This topic comes from a lunch talk days ago with a visiting scholar from China and a colleague in our department, who is quite ignored on the Chinese issues. Though under most conditions, the discussions about China that covers the riskiness of the banking system, unfairness of educational resources, the bribery among the official servants and governmental departments, can easily reach a consistent conclusion, this time we are facing dispersion. Such dispersion, however, can mean the ignorance of knowledge on fundamental theories of accounting and finance, the reality of Chinese society, and, of course, so-called ‘face’ that is widely seen in Chinese cultures (面子：笔者注）. To avoid some unnecessary troubles, this article only summarizes the viewpoint of mine.
This article investigates the development of China in past thirty years and its related issues on the social well-beings. However, it is far from adequate for an unbiased and justified discussion as the limitation of contextualization applies. The limitation also partly explains why I write this blog in English rather than in Chinese. Because I do not want to trigger the censorship from that ancient country, though the censoring system can have little impact on my blog given its highly limited readers coverage.
- The Role of Government and The Development of Economy in General
The very first question refers to the development of China in past 30 years in fundamental. This is the most prestigious part of the recent Chinese history that should be discussed than any other ones. As, in the past thirty years, China has transferred itself from a less developed country into a comparatively developed star. People becomes richer than they used to be, and the living styles has been changed a lot. The government and academicians accompanied starts to bury themselves in such results, and they assert, they have created a puzzled that to be solved by the whole economic world, namely, how and why the Chinese economy boomed in past thirty years and what can be implied? However, to my understanding, the development of Chinese economy is quite simple. That is the concentration of resources and great sacrifice on social well-beings and fairness.
The prolonged understatement of currency rate and good controls on the foreign currencies transfer for past thirty days ensures the benefit of cheap labor and limited import transactions. Given a balance sheet that the asset sides always exceeds its liability side, the firm can boom up rapidly with a fast increase on net assets. Such booming up can even accelerate when the distribution of earning is controlled. Indeed, if India follows a similar way of governing, there would be a second China in Asia. However, after hundreds of years governed by the United kingdom, their philosophy has been changed. That is, the government can be extremely hard to imitate such a method like his Chinese neighbor adopts, as is suggested by an article on Economist. The only difficulty that traps numerous economist in US and Europe is that, how can the public accept such concentration and where the public monitoring is. In general, they just cannot believe in their eyes.
Evidence can be easily shown regarding this issue if you readers want some. A good example that confirms my argument comes from the difference on size and profitability between the state-owned firms and entities of other ownership. The most profitable industries, including the telecommunication service providers, electricity and water supplies, petrol and gas, mass media, publication houses, etc are all state-owned that form a chain of monopolies in reality. In fact, such controlling avoids the market competition and the public requirements on optimization, which in turn, ensures good income for the country for the investments on infrastructure. However, by doing so, it enlarges the differences between state-owned firms and others, and strengthens the voting power of government in the market, and eventually, induces some other issues.
- The Consequence of Governmental Controlling: Social Disorders
The strengthening of voting power of governments in markets can lead to good rent-seeking motivations and can result in a widespread of corruptions. The corruption can partly be explained by a social basis on personal connections rather than that of rule-in-law principles as in US and Europe. However, I prefer an alternative explanation on the lack of public monitoring. Given a central role of government in resource allocation and distribution, the public monitoring can alleviate the rent-seeking motivation in this process and secure the fundamental fairness, which is the main responsibility of Congress in most countries of the world. However, the Congress of China failed to control this.
Such failure on monitoring results in a social fashion in China: Guanxi (Relationship) Economy. The worship on money and power eventually exceeds the merit of being honesty and diligent. Namely, if you want to be successful in China, an easy approach is to find the right person.The rent-seeking on governmental officers and the fashion of bribery in daily lives in fact promotes the popularity of entrance exams for civil servants. In a developed country, this is rare to see. An intriguing point underlying its popularity is its motivation. Because it is actually not reasonable for a great amount of graduates, holding a master’s and PhD diploma, to pursue a position that can indeed be fulfilled by a trained secretary, except for a fabulous temptation from Satan.
The offer from Satan, however, is a package comprised of various benefits: priorities on cheap housing that should be for low-incomers, special treatment on medical care system that is designed for all the public, VIP treatment for kid’s education from the schools that are established by the tax income from the public, perks and bribery that is created from the dominant role of government in market, etc. In addition, they are rewarded an outstanding pension plan that is unavailable to other public except for employees in state-owned firms and government-sponsored departments. Regarding this, there forms a mainstream of conflicts in Chinese society: the officials and privileged groups versus the rest.
The conflicts between the privileged groups and the rest are manifested in not only the population of such exams takers, but also popularity of immigration. Students without good family background and very little hope of being employed in state-owned firms and governmental-sponsored departments tend to seek opportunities of studying overseas. The scholarship and sponsorship overseas in fact provides students from a poor family but hold very good academic recordings an outstanding chance of developing their own careers, and provides a substituting mechanism for this group that has long been overlooked. A survey conducted by the Chinese government shows the returning rate of students studying overseas with high ranking on academia is only approximately 10% in past thirty years. I suppose, the unfairness existed and fear from the privileged groups should contribute much to this result. The escaping of such excellent students, especially those with PhD degrees and good contribution to their own fields, however, withdraws the potentials of the developing of Chinese society, and thus, ruins its perspective.
- The Governmental Role and Risk Control of Banks
The dominant role of government in the market, though ensures the short term profit by securing the monopoly role of state-owned firms in key industries, also leads to some potential risks in banking sectors. The banking system in China takes two layers that consist of national and regional banks. They are both charted and supervised by China’s Bank Regulatory Commission, a group that is formally independent of but implicitly holds a good relation with the central bank and government.
The banks are all highly staked by the government no matter which type the ownership is. Due to the restriction on banking business, banks in China in fact earns highest both fee and interest income comparing to their counter-parties in other countries. However, it is also their links to the government that their risk management strategy is under challenge.There is a strong regulatory requirement that prevents the banks in China to operate risky transaction including high volume of derivatives and structured products, but their high dependence on fee income and interest spreads generally compensates this drawback.
Given the stringent auditing policy for firms in China that seeks IPO opportunity, which involves both strict benchmark on their performance and bribery implicitly acknowledged, firms in China, no matter its size, are totally bank loan dependent. That is, loan from banks performs central role in Chinese markets. Given the conclusion stated above on the central role of Chinese government, the governmental decision can have a strong impact on banks’ loan contribution. Reasonably, firms with governmental background can have an easier access to the bank funding than others. That explains why the Ministry of Railway in China can have a 5,000 billion RMB loans with particularly low quality, but private firms with good performance can only receive funding through underground banking systems.
The conflicts between the risk controls and the governmental impacts eventually raises the riskiness of banks’ asset portfolio in part, and the concentration on land business forms the other. Given the land are allocated by the government, who takes the ultimate ownership, the transfer of utility rights of lands form a central item of governmental income, not only for central government, but also for local ones. The demand and supply of the utility rights, eventually boosts the price of landing, enlarging the governmental income and the cost for housing companies, finally creates a high level of housing price, comparing with the GDP per person and the average income.
The governmental controlling and their pursing the profit from land leasing result in the housing bubble that is similar to the United States before the crisis in 2007. Though the existence of high demand in houses, the bubble can hardly stay long with its great dispersion from average income. Thus, assuming the depreciation of house pricing in the future, the default risk and prepayment issues can be apparent, and the value of collateral is dropping down, the capital adequacy ratio set by Basel Accords can vapor in a dramatically fast manner and soon the banks, no matter whom they are, can face a short of funding. The SHIBOR rates can boost due to such demand, and finally, the financial stability of the whole country is threatened.
I am not sure about the percentage that the loans take in banks’ asset side of the balance sheet in China but it can apparently exceeds 60%, the average of US banks. This implies a very high leverage and a good potential catalyst for death when the market depreciates. The strong power of United States eventually saved up his banking system after bailing out several of its largest banks but I do suspect if the Chinese government can be powerful enough to pay the bill when such disaster eventually comes. If the answer is no, the proposed financial crisis raised from a crash of the banking system can then turn itself into the sovereign debt crisis as what the Europeans are now suffering. Though the probability of such happening can be low according to the current situation, but the consequence can be disastrous.
- Remarks and Contribution
Above all, though China has experienced its dramatic development since the 1980s as the starting of its open-door policy, some drawbacks remains. I assert that such drawbacks are induced by a unique social structure and can induce some unsolved issues on interest of conflicts among different social classes. The conflicts, however, further leads to numerous social issues that threaten the stability and future development opportunities.
This article also provides an answer to a question on why the economic growth in China maintains a high percentage by suggesting the central role that the government play in this market. The economic growth of China in past thirty years in fact is a substitution of loss on social well-beings for the public by the artificial intervene on the process of allocating and distributing the resources.
This article also anticipates that such intervene can result in a reduction on risk controlling efficiency for banks and thus harm the economic system in return.This article is also consistent to the recent discussion from the media that refer to the worries from the West on China’s being the third polar of the world. I would like to say that it is still too early to worry about this issue as China is still at its very early stage on development. It can only be a powerful country in reality when the internal conflicts can be reasonably solved and the fairness secured. Considering its political structure and uniqueness of contextualization, reaching this target means a long way to go.
This article is based on an academic analysis on the Chinese economy and does not represent any official point of view from or related to Chinese government. I personally maintain all the copyrights on this article. Please let me know if you want to re-post that somewhere else.