Trial and error in China

The roller-coaster ride of the Chinese stock market came to a halt after the government jammed the brakes on its downward spiral. The extent of the government’s heavy-handedness, however, raised troubling questions.

The Chinese authorities were resented and criticized by retail investors when the free fall didn’t stop even after the main index on the Shanghai bourse lost more than 30 percent in just three weeks from June 12 despite a combination of actions, including an interest rate cut, easing of restrictions on debt-based stock investment and a ban on short selling.

So they took the kind of stronger measures that are only possible in state-controlled economies: prohibiting stock sales by controlling stake-holders (largely state-run enterprises) and providing unlimited financing for stock purchases.

The draconian intervention by the Communist Party worked, but critics believe the actions will undermine market mechanisms and investor confidence in the Chinese bourse down the road.

It is hard to draw the line at how much state authorities can interfere in a market. The government should be fully responsible for public services like security and defense. If private consumption and corporate investment is tepid and there are concerns about high unemployment, authorities should lower interest rates and expand fiscal spending to prop up the economy.

Economists, however, differ on the extent of government intervention in markets. Governments’ actions to reduce bubbles in real estate and stock markets are often disputed.

There is no panacea or perfect economic prescription. Different economies require different government roles. Intervention depends on the developmental stage of an economy, level of market maturity and capabilities of policy makers.

The so-called Washington Consensus dominated the global order in the 1990s through opinions from Washington, where the U.S. government and international organizations were based. Their prescription based on market capitalism advocated free competition, privatization, liberalization in trade and capital and minimum government intervention.

With the rise of China, the so-called Beijing Consensus challenged the pro-market views of Washington. China, run by a single Communist Party, champions a hybrid economy in which extensive state control exists with gradual liberalization and partial private ownership of assets and capital.

Chinese chauvinists have been selling the Chinese model to developing countries awed by the staggering turnaround the country has enjoyed over the last two decades. But no one can say which economic ideology is ideal for a country.

It was not quintessential or unique Chinese characteristics that drove the country’s spectacular ascent. A high degree of consumer savings, trade opening, excellent human resources, sold fiscal integrity and recognition of private ownership played the greater parts in fueling growth.

China’s development model is not much different from other Asian countries including Korea in the early industrialization stage driven by authoritarian governments.

Economists are mixed in their opinions of the governmental role in intervening in the economies of East Asia. Many agree that government-led policies to support manufacturing industries and exports have helped propel growth. But there were many failures when the government intervened too much, especially to foster individual industries.

Excessive meddling in the financial sector can lead to reckless lending, bad loans and a financial crisis. It is not only how much a government gets involved - it is how well it does it.

What would have happened if the Chinese government sat on its hands and let the market tank? Since the stock market and financial system still account for a small amount of the colossal Chinese economy, it would not have made a major dent on overall economic performance.

Because retail investors make up the bulk of stock investors, they would have been disappointed and lost faith in authorities. But at the end of the day, the investors would have learned a lesson from their irrational reckless investments and the lesson may have curtailed moral hazard in the future.

The stock fiasco, however, exposed potential dangers in a Chinese economy saddled with snowballing debt and slowing growth. According to McKinsey Global Institute, China’s total debt has reached 282 percent of its GDP last year, outpacing the U.S.’s.

Loans from unregulated shadow financial institutions reached 65 percent of the GDP. Many believe the world’s second largest economy has underperformed its official growth rate of 7 percent in the first half.

The Chinese government has been focusing on mid and long-term restructuring to improve domestic industries, privatize state enterprises and liberalize the financial sector since last year. The government will have to rely on trial and error to push ahead with modernizations and reforms.

The government response may not work as it did before because the economy has become bigger and more unpredictable. We just have to hope Beijing has studied the failures of Japan and Korea in detail to deal with its challenges wisely.

Translation by the Korea JoongAng Daily staff

JoongAng Ilbo, July 24, Page 31

*The author is an economics professor at Korea University.

by Lee Jong-wha