Tuesday, January 31, 2006

Is Too Much Capital in the Hands of the Chinese Government?

Arnold Kling at Econblog wrote:

"At lunch last week, Tyler Cowen and I both expressed pessimism about China. Our view is that the state appears to control too much capital." Read the whole thing here.

If one just looks at the amount of savings in the vaults of the 4 largest state-owned banks (the funds of course are owned by the public but the presumption is that the state-banks still are not motivated to allocate the capital to the most valued uses), the capital embodied in state-owned enterprises and the forex reserves in the hands of the Chinese government, the above statement made by Cowen and Kling made a lot of sense. But they forget the other side of the coin, the amount of capital that is not controlled by the government.

Indeed, private entrepreneurs in China rely heavily on informal financial institutions for their working and start-up capital. John Hopkins scholar Kellee Tsai is an expert in this area, read her paper here and you may also want to get her book on the same topic.

There is no denying that the capital now in the government's hands is a contraint on growth, but it has been that way ever since reform started in 1978 and this fact has not prevented the 9% annual average growth rate for the past two decades from happening. In other words, growth in China has occured for the two decades since reform despite the fact that the government has a lot of capital in its hands. And with the listing of the state banks on the capital market, the situation will certainly improve in the future.

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