China's Trilemma: Growth, Reform and Stability
The Social Order of Chinese Capitalism in the (shadow) banking sector after the Global Financial Crisis
B.Y. (Boudewijn) Bisschop
Universiteit van Amsterdam, Graduate School of Social Sciences
Author Note
Master Thesis for the degree M.Sc. in Political Science: specialisation Political Economy Name: B.Y. (Boudewijn) Bisschop
Student number: 11683546
Supervisor: Dr. J.Y. (Julian) Gruin Second reader: Dr. L.A. (Lukas) Linsi
Research Project: China’s rise and the Global Economy: Capitalism and Power in the 21st Century (7324E205ZY)
Graduate School of Social Sciences (GSSS) University van Amsterdam (UvA)
Words: 20828
“Only when the tide goes out, do you discover who has
been swimming naked”. - Warren Buffet
Statement of Originality and Copyright
This document is written by Boudewijn Bisschop who declares to take full responsibility for the contents of this document. I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Social and Behavioural Sciences is responsible solely for the supervision of completion of the work, not for the contents.
The author has copyright of this thesis, but also acknowledges the intellectual copyright of contributions made by the thesis supervisor, which may include important research ideas and data. Author and thesis supervisor will have made clear agreements about issues such as confidentiality. All remaining errors remain my own.
Table of Contents
Statement of Originality and Copyright ... i
Table of Contents ... ii
List of Figures ... iii
List of Tables ... iii
Abstract... iv
Acknowledgments ... v
Abbreviations ... vi
Introduction ... 1
Literature review and the state of the art ... 6
Pre-GFC risk environment ... 7
Reconstructing the Chinese Capitalist system... 9
Shadow banking and the regulatory environment in China ... 13
Theoretical Framework ... 18
The Chinese Credit Cycle and Asset quality ... 19
Chinese Capitalism and the management of socio-economic uncertainty ... 23
Methodology... 26
Analysis ... 31
Constructing shadow money and the boundaries of the post-GFC risk environment ... 32
Prolongation of stable instability... 36
Socio-economic risk management: changing ‘structures of expectations’ ... 41
Outspoken awareness of financial risk ... 42
Regulatory reforms and the deceleration of shadow money growth ... 45
Party-State reforms and a network of confidence ... 50
Conclusion ... 57
References ... 63
Appendix A: Chinese Capitalist System: Formal Banking and Shadow Banking ... 83
List of Figures
Figure 1: Change in Credit-to-GDP ratio (in percentage point)... 2
Figure 2: Economic Planning in China (1949-1978) ... 8
Figure 3: WMPs: Two Forms of Informal Securitization in Money Markets ... 16
Figure 4: Minsky’s Credit Cycle and Financial Instability... 23
Figure 5: Debt Service Ratios and Debt in 2016: nonfinancial private sector ... 27
Figure 6: Interest Rates 2008-2018 ... 34
Figure 7: Money Supply in China, supervised and defined by the PBoC ... 35
Figure 8: Moody's: sensitivity of "debt at risk" ration to interest coverage ratio criteria ... 37
Figure 9: Network of guarantees of conglomerates heightens chain reaction of defaults ... 38
Figure 10: Sources of local government income ... 39
Figure 11: The Anatomy of an HNA Shadow Loan ... 40
Figure 12: Chinese bank claims on Non-Bank Financial Institutions, 2008-2017 ... 46
Figure 13: Credit-to-GDP gap has reduced over the last 6 quarters ... 47
Figure 14: Rising Chinese Bond Prices ... 48
Figure 15: Investors more attuned to LGFV risk ... 49
Figure 16: Institutional and regulatory reforms in (shadow) banking sector... 52
Figure 17: Central role of the CCP’s COD in the Financial System ... 56
Figure 18: Chinese Corporate Financing ... 60
Figure 19: Stylised Map of Linkages within China’s Financial System ... 84
Figure 20: Regulatory oversight in China ... 85
List of Tables
Table 1: Sovereign and Nonfinancial Private Sector Debt-to-GDP Ratios ... 1Table 2: Research Model ... 26
Table 3: Key people in China’s financial reform agenda... 54
Table 4: Comparison between formal banking and shadow banking ... 83
Table 5: Regulations on the shadow banking system ... 86
Table 6: The 2013 Third Plenum decisions on Financial Reforms ... 87
Table 7: The 2018 Thirteenth Five-Year Plan for the Financial System ... 88
Abstract
The Chinese economy has resisted the effects of the global financial crisis (GFC) due to the broad financial stimulus package. In turn, this stimulus package, financial repression, and sources of legitimacy for the Chinese Communist Party (CCP) enabled a large shadow banking sector in China to emerge. We learned from the GFC in the United States that shadow money was the source of the bank-run and the subsequent socio-economic instability. Moreover, shadow money and its credibility are rooted in interinstitutional and interrelational confidence as argued by Gabor and Vestergaard (2016). Therefore, shadow money plays an important role in the social order of any financial system. Now, China’s contemporary financial situation seems to parallel the United States at first glance, foreshadowing systemic financial risk.
This thesis, however, would like to argue that the Chinese capitalist system manages financial risk different. The top leadership in the Party, through the words of president Xi amongst other, identified reducing financial debt a matter of national security. Consequently, the Chinese Communist Party manages socio-economic stability at the intersection of the state and the market in line with Chen and Naughton (2017), and Gruin (2016). Through socially constructed mechanisms this thesis will show how the Party constructs, perpetuates and manages the post-GFC financial risk environment. Key drivers for stability and the decision-making process by financial elites are the financial de-risking campaign and the Party-State Reforms. With these measures, China tries to balance the Chinese Trilemma, while Xi Jinping, Liu He, and Guo Shuqing further centralise, institutionalise and rationalise the role of the Party. Ultimately, this thesis theorises that Chinese capitalism is not market-led nor state-market-led capitalism, but it has transformed under Xi to an centralised elitist Party-market-led capitalist system with roots in business networks of confidence.
Keywords: China, Chinese Capitalism, Financial Crisis, Social Order, Financial Risk Management, State-Party Reforms, Financial Elites, Chinese Communist Party
Acknowledgments
This thesis has been the result of an increasing interest in China and a personal development towards the field of the political economy of finance. Hereby, I would like to thank all people involved in this process and who helped me finish this master’s thesis. First and foremost, I would like to thank dr. Julian Gruin1 who has been a strong academic guide exploring the world of Chinese financial governance and the social order of Chinese capitalism throughout the course of my writing. dr. Gruin insisted on academic focus and a clear narrative steering away from incomplete questions, irrelevant subsections and inadequate argumentation. His conceptual analyses of the Chinese capitalist system have helped me to shape my increasing understanding of macro- and microlevel events in China. This has helped me to better understand the Post-Global Financial Crisis financial risk environment in China with its subsequent impact on the global economy and financial system.
Also, I would like to thank three inspiring teachers who all helped give direction to my academic development. First, I would like to thank dr. Naná de Graaff2 for her enthusiasm and compelling interest in International Political Economy, International Relations, and China. She has been a strong inspiration and acted as a mentor throughout my studies. Secondly, I would like to thank prof. dr. Ray Yep3 who, although he might be unaware of his influence, further developed my interest in economic and fiscal reforms in China whilst attending City University of Hong Kong. Lastly, in this category, I would like to thank dr. James Perry4, who helped me to focus on the role of financial regulation and provided a strong boost for me at the start of this academic year at the University of Amsterdam.
Another group of people I would like to thank are my family and friends who have supported me all these years throughout my academic and non-academic endeavours. Here, I would like to say thanks to my friends of ‘Dozijn’, especially Ewout Zwaaneveld for sharing his interest in (corporate) finance with me. Also, I would like to thank everyone at ‘Mutual Fund’ and my fellow board members of SAMUN for their understanding, knowledge, insights, and shared experiences. Lastly, I would extend a special thanks to my family, especially my parents Wil and Jan-Roel, who always supported me, allowed me to pursue my studies and whom I love dearly.
1 Julian Gruin ( ) is an Assistant Professor of Transnational Governance at the University of
Amsterdam and ESRC FRL Fellow at the University of Warwick, where he works on research project: 'Reshaping Global Capital: The Politics of Uncertainty in China's Financial Transnationalization'.
2 Nána de Graaff is Assistant Professor in International Relations at the department of Political Science
and programme director of the Graduate School of Social Sciences at the Vrije Universiteit Amsterdam.
3 Ray Kin-man Yep ( ) is a Professor and the Associate Head of the department of Public Policy
at City University of Hong Kong, Hong Kong S.A.R.
4 James Perry is a senior associate, strategy and economics at the London-based Financial Conduct
Abbreviations
(Chinese equivalents are given for existing institutions) ABC Agricultural Bank of China
ADBC Agricultural Development Bank of China AMC Asset Management Company
BComm Bank of Communications BOC Bank of China
CBIRC China Banking and Insurance Regulatory Commission CBRC China Banking Regulatory Commission
CCB China Construction Bank CCP Chinese Communist Party
CCPCC Chinese Communist Party Central Committee CCPCOD CCP’s Central Organisation Department CDB China Development Bank
CIC China Investment Corporation 》
CIRC China Insurance Regulatory Commission
CISF China Insurance Security Fund CLG Central Leading Group
CFEAC Central Financial and Economic Affairs Commission 。
CSRC China Securities Regulatory Commission
DRC Development Research Centre of the State Council FSDC Financial Stability and Development Committee GFC Global Financial Crisis
ICBC Industrial and Commercial Bank of China ICR Interest Coverage Ratio
IEB China Import-Export Bank (also: Chexim) LGFV Local Government Financing Vehicle 》
MoF Ministry of Finance of the PRC 。
NDRC National Development and Reform Commission NPC The National People’s Congress
NPL Non-preforming loan
PBoC The People’s Bank of China (Central Bank of China) PRC The People’s Republic of China
PSC Politburo Standing Committee RMB Renminbi (commonly known as yuan) SAFE State Administration of Foreign Exchange
SASAC State-Owned Assets Supervision and Administration Commission
》
SOB State-owned commercial bank SOE State-owned enterprise
VoC Varieties of Capitalism
Introduction
The year 2018 marks two important historical events in the financial governance of China, namely the 40-year anniversary of the Reform and Opening-Up Policy [ ] under Deng Xiaoping and the 10-year anniversary of the 2008 global financial crisis. The financial crisis is significant as it raised awareness about debt, the numbing effect of crises and shadow banking activities. In spite of the negative effects of excessive borrowing, the world continues to leveraging (up) (Taylor 2014, Dobbs, Lund et al. 2015). Arguably debt levels have been rising as a result of easy financing conditions after the financial crises (International Monetary Fund 2017). As shown in Table 1, China’s aggregate debt went from 6 trillion dollars to 28 trillion dollars between 2007 and 2016; and from 148 to roughly 260 per cent of GDP.
Table 1: Sovereign and Nonfinancial Private Sector Debt-to-GDP Ratios
Advanced Economies Emerging Market Economies
JAP CAN USA GBR AUS KOR DEU CHN BRA IND RUS ARG IDN
General 2006 184 70 64 41 10 29 66 25 66 77 10 70 36 Government 2016 239 92 107 89 41 38 68 44 78 70 16 54 28 Households 2016 2006 59 57 101 74 96 79 90 88 105 123 70 93 53 65 44 11 23 14 10 10 16 8 6 4 11 17 Nonfinancial 2006 100 76 65 79 73 83 49 105 39 38 32 20 14 Corporations 2016 92 102 72 73 79 100 46 165 44 45 52 12 23 Total 2006 343 221 225 210 187 183 180 142 118 125 49 93 61 2016 388 295 259 250 243 232 168 254 145 125 84 73 68
Source: International Monetary Fund (2017)
Clearly, credit in Chinese financial system expanded rapidly, consequently, China is above average leveraged as shown in Table 1 and Figure 1. Beck argues that “a rapid increase in credit has been associated with higher bank fragility and the likelihood that a country suffers a systemic banking crisis” (2014, p.303). Hence, a financial crisis seems to be looming over the (debt) hills behind the Chinese credit wall. Consequently, this thesis will explore how the Chinese capitalist system has been resilient to crisis thus far. By exploring the sociological mechanisms that construct and set the risk boundaries, this thesis will advance the fields of comparative capitalism and the political economy of finance. By exploring the origin and substantive nature of financial expectations it yields insights into how China avoids financial crises without ad hoc or state-market dichotomic explanations of comparative capitalism while focussing on shadow banking. The financial crisis showed that sociological factors deserve more attention in academia when exploring shadow money. Hence, this thesis will explore the frames, social institutions and networks that underpin the Chinese Trilemma of growth, reform and stability. Thus, the question driving this thesis is; how is the social order
Figure 1: Change in Credit-to-GDP ratio (in percentage point)
Data source: International Monetary Fund (2017)
The financial crisis of 2008 showed that a new framework is required to view socio-economic and financial stability. As the Chinese financial system has not (yet) collapsed, we need to assume that the Chinese financial system manages financial risk and socio-economic uncertainty differently compared to Western-style financial systems. The global financial crisis (GFC) showed that financial crises lead to various socio-economic phenomena such as “panics, deflation, flight-to-safety, liquidity traps, fiscal policies” (Taylor 2014, p.37). Most of these phenomena and the subsequent increasing calls for socio-economic and political regime change could be observed throughout Europe and the United States. For China, the socio-economic uncertainty due to a financial crisis will have significant effects on the social order of Chinese capitalism as Gruin argues: “the role of the financial system in this growth strategy is also rooted in the requirement that authority over financial capital remains closely tied to state institutions and policies, due to elite concern over politico-economic instability” (Gruin 2013). Thus, considering the implications of a financial crisis, this thesis theorises that the Chinese Communist Party (CCP) therefore tries to mitigate this risk. In consequence, this will help overseas investors, financial markets’ watchers and policymakers to better understand the socially constructed mechanisms that underpin the Chinese (shadow) financial system, China’s exceptionalism and its resilience against financial crises.
Secondly, this thesis will shed light on the management of uncertainty that is added through shadow banking activities. This thesis will show how financial repression constructed the Chinese shadow financial system and faded the duality of the formal and shadow banks. As a result of government stimulus to avoid the impact of the GFC, local governments, private enterprises and state-owned enterprises alike accumulated large amounts of shadow money.
Average of credit booms that led to financial crises
Average of credit booms that did not
lead to financial crises Canada China Australia South-Korea -10.00 0.00 10.00 20.00 30.00 40.00 50.00 60.00 70.00 80.00 0 1 2 3 4 5 6 7 8 9 10 11 Ch an ge in Cr ed it-to -GDP R at io (P er ce nta ge p oin ts )
This expansion of shadow money needs to be considered more carefully as it was “at the heart of the [U.S.] credit crisis” (Pozsar 2008, p.17). Following Gabor and Vestergaard’s logic (2016) in ‘Towards a theory of Shadow Money’, this thesis will observe shadow money as a social institution, arguing that shadow money is rooted in the interrelational confidence of
on-demand at par monetary exchange. In consequence, sociological mechanisms play an
important role in the boundaries of the risk environment. Moreover, capital in pursuit of economic growth is now challenged with the uncertainty created by shadow money.
Thirdly, the formal and shadow banking sector are increasingly interconnected due to mutual and cross guarantees. Again, following Gabor and Vestergaard, the shadow financial system is upheld by the confidence that the loans of (wholesale) creditors, both the principal and the interest, can be repaid. This again is similar to the pre-GFC U.S. financial architecture (Wilhelm 2018, Shin 2009). In 2008, confidence in the financial system was abruptly shattered when financial actors were confronted with uncertainty concerning imminent defaults, deteriorating asset quality and liquidity risks. This loss in confidence was due to maturity- and liquidity transformation, leveraged and financialised products and the default (bankruptcy) of a large (shadow) financial institution in the United States (Wilhelm 2018, Shin 2009). Therefore, shadow money adds another layer of complexity to preserve domestic socio-political stability and authority. Or as Ben Bernanke put it: “as in all past crises, at the root of the problem is a loss of confidence by investors and the public in the strength of key financial institutions and markets” (Bernanke in Earle 2009). Incorporating economic sociology, this thesis goes beyond traditional approaches such as Chen and Kang (2018) to identify how China’s credit boom is different. The notion of trust and confidence shows the importance to integrate economic sociology when doing comparative capitalism post-GFC. To answer the research question, I will follow the logic and framework of Gruin’s (2016) article ‘The social order of Chinese Capitalism’ to study financial risks and subsequent uncertainty through socially constructed mechanisms. Although Gruin uses interviews for his causal inference, this thesis uses process tracing through speech and policy analysis. As such, this thesis will start by providing an overview of the pre-GFC risk environment and financial system. By explaining the socialist legacy of the Chinese system, as well as implicit and explicit guarantees ‘longstanding structures of expectations’ can be better understood. Secondly, by critically reviewing existing literature on the political economy of finance in China the literature review will identify shortcomings in existing comparative capitalist approaches. Lastly, the literature review introduces concepts regarding shadow banking.
In the theoretical framework, this thesis will argue how Chinese capitalism deals with the social order of finance and the significant role of shadow money. By reflecting on the
global financial crisis, rapid credit expansion, and shadow money as a social institution as argued by Gabor and Vestergaard (2016) we can understand the effect on decision-making, trust and confidence by financial elites. Moreover, the theory will provide the theoretic understanding of the social order underpinned by the role of the Party. Here, Chen and Naughton (2017) argue that the financial resilience and inclusiveness underpin the legitimacy of the Party. Moreover, the Chinese debt expansion is also due to the co-evolution of the political and economic power as argued by Chen, Naughton (2017) and Gruin (2016). Here, credit expansion is part of the drivers of the CCP’s legitimacy rooted in performance and inclusiveness (Chen, Naughton 2017). Moreover, Gruin argues that “the CCP has faced the challenge of preserving domestic socio-political stability by harnessing capital in pursuit of economic growth, whilst managing the risk to its political authority posed by this capital embedded within domestic and global markets” (Gruin 2016, p.27). The uncertainty of credit expansion and the potential for financial crises, in consequence, allows the CCP to propagate and manage this risk environment. Similarly, the CCP retains its power due to “China’s economic success [that] derives from the co-evolution of the political and economic systems” (Chen, Naughton 2017, p.18). This provides an explanation for the contradictory policies that unceasingly balance the role of the ‘market’ and the ‘state’. As a result, this thesis opts to focus on socially constructed mechanisms to explain the role of the CCP in shaping the social order of Chinese capitalism. Next, the methodological considerations are presented, followed by an overview of the data. Here, speech and policy analysis yield insights into the decision-making process of financial elites. Also, this section shows how the Chinese financial system is a deviant case. Moreover, large conglomerates, like Anbang Insurance Group and HNA Group, are presented as cases that directly impact the ‘structures of expectations’.
In the analysis, this thesis will argue how financial elites are increasingly aware of the risks in the shadow money system. Speeches and quotes by the top Party leadership, the subsequent Party-State Reforms and reform agenda show how the financial risk is managed. Additionally, regulatory implementation and enforcement through a Party-centred network of confidence show how the ‘structures of expectations’ are reformed. To understand the severity of the situation and the need for financial reforms in China, the words of president Xi are repeated identifying reducing financial debt a matter of national security (Zhang, Woo 2018). Since, although in most sectors crises lead to the Schumpeterian idea of creative
destruction, in banking and finance, capital is eradicated since crises in this sector lead to
‘deflationary destruction’ (Barbera 2009, The Economist 2009). The Party is ultimately confronted with the trilemma of economic growth, financial reforms and socio-economic stability. This thesis will argue how the Party continues to play the central role in constructing
the risk boundaries. Moreover, the influence of the Party on the social order of Chinese capitalism is growing. This is the result of two factors; governance and power. Whereby
governance shapes the mechanisms that enable long-term financial stability, such as the
financial de-risking campaign and the 2018 Party-State reforms. Additionally, the notion of governance is supplemented with mechanisms of power that shape the distribution of economic growth. Gruin (2016) claimed that: “the institutional dynamics within this interpenetration of state and market in China remains sorely lacking” (2016, p.29). However, through the 2018 Party-State reforms and the subsequent socially constructed mechanisms, this thesis will further argue how the CCP and the financial elites further centralise, rationalise, and institutionalise their role at the intersection between market and state. Moreover, this thesis observes a decrease in the growth of shadow money and shadow banking products, such as wealth management products and local government financial vehicles due to regulatory innovation and enforcement since 2016. As a result of the co-evolution of the political and economic system and the CCP’s sources for legitimacy, it is unlikely that the Party will allow for a great disruption of socio-economic stability due to a financial crash. However, as the Party can merely shape the financial system of trust, expectations, and confidence, the true test will come as more systemic risks are exposed.
Lastly, the conclusion will reflect on the potential for systemic risk and the role of the CCP in the Chinese risk environment concerning the shadow banking sector after the start of the global financial crisis in 2008. Moreover, it will argue how China manages financial risks through an elitist Party-led system rooted in networked confidence. Furthermore, it will provide additional policy recommendations for sequential financial risk management. In sum, this thesis shows how sociological political economy backed by behavioural finance can explain how the Chinese financial system and the subsequent social order post-global financial crisis are shaped. The uncertainty of the financial system is utilised by the CCP and key Party members to further centralise, legalise, institutionalise and rationalise their role. Hence, the Party shapes the risk environment and the subsequent boundaries in which both allows for more market-forces supplemented by a state-led approach. Here, increasing market forces create more uncertainty, but more productive and higher quality growth. Contrastingly, preventing socio-economic instability requires a state-led approach reiterating stability as a source of CCP legitimacy. This dual-track approach to understanding how China manages financial risk restates the inability for dichotomous comparative capitalism approaches to explain the Chinese risk environment. Through the socially constructed mechanisms, this thesis will argue how the Chinese Communist Party constructs, manages and perpetuates its (contemporary) reliance on financial risks post-global financial crisis.
Literature review and the state of the art
The construction of the Chinese financial and banking system has been a gradual development since the Reform and Opening Up agenda was set out by Deng Xiaoping. The management of the financial system co-evolved into an interdependent relationship between
economic governance and political power (Gruin 2016, Chen, Naughton 2017). Chen and
Naughton (2017) argue that: “in order to maintain the continuity of CCP authority, the leaders of the government and Party seek legitimacy through performance and inclusiveness” (2017, p.17). The inability to manage systemic financial risk, therefore, poses a threat to the legitimacy of the CCP. However, simply acknowledging this risk does not provide any explanatory power on how the CCP and Chinese capitalism construct, propagate and
manage the implied risks in the (shadow) banking sector as put forward in the introduction.
Therefore, this section will start by reconstructing the debate regarding the risk environment in Chinese capitalism pre-GFC. Secondly, it will review Chinese capitalism by highlighting the limitations of other theoretical approaches in Comparative Capitalism. Thereafter, different views on risk, confidence, trust and risk management in shadow banking will provide the historic understanding of shadow banking. Lastly, the contemporary status of the regulators, as well as various concepts and financial products in shadow banking will be examined, such as the role of the People’s Bank of China (PBoC) and the China Banking and Insurance Regulatory Committee (CBIRC), as well as Wealth Management Products (WMPs), and Local Government Financing Vehicles (LGFVs). By combining the perspectives of political economy and finance-driven theory this thesis will show the elitist role of the CCP regarding the constant of social stability. Moreover, it allows for greater understanding of credit expansion, and systemic risk of shadow banking in China under the key leadership of the CCP within Chinese capitalism. All in all, these debates drive the need for a better understanding of social order shaping the (shadow) banking sector within the Chinese capitalist system. This is underpinned by the question: how is the Social Order of Chinese Capitalism constructed,
perpetuated and managed post-global financial crisis?
This question is supported by three sub-questions that help to (re)construct the post-GFC risk environment in China. With the first question, this thesis will identify the structural intendedness and agency factors that enabled the Chinese capitalist system to accumulate debt rapidly. Moreover, it helps to identify the significant role of credit expansion in the private sector as well as the fading of the duality in the (shadow) banking sector. Here, the drivers of credit expansion and the role of (shadow) banking will be identified. Furthermore, showing the more prominent role for shadow money and the risks due to liquidity, maturity, and credit transformation. Lastly, it will help acknowledge the role of the Party in setting the boundaries
of the risk environment. This can be regarded as closely linked to the factor of economic growth and the legitimacy of the CCP through growth targets and extra-legal factors in the law–finance–growth nexus as argued by Tsai (2015) and Allen, Qian and Qian (2005).
How is the post-GFC risk environment constructed?
The second question deals with if and how the CCP continues to keep the socialist, strongly state-led financial system intact. The intervening factors in risk and risk pricing can be identified as early (local) government financial intervention through bailouts and preventing default. Other features that prolong a financial bubble show how the CCP maintains stability in the (shadow) banking sector.
How does the CCP perpetuate existing ‘structures of expectations’?
The third and last question deals with the financial de-risking campaign and the Party-State reforms of 2018. As Xi prioritised reducing financial risk and debt deleveraging as a matter of national security, the CCP sets out to actively change the ‘structures of expectations’. However, too often investors believe that all investments are state-guaranteed which implicitly makes "moral hazard […] still ingrained" (Guo 2018)5. In consequence, the CCP works at the intersection of the state and the market to alter these ‘structures of expectations’ regarding implicit guarantees. Here, speeches and quotes show the awareness and willingness of financial elites to break the guaranteed bailouts regarding financial risk. Moreover, this is shown by improved risk pricing due to an increased market-based approach to risk, and raising and enforcing investor awareness through regulatory policy.
How do the risk boundaries change and impact existing ‘structures of expectations’?
All in all, different cognitive frames, social institutions, and relational networks will show how the CCP continues to rationalise, legalise and institutionalise its political and economic power. This is the result of relegitimization after the start of the 2008 global financial crisis and the continued co-evolution of power through performance and inclusiveness by the CCP. Consequently, by reconstructing the Chinese capitalist system this thesis will provide the structure in which the agency of the CCP can be better understood.
Pre-GFC risk environment
The political-economic transformation of the People’s Republic of China has been remarkable since the ‘Reform and Opening Up’ policy under Deng Xiaoping. The inward-looking and autarkic stance of the Chinese leadership shifted to towards a policy of state-led
export-driven economic growth. Since the leadership of Deng Xiaoping, the political-economic situation has transformed. In this section, an overview of relevant academic literature will provide the background for understanding China’s socialist legacy of state control, the economic transformation and the role of the Chinese political, legal and governance system and the challenges for the economic reforms.
Figure 2: Economic Planning in China (1949-1978)
Source: Chow (2015), Kornai (1992), Naughton (2007), Riskin (1987).
In 1978, the Chinese economic system had to recover and transform from the Maoist system, which was based on a “catch-up mentality”, to a modern economy. This was linked to a great anxiety for rapid growth and development. The main function of the Chinese economy under Mao was underpinned by state-ownership and a planning mechanism. In effect, state-owned also meant state-run as the government was responsible for the appointment of management, had control over resources and made all production decisions. This is also presented in the overview as exemplified by Figure 2 (Chow 2015, Kornai 1992, Naughton 2007, Riskin 1987). Moreover, in the socialist system, investments were mostly financed by interest-free budgetary grants and to a lesser extent, from the retained profit of enterprises (Naughton 2007, Tsai, Naughton 2015). In effect, a strong link between state-owned banks and state-owned enterprises started to emerge. Contrastingly, because of this link, private enterprises continue to struggle with the idea of guó jìn mín tuì [ ]. Where "the state advances, the private sector retreats" which shows the persistent difficulty of private enterprise to attract credit. As a result, in first attempt to give an overview of the political economy of China after the reforms in the 1990s, Allen, Qian and Qian in the article “Law,
Finance, and Economic Growth in China” (2005) argue that “neither its legal nor financial system is well developed, yet it has one of the fastest growing economies”. The authors argue that this mismatch in the law–finance–growth nexus is the driver of alternative financing channels. In consequence, the law-finance-growth nexus is the first indicator of shadow banking activity in China. Although the contemporary financial system has evolved since6, this mismatch remains the driver for shadow money which created a dual system for corporate financing.
The Opening-Up and Reform transition to a state-led export-driven economic growth model was further developed under Deng Xiaoping, Jiang Zemin, and Hu Jintao. Here, Deng remained strongly influential, ensuring economic growth and socio-economic stability through market-orientated reforms led by the Chinese government7. Moreover, the structures managing state-owned enterprises were transformed, creating SASAC by “grasping the large and letting the small go” (Yang, Jiang 2012, p.37). As a result, businesses were shut down, privatised or decentralised to a local government level (Naughton 2007, Yang, Jiang 2012). Still, due to the socialist legacy, the high growth targets set by local governments, and strong SOB-SOE links implicit guarantees perpetuated. In consequence, it was argued by policy-makers in Beijing that “moral hazard is state policy” (BJ:2012.11.29 in Gruin 2016, p.31). As a result, implicit guarantees were considered the norm and fuelled the market for shadow money (Bloomberg 2017b). All in all, the weak legal framework, the socialist legacy, implicit guarantees and a duality in credit accessibility shape the boundaries of socio-economic risk environment pre-GFC and set the expectations for financial elite decision-making.
Reconstructing the Chinese Capitalist system
Political economists try to explain the differences between political economic models, set-ups and institutions across countries. In this regard, political economists attempt to identify the institutional variations to explain countries’ performance. In comparative capitalism, the question is underlined with the question of market juxta-positioned against the state. By reconstructing the debate regarding Chinese capitalism this thesis will place emphasis on the development and role of the social order in Chinese capitalism. Moreover, this is stressed by the co-evolution of economics and politics in China. The most widely-used framework in the analysis of comparative capitalism was put forward by Hall and Soskice (2013) through the idea of ‘Varieties of Capitalism’ (VoC). However, other works on Chinese capitalism in a
6 Allen, Qian and Qian have since their first publication updated their analysis of the Chinese financial
system, for an overview of the contemporary financial system, see Allen, Qian et al. (2017, p.196).
7 Deng Xiaoping guided the reforms by the following principle: “whether a little more plan, or a little
more market; this is not the fundamental difference between socialism and capitalism. The plan and the market are both economic tools” (Deng in Gruin 2016, p.25).
broad comparative context include Politicised Capitalism by Nee and Opper (2007),
Sino-Capitalism by McNally (2012), and the Authoritarian Sino-Capitalism by Gerring and Witt (2013).
This section will discuss these different approaches to Chinese capitalism. However, due to the rationalised, institutionalised and centralised role of the CCP this thesis will take these approaches as partially explaining Chinese capitalism. Here, the role of Party as described by Chen and Naughton (2017) and Gruin (2016) allows for increased explanatory power. This is because it allows for a more accurate description of China-specific (micro- and macro-level) factors affecting the social order. In sum, this thesis will use different capitalist approaches to reconstruct Chinese capitalism whilst highlighting the insufficiencies that exclude the central role of the Chinese Communist Party.
In political economy, the most significant comparative model for Western capitalist systems is the VoC-approach by Hall and Soskice (2013). The VoC toolkit for comparative capitalism includes both policy analysis, state structure and interfirm strategies to assess a state’s capacity to meet various challenges. This approach allows for the analysis of a multi-actor system, where relevant multi-actors can be individuals, state-owned and/or private enterprises, business groups or government(s) (Hall, Soskice 2013). For the VoC approach, the main defining features have been formulated as follows: industrial relations, education and training, corporate finance, interfirm relations, and corporate governance (Tsai, Naughton 2015, p.14). Although China arguably behaves as a CME-country in the VoC approach, similarly to Germany or Japan, as it “acts along the lines of extensive, nonmarket contracting relationships […] with lower rates of unemployment, and incremental innovation” (Naughton, Tsai 2015). Other authors argue that for understanding Asian societies and their institutional structure, the classic dichotomy between CMEs and LMEs is insufficient (Amable 2003, Witt, Redding 2013). Largely, because the VoC approach is firm-centric, whereas the Chinese capitalism needs to be defined through a state-centric approach (Witt Redding 2013). Hence, Witt and Redding include employment relations, financial system, interfirm relations, internal structure, ownership and governance, social capital, and the role of the state (2013b)8. However, as Oi (2011, p.9) argues “the state attempts to intervene to either attenuate the problems or to pay the costs of the inefficiencies created by the lack of institutional complementarities” (Oi 2011). Accordingly, the political economy of China is different from any Western economic model. In this regard, state-led capitalism is seen as the basis for the social market economy that China is turning into with an emphasis on the role of the state. According to Xi Jinping, China mixes the invisible hand of the market and visible hand of the state. For example, traditionally, SOEs and SOBs have been vehicles of state policy delivery
institutions (Fan, Morck et al. 2012). Because of the importance and influence of the state within the Chinese capitalist system, Witt and Gerring refer to this part of the institutional structure as authoritarian capitalism (Witt, Redding 2013).
Consequently, other authors point to the politicised role of capitalism within China. Nee and Opper (2007, p.93) define politicised capitalism when “state actors set the regulatory framework and remain directly involved in guiding transactions at the firm level” (Nee, Opper 2007). Here, the party remains in control in terms of ownership, business environment, and regulatory oversight through the dual role of redistributive allocator and owner of productive assets. Nee and Opper further argue that this form of Chinese politicised capitalism can be classified as “ad hoc improvisations to address the needs and demands arising from rapid market-oriented economic growth” (Nee, Opper 2007, p.94). In consequence, the Chinese political-economic system is politicised through the influence of the Chinese state and state actors. Although the influence of the state plays a part in this method, the approach by Nee and Opper overlooks the networked effect in the Chinese capitalist system and disregards the specific influence of the Chinese Communist Party easily as ‘ad hoc improvisations’.
Hence, the next step in understanding the Chinese capitalist system is to bridge the networked society with the strong role of the state. Where the strong role of the state is due to the Leninist socialist heritage of the country. Moreover, McNally argues that the Chinese model of capitalism also works differently due to the nature of doing business;
“Sino-capitalism relies on informal business networks rather than on legal codes and transparent rules. It also assigns the Chinese state a leading role in fostering and guiding capitalist accumulation. China, ultimately, is a large developing economy with a distinct socialist and imperial legacy” (McNally 2012, p.744).
The business networks McNally refers to are described by Witt and Gerring as interfirm relations influenced by the role of the state. Moreover, these business networks are now (semi-)institutionalised where on a local level, layers of regulatory oversight are built on top of each other (Tsai, Naughton 2015, Tsai 2015, Witt, Redding 2013). Another aspect with regards to the business network and social, political and economic ties is as Witt and Redding (2013) argue the concept of guānxì9. This was first exemplified by a survey in Guangdong in 1999. Here, almost twenty years ago, in a survey in China's private enterprise development report No.4, 40,9% of private entrepreneurs already reasoned that joining the
9 Guānxì [ ]: the Chinese idea and way of networking, a network that is rooted in an individual
interpersonal relationship. It mixes the Western distinction between private and work-related relationship and this can extend to include family, political and business ties (Witt, Gerring. 2013a).
CCP would be ‘useful for business’ (Liang, Ming et al. 2002). The last feature of the socialist legacy of the leading Chinese state is reflected in business link with private entrepreneurship (Milhaupt, Zheng 2015). Milhaupt and Zheng (2015) argue that the state exerts extra-legal control over private governance. Party officials retain informal control over private enterprises through the establishment of industrial associations, interviews, and the “practice of prodding into” or “enforcing state-led industry-restructuring efforts” (Milhaupt, Zheng 2015, pp. 685-688). All in all, the relational, political and corporate business networks are extra-legally linked to the Party through guānxì, industrial associations, interviews, and the practice of prodding.
Consequently, De Graaff at the Vrije Universiteit Amsterdam maps out the elite networks of Chinese conglomerates, financial institutions, amongst others, to show the importance of political connections in Chinese business networks (De Graaff, forthcoming)10. As a result, de Graaff highlights the importance of political connections and CCP factions in a network analysis to provide another layer of explanatory power for political, corporate and business networks on a micro-level, inferring from earlier work on corporate elites (Van Apeldoorn, De Graaff et al. 2012, De Graaff, Van Apeldoorn 2017). All in all, the business network approach by Witt and Gerring makes a compelling argument for the institutional values and drivers of Chinese Capitalism. Still, it fails to explain how crises are managed and how the Chinese capitalist system deals with socio-economic uncertainty beyond the business network. Here, the influence of guānxì in business relations should not be underrated, leaving space for a sociologic approach in financial risk management where networked entrepreneurs and businessmen sometimes have privileged relationships with governmental and regulatory officials that build confidence and trust. Moreover, the central role of the CCP and the key reasons for joining the CCP first indicated the strong influence of the CCP in the business network for networked confidence.
In the reconstruction of Chinese Capitalism, the system is arguably understood through a networked society with a central role of the government, but more strongly the CCP. The social order of Chinese Capitalism and the sociological effect of risk management in China should, therefore, be understood through the central role of the CCP. Managing
10 The author of this thesis was working as a teaching and research assistant at the time of writing at
the Vrije Universiteit Amsterdam, the department of Political Science, under the guidance of dr. Naná de Graaff. In the capacity of research assistant, the author was loosely involved in a project on Chinese elites, headed by dr. De Graaff (Mapping Elite Networks and Governance in the 21st Century: MENG
21). Hence, the author would like to thank dr. De Graaff and others for the various insights and discussions on the role of politically connected elites in (Chinese) business networks. The outcome of this research group, the network analysis and De Graaff’s publication on Chinese elites are forthcoming (in collaboration with dr. Bastiaan van Apeldoorn and Friso Stevens LLM). The research group nor dr. De Graaff are responsible for the content or conclusion of this thesis.
financial risk and socio-economic uncertainty moreover goes beyond the VoC dichotomy of state versus market. As Fligstein and Zhang (2011) argue:
“Market activity has certainly increased across the Chinese economy, but the enormous continuing presence of the Chinese government in every market as regulator, financier, developmental state, and owner of the means of production suggests that, while the government’s role in the economy has been dramatically altered in the past 30 years, it remains enormously influential” (Fligstein, Zhang 2011).
As a result, Chinese capitalism is best understood through the interrelationship of a strong government and a market economy (Chen, Naughton 2017). Thus, by approaching the shadow banking sector and the subsequent questions of financial risk, economic growth and political-economic governance through the clear significant role of the CCP help establish the framework for China’s risk management assessment otherwise reduced to the mutually exclusive notion of CME or LME country. This helps to understand what the theoretical drivers for the construction of Chinese capitalism are by focusing on the substantive nature of the generation of financial expectations managed by the CCP. However, there is a dual role for the CCP since it both manages and propagates socio-economic uncertainty as a means of exerting control over the economy. Here, governance strategy of the Chinese Communist Party and the Chinese government regarding economic and political systems co-evolved, but within the boundaries established by the Party itself according to Chen and Naughton (2017). Empirical results presented in this thesis will consequently disagree with the claim by Gruin (2016) that: “the institutional dynamics within this interpenetration of state and market in China remains sorely lacking” (2016, p.29). All in all, the theoretical understanding of the CCP’s role in the financial system will further be theorised and operationalised in the theoretical framework through the works of Pistor (2012), Fligstein and Zhang (2011), Chen and Naughton (2017) and Gruin (2016).
Shadow banking and the regulatory environment in China
While the social order of Chinese capitalism is arguably constructed through the sole ability of the CCP to manage and propagate socio-economic uncertainty. Understanding the source, depth, and spread of this uncertainty will add another layer of understanding how the CCP plays a central role in Chinese capitalist system. To better understand the post-GFC the risk environment, institutional dynamics and a possible financial crisis in China, this thesis will explore political economic and sociologic structures. Trust, confidence and uncertainty management explain the resilience and weaknesses of the Chinese financial system. Here, Sheng and Ng (2016) point to the “nexus between shadow banking, the formal banking
system and inter-enterprise networks” that reveal an important level of risk and interconnectivity that reiterates the highly networked capitalist system. Or put differently, a “key characteristic of China’s shadow banking is that the shadow banking sectors are more or less financed by the banking sector” (Sheng, Ng 2015). This part will, therefore, provide a critical overview of the literature regarding shadow banking. As the outcome of the Global Financial Crisis has exposed, financial crises are hard to predict and hard to measure. In consequence, proof for the management of socio-economic uncertainty will come from examining cognitive frames, social institutions and CCP relational networks against the structural factors that shape the financial risk environment, such as high domestic savings, and a low loan-to-deposit ratio (Chen, Kang 2018). Where, (shadow) money as a social institution plays a significant role in constructing the post-GFC risk environment.
The financial risk affecting the social order of the Chinese Capitalist system will be assessed by examining financial regulation, stimulus packages, (implicit or explicit) guarantees from the central government and the subsequent ‘structures of expectations’ centred around the role of the Chinese Communist Party. This is underpinned by the idea of a ‘Minsky Moment’, a sudden economic and financial collapse. The Minskian theory is an approach that was left out of frame before the GFC but gained academic attention and shows the financial risk of rapid credit expansion, especially in opaque segments of a financial system, such as shadow banking. Beck (2014) argues “a rapid increase in credit has been associated with higher bank fragility and the likelihood that a country suffers a systemic banking crisis” (p.303). Moreover, shadow money is an interrelational social institution that is rooted in mutual trust and confidence. All in all, this section will provide the background for understanding crises and the consequences in the form of socio-economic uncertainty. First, a discussion on the definition of shadow banking is presented. Thereafter, the largest sources for financial instability, the LGFV and WMP are introduced. The LGFV is widely used throughout all Chinese provinces is considered a macroeconomic risk factor. Contrastingly, WMPs have a nation-wide micro-level impact. By defining the informal securitisation in the money market and the presenting the WMP design, the micro-level impact can be better understood. Lastly, the regulatory framework on financial oversight is presented to understand the central role of the Chinese government and the Party in financial supervision. There is a broad extent of academic and non-academic literature that elaborates on the expansion of shadow banking, LGFVs, WMPs, and credit expansion. Moreover, there is a variety of interpretation regarding what qualifies as shadow banking in different financial systems. The term was first introduced by McCulley in 2007 arguing that the “shadow banking system’ refers to “the whole alphabet soup of levered up non-bank investment
conduits, vehicles and structures, […] unregulated shadow banks [that] fund themselves with uninsured commercial paper which may or may not be backstopped by liquidity lines from real banks”, therefore contrasting “regulated real banks, who fund themselves with insured deposits, backstopped by access to the [lender of last resort]” (McCulley 2007). Thereafter, the Financial Stability Board (2013) defines shadow banking as “credit intermediation involving entities and activities outside the regular banking system or non-bank credit intermediation in short” (FSB 2013). Other definitions include Pozsar et al (2013): “financial intermediaries that conduct maturity, credit, and liquidity transformation without explicit access to central bank liquidity or public-sector credit guarantee.” Moreover, Poszar (2014) argues that (shadow) “money begins where the deposits created by banks (M2) ends”, where (shadow) money trades at par on demand (Poszar in Gabor, Vestergaard 2016, p.2). This notion of exchange is crucial for understanding shadow money in the money market as a social institution. And lastly Kodres (2013) provides four key aspects of intermediation in shadow banking activities:
1) “maturity transformation: obtaining short-term funds to invest in longer-term assets. 2) liquidity transformation: using cash-like liabilities to buy assets such as loans.
3) leverage: employing techniques such as borrowing money to buy fixed assets to magnify the potential gains (or losses) on an investment.
4) credit risk transfer: taking the risk of a borrower’s default and transferring it from the originator of the loan to another party” (Kodres 2013, p.42).
For this thesis, the definition merges the four key aspects of risk awareness from Kodres and Pozsar with the institutional background from the FSB. Further reiterating shadow money as a social institution, to define shadow banking in China as:
“credit intermediation involving entities and activities outside the regular banking system or non-bank credit intermediation that conduct maturity, credit, and liquidity transformation without explicit access to central bank liquidity or public-sector credit guarantee, moreover outside of the broad money measure (M2)” (FSB 2013, Pozsar et al. 2013, Poszar 2014).
Hereby including the role of the Chinese government with regards to the function of a public backstop. Moreover, highlighting the explicit notion of maturity, credit, and liquidity transformation and guarantees. This makes shadow banking inherently different from regular or traditional banking, this is elaborated upon in Appendix A: Table 4.
Additionally, the two sources of shadow banking credit expansion need to be defined, namely LGFVs and WMPs. These products have had a significant impact on the credit
expansion in China and the rise in non-financial private sector debt. Here, Clark and Lu define
local government financing vehicles as “companies capitalised and owned by local
government and established for the purpose of raising funds for municipal infrastructure construction” created as a “response to the severe constraints on indebtedness by local governments” (Clarke, Lu 2017, p.751)11. By this definition, LGFV engages in a maturity and liquidity transformation by investing in municipal infrastructure. This option of infrastructure investment gained momentum through the before mentioned housing market developments with rapidly increasing prices. Also, Perry and Weltewitz (2015) define WMPs in China as “wealth management products […] are investments that offer fixed rates of return well above regulated interest rates for deposits and are often used to fund investments in sectors where bank credit is restricted”.
Figure 3: WMPs: Two Forms of Informal Securitization in Money Markets
Source: Liao, Sun et al. (2016, p.17) and Wei (2016, p.120)
This notes the market demand for credit expansion where the private sector is willing to seek alternative sources of credit when SOB (bank) credit is limited. Figure 3 shows how investors
11 Clarke and Lu (2017) remark that exact figures or estimations of “local government debt […] often
and bank capital both make use of informal securitisation in the money market to seek high yielding products. It also shows the complexity and interconnectedness of the Chinese financial system after informal securitisation has taken place12.
Lastly, the regulatory environment in which the CCP operates helps to understand how the agency of the CCP shapes the socio-economic risk environment. This thesis will attempt to provide a similar, but updated overview of the position of regulation, finance, and the economy as Allen, Qian and Qian (2005) laid out with regards to the contemporary financial system. However, three important changes have taken place. Namely, firstly the global financial crisis, secondly the economic reform agenda after the Third Plenum in 2013 (C. Huang 2013) and the Supply-Side Structural Reforms, and thirdly the identification of financial risk as a matter of national security against the continuous expansion of the Chinese economy. Before the GFC the regulatory environment in China was clearly separated, with limited responsibility for the various regulatory bodies, here the PBoC was responsible for monetary policy, the CBRC for the banks, the CSRC for securities, the CIRC for insurance and the MoF for government bonds and fiscal policy13. Moreover, the duality of banking and shadow banking has faded over time and the financial and banking sector has become increasingly complex which will be elaborated upon in the analysis. When assessing the role of debt with potential government guarantees within the financial system two factors remain crucial, namely moral hazard and non-preforming loans.
In sum, this thesis will attempt to project the social order of Chinese capitalism as a result of socio-economic uncertainty management by the CCP. Here, case studies closely involved with the practice of shadow banking as well as macro-level factors such as the regulatory developments provide insights into how the risk environment is constructed, perpetuated and managed. The different micro-level cases in this thesis are Chinese conglomerates who all have different effects on the shadow banking system. Through the case studies of corporations directly involved in shadow banking, this thesis will exemplify the complexity of the Chinese shadow banking system and the explicit role of the CCP in the Chinese capitalist system. As a result, this thesis aims to better understand the credit risks and socio-economic instability management in a deviant capitalist system.
12 Risks and interconnectedness of shadow banking are shown in Appendix A: Figure 19
13 For an overview of regulatory oversight on financial instruments and shared responsibilities in China
Theoretical Framework
To understand the role of the political economy within the financial system of China the theoretical framework will create the frame through which this thesis will explain the Chinese credit expansion in non-financial corporations after the global financial crisis. As argued, the dichotomous distinction through the Varieties of Capitalism approach is unfitting for Chinese capitalism, because it does not pay enough attention to the networked effect as brought forward in Sino-Capitalism mixed with the state-led approach of authoritarian capitalism (McNally 2012, Witt, Gerring 2013a, 2013b). Therefore, to explain the resulting social order the central role of the CCP is argued to play an important part at the intersection of the market and the state. At this intersection, the Party constructs, perpetuates, and manages the risk boundaries and the ‘structures of expectations’ for investors, government, bankers and the broad financial elites. Moreover, by exploring how the Chinese capitalist system and its subsequent social order are different from Western or advanced economies’ systems this thesis tries to provide a better understanding of the deviant case of China’s financial system. Here, the theoretical framework will provide the framework for understanding the resilience of China’s exceptionalism to manage financial risk.
As neoclassical economics proved insufficient to explain and predict the financial crisis of 2008, there have been increasing calls to rethink economics. Consequently, heterodox political economy, including behavioural finance and sociological factors should be explored. Especially in the case of the Chinese (shadow) financial system and the strong link to social order, neoclassical (macro)economic thinking proves to be inadequate. Hence, exploring the social institutions and subsequent ‘structures of expectations’ support (shadow) money as rooted in interpersonal and interinstitutional trust and confidence. To answer these questions on the role of the state and of the market, firstly credit, moral hazard and the credit cycle (Minskian cycle) need to be theorised. Especially, after the global financial crisis of 2008 Minsky-Kindleberger theory on the credit cycle gained important influence on financial regulation and debt deleveraging theory14 (Minsky 1982, Rosser, Rosser et al. 2012). Moreover, the inherent risks of debt build-up constructed a new risk environment. Here, this thesis follows the heterodox logic in the line with Minsky and Keynes amongst others. Through the theoretical backing by behavioural finance theory, this thesis sets out to assess the impact of the shadow money. Secondly, the agency of the Chinese Communist Party is co-evolved through political and economic power. Due to their centralised and rationalised
14 For extensive literature on financial crises, debt, deleveraging and the liquidity trap, see Eggertsson,
Krugman (2012), Rosser, Rosser et al. (2012), Borio (2014), Jordà, Schularick et al. (2011), Schularick, Taylor (2012), Kindleberger (1989), and Aliber, Kindleberger (2015).
role of the CCP, the Party is able to construct, perpetuate, and manage these decision-making processes. Moreover, the ‘structures of expectations’ shape the decision-decision-making processes of Chinese financial elites. Therefore, this section will theorise that the CCP has constructed Chinese capitalism as an Authoritarian and Sino-Capitalist system with monetary constraints to (re-)legitimise its central role. All in all, since the Chinese Communist Party is interconnected with SOEs, SMEs, SOBs, LGFVs or WMPs, at what point will the Party let institutions default or are they ‘too big to fail’? In order words, when will the CCP accept defaults given the risk of socio-economic uncertainty that these institutions pose. This section will provide the theoretical understanding for the Chinese Trilemma as the management of socio-economic uncertainty.
The Chinese Credit Cycle and Asset quality
The financial crisis of 2008, the subsequent stimulus response of the Chinese government, the increasing shadow banking activities and interconnectivity, have reshaped the risk environment in China (Andreosso-O’Callaghan, Gottwald 2013). This section will explore the theoretical assumptions of the credit cycle, the quality of assets, efficient resource allocation, and debt deleveraging to understand the new risk environment that has emerged in China after the GFC. Using this structural embeddedness will provide the ability to better understand the consequential social agency and the role of the CCP in Chinese capitalism.
It is important to note that Chinese banks largely continue to act as economic and monetary policy instruments of the Chinese government. As a result, they also act less risk-averse due to the ‘too big to fail’ principle and practice (Jenkins in Wei 2016, p. 48). This is because implicit guarantees perpetuate in the Chinese financial system as a result of the “soft budgetary constraint syndrome” (Kornai 1979, Kornai, Maskin et al. 2003). Although various laws and regulations have tried to mitigate this over time, such as the 1995 Budget Law, soft-budgetary constraints are enjoyed by both SOEs and local governments in support of local projects (Xiong, Song 2018). Lastly, Allen et al. (2017) also mention in a draft paper that the implicit guarantees also apply to the case of the shadow banking sector by examining stock market reactions which are further underpinned by the notion of a public backstop (Allen, Gu et al. 2017, Kane 2014). Where Matthews (2013) argues that high NPL ratios are also due to the link with SOEs and strong government linkages (Matthews 2013). As result of moral hazard and NPLs, Zhang, Cai et al. (2016, p.58) conclude that “inappropriate credit expansion may result in further deterioration of asset quality and cause further financial difficulties for banks” (Zhang, Cai, et al. 2016). Moreover, Cull, Li, Sun and Xi (2015) argue that government connections play an important role in explaining Chinese firms' financing conditions, exemplified by a network analysis between SOBs and CEO appointment. In this
regard, they determine that “government connections are associated with substantially less severe financial constraints” (Cull, Li et al. 2015). Furthermore, Chan, Dang, and Yan (2012) further argue that financial constraints and the barriers to credit are higher for non-connected family-controlled firms compared to non-connected state-owned firms (Chan, Dang et al 2012). These research papers empirically show the importance of the political connections and the difference between private and state-owned enterprises. Similarly, the central bank has no obvious incentive to tighten the growth of credit (Mitchener, Eichengreen 2004)15. Additionally, Jensen and Meckling (1976) suggest that bank managers may have several motivations to pursue more risky lending due to risk-shifting towards depositors (Jensen, Meckling 1976). In the case of China, various studies have been conducted with regards to the housing price inflation in China. Zhi, Li et al. argue that “conventional purchase and credit restrictions haven’t had the desired effect in curbing excessive increase of housing prices” in Tier 1 cities (Zhi, Li et al. 2018)16. All in all, these various factors encourage risk-seeking behaviour consequently before trust and confidence fade there is a strong upward trend in credit expansion. Accordingly, Hanson, Kashyap, et al. argue that financial stability in China needs to move in a macro-prudential direction (Hanson, Kashyap et al. 2011).
Increasingly risky behaviour is explained in behavioural economics by the so-called ‘hot hand fallacy’. This theorem argues that increasing risk-taking further blows up the credit cycle in the first two phases of the credit cycle. Gilovich, Valone and Tversky (1985), in a basketball analogy, argue that people, in this case, investors, wrongfully assume that the markets will continue to grow as they did in previous months, quarters, or years. Here, countercyclical variables, such as growth retraction, revulsion, and deterioration of asset quality, are easily disregarded due to the strong effects of mood upon risk-taking (Isen, Means, et al. 1982). And as credit grows and the behaviour of the state and market are procyclical, people will continue to linger on the effects of prior outcomes. As a result, markets will inflate, credit bubbles are enabled leading to a liquidity-fuelled asset bubble (Isen, Means et al. 1982, Gilovich, Vallone et al. 1985, Thaler, Johnson 1990, Stöckl, Huber et al. 2015). Lastly, given the theoretical potential of bubble inflation Zwiebel argues that "one can portray the financial crisis as being triggered by a bunch of mistakes, or one can portray
15 For an elaborate discussion on the interdependence between credit cycle and financial instability,
see Bordo and Meissner (2016), Brunnermeier and Schnabel (2016), Jordà, Schularick et al. (2013), Mitchener and Eichengreen (2004), Schularick and Taylor (2012), or Taylor (2015).
16 The housing bubble is an example of the upward effects in a credit boom for China over the period
2008-2017. This thesis will not explore the role of the housing bubble, since it has not the space to do so, moreover extensive research has already been done by Zhi, Li et al. (2018), Barth, Lea et al. (2012), Brei and Schclarek (2015) Glaeser, Gyourko et al. (2005) Jianglin (2010), Liang, Gao et al. (2006), Xu and Chen (2012) or G. Zhang and Fung (2006) on the policy and financial crisis implications.
