Capitalizing China

December 15-16, 2009
Joseph Fan and Randall Morck, Organizers

Roger H. Gordon, UC, San Diego and NBER; and Wei Li, University of Virginia
Provincial and Local Governments in China: Fiscal Institutions and Government Behavior

The Gordon-Li paper studies the implications of fiscal incentives that local government officials in China have faced since economic reforms began in 1978 and contrasts those with the standard models of local governments in the West. The authors argue that neither the Tiebout Hypothesis nor Buchanan's "Clubs Theory" can describe how China works. Instead, these authors put forth a revision of the Tiebout argument that lets capital flow relatively freely but constrains labor mobility (as China's Hukou system does). They argue that this theory explains observed distortions to China's growth, and an imbalance between the accumulation of physical capital and "human capital."

William Allen, New York University; and Han Shen, Davis Polk & Wardwell, Hong Kong
Assessing China's Top Down Securities Markets

China’s mainland securities markets are unlike those of Amsterdam, London, or New York, which evolved over centuries from myriad interactions between entrepreneurs or established businesses seeking finance and investors seeking investment opportunities and a means for relatively easy and quick liquidation of such investments. Such spontaneous securities markets did emerge throughout China in the 1980s following the start of liberalization, but these spontaneous markets were closed by the government in 1992 in favor of new, tightly controlled, exchanges, originally established in 1990 in Shenzhen and Shanghai. These new markets are different from those that had evolved spontaneously in the west or earlier in China. They have been designed and largely limited to serve state purposes, that is to assist in financing the state sector of the economy. Allen and Shen review the development of these markets as of late 2009, including the regulatory structure that controls and shapes them and the governance mechanisms – legal and otherwise -- that control the management of the listed companies. These markets represent a signal accomplishment of the Chinese leadership: producing, in less than twenty years, modern, albeit not yet fully developed, securities markets. Whether they can be developed further to serve a more basic economic role than they have been permitted to play is a question with which the essay concludes.

Franklin Allen, University of Pennsylvania; Jun Qian, Boston College; Chenying Zhang, University of Pennsylvania; and Mengxin Zhao, University of Alberta
China's Financial System: Opportunities and Challenges

Allen and his co-authors provide a comprehensive review of China’s financial system, and explore directions of future development. The current financial system is dominated by a large banking sector. In recent years banks have made considerable progress in reducing the amount of non-performing loans and improving their efficiency, and it is important that these efforts be continued. However, the role of the stock market in allocating resources in the economy has been limited and ineffective. The most successful part of the financial system, in terms of supporting the growth of the overall economy, is a non-standard sector that consists of alternative financing channels, governance mechanisms, and institutions. In the future, this sector could co-exist with banks and markets and continue to support the growth of the Hybrid Sector (non-state, non-listed firms). In order to sustain stable economic growth, China will have to prevent and halt damaging financial crises, including a banking sector crisis, a real estate or stock market crash, and a “twin crisis” in the currency market and banking sector.

Katharina Pistor, Columbia University
The Governance of China's Finance

The governance of finance comprises a set of mechanisms aimed at directing the collective behavior of market participants – whether intermediaries or regulators, investors or consumers – which in turn is constitutive for the operation of financial markets. These mechanisms can take different forms, including ownership, legal mechanisms, such as liability rules and regulatory oversight, or personal ties based on kinship, common origin, or association with a common cause. Most governance regimes for finance combine several such mechanisms. Yet, their relative importance as a dominant form of financial governance differs from country to country. Pistor explores the governance of finance in the Peoples’ Republic of China (PRC) and argues that notwithstanding important legal, regulatory, and ownership changes over the past decade, the dominant form of governance in China is a network of financial cadres that is maintained and supervised by the Communist Party (CCP). Far from being a leftover of the Maoist period, this regime was strengthened over the past decade in response to perceived threats to the stability of China’s financial -- and by implication, political -- system: The East Asian Financial Crisis; China’s membership in the WTO and the implied loss of control over formal entry barriers; and the global financial crisis. It is therefore unlikely to simply fade away as China becomes more integrated into the global financial system. The apparent compatibility of this system with China’s rise to prominence in global finance raises important questions about the future governance of the global financial system.

Tamim Bayoumi and Hui Tong, International Monetary Fund; and Shang-Jin Wei, Columbia University and NBER
The Chinese Corporate Savings Puzzle: A Firm-level Cross-country Perspective

China’s high corporate savings rate is commonly claimed to be a key driver for the country’s large current account surplus. The mainstream explanation for the high corporate savings is a combination of windfall profits in state-owned firms, especially in resource sectors, and misgovernance of state-owned firms represented by their low dividend payout. Bayoumi, Tong, and Wei cast doubt on these views by comparing the savings of 1,557 Chinese listed firms with those of 29,330 listed firms from 51 other countries over 2002 to 2007. First, the Chinese firms do not have a significantly higher savings rate (as a share of total assets) than the global average, because corporations in most countries have a high savings rate. Second, there is no significant difference in the savings behavior and dividend patterns between Chinese majority state-owned and private firms, contrary to the perceived wisdom.

Joseph Piotroski, Stanford University; and T.J. Wong, Chinese University of Hong Kong
Institutions and Information Environment of Chinese Listed Firms

Piotroski and Wong describe the financial reporting practices and information environment of Chinese listed firms and document the influence that local and country-level institutions have on reporting incentives and the resultant information environment. They identify four key institutional arrangements that influence the supply and demand for information about Chinese listed firms: the State’s controlling ownership of listed firms; the government’s control of capital markets; the limited protection of property rights and weak market institution;, and a lack of independence of local auditors. Their paper concludes by discussing how changes in these institutional arrangements would likely influence China’s information environment.

Dennis Yang, Chinese University of Hong Kong; Junsen Zhang, Chinese University of Hong Kong; and Shaojie Zhou, Tsinghua University
Why are Saving Rates so High in China?

From international comparisons of national savings, Yang and his co-authors define “The Chinese Saving Puzzle” as persistently high savings at 30-50 percent of the GDP in the past three decades and a surge in saving rates of 10 percentage points over the last ten years. Using aggregate data from the Flow of Funds Accounts and micro data from Urban Household Surveys, they present evidence that sheds light on the causes of China’s high and rising savings for both enterprises and households. They argue that while the ongoing massive stimulus spending may help prevent a slowdown in the Chinese economy in the short run, sustained long-term growth will depend crucially on future structural adjustments that could successfully boost aggregate consumption.

Joseph Fan, Chinese University of Hong Kong; Jun Huang, Shanghai University of Finance & Economics; Randall Morck, University of Alberta and NBER; and Bernard Yeung, National University of Singapore
The Visible Hand behind China’s Growth

China is growing rapidly, despite doing poorly in terms of institutional and market development. This paradox is resolved by examining the promotion decisions of China’s local (city)-level bureaucrats. Their promotions correlate strongly with growth rates in local GDP and local capital spending (both domestic and FDI). This suggests that an incentive-compatible "promotion-for-performance" compensation scheme for Party bureacrats might substitute for institutional features that align government policies with economic growth in Western economies. However, China's GDP and capital spending statistics are widely seen as subject to manipulation. No correlation is found between bureaucrats' promotions and the variables that plausibly ought to capture rising local prosperity: education spending, green space expansion, spending on health care, and the like. Linking bureacrats' promotions to readily manipulable economic performance measures thus may only encourage biased national income accounts. Fan, Huang, Morck, and Yeung speculate that alternative policies linking promotions to evaluations of living standards by third parties might prove more credible substitutes for direct political accountablility to voters.

Zhiwu Chen, Yale University; and William N. Goetzmann, Yale University and NBER
Financial Strategies for Nation Building

Goetzmann and Chen argue that China's policy of building up huge stores of wealth through high savings by state-owned enterprises is misguided, and gives the government too much freedom from the immediate economic consequences of its actions on the economy (taxpayers). They suggest that governments dependent on annual tax revenues are much more careful not to damage the economy, and they present historical evidence of this.

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