The New State Capitalism: Will China's Evolving Financial System Serve as an Example for Reforms in the Western World?

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At the conclusion of her presentation, Shruti Rana, Associate Professor of Law at the University of Maryland, left us with a final question: As the financial systems across the globe are in trouble, what will emerge: a stronger free market? Or the rise of state capitalism? According to her research, Professor Rana predicts that the structural changes to the financial system employed by the Chinese government will facilitate their rise to becoming a new global power and that China’s mixed public/private banking structure is the model for state capitalism of the modern world.

In the wake of the global economic crisis we face today, the Chinese economy remained temporarily isolated from the struggles that plagued the rest of the world, in part due to their exceedingly strict and government run banking regulations. But because of China’s sizable reliance on global trade, the weakened condition of Western financial markets were sure to hinder its economic growth. It was China’s unconventional solution to this grim economic outlook that Professor Rana suggests will shape the new financial arena.

One solution employed by the Chinese government was to invest a massive amount of stimulus money into the country. This remedy was very similar to the method used by the United States; however, China opted to direct considerable fiscal resources not only to boost productivity, but also to non-tradable resources such as education. Professor Rana explained that there were many students graduating from Chinese colleges but not enough jobs to employ them. To solve this problem, the Chinese government developed new scholarship incentives that would encourage the graduates to stay in school until the job market recovered. The benefits of this scheme, were confirmed by the International Monetary Fund which found that increased education has a secondary benefit as well. Investing in domestic resources like education will increase household income. In turn, the stronger domestic economy will decrease China’s reliance on export revenue and increase their consumption of imports, resulting in a stronger position in the global economy.

Another notable difference between the Chinese financial structure and the Western model is China’s regulation of bank lending and the housing market. Professor Rana explained that China’s government imposes strict regulations on home financing and that there is a limited scope of mortgage products available to borrowers. For example, to purchase a house in China, banks typically require a 40% to 50% down payment from prospective buyers. As a result, the housing market has enjoyed relative stability. This conclusion, is shared by the IMF, which reports that Chinese government measures have been successful in bracing the housing market amidst the threat of rapid price inflation. As a result, it seems China’s public/private hybrid system is better equipped to withstand a global financial crisis.

As a final point, however, Professor Rana warns that the Chinese model is not without its flaws. In the United States, we link the free market with innovation; by contrast, in China there is a strong national banking system. The primary concern is that the considerable government involvement in financial matters may limit investment opportunities. For instance, domestic investors are hindered by the limited availability of financial instruments and foreign investors fear that government regulations will be construed to favor state-owned companies. The solution Professor Rana proscribes is for China to continue to loosen its banking restrictions to encourage innovation. However, this process is happening slowly. As a result, it remains to be seen whether China’s public/private financial model has what it takes to sustain China’s place as a global power.

Posted by Naiema I. Blanchard on Sun. February 26, 2012 11:43 AM
Categories: Direct foreign investment, Symposium

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