China's Emerging Financial Markets

Challenges and Global Impact

Martha Avery, Min Zhu, Jinqing Cai, Martha Avery, Min Zhu, Jinqing Cai

• Publisher: Wiley
• Year: 2011
• Print ISBN: 9780470822494
• eBook ISBN: 9781118179024
• Edition: 1
• Topic: Business
• Subtopic: International Business
• Index: Business

"The 19th century belonged to England, the 20th century belonged to the US and the 21st century belongs to China. Invest accordingly."
Warren Buffet

This comprehensive resource presents the views of China's most highly respected economists, bankers, and policy makers--along with opinions from Western authorities--on the current state of banking and finance in China. Tracing the history of China's banking and finance system and looking toward its future, the book offers valuable insight for financial service providers, bankers, private equity and hedge fund managers, and equity research and credit analysts.

Contributors to the book includes:
Jamie Dimon — Chairman & CEO, JPMorgan Chase Bank
Guo Shuqing — Chairman, China Construction Bank
Paul Volcker — Former Chairman, U.S. Federal Reserve
Stephen S. Roach — Chairman, Morgan Stanley Asia
Wang Dongming — Chairman, CITIC Securities Co., Ltd; and many more!

SECTION 1

MACRO

Chapter 1

Fundamental Issues and Challenges Facing the Chinese Economy Guo Shuqing

Chairman, China Construction Bank

China’s economy has sustained rapid growth for over 30 years now, which is a remarkable record in the history of the world. Globalization and the revolution in new technologies have helped, by giving China, as well as other developing economies, the chance to develop industrial and information societies in tandem. The significance of this is that what had been regarded as “non-economic variables” in the past are now influencing the course of economic modernization, in addition to traditional economic variables. Later-developing countries have also been able to take advantage of lessons and experiences gained elsewhere in dealing with environmental protection issues. Theoretically, China should be able to avoid repeating most of the mistakes of Western countries in this regard. Actual development in different countries presents great variation, however, no single country can be regarded as wholly ideal. Some have imbalances in a certain respect, others in some other respect. It may well be that China’s circumstances are most controversial.

BASIC CHANGES IN CHINA’S ECONOMY SINCE REFORM AND OPENING

Since Reform and Opening began in the late 1970s, China has been experiencing growth in a way that neither resembles our own past nor the experience of foreign countries, but that has absorbed and inherited from both. After adopting the overarching policy of “opening to the outside and enlivening the inside,” both government and market in China have served as guiding entities in the process. Rural communities and cities have been mobilized, quantitative and qualitative goals have enjoyed equal standing, and China’s economy has industrialized in concert with its development as an “information society.” The market has played an important role in this process. It has spurred foreign trade and foreign investment. The importing of advanced technology and management that resulted has had a revolutionary impact. At the same time, we can see the influence of development policies that we espoused in the past; for example, loosening ownership rights and allowing profit, mobilizing the efforts of local regions, raising up large, middle and small enterprises at the same time, merging both native Chinese and foreign elements, allowing villages to engage in industry, and so on.

After more than 10 years of Reform and Opening, the machinery set in motion to reform the Chinese economy was producing real change by the end of the 1980s and the beginning of the 1990s. An economy that had specialized in long-term shortages as a defining feature now specialized in warehouses overstocked with consumer goods and indeed overstocked inventories of all kinds. Imports had exceeded exports for many years; this changed as the balance of trade swung in the other direction. Structural imbalances continued to be the main source of price inflation—for example, bottlenecks of grain, resources, and transportation—but these ceased to be a major cause of alarm in terms of supply and demand of goods. The price indicators of interest rates and exchange rates began to play a role in China’s economy in the late 1980s. Even though that role was extremely limited at the time, the effectiveness of policy measures in dealing with two periods of inflation in the latter part of the twentieth century exceeded the expectations of most economists, and savings deposits were able to maintain their value through subsidies.

The qualitative changes, or one could say semi-qualitative changes in economic operations, had a significance that was not trivial. First, they indicated that the traditional planned economy or “command economy” of the country had already gone halfway in its transition toward a market economy. This was called at the time a “commodity-oriented planned economy.” Although difficulties remain in realizing a fully transitioned economy, it is now not so far in the distance that it is impossible to hope for. Second, the changes indicated that, in terms of managing the economy, we could no longer rely solely on administrative measures, but instead had to shift to indirect measures to influence economic performance. It became impossible not to change the entire formulation and operating mode of macroeconomic policies in China. Third, taking a gradual, step-by-step approach to moving the economic system from one track to another made it apparent that this approach had both benefits and drawbacks. It is now our task to take advantage of practical experience, to enhance the benefits and eliminate the drawbacks and effect a faster and smoother transition to a market economy.

The achievements of economic growth during this transitional period cannot be denied, but the process also incurred negative consequences. Problems became severe in the mid-1990s when economic contradictions began to sharpen. The causes were multifaceted. First, as the level of industrialization rose in China, ordinary manufactured goods were soon in over-supply and competition became fierce. Not just state-owned enterprises (SOEs) but also town-and-village enterprises began to feel the results. Second was the way in which industrialization took place across the landscape with no regard for environmental factors: the ecological situation worsened as dramatically as people’s living conditions. The true costs of economic growth soon became something from which people could no longer avert their gaze. Third, as foreign-invested enterprises continued to increase, not only did this lead to greater foreign trade, but it influenced domestic markets and sectors as well. Fourth, nonperforming loans (NPLs) at China’s banks became more unsupportable by the day, and it was increasingly hard to rely on massive loans to finance a rapidly growing economy. Fifth, for a long time, agriculture continued to employ small-scale family-farming operations—it was increasingly hard to reconcile these with modernized industry and markets, leading to volatility and duplication of efforts.

When the ninth Five Year Plan was being researched and formulated, we proposed a so-called “two transformations” policy that was aimed at transforming both the economic system and economic growth mode. The eruption of the Asian Financial Crisis increased the urgency of making strategic changes in the economic system in China. Since that time, the economy has performed extremely well, but the transformation of the growth mode has not been as ideal as we might have hoped.

Starting in 1998, China’s economy began to experience an overall surplus on the supply side. It became difficult to sell products, there was an excess of labor, investment funds sat idle, and since inventories of grain were now excessive, for a time even land became a non-scarce resource. All of this happened in a Chinese economy that was sustaining a rapid rate of growth. This was not only unprecedented in China’s history, but unique in the history of the world.

All of the above problems could correctly be summarized as having insufficient effective demand. They could also, however, be attributed to the irrational structure of production and thus to having insufficient effective supply. The economy was experiencing duplication in productive efforts and excessive competition at the low-end level, but at the same time, scarcity at the high-end level of value-added products. A key issue was that our manufacturing industries were extremely weak in opening up markets, guiding demand, and creating new products. In addition, they needed to import a relatively high percentage of high-tech equipment. While quantities of products were stuck in inventory, many social services in support of citizens and the society at large were in short supply. Indeed, close analysis shows that virtually all service industries were in short supply. Wholesale and retail industries were far below the quality standards of developed countries; in contrast to those countries, counterfeit and shoddy goods were pervasive throughout China. The phenomenon of producers cheating consumers in all ways could be seen everywhere. Meanwhile, financial services provided to individual citizens were substantially below the level that developed countries had achieved decades earlier. Education, culture, science and technology, healthcare and hygiene, law, accounting and auditing, were even more severely stunted. Without doubt, there was a severe imbalance in allocation of resources.

Since entering the twenty-first century, especially with the entry of China into the World Trade Organization (WTO), China’s economy has seen a more profound change. On the one hand, China has entered the global economy on a higher level and broader scale, and begun to play an important role in the international division of labor. The country has thereby become an important stimulus in world economic growth. On the other hand, as market reform has proceeded apace inside China, and as the fundamental nature of market mechanisms has taken hold, it has become evident that there is a greater need to employ macroeconomic management and other economic and legal measures to assure the improvement of the socialist market economic structure. Employing these measures will provide the material basis and foundations of a system that ensures relatively fast growth into the future.

CHINA’S UNIQUE ECONOMIC ISSUES

China’s macroeconomic policies are fundamentally different from those of the West for the key reason that we cannot afford to attend only to the short-term economic balance, but must keep our attention focused on mid- and long-term change. In evaluating the course of China’s economic development in the future, we must keep in mind unique circumstances that pertain to China, even as, equally important, we make reference to the experience of the rest of the world. On the one hand, this requires looking back over the process of industrialization; and on the other, looking forward to future modes of development.

China should not follow the same sequence of development that countries which have already reached post-industrial mode have followed. This is due primarily to the fact that scientific advances have brought on structural changes in economic activity that allows backward countries to enjoy certain “benefits of being later in development.” In theory, China should be able to experience the three stages of development concurrently, or one could say pursue policies that turn it into an industrial and information society at the same time.

In reality, this concept encounters severe challenges. The growth rate of China’s service industries has neither surpassed the growth rate of industrialization nor remotely reached the rate existing in other countries some decades or even centuries ago. Even at the most favorable estimation, China’s secondary industries occupy something approaching one-half of the country’s GDP, while tertiary industries occupy only around 40%. The imbalance of this ratio has unfortunate consequences for income distribution, consumption ratios, growth potential, and environmental protection. There are perhaps two fundamental reasons for this. The first is that urbanization has fallen behind industrialization and the overall economic rate of growth; the second is that universal education remains far below its potential.

China has pursued an unusual course of development over the past 50 years, which is a root cause of the country’s current structural issues and delayed urbanization. From the 1950s, when People’s Communes were established, industrialization began to extend throughout the country’s towns and villages. With the failure of the “Great Leap Forward” in 1958, however, in order to adjust the economy, it was imperative to send large numbers of people to the countryside, and a stringent policy of dividing urban and rural residents was enforced so that the country’s economic structure was de facto segmented as well. The industrialization of cities was undertaken to service those cities, while villages were permitted to create their own forms of industrialization. “Commune Troop Enterprises” were already forming in the 1970s. After Reform and Opening began, their commercial activity burst through the dikes and began to surge throughout the country in a positive flood.

The appearance of Town-and-Village Enterprises (TVEs) was fundamental in the structural change of the economic system during China’s economic transition. Without this new force, China’s economic reform would not have had the same rapid and sustained growth and the mechanisms of a market economy would not have steadily achieved irreversible dominance. Urban economic institutions at the same time would not have played the stable and irreversible role of supporting that change. However, since governmental policies and the entire system followed a dual arrangement, TVEs, together with their resources, were forced to operate outside the urban economic system. They were forced to find their own way. The tremendous blooming of such enterprises led to industrial entities being widely dispersed in terms of spatial distribution. In the early 1990s, roughly 87% of TVEs were located in rural communities, and even today only around 30% have entered towns and cities and commercial parks. One consequence is that the market for service industries has lagged behind. This phenomenon of overly dispersed industrialization presents negative consequences for long-term sustained development and for a balanced domestic structure. Such consequences have become more pronounced in the past decade. In addition to ongoing problems over many years of NPLs in the banking sector, and waste of capital investment in recent years, a heavy price has been paid in terms of resources, environment, and people’s quality of life.

THE AGRICULTURAL SECTOR

The importance of agriculture in the economy of any country is a given. China’s urbanization issues are similar to those long ago encountered by all industrialized countries. These include what are known as the three “agricultural issues” facing all levels of government in China: the agricultural industry itself, people engaged in agriculture and the condition of rural areas in general. In order to manage an appropriate scale of agriculture, turn farming into a profession, guarantee services, and transfer high technology, one vital precondition is the essential mobility of the farming population.

Unfortunately, there are fundamental constraints on this essential mobility in China. We have an extremely complex employment structure. A person engaged in farming is often also a construction worker on a seasonal basis, he or she might also be a part-time salesperson, or work in a restaurant or perhaps in an abattoir. Division of labor in both farming and in towns and villages is an extremely slow process and this situation of multiple extra jobs and mixed-employment will necessarily persist for a long time. It is one reason both agriculture and rural areas stagnated after the 1980s in China. Another complexity arises from the fact that many farming areas with highly developed enterprises have in fact gradually become cities. This has happened even as the farming population of other areas moved into existing cities to work and do business.

People who have moved into cities have not been absorbed by them on a long-term basis, however. They are still labeled with the somewhat pejorative term “peasant workers.” Meanwhile, towns and villages that have long since become de facto cities and that are dominated by non-farming commercial activities are still, in policy terms, being administered as “rural areas.” The legal status of the inhabitants of these places is different from the status of people in cities; this is seen most clearly in terms of employment, public services, and social benefits. In recent years, recognition of de facto urbanization has been increasing in the policy sphere, but awaits clarification in terms of actual strategy. Appropriate laws and regulations need to be formulated and there is an urgent need to address issues arising from the spontaneous urbanization of China.

INDUSTRIAL STRUCTURE

From the early 1990s, severe structural imbalances were apparent in China’s industrial and manufacturing sectors. Basic industries were stagnating behind value-added industries, an imbalance that was gradually addressed after price and tax reforms. By the early twenty-first century, people even began to be concerned about whether or not there had been an excessive shift to making industries more “heavy.” A second imbalance related to the slow pace of upgrading value-added industries: the manufacturing chain was too short and overly concentrated on the low-end, with insufficient value-added. A third was that industry was overly concentrated along the coastal areas: the regional distribution that could be seen in other industrialized countries was hard to find in China and in fact the opposite tendency was the rule, the so-called “peacock flies to the south and east” phenomenon. The latter two issues have been tied together in remorseless...

Table of contents

• Cover
• Half Title page
• Title page
• Copyright page
• Acknowledgments
• Preface
• Introduction
• Overview
• Biographies
• Section 1: Macro
• Section 2: Banking
• Section 3: Capital Markets
• Section 4: Insurance
• Section 5: Monetary Policy
• Section 6: Services
• Index