286o12 (:10.1001 RESEARCH ARTICLE Growth,Institutions,and Entrepreneurial Finance in China:A Survey Carlo milana Birkbeck College,University of London,UK Harry X.Wu Institute of Economic Research,Hitotsubashi University,Japan China's economy is at a Rptoopgwgoe ve gr in China and for a rebalanced global economy. han three decades,during which the sta ate has played an Some people regard private ente rprise s a predatory tiger to be shot.Others o important role.A crucial on it as a cow they can milk.Not enough people see it as a bealthy horse. question is what reforms and pulling a sturd内agon. strategic changes in economi -Winston Churchill and social policy can make When prosperity comes,do not use all of it. China quickly and successfully shift to intensive growth -Confucius through innovation. The truth is rarely pure and never simple.Modern life would be very tedious if it were either,and modern literature a complete impossibility! Free enterprises and entrepreneuship are essentia -Oscar Wilde for a sustained ec Introduction where the culture The editorial in the previous issue of this Journal,dedicated to the themeMea innovative private firms needs sures and Instruments to Sustain Entrepreneurial Performance,'stressed how to be fostered and national economic systems have changed over time and vary so widely across the encouraged through a healthy world.Their differences account for uneven geographic distributions of wealth development of efficacious income,and production activities.Persistent imbalances in trade and financial institutions. accounts between the have accumulated over the years into huge stocks Continuous innovation can be of credit and debit giving rise to 'fault lines'in the international financial system achieved and sustained with that caused recurrent financial earthquakes of enduring consequences. new financial institutions. Economic Rese what is written in this article. rial Finance D0:10.102C1397
RESEARCH ARTICLE Copyright © 2012 John Wiley & Sons, Ltd. Strategic Change: Briefi ngs in Entrepreneurial Finance Strategic Change DOI: 10.1002/jsc.1897 Strat. Change 21: 83–106 (2012) Published online in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/jsc.1897 Growth, Institutions, and Entrepreneurial Finance in China: A Survey1 Carlo Milana Birkbeck College, University of London, UK Harry X. Wu Institute of Economic Research, Hitotsubashi University, Japan Some people regard private enterprise as a predatory tiger to be shot. Others look on it as a cow they can milk. Not enough people see it as a healthy horse, pulling a sturdy wagon. —Winston Churchill When prosperity comes, do not use all of it. —Confucius Th e truth is rarely pure and never simple. Modern life would be very tedious if it were either, and modern literature a complete impossibility! —Oscar Wilde Introduction Th e editorial in the previous issue of this Journal, dedicated to the theme ‘Measures and Instruments to Sustain Entrepreneurial Performance,’ stressed how national economic systems have changed over time and vary so widely across the world. Th eir diff erences account for uneven geographic distributions of wealth, income, and production activities. Persistent imbalances in trade and fi nancial accounts between the countries have accumulated over the years into huge stocks of credit and debit giving rise to ‘fault lines’ in the international fi nancial system that caused recurrent fi nancial earthquakes of enduring consequences. China’s economy is at a turning point after a fast and extensive growth for more than three decades, during which the state has played an important role. A crucial question is what reforms and strategic changes in economic and social policy can make China quickly and successfully shift to intensive growth through innovation. Free enterprises and entrepreneuship are essential for a sustained economic growth, particularly in China, where the culture of innovative private firms needs to be fostered and encouraged through a healthy development of efficacious institutions. Continuous innovation can be achieved and sustained with new financial institutions. Recent studies confirm that financial support for innovative entrepreneurial firms is important for sustainable productivity growth in China and for a rebalanced global economy. 1 J.E.L. classifi cation codes: E44, F21, F32, F43, O16. Th is article is part of the research “Reassessing China’s Economic Performance” that both authors are carrying out under the fi nancial support IERPK1211 of the 2012FY Joint Research Fund of Institute of Economic Research, Hitotsubashi University. Th e authors take sole responsibility for what is written in this article
84 Carlo Milana and Harry X.Wu Rebalancing the global economy seems to be essential obtained in the economic literature on china's entrepre for solving the curent problems.The countries neurial firms and institutional problems that affect the with persistent surpluses in the current accounts of their development of entrepreneurial finance. balance of payments (primarily the oil-exporting coun- The literature on the Chinese economy and finance is tries,China,Japan,Germany,and Russia)should aim at vast and fast-growing.No other country has such a higher sustaining their domestic demand and restructuring the number of academic journals and papers dedicated to its economic and financial issues.An impressively large and In order to achieve the needed profound transforma fast-growing number of studies appear every year contri tions,the adiustment of nominal exchange rates is clearly buting to the knowledge of a reality that continues to not the panacea,as other conditions should be satisfied. greatly affect the global This review is designed A generalized growth in real personal incomes must also as a briefing on the debate on China's economic trends be attained.At the macro level,this result can be achieved and policy issues. through productivity growth and an efficient distribution The second section reviews the debate on Chinas of gains in national incomes.In turn,a sustainable pro economic growth.The third section describes the strategic ductivity growth should result from genuine technologica changes that are required in China's economic policy.The advances,together with improved efficiency,rather than fourth section presents the evolution of the national finan mere scale economies. cial system.The fifth section examines the so-calledfinan- How can technological progress be assured in the cial repression of the Chinese economy in transition.The medium and long run?This is the crucial question that sixth section considers the emergence of Chinese entre- lies at the heart of today's economic problems.Techno preneurial finance as a necessary instrument to foster logical progress is,in fact,mainly due to constant innova- innovation and productivity in fast-growing private firms tion and can be enhanced through entrepreneurial projects The last section concludes the article. Fine-tuning of the financial system convey the needed financial resources from savers to Economic policy at a crossroads between governments of various areas of the world is The high speed of economic growth in the emerging essential to rebalance the world economy through the economies of Eastem Asia,and in particular in China, ha international financial system surpassed the most optimistic predictions even if the The case of China is emblematic as it is one of the actual growth speed is debatable.China's economy has most important drivers of global imbalances and,given undertaken profound transformationsOne could easily its,it is of primary importance that itran reach the conclusion that the engine power of the global forms itself from the 'factory'of the advanced economies economy is being shifted towards China at the cost of an into one of the primary 'engines of global economic inexorable decadence of the Western developed countries growth.In view of the circular chain between growth in Business futurists glimpse an even brighter trend in the domestic consumption,real personal incomes,productiv- next few decades (see.for example,Feather [2009].who ity through innovation,sustained entrepreneurial firm forecast that China will quadruple the present-day level through efficient finance,this article focuses on the results 2008) The name China'refers to the People's Republic of China Naughton (2008).On the actual growth rate of the Chines throughout this article. economy,see Maddison and Wu (2008). Copyright 2012 John Wiley Sons,Ltd
84 Carlo Milana and Harry X. Wu Copyright © 2012 John Wiley & Sons, Ltd. Strategic Change DOI: 10.1002/jsc Rebalancing the global economy seems to be essential for solving the current economic problems. Th e countries with persistent surpluses in the current accounts of their balance of payments (primarily the oil-exporting countries, China,2 Japan, Germany, and Russia) should aim at sustaining their domestic demand and restructuring the international integration of their economies. In order to achieve the needed profound transformations, the adjustment of nominal exchange rates is clearly not the panacea, as other conditions should be satisfi ed. A generalized growth in real personal incomes must also be attained. At the macro level, this result can be achieved through productivity growth and an effi cient distribution of gains in national incomes. In turn, a sustainable productivity growth should result from genuine technological advances, together with improved effi ciency, rather than mere scale economies. How can technological progress be assured in the medium and long run? Th is is the crucial question that lies at the heart of today’s economic problems. Technological progress is, in fact, mainly due to constant innovation and can be enhanced through entrepreneurial projects. Fine-tuning of the fi nancial system is required in order to convey the needed fi nancial resources from savers to growth-oriented entrepreneurial fi rms. Cooperation between governments of various areas of the world is essential to rebalance the world economy through the international fi nancial system. Th e case of China is emblematic as it is one of the most important drivers of global imbalances and, given its relative size, it is of primary importance that it transforms itself from the ‘factory’ of the advanced economies into one of the primary ‘engines’ of global economic growth. In view of the circular chain between growth in domestic consumption, real personal incomes, productivity through innovation, sustained entrepreneurial fi rms through effi cient fi nance, this article focuses on the results obtained in the economic literature on China’s entrepreneurial fi rms and institutional problems that aff ect the development of entrepreneurial fi nance. Th e literature on the Chinese economy and fi nance is vast and fast-growing. No other country has such a higher number of academic journals and papers dedicated to its economic and fi nancial issues. An impressively large and fast-growing number of studies appear every year contributing to the knowledge of a reality that continues to greatly aff ect the global economy. Th is review is designed as a briefi ng on the debate on China’s economic trends and policy issues. Th e second section reviews the debate on China’s economic growth. Th e third section describes the strategic changes that are required in China’s economic policy. Th e fourth section presents the evolution of the national fi nancial system. Th e fi fth section examines the so-called ‘fi nancial repression’ of the Chinese economy in transition. Th e sixth section considers the emergence of Chinese entrepreneurial fi nance as a necessary instrument to foster innovation and productivity in fast-growing private fi rms. Th e last section concludes the article. Economic policy at a crossroads Th e high speed of economic growth in the emerging economies of Eastern Asia, and in particular in China, has surpassed the most optimistic predictions even if the actual growth speed is debatable. China’s economy has undertaken profound transformations.3 One could easily reach the conclusion that the engine power of the global economy is being shifted towards China at the cost of an inexorable decadence of the Western developed countries. Business futurists glimpse an even brighter trend in the next few decades (see, for example, Feather [2009], who forecast that China will quadruple the present-day level 2 Th e name ‘China’ refers to the People’s Republic of China throughout this article. 3 On China’s economic transformation, see, for example, Brandt, Hsieh, and Zhu (2008); Brandt and Rawski (2008); Naughton (2008). On the actual growth rate of the Chinese economy, see Maddison and Wu (2008)
Entrepreneurial Finance in China 85 of national production and will overtake that of the USA have been faced by the population with migration to new in the 2020-2040 timeframe,although per capita income activities or new working areas.Maior sectoral shifts of will remain relatively low for a while) production have also taken place through the accelerated However,looking at things a little more closely,the urbanization of rural areas.The reallocation of labor and follwing posed by Sir Arthur Lewis()a capital in favor of manufacturing and construction indus the start of his Nobel Price Lecture,appears still valid tries has challenged the sustainability of the unbalanced today,even in the case of China: growth.New individual and social needs have emerged, providing not only good opportunities for economic pro Let me begin by stating my problem.For the past motion,but also new needs in infrastructure,housing. hundred years the rate of growth of ouput in the health care,and human capital formation.The need to developing world bas depended on the rate of growth of ouput in the developed world.When the deve organize such changes in an orderly fashion in a vastly loped populated country has been met starting from a centrally grow fast,the developing grow fast,and when the planned system that was itself changing towards developed slow down,the developing slow down.Is this a gradual but still revolutionary opening to relatively free- linkage inevitable?(Lewis,1979) market regime. The crucial point is whether and how we can break A number of insights into the Chinese economic per such a persisting linkage.During the first two years of the formance have emerged in the recent economic literature, current financial crisis,a common view was that China which are useful to dispel the major myths that still sur had been relatively untouched by the severe economic round the economic miracle of this country.A first issue slowdown of the developed world.Eventually,the news regards the degree of accuracy of the official statistics.Do became much more focused on the evidence of the rather onomic measures based on the government's data reflec the real dynamics of the economy?Secondly,how far does trivial consequences of the nature of the linkage between the Eastern Asian economies and the global supply chain the current stage of economic growth differ in breadth that links together the national industrial systems across and duration from the experience of other fast-growing the world.Indeed,China's economy was severely struck economies that sooner or later encounter limits to growth? by the global financial crisis.Many small-and medium Can the Chinese political and institutional system chang further in order to guarantee a stable economic and social sized enterprises(SMEs)were led to bankruptcy.During development of the country? the great recession of 2008-2009,more than 50,000 SMEs were shut down in Guangdong province,with the The association of high returns to capital resulting from the fast-growing economy with a growing foreign net exports contribution to economic growth becoming negative.In the overall was a sudden co 1 cconomists..号 lapse in demand and about 20 million migrant labor jobs High investment rates would bring about falling returns to capital.Moreover,high returns to capital would encour- were lost (Eichengreen etal.,2011;The Economist,2012d). The rapid has inevitably posed new age foreign capital inflows rather than domestic capital problems and exposed the country to new challenges and dilemmas (Prasad,2009.Lin,2011).Profound changes In the case of China,see,for example,Huang and Tao (2010,2011. er may eiatisuical See Maddison(2007)and also Perkins and Rawski (2008): das discu (. shown that China has been experiencing a faster-than-normal- decline in return to capital
Entrepreneurial Finance in China 85 Copyright © 2012 John Wiley & Sons, Ltd. Strategic Change DOI: 10.1002/jsc of national production and will overtake that of the USA in the 2020–2040 timeframe, although per capita income will remain relatively low for a while4 ). However, looking at things a little more closely, the following question, posed by Sir Arthur Lewis (1979) at the start of his Nobel Price Lecture, appears still valid today, even in the case of China: Let me begin by stating my problem. For the past hundred years the rate of growth of output in the developing world has depended on the rate of growth of output in the developed world. When the developed grow fast, the developing grow fast, and when the developed slow down, the developing slow down. Is this linkage inevitable? (Lewis, 1979). Th e crucial point is whether and how we can break such a persisting linkage. During the fi rst two years of the current fi nancial crisis, a common view was that China had been relatively untouched by the severe economic slowdown of the developed world. Eventually, the news became much more focused on the evidence of the rather trivial consequences of the nature of the linkage between the Eastern Asian economies and the global supply chain that links together the national industrial systems across the world. Indeed, China’s economy was severely struck by the global fi nancial crisis. Many small- and mediumsized enterprises (SMEs) were led to bankruptcy. During the great recession of 2008–2009, more than 50,000 SMEs were shut down in Guangdong province, with the net exports’ contribution to economic growth becoming negative.5 In the overall economy, there was a sudden collapse in demand and about 20 million migrant labor jobs were lost (Eichengreen et al., 2011; Th e Economist, 2012d). Th e rapid economic growth has inevitably posed new problems and exposed the country to new challenges and dilemmas (Prasad, 2009a, Lin, 2011). Profound changes have been faced by the population with migration to new activities or new working areas. Major sectoral shifts of production have also taken place through the accelerated urbanization of rural areas. Th e reallocation of labor and capital in favor of manufacturing and construction industries has challenged the sustainability of the unbalanced growth. New individual and social needs have emerged, providing not only good opportunities for economic promotion, but also new needs in infrastructure, housing, health care, and human capital formation. Th e need to organize such changes in an orderly fashion in a vastly populated country has been met starting from a centrally planned economic system that was itself changing towards a gradual but still revolutionary opening to relatively freemarket regime. A number of insights into the Chinese economic performance have emerged in the recent economic literature, which are useful to dispel the major myths that still surround the economic miracle of this country. A fi rst issue regards the degree of accuracy of the offi cial statistics. Do economic measures based on the government’s data refl ect the real dynamics of the economy? Secondly, how far does the current stage of economic growth diff er in breadth and duration from the experience of other fast-growing economies that sooner or later encounter limits to growth? Can the Chinese political and institutional system change further in order to guarantee a stable economic and social development of the country? Th e association of high returns to capital resulting from the fast-growing economy with a growing foreign surplus has always puzzled the mainstream economists.6 High investment rates would bring about falling returns to capital. Moreover, high returns to capital would encourage foreign capital infl ows rather than domestic capital 4 See Maddison (2007) and also Perkins and Rawski (2008); Jacques (2012). 5 See, for example, Wang et al. (2011, p. 17). 6 In the case of China, see, for example, Huang and Tao (2010, 2011). However, this puzzle may just be a statistical artifact given that the growth of output could have been exaggerated as discussed below. Indeed, Wu (2011a) has shown that China has been experiencing a faster-than-normaldecline in return to capital
86 Carlo Milana and Harry X.Wu outflows.Recent attempts to explain this paradox appeal (Branstetter and Lardy,2008).The nature of export-led tofinancial frictions and reallocation of resources across growth has been confirmed:exports have been more sig the firms that reflect the current Chinese economic trans- nificant for growth in China than in other countries,even formation.The reallocation of resources is occurring from in comparison with other transition economies(Akyuz, less productive externally financed firms to fast-growing 2011;Tingvall and Ljungwall,2012).However,some entrepreneurial firms that have less access to external observers worry that China is investing too little,not too financing.As this process goes on,an increasing propor- much,as it is usually believed.Even if the investment tion of domestic savings has been made available for flows are relatively high with respect to those undertaken investments in foreign assets. by other countries in the same stage of development,the The debate on Chinas economic growth has not Chinese economy still remains undercapitalized.It would reached a consensus.Even the data have been called into need to continue to invest efficiently in order to modern question.A number of authors have re-estimated the many aspects and sectors and achieve the status of a national economic accounts.The dynamics of the main developed economy by 2030. eappear rather fer that statistics.The offcia estimates growth in the real value added both in industry and the Strategic change in economic policy so-called 'non-material services'were found to be exagger At the time of writing,the Chinese Premier,Wen Jiabao ated because of methodological problems and politica at the annual opening ceremony of Parliament,declared incentives inherited in the reporting system.After adjust- to reduce the target for economic growth in 2012 to ing for the exaggeration of industrial performance and 7.5%,dropping it below 8%for the first time since 2004 growth,China's annual GDP growth has been corrected thus signaling the cnd of the era of double-digit growth downwards almost 2 percentage points for the transition He also indicated that the government's intention is to period 1978-2003.After these corrections,it seems tha reorient aggregate demand towards consumption,away China's post-reform performance is in line with the expe- from investments and exports.In particular,he said: rience of other newly industrialized economies in Eastern Asia between the 1950s and the 1970s. The key to solving the problems of imbalanced. The critical reappraisal of Chinese economic growth uncoordinated,unsustainable development is to accelerate the transformation of the pattern of economi is not limired to readdressing the issues of measu development.This is both a long-term task and ou Also,the type of analytical model of the path undertaken by the Chinese economy is called into question most pressing task.at present [..I We will move faster to set up a permanent mecbanism for boosting consumption.We will vigorously adjust income distribution,increase the incomes of low-and middle- on and Wu (20 (Premier Wen liabaos speech to the Chinese (2012):Iin (2012)Wan Parliament,as reported by Anderlini,2012). The global ecc nomie downturn is also affectine china's trade. The fall in exports combined w e in Although many commentators have pointed to the the v n ore)hav level of consumption in China as unusually low,it should 2012 (ses,for example,Hook,2012 and 20120 See,for example,Fan etal (2011):Jacob (2012). Copyright 2012 John Wiley Sons,Ltd
86 Carlo Milana and Harry X. Wu Copyright © 2012 John Wiley & Sons, Ltd. Strategic Change DOI: 10.1002/jsc outfl ows. Recent attempts to explain this paradox appeal to fi nancial frictions and reallocation of resources across the fi rms that refl ect the current Chinese economic transformation. Th e reallocation of resources is occurring from less productive externally fi nanced fi rms to fast-growing entrepreneurial fi rms that have less access to external fi nancing. As this process goes on, an increasing proportion of domestic savings has been made available for investments in foreign assets.7 Th e debate on China’s economic growth has not reached a consensus. Even the data have been called into question. A number of authors have re-estimated the national economic accounts.8 Th e dynamics of the main economic aggregates appear rather diff erent from that suggested by the offi cial statistics. Th e offi cial estimates of growth in the real value added both in industry and the so-called ‘non-material services’ were found to be exaggerated because of methodological problems and political incentives inherited in the reporting system. After adjusting for the exaggeration of industrial performance and growth, China’s annual GDP growth has been corrected downwards almost 2 percentage points for the transition period 1978–2003. After these corrections, it seems that China’s post-reform performance is in line with the experience of other newly industrialized economies in Eastern Asia between the 1950s and the 1970s.9 Th e critical reappraisal of Chinese economic growth is not limited to readdressing the issues of measurement. Also, the type of analytical model of the path undertaken by the Chinese economy is called into question (Branstetter and Lardy, 2008). Th e nature of export-led growth has been confi rmed: exports have been more signifi cant for growth in China than in other countries, even in comparison with other transition economies (Akyuz, 2011; Tingvall and Ljungwall, 2012). However, some observers worry that China is investing too little, not too much, as it is usually believed. Even if the investment fl ows are relatively high with respect to those undertaken by other countries in the same stage of development, the Chinese economy still remains undercapitalized. It would need to continue to invest effi ciently in order to modernize many aspects and sectors and achieve the status of a developed economy by 2030.10 Strategic change in economic policy At the time of writing, the Chinese Premier, Wen Jiabao, at the annual opening ceremony of Parliament, declared to reduce the target for economic growth in 2012 to 7.5%, dropping it below 8% for the fi rst time since 2004, thus signaling the end of the era of double-digit growth. He also indicated that the government’s intention is to reorient aggregate demand towards consumption, away from investments and exports. In particular, he said: Th e key to solving the problems of imbalanced, uncoordinated, unsustainable development is to accelerate the transformation of the pattern of economic development. Th is is both a long-term task and our most pressing task, at present [. . .] We will move faster to set up a permanent mechanism for boosting consumption. We will vigorously adjust income distribution, increase the incomes of low- and middleincome groups and enhance people’s ability to consume (Premier Wen Jiabao’s speech to the Chinese Parliament, as reported by Anderlini, 2012). Although many commentators have pointed to the level of consumption in China as unusually low, it should 7 Th is theoretical explanation is proposed, for example, by Song et al. (2011). 8 See, for example, Maddison (1998, 2007); Maddison and Wu (2008); Wu (2002, 2011a); Bai and Qian (2010); Feenstra (2012); Lin (2012); Wang and Szirmai (2012). 9 Th e global economic downturn is also aff ecting China’s trade. Th e fall in exports combined with a strong increase in the value of imports (particularly crude oil and iron ore) have brought about a defi cit that hit $31.5 billion in February 2012 (see, for example, Hook, 2012 and Th e Economist, 2012f). 10 See, for example, Fan et al. (2011); Jacob (2012)
Entrepreneurial Finance in China 87 be stressed that the economic literature has nonetheless enterprises (SOEs)were reformed and some meritocracy described this behavior as being consistent with the was introduced.However,the intervening financial crisis theoretical expectations for a country at this stage of has unveiled the weakness of the extensive growth that ha development.This does not exclude.however.differences taken place so far.As The Economist (2012a:9)recently in local preferences.In China,urban residents,for observed: example,exhibit a special consumption pattern under the influence of both traditional culture and dynamic The paradox L is that for China to succeed it mus change of the national cconomic system (Jin,2011).In move away from the formula that bas served it so well. recent years,the saving ratio in China has,indeed,reached In order to sustain national income with lower shares the eepional level f,but this fact smtobe related to the particular phase of growth experienced by of savings and investments while shifting away from exports,productivity growth has to be fostered,particu the country (Ma and Yi,2010).Looking back to the 1950s,one can see that the saving ratio in China larly in its enduring innovation component.This is the direction recommended in a voluminous document pub at that time,as low as 5%!This change towards a thrifty lished jointly by the World Bank (WB)and Development society seems to be better explained under the life-cycle Research Center for the State Council(People's Republic hypothesis (LCH)The national saving ratio may,in of China)(2012).It is claimed that,in the present stage fact,depend on the long-term rate of income growth of development,China has to foster competitiveness and (rather than on per-capita income)and demographic structure.Given the evolution of these two important nn omeet the challenges thatthe of the global economy is posing.Public infrastructures factors,the Chinese saving rate has progressively soared should become more uniformly modernized.Factors of under the economic reforms that started in 1978 production should become more efficiently allocated (Modigliani and Cao,2004).As the growth rates tend across industries and firms.Certain imbalances that arise to reduce and the demographic structure stabilizes,the national share dedicated to savings and investments will from the dualistic nature of the economy should be smoothed out with the diffusion of modern housing. tend to progressively decline. health care,and education to a much wider extent than ship,was common also to developed countries like Japan is the case today.As the president of the WB has clarificd. and Italy,but also to newly industrialized countries like this is more of an issue of stress points that will expand over time,rather than a crisis. Korea and Singapore.In addition,thethrifty behavior of the population has been accompanied by proactive According to the WB report,strategic change should be undertaken in China in six directions(transition to a growth-oriented policies.Deng's reforms were based on the prospect that,without economic growth,the market-led economy,acceleration of innovation,easing environmental stress,improving social security and healt Communist Party would be history.The state-owned care,strengthening the fiscal system and better funding of local authorities,improving relations with the rest of the The LCH was proposed by Modigliani and Brumberg world). (1954)for the dev The first direction indicated by the WB report,par- cture.He ticularly the reform of SOEs,has grabbed the attention former centrally planned sconomies including China tended to overcome the constraints,but paid a high cost that eventually toppled the communist bloc. Reported by Moody(2012:1). DO:10.100
Entrepreneurial Finance in China 87 Copyright © 2012 John Wiley & Sons, Ltd. Strategic Change DOI: 10.1002/jsc be stressed that the economic literature has nonetheless described this behavior as being consistent with the theoretical expectations for a country at this stage of development. Th is does not exclude, however, diff erences in local preferences. In China, urban residents, for example, exhibit a special consumption pattern under the infl uence of both traditional culture and dynamic change of the national economic system (Jin, 2011). In recent years, the saving ratio in China has, indeed, reached the exceptional level of 40%, but this fact seems to be related to the particular phase of growth experienced by the country (Ma and Yi, 2010). Looking back to the 1950s, one can see that the saving ratio in China was, at that time, as low as 5%! Th is change towards a thrifty society seems to be better explained under the life-cycle hypothesis (LCH).11 Th e national saving ratio may, in fact, depend on the long-term rate of income growth (rather than on per-capita income) and demographic structure.12 Given the evolution of these two important factors, the Chinese saving rate has progressively soared under the economic reforms that started in 1978 (Modigliani and Cao, 2004). As the growth rates tend to reduce and the demographic structure stabilizes, the national share dedicated to savings and investments will tend to progressively decline. Th is tendency, obeying a certain structural relationship, was common also to developed countries like Japan and Italy, but also to newly industrialized countries like Korea and Singapore. In addition, the ‘thrifty’ behavior of the population has been accompanied by proactive growth-oriented policies. Deng’s reforms were based on the prospect that, without economic growth, the Communist Party would be history. Th e state-owned enterprises (SOEs) were reformed and some meritocracy was introduced. However, the intervening fi nancial crisis has unveiled the weakness of the extensive growth that has taken place so far. As Th e Economist (2012a: 9) recently observed: Th e paradox [. . .] is that for China to succeed it must move away from the formula that has served it so well. In order to sustain national income with lower shares of savings and investments while shifting away from exports, productivity growth has to be fostered, particularly in its enduring innovation component. Th is is the direction recommended in a voluminous document published jointly by the World Bank (WB) and Development Research Center for the State Council (People’s Republic of China) (2012). It is claimed that, in the present stage of development, China has to foster competitiveness and innovation in order to meet the challenges that the state of the global economy is posing. Public infrastructures should become more uniformly modernized. Factors of production should become more effi ciently allocated across industries and fi rms. Certain imbalances that arise from the dualistic nature of the economy should be smoothed out with the diff usion of modern housing, health care, and education to a much wider extent than is the case today. As the president of the WB has clarifi ed, ‘this is more of an issue of stress points that will expand over time, rather than a crisis.’13 According to the WB report, strategic change should be undertaken in China in six directions (transition to a market-led economy, acceleration of innovation, easing environmental stress, improving social security and health care, strengthening the fi scal system and better funding of local authorities, improving relations with the rest of the world). Th e fi rst direction indicated by the WB report, particularly the reform of SOEs, has grabbed the attention 11 Th e LCH was proposed by Modigliani and Brumberg (1954) for the developed market economies. 12 See Modigliani’s (1985) Nobel Prize lecture. However, forced saving to achieve a fast heavy industrialization in the former centrally planned economies including China tended to overcome the constraints, but paid a high cost that eventually toppled the communist bloc. 13 Reported by Moody (2012: 1)
88 Carlo Milana and Harry X.Wu of analysts and observers.The state should progressively growth of other Asian countries has pointed tothe impo unleash the positive forces of markets in order to secur tance of the relative contribution of changes in facto the sustainability of economic growth of the country. inputs and total factor productivity. The soes.which control half of the national industrial The famous discussion by Krugman (1994),Young assets,still absorb an even larger share of the financial (1994),and Kim and Lau (19)raised serious doubtson capital made available by the state-owned banking system. the sustainability of economic growth in Eastern Asian They are notoriously inefficient and prevent the conri countries,which they found more input-intensive and bution of productivity gains to economic growth to rise. benefiting from returns to scale rather than technological Many SOEs are listed in the major stock exchange progress.This would lead to a reduction in the possibility markets of the world,but remain under the regulatory of sustained economic expansion of these countries as the protection of the State-Owned Assets Supervision and limits in the availability of factor inputs are inevitably Administration Commission (SASAC).Because of this reached in abence of productivity gains.Their extremely favorable position,the reform of SOEs is the was,however,called into question by others leaving the key to a successful strategic change towards a market- debate open to further insights. driven economy. The debate on China's conmic growth is similarly The WB report underlines that the number of sectors open.Many studies based on growth accounting and in which the SOEs dominate seems to be too high for other methods have not reached unanimous conclusions them all to be strategically important.In fact,the alleged although they seem to recognize a minor role of TFP strategic importance does not appear to be justifiable in erowth with some variations.>On average,it seems that many of these sectors.Opening them to new competitors about one-third of China's growth can be attributed to would contribute substantially to an increase in produc TFP growth.Such a measure is not as high as that found tivity and make economic growth sustainable. in the most advanced economies,it indicates that further Alarge body ofeconomicliteraturearguesthat- growth is attainable tosome xe.However,substantial cially in developing countries- low aggregate total factor variation can be noted among the results of the studies In particular.these results seem to be sensitive to the choice of techniques,models,types of analysis used and regulatory regimes.In particular,because of institutional ways of handling data and measurement problems for productivity assessment. cally advanced firms fail to attract the quantity of financial Recent studies found that the major source of eco resources that would be economically optimal.* nomic growth in China is input growth,with human The study of productivity growth in China has been capital still remaining inadequate ().Pro one of the subiect matters that have been more closely ductivity growth was of minor importance and was due scrutinized in recent times.One of the reasons for this mainly to technical progress,whereas scale effects had interest lies in the need to understand Chinas growth become visible only in recent years (Cao et,2009;L mechanism and how to sustain prolonged periods of high et al 2009,Li and Liu 2011;Ozyurt,2009;Ozyurt and growth rates in the future.The debate on economic Guironnet,2011).In some Chinese provinces,scale See for exa and Shea (2008)Restuccia and (201h)has taken into nt 151 empirical studie Ro wth and constructed Klenow(2009:Xu(2011). Copyright 2012 John Wiley Sons,Ltd
88 Carlo Milana and Harry X. Wu Copyright © 2012 John Wiley & Sons, Ltd. Strategic Change DOI: 10.1002/jsc of analysts and observers. Th e state should progressively unleash the positive forces of markets in order to secure the sustainability of economic growth of the country. Th e SOEs, which control half of the national industrial assets, still absorb an even larger share of the fi nancial capital made available by the state-owned banking system. Th ey are notoriously ineffi cient and prevent the contribution of productivity gains to economic growth to rise. Many SOEs are listed in the major stock exchange markets of the world, but remain under the regulatory protection of the State-Owned Assets Supervision and Administration Commission (SASAC). Because of this extremely favorable position, the reform of SOEs is the key to a successful strategic change towards a marketdriven economy. Th e WB report underlines that the number of sectors in which the SOEs dominate seems to be too high for them all to be strategically important. In fact, the alleged strategic importance does not appear to be justifi able in many of these sectors. Opening them to new competitors would contribute substantially to an increase in productivity and make economic growth sustainable. A large body of economic literature argues that — especially in developing countries — low aggregate total factor productivity (TFP) growth is the result of misallocation of resources across the fi rms due to frictions and various regulatory regimes. In particular, because of institutional barriers and market imperfections, the most technologically advanced fi rms fail to attract the quantity of fi nancial resources that would be economically optimal.14 Th e study of productivity growth in China has been one of the subject matters that have been more closely scrutinized in recent times. One of the reasons for this interest lies in the need to understand China’s growth mechanism and how to sustain prolonged periods of high growth rates in the future. Th e debate on economic growth of other Asian countries has pointed to the importance of the relative contribution of changes in factor inputs and total factor productivity. Th e famous discussion by Krugman (1994), Young (1994), and Kim and Lau (1996) raised serious doubts on the sustainability of economic growth in Eastern Asian countries, which they found more input-intensive and benefi ting from returns to scale rather than technological progress. Th is would lead to a reduction in the possibility of sustained economic expansion of these countries as the limits in the availability of factor inputs are inevitably reached in absence of productivity gains. Th eir conclusion was, however, called into question by others leaving the debate open to further insights. Th e debate on China’s economic growth is similarly open. Many studies based on growth accounting and other methods have not reached unanimous conclusions, although they seem to recognize a minor role of TFP growth with some variations.15 On average, it seems that about one-third of China’s growth can be attributed to TFP growth. Such a measure is not as high as that found in the most advanced economies, it indicates that further growth is attainable to some extent. However, substantial variation can be noted among the results of the studies. In particular, these results seem to be sensitive to the choice of techniques, models, types of analysis used and ways of handling data and measurement problems for productivity assessment. Recent studies found that the major source of economic growth in China is input growth, with human capital still remaining inadequate (Li et al., 2009). Productivity growth was of minor importance and was due mainly to technical progress, whereas scale eff ects had become visible only in recent years (Cao et al., 2009; Li et al, 2009, Li and Liu 2011; Özyurt, 2009; Özyurt and Guironnet, 2011). In some Chinese provinces, scale 14 See, for example, Wu and Shea (2008), Restuccia and Rogerson (2008); Gancia and Zilibotti (2009); Hsieh and Klenow (2009); Xu (2011). 15 Wu (2011b) has taken into account 151 empirical studies of the contribution of TFP to China’s growth and constructed statistical averaging indicators of the results obtained by them
Entrepreneurial Finance in China 89 effects were even negative and efficiency was increased manufacturing exporting industries.7 As we write this only through technical progress. review.China's government has iust announced its inten The main conclusion of the studies carried out on tion to cut the banks reserve ratios in a bid to counter the revised data is that productivity growth has con- economic slowdown.This policy appears to be an urgent except during recent years,when it appears to have been significant,even though still remaining much less to alleviate the crisis with diffused expansionary credit important than input growth.The decomposition of This move has been followed by capital rules imposed on productivity growth into technical progress (imported the banks themselves by adopting even stricter rules than or spurred by innovation)and returns toscale is,however, Basel III standards in an attempt to protect them from to be systematically explored.Sustained productivity the risk of default of certain loans accumulated in thei growth could be,however,not always attainable.Some assets nalysts have suggested to recover the old concept of The change towards a market-driven economy will industrial policy using the old instrument of subsidies. require reforms in the country's financial system.An over Costs and prices of tradable products could be kept view of the current institutional setting may help to visu under control using this instrument in order to increase alie the sctors where financial reformsare mostly needed domestic consumption and reduce trade imbalances Figure 1,derived from Allen etal(2008,2012a)offers a (Rodrik,2010).Using policy instruments to support complete picture of this system.Among the four macro entrepreneurial firms require,in any case,afine-tuning sectors,the banking and financial intermediation is by far of the financial system. the most developed sector.Very little funding is raised from stock and bond markets.The non-standard financial sector is fairly important in rural areas and agricultural Financial Institutions activities,while hybrid coalitions of firms and their inves- The Chinese financial system has been scen as remarkably tors are becoming of some importance in other specifi stable during the financial crisis notwithstanding signs of contexts.Foreign sectors are important,as they include slowdown in the export-led growth process of the direct investm tsandother capital fows that have played economy.While Western financial institutions have suf a key role in the integration of a country's national pro- fered since the beginning of the crisis from inadequate duction with international supply chains. capital and toxic assets in their balance sheets,the Chinese The banking and intermediation sector is by far the nterparts were endowed with bet er quality capital and most important source of new funds to the economy. plenty of liquidity,with an average loan to deposit ratio Over the past decade,bank lending has remained at a level of around 60%. above 85%of total financial services,whereas bonds and However,this position of the Chinese financial system equity have been at around 10%and 5%,respectively reveals its own Achilles'heel.Its credit assets are dispro- (see also Table 1).This distribution of funding sources portionarely composed of loans allocated to SOEs and can be better seen by looking at financial system from a state institutions(Wu and Shea,2008).Many of these entities are now suffering because of the global economic 7 downturn through direct and indirect linkages s with See,for example,Branstetter (2007),based on the data of See,for example,Hu (200):Walter and Howie (2012). the People's Bank of China
Entrepreneurial Finance in China 89 Copyright © 2012 John Wiley & Sons, Ltd. Strategic Change DOI: 10.1002/jsc eff ects were even negative and effi ciency was increased only through technical progress. Th e main conclusion of the studies carried out on the revised data is that productivity growth has contributed very little to China’s economic development, except during recent years, when it appears to have been signifi cant, even though still remaining much less important than input growth. Th e decomposition of productivity growth into technical progress (imported or spurred by innovation) and returns to scale is, however, to be systematically explored. Sustained productivity growth could be, however, not always attainable. Some analysts have suggested to recover the old concept of industrial policy using the old instrument of subsidies. Costs and prices of tradable products could be kept under control using this instrument in order to increase domestic consumption and reduce trade imbalances (Rodrik, 2010). Using policy instruments to support entrepreneurial fi rms require, in any case, a fi ne-tuning of the fi nancial system. Financial Institutions Th e Chinese fi nancial system has been seen as remarkably stable during the fi nancial crisis notwithstanding signs of slowdown in the export-led growth process of the economy. While Western fi nancial institutions have suffered since the beginning of the crisis from inadequate capital and toxic assets in their balance sheets, the Chinese counterparts were endowed with better quality capital and plenty of liquidity, with an average loan to deposit ratio of around 60%.16 However, this position of the Chinese fi nancial system reveals its own Achilles’ heel. Its credit assets are disproportionately composed of loans allocated to SOEs and state institutions (Wu and Shea, 2008). Many of these entities are now suff ering because of the global economic downturn through direct and indirect linkages with manufacturing exporting industries.17 As we write this review, China’s government has just announced its intention to cut the banks’ reserve ratios in a bid to counter economic slowdown.18 Th is policy appears to be an urgent adjustment after the government’s reaction to the recession, which had driven the state-owned banking system to alleviate the crisis with diff used expansionary credit. Th is move has been followed by capital rules imposed on the banks themselves by adopting even stricter rules than Basel III standards in an attempt to protect them from the risk of default of certain loans accumulated in their assets. Th e change towards a market-driven economy will require reforms in the country’s fi nancial system. An overview of the current institutional setting may help to visualize the sectors where fi nancial reforms are mostly needed. Figure 1, derived from Allen et al. (2008, 2012a) off ers a complete picture of this system. Among the four macro sectors, the banking and fi nancial intermediation is by far the most developed sector. Very little funding is raised from stock and bond markets. Th e non-standard fi nancial sector is fairly important in rural areas and agricultural activities, while hybrid coalitions of fi rms and their investors are becoming of some importance in other specifi c contexts. Foreign sectors are important, as they include direct investments and other capital fl ows that have played a key role in the integration of a country’s national production with international supply chains. Th e banking and intermediation sector is by far the most important source of new funds to the economy. Over the past decade, bank lending has remained at a level above 85% of total fi nancial services, whereas bonds and equity have been at around 10% and 5%, respectively19 (see also Table 1). Th is distribution of funding sources can be better seen by looking at fi nancial system from a 17 Previous studies have analyzed the industrial linkages within the Chinese economy. See, for example, Heimler (1991). 18 See, for example, Rabinovitch (2012). 19 See, for example, Branstetter (2007), based on the data of the People’s Bank of China. 16 See, for example, Hu (2009); Walter and Howie (2012)
90 Carlo Milana and Harry X.Wu China's Financial System Banking and GCCa。 Figure 1.Overview of Chinas financial system Source:Allen,(2008,Fig.1,p.512)(012a,Fig.1). Table 1.State-owned and private banks in China,2009(RMB billion) Types of banks Total Profit deposits % Bi five bank 40,08 29,50 205 1.8 Joint equity .78 ROOp Fore 66 5,493 4 5,421 4B),based on the 00-008CEICdatabase, k of Chi Copyright2012 John Wiley Sons,Ltd
90 Carlo Milana and Harry X. Wu Copyright © 2012 John Wiley & Sons, Ltd. Strategic Change DOI: 10.1002/jsc China’s Financial System Policy Banks Commercial Banks State-Owned Partially State-Owned Private Owned and Foreign Non-Bank Financial Banking and Intermediate Sector RCC, UCC, and Postal Savings TIC, Mutual Funds, and Finance Companies Financial Markets Stock Market (SHSE, SZSE, and HKSE) Bond Market Government Bond Corporate Bond Venture Capital/PE Real Estate Foreign Sectors (FDI, capital flows) Nonstandard Financial Sector Informal Financial Institutions Coalitions/ Institutions among Hybrid Sector Firms and their Investors Figure 1. Overview of China’s fi nancial system. Source: Allen, et al. (2008, Fig. 1, p. 512) (2012a, Fig. 1). Table 1. State-owned and private banks in China, 2009 (RMB billion) Types of banks Total assets Total deposits Outstanding loans Profit NPL** rate (%) Big fi ve banks* 40,089 29,507 20,152 400.1 1.8 Other commercial banks 17,465 15,042 9,607 42 .2 1) Joint equity 11,785 10,549 6,707 92.5 1.0 2) City commercial banks 5,680 4,493 2,899 49.7 1.3 Foreign banks 1,349 669 727 6.5 0.9 Urban credit cooperatives 27 40 — 0.2 Rural credit cooperatives 5,493 4,742 5,421 22.8 Source: Allen et al. (2012a: Table 4B), based on the Almanac of China’s Finance and Banking 2000–2008, CEIC database, the Quarterly Monetary Report of the People’s Bank of China. *Th e Big fi ve banks are the state-owned big four banks (Bank of China, China Construction Bank, Industrial and Commercial Bank of China, and Agricultural Bank of China) and the Bank of Communications. **Non-performing loan
Entrepreneurial Finance in China 91 Table 2.Sources of financial capital Type Debt capital Equity capital Loans from owne Retained ear Public markets Bond issues Stock issues Source:Temin (2004,p.709) functional perspective together with an institutional per- than by strangers especially in contexts with a low level of spective.The structure of the financial sources is shown legal protection (Allen et al,2005).In China,the infor- in Table 2.2 This enables us to track the evolution of a mal finance is very imporant in rural areas and agricul- financial system in its development. tural activities,as well as in commerce and a number of The entries in the first row of Table 2 represent the personal services(Hsu,2009a,b;Li and Hsu,2009;Jiang, sources of capital for autarkic farms or business.This 2009a,b;Tsai,2009) source of capital is still used in the developed and emerg- The third row/second column of Table 2 regards ing economies alike,although with different scales and funding sources which derive financial capital from degrees of frequency.The (arguably)lower cost of own pooling savings from third parties (households,firms, capital with respect to external capital still brings modern institutions).Intermediaries,notably the banks,convey business to see selffinancing asa preferred source.In flows of money deposited by savers to investors for pro China,the internal financial source is very important for ductive uses (the amount of loans to consumers is still all private enterprises and especially for the start-ups and very low).There is no direct connection between the two young firms. parties,not even with reference to the time horizon of The second row of Table 2 considers the informal their financial operations.The bank iudiciously assumes external sources of capital These are widely used inecon the risk of not being reimbursed by the lenders and mies without highly developed financial systems,but are receives a reward in the form of a differential interest rate also present in the most advanced financial systems.These for this calculated risk.A modern banking system is orga are the typical sources in the entrepreneurial finance of nized and supervised in such a way that the risks assumed start-ups and early stages of small enterprises.The asym- by the single banks are in some way mutually insured and metric information is reduced at a minimum as the ent upported by the whole society and the stare.In China preneurs who borrow from their relatives and friends,or official intermediaries are all highly regulated.As shown even from traders in local communities,capitalize on their in Table 1,four big state-owned banks dominate the reputation.They are trusted more by relatives and friends domestic credit market The intermediaries in the third row/third column of We follow Temin's(2004:707-719)description of the Table 2 are typically non-banking.'On an individual basis,,joint-stock companies pooled resources raised by selling shares to finance expeditions times,private(PE)or tions raise capital to invest in firms,for which they assume DO:10.100
Entrepreneurial Finance in China 91 Copyright © 2012 John Wiley & Sons, Ltd. Strategic Change DOI: 10.1002/jsc functional perspective together with an institutional perspective.20 Th e structure of the fi nancial sources is shown in Table 2.21 Th is enables us to track the evolution of a fi nancial system in its development. Th e entries in the fi rst row of Table 2 represent the sources of capital for autarkic farms or business. Th is source of capital is still used in the developed and emerging economies alike, although with diff erent scales and degrees of frequency. Th e (arguably) lower cost of own capital with respect to external capital still brings modern business to see self-fi nancing as a preferred source. In China, the internal fi nancial source is very important for all private enterprises and especially for the start-ups and young fi rms. Th e second row of Table 2 considers the informal external sources of capital. Th ese are widely used in economies without highly developed fi nancial systems, but are also present in the most advanced fi nancial systems. Th ese are the typical sources in the entrepreneurial fi nance of start-ups and early stages of small enterprises. Th e asymmetric information is reduced at a minimum as the entrepreneurs who borrow from their relatives and friends, or even from traders in local communities, capitalize on their reputation. Th ey are trusted more by relatives and friends than by strangers especially in contexts with a low level of legal protection (Allen et al., 2005). In China, the informal fi nance is very important in rural areas and agricultural activities, as well as in commerce and a number of personal services (Hsu, 2009a,b; Li and Hsu, 2009; Jiang, 2009a,b; Tsai, 2009). Th e third row/second column of Table 2 regards funding sources which derive fi nancial capital from pooling savings from third parties (households, fi rms, institutions). Intermediaries, notably the banks, convey fl ows of money deposited by savers to investors for productive uses (the amount of loans to consumers is still very low). Th ere is no direct connection between the two parties, not even with reference to the time horizon of their fi nancial operations. Th e bank judiciously assumes the risk of not being reimbursed by the lenders and receives a reward in the form of a diff erential interest rate for this calculated risk. A modern banking system is organized and supervised in such a way that the risks assumed by the single banks are in some way mutually insured and supported by the whole society and the state. In China, offi cial intermediaries are all highly regulated. As shown in Table 1, four big state-owned banks dominate the domestic credit market. Th e intermediaries in the third row/third column of Table 2 are typically ‘non-banking.’ On an individual basis, in earlier economies, joint-stock companies pooled resources raised by selling shares to fi nance expeditions overseas. In modern times, private equity (PE) organizations raise capital to invest in fi rms, for which they assume Table 2. Sources of fi nancial capital Type Debt capital Equity capital Internal sources Loans from owners Retained earnings Informal external sources Loans from family and friends: trade credit, brokers Investments by informed participants Financial intermediaries Lending by fi nancial institutions (banks) Some joint-stock companies Public markets Bond issues Stock issues Source: Temin (2004, p. 709) 20 We follow Temin’s (2004: 707–719) description of the historical development of a national fi nancial system. 21 A fi nancial system can be better studied by considering also the evolution of its functions, rather than focusing only on its ever-changing institutions (see, for example, the contributions collected by Bodie et al. [1995])
Carlo Milana and Harry X.Wu some form of control.A special form of PE is made up regional headquarter(RHQ)structure was approved in of venture capital (VC),where the investor mainly uses order to allow multinational companies (MNCs)to its own resources rather than external capital.In China, operate in Shanghai.A dual system is adopted to maintain PE/VC is only at an carly stage of development,but it is the non-convertibility of the renminbi while ensuring expected to grow very quickly with the transition to a that its foreign exchange level is kept within a band of a consumer-oriented economy (Batjargal and Liu,2004). basket of reference currencies (Darby,2007;Eichengreen The fourth row of Table 2 regards the non-banking 2007). intermediaries that are organized in'markets where stocks Payments in local currency are also subject to certain (bonds and equities)are freely exchanged by the public anti-infation restrictions.The Aows of notes,local cur- through brokers within a certain regulatory regime.This rency interest rates,and mechanisms of moving funds is the typical financial source used by private corporations. from corporate to individual accounts are subject to spe- In China,successful private SMEs and the SOEs(when cific conditions.A representative office can use only basic these undertake a progressive privatization process)will be accounts that cover physical cash withdrawals and payroll the focus of this important financial source. As for foreign currency surpluses (FCS),there is a time The working of a country's financial system is deeply frame in which they must be converted by the Chines affected by the regulatory regime concerning liquidity.In owners into renminbi balances.Certain bank-designed fact,fund raising has the objective to finance the acquisi- solutions are available on a'menu basis'offering various tion of capital goods and services through medium-and credit facilities in local currency (Prasad and Wei, long-term loans,but also to ensure the necessary liquidity Rosen.2007:Wittman.2009:Hersh.2011).Institutional through short-term credit in addition to functional cash problems created macrocconomic dilemmas that in tu flow.In China,efficient cash and liquidity management resulted in severe credit problems in renminbi(Liew and is under a complex and fragmented regulatory system 7u.2007). This is effectively described by Wittman(2009:81) The forced conversion of the foreign currency sur pluses into the renminbi tends to increase the domestic A China treasurer has to understand the fragmented money supply.In order to keep inflation under control, yet punitive nature of the regulatory framework in the central bank has taken two types of action,referred which financial transactions and forex are regulated.A to as sterilization (or neutralization).First,since 2003 good rule of thumb is that the capital structure of an the central bank has issued interest-bearing paper to be entity in China will determine what liquidity and bought by commercial banks,thus reducing domestic money supply.Second,the central bank has raised the required reserve ratio (i the share of deposits that the banks had to place at the central bank itself),thus con- Financial repression tributing to a further reduction of the domestic mo The movements of local and foreign currencies are under supply.However,as the magnitude and duration of the varying levels of restrictive regimes.Depending on intervention on foreign currency market increase,the whether the relevant capital structure is an equity joint capacity of bond absorption on the part of the banking venture (EJV),a cooperative joint venture (ClV),or a system is put under stress,so the sterilization costs tend wholly owned foreign enterprise(WOFE),various levels to rise (Liew and Wu.2007).The difference between the of freedom of liquidity management could be allowed interest rates that the central bank has to pay to domestic From July 2006.the status of holding company and banks and the more stable active interest rates that it gets Copyright 2012 John Wiley Sons,Ltd
92 Carlo Milana and Harry X. Wu Copyright © 2012 John Wiley & Sons, Ltd. Strategic Change DOI: 10.1002/jsc some form of control. A special form of PE is made up of venture capital (VC), where the investor mainly uses its own resources rather than external capital. In China, PE/VC is only at an early stage of development, but it is expected to grow very quickly with the transition to a consumer-oriented economy (Batjargal and Liu, 2004). Th e fourth row of Table 2 regards the non-banking intermediaries that are organized in ‘markets’ where stocks (bonds and equities) are freely exchanged by the public through brokers within a certain regulatory regime. Th is is the typical fi nancial source used by private corporations. In China, successful private SMEs and the SOEs (when these undertake a progressive privatization process) will be the focus of this important fi nancial source. Th e working of a country’s fi nancial system is deeply aff ected by the regulatory regime concerning liquidity. In fact, fund raising has the objective to fi nance the acquisition of capital goods and services through medium- and long-term loans, but also to ensure the necessary liquidity through short-term credit in addition to functional cash fl ow. In China, effi cient cash and liquidity management is under a complex and fragmented regulatory system. Th is is eff ectively described by Wittman (2009: 81): A China treasurer has to understand the fragmented yet punitive nature of the regulatory framework in which fi nancial transactions and forex are regulated. A good rule of thumb is that the capital structure of an entity in China will determine what liquidity and repatriation tools are possible. Financial repression Th e movements of local and foreign currencies are under varying levels of restrictive regimes. Depending on whether the relevant capital structure is an equity joint venture (EJV), a cooperative joint venture (CJV), or a wholly owned foreign enterprise (WOFE), various levels of freedom of liquidity management could be allowed. From July 2006, the status of holding company and regional headquarter (RHQ) structure was approved in order to allow multinational companies (MNCs) to operate in Shanghai. A dual system is adopted to maintain the non-convertibility of the renminbi while ensuring that its foreign exchange level is kept within a band of a basket of reference currencies (Darby, 2007; Eichengreen, 2007). Payments in local currency are also subject to certain anti-infl ation restrictions. Th e fl ows of notes, local currency interest rates, and mechanisms of moving funds from corporate to individual accounts are subject to specifi c conditions. A representative offi ce can use only basic accounts that cover physical cash withdrawals and payroll. As for foreign currency surpluses (FCS), there is a timeframe in which they must be converted by the Chinese owners into renminbi balances. Certain bank-designed solutions are available on a ‘menu basis’ off ering various credit facilities in local currency (Prasad and Wei, 2007a,b; Rosen, 2007; Wittman, 2009; Hersh, 2011). Institutional problems created macroeconomic dilemmas that in turn resulted in severe credit problems in renminbi (Liew and Wu, 2007). Th e forced conversion of the foreign currency surpluses into the renminbi tends to increase the domestic money supply. In order to keep infl ation under control, the central bank has taken two types of action, referred to as sterilization (or neutralization). First, since 2003, the central bank has issued interest-bearing paper to be bought by commercial banks, thus reducing domestic money supply. Second, the central bank has raised the required reserve ratio (i.e., the share of deposits that the banks had to place at the central bank itself), thus contributing to a further reduction of the domestic money supply. However, as the magnitude and duration of the intervention on foreign currency market increase, the capacity of bond absorption on the part of the banking system is put under stress, so the sterilization costs tend to rise (Liew and Wu, 2007). Th e diff erence between the interest rates that the central bank has to pay to domestic banks and the more stable active interest rates that it gets