Cornell Studies in Money

China's Troubled Pursuit of Financial Reform and Economic Rebalancing

Stephen Bell, Hui Feng

• Publisher: Cornell University Press
• Year: 2022
• ISBN:
  9781501762543
• Topic: Economics
• Subtopic: Political Economy
• Index: Economics

Banking on Growth Models contends that China's rapid economic rise from the late 1970s to today has been built on and shaped by a highly politicized and inefficient bank-centric financial system. Stephen Bell and Hui Feng argue that if the Chinese growth model drives how key economic sectors interact, no amount of incremental reform can have much impact on the financial system—meaningful reform can stem only from a revised growth model.

For a time after the global financial crisis, it appeared that the expansion of a more market-oriented shadow banking system might help sustain China's economic growth. Since around 2015, however, Xi Jinping's regime has reversed this trajectory and placed China's financial system under heavy state control, resulting in slowed economic development and skyrocketing national debt. China's market transition and economic rebalancing are now in doubt, as is the fate of the nation's economy. By pinpointing finance as a vital element of the growth model, Bell and Feng provide a convincing assessment of financial risks and the prospects for economic rebalancing in China.

Banking on Growth Models demystifies the world of Chinese banking and finance as it investigates an ever-rising national debt, a declining rate of economic growth, and the possibility of dire and drastic reform by the Asian superpower's government.

1

INTERACTIONS BETWEEN CHINA’S GROWTH MODEL AND THE FINANCIAL SYSTEM

Western descriptions of China’s “market transition,” or of China as an “emerging market economy,” tend to overlook the fact that the economy and its market elements operate under the shadow of state hierarchy. This certainly applies to the financial and banking system, and this chapter outlines how this system has been constructed by the party-state to primarily serve the needs of the party’s statist economic growth model. China’s financial system is primarily one that collects together extraordinarily high levels of savings, primarily from the household and corporate sectors, and which then channels these savings through the banking system, which allocates credit and investments to a range of destinations. The distinctive characteristic of this system is that all of its components, including savings levels and credit allocations, are strongly influenced by the state and the credit requirements of its growth model.

The management of economies through a combination of statism and markets, as well as the contribution from the key economic sectors that power an economy, is now the focus of an emerging field of “growth model” analysis (Baccaro and Pontussen 2016; Hope and Soskice 2016). This chapter explores China’s growth model dynamics, particularly its statist, investment-led growth, which has increasingly relied on debt funding and which has distorted the banking and financial system. It was once widely recognized, including by the Chinese leadership, that the prevailing growth model and the financial and banking system needed to change. As we have seen, Premier Wen outlined his dire “Four Uns” warning about the economy in 2007, and Premier Li Keqiang followed up in 2012, stating that “China has reached a crucial period in changing its economic model and [change] cannot be delayed.” (Yao and Qing 2012). For a time after the credit surge associated with the GFC, liberalizing changes in the financial and banking system and the rise of shadow banks provided a greater flow of credit to the private and household sectors, long starved of credit under the statist credit system and growth model. An alternative growth model based on private-sector expansion and higher levels of domestic consumption appeared to be gaining ground. These changes for a time seemed to be highlighting the limits to state capitalism as a control mechanism. It has since transpired, however, that the Xi Jinping regime is now doubling down on the statist growth model, a move that will impede China’s economic rebalancing and continue to distort the financial system.

Growth Model Analysis

Neoclassical economic theory assumes that economic growth is driven by supply-side factors, such as productivity, labor force participation, and population growth. Nevertheless, the structure or composition of economic growth also reflects the structure of aggregate demand in the economy and especially the major contributions from consumption (public and private), investment, and net exports. Baccaro and Pontussen (2016) have pointed to the way in which these different components of aggregate demand can define varying “national growth models” aimed at spurring economic growth and dealing with growing distributive tensions over income shares. These authors focus comparatively on an export-led growth model, an investment-led model, and a debt-consumption-led growth model. In the face of relatively weak domestic demand as a source of growth, countries such as Japan, South Korea, and Germany, as well as various Nordic countries to varying degrees, have emphasized an export-led growth and the associated accumulation of savings and current account surpluses. In the last two decades, as argued more fully below, China has combined varying degrees of an export-led model with an investment-led growth model, one that has repressed domestic demand and consumption and relied on high levels of domestic savings.

Baccaro and Pontussen (2016) argue that under export-led growth models, wages and domestic consumption are repressed to aid cost and export competitiveness and to also provide a large pool of savings. China’s domestic consumption is comparatively low compared to GDP, with wages repressed, well below the level of productivity growth. China ran small trade surpluses or deficits until around 1996 when the surplus started growing. After China entered the WTO in late 2001, particularly since 2003, the trade surplus (net exports) surged to 10 percent of GDP. In 1990 investment was about 23 percent of GDP, but by 2011 it had soared to a whopping 47 percent of GDP. The current growth model was launched in the 1990s, but since the GFC in 2008 it has increasingly been driven by debt-fueled investment, with a post-GFC decline in the reliance on exports.

By contrast, and in order to deal with growing inequality and weakening domestic demand, the United States and other neoliberal market economies have relied more on a debt-fueled consumption model. In the United States, this formed the basis for a huge housing and consumption boom in the 2000s that eventually collapsed into the 2008 financial crisis (Stockhammer 2015; Bell and Hindmoor 2015).

Growth model analysis can be linked to the Varieties of Capitalism approach to comparative political economy, which focuses on the organization and management of production on the supply side of the economy (Hall and Soskice 2001). This approach differentiates between liberal market economies such as the United States, the UK, and Australia, which tend to rely mainly on markets to coordinate production relationships, and more coordinated market economies, as found in Germany, Japan, a number of European and Nordic countries, and indeed China. The liberal market economies are associated with relatively high consumption-to-GDP ratios, indicating a consumption-led growth path. Conversely, coordinated market economies have relied to a greater extent on an export-led growth model, featuring much higher net-exports-to-GDP ratios than found in the liberal market economies. In China’s case, however, it has historically relied quite heavily as well on a domestic investment-led growth model.

These divergent growth models are strongly symbiotic. Consumption-led economies have depended on the flow of competitive exports and capital from the export-led economies, while the export-led economies have relied on the key export markets provided by the consumption-led economies—a dynamic that has featured perhaps most strongly in the China-US relationship over the last two decades. Yet these differing growth models are problematic, reflecting unstable current account imbalances in the world economy, destabilizing credit flows, distributional tensions between economic winners and losers within the countries concerned, and increasing efforts by governments to spur growth to help ameliorate such tensions (Stockhammer 2015). The latter is a central agenda in China as growth slows and inequality reaches new highs. More generally, current growth models also reveal the limits of both export-led and debt-based and consumption-led models as inequality increases, global growth slows, export markets weaken, and debt levels increase (Rajan 2010). The recourse to higher debt in a number of countries has also led to major problems of financial vulnerability and crises (Turner and Lund 2015). China is not immune to these threats, and as is widely recognized, there are clear limits to the current dominant growth model in China.

State Capitalism and the Statist Growth Model

China’s growth model over recent decades has been managed under China’s system of state capitalism. Neoliberals see state capitalism in largely negative terms, as a system of statist, market-manipulating political economy (Bremmer 2009). State-directed capitalism is of course not a new idea, with late industrializers and rising powers typically using the state to try and develop markets and kick-start growth through various means (Gerschenkron 1962). We employ “state capitalism” here to denote the Chinese state’s dominant role in the economy, which has amounted to a more extreme version of the statist political culture and model found in other East Asian developmental states. The statist tradition from China’s imperialist past was further reinforced under the planned economy model adopted from Soviet Russia following the 1949 seizure of power by the Chinese Communists, in which the state monopolizes and organizes the economy. In China, market expansion is an important goal, but so too has been the state’s control and politicization of the economy. According to Bremmer (2009, 42), in China, “the state acts as the dominant economic player and uses markets primarily for political gain.” State capitalism is alive and well in China, and there is no blind faith in Western models, especially since the market-led traumas of the AFC and the GFC and the installation of the Xi regime in 2012. State-directed credit will therefore remain important, especially as part of state efforts to drive or revitalize sectors of industry. It is also true, however, that private initiative and managed markets have also emerged over the last few decades as the main driver of economic growth in China (Lardy 2014).

Under state capitalism, which has been ramped up under the Xi regime, the state retains direct control of strategic assets in the economy in the form of state-owned enterprises (SOEs) and promotes its economic priorities through economic coordination and industrial policies. The party-state further retains control over the management of the SOEs and a wide range of other organizations through a nomenklatura system, which selects key personnel and administrative leaders. At the same time, the rest of the economy, such as light industry and export manufacturing, operates on market or at least managed-market principles influenced by the state. These sectors are largely subject to competition and are dominated by private small and medium-sized enterprises (SMEs) and foreign enterprises. This results in a dualist, hybrid political economy based on a nexus of state and market, where China’s market elements operate under the hierarchy of the Chinese state. This is often referred to as state capitalism, but other labels include “centrally managed capitalism” (Lin 2011), “Sino-capitalism” (McNally 2012), and “Chinese market-liberal state capitalism” (Brink 2012). Amid this mix, the state has favored high levels of directed investment and the promotion of large SOEs, the key power base for the Communist Party. This system has also entailed the main banks playing a central role in serving the credit and investment needs of the statist growth model.

China’s growth model has been evolving during the reform era. In the 1980s, in what Naughton (1995, 10–11) refers to as the first era of reform, the liberalization of agriculture and the rise of township and village enterprises were an important source of growth. From the early 1990s, however, factional struggles and the rise of new leadership within the party saw the shift to a second reform era that privileged state-led infrastructure investment and industrial growth, the latter based on the SOEs and on private-sector export-oriented manufacturers. Infrastructure investment and industrial growth have been dominant features of the growth model since the early 1990s and were further emphasized in the 2000s. Correspondingly, the credit and banking systems have been dominated by the credit needs of the state-led infrastructure and SOE sectors.

A central feature of China’s state capitalism and the prevailing growth model is the SOE sector. SOEs and their subsidiaries often enjoy a range of benefits in the system, such as access to cheap credit from banks, operational funds and debt write-offs from banks or the state budget, and favorable tax treatment. The state also limits competition to favor national champions in the SOE sector and controls foreign ownership in the sector (Szamosszegi and Kyle 2011). This sector, including the state-owned banks (SOBs), is of critical importance to the Chinese party-state. The SOEs enable the Communist Party to directly control economic and financial resources in achieving its various goals and policies. In turn, the state uses SOEs as political and policy vehicles to boost employment and gain new technology and raw materials from overseas. The SOEs are also ideologically and politically important for the Communist Party and provide a training ground for party cadres, equipping them with management skills and experience. The SOEs also serve as a bulwark for the party against the rising private sector, and as the “white gloves” of the party, allocating economic and other benefits to followers and loyalists through a revolving door between the party, the government bureaucracy, and the corporate sector (Pearson 2005). As one government official commented, “Why are SOEs so important? The answer to this question lies in the question of what happens if there were no SOEs. Would that be called socialism? Can you imagine the Communist party surrounded by private entrepreneurs and capitalists?”1

Indeed, the party has been wary of the rise of private-sector business interests and has largely absorbed such interests into the party hierarchy since the late 1990s under Jiang and made them reliant on state support and privileges and, if necessary, sanctions (Tsai 2007; Dickson 2008). As Fewsmith (2013, 135) puts it, “The expansion of the party into the private realm reflects a continued refusal to acknowledge a legitimate line dividing state and society as well as continuing distrust of the private sector.” The party-state’s relation with foreign capital is also distinctive. China’s penchant for foreign direct investment distinguishes it from the other East Asian developmental states that tended to insulate domestic producers from external capital (Hsueh 2011; Kroeber 2013). In China, by contrast, it appears that the party would rather accommodate foreign capital as a bulwark against the domestic private sector that could potentially challenge its dominance.

The state sector of the economy has three components. First, there are firms fully owned by all levels of government, central and local, which are usually administered by the State Assets Supervision and Administration Commission and its local agencies. Second, there are firms that are not formal SOEs but are controlled by SOEs as majority shareholders. Finally, a range of urban collective enterprises, local-government-owned township and village enterprises, and state-controlled firms linked to domestic and foreign affiliates can also been counted in the state sector. It is estimated that there are around 150,000 SOEs in China in the broad terms. The assets of the centrally controlled SOEs alone reached 72 trillion yuan ($10.4 trillion) in 2017, not far short of China’s $14.2 trillion GDP in the same year. The SOEs also account for most of the Chinese companies that make it onto Fortune’s Global 500 list. The number of Chinese SOEs on the list grew from nine in 2000 to seventy-five in 2017 (Lin et al. 2020, 37).

Not only are the SOEs aimed at being the “national champions” that dominate China’s domestic economy, but they are also major investors in foreign countries and are playing a leading role in China’s Belt and Road Initiative, which aims to project the model of credit-fueled investment-led infrastructure growth offshore (Yu 2018).

The Guiding Opinion on Promoting the Adjustment of State-Owned Capital and the Reorganization of State-Owned Enterprises, released by the State Assets Supervision and Administration Commission in 2006, highlighted a major role for the SOEs. It stated that “the investment and operation of state-owned capital should serve national strategic goals and should be directed more toward the important industries and key sectors connected to national security and the life-lines of the national economy.” The document defines defense, electric power and grid, telecommunications, petroleum, coal, civil aviation, and ship building as “strategic industries,” and equipment manufacturing, auto, information technology, construction, iron and steel, nonferrous metals, chemicals, and surveying and design as “pillar industries.” The party insists it will maintain “sole ownership and absolute control” over the strategic industries and “strong control” over the pillar industries (SASAC 2006).2 At the Third Plenum of the Eighteenth Chinese Communist Party Central Committee in November 2013, the leadership also argued that state ownership is a “pillar” and “foundation” of China’s distinctive “socialist market economy” (Central Committee of the Chinese Communist Party 2014).

Savings, Financial Repression, and the Banking System

The nature of the Chinese financial and banking system is shaped by its structured relationship with five key sectors of the economy and with the prevailing statist growth model more generally. Indeed, it is the operation and interactions of these sectors that constitute the Chinese growth model. The sectors include the household and corporate sector, which provides high levels of savings and acts as a key source of domestic consumption; the SOE sector; the state-led central and local infrastructure sector; the largely privately dominated export manufacturing sector; and the services sector, which has mixed ownership. The credit needs and credit and investment allocations of the Chinese growth model flow from these sectoral relationships. Different political and economic interests are associated with each of these sectors, but under the prevailing growth model, it has been the state-led sectors that have been its main beneficiaries, and that have shaped the way in which the savings and credit system and the banking system operate. Under this model, the household sector and nonfinancial institutions, in particular, provide around two-thirds of the total savings that are channeled into the formal banking and credit system.

Urban and rural households still contribute most of their savings to banks in China, in part because the state limits any alternative placements of funds. The trend of Chinese savings has been well above the global average for decades. The average ratio of savings to GDP across the world stands at around 20 percent, but the 2000s in China saw a dramatic increase in that ratio, from 38 percent in 2000 to a peak of 51.7 percent in 2010. This persistently high savings rate is indeed something of a puzzle that does not conform to conventional modeling of income and consumption (Modigliani and Cao 2004).

The national savings account consists of three components: government/public savings, corporate savings, and household savings, of which the latter two are roughly equal in contribution and by far the most important in terms of their contributions to national savings. The literature explaining the drivers of high savings in China has mostly focused on household savings (Chen and Kang 2018). The savings rate had increased across all demographic groups before the GFC, the highest being among the young and the old (Chamon and Prasad 2008). There were a number of pressures that boosted savings in the 2000s. First, demographic factors have been important, with the one-child policy, for example, resulting in less need to spend on children and a greater need to save for retirement. Second, as Nabar (2011) finds, Chinese households save with a target level in mind. Repressed and sluggish wage growth, together with declining real interest rates prior to the GFC, forced households to save a larger proportion of their income to meet their savings target. In addition, according to Chu and Wen (2017), interpersonal income inequality has been positively correlated with its marginal impact on household savings rates. In particular, the rising income inequality during this period, with the Gini coefficient peaking in 2008, has also contributed to the increase in savings. Third, economic reform has seen the government shift the burden of retirement incomes and public services from the public budget to households (Shimek and Wen 2008), which in turn has driven up the pressure for precautionary savings.

In particular, reforms since the 1990s have seen the dismantling of the generous welfare system that was formerly associated with danwei (welfare services provided by the public sector, including government agencies and SOEs). Concurrently, most employment growth since the 1990s has been in the private sector, which, beyond offering wages, does not offer welfare support to workers. The proposed new social safety net that is meant to replace the old welfare system has been slow in the making, and has been fragmented, inefficient, inflexible, and with poor accessibility and spotty coverage (Frazier 2014; Wills 2018). For example, according to Zhang et al. (2018), health care benefits for urban workers declined by 17 percentage points between the 1990s and 2000, while pension benefits declined by more than 30 percentage points. Consequentially, out-of-pocket expenditures for health care rose almost 40 percent between 1978 and 2000, and for education by more than 10 percent between 1990 and 2001. The marketization reform of the health care and education systems in the early 2000s under the Zhu Rongji administration further exacerbated the situatio...

Table of contents

• List of Figures
• Acknowledgments
• List of Abbreviations
• Introduction
• 1. Interactions between China’s Growth Model and the Financial System
• 2. Interests, Ideas, Institutions, and the Politics of Banking and Economic Reform in China
• 3. Growth Model Reform and the Banks as the State’s Cashier, 1979–96
• 4. Quick-Fix Banking Reforms after the Asian Crisis, 1997–2002
• 5. Further Banking Reforms, 2003–8
• 6. The GFC and State Capitalism on Steroids
• 7. The GFC Critical Juncture and the Rise of Shadow Banking
• 8. Shadow Banking after the GFC
• 9. The Politics of Banking Regulation and Reform
• 10. Mounting Debt and Lurking Risks
• 11. China’s Troubled Road to Economic Rebalancing
• Conclusion
• Notes
• References
• Index