Organizer: Kaja Sehrt, Dartmouth College
Chair: Jean Chun Oi, Stanford University
Discussant: Albert Park, University of Michigan
China’s rapid economic growth over the past decade has been fueled by the development of local enterprises with diverse ownership forms. Urban collective enterprises, township and village enterprises (TVEs), and private entrepreneurs constitute the most dynamic sector of the economy, however, during the reform period these enterprises frequently have been denied access to loans from China’s financial institutions. Instead, state-owned enterprises continue to receive the bulk of loans from state banks despite dramatic reductions in their national share of industrial output and, more recently, employment.
This tension in the allocation of resources raises the question of whether the development of local enterprises is constrained by lack of access to credit or whether these enterprises have found alternative means to finance their operations. If the former, will ongoing financial reforms correct the problem? If the latter, what mechanisms facilitate the flow of scarce financial resources to the non-state sector? In this context, what is the role of local governments, who have strong incentives to promote economic development in their jurisdictions (Oi’s "local state corporatism") but also are responsible to higher level governments?
Despite the importance of these questions for the continued success of China’s economic reforms, there is limited empirical evidence on how local enterprise development is financed. This panel features four presentations that address these issues on the basis of extensive field research in China between 1996 and 1998. Kaja Sehrt examines financing of small and medium urban enterprises by urban credit cooperatives. Minggao Shen discusses the changing relationship between rural financial institutions and TVEs, and Carsten Holz reviews patterns of TVE fixed asset investment. Kellee Tsai looks at the ways in which private entrepreneurs finance their operations. The analyses reveal continued tensions between political and regulatory concerns on the one hand, and economic needs driven by market demand on the other.
The Political Logic of Urban Cooperative Finance
Kaja Sehrt, Dartmouth College
While in other sectors of the Chinese economy the introduction of competition by non-state enterprises has helped to improve incentive structures and performance of state-owned companies, in the financial sector the diversification of financial institutions has proceeded at a much slower pace. I argue that this is in part because the design and evolution of a financial system is contingent upon political decisions that are not market-determined. In the PRC, the allocation of bank funds is a contested issue between different levels of government, and these tensions are played out in the formulation and implementation of policies towards new financial intermediaries.
This paper analyzes this process by reviewing licensing policies towards urban credit cooperatives (UCCs), new and dynamic financial intermediaries established in the early 1980s that have grown rapidly since and now have substantial market shares in many of China’s largest cities. UCCs were established with a mandate to serve the credit needs of small- and medium-sized urban enterprises previously excluded by the formal banking system. Their rapid expansion raised a number of regulatory and political concerns that resulted in repeated attempts to consolidate this sector and subsequently in their incorporation into urban cooperative banks. The role played by central and municipal governments in this process provides insights into the political logic behind the evolution of China’s financial system, as central preferences for inflation control and stability of the financial system are asserted against local interests.
Reform, Competition, and TVE Financing by China’s Rural Financial Institutions
Minggao Shen, Stanford University
This presentation examines the changing relationship between rural financial institutions (RFIs) and township and village enterprises (TVEs) in an environment in which RFIs face growing competition and pressure to reduce financial losses and many TVEs are being transformed (zhuanzhi) into limited liability companies (youxian gongsi) with clearly defined ownership shares and partial privatization.
Based on a 1998 survey in Zhejiang and Jiangsu of nearly 200 branches of the Agricultural Bank of China, rural credit cooperatives, and rural credit foundations, as well as local enterprises in the same townships, this study assesses whether enterprise and financial reforms are resulting in a greater commercial orientation of bank lending decisions. More specifically, how has bank behavior changed (e.g., screening, approval requirements, loan conditions, monitoring, enforcement of loan repayment), what are the main reasons for these behavioral changes, and what are the implications of such changes for the ability of different types of local enterprises to finance their development?
We expect increased competition and commercialization to lead to better lending decisions and such changes to be complementary to privatization reforms, since the ability of local political leaders to influence bank lending decisions should diminish. But banks in China remain highly regulated and enterprise reforms may alter the perceived credit-worthiness of transformed firms—positively because of improved managerial incentives accompanying clarified property rights or negatively because of reduced collateralization and risk diversification implicit in close ties with local governments.
Financing and the Growth of Township and Village Enterprises in China
Carsten Holz, Hong Kong University of Science and Technology
Previous research has linked the rapid growth of township and village enterprises in China to a number of factors such as their access to cheap labor, low tax rates, their collective or private ownership form, and imperfect asset markets. This paper, in contrast, suggests that financial intermediation plays a crucial role in determining investment in fixed assets and thus the accumulation of capital which drives output expansion and implements technological progress.
Provincial-level data shows that investment in fixed assets by township and village enterprises depends primarily on the availability of funds. Profitability criteria as well as the demand for an enterprises’ products do not matter. Since the volume of long-term bank loans to township and village enterprises has stagnated in recent years, enterprises constrained in their access to long-term bank loans have substituted with both expensive other external borrowing as well as working capital.
If township and village enterprises invest independent of the demand for their products and independent of their profitability, their investment behavior appears little different from that of state-owned enterprises. This raises questions about the allocative efficiency of investment in the township and village enterprise sector and about its future growth prospects, as well as about the impact of such solely finance-determined investment on the soundness of financial intermediation.
Private Entrepreneurs and Informal Finance in China
Kellee S. Tsai, Harvard University
Private businesses in China have increased dramatically in number and scale since the initiation of economic reform in the late 1970s; yet the private sector is all but excluded from the official banking system. As such, it was not surprising to find in the course of fieldwork that microentrepreneurs (getihu) rely on a wide range of non-governmental financing mechanisms and institutions. More puzzling, though, is the fact that many non-bank financial institutions have managed to evade the regulatory efforts of China’s central bank. The proposed paper analyzes the varied forms of financial intermediation employed by microentrepreneurs in post-Mao China, with a focus on the interaction between financial entrepreneurs and local state bureaucrats.
The paper argues that the financial institutional environment in any given locality stems from a process of mutual monitoring between profit-seeking economic actors and rent-seeking regulators. Private entrepreneurs have to work around political and regulatory constraints in devising financing mechanisms and in so doing, they may turn to the informal financial sector. At the same time, local state officials face political incentives for carrying out their regulatory mandates, as well as economic incentives for collaborating with private entrepreneurs who may attempt to evade certain regulations. The tension among these cross-cutting dynamics is illustrated through detailed analyses of specific financial institutions at the local level.