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Victor Shih and Carl Walter on China’s Banks

August 20, 2011

Recommended reading – or in this case, viewing — for this week is a series of video interviews sponsored by G+ with Victor Shih, of Northwestern University, and Carl Walter, co-author of Red Capitalism, on China’s banking system.  You can watch Part 1, Part 2, Part 3, and Part 4 by clicking on the appropriate links.  The interviews tell a familiar story for anyone who’s been reading this blog, but it’s good to hear it laid out in detail by two experts who really know their stuff.  The tale they tell — particularly at the beginning of Part 2, under the title “2009: how a flood of credit drowned reform” — is exactly what I warned would happen in a Wall Street Journal op-ed I wrote in May 2009 (“Undoing Chinese Bank Reform”).

Incidentally, Victor Shih also wrote a guest blog in yesterday’s Financial Times that is well worth reading.  He argues that the expansion of China’s state sector is fueling corruption that threatens to undermine the country’s economic progress:

Given the dominance of the state at every level of government, government officials learned long ago that the best way to make some money on the side was to form their own companies, which “bid for” and often won lucrative contracts from the government and from state-owned enterprises.

In many cases, these parasitic companies do not do the contracted work themselves but instead farm out the work to the highest bidders. The owners of these connected companies, often officials themselves or their close friends and relatives, can make money without doing anything. It is rent-seeking in its most naked form.

As this “unspoken rule” way of business proliferates to every corner of the Chinese economy, quality, safety, and basic trust all go out the window, replaced by the subcontractors who could pay the highest bribes.

Victor correctly points to the proliferation of rent-seeking (rather than wealth-creating) behavior as a serious problem.  Not only does it undermine economic growth, it also fuels growing public anger over careless and greedy practices that people perceive as profoundly unfair.

One of the topics Victor and Carl discuss in their interview is China’s dangerous levels of overinvestment as a result of its stimulus-driven credit boom.  Reporter David Pierson offers a good perspective on this in Tuesday’s Los Angeles Times, noting the many empty malls and office buildings one sees, even in booming Beijing.   David quoted me about “the limits of stimulus” and my concern that China will reopen the credit floodgates should growth begin to slow.  Another comment in the article, from a Chinese scholar, seemed to more directly echo Victor’s concerns:

“If all this investment remains unprofitable for the long term, there will be serious risk to the banking system,” said Yi Xianrong, a researcher at the Chinese Academy of Social Sciences, a government think tank. “The problem is it’s become a tool for local government officials to compete and a hotbed for corruption.”

Along similar lines, reporter Michael Gsovski recently wrote a two-part article on overconstruction in China’s real estate market for The China Beat, which you can read here.  Part 1 takes a concrete look at the “ghost city” phenomenon, in which investors stockpile entire developments (or entire cities) full of empty high-priced apartments, this time on the outskirts of Kunming in southwestern Yunnan province.  Part 2 steps back and looks at the bigger picture, what is driving these distortions, what risks they pose, and what (if anything) can be done to correct them:

economists like Tsinghua University’s Patrick Chovanec are doubtful that local officials are going to comply with the central government policies to slow the pace of development due to the financial incentives they face to continue encouraging high levels of construction …

Chovanec believes the price and purchase controls on consumers were ineffective, as they did not lessen the demand to invest in housing … As for the monetary tightening, Chovanec argues that unless investors believed the periodic increases in the interest rate and reserve requirement were a message portending further, more drastic policies, they were not large enough to be a deterrent, due to the high rates of return real estate has thus far produced.

It’s interesting to note that this view, which used to be quite contrarian, is rapidly becoming conventional (or at least accepted) wisdom.  I was pleased to read an IMF blog post by the organization’s resident China expert, Nigel Chalk, on what he now calls “China’s bubbly housing market.”  He notes — as I’ve been arguing for some time now – that demand for property-buying in China is driven by a deeply entrenched combination of high savings rates, lack of investment alternatives, and low holding costs, which cause people to stockpile empty units as a “store of value,” like gold.  Nigel goes on to observe that:

all of these efforts [to rein in the property market] are still only treating the symptom of the problem—the pace at which house prices are going up—but the underlying impetus remains in place. Ultimately, the solution has to involve higher interest rates (on both deposits and loans), efforts to create a broader set of financial assets for the population to invest in, and a broad-based property tax that covers the majority of China’s housing stock. None of this will be politically easy and it will all take time. However, only this kind of deep-rooted change will create the environment where households view their apartments as shelter rather than as a (literal) concrete store of value.

I couldn’t agree more.  This is precisely what I’ve been arguing since China began its “cooling measures” in April of last year, as you can see from this clip from Chinese TV from July 2010.

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7 Comments leave one →
  1. Minh permalink
    August 21, 2011 6:47 pm

    Many thanks for the plug Patrick.

  2. Bei Jialin permalink
    August 22, 2011 9:21 am

    It seems Michael Gsovski and Mr. Chovanek are old buddies. Mr Chovanek quotes himself as quoted by Michael.

    This is called circular reasoning and diminishes the value of all premises instead of reinforcing the arguments. In fact is affects the entire article. If one does not have the intellectual honesty to refrain from such cheeky inclusions, what other tricks does one have up his sleeve?

    • prchovanec permalink*
      September 11, 2011 6:57 pm

      “Old buddies”? I wonder how you come to that conclusion. In fact, Michael Gsovski interviewed me once, and I have never met or talked to him otherwise. I then quoted and linked to the article in which I was interviewed. He also made several good points unrelated to my own comments, which I thought worth highlighting. How is this so sinister?

      Full disclosure: I’ve met Carl, Victor, and Nigel before. Shocking, I know.

      If you are referring to Minh writing “thanks for the plug,” he works for G+ and I suppose they’re just happy I directed people to the material on their site. Nothing sinister there, either.

  3. Hua Qiao permalink
    August 22, 2011 12:46 pm

    Victor’s piece on corruption is quite sad. I wonder what it will take to eliminate such bad behavior. Obviously, free press is one thing since now, whistle blowers have no place to go. Party reform will be needed to shake the sort of fraternity like expectations of lower level cadres who subordinate their personal gain to earn their stripes with the expectation that when they are Ling dao, they will enjoy the fruits of position.

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