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