Financial repression, financial legal governance and economic growth in China

• Author: BAI Jiang
• Pages: 86-122

FRONTIERS OF LAW IN CHINA

VOL. 11 MARCH 2016 NO. 1

DOI 10.3868/s050-005-016-0006-3

ARTICLE

FINANCIAL REPRESSION, FINANCIAL LEGAL GOVERNANCE AND ECONOMIC

GROWTH IN CHINA

BAI Jiang*

Abstract Financial rep ression usually exists in developing countries. By nature, it is

like a hidden tax and can liquidate public debt of the government effectively. The policy

of financial repression will likely hinder financial deepening, negatively influence the

building-up of efficient and inclusive financial systems, and eventually harm sustainable

economic growth in the long run. The fine legal infrastructure plays an important role in

financial deepening and development. In China the major measures to reduce financial

repression and improve the legal governance in finance are the following: the strict

respect and protection of private property rights, including the obligation rights of the

common depositors against the banks and the shareholders’ rights of the common

investors, the respect and protection of the contract freedom and contract enforcement,

the sequential openness of financial market entry and introduction of the principle of

free and equal competition in the financial market, and the improvement of the judicial

system to increase the adaptability of Chinese law, such as the strengthening of judicial

independence and the establishment of case law.

Keywords financial repression, financial deepening, legal governance, economic growth

INTRODUCTION ...................................................................................................................... 87

I. FINANCIAL REPRESSION ............................................................................................ 89

A. Concept and Characteristics .................................................................................89

B. The Effects of Financial Repression: Implicit Tax and Liquidation of

Government Debts .................................................................................................90

C. The Situation of China...........................................................................................92

1. The Repression on Interest Rates ......................................................................92

∗ (󱍒󰤴) Dr. iur. of University of Humboldt in Berlin (2006); Visiting Professor in Harvard Law School,

Aug. 2011–Aug. 2012; Senior Prosecutor of Shanghai People’s Procuratorate; Associate Professor, at Law

School, Fudan University, Shanghai 200438, China; Contact: jbai@fudan.edu.cn

This article is a staged research result of National Social Science Fund Youth Project “Research on

Corporate Social Responsibility and Corporate Governance” (Project No. 10CFX070), and is also supported

financially by China Scholarship Council. This article is presented on the First Fudan University and

University of California Young Scholars’ Conference on Governance in China, held in University of

California at San Diego on May 14–15, 2015. The author is grateful to Professor Barry Naughton for his

advice and comments and thanks Assistant Professor Andrew Verstein for his friendship and editing.

2016] FINANCIAL REPRESSION, FINANCIAL LEGAL GOVERNANCE AND ECONOMIC GROWTH IN CHINA 87

2. The Control of Banks ........................................................................................94

3. The Control of the Securities Market................................................................96

4. The Control of the Capital Accounts.................................................................97

II. FINANCIAL REPRESSION AND ECONOMIC GROWTH ................................................. 98

III. LAW, FINANCE AND ECONOMIC GROWTH............................................................. 101

A. Legal Environment and Financial Development.............................................. 102

B. Finance and Economic Growth........................................................................ 106

IV. PATH S F OR AMELIORATION OF FINANCIAL REPRESSION AND PROMOTION OF LEGAL

GOVERNANCE IN FINANCE.................................................................................... 108

A. Strict Protection of Private Property Rights .....................................................109

1. Strict Protection of the Obligation Rights of the Residents on Their Bank

Deposits.........................................................................................................11 0

2. Strict Protection of the Right of Ordinary Residents as Minority

Shareholders.................................................................................................. 114

B. Strict Protection of Contract Freedom and Contract Enforcement ..................116

C. The Sequential Openness of Market Access and the Introduction of the

Principle of Free and Equal Competition........................................................118

D. The Improvement of Judicial System................................................................120

1. The Necessity to Enhance Judicial Independence .......................................120

2. The Necessity to Recognize Case Law to Improve the Adaptability of

the Laws.......................................................................................................121

CONCLUSION........................................................................................................................ 121

INTRODUCTION

A great deal of foreign and domestic research literature shows that financial

development has a primary influence on sustainable economic growth in the long run.1

Finance can be divided into indirect finance (banks) and direct finance (securities). It is

said that the development of banks and securities market is a good indicator of economic

growth. 2 From the aspect of micro economics, financial institutions are of great

1 Robert G. King & Ross Levine, Finance, Entrepreneurship, and Growth: Theory and Evidence, 32

Journal of Monetary Economics 513, 513–542 (1993); R. Atje & B. Jovanovic, Stock Markets and

Development, 37 European Economic Review 632, 632–640 (1993); R. Levine & S. Zervos, Stock Markets,

Banks, and Economic Growth, 88 American Economic Review 537, 537–558 (1998); T. Beck, R. Levine &

N. Loayza, Finance and the Sources of Growth, 58 Journal of Financial Economics 261, 261–300 (2000);

TAN Ruyong, 󲺦󲑢󱮤󰨣󳉔󱧐󱍙󲢖󱓩󱝋 (Empirical Research on the Relation of Financial

Development and Economic Growth in China), 10 󱮤󰨣󱓩󱝋 (Economic Research Journal) 53, 53–61 (1999);

ZHOU Li & WANG Ziming, 󲺦󲑢󱮤󰨣󳉔󲢖󰑥 (Empirical Analysis about Financial

Development and Economic Growth in Different Areas of China), 10 󲺦󲑢󱓩󱝋 (Journal of Financial Research)

1, 1–13 (2002); WANG Zhiqiang & SUN Gang, 󲺦󲑢󲚙󰛶󱮨󰑙󰈝󱁜󱮤󰨣󳉔󱧐󱍙󱮤󳝡󰑥

(Empirical Analysis of the Relation of the Scale, Structure and Efficiency of China’s Financial Development

and Economic Growth), 7 󱡶󱃛󱈡 (Management World) 13, 13–20 (2003).

2 See Levine & Zervos, Id. at 537–558.

88 FRONTIERS OF LAW IN CHINA [Vol. 11: 86

importance to corporate and industrial expansion.3 Although there are different views on

this issue, massive existing evidence supports a strong relation between financial

development and economic growth. In addition, the theory of law and finance which rose

in the mid to late 1990s, emphasizing and highlighting the role of the legal systems in

explaining the international differences of financial development.4 The theory argues that

in the countries where the legal systems provide stronger protections of private property

rights, private contracts, and the rights of investors, ordinary residents are more willing to

invest in the corporations, and this leads to the prosperity of financial market. On the

contrary, the legal systems that are weak in protecting private property rights and private

contracts hinder corporate finance and the development of finance. In the early 1970s,

American professors McKinnon and Shaw proposed the theory of financial repression

and financial deepening, which has a far-reaching impact. This theory argues that

financial repression, mainly showing as the repression on real interest rates by the

government, commonly exists in developing and transition countries, and it hinders

financial deepening. 5 In the environment of financial repression, the government

allocates disposable scarce credit resources to the so-called priority sectors, thus

hindering economic development by having adverse impacts on the amounts and output

rates of investment. China, as an emerging power and with a transitional economy, is

confronted with the arduous task of deepening the reform of financial system step by step

and maintaining a healthy and sustainable national economic growth which has not only

the quantity but also the high quality.

Since the launch of the reform and opening up policy in 1978, China’s economic

development has achieved a great success in the past more than three decades.

Particularly after China joined the WTO in 2001, its GDP more than tripled in only 12

years, an annual rate of growth of 10.09%. China’s macroeconomic performance in the

past decade has been characterized by high domestic investment, high dependence on the

foreign market and a low consumption ratio. In the long run, however, this current growth

model may not last forever. China has paid much environmental price and the industrial

debt has risen to about 250 percent of GDP. Because of lacking technology and

3 A. Demirgüç-Kunt & V. Maksimovic, Law, Finance, and Firm Growth, 53 Journal of Finance 2107,

2107–2137 (1998); Raghuram G. Rajan & Luigi Zingales, Financial Dependence and Growth, 88 American

Economic Review 559, 559–586 (1998).

4 Rafael La Porta, Florencio Lopez-de-Silanes & Andrei Shleifer et al, Legal Determinants of External

Finance, 52 Journal of Finance 1131, 1131–1150 (1997); Rafael La Porta, Florencio Lopez-de-Silanes &

Andrei Shleifer et al, Law and Finance, 106 Journal of Political Economy 1113, 1113–1155 (1998).

5 Ronald I. McKinnon, Money and Capital in Economic Development, Brookings Institution (Washington,

DC), at Sections I, II & III (1973); Edward S. Shaw, Financial Deepening in Economic Development, Oxford

University Press (London), at Sections I & II (1973); Vicente Galbis, Financial Intermediation and Economic

Growth in Less-Developed Countries: A Theoretical Approach, 13 Journal of Development Studies 58, 58–72

(1977); Basant K. Kapur, Alternative Stabilization Policies for Less Developed Countries, 84 Journal of

Political Economy 777, 777–795 (1976); Maxwell J. Fry, Money and Capital or Financial Deepening in

Economic Development?, 10 Journal of Money, Credit and Banking 464, 464–475 (1978).