Financial System in China - Literature review Example

Financial System in China Contents Introduction 3 Literature Review 3 Financial Systems of China 6 The Banking Sector 6 The Bond Market 8 The Stock Market 9 Conclusion 10 10 Reference List 11 Introduction State capitalism indicates an economic system in which the economic and commercial activities are managed and organised by the state itself. In this type of economic system, the means of productions such as capital accumulation and wages of labours are determined by the centralised management as well (Bichler and Nitzan, 2014). The concept of state capitalism is distinct from that of the free market economic system in which demand and supply equilibrium is achieved on the basis of a mutual treaty between buyers and sellers with little or no government interference. Recently, a trend of rejecting the doctrine of free market economy has become prominent mainly among the developing nations. Among these, the economy of China is considered to be one of the most important countries to practice state capitalism. Exercising of state capitalism has aided the country to experience a uniform average economic growth rate of 9.5% since last 30 years (Li, Liu and Wang, 2012). The volume of international trade has also increased by 18%, making China the second largest economy in the world, only after the United States. In this paper, a literature review will be done on the economic model of state capitalism and all the important aspects of Chinese financial system such as banking sector, the bond market, and the stock market will be critically examined to analyse to what extent the financial system of the country reflects state capitalism. Literature Review In this segment of the paper, the state capitalist economic system will be critically analysed. Many economists have surfaced different opinions regarding state capitalism on various point of time. Examining the researches of Schimank and Volkmann (2012), it can be comprehended that the world is currently going through the most dramatic changes in terms of balance of power. Statistics have shown that exponential growth of emerging nations may result in capturing half of the Gross Domestic Product (GDP) of the world economy by the end of the decade. Among all such developing countries, China is expected to outnumber the United States, the biggest economy in the world. Experiencing such drastic changes in the world economic construction, Yu (2014) has raised a question that whether such economic transformation is the consequences of economic shift from the era of liberal capitalism to state capitalism. His concern is based on the observation that not only China but most of the developing nations have adopted state capitalism in contrast with developed countries whereas liberal capitalist approach of developed western countries led them to experience economic recession and severe financial crisis in 2008. Therefore, viability of this new economic model of state capitalism has created a long enduring debate among the economists. Some economists are of the opinion that the progress of world economy is relied on state capitalism and the phenomenon has been proved by the rapid growth of developing countries, whereas, the others have suspected the feasibility of this economic system. According to them, such progression of emerging nations may prove to be short lived and it may also be possible that those nations may regret in future regarding their decision of incorporating state capitalism in their economy (Li, Cui and Lu, 2014). Bremmer (2009) believed that in capitalism system, economic activities are administered by political entities for the betterment of larger population. In contrast, a research article published by Quiroz and González (2014) have shown that if the autocratic businessmen are kept in power, the production and level of wealth are bound to fall in the long run. He is of the opinion that state capitalism does not involve two most important features required for constructing a dynamic economics. First, free circulation of information that encourages entrepreneurship and secondly, the concept of creative destruction i.e. replacing old and sick firms with a new one. On contrary, Schimank (2014) has argued on the grounds that gone are those days when powerful bureaucrats were used to be appointed by government for running enterprises. In today’s state capitalists system, the government, no matter democratic or autocratic in nature, leads to influence the activities in the economy through direct ownership or numerous subsidies existing in the market. In fact, he has shown that large state-owned enterprises are traded in public markets principally by institutional investors. Torre and Wallet (2014) have highlighted three distinct positive aspects of state capitalism. According to them, the hybrid form of economic system influences and facilitates global champions to rise quickly and establish their place among top companies in the world. It aids the companies to concentrate more on long term business objectives and invest accordingly, rather than running behind short term profitability. Moreover, state capitalist economic system smoothens the economic cycle of the country. For example, state capitalist economies such as China coped up with the adverse effects of financial crisis much faster than any liberal capitalist countries. Therefore, Torre and Wallet have portrayed state capitalism as a much more market friendly economic system as compared to its predecessor. However, they were contradicted by Torre and Wallet (2014) who have stated that the concept of state capitalism is much more influenced by political consideration, rather than economic deliberation. In fact, their researches have shown that, as a result of frequent interference by the government in the functioning of state- owned companies, efficiency of such companies reduces to a great extent as compared to their private sector equivalents. This is reflected in all aspects of such companies such as determination of wages, utilization of available capital etc. Chinese Communist Party’s endeavour to swap the CEOs (Chief Executive Officer) of big corporate further strengthens the statements of Torre and Wallet. The concept of creative destruction proposed by Quiroz and González (2014) is also nullified by Bichler and Nitzan (2014) as their research has revealed that all these emerging nations are going through their first stages of modernization. Moreover, such economies were already sufficiently equipped with labour and capital. What they are doing now is to exploit such existing resources for utilizing them to the maximum. In contrast, the western corporate have to concentrate on bringing efficiency in order to confirm their subsistence in the competitive global business rather than focusing only on resource and infrastructural problems. Whether the state- owned companies in emerging nations will be able to continue their operations with expertise and bring innovation and creativity in business operations in the next phase of modernization, still remains a question. Andréani and Herrerab (2015) also confirmed the opinion of Bichler and Nitzan by stating that the utility model tends to vary during different stages of development. According to them, though state capitalism has truly gained success in the early stages of modernization, there is no conformity that the system will continue to prove its effectiveness in the forthcoming days when the economy demands innovation and transformation of production process, rather than bulk of production. The economists were further challenged by Bichler and Nitzan (2014) who have shown inclination of state capitalism towards technological advancement. As the state capitalist economic system operates in pure profit maximizing motive, they give huge emphasis on increasing productivity through application of latest technologies in the production process. In fact, the system highly encourages recruitment of labours with high skill possessions and technical knowledge, implements latest technologies such as learning curve methods as well as facilitates training and development programs in order to keep the business operations upgraded. Technology and innovation are given high emphasis in the first stage of modernization itself; then it is expected from the state capitalism to continue to infuse such innovation and creativity into the organizations in the upcoming stages of modernization as well. In the next segment, financial system of China will be examined in order to evaluate the degree of inclination of the financial system towards state capitalism. Financial Systems of China The financial system of China has become highly regulated, especially after the implementation of reform policies in 2004. Such regulation has been imposed by the monetary policy of the country that tends to monitor and control all the macroeconomic variable of China. It also plays a crucial role in the economic expansion of the country. The financial market of China is characterised by existence of banking sector and other financial intermediaries such as stock and bond markets. Optimality of the financial system largely reflects the social values of the country and more importantly, structure and consistency of the political system of the country (Elliott and Yan, 2012). Recently, the country has entered into a new stage of economic development and at the same time, going through major political changes under the leadership of Chinese Communist Party and the central. Under such circumstances, the prevalence of state ownership is becoming implicit. Therefore, those state owned enterprises (SEO) which are controlled by powerful central governments are showing greater stability under the same financial system in comparison to the SEOs owned by relatively less powerful governing bodies. In fact, as a result of practicing state capitalism, functioning of the state owned financial systems are highly influenced by the political changes. Incorporation of the local government officials in the high designated posts of the financial institutions and intermediaries gives such institutions a high bargaining power with local governments for acquiring loans and grants. Therefore, changes in those power positions due to political change tend to alter the bargaining power and position of the state owned organization to a great extent. Considering the composition of Chinese financial system, the banking sector, including the private and credit sector constitutes for more than 128% of the Gross Domestic Product of the economy, as per the statistics of 2014. The bond market is comparatively less developed, contributing approximately 41% to the domestic GDP,whereas, the market capitalization of the stock market comprises of 44% of the country’s GDP (Elliott and Yan, 2012). Functioning of the different segments of the financial systems of China will be analysed in the following segments. The Banking Sector In the series of financial reforms undertaken by China, the major transformations have been introduced to the banking sector of the economy. Efforts have been made to initiate shareholding systems within state-owned commercial banks and improving corporate governance structure for managing financial risks in a better manner and protecting the interests of the investors. Experiencing the subprime crisis in the United States in 2008, the banking sector of China understood well in advance that financial innovation is not a viable option in absence of strict control and supervision of corporate governance; else lack of transparency and accountability may result in failure of corporate governance and dysfunction of market mechanism. Therefore, while concentrating on economic openness as well as making the interest rates favourable for expansion of investment avenues and international trade, Chinese financial system also establishes strong corporate governance which was possible only through incorporation of state capitalist economic system. Such economic system ensures the functioning of the banking sector complying with the standard norms of corporate governance and business ethics (Musacchio, Lazzarini and Aguilera, 2014). Considering the structural features of the Chinese Banking sector, the sector is broadly divided into two segments. The People’s Bank of China which is the central bank of the country, engaged in formulation of monetary policies and monitoring the extent of implementation of such policies in the economy. Apart from that, the banking sector of China is highly concentrated with existence of four sate owned banks which are operating efficiently since 1980 such as, the Agricultural Bank of China (ABC), Bank of China (BOC), the Industrial and Commercial Bank of China (ICBC) and the China Construction Bank (CCB), 349 commercial banks including five large partially state owned commercial banks, Agricultural Bank, Export and Import Bank as well as 85 Rural Banks and 223 Credit Cooperatives. The main reason behind such superior construction of banking may be attributed to the state ownership and control. In 2002, it was decided by the central government to privatise four biggest commercial banks of China, partially to monitor the effect of such limited ownership in terms of non- performing loans (NPA), risk management, corporate governance, accounting standards and other similar concerns (Li, Liu and Wang, 2012). Such state ownership led the economy to witness multiple positive consequences. For instance, exercise of accounting standards improved substantially over the period of time. Risk management was also professionalised through hiring top managers with salaries in multi-million dollar for forecasting the risks and formulating strategies to mitigate such risks. The ownership structure is definitely a crucial aspect in terms of corporate governance. In this structure, the stocks and incentives offered to the executives are not directly influenced by their contributions towards the economy. However, it has also been experienced that the state owned banks are prone to lend the state owned enterprises, resulting in amounting non-performing loans that affects the efficacy of banking sector and even the financial system of the economy. As the managers of the commercial banks operate in a profit maximizing motive, taking into consideration the implicit and explicit governmental support towards the borrowers, the government and political party plays an important role in this regard. Therefore, the banking sector of China reflects high orientation towards state capitalism and such economic system can be attributed as one of the main reasons behind the stability of the system (Li, Cui and Lu, 2014). The Bond Market Though the bond market under Chinese financial system is weaker as compared to the banking or securities market of the nation or the bond markets of other countries with similar economic condition, the effect of state capitalism is prominent in this sector as well. According to the 2014 reports from IMF, more than 35% of the corporate bonds in China are issued by the banking sector (The Economist, 2012). Though secondary trading of such corporate bonds are relatively inactive in China, the banking sector dominates such trading as well though capturing 70% of the market share in this regard. Prior to the existence of state capitalism in China, ineffective management of the three regulatory authorities of bond market such as the National Development and Reform Commission (NDRC), People’s Bank of China and the China Securities Regulatory Commission (CRC) often used to show irregular or preventive orientation towards issuing corporate bonds (Li, Cui and Lu, 2014). With the enforcement of recent reforms and allowance of state interventions, structural pattern has been established for issuance of corporate bonds in China. Now, the NDRC starts the process of issuing corporate bonds one year before the date of issuance. During the initial period of 2010, the three regulatory authorities showed high level of coordination among each other regarding issuance of bonds and eliminating the difficulties associated with the process of bond issuance. The People Bank’s of China established medium term bond market where firms satisfying certain criteria, are encouraged to issue bonds and general public are also influenced to invest on those bonds for securing a low but guaranteed return. Followed by such initiative of People’s Bank of China, CSRC instituted registration issuance system in a high yield bond market. Such positive effort of state owned enterprises resulted the bond market to experience issuance of more than double corporate bonds by the end of 2014. According to reports from Wang, Lai and Yen (2014), China state ownership and government started giving emphasis on bond issuance since the financial crisis of 2008 when the central government understood the importance of identifying requirements and financing large scale infrastructural projects. At the same time, the government and the leading political party of China decided to run fiscal deficits in local governments through issuing bonds for accumulation of capitals for future investments. Such initiative has resulted in 2013 to issue corporate bonds worth of 2.75 trillion RMB which accounts for approximately 16% of the total social financing of China (Wang, Lai and Yen, 2014). From the discussion, influence of state ownership on the bond market of China has also been established. The Stock Market The stock market of China consists of two stock exchanges viz. Shenzhen Stock Exchange (SZSE) and Shanghai Stock Exchange (SHSE), the majority of which are owned by the government. However, in order to get an access to the foreign equity capital, the investors have to invest through Hong Kong Stock Exchange. The shares of Chinese firms denominated in foreign currencies which are permitted to be possessed by the foreigners, are known as number B shares and are listed on any or both of SHSE and SZSE (Bian, 2014). During the period of 1980s, the government and political parties noticed that the wave of private enterprises were undermining the interest of SOEs, deteriorating the interest of numerous stock market investors. After experiencing the situation and assuming the probabilities of potential losses of state owned assets, the proposition of full privatisation was eliminated and stock markets were premised on the basis of state owned capitalist economic system. The stock market of China is characterised by high speculations which indicates the propensity of the Chinese investors to invest at a larger scale in stock market. The reason behind such behaviour of the investors in China is the belief of the investors that the stock price is going to rise in the upcoming future and they will be benefitted by selling their holding at a higher price while others will purchase at that increased price, without analysing the underlying value of the stocks (Bian, 2014). The largest and most significant firms in China are owned by the state or having a stake of government at the minimum. As the stock prices reflect the underlying value of the firms and their ability to generate positive cash flow in future, the Chinese investors are rest assured in investing in stock market, knowing that the enterprises are financially backed by the state or government authorities. In fact, the largest IPO (Initial Public Offering) of the Chinese stock market are the IPOs of state owned enterprises. The capital structures of the SOEs are always divided into two accounts: tradable shares issued for the investment purpose of general investor and non- tradable shares, undertaken by the state or government (Bian, 2014). Therefore, in stock market as well, influence of state capitalism is very prominent. Conclusion The justification behind application of state capitalism has given rise to significant arguments among economists and politician. Some of the experts have exemplified the success story of China and other developing nations to institute the rationale behind incorporating state capitalist economic system in a particular country. On the other hand, another group of analyst oppose the system on the ground that such economic system has yielded better results in developing nations only; if applied in developed countries, where more complexities prevail in the economy, the validation of such economic system is uncertain. Though the concern is still debatable, analysing the financial system of China it can be inferred that the economy of China has been able to flourish and maintain its growth rate at a constant manner, principally because of adopting state capitalist economic system. Reference List Andréani, T. and Herrerab, R., 2015. Which Economic Model for China?—Review of La Voie chinoise by Michel Aglietta and Guo Bai. International Critical Thought, 5(1), pp. 111-125. Bian, J., 2014. Chinas Securities Market: Towards Efficient Regulation. London: Routledge. Bichler, S. and Nitzan, J., 2014. The Enlightened Capitalist. Philosophers for Change, 3(2), pp. 25-86. Bremmer, I., 2009. State capitalism comes of age: the end of the free market? Foreign Affairs, 2(3), pp. 1-11. Elliott, D. J. and Yan, K., 2012. The Chinese Financial System An Introduction and Overview. [PDf] Available at: [Accessed 3 April 2015]. Li, M. H., Cui, L. and Lu, J., 2014. Varieties in state capitalism: Outward FDI strategies of central and local state-owned enterprises from emerging economy countries. Journal Of International Business Studies, 45(5), pp. 980–1004. Li, X., Liu, X. and Wang, Y., 2012. A Model of China’s State Capitalism. The Hong Kong University of Science and Technology, 1(1), pp. 2-38. Musacchio, A., Lazzarini, S. and Aguilera, R., 2014. New Varieties of State Capitalism: Strategic and Governance Implications. Academy of Management, 10(5), pp. 235-264. Quiroz, P. A. and González, N. F., 2014. Power in Advanced Capitalist Society: A Review Essay on Recent Elitist and Marxist Criticism of Pluralist Theory. Social Problems, 17(3), pp. 418 – 430. Schimank, U. and Volkmann, U., 2012. Economizing and Marketization in a Functionally Differentiated Capitalist Society – A Theoretical Conceptualization. Welfare Societies Conference Paper, 1(1), pp. 37-48. Schimank, U., 2014. 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