Supporting Sunset Sectors: The Financial System in China ’ s Economic Development Kaja Sehrt International and Area Studies, UC Berkeley Shanghai Forum, May 24-25, 2007

Overview Understanding Financial Sector Reform Existing Explantions The Argument Supporting Sunset Sectors Conclusions and Implications

Indicators of Financial Liberalization Restrictions on international financial transactions (capital and current account convertibility, exchange rate controls etc.) Interest rate controls Entry barriers in the banking sector (licensing requirements, limits on participation of foreign banks etc.) Operational restrictions (on staffing, branching, advertising etc.) Credit controls, such as directed lending towards favored sectors or industries

The Puzzle: Why do governments that have demonstrated a commitment to a market-oriented reform agenda, postpone, delay or fail to implement reforms of the domestic financial sector? Perhaps particularly surprising in the case of PRC since there have been extensive reforms in most other sectors of the economy.

Existing Explanations for Financial Liberalization Economic Explanations  Requirements of the real economy International Factors  International Factors “Globalization” Impact of Shocks/Crises Domestic Factors  Country case studies  China-focused explanations

The Argument Bank funds afford governments a way to soften the impact of market-oriented reforms. This helps account for the simultaneous liberalization in some sectors of the economy, while the financial system remains under a more restrictive regime.

Under these circumstances… … governments will be tempted to license banks to themselves, rather than to grant private agents the right to create and allocate credit. …governments will attempt to direct bank lending to priority sectors. These priority sectors are likely to be in sunset industries and/or regions to help compensate losers of the overall economic reform process.

Evidence from the PRC Licensing Direction of Lending  Industry  Agriculture  Financial mediation across regions

The Chinese Financial System, 1984

The Chinese Financial System, 2007

Distribution of Deposits in the Chinese Banking System, 2003

Distribution of Loans in the Chinese Banking System, 2003

Direction of Lending Industry Agriculture Financial mediation across regions

Industry Legacy of the credit plan

Industry Year Lending by PRC Banks (As percentage of total loans) Private enterprises Foreign-invested enterprises %2.5% %3.1% %4.0% %4.3% Source: Calculated from PBC, various years.

Industry Legacy of the credit plan Government priorities:  Providing employment  Creating infrastructure

Agriculture Government concerned about Rural incomes Widening urban-rural gap

Government Support for Agriculture via the Banking System, Sources: ADBC annual reports; PBC annual reports; JRNJ.

Financial Mediation Across Regions Government concerned about Rising income inequalities Uneven development

Financial Mediation Across Regions Note: Average annual growth rate of provincial per capita GDP has been adjusted for inflation. Provincial per capita GDP and growth rates calculated from NBS, various years, tables 3-9 and 9-7; financial system data calculated from PBC, 2001, pp

Conclusions Bank funds afford governments a way to soften the impact of market-oriented reforms. This helps account for the simultaneous liberalization in some sectors of the economy, while the financial system remains under a more restrictive regime.