Economic reform in Menghe
Economic reform in Menghe refers to a series of economic reforms undertaken in the Socialist Republic of Menghe from 1987 onward. Broadly speaking, these changes consisted of a gradual transition from a state socialist command economy to a state capitalist mixed economy. Private firms were legalized, state-owned enterprises were corporatized, and mixed-ownership Jachi-hoesa came to dominate the Menghean economy. As a result of these reforms, Menghe experienced rapid economic growth from the late 1980s onward, a phenomenon known as the Menghean economic miracle.
In Menghe, the reforms are grouped under a variety of names, including the Second Opening-Up (Menghean: 두 번째 캐방, Du Bŏnjjae Kaebang), the Choe-Cho Reforms (최-초 개혁, Choe-Cho Gaehyŏk), and the New Socialism (신세대 사회주의, Sinsedae Sahoejuyi). While many of the reforms are capitalist in nature, centering on an increased role for markets and a loosening of central control, the ruling Menghean Socialist Party has insisted on classifying them as reforms within Socialism, and retains a central if indirect role for state economic policy.
Notably, economic reform in Menghe is not complete, and remains an ongoing process. State-owned enterprises still dominate certain economic sectors, including natural resources, and Jachi-hoesa corporations remain dependent on their political ties. Despite state efforts to combat corruption, bribes and personal connections often override market competition, creating barriers to the expansion of impartial rule of law. Most recently, the government has embarked on a "Domestic Innovation Campaign," attempting to break out of a production chain where products are designed abroad and assembled in Menghe.
Background
Economic conditions in 1987
At the end of 1987, Menghe was in a state of deep economic crisis. State-led industrialization drives under Sim Jin-hwan had produced a strong core economy built around heavy industry, particularly sectors related to defense. But the light industry and consumer goods sectors were very weak, and actual household incomes remained low, in part due to high defense spending. Menghe's large state-run factories were also notoriously inefficient, and much of the growth of the 1960s and 1970s was driven by increased employment of resources and post-war reconstruction rather than improvements in productivity.
Ryŏ Ho-jun's tenure as Chairman of the Menghean People's Communist Party created even larger crises. As part of his drive for mass-led communism, Ryŏ forcibly broke up many of the large state-owned enterprises, splitting apart the administrative planning system and in some cases literally breaking up factories to ship individual pieces of equipment to village workshops. The resulting backyard furnaces produced low-quality steel which was often unusable, and at the height of Ryŏ's decentralization drive, many farmers melted or disassembled cooking pans and farming equipment in order to supply the needed iron.
The DPRM's controversial nuclear weapons program also contributed to this period of stagnation and decline. After Menghe conducted its first nuclear test in November 1984, the Septentrion League voted to enact STAND's enforcement clause, imposing a total economic embargo on the DPRM. Even longtime communist allies like Maverica, Innominada, Polvokia, and East Dzhungestan severed trade with Menghe, alienated by Ryŏ's belligerent rhetoric and concerned that standing with Menghe could provoke a broader conflict. The embargo led to severe shortages of oil, plastics, sugar, and high-grade machine parts, and struck at a time when domestic stockpiles of strategic goods had already been depleted by Ryŏ's economic decentralization drive.
In the midst of this already dire situation, an El Niño cycle struck in the mid-1980s, causing a severe drought across southern Menghe. Menghean farmers were still struggling to adjust to a large-scale collectivization campaign, as well as shortages of farm tools and other industrial inputs. Due to embargo-related trade restrictions, Menghe was unable to import food, and past disruptions to the country's railway infrastructure and planning apparatus greatly hindered the delivery of food aid from the still-rainy northeast. This resulted in a devastating famine which may have caused upwards of 20 million deaths.
Regime change
On December 21st, 1987, Choe Sŭng-min seized power in a military coup, disbanded the Menghean People's Communist Party, and established the Interim Council for National Reconstruction. Among his early goals was thorough revitalization of Menghe's economy and the immediate delivery of foreign aid to famine-stricken regions. Choe revived the popular slogan of Buguk Gangbyŏng, or "Enrich the Country, Strengthen the Military," which first gained popularity in Menghe during the late 19th and early 20th centuries. Compared with rulers of the Greater Menghean Empire, however, Choe added a new twist of interpretation, stressing that a rich economy was a precondition to a strong military.
Early reforms: 1987-1994
Ideological changes
Choe and his allies recognized that repairing the damage of the Ryŏ years would require a major overhaul of the country's economic policy, but at the outset, they lacked a clear blueprint about what to change. Most high-ranking military officers and economic planners favored a return to the highly-centralized planned economy of the Sim Jin-hwan years, which had succeeded in raising steel output and supporting the growth of the armed forces. Other reformists, particularly rehabilitated MPCP members purged by Ryŏ, called for a new emphasis on light industry, agriculture, and consumer goods, as well as public services like healthcare and education. With the MPCP out of power and hardline leftists imprisoned or executed, the new government faced few ideological constraints, but there was still a widespread belief in the country that economic revitalization would rely on some kind of reformed socialism. The renaming of the Democratic People's Republic of Menghe to the Socialist Republic of Menghe reflected this conviction.
Choe Sŭng-min initially agreed with this assessment. In his pre-coup writings, he was fiercely critical of individual greed and the merchant-led order of the Republic of Menghe, which was widely regarded as corrupt, unjust, and dependent on foreign powers. In his first speeches after the coup, he affirmed that the new regime would return Menghe from Ryŏ's dysfunctional communism to a new form of socialism, which listeners at home and abroad interpreted as a return to the Sim Jin-hwan years. At the same time, Choe spoke extensively about the need to establish a more efficient or rational form of Socialism, with the aim of generating higher productivity and economic growth without the destabilizing effects of private enterprise. Choe first termed this system saesan jungsim sahoejuyi, or "socialism based on the assessment of productivity," though in the international press it became better-known as "meritocratic socialism."
Meritocratic socialism never acquired a clear, unified formula, and the Menghean Socialist Party later dropped the term in the late 1990s in favor of "new-age socialism" (sinsedae sahoejuyi). Its main underlying principle was that workers and managers should receive stronger incentives to increase productivity in the context of state-owned enterprises. For workers, this meant the expansion of piecework wages and cash bonuses awarded for meeting quotas. Reforms to layoff regulations meant that managers could more easily dismiss workers who consistently fell below quota, though only if they could provide documentation to this effect. Similarly, upper-level managers were instructed to promote, relocate, or dismiss lower managers depending on measures of job performance at their firms. Work units which consistently failed to meet their quotas would be placed under new management or disbanded altogether.
The new regime also embarked on a new campaign of construction, signaling further parallels with the DPRM's past emphasis on heavy industry. Having opened the country to international trade, and negotiated a small détente with Dayashina, Choe ordered provincial and prefectural governments to organize the construction of new factories with state-of-the-art machinery, with a particular focus on steel, fertilizer, and electronics. Entire plants were imported from overseas, many of them export-oriented, with the intention of repaying construction and aid loans with the hard currency won from international trade. All factories built during this early period were state-owned, and constituted outright purchases of equipment rather than foreign direct investment.
Planning documents and policy studies from 1989 and 1990 signaled ambitious plans for meritocratic socialism. One ministerial paper proposed a standardized wage-productivity scale for all workers, and another laid out plans for the installation of a large computer network to record inputs, outputs, and stockpiles in all factories. In actual practice, however, subsequent reforms took a very different direction.
Agricultural decollectivization
While most early ideological discussion in the Menghean Socialist Party focused on heavy industry, the first emergency reforms targeted the agricultural sector. In early Jamuary 1988, the new Menghean government secured an agreement with the Septentrion League in which Menghe would turn over its nuclear weapons stockpile in return for immediate food and medical aid. Themiclesia was among the first countries to send the needed aid on a large scale. The Army also dispatched its own logistical units to ship grain from less-affected to more-affected regions.
Under pressure to prevent a fourth year of famine in 1988, the Interim Council for National Reconstruction passed the Emergency Guideline on Agricultural Contracting. This guideline maintained state ownership over all agricultural land, but it instructed village committees to divide up their farmland into individual plots, each of which would be farmed by a single household for the entirety of the year. The basic principle, shared with previous agricultural reforms in some communist countries, was to improve productivity by eliminating redundancies and coordination problems and allowing each household to specialize on a given plot. Farmers in Gangwŏn Province had experimented illegally with similar measures in the mid-1980s, earning the recognition of Army officers. Approximately 40% of Menghean villages enacted some form of agricultural contracting in 1988, and an additional 30% adopted it in 1989.
At the outset, the Interim Council government regarded agricultural contracting as an emergency relief measure rather than a permanent solution. The Emergency Guideline was drafted in less than a month so that it could be distributed ahead of spring planting, and it did not incorporate any in-depth input from agricultural experts. Speeches and documents from the summer of 1988 mention long-term plans for agricultural industrialization and the consolidation of village plots into large farms, which would have necessitated a return to collectivization or direct management. In light of this, the Emergency Guideline was specific in stating that the state would maintain ultimate legal ownership of all land, even as village committees were left free to contract out small plots to households.
This outlook changed in the fall of 1988, when the first half-year harvests began coming in. Counties that had implemented agricultural contracting reported substantially larger yields than those that had not, and overall yields rose well above their peak numbers in the early 1980s. Not all of this change stemmed from the reforms: the summer monsoon cycle of 1988 saw normal rain levels, bringing an end to the past three years' drought, and villages in formerly drought-stricken regions were more likely to implement agricultural contracting. Nevertheless, it quickly became clear that household farming was more productive than collective farming, even in large industrial farms. Because the DPRM had only implemented large-scale collectivization in 1983, most farmers still had recent memories of farming personal plots, and in many cases the household contracting plots lined up with pre-collectivization plots.
Choe Sŭng-min quickly picked up on the implications of this trend, positioning himself as the personal architect of Menghe's agricultural reforms. In the spring of 1989 he made a widely publicized tour of farming villages in North and South Chŏllo to oversee the contracting process and congratulate farmers on the past year's harvest. This move made him dramatically popular among the rural population, particularly in the south, and helped cement his position as the most visible figure in the post-coup government. Other top military officials were slower to change their course and remained fixated on heavy industry, in some cases openly criticizing the Chairman for his repeated tours of rice fields and grain mills.
The success of agricultural decollectivization opened the way for deeper reforms of Menghe's agricultural system. In August 1989, the Supreme Council issued an executive order authorizing county governments to experiment with household surplus retention. Under the surplus retention system, each household plot in a farming village was required to turn over a certain quota of grain or other crops to the village's state-run food distribution center, but it could sell the remaining surplus food directly to consumers or enterprises at market value. Some villages had already experimented with similar reforms during the previous year in an effort to incentivize farmers to work harder, but these experiments now had official government support. This time, Choe Sŭng-min took a visible role in the new policy from the outset, even when it brought him into open debate with leftist conservatives worried about speculation and price gouging. With the drought period at an end and food production rising, the increase in food prices was only modest, winning Choe more support from rural Menghe.
Emergence of private firms
Another source of unexpected success was the emergence of small, privately run firms, especially in the countryside and the urban periphery. The small business boom directly benefited from the surplus retention system of 1989, which effectively allowed farming households to set up private food stalls and transport companies, but even before the Decembrist Revolution some prefectural governments in the Donghae region looked the other way as villagers set up private workshops to make much-needed goods. Like the agricultural reforms, the toleration of small private business proved popular among the general population after it delivered higher productivity, and state media exaggerated Choe Sŭng-min's role in its adoption. By 1990, many county governments were using state construction funds to build permanent market buildings where private sellers could rent out stalls to sell food and handicrafts.
Initially, the Menghean Socialist Party sought to impose some limits on the growth of private business, which still contradicted its statist ideology. The 1989 surplus retention reform stated that households could not hire any workers from outside their families to work contracted plots or transport and sell goods, but in a culture with large extended family networks, this restriction proved impossible to enforce. A revised law passed in 1991 stated that village enterprises could hire paid workers outside the owner's family, provided that they did not hire more than ten. This law was also poorly enforced, though the ten-worker ceiling would remain important in Menghean economic regulations until the 2000s.
Impressed with the success of private farming and food distribution, and encouraged by the central government's stated support for these practices, many local governments began tacitly encouraging town and village households to diversify into other sectors, such as weaving cloth, making household implements, and repairing farm tools. This, too, was initially treated as a temporary measure: once industrial control had been rationalized, the argument went, these small firms could be rationalized as well.
Special economic zones
In a further bid to experiment with foreign imported facilities, the city of Sunju established a special economic zone in 1990. Covering just four square kilometers around the former foreign trading port, this zone was open to foreign direct investment: foreign private companies could set up privately run workshops or factories within its boundaries, and could import and export goods without working through a state-owned intermediary. Haeju Prefecture followed suit in 1991, setting up a ship breaking facility and adjacent space for steel-recycling mills.
These moves stirred controversy in upper government circles, as private enterprise and foreign investment were still forbidden in most of the country. Many in the Menghean Army's officer corps remained hostile to the idea of letting foreign profit-driven firms operate on Menghean soil, and Choe himself initially opposed the idea. But as the world economy emerged from a prolonged period of stagnation, and as rising economic instability in Fyrland began driving away investors, the administrators of both zones were quickly inundated with business applications. Sunju expanded its SEZ to the entire district in 1992, and in 1993 the neighbouring government of Yobu Prefecture set up a special economic zone north of Altagracia, where the border with Menghe had recently been opened to trade and travel. Bonggye, once a small fishing town, quickly grew into a minor city as peasants from other parts of the country flocked there to seek work in the export-processing sector.
Changing course
While small private farms and firms performed far outside of state expectations, the Socialist government's first central planning initiatives fell short of their goals. Crippled by Ryŏ Ho-jun's purges and decentralization campaigns, the economic planning bureaucracy was in no condition to monitor productivity with the rigor and consistency that meritocratic socialism demanded. As late as 1991, the Ministry of the Economy had yet to produce a set of piecework quota schedules for individual workers in different industries, let alone a plan for monitoring output consistently. Production bonuses were mostly left at the discretion of factory managers, and served mainly as symbolic rewards for model workers rather than a widespread incentive system. Factory managers did begin using their power to lay off unproductive workers, but city and county governments discouraged them from restructuring the workforce too deeply, out of fears that widespread unemployment could lead to social unrest. And higher managers in state-owned enterprises rarely made use of their new power to dismiss and promote lower managers based on their performance, effectively returning to the previous planning system in which both sides falsified production reports in order to avoid punishment.
The new model factories ordered by the central government also proved disappointing. While the delivery of cutting-edge machining equipment from Dayashina and Hallia drew media fanfare, it soon became clear that the problems of state-run inefficiency persisted even in new firms. Local governments moved to protect important firms from competition, command prices remained unable to keep up with shifts in supply and demand, and a shortage of hard currency forced planners to cancel many of the foreign-imported factory projects they had laid out in 1989. One internal economic white paper warned about a return to the slowing economy of the early 1980s, followed by eventual stagnation.
Faced with disappointing results from the state sector, and concerned that stagnation could bring a rival faction into power or topple his new government altogether, Choe Sŭng-min made a remarkable about-face on economic policy. Previously an outspoken advocate of centralized economic planning, he gradually softened his tone on private enterprise, and by the end of the decade he would openly embrace it. Biographers disagree on whether this change in tone represented a pragmatic embrace of market economics or a tactical move to abandon the declining planning faction. Go Hae-wŏn, an ideological leftist, resigned from his post as General-Secretary of the Menghean Socialist Party on 23 July 1992, likely under pressure from Choe and others over his opposition to further market reform. Choe Sŭng-min took his place as General-Secretary at a special session of the Central Committee of the MSP, consolidating his power as the supreme ruler of Menghe. In a live, televised speech from that session - an unprecedented gesture in Menghe - Choe praised the spectacular success of the rural economy, noting that small enterprises, rather than large ones, had emerged as the drivers of Menghe's economic recovery. In addition to shifting the MSP's official ideology, this televised speech further strengthened Choe's nationwide image as a leading supporter of economic reform.
The Menghean elections of 1994 firmly consolidated Menghe's economic reform program. In the second round of legislative elections after the Decembrist Revolution, the MSP secured 87.4% of the seats in the National Assembly. Although genuine opposition parties were banned and the MSP's vote share declined compared with the sham elections of 1989, high turnout at polling stations and low support for the MSP's coalition parties signaled widespread acceptance of the economic reform agenda. At the National Assembly's opening session, Choe Sŭng-min was re-elected Chairman of the Supreme Council by unanimous acclamation, in a procedure which was carefully orchestrated to prevent the voicing of any Nay votes. When assembling his new Supreme Council, Choe appointed Cho Ha-jun as the new Minister of the Economy, dismissing Bak Jun-chang, the architect of Choe's previous state-owned enterprise initiative. As governor of South Chŏllo Province, Cho had gone further than any other province head in encouraging the growth of small private firms, and he had already gained a reputation as an unusually avid supporter of market reform. His appointment sent a clear signal that Choe Sŭng-min was committed to further economic reform, even if it meant challenging top players in planning faction.
Boom years: 1994-1999
Gradual privatization
With Cho Ha-jun's faction solidly in control, economic reform shifted in a more liberalizing direction. The National Assembly passed the Provisional Law on People's Enterprises near the end of 1994, allowing private businesses to hire as many as 100 employees if they secured a license from their town or village government. In keeping with the model recently applied to farming, people's enterprises were formally owned by local governments, but in practice their managers could run them like private businesses, retaining the profits and making independent management decisions outside the five-year plan. Large numbers of people's enterprises emerged in the mid-1990s, and many small enterprises which had previously evaded the 10-worker limit sought reclassification. Because small and medium enterprises were the fastest-growing sector of the economy, the de-facto private sector steadily grew relative to the state sector, even as official privatization remained off the table.
While small private firms remained the main drivers of growth in this period, Cho Ha-jun saw reform of the inefficient state sector as his main priority. Over the previous six years, efforts to drive up produtivity in state-owned enterprises had yielded disappointing results, and because heavy industry was so central to Menghe's economy, this outcome was unacceptable. Rather than simply pursuing new efforts at incentivizing growth, as his predecessor had done, Cho pursued more radical restructuring. One of his first steps was the corporatization of state-owned enterprises. Previously, most Menghean SOEs had been directly linked to government budgets, paying all revenues directly into local treasuries but also using state funds to pay for regular business costs. Corporatization involved separating an SOE's finances from the state. Corporatized SOEs could still receive subsidies, and in place of sharing revenue they were now required to pay taxes, but corporatization forced them to become more financially independent and made it easier for economic policymakers to identify poorly performing firms.
As a further policy experiment, Cho Ha-jun singled out a number of state-owned heavy industry firms and increased their autonomy further. These "charter enterprises" or "autonomous enterprises" were placed under the control of a new management team and fully separated from the planning apparatus. Like large-scale versions of local people's enterprises, charter enterprises were formally owned by provincial or national governments, but in practice they functioned like manager-owned private firms. They could buy and sell goods on the free market, hire and fire workers independent of government workforce quotas, negotiate production contracts with smaller private firms, and reinvest profits at the manager's discretion. In a bid to help forge a new corporate identity, these firms were also allowed to engage in branding and advertising, and encouraged to compete with one another. In particular, Cho used the contracting system to break up state monopolies: his selection of plants for contracting ensured that in individual product sectors, such as steel, heavy industry, and concrete, there were always at least three major competitors, and often more. Greater autonomy, however, also came with a downside: contracted enterprises were cut off from direct state financial support, and Cho warned that the Ministry of the Economy would allow poorly-run or unprofitable charter enterprises to go out of business.
The National Assembly formally consolidated this experiment by passing the National Enterprise Law in 1998. This law provided a formal legal basis for the wide array of state-owned, private, and quasi-private firms which had emerged in the first ten years of reform. It also laid out a legal framework for the taxation, regulation, and ownership of each type. Five official categories of business now existed, listed in order of increasing autonomy:
- Public Services (Gong'ik-saŏb)
- State-Owned Enterprises (Gukyu-hoesa)
- Autonomous Enterprises (Jachi-hoesa)
- Medium Enterprises (Jung-giŏb)
- Small Enterprises (So-giŏb)
Public services encompass a range of work units run for the public benefit, such as state healthcare and education providers. Service providers in these sectors are not held to profit motives, and can be financed out of government budgets, but they are also subject to more stringent regulations. State-owned enterprises maintain separate financial accounts from local and national governments, and may be expected to hit profitability or production quotas, but the local governments owning them can appoint their board members and issue management directives. Autonomous enterprises formally oversee state-owned assets, but are more heavily insulated from government interference and support. Small and medium enterprises are fully privately owned and run, the difference being that small enterprises have fewer than ten workers and are exempted from certain government regulations. The latter two categories amounted to an official legalization of private enterprise in Menghe, ending a ten-year period in which private firms had existed in a de facto sense without formal legal support. People's Enterprises, as defined in the 1994 Provisional Law, were given a sunset period in which to seek classification as either medium enterprises or autonomous enterprises.
Financially, the National Enterprise Law meant that the Menghean government could no longer rely on SOE profits as a primary revenue source. State-owned enterprises and autonomous enterprises were now fully corporatized, and while public service providers could collect fees, they were run for the public benefit and generally operated at a loss. To make up for the gap, the National Assembly passed a separate law creating a 19% value-added tax on all market transactions and an income tax on individuals, though 90% of households earned incomes below the bracket at which the income tax took effect. The national government benefited healthily, as it could reap all VAT and income tax revenues, as well as the standardized schedule of luxury taxes, which frequently surpassed 100%. Local governments were limited to property taxes and stamp taxes, but were still expected to finance the same array of services. To fill the gap, county and prefecture-level governments turned to land sales and licensing fees, as well as bulk fiscal transfers from above.
Administrative reforms
One of the few successful innovations to come out of the meritocratic socialism initiative was the cadre evaluation system. Under this system, leading officials at the town, county, prefecture, and provincial levels were given annual scorecards based on economic output in their jurisdictions. These scores, in turn, informed higher officials about which subordinates to promote and which to dismiss.
As economic growth emerged as the leading priority of the Menghean Socialist Party, cadre scorecards became increasingly important in personnel management. Higher officials also favored the scorecards because their simple numerical measures were easier to compare than more subjective assessments of good governance and quality of life. This had a twofold effect on cadre promotion: it forged strong incentives to maximize economic growth in one's own jurisdiction, and it created a filtering effect in which better economic policymakers moved up the ranks into higher posts.
Growth of trade
This period also saw an explosion in the number of special economic zones. Interpreting the 1994 elections as a positive sign, both Sunju and Haeju expanded SEZ status to their entire jurisdictions in August 1994. The following year, twelve other coastal cities followed suit: Quẚng Phẚ, Pyŏng'an, Giju, Dongchŏn, Chanam, Gyŏngsan, Ranju, Anchŏn, Donggyŏng, Changtae, Chŏngdo, and Baekjin. In addition to legal approval, foreign firms in these cities also enjoyed preferential tax treatment. This brought a major surge in foreign direct investment: as Fyrland's economic position continued to slide and the world economy entered a period of upswing, Menghe quickly emerged as a major center of supply-chain manufacturing, with a competitive advantage in cheap but skilled labor.
Crisis and recovery: 1999-2002
Financial crisis
Breakneck economic growth came at a cost to stability. As wages rose and price controls were lifted, inflation increased, and CPI increases of 5-10% per year became the norm. Policymakers at the Ministry of the Economy generally showed a high tolerance for inflation, as it gave households an incentive to invest their money in banks, buy durable goods, or take part in neighborhood credit circles, rather than storing cash at home. By 1998, however, inflation was reaching dangerous levels, surpassing an annualized rate of 50% in the first quarter of 1999.
This put severe pressure on poorly performing enterprises, many of which were owned by city, town, or prefectural governments. Debt of all kinds had increased during the reform period, but debt to foreign investors was particularly high, as the country's soaring GDP growth rates had drawn in large amounts of foreign capital.
As news of inflation spread, the Inminpye abruptly plummeted in value on foreign exchange markets, just two years after the Menghean Central Bank had loosened restrictions on currency trading. This wiped out the accumulated profits of offshore enterprises in Menghe, leading to a panicked flight of capital from the country. Attempts to prop up the Inminpye only succeeded in draining Menghe's foreign currency reserves. Caught in the squeeze between high input costs and low exchange rates, state-owned enterprises began defaulting on foreign loans, setting off renewed capital flight and a second drop in the Inminpye's foreign value.
Technically speaking, the Menghean economy did not enter a recession during this period, as annualized GDP growth in 1999 stabilized at 2.41% (though growth was negative in the third quarter of the fiscal year). Yet it ended four straight years of GDP growth rates above 10 percent, and led to fears of a prolonged slowdown.
Government response
In the short term, the Menghean government reacted swiftly by buying up non-performing loans, thereby transferring the debt from local SOEs to the central bank. This assuaged international fears of a large-scale debt default or a confiscation of foreign capital. The state also took steps to rein in inflation, including the forced sale of government bonds to Jachi-hoesa. In an unprecedented move, Choe Sŭng-min agreed to relinquish Menghe's long-standing territorial claim to the Renkaku Islands in exchange for debt forgiveness from Dayashina. In all, only 26% of foreign capital in Menghe was lost to default.
In the wake of the crisis, the Menghean government identified two main culprits. The first was the cumbersome state-owned sector itself. Despite being more exposed to foreign debt, jachi-hoesa enterprises managed a faster recovery, as they were able to shed unproductive assets and rely on their more productive ones. Locally-owned SOEs, however, were often poorly run and had racked up a higher share of non-performing loans. Once the initial crisis had stabilized, Cho Ha-jun called for a program of "bringing together and letting go." Large SOEs in the natural resource and energy sectors were consolidated under the management of the most successful SOEs in that sector, and in some cases converted back into public services to discourage risky investments. Meanwhile, small and medium SOEs, particularly for-profit SOEs run by town, county, and prefecture governments, were either reclassified as private firms or auctioned off to existing jachi-hoesa. The auctioning process was carried out gradually under the oversight of economic regulators to avoid instability and corruption, though in practice businesspeople with personal connections were often able to negotiate insider sales.
The second culprit reformers identified was foreign capital itself. The Menghean economy, they argued, had been too vulnerable to the interests of foreign investors, who too easily turned to speculation or panic in times when stability was most important. The government canceled its proposals to legalize private banks or banks within Jachi-hoesa, and cracked down on large lending circles. It also required that foreign loans above a certain size be subjected to central review, and imposed new restrictions on foreign businesses operating within Menghe. All of these moves centralized the nexus of capital flows around Menghean state-owned banks, solidifying government control over macroeconomic policy.
Reforms under fire
Especially in its first year, the Menghean financial crisis generated a crisis of confidence in the Menghean leadership. Choe Sŭng-min's cult of personality was at its peak in the late 1990s, and few in the top elite dared to challenge him openly; to do so would have been suicidal. Instead, most reform opponents took the safer route of pinning the blame on Cho Ha-jun, whose high tolerance for inflation, foreign capital, and risky pro-growth measures had laid the conditions for a crisis. Choe was reluctant to dismiss Cho, as he still needed a qualified economist to handle the recovery process, but in remarks to other top officials he indicated that his own patience with free-market solutions was wearing thin.
After GDP data showed 10.16% year-on-year growth at the end of 2001, Cho announced his early resignation, stating that the recovery was complete and that his presence was no longer needed. In his absence, the Supreme Council moved forward with a plan to split the powerful Ministry of the Economy into two separate agencies: the Ministry of International Trade and Investment, and the Ministry of National Economic Development. Provisional appointees to both organizations had a decidedly more statist bent, feeding fears that Menghe would change course economically.
Nevertheless, by the mid-2000s, Menghe's program of economic reform seemed broadly secure. GDP growth in 2002 topped 11.5%, with jachi-hoesa and medium enterprises again accounting for most of the increase. Aggregate GDP at the start of 2003 was four times higher than what it had been at the start of 1988, and nominal GDP per capita was three times higher. Starting in 2000, the National Assembly had also approved a series of increases to the defense budget, assuaging military fears that national defense had fallen behind economic growth. Even conservative politicians wary of further privatization were forced to concede that a return to economic planning was not plausible.
Second generation of reforms: 2002-2012
The ten years that followed represent a second phase of economic reform, this time focused on consolidating good governance rather than unlocking economic growth. The 2000s were also punctuated by a major disruption in 2005: the Ummayan Civil War, which led to a realignment of Menghean trade and a major increase in defense spending. Both of these changes brought about a reduction in the rate of economic growth, with annual GDP growth averaging 10.63% in 2000-2004 but 7.96% in 2005-2010. Menghean policymakers responded by pivoting to the east, strengthening trade ties with Hemithean economies and placing a larger emphasis on domestic consumption.
Administrative reform
While in 1988 Menghe had a severe shortage of trained economic staff, by the early 2000s the level of training among civil servants was increasing. College-educated managers, bureaucrats, and policymakers became more common, though they often held degrees in engineering rather than economics or business management, and those with degrees in the latter fields had usually earned them overseas. Generous pay increases, coupled with high technocratic requirements in the application process, brought skilled employees into the lower-level bureaucracy as well.
Greater economic knowledge allowed Menghean government agencies to adopt qualitatively different strategies in the realm of industrial policy. Rather than encouraging small-enterprise growth across the board, as they had done in the 1990s, local governments began focusing their efforts in specific areas and directly coordinating with private businesses. This resulted in the consolidation of small private firms into more stable mid-size enterprises, and the emergence of local areas of specialization.
The National Economic Research Agency (NERA) was another influential addition. By giving the Menghean government in-house offices for economic research, it eliminated the need to consult with private enterprises, foreign firms, or international organizations, which might have conflicts of interest - a frequent accusation in the wake of the 1999 financial crisis. The NERA was placed within a new Ministry of Information and Statistics, which, in addition to conducting censuses and monitoring the government's expenditure, required firms above a certain size to submit regular information on inputs, outputs, and profitability.
Embedded autonomy
The Menghean reforms of the 2000s also witnessed the full emergence of a system which political economists have termed "embedded autonomy," or sometimes "governed interdependence." These terms were originally developed in reference to developmental policy in Dayashina during the 1970s. More broadly, there is scholarly agreement that Menghe has developed into a true developmental state, rather than a transitional Socialist economy.
Generally speaking, Menghean embedded autonomy means that the economic bureaucracy is sufficiently accountable to private interests that it focuses its efforts on development, but not so accountable that it is vulnerable to regulatory capture. This distinguishes it from liberal market economies, on the one hand, and developing-country kleptocracies, on the other.
During this period, central subsidies increasingly focused on key industrial sectors, and were nearly always made conditional on performance - firms which failed to meet deadlines or maintain adequate profit margins would see their funding transferred to more efficient competitors. The creation of an Economic Planning Forum, gave managers and bureaucrats an institutionalized way to coordinate development policy, often with personal input from Choe Sŭng-min himself.
Pivoting east
Though it started as a small conflict in a distant country, the Ummayan Civil War led to a serious breakdown of relations with Maverica, Innominada, and Sieuxerr, as well as other members of the Entente Cordiale. Concerned about retaliatory sanctions or open conflict, many Casaterran investors withdrew their assets from Menghe, and Entente companies in particular began moving their supply chains to Maverica and Khalistan. Fearing another economic crisis, the Ministry of National Economic Development launched a major stimulus package. The Menghean Army also stepped up conscription and expanded arms production to put more troops on the Maverican border, widening the deficit but also limiting the impact of unemployment.
In response to the loss of Western trading partners, Menghean economic policymakers launched an initiative to "pivot east," shifting trade and investment ties to safer countries. At the beginning of the shift east program in 2005, this mainly meant increasing trade with Hanhae and Dayashina, but the initiative soon expanded to other countries, like Tír Glas, Themiclesia, and Neo-Pillowlandia. Trade with Hallia, Ummayah, and Ostland also continued to increase, even though this required shipping goods through the Strait of Portcullia, which the Entente Cordiale could blockade in a major conflict.
The eastward pivot led to a virtuous circle of economic relations for Menghe. As Menghe traded more with the targeted countries, their diplomatic stances toward Menghe softened. This, in turn, led to further increases in trade, as tariffs fell and private investors responded to lower risks. Military ties with these countries also increased, laying the groundwork for future alliance networks. Glasic and Dayashinese diplomats did continue pressuring Menghe to implement more political reforms, but this pressure no longer stood in the way of stronger trade ties, which some think tanks hoped would lead to eventual democratic change in Menghe.
Ongoing efforts: 2012-present
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The most recent reforms, those implemented after 2012, have focused on a second transition: that from an industrial economy to a knowledge economy. As Menghean wages and living costs grew, the country could no longer compete on the basis of cheap labor alone, and risked falling into a middle-income trap if it failed to develop a domestic knowledge sector. These reforms were also motivated by a desire to escape the assembly stage of the smile curve, where profits are lowest, and move into design and marketing.
Notably, this effort has not constituted an abandonment of industrial policy as such. Instead, planners have worked to integrate research and development with improved in-house manufacturing capability, usually with the use of labor-saving equipment. This has been accompanied by a drive to improve the quality standards of Menghean goods, in order to escape Menghe's reputation for producing inexpensive copies.