459-95-8824
October 28, 1998
Drs. Henry & Boone
Country Profile: People's Republic of China
I. Introduction
Since Deng Xiaoping began the process of liberalization and "opening up"
in 1978, the Chinese economy has grown at rates that continually defy the
predictions of international analysts. In direct contrast to the rapid
economic liberalizations undertaken in other reforming command economies,
China has followed a ponderous reform strategy known as "crossing the
river by feeling for the stones." The Chinese economy has been protected
from international competition with high tariff barriers and a largely
inconvertible currency. China also differs from other reforming communist
systems in that it remains a one-party system. This combination of
protectionism, slow reform, and entrenched government makes difficult to
place the Chinese financial system into the typology created by John
Zysman. Furthermore, the charismatic, highly personalized nature of the
Chinese political system appears to directly counter the prescriptions for
a professionalized, Weberian bureaucracy provided by Sylvia Maxfield and
Ben Ross Schneider. Two questions immediately arise. First, if the
Zysman typology cannot be applied to China, is it still possible to
understand the nature of Chinese financial reforms by examining the
structural power of different economic sectors? Second, can the
professionalization of the economic bureaucracy, including the state-owned
banks, be accomplished within the existing Chinese regime structure?
Before these questions can be examined, a brief exploration of the history
of Chinese banking is in order.
II. History of Chinese Banking
In pre-revolutionary China, the domestic financial system was dominated by
Shanghai banking houses. As the Communist forces fought their way south in
1948-49, they closed-down or nationalized most of these banks.
Consequently, the history of banking in the People's Republic of China
begins with the founding of the People's Bank of China in December 1948.
Under its original structure the People's Bank was placed directly under
the control of the State Council, giving it a bureaucratic rank equal to a
government ministry. The bank was responsible for regulating money
supply, extending credit to state enterprises, regulating foreign
exchange, and controlling all other financial institutions. China
continued to operate with this "monobank" system the eve of economic
reforms in 1979.
The first modifications to the banking system were quite modest. In
February 1979, the State Council established the Agricultural Bank as an
independent entity, reflecting in part the rural thrust of early reforms.
A month later the Bank of China (BOC), which had existed as a bureau of
the People's Bank, was given independent status as a ministry level entity
under the direct supervision of the State Council. The BOC became China's
primary financial institution handling foreign currency accounts.
Finally, the Construction Bank, which had formally existed only as a
bureau within the Ministry of Finance, was brought under the direct
control of the State Council.
As reforms deepened, the People's Bank continued to operate both central
and commercial banking functions. Only in 1984 were moves made to
separate these two functions. The People's Bank headquarters in Beijing
were transformed into the central bank, responsible for issuing currency
and managing credit allocation. The vast People's Bank branch network was
transformed into the Industrial and Commercial Bank (ICB), which took-over
all deposit-taking and lending functions. Upon creation, the ICB became
China's largest financial institution.
China's banking industry expanded in the late-1980's with the creation of
national and regional commercial banks. National commercial banks were
owned by the central government and allowed to operate throughout the
country. Regional banks were typically owned by a provincial government
and were restricted to operations within their home province. While these
banks theoretically operated on a commercial basis, in fact they were
little more than policy banks, extending credit at the request of
government agencies.
During this same period, foreign banks were allowed to open branch offices
in China, but these operations were largely limited to handling the
banking needs of foreign companies and joint-ventures operating in the
coastal Special Economic Zones. Operationally, the foreign banks were
excluded from domestic currency transactions. These limitations
significantly hindered the profitability of the banks, but the promise of
further liberalization convinced them to remain in the China market.
Of the banks that emerged in the late 1980's, the Communication's Bank,
deserves particular notice. This bank was one of the original Shanghai
banking houses which had been absorbed by the People's Bank in 1949,
although its Hong Kong branch continued to operate as an independent bank.
In 1984, Premier Zhao Ziyang, one of the leading figures pushing for
further, deeper economic reforms, personally ordered the reformation of
the bank. While it cannot be proven, the logic of the Chinese political
system would indicate that supervision of the bank fell into Zhao's
personal portfolio of responsibilities. The personal nature of the
connection to Zhao would also explain the need to formally reconstitute in
the early 1990's as a joint venture between state and provincial
governments. Zhao fell from power as a result of his moderate stance
during the Tiananmen crisis. After the fall of Zhao, supervision of the
bank fell to then vice-prime minister Zhu Rongji. Zhu appointed his
associate Dai Xianglong to the position of bank general manager.
Control of the bank by Zhu meant that it remained in the hands of the most
dedicated economic reformer in the Chinese government.
Zhu's efforts insured that in 1993 the Communications Bank was the first
in China to begin using asset-liability management to direct loans. The
bank was also never openly required to direct policy loans on behalf of
the government. As a consequence, the Communication's Bank currently has
one of the lowest levels of non-performing loans in China, and is widely
regarded as the best managed bank in the country. The importance of Zhu
and the Communication's Bank as a possible model for other Chinese banks
will become evident in a later discussion of the possibilities for the
professionalization of the financial industry.
In 1994 Chinese officials instituted one final attempt to
rationalize the banking sector. That year, the State Council approved the
creation of three new policy banks, the State Development Bank of China,
the Import-Export Bank of China, and the Agricultural Development Bank of
China. In the language of the Chinese bureaucracy, these new banks were
considered to be "policy banks" while the older, established institutes
were referred to as "specialized banks." The policy banks were never
intended to be commercial banks. Rather, they were designed to take the
pressure off the specialized banks and allow them to operate on a
commercial basis. Unfortunately, there is little indication that this
separation has been successful. From the beginning, the nature of policy
bank capitalization undercut their purported purpose. Rather than receive
credit directly from either the State Council or the People's Bank, the
policy banks issued bonds, which were allocated to the specialized banks
on a quota system. The specialized banks hold these bonds as assets, but
since the policy banks are designed to never make a profit, they are
unlikely to ever be significantly reclaimed without further intervention
by the People's Bank.
Currently, the Chinese banking system is typified by the four types of
banks previously mentioned: policy, specialized, national commercial, and
regional commercial. Of these types, the specialized banks continue to
dominate the system. The four specialized banks controlled 69% of all bank
assets in 1995. Examining the system from a policy versus commercial
standpoint, it is clear that the policy-oriented banks, including the
central bank, controlled slightly more than 93% of assets in the same
year. Of the four commercial banks which operate on a national level,
one, the Communication's Bank, controls 73% of total assets. These basic
figures reveal a banking structure that is highly state-centered, highly
policy oriented, and heavily concentrated.
In the early years of reform, it was hoped that policy loans would be a
temporary measure which would allow targeted industries to grow. As these
industries expanded, they would move beyond the need for designated loans
and instead become revenue generators for the state. Unfortunately, in
most industries growth never occurred and loans continued to be required
in order to keep enterprises running and the population employed. The
problem has steadily grown worse, but only in the last few years has its
shear enormity become evident. While the Chinese government continues to
claim that only 6-7% of loans are non-performing, more reasonable
estimates place the number no less than 20%. The most alarmist observers
believe that up to 70% of all outstanding loans will never be recovered.
Even at the 20% level, total bad debt would equal $170 billion, or
approximately 26% of 1995 GNP.
Even in the face of banking sector insolvency, depositors continue to
place their savings into banks. In fact, the Chinese system could not
operate without high domestic savings rates. Between 1985 and 1995, M1 as
a percentage of GNP has averaged slightly more than 12.6%. This figure
reflects a rather large cash economy, in line with the fact that Chinese
banks still do not provide consumer checking or other means of payment.
Meanwhile, domestic savings rates averaged 41.5% between 1993-1995. In
part, the high savings rate indicates a lack of other locations for
savings. While rates on savings may be low, the state continues to
effectively insure savings by bailing out any bank which experiences
trouble. At the same time, the state is using the credit created by
domestic savings to support its policy loans.
Economically, the Chinese banking system is an almost complete failure.
In many cases, even the label of "bank" seems to be unwarranted. These
institutions do not operate in a way that any Western banker would
understand. Even if the bank label is accepted, the distinctions between
"policy", "specialized," and "commercial" are economically meaningless.
All banks, even the well-run Communication's Bank, fall victim to policy
considerations. Still, the banking system does serve a clear political
function, to protect the regime from the politically destabilizing effects
of mass urban unemployment. To understand this function on the banking
sector, it is necessary to delve inside the political logic of the CCP
regime. John Zysman's typology of financial systems provides a starting
point from which to examine this logic.
III. A First-cut Political Explanation
John Zysman distinguishes three basic types of financial structures; the
Anglo-American, the German, and the French models. Of these systems, only
the French model is of interest in understanding China. The French model,
according to Zysman, is appropriate for late-industrializing states which
have a strong coercive ability. These states effectively dictate credit
allocation policy to their constituent banks. Under this system, the
"borderline between public and private blurs." At first pass, China's
state dominated economy appears to be most closely associated with the
French model, but the comparison is very weak. Under the traditional
state-centered Chinese system, the distinction between public and private
is not blurred; it is completely obliterated. In a recent article,
Clement Henry classified similar politically dominated financial
structures in North Africa as "statist." While this label may appear to
adequately describe the Chinese situation, the elaborate interplay between
the various Chinese political actors ultimately makes the simple statist
label unsatisfactory.
Examined from the outside, the Chinese Communist Party does appear to
dominate all major financial decisions. Economic policies are created
behind the closed doors of the CCP Central Standing Committee, and
promulgated by the State Council. Credit continues to be extended through
state-owned banks to state-owned industry. The complete government
ownership of all significant economic actors tends to favor Henry's
statist label. However, the process of economic liberalization in China
has served to separate the fact of government ownership from role of
government control. As the command nature of the economy has eased over
the past 20 years, bank managers and industrial enterprises have
continually gained structural power at the expense of government
administrators. What has emerged is a competitive bargaining relationship
between government, banks, and industry, all of which occurs within the
closed walls of the CCP regime.
IV. Political Motivations for Reform
Any understanding of the current Chinese financial situation must begin
with the political priorities of the State Council and the Central
Standing Committee. These institutions did not begin the process of reform
as a result of outside pressures or balance of payments problems.
Furthermore, the move towards reform was not motivated by any clear
economic need. The Chinese economy had grown significantly throughout the
Maoist era, and was growing slowly but steadily in the immediate post-Mao
years. The most compelling explanation for why reforms began involves the
need for Deng Xiaoping to legitimate his new post-Cultural Revolution
regime by quickly improving the basic living standards of the Chinese
peasants. Movement away from the command system was never intended, but
for complicated reasons, abandonment of the state system was the outcome,
at least in the rural areas.
As the Party eased its grip on the peasantry, allowing
de-collectivization and limited profit retention, the pressure to increase
the pace of reforms quickened. Small-scale township and village
enterprises were allowed to experiment with profit retention. The process
of expansion has continued for the past 20 years, as political actors take
one small reforming step after another. However, throughout this time
period, the reform process never reached significantly reached the large,
urban state-owned enterprises. The need to protect these enterprises from
competition has dominated Chinese economic thought throughout the reform
period.
As economic reforms began in 1978, the state-owned enterprises (SOEs)
dominated the economic landscape, accounting for 77.3% of total industrial
output, of which the largest urban firms accounted for 41.5%. In 1991,
after thirteen years of rapid economic growth, the total production by
SOEs had fallen to 52.8%, but the output of the largest enterprises
remained almost unchanged at 40.6% The employment created by these
enterprises absorbed almost 40% total urban workforce.
Both manufacturing and employment figures actually understate the
importance of the SOE's. For example, these firms have traditionally
carried a huge social welfare obligation. A typical SOE provides housing,
healthcare, subsidized meals, education programs, and even laundry service
for its employees and their families. SOEs also insured employment for
life, and provided modest but sufficient pension programs. Furthermore,
the SOEs were the primary mechanism for generating state revenue. Rather
than generate revenues through tax collection, state-ownership of industry
allowed the system to finance itself through the retained earnings of the
SOEs.
Unfortunately, for all their social and economic importance, the SOEs
remain pathetically inefficient. Production models for most products are
decades behind world standards. Production methods are equally
antiquated. For the goods that are produced, quality is abysmally low.
Volkswagen, after almost 15 years of capital investment and training with
its Chinese partners, still refuses to sell Chinese-produced automobiles
on the world market for fear of damaging the Volkswagen brandname. Even
with these problems, the Chinese leadership has remained committed to
protecting SOEs and insuring that they stay afloat.
Politically, the Deng government staked its future on its ability to
insure the needs of all sectors of the Chinese economy. The Jiang
government has continued the same tradition, largely because no other
ideology seems capable of legitimating the continued rule of the CCP.
Politically, the most important sector to appease has been the large
state-owned manufacturing sector. Privatization would create unemployment,
so it is ruled-out. Reduction of tariff barriers would create
unemployment, so it is ruled-out. In fact, any economic policy that might
result in hordes of unemployed workers and pensioners filling the streets
of Beijing must be avoided. A recent speech by Jiang Zemin clearly states
the government consensus. Enterprises which wish to lay-off workers must
first insure the basic living expenses of the worker, provide re-training,
and insure that the unemployed "do not drift."
Enterprise managers learned the political logic of the Beijing authorities
early in the reform process. They learned that they could act with
impunity, because they were needed and because they possessed a monopoly
on critical enterprise information. Under the traditional system, central
authorities relied on enterprise managers to perform self-audits, and to
pass both information and revenues up to higher bureaucratic levels.
Managers willingly, and generally truthfully, performed this task because
successful completion of the enterprise plan was critical to any hope of
career advancement. Consequently, Beijing was never forced to develop
independent monitoring and supervision mechanisms. While some reforms have
been made in this area, authorities wishing to determine the true needs of
an enterprise are still compelled to consult the manager. At the same
time, the incentives of the managers have changed completely. Managers now
seem to prefer growing wealthy through retained earnings, loans and
subsidies to a ministerial position. Managers have clear incentives to
hide any productive behavior. If a firm reports a loss to Beijing,
central authorities often respond by increasing the credit extended to the
firm. If the company reports a profit, a portion must to be remitted to
Beijing.
China's bank officials have followed a logic similar to that of the SOE
managers. Chinese banks to not hold the employment trump card that the
SOEs enjoy, but their critical function in mobilizing savings and
providing credit to the SOEs makes them almost as impervious to central
bureaucratic control. Banks have traditionally not been allowed to fold.
China's first reported bank failure occurred only in June 1998. A
provincially-owned bank, the Hainan Development Bank, was closed after
defaulting on approximately $1 billion in debt. Unfortunately, the
closure had little economic meaning, because the bank was simply absorbed
entirely within the Industrial and Commercial Bank of China. The ICBC was
pledged to fully honor all obligations of the Hainan Bank. The closure
was really little more than a transfer of the problem from the provincial
to the central state level. Under the most recent financial laws, the
worst punishment the officials who ran-up the bad debts can receive is a
loss of office.
Under these conditions the incentives for bank managers are clear. So long
as the policy loans are extended to the SOEs, banks can extend any other
loans they chose. Central authorities have little ability to audit bank
records but are simultaneously pledged to meet any obligations that the
banks accrue. An increased loan portfolio increases the assets, and thus
the political importance, of the banks. Chinese accounting practices do
not recognize a loan as "bad" until 3 years after the last service payment
is made. This only further increases the incentive to extend unreclaimable
credit. The possibilities for corruption and clientilism are more than
evident. The larger a manager's client network, the better his safety net
should the worst happen and he loses his job.
The picture that emerges from these discussions is far from the
top-down command structure that would typically characterize a statist
system. Chinese central authorities have almost no ability to dictate
either financial or industrial reform. The political necessity of urban
employment effectively leaves Beijing at the mercy of both industry and
banking. It remains to be seen how long this arrangement can be
sustained. The total volume of non-performing loans is so extensive that
it threatens to undermine the entire reform effort. The recent Asian
economic crisis only compounds the problem, as Chinese exports lose
competitiveness on the world market.
V. A Weberian Bureaucracy in China?
According to Peter Evans, a governmental development bureaucracy can be
successful if it is both insulated from, and imbedded in the national
business structure. Such a bureaucracy must be professionalized and
meritocratic. Furthermore, it must enjoy a level of social compensation,
either in salary, privilege, or prestige, which is comparable to that of
the business elites with which the bureaucracy interacts. Given the scale
of China's financial troubles, the possibility of a Weberian financial
bureaucracy developing in the country may appear excessively remote. The
likelihood of professionalization is further restricted by the twin need
to develop both an adequate ministerial bureaucracy and a core of bank
managers and governors which could serve to rationalize the lending
behavior of the banks themselves. For China, the professionalization of
the government ministries appears to be well underway, while the reforms
of bank administration is only beginning. The driving force behind both
these reforms is the new Chinese premier, Zhu Rongji.
Widely regarded as China's "Economic Czar," Zhu Rongji is the first
trained economist to reach the highest ranks of the Chinese governmental
bureaucracy. Zhu has spent his career working within the Chinese
financial system. He has served both within the state bureaucracy and the
banking system. In 1991 he was appointed vice-premier in charge of
financial affairs. His austerity programs successfully controlled
spiraling inflation in the early 1990's. His role in the successful
management of the Communication's Bank has already been noted. In 1993,
he was appointed as governor of the People's Bank. During his tenure as
governor he promoted Dai Xianglong into the bank, and insured that Dai
would receive the governorship when Zhu resigned the office.
At the November 1997 People's Congress, Zhu was elected to replace Li Peng
as China's Premier. Since he took office in March 1998, Zhu has been the
primary engineer behind the recent efforts to promote the "Five Reforms."
These reforms include grain distribution, housing reform, healthcare
reform, taxation reform, and credit policy reform. Focusing only on
banking and credit reforms, Zhu has already made impressive first attempts
at rationalizing the system. These policies include a $33 billion bail-out
of the four large policy banks, promulgation of new banking laws, a 50%
staff reduction at the People's Bank, and moves to develop a depositor's
insurance program.
As impressive as these policies may be, Zhu's biggest reforms have been
within the state bureaucracy, where his program cut the number of
ministries from 40 to 29. While much of the restructuring was
accomplished through mergers, many top-level ministers have found
themselves out of work. Over the long term, these bureaucratic cuts may
be more important to the professionalization of the banking sector than
any other policy. First of all, Zhu's restructuring is a clear indication
of his political strength and his determination to significantly reform
all levels of the Chinese state system. Secondly, by clearing out the
bureaucracy, Zhu has significantly reduced the possibilities for
clientilism and patronage within the system. Finally, as ministers flow
out of government, they are increasingly seeking positions within the
state banking sector. Established banking officials feel the pressure of
these newcomers. Zhu thus has two parties to play off against one another
in his attempts to reform banks. Established officials are compelled to
follow through with reform efforts or lose their privileged positions.
Cuts in staff and the closure of the Hainan Bank reinforce the message
that bankers must begin to seriously address the problems of reform.
Taken together, these reforms provide at least the hope that merit and
ability, as opposed to political ideology or personal connections, will
begin to play a significant role in China's financial bureaucracy.
Admittedly, this is not the type of professionalism envisioned by Evans,
but it is a significant step for China. Personal connections to Zhu
certainly help secure positions. Personalism is clearly evident in the
rise of Dai Xiaolong, but Dai is also a trained financial expert. In his
tenure at the Communication's Bank and the People's Bank, he has proven to
be an extremely effective administrator. Favoritism may exist within the
system, but currently it appears to be favoritism based on ability. If
Zhu can continue to appoint officials on the basis of training and merit,
while simultaneously instilling a sense of accountability in the old
guard, he may yet develop an efficient, professional financial
bureaucracy.
VI. Conclusion
Despite the best efforts of Zhu and a handful of other officials, it
remains entirely unclear whether any amount of bureaucratic
professionalization and financial sector reform can save China from a
devastating banking crisis. Many structural factors, such as
non-convertibility on the capital account, high levels of direct as
opposed to portfolio investment, and a huge foreign exchange reserve,
indicate that China may escape a banking crisis brought about by current
account deficits, changes in investor confidence, or currency speculation.
Consequently, the key to any future banking crisis will likely be changes
in domestic confidence in the system. If savings rates drop, or if
depositors attempt massive withdrawals of savings, a banking crisis would
immediately erupt. Economically, there are a number of solutions to
China's current situation. Nicholas Lardy argues that a policy of
re-capitalization, privatization, and increased foreign competition would
significantly increase the efficiency of the banking system, and the
health of the economy overall.
These economic solutions are hampered by a political logic that cannot
accept the consequences of high urban unemployment. So long as the
central government makes protection of large state-owned enterprises a
priority, banks simply cannot operate on a commercial basis. Until the
government manifests the political will to deal with unemployment, Lardy's
economically practical recommendations are futile. Even Zhu's financial
reform efforts will have only a limited impact. Under these conditions,
the collapse of the Chinese banking system appears to be a certainty. The
only real question is how long the crisis can be delayed.
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