SHA 385
The Party State and the Relationship of Government and Markets
Jean Oi, The Role of the Local State in China’s Transitional Economy
What kind of state does China have?
Laissez faire
Leninist state with command economy
Developmental state
Leninist developmental state + local state corportism
Disciplined multiple states with strong incentives to promote economic growth
through entrepreneurial action
It is the local Chinese state that is the most active agent in promoting economic
growth, creating capitalist firms and acting as capitalists. This is a Maoist state
acting as a developmental state, which leads to a fundamentally different kind of
state. Maoist state had to be changed to permit local initiative and develop
incentives for economic development but its capabilities for promoting growth were
substantial.
Maoist state bureaucracy was disciplined and organized down to local levels.
Makes the case for TVEs as collective enterprises, not as private firms
 Property rights of TVEs remain with the local government and much of the
decision making responsibility lies with local officials
 But the day-to-day operation is with contracting officials who operate the firm
How did the system of TVEs – Local government operate?
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Economic reforms remove the restraints created by a command economy and
marketize the economy and create incentives that push local officials toward
entrepreneurial action
Decollectivize agriculture changes the access of local governments to revenues
Local officials must act to create incomes for themselves: entrepreneurial
reward and risk with hard budget constraints
County officials could operate multiple TVEs and reap rewards
General secretaries were judged by higher levels on the basis of economic
growth
The administrative bureaucracy becomes a channel of information and resources
for promoting market production
This information and resource system extends across the region and regions to
give firms access to inputs and markets
Officials serve to provide information and proposals of an entrepreneurial
developmental state – officials and managers as entrepreneurial partners with
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the official facilitating firm interactions across the area and region
Property rights allow officials to allocate and reallocate resources
TVEs assume debts of other local TVEs that fail and extend loans to other local
TVEs
Targeted subsidies/loans/resources to TVEs based on performance:
administrative guidance of Japan plus the chaebol direction of Korea
Local governments as owner and regulator of TVEs – nature of embeddedness
and autonomy
Why did local officials act as entrepreneurs and not as predators?
Role of the CCP?
Guanxi is not the same as predatory corruption
Local officials do gain some measure of autonomy of central government but
still remain under the supervision of the CCP
Is the Leninist nature of the CCP the key to its economic success?
Bureaucrats in Business, Chinese-Style: The Lessons of Market Reform and State
Entrepreneurialism in the People's Republic of China
JANE DUCKETT *
In the 1990s, departments within the state administration in China have been setting up
profit-seeking businesses to earn income for themselves and to employ their officials.
These new state businesses differ from the state enterprises that existed under the
command economy in terms of both their organization and their sources of investment,
and they have been neither planned as part of the market reform program nor anticipated
by central government policy makers. Rather, they are a spontaneous response by
individual departments to the needs and opportunities that have emerged in the process of
economic liberalization.
This state activity is novel in the experience of implementing liberalization policies
around the world. Moreover, it is unanticipated in the literature on the political economy
of market reform, where states are typically expected to resist liberalization policies
because they reduce their influence.
Neoliberal thinking - These findings reinforce expectations that state intervention
creates bureaucratic and societal vested interests that will seek to maintain the lucrative
status quo and resist economic liberalization, and they apparently give empirical support
to NPE theory. As John Waterbury has noted: ``From different disciplinary origins there
has been a conflation of assumptions about the likely behavior of public bureaucracies
that yields powerful insights into their pathologies but little that would explain why they
might change'' It has become part of the orthodox thinking on economic
liberalization that state bureaucracies would have little interest in promoting
market reform.
At the same time as the dominant thinking in development theory and practice has
converged toward anticipating state resistance to economic liberalization, market reform
in China has produced a quite contrary phenomenon in which mid- and lower-level
officials within the state bureaucracy embrace markets by setting up their own
businesses. As competitive markets have emerged, Chinese bureaucrats have
become involved in business in a way unanticipated in the dominant thinking on
market reform. This paper argues that some of these activities are genuinely
entrepreneurial, and concludes that state entrepreneurialism in China reveals
weaknesses in current thinking about the state and marketization in development.
the state businesses are only semi-legitimate, and as a result are not generally reported in
China. This means that there are no available quantitative data, and documentary reports
are scarce. It is because the state officials have invested state assets in the businesses
to earn income in a market environment, that I characterize them as adaptive,
embracing market reform and acting entrepreneurially. They are promoting rather
than hindering market reform in that they are using the businesses to implement
policies to cut back state personnel rather than blocking cutbacks. It remains for
further research, however, to determine whether the enterprises have in fact operated
without advantage derived from their bureaucratic parentage, promoted further
deregulation and market reform, and led to state restructuring in the longer term.
ranging from small trading companies or restaurants with only a handful of
employees, to large department stores and real estate development companies with
several dozen or more sta.. A large number were service sector businesses, partly because
this was a small part of the prereform command economy and therefore had most scope
for development, and partly because such businesses often require relatively little initial
capital investment. Sometimes the businesses were related to the administrative work of
the parent department, but many conducted unrelated business. For example, public
property departments tended to establish real estate development companies ‹often more
than one‹but some had also set up trade companies and one had opened a large
department store. Commerce departments, which had managed the distribution of
consumer
goods in the prereform planning system, often set up businesses trading in those goods,
but they had also created other kinds of business (Liu, 1993). In addition to several
trading companies, the municipal commerce bureau
Sometimes joint venture companies were established with foreign business capital. For
example, one Tianjin government department had created several real estate
development ventures together with investors from Hong Kong. The profits
generated by the businesses are shared with the parent department and are used to pay
o.cials' bonuses, supplement administrative expenses, and carry out departments' o.cial
work. The new businesses thus help relieve financial problems that have grown for
departments in the reform period as the demands on them increase and inflation devalues
state funds and officials' salaries.
Leading o.cials have been under pressure to cut back sta.ng levels during the reform
period so as to restructure the bureaucracy for the market economy and to reduce
budgetary spending. 28 The pressure has been particularly evident in departments
required to restructure because markets have encroached on their work, and there the
businesses have clearly provided a convenient means of reducing personnel.
The motivation for the new businesses was primarily that they allowed individual
departments within the state administration simultaneously to earn new income and
comply with the sta. reduction policy without making their personnel redundant.
Some further clarification of ``state entrepreneurialism'' and an outline of the key
features of ``the entrepreneurial state'' are therefore necessary. Some of the new state
businesses, like those described above, are best seen as a distinctive kind of state
involvement in the economy and one that can be distinguished from corruption and
profiteering.
Indeed this activity is best termed ``entrepreneurial'' since it involves individual
departments investing directly, to generate income, in businesses that operate in a market
environment.
In these cases, individual departments invest their own finance in businesses, which
therefore di.er from traditional state enterprises that receive budgetary funding as
designated in state plans. Moreover, they do so to employ some of their own sta. and to
generate pro®ts for themselves rather than for local or central government. These
business ventures also involve an element of risk, often seen as a
defining feature of entrepreneurship. they are set up to build buildings, produce
goods, provide catering services and trade commodities in a competitive market
environment. Many were set up to trade in consumer goods or provide services
(restaurants and dance halls) in sectors where markets were at their most
developed.
It is not yet clear whether the entrepreneurial state will be a short-lived phenomenon in
the process of reforming state planning and introducing a market economy in China, or
whether it will prove more enduring
State entrepreneurialism also involves a different kind of activity from that found in the
``developmental state'' identified by some as directing development in other parts of East
Asia indeed perhaps also in China itself
Did this low level kind of state entrepreneurialism at the local level reflect a more
deep-seated form of practice that was augmented and redefined in the reform of
state owned enterprises in the 1990s?
Is state entrepreneurialism very different from that in TVEs or from the peasant
behavior in responding to new incentives in farming and production?
Sources of social support for China’s current political order: The “thick
embeddedness” of private capital holders
Christopher A. McNally, Teresa Wright
Why hasn’t massive economic growth and the explosion in the size and economic power
of the capitalist class led to radical political change?
Why hasn’t some form of cascading institutional change led to cascading political
change?
contrary to conventional expectations, China’s capitalists appear to have little interest in pushing
for systemic political reforms, but instead seem to seek to embed themselves in the party-state,
thereby perpetuating Chinese Communist Party (CCP) rule.
this article investigates the nature and implications of the political embeddedness of
China’s private capital holders. The embeddedness of these individuals is “thick” in the
sense that it encompasses an inter- twined amalgam of instrumental ties and
affective links to the agents and institutions of the party-state. Thick embeddedness
therefore incorporates personal links that bind private capital holders to the partystate through connections that are layered with reciprocal affective components.
Such close relations work against the potential interest that private capital holders
might have in leading or joining efforts to press for fundamental political
liberalization.
this “thick embeddedness” is not solely instrumental. Rather, instrumental ties are layered with
guanxi and kinship ties – personal links that bind this group to the party-state through
sentiment and a reciprocal affective component.
the key is that China’s leaders have successfully embraced and encouraged economic
freedom while simultaneously restricting political freedom. In a somewhat more hopeful
reading of the policies of post-Mao CCP elites, some argue that significant administrative
reform has resulted in a party-state that is much more institutionalized, meritocratic, and
responsive to public sentiments and grievances.
From a legal standpoint, private businesses in China may be divided into two groups: first are
small enterprises with fewer than eight employees the getihu; second are larger enterprises with
eight or more employees private entrepreneurs. Getihu typically run firms that involve family
members and rely on very limited capital. In general, these entrepreneurs are not prosperous, but
rather are situated within China’s lower classes. Thus, in official Chinese government documents
getihu are not considered “private entrepreneurs” or “private capital holders.”
China’s private entrepreneurs are at the helm of the most dynamic and rapidly growing
sector of the economy. Domestic private enterprises account for between one third and one
half of China’s GDP, employ more than 100 million people, and, together with foreigninvested private firms, provide an estimated 75 percent of employment growth and 71
percent of Chinese tax revenues
Private entrepreneurs have willingly joined government-sponsored business associations, such as
the Private Enterprises’ Association and the Industrial and Commercial Federation. These quasicorporatist organizations are intended both to “maintain state control” over private entrepreneurs
and to represent their interests. medium and large private enterprise owners do not see any
incompatibility between the associations’ dual functions of state control and member
representation. Intriguingly, the more privatized and prosperous a locality is, the higher the
likelihood that a private entrepreneur will view him or herself as a partner, not adversary, of the
party-state
“thick embeddedness” denotes that relations between China’s private business owners and
the party-state feature a blend of material interest and benefit, and affective bonds. This
affective element encompasses direct kinship ties and/or affective connections mediated by
guanxi practices. Guanxi are reciprocal ties that center on informal and intimate networks of
social exchange. Guanxi practices derive from China’s Confucian legacy, but have undergone
substantial trans- formation during China’s socialist and post-socialist periods. In the post- 1978
period, guanxi practices have become broader in scope, forming networks of particularistic ties
that are maintained and mobilized for combinations of instrumental and affective purposes
Guanxi practices are an expression of a particular Chinese type of personal network. In it the
relationship per se, that is, the affectionate/intimate aspect of the transaction comes first or at least
is equally seen as an end in and of itself. Relationships are instrumental, but this aspect is layered
with affectionate ties and the conscious building of trust (xinyong). In short, guanxi practices
represent “strong ties,” ties that have enabled China’s private capital holders to establish longterm reciprocal personal relationships with the institutions and agents of the party-state.4 The
result: frequent interactions, sentiments of familiarity and trust, and a “we-group” feeling toward
each other that have closely aligned the interests of China’s private capital holders with those of
the party-state, at least for the time being.
scholars have investigated the ways in which “early” versus “late” economic development shapes
the political attitudes and behavior of emergent socio-economic classes. In general, most agree
that a group’s political attitudes and actions derive from its material interests (Bellin, 2000, p.
177). In Barrington Moore’s (1966) analysis of earlier capitalist developers, the rising capitalist
class pushed for democracy as a way to challenge the feudal and/or authoritarian state that was
perceived to be hostile to its interests. In Rueschemeyer et al.'s (1992) examination of mostly later
developers, the working class was the champion of democratic reform. Yet even so,
Rueschemeyer et al. emphasize that the working class has needed allies, especially in latedeveloping countries with smaller and weaker urban working classes. They note that, historically,
other sectors – especially capitalists and intellectuals – whose interests have been harmed by an
authoritarian political structure have played this role.
Focusing more explicitly on later developers, Eva Bellin (2000, pp. 186 & 194) argues that the
perceived material interests of labor and capital shape their political attitudes. For the capitalist
class, dependence on the state and fear of working class inclusion may breed opposition to
democracy and support for authoritarian stability. Similarly, when organized labor is dependent
on the state and enjoys a privileged status relative to unorganized workers, it may oppose liberal
political change as well.
Clearly, the once dominant role of the capitalist class in pushing for political liberalization is
reduced in later developers.
“Embeddedness” refers to the fact that as individuals and institutions are engaged in ongoing
social relations they cannot be understood as independent of one another (Granovetter, 1985, p.
182). Although all institutions and individuals are to some extent embedded in their sociopolitical environment, some are more embedded than others. “Political embeddedness” refers to
the depth and extent of an individual’s or institution’s inter-relationship with the polity. Existing
works on political embeddedness tend to focus on the political constraints that shape economic
institutions – the embeddedness of economic relations in their political surroundings (Zukin and
DiMaggio, 1990, pp. 20–23). Taking a slightly different approach, we contend that the political
embeddedness of China’s private entrepreneurs with the agents and institutions of the party-state
is characterized by a distinctive “thickness” – private capital holders are not only shaped by the
structuring force of the party-state’s power; they are actively engaged in ongoing relations with
the party-state and its actors – relations that are characterized by combinations of institutional,
instrumental and affective ties that are inescapably linked with each other.
1. The state-created private firm: ZCC insider privatized TVE
case of Z Chemical Corporation (ZCC), a former township and village enterprise,
first type of large private enterprise owner emerged in reaction to the privatization of public
sector enterprises, which picked up steam in the mid-1990s and then gained official support under
the policy of fang xiao (“let go of the small”) in 1997. This group includes managers of stateowned enterprises and township and village enterprises who became the largest
shareholders as these enterprises were transformed into limited liability corporations. Some
entrepreneurs also purchased former state firms outright, often facilitated by their ties with
local government officials. In most cases, these entrepreneurs gained the assets of the enterprise
without being responsible for their debts or for guaranteeing continued employment to former
workers. This group of large private business owners tends to be quite wealthy and has
strong connections with the party-state Indeed, many of these enterprises have literally
“grown out” of the state, benefiting from their prior history under public ownership to
generate profits for their new private owners.
ZCC began as a venture between a chemical research institute of a large Chinese province and a
village at the outskirts of the provincial capital. The firm was founded in February 1985 as a
township and village enterprise 100 percent owned by the village, though with technology and
personnel transferred from the research center. By 2003 ZCC focused on manufacturing head
gaskets, occupied three acres of factory space, employed more than 160 workers and had about
30 million yuan in sales.
As in other parts of China, the collective ownership structure of ZCC underwent reform
(gaizhi) by implementing a share- holding cooperative structure in 1998. Since ZCC was
100 percent owned by the village, the privatization process was solely managed by the
village government. Higher government levels did not interfere because their objective was
to get rid of small factories under public ownership. However, the township government one
level above the village needed to be persuaded to approve the privatization arrangements;
as a result, key officials received gifts and promises of future tax revenues.
A few privileged employees, most of whom were connected to the village government, took
control of ZCC in a process of insider privatization. The factory director, who also acted as the
village head, gave up his government job to become the full- time chair of the new board of
directors of ZCC. Other leaders of the village became members of ZCC’s management team. The
new ownership structure therefore included the new chair (former village head) with 30 percent
share ownership, the vice- chair (the former village Party secretary) with a bit more than 20
percent of the shares, a niece of the former village head and her husband each with a few percent
of the shares, former/present long-term employees (employed prior to 1990) with a bit more than
20 percent of the shares, and a chief engineer from the chemical research institute who had
worked at ZCC since its founding with 5 percent.
The history of ZCC is typical of many privatized township and village enterprises. None of the
managers invested a cent of their own money up until privatization. Rather, they used their
knowledge, entrepreneurship, personal connections and government positions to access state
assets and bank loans, which were used as investment capital. Subsequent to its privatization,
ZCC’s continued development has been facilitated by its managers’ thick embeddedness with the
agents and institutions of the local party-state. In sum, ZCC has grown out of the local state and
remains linked to it via guanxi ties – instrumental, institutional and affective bonds that create
sentiments of familiarity and trust.
2. The state official/actor created private firm – connections and background as able
administrator are leveraged to create a private firm – X Real Estate – ownership
interpenetration between state and private - private ownership under the protective hat of
“state ownership.”
The second category of large private enterprise owners resembles the first group in some key
respects. Both benefited from close political connections, but the second type has not grown
directly out of state ownership. Rather, these entrepreneurs have used their embeddedness
in the party-state to gain insider information and/or market access, especially during the
early phases of reform lasting from the late 1970s through the mid-1990s. For example,
many profited from the dual-pricing structure for consumer and some industrial products
that was established in 1985, reaping significant rewards from “buying low and selling
high.” Similarly, starting in 1987 and lasting in most regions into the late 1990s, much stateowned land was leased to the private sector. This did not occur via a fair and open bidding
process; to the contrary, those with close relations with party-state officials typically
obtained the land, often at low prices. Subsequently, these real-estate entrepreneurs expanded
into finance, construction, advertising and insurance. This second group of large private
enterprise owners thus benefited from their privileged backgrounds, including relatively high
levels of education and close relations with representatives of the party-state.
The key founder, Mr. X, left his government job (xia hai) in 1992 and moved to Shenzhen. There
he registered a trading company with a partner in Singapore and cultivated a guanxi network with
several former classmates and colleagues who had started to work in the oil business in Shenzhen.
As a result of this network of affective ties with long-term contacts, he invited a large Chinese
state-owned oil company to take a 51 percent stake in the Singaporean company’s ownership. Mr.
X and his partner kept the remaining 49 percent. Next, the trading company established a
subsidiary in Shenzhen. Due to the state- owned oil company’s majority stake in the trading
company, this subsidiary obtained a coveted license to import oil products cheaply and gain the
difference between world market prices and higher prices in China – it “bought low and sold
high.” Is this rent-seeking?
As the China-based company’s profits bulged, it started to buy out the shares that the state-owned
oil company owned in the Singapore trader. Both mother and daughter enterprises thus
transitioned to full private ownership, but still were registered as state-owned entities from
the Chinese government’s perspective. After policy changes regarding oil imports, both
companies exited the oil business and used their capital to set up a real estate development
company in a major province in China’s interior. Since it was established by a state-owned
entity, the new real estate company was also regarded as state- owned; a factor beneficial to
doing business in China’s politicized real estate market. The result was a paradoxical entity: a
privately managed “state-owned” real estate developer – XRE.
When a new land auction policy requiring that all land be sold by open tender began taking effect
in the early 2000s, Mr. X and his partner sold a 51 percent stake in their “state-owned” XRE to a
state-controlled enterprise (guojia konggu) that just had listed on Shanghai’s stock market. Again,
this transaction could only take place because Mr. X had long-standing guanxi with a key official
in the listed state-controlled enterprise. As Mr. X put it, “we will use whatever type of ownership
structure is favorable to business and provides policy benefits and profit opportunities. At present,
the best ownership form is to belong to a listed state corporation, since it gives us greater access
to capital and better recognition by the government.” The price for the stake was 90 million yuan,
all of which Mr. X and his partner pocketed.
The urban district government with which XRE was officially registered as state-owned did not
interfere, since XRE had never received any state investment. The district government actually
feared that XRE might move its registration to another district and pleaded with it to continue its
registration and local tax payments. XRE’s new-found status as part of a listed state-controlled
corporation improved its opportunities to cultivate guanxi with powerful agencies in the local
party-state, including the mayor’s office, the city’s economic commission, and various district
governments. As a result, it gained better access to land, investment capital and regulatory
approvals. Despite its state-controlled status, however, XRE has remained independent of party
and state bodies. Its party committee, of which Mr. X is a member, is not appointed by any
outside party body and mainly exists to leave a good impression on party-state officials.
Therefore, what started as a rent- seeking opportunity in the oil trade morphed into a major real
estate business. XRE is an unadulterated example of private ownership under the protective hat of
“state ownership.”
3. Private firm with good state guanxi – T High Tech
The third group of private enterprise owners encompasses entrepreneurs who generally have
relied on their skills and savvy to grow businesses. By and large, they have attracted
investment capital through the creation of technology-intensive and creative projects, and
have not directly profited from their political connections. Most of their firms were founded
after China’s market economy matured, that is, starting in the mid-1990s. T High-tech is an
example of such a firm
Even though private business owners of this type typically have not held formal political posts
and have not profited directly from their ties with political officials, many have guanxi ties with
agents and institutions of the party-state that have facilitated their success. Because China’s
economy retains Leninist features – relevant to the case of T High-tech, for example, the major
telecom providers are all state-controlled, and innovation in the industry has been heavily
supported by government agencies – these ties have been extremely helpful, even for companies
that have not profited through insider “deals.” For T High-tech, affective connections with
relevant government entities and a partly government-owned joint- venture firm have been key in
facilitating the firm’s success.
Guanxi is not predatory and can be efficiency enhancing
T High-tech was set up in the region’s premier industrial high-tech park, a key factor in the
company’s success. The park management provided good infrastructure, did not
discriminate against a small private start-up, and, most importantly, allowed T High-tech to
register as a collective enterprise under the park’s management bureau. Unofficially,
however, T High- tech remained a 50/50 venture between its two founders. In 1998, as China’s
government encouraged fake collectives to re-register as actual private firms, the two founders
decided to convert T High-tech into a limited liability corporation, a process that unfolded
smoothly. By the early 2000s, T High-tech was able to penetrate China’s national telecom
equipment market.
Although the company has not relied on insider “deals,” its owners openly state that the firm’s
profits have been driven by “guanxi sales.” As one owner put it: “Good guanxi with China’s
large telecom providers (all of which are state-controlled) must be cultivated to be successful in
this market.” T High-tech owners have engaged in constant communication and have had
multiple meetings with the city government’s economic commission and, especially, the science
and technology bureau. This interaction has been facilitated by mutually-beneficial instrumental
incentives as well as pre-existing affective bonds. The most notable example of the intertwined
nature of this guanxi is that the wife of one of the founders previously was the representative of a
large state-owned electronics producer, giving her the opportunity to develop excellent guanxi
with various local government agencies. She is now handling the public relations of T High-tech.
Accordingly, T High-tech has gained considerable access to local government agencies and
officials in charge of science and technology development.
As the founders remarked, “We do not fear the government at all. They are our partners,
especially the industrial high-tech park’s management (the park is government-owned and
managed).” Indeed, there is now little predatory behavior from government agencies,
according to the founders, and the city government has extended substantial support,
facilitating T High-tech’s development.
T High-tech reflects the great diversity of China’s private capital holders. While most large
private firms are politically embedded in the party-state, some are more embedded than others.
Clearly, T High-tech’s owners are less thickly embedded than their counterparts in ZCC and
XRE. The latter two possess deep institutional and affective ties to power-holders in the partystate. Even so, T High-tech’s success has been facilitated by its intertwined affective and
instrumental connections to science and technology agencies and large state-owned telecom
providers. High-tech entrepreneurs have been given access to the Chinese party-state and, as a
result, have nurtured guanxi ties with its officials. Despite high-tech entrepreneurs’ distance to the
party-state relative to other types of private capital holders, they are embedded with its
institutions and agents and feel little motivation to confront it. To the contrary, one of T Hightech’s founders states, “The government has been very supportive of our firm, and we try to
support the government whenever we can.”
The thick embeddedness of China’s capital holders in the state apparatus is not without precedent
in Chinese history; it in many respects mimics relations between the state and the
merchant/gentry classes in the late imperial era. At that point, a preference for interpersonal
accommodation undermined China’s attempts to develop well-functioning bureaucracies with
formalized and universally applicable rules (Mann, 1987; Boisot and Child, 1996). A reliance on
personalized ties to undertake business dealings was strongly reinforced by state officials, since
they viewed impersonal business dealings that could lead to the amassing of large fortunes as a
potential threat to state dominance (Gates, 1996, p. 32). While China’s political economy differs
in many respects from the late imperial political economy, the country might be slipping back
into her pre-communist history of capitalist accumulation under state tutelage.
Kellee S. Tsai
Associate Professor of Political Science Johns Hopkins University
Testimony before the US-China Economic and Security Review Commission on
China’s Financial System
August 22, 2006
By 2005, there were 29.3 million private businesses, employing over 200 million
people and accounting for 49.7 percent of the GDP.1 Yet as of mid-2006, less than 1
percent of all loans extended by state commercial banks were going to private
businesses, and private firms constitute less than 6 percent of those listed on China’s
equity markets.
my book Back-Alley Banking estimated that during the first two decades of reform
informal finance accounted for up to three- quarters of private sector credit. A study
conducted by a Chinese economist estimates that the total volume of curb market lending
in 2003 ranged from 740.5 (US$91.42 billion) to 816.4 billion RMB (US$100.79 billion),
which on average represents 28.07 percent of the total scale of lending by formal
financial institutions
there are four main reasons why private entrepreneurs have experienced considerable
difficulty in borrowing from official banks.
The first reason relates to political concerns about supporting the state sector and
maintaining social stability. Until very recently, state banks have been pressured by local
governments to provide soft loans to state-owned enterprises (SOEs) as a means to avoid
mass unemployment. (This is also one of the main reasons why state banks have such
high levels of non-performing loans.
The second reason derives from the developmental priorities of central and provincial
governments. State banks may extend loans to enterprises in sectors that have been
identified for preferential treatment as a matter of domestic industrial policy (e.g.,
automobiles, pharmaceuticals, computer components). This type of targeted lending is
not corrupt or illegal per se; it is policy oriented.
The third reason for the private sector’s exclusion from official credit relates to the
limited organizational and technical capacity of state banks to serve the non-state
sector. Credit officers have not been trained to evaluate loan applications according to
commercial standards of creditworthiness, and until the late 1990s, they were not held
accountable for high levels of non- performing loans in their portfolios
Tsai - 3
reform, loan officers were reluctant to work with private entrepreneurs due to uncertainty about
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following
table shows that the informal
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China.
Table 1. Overview of Curb Market Activities in China
Legal
Quasi-Legal
Illegal
Interpersonal Lending
Rural Cooperative Foundations
(illegal since 1999)
Professional Brokers and
Money Lenders (Loan Sharks)
Trade Credit
Private Money Houses
Rotating Credit Associations
(in some areas)
Pawn Shops
(in some areas)
Shareholding Cooperatives
Red Hat/Hang-on Enterprises
Financial Societies/
Capital Mutual Assistance
Associations
Rotating Credit Associations
(in some areas)
Pyramidal Investment
Schemes (scams)
Pawn Shops
(in some areas)
Diversion of bank loans via
state units
Note: None of the practices/institutions in the second and third columns are sanctioned by the People’s Bank of
China. Those in the first column are only “legal” if they do not entail the use of interest rates. “Quasi-legal”
practices are those registered by a bureaucracy outside of the financial hierarchy. Source: Adapted from Back-Alley
Banking, Table 2.3, p. 37.
Starting from the legal end of the spectrum, financial regulators generally condone casual
In reality,
however, most forms of informal finance that private entrepreneurs use
lending among friends and relatives as an innocuous form of mutual assistance at the grassroots
fall
intoInthe
gray
of quasi-legality.
I mean
the financial
level.
most
partsarea
of China,
rotating credit By
and “quasi-legal,”
savings associations
(ROSCAs)
fall into this
institutions
that
are
not
sanctioned
by
the
People’s
Bank
of
China,
but are
legally
benign category of “popular finance” (minjian jinrong). ROSCAs became illegal
in certain
registered
by another
governmental
localities because
they mutated
into ponziagency.
schemes that adversely affected large portions of the
local population, but generally speaking, informal financing strategies such as personal loans,
Besides turning to informal financial intermediaries, private entrepreneurs also rely on
8
deceptive
ways
of raising
capitalmeasures
such asintended
registering
a business
as a incollective
Over the last
three years,
credit-tightening
to quell excessive
investment
overheated sectors
has
reinforcedeven
this reluctance.
enterprise
though the business is actually privately owned. This is called
9
“wearing
a conversion
red hat”ofbecause
the
color red
A related
Note that the
urban credit
cooperatives
intosymbolizes
city commercialcommunism.
banks starting in 1997
was intended to
strategy
isavailability
registering
as a subsidiary
of residents,
a SOE,including
which business
is called
a “hang-on”
enhance the
of commercial
credit to urban
owners.
As of 2006 there were
117 urban commercial
of which
are starting
to attract investment
foreign
Seename
“Chinafor
to the
enterprise
becausebanks,
the some
private
business
basically
hangs onbyto
the banks.
SOE’s
Merge 10 City Banks into One,” August 7, 2006 and “City Lenders Lure Foreign Investors,” China Daily, April 5,
purpose
of getting credit from state banks. Both red hat and hang-on enterprises are
2005.
quasi-legal and generally left alone because they have formal registration status
a conservative estimate would be that informal finance has accounted for at least
one quarter of all financial transactions in the Chinese economy, and as mentioned
above, the curb probably accounts for up to three-quarters of private sector finance.
During periods of tighter credit controls, investors seeking higher returns divert their
savings from formal financial institutions into the curb market.
Although China’s private entrepreneurs share the structural condition of restricted access
to formal bank credit, substantial variation exists among localities in the scope and scale
of curb market finance. These differences are due to a combination of infrastructural,
economic, and political factors. it is estimated that farmers and individual entrepreneurs
in rural areas derive at least 70 percent of their capital requirements from the curb
market.18
Second, the volume of curb market activity is higher in areas with more developed nonstate sectors because the demand for credit outstrips its official supply. This is especially
the case in the coastal south.
vibrant informal financial markets have flourished where the local government has
protected curb market operators from the repeated disciplining efforts of state banking
regulators. This variation in curb market activity reflects differences in the developmental
orientation of local governments. In certain areas that were less industrialized on the eve
of reform, however, local officials have allowed the establishment of quasi-legal and
illegal financial institutions that compete with one another and infringe upon the business
of official state banks. The case of Wenzhou in Zhejiang is the archetypal example of this
situation. Wenzhou is also an example of a locality that consistently ignored national
economic policies—but eventually managed to receive concessions from the center to
experiment with alternative financial instruments.
Wenzhou examples: higher interest rates to savers to attract funds
Despite the explicit prohibition on private banks, Wenzhou’s entrepreneurs found
alternative ways of registering their financial service operations (e.g., as urban credit
cooperatives or regular businesses). Meanwhile, local officials maintained a highly
defensive, if not defiant attitude towards national policies that constrained the innovative
activities of its entrepreneurs. In 2003, when 71.8 percent of all financial transactions in
Wenzhou were occurring outside of the formal banking system,25 the People’s Bank of
China designated Wenzhou as an official experimental district for financial and banking
reforms. Although Beijing is watching it closely, Wenzhou and other cities in Zhejiang
province now have legal, commercial banks that are allowed to accept private investment,
extend small loans (less than half a million RMB or about US$60,975), and float its
interest rates.
Most economists explain the rise of curb markets as reflecting the inability of the
formal financial system to meet the needs of some portion of the economically active
population. In other words, when the demand for credit exceeds the official supply
of credit, would-be borrowers will turn to unofficial sources. This explanation makes
particular sense for China during the 1980s when state banks engaged mainly in policy
lending to state and collective enterprises, while private businesses were excluded from
official bank credit. Based on the assumption that the private sector relies on informal
finance due to its exclusion from the formal financial sector, both the central and local
governments have implemented various reforms and initiated various experimental
measures to increase the availability of credit to private entrepreneurs.
I would like to conclude by emphasizing that local political and social factors also
mediate the workings of the curb market. This means that increasing the availability of
formal bank credit (and indeed, even microfinance) may reduce the overall volume of
curb market transactions, but is not likely to eliminate them completely.31 The rationale
for this contention is based on the observation that local political and economic actors in
China often have interests that diverge from that of Beijing.
China's banks
Great Wall Street
The rise of China’s state-backed banks is stunning. But success will force the model
to change
The Economist
Jul 8th 2010
THERE is no more potent symbol of the relative decline of Western finance than the
revolution in Chinese banking over the past decade. While American and European
banks have been busy blowing up, China’s have been transformed from communist
bureaucracies crippled by bad debts into something resembling world beaters.
China’s rise is more solid than that of Japan’s banks in the 1980s. Finance has huge
potential in China—less than 1% of AgBank’s retail customers have mortgages. And the
country’s banks had a good crisis, largely because they never entirely left the
government’s embrace. So although they make money and have the trappings of public
companies, the state owns a majority stake and the Communist Party appoints the top
brass, whose pay is a fraction of that of their Western peers. Those bosses, with their dual
role as party bigwigs and chief executives, are beholden to a higher authority than the
stockmarket. Their regulators, meanwhile, wield supposedly crude tools to control banks,
such as lending caps and reserve ratios, long dismissed by “light touch” supervisors
elsewhere. And the system is pretty closed. Some foreign banks have minority stakes in
Chinese firms. But foreigners’ own operations on the mainland have a market share of
less than 1% by profits, while Chinese banks make less than 4% of their profits abroad.
As in 1999 after the Asian crisis, China’s politicians just cut out the middleman and told
the banks to supply more credit. Loans grew spectacularly, from 102% of GDP in 2008 to
127% in 2009, funding everything from motorways through paddy fields to yuppie flats
in Pudong. Growth stayed strong and China won many admirers. In India and Brazil it is
no longer retrograde to argue that state-controlled banks should help counteract the
economic cycle. Even in rich countries with privately owned banks, supervisors are
eyeing the tools used by China’s regulators to control credit. Communist Party diktat has
been relabelled as “macroprudential supervision”.
A repeat performance is exactly what some fear after the latest binge. Most worrying are
loans to infrastructure projects sponsored by local governments (perhaps a sixth of
outstanding loans) and, given a frothy property market, real-estate financing and
mortgages (a fifth of the total, with some overlap with infrastructure loans). China’s
bankers say they are relaxed but some investors are kept awake by visions of corrupt
officials, roads to nowhere and deserted shopping malls.
Although potentially severe, these bad debts will not be the downfall of the Beijing
model of banking. Even if a chunk of the loans is written off, the system can absorb the
hit. That is partly thanks to an impressive regulator, which has prodded the banks to raise
capital this year—by about an eighth, if all goes to plan. But it is mainly because of
China’s high savings rate. With piles of excess deposits banks do not rely on fickle debt
markets for funding. That buys them time to earn their way out of a bad-debt problem,
using their high lending profits to replenish capital. As a backstop, China’s government,
with little debt and large foreign reserves, has deep pockets.
China’s banks could then end up looking a lot like banks elsewhere, although the state
will still have control. Yet even that could change gradually. At current growth rates
China’s banks will need capital injections every few years. The government may tire of
these shakedowns—its participation in this year’s equity raisings has been a little
grudging—and allow its stake to be diluted instead. And, as China’s banks claim their
rightful place among the global leaders, they will find doing big foreign deals is hard
when the government has a hand on the steering wheel. The rise of China’s banks is
stunning and a little frightening. Yet they are not the pallbearers of market-based finance,
just a work in progress.