinese society were utterly transformed. An extraordinary distance separates the vibrant upper-middle-income, predominantly market-based, economy that is China today from the troubled, isolated low-income country that was China at the end of the Cultural Revolution. This chapter builds its narrative around the systemic and structural changes that transformed China, especially in the thirty years between 1978 and 2008.

China began its transition to a market economy nearly thirty years ago under an authoritarian and hierarchical political system. Today, after market transition has wrought fundamental changes in China's economy and transformed every aspect of China's society, that political system survives, with its basic features intact. Indeed, the two most surprising aspects of China's recent past are the thoroughness of economic change and the durability of the Communist Party (CP)-run political system. During the economic transformation, the CP hierarchy did not sit off to one side, frozen in time while everything else in China changed. Rather, the hierarchical political system shaped the process of market transition, and the political hierarchy itself has been reshaped in response to the forces unleashed by economic transition. The critical economic transition policies were made by national leaders acting in the context of their positions in the authoritarian political system and as a result, many of the basic features of the reform process can be explained by the structure of the political system and the changing needs of politicians within that system.

China's enduring “gradualist” approach to transition obviously suits the needs of its authoritarian leaders. More interesting is that the concrete policy content of China's transition – which differed dramatically in different periods – can also be traced to the changing structure of power and strategic calculations of leaders within the authoritarian system.

During the 1980s, China experienced a steady decline in central government control over the economy, the political system, and society as a whole. Economic reforms emphasized decentralization of resources and decisionsion-making authority, which empowered local governments and enterprises at erprises at the expense of the national government. Economic liberalization fostered the creation of literally millions of new economic entities, combined with new market rules and incentives. Rapid economic growth not only led to a much larger and more complex economy but also greatly expanded regional diversity. Government demands for conformity receded, allowing a more relaxed and diverse society to develop. Although conservatives sought to roll back some of these reformist changes after the Tiananmen massacre, they were unable to reverse the most fundamental changes. Indeed, there is universal agreement that the 1980s witnessed a historic retreat of the Chinese central government. Given breathing space by the rollback of the Chinese state, Chinese society and the Chinese economy came alive.

Nevertheless, the decline in the authority of the Chinese state was not a smooth or trouble-free process. Like governments in all transitional economies, China's leaders abandoned crude but powerful tools of government resource allocation before market-friendly indirect and regulatory institutions were available. Inevitably, government effectiveness declined and the central government's financial prowes steadily eroded. The Chinese government simply seemed ill equipped to carry out the tasks demanded of it in the new economic environment. Even more troubling, the Chinese government frequently seemed unable to override particularistic, regional, and sectional interests.