Assess the impact of China’s financial system reforms since
1979 in terms of promoting economic development.
The IMF (International Monetary Fund) and World Bank and WTO
(World Trade Organisation) are constantly calling on China to further
liberalise and reform its financial system. The financial system was
monopolised as late as 1978 when reforms began (Naughton, 2007) . Since then it has
been liberalised enough to allow accession to the WTO (International
Monetary Fund, 2011) while still asserting control over
so-called ‘Policy Banks’ which allow the government to direct investment to
government directed projects and state-owned enterprises (Naughton, 2007; Laurenceson & Chai, 2001) . The way in which
China has controlled the financial system has also allowed the promotion of
economic development although sometimes unforeseen effects may be considered to
have occurred. In this essay I would argue that the roles of China’s ‘policy
banking’ for development should not be underestimated and that the financial
reforms have not diminished the promotion of economic development but
reinforced it. Splitting the reform period according to general reform policies
let us examine the periods in turn.
Firstly, the 1979 to 1990s period saw some reform in the
controls of banks and partial reform in the role of the banks which were still
used to promote economic development via government initiatives, remaining
basically a cashier in part to the government, while slowly growing apart from
the government control (Naughton, 2007) . As of 1983 the role
of banks was as the external finance of industrial enterprises and the banks were
given some accountability for the distribution of finances, although still
required to fulfil state policy on investment (Lo, 2011; Naughton, 2007) . The effectiveness
of this policy could be seen as limited in its effectiveness due to ‘soft
budget constraints’ (Naughton, 2007) which mean that
since banks were reimbursed to some extent on lending to non-profitable
state-owned enterprises via the government budgetary funds, social insurance
and postal and investment funds, their investment was less efficiently directed [Liu, 2002; Laurenceson Chai, 2001] . However, the
creation of NPLs (Non Performing Loans), while often seen as a sign of
inefficiency of the system do not necessarily reflect a negative impact on
economic development, argues Laurenceson and Chai, since it should be realised
that some economic development investment will come at a cost (Laurenceson
& Chai, 2001)
and with externalities worth considering such as social benefits of public
goods and infrastructure.
It may also be argued that the method control of the banks during
the early part of this period was inefficient. This is because the system
created an over-expansion of credit by allowing banks to lend more if they had
more deposits, ignoring the fact that deposits could be created out of loans in
the first place (Lo, 2011; Mehran, 1996) . This would have had
some negative effect on the promotion of economic development as it could lead
to inefficient finance allocation. However by 1984 the empowerment of the
People’s Bank of China (PBC) as a central bank in order to monitor this shows an
improvement that would counter this negative impact via credit ceilings and
non-bank lending activities being prohibited [Naughton, 2007;
Mehran, 1996] [Ma, Xiandong, Xi, 2011] ) in 1985 at 10%,
moved to 13% in 1987 and 1988 and later 8-6% [Ma, Xiandong, Xi, 2011] (Wu & Transition, 2006;
Laurenceson & Chai, 2001) . According to Wu,
this caused a ‘periodic boom-bust credit cycle’ and economic overheating due to
inattention to loan quality (Wu & Transition, 2006) . Suggested is that a
removal of bias to state-owned enterprises would be more efficient however,
once again the argument of Laurenceson and Chai seems to be of relevance here. It
should be noted that some failures were encountered and this misallocation will
have had a negative effect on the promotion of economic development, however Laurenceson
and Chai do offer some evidence that the investment was used to meet goals such
as bringing greater integration and development of Western provinces of China
and other lesser developed areas (Laurenceson & Chai, 2001) , which benefits the
promotion of economic development.
The mid/late 90s period saw further reforms with a
continuation in government direction of loans which was of benefit to the
promotion of economic development. In the mid-90s period the quality of assets
and the restricting of risks involved in loans came about via the introduction
of a Capital Adequacy Standard (Wu & Transition, 2006) . The risks were also
restricted by a regulation on long and medium term loans in relation to the loan
as a percentage of total deposits and a requirement to maintain a certain
amount of liquid assets (Lo, 2011; Mehran, 1996) . A tightening of the
accountability of banks and regulation helping lower risks taken by banks (Wu &
Transition, 2006)
while still following state development directives seems to show good promotion
of economic development while attempting to streamline the efficiency of banks
although the number of NPLs must once again be considered within the Laurenceson
and Chai arguments of how to assess the China banks as development banks not
commercial profit maximising banks (Laurenceson & Chai, 2001) . A strong argument
for government intervention in terms of the use of the distribution of
investment for development is also put forward by Kalecki who argues that the
market will not always allocate it efficiently (Kalecki, 1993) . This supports the
separation of commercial and investment banks in the 90s (International
Monetary Fund, 2011) , which basically kept the investment
banks in use as policy banks for the government while potentially creating an
efficient financial system for private enterprise. Kalecki’s theory also backs
up the Laurenceson and Chai argument previously mentioned and indicates that
economic development promotion needn’t be of a purely ‘economically efficient’
nature. Then again, according to Wu, NPLs were worth some 45% of Gross domestic
Product (GDP), with clear over-investment leading to a supply glut (Wu &
Transition, 2006) .
While it may be unfair to treat the banks as commercial banks thus far the NPLs
cannot be ignored (Naughton, 2007) , and this is
compounded by the IMF report in 2011 on China’s financial system which noted
that China actually had a 40% lower investment efficiency in comparison to
Japan and Korea in their take-off periods of development (International
Monetary Fund, 2011) . However, perhaps most tellingly, over
this period there was a stagnation of growth rates in the LDCs observed while
they took on much more liberalised systems (Chang,
2003; Arestis, 2005; Kenny, 2011) than China’s which
could have some indication as to the usefulness of the policy directed banks of
the period for China who enjoyed high growth over the period (Laurenceson
& Chai, 2001) .
The 1998-now period was to bring further important reforms and further high
levels of economic growth.
In 1999 an important step was made in the formation of the
AMCs (Asset Management Companies) which were created to dispose of the NPOs of
the Big 4 banks (ICBC [Industrial and Commercial Bank of China], CCB [People’s
Construction Bank of China], ABC [Agricultural Bank of China] and BOC [The
Bank of China]) in China (International Monetary Fund,
2011) (Laurenceson
& Chai, 2001) .
This, in conjunction with the recapitalisation of the Big 4 helped the Big 4
lower the number of NPLs they had ended up with (International Monetary Fund,
2011) .
Actually by the end of the decade the NPLs were on a downward trend and at just
1.1% of total loans (International Monetary Fund,
2011) .
This shows a more efficient allocation of resources and the Central and
Commercial Bank Law and those thereafter were not to neglect the importance of
development projects (Laurenceson & Chai, 2001) which could indicate
good promotion of economic development. The banks had thus far moved from the
mono-bank to the PBC as central bank and the Big 4 functioning as the
non-central banks in 1983-4, followed by the establishment of policy banks in
1994. The first joint-stock bank was established in 1986 and by 2001 there were
eleven. 100 city banks were also established, mostly organised by the local
authorities and mainly used by small scale urban firms (Naughton, 2007; Lo, 2011) . The rate of
commercialisation in China over this period was somewhat slow (Laurenceson
& Chai, 2001) .
However, in the 2000s remarkable ‘progress’ was made in the form of the development
of legal frameworks (including the adoption of Property Law), market
development (such as the introduction of foreign exchange swapping between
banks being allowed, i.e. interbank FX swaps, in 2006 and the launching in 2010
of ‘Margin trading and short selling, and stock index futures’) and
implementation of an interest rate reform (International Monetary Fund,
2011) .
This coupled with accession to the WTO in 2001 initiated a deepening of the financial
system which has continued since, even with some change in the exchange rate
policy (Naughton, 2007) (International Monetary Fund,
2011) .
The introduction of new Capital requirements in 2004 further mark progress
although they are accused of still showing bias towards State-owned Enterprises
by Wu (Wu & Transition, 2006) . They require banks
to meet a target of 8% in terms of Total Capital Adequacy and 4% on Core
Capital Adequacy by 2007 which may encourage the move away from bias writes Wu (Wu & Transition, 2006) . The creation of new capital markets and reform
of the joint stock banks (International Monetary Fund,
2011)
has increased commercialisation and by increasing the banks’ efficiency and
ability to lend efficiently it may be argued that all these reforms of the
2000s have to some extent helped to promote economic development.
However there have still been some problems which Wu (2006)
points out, such as a continued domination in loans by the Big 4 (The IMF
report (2011) highlights that the 4 largest commercial banks in 2011 all had
assets worth over 25% of GDP each and make up ‘almost two thirds of the
commercial bank assets altogether) and a lack of control and regulation in some
cases still, which saw in the mid 2000s bank lending at a rate of 140% of GDP (twice
as much as most industrial countries) and the problem of informal credit
markets (for example, 0.8-1.2% of GDP diverted to underground capital markets
over about 2 months in 2004 according to the China Daily) (Wu &
Transition, 2006) (International
Monetary Fund, 2011) . Another problem pointed out in the IMF
report (2011) is that of a high precautionary saving rate diverting funds away
from investment due to a lack of insurance products. Considering the importance
of investment for the promotion of economic development (Kalecki,
1993)
it seems that this could be a significant shortcoming. The report also points
to the continuation of soft budget restraints via state control and ownership of
banks. As a principle shareholder the state can still control the banks by
appointing the management of the banks. It also ‘implicitly insures all
deposits’. The report says this ‘reduces market discipline’ (International
Monetary Fund, 2011) . To some extent this may also be of
significance in the efficiency of allocation of investment. However, with the
low NPL rate this may be contested I think and once again the allocation to ‘economically
inefficient’ projects may not actually be counter-productive to the promotion
of economic development (Laurenceson & Chai, 2001) although avoiding
soft budget constraints must also be of some priority in promoting economic
development[1].
The promotion of
economic development must be seen in more than the amount of NPLs. Although
NPLs are seen as important indicators of the allocative efficiency of loans,
Laurenceson and Chai point out that the number of NPLs were not any higher in
the state banks compared to the Non Bank Financial Institutions in 2000 (Laurenceson
& Chai, 2001) .
What may be an important point to consider is the protection China has afforded
the sector. State involvement in the system allowed the government to issue a
stimulus package to fight the global financial crisis effects in 2008-9, using
state assets liabilities as collateral to increase funds which saw China manage
to protect its growth rate (International Monetary Fund,
2011)
(and thus implicitly its development). It also managed to avoid a dramatic
situation such as seen in Russia and Eastern Europe caused by so-called ‘Big
Bang’ reform (sudden switch to neo-classical style system) which saw financial
demolition in those countries (Naughton, 2007) . Such protection has helped to promote
economic development where otherwise it would seem more difficult to promote.
Wu says that the government in fact has protected the financial system by
keeping capital controls tight and that through directed lending policies and
interest rate control the Small and Medium Enterprises (SMEs) and Private
Enterprises have received more loans (Wu &
Transition, 2006)
(although meanwhile this has also fuelled a speculative bubble in the retail
market (Laurenceson & Chai, 2001) (International
Monetary Fund, 2011) ). This is important for encouraging non
state organised development and if non-state enterprises are being encouraged
and being ‘given an environment in which to grow by directed investment in
infrastructure’ and can further thrive then it would seem that the promotion of
economic development has been somewhat effective (Naughton,
2007) (Arestis,
2005) .
Protectionism and state intervention of
some markets and sectors is important for development (as was seen in the now
developed countries historical development patterns) (Chang, 2003) (Kenny, 2011) , and this has
clearly been a factor in China’s promotion of development through its financial
system reforms which did not leave the system fragile and susceptible to
exogenous shocks as financial liberalisation would do (Arestis,
2005) .
Some economists have debated the relevance of finance to
growth, with Lucas (1988) and Modigliani and Miller (1958) arguing it is of no
relevance (Arestis, 2005) . In particularly for
China, where the state has controlled finance to a large extent I think this is
evidently wrong. Of more relevance are arguments that government intervention is
always of negative effect on the ‘quantity and quality of investment’ led by
Levine, King, Shaw and McKinnon (Arestis, 2005) . However, evidence
such as China’s growth rate compared to those LDCs which did liberalise their
financial systems, and historical patterns mentioned before which show
intervention in now developed countries to some extent detract from the
argument. However, there may be something to learn from these arguments about
the quality of investment (although the sustained rate of growth over 3 decades
doesn’t necessarily reflect this). Keynes and Robinson both said that within
the correct institutional setup that economic growth and finance are ‘bidirectional’
and that Keynes supported ‘direct government control of investment’ (Arestis,
2005) .
Further tentativeness in financial liberation would be recommended by Stiglitz[2]
and Laurenceson[3]. It
is argued that financial liberalisation and growth are in fact only related
through the institutions in place which are of more importance to economic
development and fragility of the sector (Arestis, 2005) , which may be applied to China also in
its state intervention and control. Restricted access of
foreign banks to stakes in Chinese banks also shows protection of a fragile
market while accessing benefits such as better risk management [Tarantino,
2008] .
The usefulness of government intervention in infrastructure
investment is not denied in mainstream economics, in the theory of
externalities and public goods [Sloman, 2006] and it seems to me that the Chinese
reforms in the financial system have helped to support an improved quality in
investment over the last 3 decades while maintaining sufficient control to help
to promote the economic development via its involvement in the financial sector
where there has been need. Then again, liberalisation need not be a problem
where the cool off period is reached, where over investment as seen in Japan at
the end of its high growth period caused a large recession. A correction of the
widening gap of rich and poor may be, however, an argument for further
government intervention.
Wordcount: 2470 (not including citations)
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[1]
‘Effectiveness of government intervention diminishes over time’ (Laurenceson & Chai, 2001)
[2]
Financial liberalisation: ‘based
on an ideological commitment to an idealised conception of markets that is
grounded neither in fact nor in economic theory’ (Stiglitz, 1998) via (Arestis,
2005)
[3] Financial liberalisation: A means to an end rather than an end itself (Laurenceson & Chai, 2001)
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