How Financial and Banking Reforms Have Changed the Economic Performance of China - Literature review Example

Business and Economy of China Business and Economy of China How Financial and Banking Reforms have changed the Economic Performance of China. Introduction History has witnessed several developed nations in the world that were certain regarding their economic success, however the factor of weak-financial system became a downfall for their entire economy (Cai, 2010). It has been noted that China has suffered a lot, economically, because of the financial crisis. China had been under serious economic crises because of the financial debts of the Chinese Banking system. To counter the economic and financial crisis, reforms were introduced to enhance the performance of Chinese economy. As it has been evidenced that good financial and banking system will ultimately result in the advancement of any economy. The purpose of this paper is to identify the financial and banking reforms in China. Furthermore, the essay will also analyze whether or not these reforms have enhanced and transformed the economic sustainability and the overall economic performance of China. Keywords: China, Chinese Economy, Financial, Banking, Communist Party of China (CCP), Economic Reforms. Background According to Ash et al., (2013), China has remained for many years as one of the fastest growing economies in the world (cia.gov, 2014). However, the background to the economy of China is totally conflicting. The financial sector of China was completely dependent of its banking sector while the banking sector was under serious threats as it was under debts and was facing challenges (Garnaut, 2013; Liao et al., 2013). If the speed and scale of the transformation that China has gone through is observed, then it certainly has no historical match. According to a survey conducted in 1978, China was among one of the poorest countries in the world as its per capita GDP was 1/40th compared to the United States (Das, 2012; Naughton, 2007). Zhu (2012) stated that since China was not doing very well economically and was left far behind in the economic world, therefore, it had to come up with strategies and reforms that may enable its entire economic system to enhance the overall operations. By 1976, many Chinese leaders agreed to the idea that reforms in the field of finance and banking are essential as they will boost up the economy (Lin, 2012). The Chinese leaders were looking for ideas and solution to counter the serious issue of economic instability and challenges that were faced by the country. To counter these issues, the financial and banking reforms were introduced in 1978 (Das, 2012; Cai, 2010). Economic Performance of China Before the Introduction of Reforms Naughton (2007) has discussed that, before the introduction of the financial and banking reforms, Chinese economy went through major issues and faced numerous obstacles. It was only during the 1930’s that the economy of the country was stable. After that it was counted in the world’s poorest economies of the world. Following the Chinese Civil War and the War against Japan during the 1930’s, the economy of China was disrupted by several factors such as the ‘Great Leap Forward’ and the ‘Cultural Revolution’, etc. (Cai, 2010; Kumbhakar & Wang, 2007) The living standards of the Urban Chinese people were going below than average and no improvements were noticed even in the 1950’s or onwards. Where on the other hand the living standards of the rural Chinese people were better during the 1930’s compared to that of 1950’s and 60’s (Cai, 2010; Zhu, 2012). China was facing major issues with its financial and banking sector (Kumbhakar & Wang, 2007) It remained under crises as opposed to the financial and banking sector of other countries such as South Korea, Japan, and many other East Asia. One major reason was the ineffectiveness and no investments in the market. It was also due to the reason that Chinese Communist Party (CCP) focused only on the industrial sector for the purpose of achieving a self-contained economy (Das, 2012; Garnaut, 2013). However, the goal to make China economically stable and prosperous was not attained due to certain reasons. The major reasons were imbalance between resources and the set goals, which never allowed the Chinese economy to accelerate. Presber (2011) illustrated that at the same time, the financial and banking sector were not given a chance to contribute towards the Chinese economy. As it has been aforementioned that banking and financial sector plays a major part in the economic sustainability of any nation. For this reason, economic reforms were introduced in China in 1978, specifically in the financial and banking sector, which accelerated the Chinese economy (Zhao, 2013; Yueh, 2010). Financial and Banking Reforms The Communist Party of China introduced the Financial and Banking Reforms under the Chinese Economic Reforms in 1978 (Ash et al., 2013; Geib & Gompf, 2012). It is the set of reforms that illustrate ‘Socialism with Chinese Culture’. The economy of the country was stable during the 1930’s while it faced many challenges prior to the twentieth century. To counter the economical issues the country was facing these reforms were introduced, led by Deng Xiaoping (Chai & Roy, 2006). According to (Wu, 2005), the reforms were introduced in two phases. The financial and banking reforms were introduced in the Chinese economy in both the phases (Kumbhakar & Wang, 2007). The banking sector in China was liberalized during the 1990’s. It was after the introduction of the reform that the country allowed Foreign Direct Investment (FDI) and joined World Trade Organization (WTO). All the restrictions that were imposed were called off. The Chinese market was open for international banks and investors (Song & Woo, 2008; Liao et al., 2013). It should be noted that four major state-owned banks control the banking sector in China (Pei, 2014). These banks are incompetent and controlling in regard to their operations. One example is that of the ICBC, which is the largest bank in China and globally. It has been revealed that the main players of the financial sector in China are banks. With the introduction of the reforms in 1978, the banking sector has undergone various reforms and changes and their implementations (Kumbhakar & Wang, 2007; Liao et al., 2013). Ye, Xu, & Fang (2012) stated that the Banking sector of China is a vital element for the Chinese economy. Undoubtedly, it can also be considered as the basis for the financial system of the country as it contributes a handsome share towards the economy. The first reform in the banking sector was introduced during 1978-1994 (Cai, 2010). It created a Two-tier Banking System. The purpose of this reform was to focus solely on the transformation and advancement of the structure and the overall operations of the administrations of China’s banking system. With the help of these reforms, the country was able to leave room for future reforms in the banking sector. After the implementation of this reform, banks in China operated more actively and contributed their part towards the developing economy of China (Liao et al., 2013). The second reform was introduced in 1995-2001 and was known as the Central Bank and Commercial Bank Law (Naughton, 2007). The purpose of this reform was to handle and manage the shortcomings of earlier reforms. The final reform was introduced in 2001 and is practiced until present in China in the Banking sector. It is known as the WTO Accession (Bao et al., 2006). With the introduction of this reform, international banks opened their branches in China. Since, before the implementation of this reform international banks were afraid of entering the Chinese markets because of their strict rules and regulations. However, the WTO Accession transformed the scenario (Naughton, 2007). Similarly, in the financial sector reforms were introduced to improve the economy of the country. For this purpose, various reforms in the financial sector were introduced which included prominent restructuring, FDI, etc. (Kumbhakar & Wang, 2007). The most notable one was the establishment of the Shanghai Stock Exchange during and the establishment of Shenzhen Stock Exchange during the 90’s. Furthermore, reforms such as the introduction of the Companies Law in 1993 and its Enactment and the Security Law that was introduced in 1998 eventually formulated a legal basis for issuance of equity (Wu, 2005; Presber, 2011). These reforms also transformed the infrastructure of the stock market. After these reforms, the stock market undergone many developments as the number of companies that were listed in the stock exchanges in China increased to 1379 in 2005 from 345 in 1995 (Cai, 2010). It should be noted that the Chinese financial system is dominated and controlled by its banking sector. This illustrates that the banking reforms also had an impact on the financial sector of the country, which eventually led towards the success of the economy (Naughton, 2007; Liao et al., 2013). Economic Performance of China After the Introduction of Reforms According to (Zhu, 2012; Cai, 2010; Ash et al., 2013), after the introduction of reforms in China, the financial system and the overall economy of the country has developed enormously. Improvements have been observed in both quality and quantity in the bank credit industry, which has enhanced the financial sector of the country. The huge growth, which China has experienced in the past decades in its economy, is because of the bold reforms that were introduced by CCP (Garnaut, 2013). It should be noted that banks are they key distributors of credits. It is through these banks that the decision of investments is made (Liao et al., 2013). Therefore, if banks in any country are working in the right and appropriate manner the entire economical output will be improved. In developing countries, the economies majorly rely on financial and agriculture sector. In the case of China, the financial sector was depending upon the banks that were not working properly (Pei, 2014). According to the Economist, Chinese economy after the 1990’s was referred to as the ‘Great Leap Forward’. It was after the introduction of these reforms that the GDP of the country accelerated to 12.4 % annually. On the other hand, the fixed investment per capita of China reached as high as 14.8% annually. If the GDP of China before and after the introduction of these reforms is compared then in 1994, the real aggregate GDP was US $542.5 billion whereas in 2005 it was US $2.61 trillion (Geib & Gompf, 2012). By 2005, China was the world’s 4th largest economy after the United States, Japan and Germany (Cai, 2010). The following year, it left behind Japan in purchasing power parity and was ranked as number third after the United States and Germany with an aggregate GDP of 8.16 trillion US$. Before the introduction of these reforms, China, in 1992, was ranked at number 10th in the world and its growth was stagnant. The main reason behind this rapid growth, stated by numerous theorists and researchers, is the introduction of structural reforms in the financial and banking sector, which were supported by similar reforms in other sectors, as well. However, the importance is given to the financial and banking sector as they form they basis of the Chinese economy (Presber, 2011). Figure showing how banking sector in China have contributed towards the economic success (Pei, 2014). According to (Ash et al., 2013), the Chinese economy is growing at a higher speed. For this reason, China is termed as the world’s fastest growing economy (Liao et al., 2013). The results of the reforms are obvious and profound. It was through the introduction of the financial reforms that free trade was opened for other countries as China was previously a closed ended market. The financial reforms have played a prominent role in advancing and improving the economy of China as the FDI has also contributed a lot in expanding the Chinese economy (Lin, 2012). The financial reforms allowed international organizations and banks to invest in China. After these reforms, China began to have a huge market share in foreign investment. For this reason, the beverage giants such as Coca Cola and Pepsi also overtook the Chinese soft drink market. The economy of China was growing at an average rate of 10% per year (1994-2004). No country has ever been able to achieve such a drastic growth rate in the world (Yueh, 2010). The performance of Chinese economy after the introduction of the financial and banking reforms had their impacts on every aspect of Chinese society. 15 millions jobs were generated annually (2006). However, the country faced the Global Financial Crisis of 2008 – 2009; the government decided to launch the Economic Stimulus Plan so that it can effectively deal with the financial crisis. According to research conducted by IMF, it was revealed that the major factor behind the enormous growth of the economy of China was the introduction of reforms in 1978. According to the report, the major credit is given to the financial reforms through which capital investment in the country accelerated, taking the lead towards a prosperous economy (Das, 2012). Garnaut (2013) stated that the cash flow, which resulted as foreign investment in the country, allowed in building factories and creating thousands and millions of jobs. Furthermore, the reforms also allowed transparency and clarity in the financial and banking sector of China. As it has been discussed that all four major banks of China are controlling and monopolizing in nature, therefore, these reforms incorporated stricter rules and supervision for the financial institutions. It also allowed the banks to get rid of any political influence. Many small commercial banks are opened in the country as a result of the banking reforms, which has collectively resulted towards the growth of the economy (Wu, 2005; Ye et al., 2012). Conclusion The economic success of China has dazzled the entire world. The pre-reform era hardly witnessed a growth of 6% per year, while the post-reform era, the Chinese economy evidenced an average growth of more than 10% per year. It is predicted that if the Chinese economy continue to expand on the same rate then in the coming twenty years it will cross the US economy. It was with the help of the economic reforms of 1978 that China was able to overcome the economic downfall. The reforms in the financial and banking sector allowed the country to boost its economy in a variety of ways. These reforms, according to many researchers and economists, are the core reasons behind the unprecedented economic performance of China. China at present holds a unique niche in the international economy. China is an outstanding example for the developing countries that are in search of great lessons. With the help of the economic reforms; financial and banking, China made a spectacular example of shifting its workforce from the traditional rural / farming lands to urban and financial markets. These reforms are a great lesson for countries that are trying to expand their economies. The financial sector of China majorly depends on the banking. With the introduction of the reforms, the banking sector was able to improve its operations; FDI investments in the country were opened and many international banks and organizations entered the Chinese economy. Thus, it can be stated that the Chinese economic reforms of 1978, to re-structure the financial and banking sector of China transformed and improved the economy of the country and accelerated the overall economic performance. List of References Ash, R., Howe, C. & Kueh, Y.Y., 2013. Chinas Economic Reform: A Study with Documents. New York: Routledge. Bao, S., Lin, S. & Zhao, C., 2006. The Chinese economy after WTO accession. Aldershot: Ashgate. Cai, F., 2010. Transforming the Chinese economy. Leiden: Brill. cia.gov, 2014. The World Factbook. [Online] Available at: [Accessed 30 April 2014]. Chai, J.C.H. & Roy, K.C., 2006. Economic Reform in China and India : Development Experience in a Comparative Perspective. Cheltenham: Edward Elgar Pub. Das, D.K., 2012. The Chinese Economy. 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