Entry of WTO in Chinese Economy - Essay Example

?Finance and Accounting Introduction China’s economy has been experiencing rapid growth since 1978 and has been the most rapidly developing economy in the world. The growth started with the reforms in 1978 and the Chinese economy has been maintaining the annual growth rate of about 9.8% since then. The outstanding loan in the financial institutions with respect to GDP has experienced an increase from 51% to 107%. China has experienced uninterrupted and fast growth for the past thirty years and have presented with an interesting case study for discussion. The paper elaborates the relationship between the financial development and the economic growth in China with the help of researches that are carried out by many proficient researchers (Zhang, Lanfang and Susheng, 2012). Allen (2005 cited in Zhang, Lanfang and Susheng, 2012), an eminent researchers has commented that China has been an important example of flourishing economy who have experienced the fastest growth in finance in more than 30 years. But it should be noted that the financial sector is governed by the state and is underdeveloped even today. The relationship between financial development and economic growth is generally negative. With the help of the provincial data between the period of 1990 to 1999 Boyreau-Debray (2003 cited in Ljungwal and Li, 2007) indentified that financial intermediation has affected the local economic growth negatively. Hasan, Wachtel and Zhou (2009 cited in Ljungwal and Li, 2007) with the help of provincial data for the period 1986 to 2002 has also pointed out the fact that finance sector has negatively affected the economic growth of the country. But Chen (2006 cited in Ljungwal and Li, 2007) has argued the fact. By using the provincial data for the period of 1985 to 1999 had showed that financial development of China has contributed positively to the growth of the economy (Choong and Chan, 2011). He also examined the two channels, which contributed to the economy to be “the substitution of loans for budget appropriation mobilization of savings” (Zhang cited in Lanfang and Susheng, 2012). With the help of the provincial data of 1995to 2003, Cheng and Degryse (2007 cited in Zhang, Lanfang and Susheng, 2012) has examined the effect of expansion of the non-bank financial institutions and the banks on the local economic growth. He indentified that the development of the banks has positively affected the economic growth of China. Guariglia and Poncet (2008 cited in Zhang, Lanfang and Susheng, 2012) have used the data of period 1989 to 2003 and has identified two indicators for examining the relationship between economic growth and financial development in China. They concluded that the indicators for measuring the state intervention in financial development are negatively correlated with the economic growth of China. The indicators of market driven financing is positively correlated with the growth of the economy. Finally, Ayyagari, Demirguc-Kunt and Maksimovic (2008 cited in Zhang, Lanfang and Susheng, 2012) took the help of firm related data for examining relationship between growth of the firm and financing pattern of the firm, which can be informal versus formal finance. They explained that the formal financial system has encouraged the growth of the firms. Park and Sehrt (2001 cited in Zhang, Lanfang and Susheng, 2012) have identified that lending policy by the state banks have not fallen during 1991 to 1997 (Ljungwal and Li, 2007). Thus, it can be said that the financial development in China has created both positive and negative impact on the economic growth of China. 2. China’s financial development and economic growth China has experienced rapid growth in the economy after the reform in 1978. It has second largest economy in the world after United States and it can become the largest economy in the world in the coming 10 years on the basis of the Purchasing Power Parity (PPP) (Allen, J. Qian and M. Qian, 2005). China has always played a significant role in the development of the world economy and its financing sector. The financial system has confronted with the structural reforms, but it is still underdeveloped and is lagging behind from other economies worldwide (Rousseau and Wachtel, 2002). 2.1 Entry of WTO in Chinese economy The swift reforms in the Chinese economy started in 1994. The series of reforms that followed from 1994 to 2000 saw dynamic progress in the independent banking operations. To eliminate the Big Four lending policy three new bank’s policy were created in 1994. The monetary policy of China was then directed towards the indirect monetary control. Credit planning that started in 1998, for banks were abandoned (Rousseau and Sylla, 2005). In 1995, the Commercial Bank Law of China was enacted and it provided with the details of requirements for the operations of a commercial banks. Four Asset Management Companies were established, which started its operation with 270 billion Yuan, which was provided by the government. The state owned Asset Management Companies collected 1.4 trillion Yuan from the public as their investments. China Minsheng Bank Corporation (CMBC) was established in 1996 and it is the first private national bank in China. Towards the end of 1999, there were more than 11 national joint equity commercial banks, which have assets of about 1,447.7 billion Yuan (Schich and Pelgrin, 2002). 2.2. Post entry of WTO China entered World Trade Organisation (WTO) in December 11, 2001. After entry into WTO, the Chinese economy was characterized by a remarkable liberalization process in finance which included mostly the liberalization of the interest rates, restrictions are reduced and there has been increased freedom for the foreign banks for entering the national grounds. Liberalization of interest rate has been an important component of financial liberalization and also in the resource allocation. Prior to the period of 1999, the interest rates in the bond and money markets are liberalized first. In 2001 after entering WTO, China eased the restrictions that are given on the interest rates of deposits and loans. The China Banking Regulatory Commission (CBRC) was established in 2003 for bringing several improvements in the quality of assets, risk control, capital adequacy and general supervision of the banking institutions. The banks which will be facing with financial crisis can be taken over by CBRC. It issued a document named Chinese Banking Sector’s Reform, Opening, and New Progress of Regulations on December 5, 2005. The document indicated that the most important disadvantages of state ownership in banking sector is the absence of incentives for monitoring the state-owned banks which have created black holes in the corporate governance. To ease the problem, CBRC revealed data of individual banks regularly and even made comparisons with the peer banks. The foreign investment in the domestic banks first started in 1996 when Asian Development Bank (ADB) occupied 1.9% share in China Everbright Bank. The practice is strengthened since 2003 after CBRC announced rules and regulations for banks to encourage and facilitate foreign share holdings (Levine, Loayza and Beck, 2000). Thus, it identified that the Chinese banks will require progress in the corporate governance, risk management and operation technologies through the foreign strategic investors. The Chinese banks gave permission to foreign ownership and they also took the initiatives for offering their shares to foreign and domestic market participants. These practices are visible in initial public offerings (IPOs), which are made by the Big Four (Liu and Li, 2001). Berger, Hasan and Zhou (2009 cited in Wang, 2000) identified that the minority of the foreign ownership had strengthened the efficiency of the banks in China. After the agreement of WTO in 2001, the presence of foreign banks in China has increased dramatically. Towards the end of 2006, “223 foreign banks from 42 countries and regions established 242 representative offices and 312 operational institutions, including branches, sub-branches and wholly-foreign-owned banks” (Wurgler, 2000). 3. Literature review In the literature review, the main concentration is given on the impact of the financial development of the economic growth of China. King and Levine (1993 cited in Shan, n.d.) indentified that the financial development progresses towards the growth of the economy and Levine and Zervos (1998 cited in Shan, n.d.) stated that the development of the banks and the stock markets have lead to the economic growth in China. Arguing on the above conclusion, Arestis and Demetriades (1997 cited in Shan, n.d.) said that few countries have supported the fact that financial development has lead to economic growth, but in case of China it may not be the same (Peng, 2006). 3.1 Positive views with regard to the relation between the financial development and economic growth in China The positive view of the financial development of the country focuses on mobilization of the domestic savings and the investment through an open and liberal financial system. Financial development also connects to the promotion of productivity through the creation of a proficient financial market. Chen (2002 cited in Shan, n.d) has pointed out the relationship between the interest rates, income and savings of the Chinese economy from the period of 1952 to 1999 with the help of Bayesian vector auto regression model and co-integration test model. From the findings of the test, he argued that “it is therefore important to establish well-developed financial institutions—particularly the independence of the Central Bank—interest rate liberalization and sound financial intermediation, all of which are important for the efficient allocation of capital, which, in turn, can help to establish sustainable economic growth” (Chen, 2002). The strict government ownership of the banks has been the chief phenomenon of the Chinese economy. It is said that the government ownership has been the main reason of slow growth in economy for China. La Porta, Lopez-de-Silanes and Shleifer (2002 cited in Shan, n.d) have collected data on the government ownership of the banks worldwide and have made the conclusion that higher the ownership of banks by the government, slower is the development of the financial sector and slower is the growth of the per capita income and productivity (La Porta and Shleifer, 2002). Schich and Pelgrin (2002 cited in Shan, n.d.) have pointed out that in case of developed countries, the financial development is linked with the higher investment levels. The result is obtained through examining panel data of 19 OECD countries taken within the period of 1970 to 1997 (Windmeijer, 2005). 3.2. Negative views with regard to the relation between the financial development and economic growth in China Apart from the positive views that are given by the researchers, there are negative responses too. Al-Yousif (2002 cited in Shan, n.d) has used panel data and time series data from 30 developing economies for examining the causal relationship between economic growth and financial development. At the end of the study, he concluded that economic growth and financial development are mutually causal and the causality is bi-directional. The conclusion went along side with the view of World Bank, which elaborated that the relationship between the financial development and economic growth cannot be generalized for all countries (Al-Yousif, 2002) Many researchers have found that in the developing economics there is no relationship between the economic growth and financial development. Cargill and Parker (2001 cited in Shan, n.d) has examined the ill consequences of financial liberalization that are confronted by Japan and thus have pointed out that reforms are needed to avoid the same consequences in China. Arestis et al. (2002 cited in Shan, n.d) has concluded that the financial liberalization is a very complex method and its impact on the economic development of China is not clear. Arestis, Demetriades and Luintel (2001 cited in Shan, n.d) examined the relation by conducting an evaluation with the help of econometric model. He thus concluded that role of stock markets on the economic growth of the country have been overstated by the previous studies. 3.3. Analysis of the relation through different theoretical models There are many theoretical models which are made for analyzing the relation between the financial development and economic growth. Nourzad (2002 cited in Shan, n.d) carried out a survey to examine the theories, which connect with the issues and have found out five possible channels which can effect growth through finance (Nourzad, 2002). The five channels are as follows: i) Provide information relating to the possible investments, so that capital is allocated sufficiently. ii) Exercising corporate governance and monitor the firm’s operation. iii) Avoid risk iv) Mobilize and pool the savings v) Reducing the difficulties confronted during exchange of services and goods (Xu, 2000) In the earlier days of 1993, cross country studies with the help of cross-sectional regressions indentified a positive relation between economic growth and financial development (La Porta and Shleifer, 2002). La Porta and Shleifer (2002 cited in Shan, n.d.) have conducted the empirical study with the help of data collected from 35 countries. The result of the study indicated a positive relation between finance and growth of economy. But the study did not address the variables for explanation methodically. King and Levine (1993 cited in Kang and Sawada, 2000) added few variables to the regression model that was made by La Porta and Shleifer. The regressions was carried out taking cross country samples of 77 countries for the period 1960 to 1989, taking the factors of the economic growth like trade, political stability and education as the dependent variables. The causality issue was not dealt properly. Levine and Zervos (1998 cited in Kang and Sawada, 2000) later added few variables of the stock market to the regression model, which controlled other factors methodically, that can affect the long run growth of the economy including the banking development. The result of the study indicated development of banks and ensured liquidity that predicted economic growth (Kang and Sawada, 2000). For finding the relation between the economic growth and financial development instrumental variables were used. Levine, Loayza and Beck (2000 cited in Kang and Sawada, 2000) has developed an advanced econometric technique that generalized the moments method (GMM) for the dynamic panel data, which consisted of about 71 countries over the period from 1960 to 1995. The advanced method gave the same outcome like the result that is obtained from the traditional cross-sectional instrumental variable regressions. The outcome was related to the exogenous elements of the financial development that showed positive relation with the economic growth. Beck, Levine and Loayza (2000 cited in Kang and Sawada, 2000) through the use of GMM estimators for the dynamic panel data found that the financial development affects the total productivity growth of a country. The dynamic panel models allow the usage of the instrumental variables for all explanatory variables thus accurate estimates can be obtained. But it can be said that the dynamic panel model is not successful to explain the relation many a times. Rousseau and Wachtel (2002 cited in Shan and Morris, 2002) has also examined whether the financial development and economic growth vary with the rate of inflation. They employed dynamic panel method to the regression analyses after including measures from the stock markets to the regression models. The result showed that there are some exogenous components of the stock market and the bank which influence the economic growth of the country (Park and Sehrt, 2001). 4. Conclusion It can be concluded that the paper seeks to examine the relationship between economic growth and the financial intermediation in China by using the views of different researchers, who have thoroughly researched on this topic. They have given contrasting views, which go against each other’s findings. There are positive as well as negative relation between the two, which is established by using regression analysis and panels of data collected from the economy of China. 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A finite sample correction for the variance of linear efficient two-step GMM estimators. Journal of Econometrics, 126, pp. 25-51. Wurgler, J., 2000. Financial markets and the allocation of capital. Journal of FinancialEconomics, 58(2), pp. 187–214. Xu, Z., 2000. Financial Development, Investment, and Growth. Economic Inquiry, 38(2), pp. 331–344. Zhang, J., Lanfang W. and Susheng W., 2012. Financial development and economic growth: Evidence from China. [pdf] Available at: < http://home.ust.hk/~sswang/PDF/Finance%20and%20Growth%202012-01.pdf > [Accessed 13 September 2013]. Read More