The Political Economy of Finance Decentralization in China: A Survey Experiment
Social scientists have produced works that emphasize and re-emphasize the importance of strong political institutions — separation of political power, an independent judiciary, free and fair elections etc. — as the foundation of economic prosperity. These political institutions are often encapsulated in one term: limited government. Limited government is particularly needed for the development of contract-intensive, future-oriented markets that cannot be sustained through informal institutions such as norms of trust or reputation. The banking market is a case in point. Yet, rarely asked is the following question: Why do such markets emerge and expand in autocracies — countries without limited governments?
Yes, I am talking about China. Consider the remarkable transformations of the Chinese banking market in the reform era:
- The whole banking system could barely find sufficient funds to cover Deng Xiaoping’s state visit to the United States in 1979; today, the banking system is the world’s largest, with its total asset being the equivalent of 40% of global GDP;
- Whereas one bank monopolized under Mao, over 2,000 compete now;
- Private firms are increasingly replacing state-owned enterprises (SOEs) as the major recipients of loans and credit;
- Private and foreign investors flock to state-owned banks to purchase their shares, despite the fact that there is not institutional protection of their property rights
My whole dissertation work was driven by this puzzle and still is.
Here’s the quick-and-dirty answer I got from 22 months of fieldwork: contrary to the established wisdom, the authoritarian government in China was not the impediment to banking market development, in fact, it is the architect of it. The state engineered a competitive market through the strategy of what I call organizational spinoff. Instead of a full-fledged market opening, the state distributed bank charters internally to local governments — much like a firm spinning off subsidiaries to increase internal competition and overall return to the whole firm.
What problems did organizational spinoff solve? It solved the problem of market formation when the state could not credibly protect private property, while also eliminating the state’s concern over losing financial control to private financiers. It also created a more secure environment for private and foreign players to enter (but still as shareholders of the state-controlled spinoffs) as competition intensifies over mobile capital. In a nutshell, through organizational spinoff, the state managed to capture increasing efficiency gains from a market that is still under its tight political control.
This summer, what I did was to run a small experiment among the loan officers that I have come to known through earlier fieldworks. The motivation of this is to provide micro-level evidence for what I learned during fieldwork as well as from analyses of observational datasets. In simple and plain terms, the experiment seeks to tease out what attributes of firms, under the condition of increasing bank competition in China, are important determinants of them accessing bank funds and the cost of accessing them — — in the minds of people who actually process the loan applications.
The research is still ongoing, and so is our attempt to understand the rise of China against existing social science theories. The larger issues I think about now are the following: for developing countries, should government just be providers of market infrastructures? Can they be players? Must there be formal institutions that clearly demarcate and credibly protect the boundaries between government and market for growth and prosperity?
Written by Adam Lui PhD candidate in Political Science, FSI Large Research Grant recipient for summer 2017.
