The Political Economy Of China's Financial Reforms

Finance In Late Development

Paul Bowles, Gordon White

• Publisher: Routledge
• Year: 2019
• ISBN:
  9781000304459
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: Asian Politics
• Index: Politics & International Relations

THIS PATHBREAKING Work analyzes the evolution of China's financial reforms since 1979. China's reformers have stressed the construction of a more diverse, flexible, and competitive financial system as a crucial element of China's economic reform program. The authors assess the theory and practice of financial reform in light of China's specific characteristics as a large, developing country that still claims to be pursuing the goal of establishing a new form of "socialist" market economy. The authors utilize two approaches. First, they place the overall design and trajectory of. financial reform since 1979 within a broad comparative framework of alternative strategies of financial reform and financial systems. Second, they use a political economy perspective to explore the complex interactions among the political and economic actors— individual, group, or institutional—that affect reform outcomes. Integrating these two approaches, the authors conclude by assessing future directions for feasible and desirable financial reform in China.

1
Introduction

CHINA'S PROGRAMME of market-oriented economic reform has been under way since 1979. During the past thirteen years, there have been some remarkable changes in the structure and operation of the economy, particularly in the rural sector and in more "open" south-eastern coastal provinces such as Guangdong, Fujian and Zhejiang. In terms of welfare and productivity, the reforms have proven to be very successful. Continuing high growth rates have been accompanied by dramatic increases in per capita real incomes for both the urban and rural population and by significant improvements in factor productivity in both state and non-state sectors.

The reforms were premised on the need to introduce "market regulation" into the economy, partially to replace the centrally planned and administered allocation of resources. In comparison to former state socialist counterparts in east and central Europe, China started reforms both late and early: late in relation, say, to Hungary, which had been experimenting with a comparably market-oriented "New Economic Mechanism" since 1968, and early in relation to the Soviet Union, which did not begin until the late-1980s. Compared to east-central European developments, the Chinese experience of reform has been distinctive in several respects: The reforms have been pushed much faster and further; they have not been accompanied or preceded by substantial political reforms, as in the Soviet case; in economic terms, they have been far more successful; and as of the time of writing in late 1992, they have not culminated in a spectacular and comprehensive collapse of the pre-existing state socialist political and economic system. The dramatic events of 1989-1991 have left China as virtually the only socialist country (with the exception of Vietnam) which is still engaged in a "market socialist" project, theoretically in transition from an old to a new form of "socialist" economy, in contrast to the post-socialist countries of east/central Europe, which are now involved in a seemingly ineluctable yet highly tortuous transition to some form of capitalism.

A central element of the reform programme in China has been a wide-ranging attempt to construct a new financial system. We use the term financial to denote financial institutions and flows outside of the state budgetary system, where a parallel process of fiscal reform has been under way since 1979.¹ The financial system channels financial resources, representing generalised command over physical resources, between savers and lenders, influences the rate of saving and the forms which it can take, and allocates purchasing power between lenders and thereby influences both the overall developmental process and the behaviour of micro-economic actors within it. The central thrust of reform has been towards a more flexible, variegated and competitive financial system, premised on the view that organising financial resources more effectively and allocating them more efficiently can bring substantial productivity benefits to the real economy.

While the monobanking system which was used in all Soviet-type economies is now discredited in China, the nature of an alternative financial system has been a matter of much dispute, raising a complex set of thorny issues: What range of financial assets should be available to savers? How should the banking system be organised? On what basis should resources be allocated to lenders? What role should the state play and what should be left to financial markets? What methods can be used to ensure macroeconomic balance? What impact do the reforms in the financial system have on other reforms—are they complementary or contradictory? How best should financial reforms be introduced and how can any potentially problematic consequences of the reform process, such as inflation, be avoided or contained? This is the territory we aim to explore.

Intention

There has been many a scholarly treatise written on the Chinese economic reform process as a whole as well as on particular sectors of the economy—especially agriculture, industry and foreign trade—and on specific policy areas such as labour, wage and price reform. The financial sector has, however, been relatively neglected in the academic literature until very recently (Byrd 1983 was a notable exception); however, the World Bank has produced a large volume of relevant literature in successive mission reports (for example, World Bank 1988 and 1990b). This relative neglect may partly reflect an implicit desire to focus on what is perceived as the "real" economy, a perspective which assigns a relatively marginal role to finance; it may also reflect a view that financial economics and financial systems are highly arcane and technical areas which are the province of a relatively small group of "money doctors" whose experience, expertise and conceptual universe are somewhat alien to the more mundane world of applied development economics. It is our belief, however, that the financial system plays a critical role in the development process, dealing centrally as it does with the mobilisation and allocation of resources, and deserves closer examination. Our objectives in this study are three: first, to understand the origins of, and rationale for, financial reform in the Chinese context; second, to sketch the specific character and impact of the reforms during the period 1979 to 1992 using a fairly broad brush; and third, to assess the likely evolution of the reforms in future. In so doing, we should stress that we do not believe that the financial reforms can be "separated" from other parts of the reform programme or the forces shaping the reform process as a whole. Thus, while our focus is on the financial reforms, we shall also refer to the evolving political economy of the reforms as a whole.

It is also important to say at the outset what we are not going to do. We do not intend to attempt any elegant econometric exercises on Chinese financial data, such as they are; nor will we try to provide a detailed chronological catalogue of specific aspects of the financial reforms or some kind of technical primer on the specific technical issues involved. As the bibliography demonstrates, these kinds of studies already exist. Rather we seek to fill a gap in the literature, first, by drawing on intellectual insights generated by contemporary comparative work in development studies and second, by using an analytical approach which seeks to understand financial processes in terms of an interplay of political and economic forces—hence the term political economy in the book's title. We shall focus primarily on the domestic financial system; though there have been important changes in China's external financial relations since 1979, this is a complex area and needs a separate and extended study. The study will also focus primarily on the "commanding heights" of the financial system in the state/urban/industrial system; there have also been important changes in the rural financial system, to which we will make only passing reference. This is an important subject in its own right and deserves separate attention.

Approach

Our approach to the Chinese financial reforms will be both "choice-theoretic" and "power-theoretic". The former engages the familiar mode of policy analysis which analyses a given situation in terms of its implications for policy choices; the latter focuses on the political factors, in both state and economy, which condition the feasibility of policy alternatives. We start from the assumption that any sensible analysis of the Chinese reform process must address both these questions, both what is desirable and what is (or what can be made) possible.

In our 'choice-theoretic' mode, we have been guided, first, by three broad analytical frameworks, or paradigms, each of which we feel throws considerable light on the theoretical and practical issues at hand, albeit from different directions and with different results. These paradigms have been available to, and influential in, Chinese policymaking circles in the 1980s. We are labelling these "market socialism", "finance and development" and "the NIC model of late development". Though these paradigms will be developed in detail in Chapter 2, a brief outline is in order here.

By 'market socialism' we mean a specific paradigm of economic reform which emerged in the state socialist countries of east/central Europe in the 1950s and 1960s (though its ancestry goes back to prewar intellectual debates in Western Europe). This paradigm provided a critique of the traditional Soviet-type system of directive central planning and represented an attempt to move socialist economies in a more rational and productive direction by introducing market mechanisms of various kinds. The paradigm was broadly adopted by Chinese reformers in the late 1970s (though there had been interest much earlier, in the early 1960s) in their attempt to construct a "socialist commodity economy". Situating our study of China within this paradigm directs our attention to the state socialist countries as a comparable family of cases and to the experience of similar attempts at theorising and attempting reform in other socialist contexts (though with the exception of Hungary and the very special case of Yugoslavia, 'market socialism' did not get much of an airing in east/central Europe until it was far too late). In relation to financial reform, the advocates of 'market socialism' have varied in their notions of policy innovation, but the general thrust has been towards some form of financial liberalisation involving the freeing of financial flows from state controls. In place of state controls, an increasingly diversified system of financial institutions and assets was advocated together with an increasing use of market mechanisms and competition to stimulate greater efficiency and effectiveness in the generation, circulation and use of financial resources. Greater openness to, and integration with, the international financial system was also advocated.

The term 'finance and development' refers to that paradigm which has guided thought and action in international development circles and agencies on the question of the relationship between financial systems and economic development over the past decade or more. Its exponents drew on the intellectual tradition of neo-classical economics to develop a critique of policies and institutions adopted by many Third World governments in the 1960s and 1970s which, they argued, created "financial repression" with damaging effects on developmental performance. The solution was some form of thoroughgoing financial liberalisation, a programmatic prescription which became virtual orthodoxy in the 1980s and part of the stock-in-trade of the international financial institutions and major Western aid donors in their advice and ministrations to Third World countries. Though this paradigm shares many policy prescriptions with 'market socialism', it is distinctive in that first, it reflects the outlook, experience and interests of the major Western economies, particularly the U.S. and the U.K.; second, and in consequence, it explicitly or implicitly operates in terms of some kind of 'transition' to financial systems which share the characteristics of those in the advanced capitalist nations; third, and in consequence, in a context of a state socialist country, its policy prescriptions would be more radical than those of most advocates of 'market socialism', ultimately involving large-scale privatisation of financial institutions, the establishment of fully fledged markets in credit and capital and the eradication of barriers between the domestic and international financial systems.

The 'NIC model of late development' refers to the analytical tradition of 'late development', which is seen most clearly in the work of Gerschenkron (1962) but also in the earlier work of Friedrich List (1885) and is derived from the experience of the first generation of late industrialisers in continental Europe in the latter half of the nineteenth century. The argument is that 'late developers' and even more so the 'late late developers' of the post-World War II post-colonial world have adopted, and indeed should adopt, certain strategic policies and distinctive political/economic institutions if they wish to develop in an international context already dominated by earlier waves of developers. This implies the explicit adoption of policies which displace, shape or otherwise manage markets in pursuit of a strategic national economic interest in an institutional context in which the degree of state involvement in the economy is high and the relationship between state and economy is much more organic, more 'hands on' than that prescribed by liberal economics. In practical terms, the most recent expression of successful 'late development' is that of the East Asian newly industrialising countries (NICs), notably Taiwan and South Korea, which have adopted in different forms the central institutional and policy features of the 'late development' model, to spectacular effect. Though this model shares some characteristics with 'market socialism' to the extent that the latter allows for the continuation of national planning, it differs decisively from the finance and development paradigm in that it insists on the responsibility of the state to intervene massively and directly in the domestic financial system to direct flows of capital in strategically desired directions and to mediate between the domestic and international financial systems in ways which maximise the benefits and minimise the costs of the latter in relation to the national economic interest.

Thus a choice between financial systems reflects a broader choice between alternative development strategies. The logical culmination of prescriptions derived from the finance and development paradigm is a market-based developmental path which drastically curtails the role of the state in the allocation of domestic financial resources and allows increasing and unimpeded interdependence with the international economy. In their different ways, the other two paradigms point to strategies which embody a crucial steering role for the state in the context of a synergetic relationship between state and market in the domestic economy and greater management of relations with the international economy in pursuit of some conception of the national economic interest.

In addition to identifying these three broad paradigms, we have also found another, more precise intellectual triad useful in clarifying our thoughts about financial systems and financial reform. This is a distinction among three institutional models of a financial system made by Zysman (1983): first, a capital market-based system along Anglo-American lines which involves a competitive diversity of financial institutions and in which equity markets play an important role; second, a state-directed credit-based system along French, Japanese and Italian lines in which governments intervene directly to determine the prices of money and to direct credit in desired directions, third, an institution-directed credit-based system along German lines in which an oligopoly of large financial institutions, private or public (usually big banks), run the financial system without reliance on state support or subordination to state controls.

Though Zysman's classification is based on advanced capitalist economies, the clarification of these three models is salutary from the point of view of policy choice in the sense that it helps us to go beyond mere reliance on the conventional distinction between state and market in classifying economic systems. Leaving aside any putatively wide institutional difference between financial systems in a state-controlled 'socialist' and a market-based capitalist system, there exists a wide range of institutional possibilities within the framework of a basically private enterprise, market economy; in other words, there are several alternative institutional futures to which capitalist developing countries may evolve. Moreover, the institutional arrangements of these types of financial systems bear a correspondence with the broader paradigms outlined previously. The finance and development literature, with its emphasis on the diversification of financial assets and institutions and the development of financial markets, tends to suggest that the capital market-based financial system is most appropriate for developing countries; to the contrary, the NIC model of late development is consistent primarily with the state-directed credit-based system. The market socialist paradigm, though more vague, hypothetical and open-ended in nature, with a wide range of internal variation (more 'radical' and more 'conservative' variants), would seem to fall somewhere between these two.

Moving now to our 'power-theoretic' perspective, we wish to analyse China's financial reforms through a 'political economy' perspective which recognises the inextricability of politics and economics in the real world of policy and institutions and tries to identify and explain the specific ways in which they interact to promote or inhibit policy reform and institutional change. By politics, we do not refer solely to the actions or effects of governments, states or political systems. Rather the political element of political economy is defined in terms of the nature of, and interaction between, actors—individual, group or institutional—which are endowed with the power to affect social outcomes and which are situated in both the political and economic systems. From this perspective, an industrial enterprise or a bank is as much a 'political' actor as a government agency or a member of the Chinese Communist Party's Politburo, even though the exercise by each of its power and the pursuit of its institutional interests and objectives may take an 'economic' form.

Thus, the individual and institutional purveyors of 'politically neutral' policy analysis and advice, however strong their claim to objectivity and however technical their methods, figure as one element in the political equation, often with substantial influence and effect (Woolley [1984: p. 9] discusses this relationship between the realms of technical and "ordinary political discourse" in the arena of monetary politics in the context of the United States). While the discourse of econocrats commonly has its own implicit ideological character, political conflict between individuals and groups in the higher reaches of the Chinese Communist Party (CCP) carries a strongly explicit ideological tinge which cannot be reduced to a mere clash of interests or jockeying for power. This latter ideological dimension is all the more crucial because China is an 'ideocratic' polity in the sense that there is an official political orthodoxy, known as Marxism-Leninism-Mao Zedong thought, which, in theory at least, supplies the regime with its legitimacy and justifies the existing economic and political systems (for an analysis of the role of ideology in the Chinese reforms, see White 1993: ch. 5). Ideological differences between key sections of the top Communist leadership have played an important role in the process of financial reform in China. Thus the ideological factor, in both the previous senses, is an important element in our broad political economy approach.

From this general perspective, the financial reforms, like other areas of reform policy, involve complex processes of conflict, accommodation and pressure between ideas, interests and institutions in both polity and economy, which structure policy agendas, condition policy outcomes and push institutional changes in certain directions. We shall endeavour to demonstrate that this approach helps us to understand both the process of and the prospects for financial reform, combining an ability to explain with an ability to predict and prescribe. Without an explicit sensitivity to the political economy of the policy process (sadly lacking in much of the recent literature on central-eastern Europe and the former Soviet Union), policy prescriptions— however intellectually sound or technically proficient—may not be worth the paper they are written on.

We proceed as follows. In Chapter 2 we analyse the three paradigms and institutional models briefly outlined in this introduction and demonstrate their relevance to an understanding of China's financial reforms. In Chapter 3, we set the scene for our analysis of the Chinese reforms by providing an account of the structure and development of China's financial system during the pre-reform period 1949-1978. The chapter concludes with a brief discussion of the structure and performance of the economy during this period, which provides the background for the watershed decision of the Chinese Communist Party Central Committee's Third Plenum in 1978 to reform the previous economic system by introducing market mechanisms and opening more widely to the world outside. In Chapter 4 we analyse the reform of the Chinese financial system from 1979 to 1992. We see how the reforms passed through three major phases, from 1979 to 1984, 1985 to 1988 and 1988 to 1992. The first phase was guided by a moderate version of 'market socialism' and mainly involved structural changes in the state banking system. The second phase expanded the parameters of reform to countenance a move towards something approximating financial markets. Financial libera...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Dedication
• Contents
• List of Tables and Figures
• Acknowledgments
• 1 Introduction
• 2 Market Socialism, Financial Liberalisation and Late Development
• 3 The Pre-Reform System: The Financial Institutions of Centrally Planned Socialism
• 4 The Process of Financial Reform
• 5 Policy Outcomes: The Macroeconomic and Microeconomic Impact of Financial Reform
• 6 Towards a Socialist Capital Market?
• 7 Conclusion: Future Trajectories
• Bibliography
• About the Book and Authors
• Index