Advancing Chinese financial research through theoretical innovation

BY ZHANG XIAOJING | 01-06-2022
(Chinese Social Sciences Today)

A vending machine which sells fresh ground coffee and requires customers to pay with electronic Chinese yuan, or e-CNY, was on display at an expo in Beijing on Sept. 6, 2021. Technology-driven financial innovation can promote the healthy development of new financial businesses. Photo: CFP

Advancing theoretical innovation is an important historical experience of the CPC’s endeavors over the past century. There is a general agreement that theory will be alive if it is continuously innovated. The development of Chinese financial research in the new era necessitates constant theoretical innovation to make novel, greater progress in absorbing the nourishments of theoretical traditions, interpreting development myths, and understanding Chinese characteristics. 

Traditional monetary thoughts
The Chinese nation features a profound cultural tradition. Its distinctive thought system reflects Chinese wisdom and the spirit of critical thinking fostered over thousands of years. Traditional economic and financial thoughts constitute a treasure house for today’s Chinese financial research to absorb nourishments. 
Wang Maoyin (1798–1865), a monetary theorist from the Qing Dynasty (1644–1911), was the only Chinese mentioned by Karl Marx in his Das Kapital. When alluding to inconvertible paper money issued by the state and having compulsory circulation with immediate origin in metallic currency in the “Money, Or the Circulation of Commodities” chapter, Marx said, “The mandarin Wan-mao-in [Wang Maoyin], the Chinese Chancellor of the Exchequer, took it into his head one day to lay before the Son of Heaven [the Emperor of China] a proposal that secretly aimed at converting the assignats of the empire into convertible bank-notes.” 
Marx was supportive of Wang’s proposal of issuing convertible paper money as a measure to ease fiscal crises. As he said in the Economic Manuscript of 1857-1858, “Convertibility into gold and silver is therefore the practical measure of the value of every paper currency denominated in gold or silver, whether this paper is legally convertible or not. A fall of real value beneath nominal value is depreciation.”
In 1912, famed British economist John Maynard Keynes wrote a review essay on The Economic Principles of Confucius and His School, which was authored by Chinese thinker Chen Huanzhang (Chen Huan-chang, 1880–1933), to recount the Chinese monetary system and thought. Keynes pointed out that Chinese scholars knew about the logic of  “Gresham’s Law” [bad money drives out good money] as well as the Quantity Theory of Money much earlier than Westerners. 
For example, in the commentary essay “Coinage,” Western-Han thinker and statesman Jia Yi (200–168 BCE) asserted that “debased money gradually drove undebased money out of the market,” approximately 2,000 years before Gresham’s Law was proposed.
The “light-heavy theory” (Qingzhong Lun) recorded in Guanzi, an ancient Chinese political and philosophical text named for and traditionally attributed to pre-Qin philosopher and politician Guan Zhong (c. 723–645 BCE), is the earliest and simplest quantity theory of money. It states that if nine tenths of all money is controlled by the state and only one tenth is in the hands of the people, the value of money will go up and the price of “tens of thousands of” goods will come down. If the government purchases the goods with the nine tenths of all money, then most currency will be controlled by the people, and prices of these goods will “go up ten times.”
Peng Xinwei (1931–), renowned Chinese monetary historian, also noted that Legalists in the Han Dynasty (206 BCE–220 CE) regarded currency as worthless per se, and currency circulation was advocated or mandated by the emperor or the state. This Legalist theory is similar to the Modern Monetary Theory (MMT) championed by Western economists including Georg Friedrich Knapp. 
All of the above views originated from economic and financial practices in traditional Chinese society and are significant sources of thought for Chinese financial research. 
China’s development myths 
Compared to mature market economies, China’s financial development is undoubtedly underdeveloped and inefficient. Though not advanced and not yet efficient, Chinese financial practices have fueled economic growth by channeling savings into investments, and thus contributed to long-term financial stability without a systemic financial crisis since the PRC’s founding in 1949. 
When it comes to economic growth, only 13 economies in the world have managed to achieve sustained, rapid growth after WWII. By comparison, China’s economic expansion has lasted the longest time and is the fastest in terms of average growth rates. Multiple factors attribute to China’s unusual success, and finance has undoubtedly played a crucial role. Relying on the high-saving and high-investment model, the financial system dominated by the development-oriented government can rapidly mobilize resources and robustly bolster China to catch up with advanced economies. 
The absence of financial crises in contemporary China is another “myth.” This can be explained by at least the following three factors. First, the Chinese economy’s rapid growth has relieved pressure on the financial system. China is good at solving problems amidst development. Following an economic catch-up model, especially during extensive development in the early stage of reform and opening up, inevitably accumulated plenty of financial risks. Nonetheless, high growth eliminated the problem. In the 1990s, for instance, the Chinese banking system faced technical bankruptcy, but as the government decisively spun off bad loans, the economy recovered its strong growth, thereby effectively solving the banking crisis. 
Second, the Chinese government presents robust balance sheet positions, which has become an anchor for macro-financial stability. Data from the Research Center for National Balance Sheet at the Chinese Academy of Social Sciences shows that the Chinese government owned nearly one fourth of the net assets of the whole country in 2019, a much higher percentage than in major developed economies. For example, the net assets of the US and UK governments were negative, and the Japanese, French, and Canadian administrations only possessed 0 to 5% of the total net assets. 
Moreover, progressive opening-up and preparations for worst-case scenarios have enabled China to hold the bottom line in terms of systemic financial risks. Compared with opening-up in industry and trade, China opened the financial sector in a progressive and prudential manner. Necessary capital control is the firewall of financial stability and security. Bottom-line thinking has raised risk awareness, including intensifying and improving regulation, enhancing financial resilience, and maintaining high foreign reserves in case of emergency.
Chinese characteristics
The logic of financial development in China is determined by the comprehensive logic of the country’s economic growth. Economic catch-up is the starting point for this logic, which entails the completion of dual tasks: transformation and development. A series of financial institutional arrangements, policies and measures, and the resultant Chinese practice in financial development can only be reasonably explained within the framework of the dual tasks. 
First, it is important to recognize that financial repression and financial catch-up coexist. Financial repression refers to different forms of government interventions in interest rates, exchange rates, fund allocation, major financial institutions, and cross-border capital flow. According to mainstrean economics, financial repression is a distortion that will lead resource allocation to deviate from its optimal state. 
However, understanding will be renewed if financial repression is placed in the context of China’s financial catch-up. Experience has shown that in the early development stage when the financial market was immature and funds for industrialization were in great demand, moderate financial repression could effectively mobilize resources and accelerate economic growth, so it can be considered a “favorable distortion.” However, as China is developing toward the ranks of high-income economies, phasing out financial repression and correcting financial distortions are vital tasks in supply-side structural reform to the financial sector. 
Financial catch-up means expanding the financial sector and developing financial technology. Generally speaking, financial repression will inhibit financial catch-up, but in China, the former has expedited the latter. The key to understanding this paradox is that, financial repression has resulted in a government-led but less diversified financial system, bringing about a dualistic pattern of formal and informal systems. Financial innovation, particularly as a result of financial technology, can break the dualistic pattern, promoting the healthy development of the informal system that includes shadow banking, alongside new financial businesses exemplified by big tech corporations’ ventures into the financial sector. 
Financial catch-up can be regarded as a breakthrough to financial repression. It leverages the development of financial technology and financial regulation which tolerates financial repression, presenting a new perspective from which to observe China’s financial development. 
Second, debt expansion and asset accumulation happen at the same time. The process in China differs vastly from those in major developed economies. While government debts in developed nations are mostly used for social security, transfer payment, and the subsidization of low-income groups, thus failing to form corresponding assets, the debts of Chinese local governments, including many financing platforms, are for the purposes of investment and infrastructure construction. Hence debt growth and capital formation are synchronous, which is obviously a salient feature of Chinese finance’s support in economic catch-up. 
Furthermore, the path of development financing has been carved out between the government and the market. Although developed countries have provided rich experience since the Industrial Revolution, the market as an invisible hand seems to lack the ability to independently address the problem of raising mid- and long-term funds. The predicament facing developing countries, whose policy priority should be lending funds for development purposes, is long-standing, because investments in such fields as infrastructure are typically marked by large scale, long construction periods, no immediate effects, and delayed cash flows. Obviously, such investments require stable long-term financing vehicles. 
China’s development financing emerged against this background, blazing new trails between the government and the market with the aim of serving national development strategies. Indeed, by relying on state credit, China follows the principle of breaking even with small profits in the application of funds, and with a market-based operational model. Thus, development financing with Chinese characteristics has supported China’s economic catch-up and helped create a financial miracle. 
Finally, with a problem-oriented mindset, the theoretical innovation of Chinese financial research aims to provide guidance on creating a symbiotic ecosystem for the joint development of economy and finance, on coordinating financial development and security, and on adhering to the people-centered outlook on financial development by improving inclusive finance, practicing the Environmental, Social, and Governance (ESG) investment philosophy, and promoting the regulated development of markets. 
Zhang Xiaojing is a research fellow and the director of the Institute of Finance & Banking at the Chinese Academy of Social Sciences.