Reform of the foreign trade and exchange system by the end of the 1980s outpaced reforms of the domestic economy. Additional adjustments of the foreign trade system might marginally improve the rationality of some trade decisions. But further improvements in the efficiency of the external sector were largely dependent on additional internal reform measures. More far-reaching domestic price reforms appeared necessary to assure the economic rationality of decentralized export decisions. Among the most important prices in need of further adjustment was the official exchange rate, which was still somewhat overvalued at the end of the decade. Second, more developed factor markets were required to facilitate the reallocation of labor and capital in response to the new opportunities created by the opening of China to the world economy. In the 1980s the entrepreneurial sector of the economy, defined later in this chapter, had responded to these new opportunities. But the state-owned sector seemed handicapped by the legacy of centralized planning. Third, greater opening was critically dependent on both further domestic financial reform and more sophisticated aggregate demand management that would lead to greater macroeconomic stability.

This conundrum of balancing internal and external reforms was confounded by the conservative leadership, which seemingly consolidated its political power in the wake of the tragic slaughter of Chinese students and other protesters in Tiananmen Square in Beijing in June of 1989.