China's Unfinished Economic Revolution

China's Unfinished Economic Revolution

China's Unfinished Economic Revolution

China's Unfinished Economic Revolution

Synopsis

China's Unfinished Economic Revolution offers a fundamentally different interpretation of China's economic reform. The common view that China's gradualistic approach has served it well overlooks the fact that state-owned banks for the last two decades have channeled a large share of sharply rising household savings into what are mostly unreformed, money-losing companies. The result is that several of China's largest financial institutions now are insolvent. To avoid a major domestic banking crisis the book argues that China must recapitalize and restructure its domestic banking system and end the long-standing practice of making lending decisions based on political rather than economic criteria. Nicholas Lardy explains that this course will inevitably be costly in political terms, in part because it will lead for a time to a slower rate of economic growth. But the alternative is even less attractive -- permanently slower growth, continued macroeconomic instability, an inability to meet the expectations of the international community for the opening of its domestic financial markets, and insufficient resources to deal with severe environmental deterioration, growing water shortages, and a rapidly aging population. This timely book also analyzes the new reform initiatives China has launched in the wake of the Asian financial crisis, suggests additional steps that must be taken, and evaluates the implications for U.S. policy.

Excerpt

Nicholas R. Lardy, in assessing China's economic transition, argues that reform has done little to improve the allocation and use of China's capital. For the past two decades state-owned banks have channeled a large share of sharply rising household savings into unreformed, money-losing enterprises, resulting in a dramatic rise in the debt of enterprises to banks. Chinese enterprises now have debt- to-equity ratios that are among the highest in the world. At the same time, banks have accrued enormous liabilities to households, which have entrusted them with nearly all their financial savings. Because most of the banks' borrowers are no longer paying interest on their loans, several of China's largest financial institutions are insolvent. To avoid a domestic banking crisis, Lardy says that China must recapitalize and restructure its domestic banking system and end the longstanding practice of making lending decisions on political rather than economic criteria.

China's financial system shares certain characteristics with the Asian countries engulfed in the financial crisis of 1997, including an overly rapid expansion of credit, a bank-dominated financial system, weak central bank regulation and supervision of commercial banks, and a massive buildup of nonperforming loans. China's Unfinished Economic Revolution analyzes the factors that so far have allowed China to escape the region's financial calamity, including the absence of capital account convertibility of the Chinese currency.

Lardy cautions, however, that China's respite from the Asian financial crisis is temporary. Unless reforms can reverse the buildup of nonperforming loans to state-owned enterprises, the drain of poor . . .

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