Financial repression in China and economic reform: 1978-1989

By 1989, the People’s Republic of China has gone through her first decade of economic reform. There is no doubt that a considerable degree of economic achievements have been made, but equally there are various economic problems, such as inflation, shortages and huge imports, that have emerged. China was the first socialist country which had chosen the path of economic reform, and her experience will not only be a treasure to other socialist countries whom are rapidly liberalizing their economies, but to China herself if she wants to further deepen her own reform achievements. This paper attempts to use a macroeconomic and financial framework in general, and the financial development and repression theories in particular, to examine China’s performance in her first decade of reform. By reviewing China’s statistical performance on income and consumption, money and banking, state budget and fiscal expenditures, savings and investment, foreign trade and investment, and prices and inflation, five components of financial repression can be identified. Various simple linear regressions are formulated and empirical results show that China is a financially repressed economy, inflation is negatively correlated to consumption, while expectation and large money supply are the major causes of inflation. Among the various financial resources, foreign direct investment, bank loans and self-raised funds performed better in general, but budget expenditures performed most inefficiently. There are two channels which can improve China’s financial productivity. One is to relax the real interest rate ceiling so that unproductive investments are discouraged and at the same time free the financial resources for more productive investments. In so doing, output expands and the shortage problem can be eased, money growth decreases as state banks exercise a more prudent credit policy, inflation and expectation fall, thereby making money a more attractive asset to hold. The other aspect is to fasten the development of the equity market. In the 1980s, equity market development in China has been slow and has made very little impact on the economy. With the establishment of the Shanghai and Shenzhen stock markets in the early 1990s, equity trading is expected to pay a more significant and leading role in financial liberalization. The advantage of a well-functioning equity market is that funds raised are managed by non-state enterprises. Improvements in both the institutional mechanism and the equity market would surely exert positive impacts on each other