Understanding China's Economy: from Academia to Reality

"A key approach successfully employed by China to reform its economy in the past 30 years is the so-called "crossing the river by touching the stones" approach, a gradualistic method that optimizes policy through experimentation. The government will start with an initial (usually small) policy change, and gradually modify the policy based on the reaction from the economy to this change."  BUT, "Can China continue to use its gradualistic approach in the presence of active financial markets?" In  Brunnermeier, Sockin, Xiong, (AER P&P, 2017) , they provide the theoretical rationale for potential ineffectiveness of gradualistic policy approach with the existence of an active financial market. In align with the well-known time-inconsistency problem (Kydland and Prescott (1977) and Barro and Gordon (1983) ), incentives of front-run by private agents in expectation of ex post non commitment of the policymaker renders the gradualistic approach ineffective. 

Shadow Banking in China receives rising attention from both the press and the academia. In  The Nexus of Monetary Policy and Shadow Banking in China   ( 2018 AER ,  NBER WP23377 ,  NBER WP21890 ), Chen, Ren and Zha discuss the interplay between China's quantity-based monetary policy and commercial banks' reaction in terms of shadow banking activity. In this blog, I highlight their theory and  findings on shadow banking in China. One feature in China's banking system is an institutional division of state and nonstate commercial banks. State banks are state owned and the remaining commercial banks, as a whole represent almost half the size of the entire banking system, are nonstate banks. State banks adhere to the government's own policy against actively bringing shadow banking products into their balance sheet. This is not true of nonstate banks, however. As found in the paper, nonstate banks take advantage of regulatory arbitrage by bringing shadow banking products in

 The failures in East Asian corporate governance are blamed for the East Asian financial crisis.  In East Asia, the predominant form of ownership is control by a family, termed as "crony capitalism", and the top managers are often from the family. In  Faccio, Lang, and Young (2001 AER, citation 1861) , they document ownership and control structures among East Asian corporations and analyze the salient agency problem, namely the expropriation of outside shareholders by controlling shareholders, by looking at dividend behavior. To start with, they show an extraordinary concentration of control in East Asia, whereby 6 groups control more than 20% of the corporations in the 9 most advanced East Asian economies. This control is obscured behind layers of corporations, hence insulated against the forces of competition on less-then-transparent capital markets. However, family control is also predominant in West Europe, though the group sizes are smaller, with 5 groups control about

Cross-country income differences for the most part reflect differences in total factor productivity (TFP) across countries. But what could explain the differences in TFP in different countries? Hsieh and Klenow (2009, QJE, citation 3021) , use establishment level data in manufacturing to measure TFP gaps between China and India and the U.S. They find that misallocation in labor and capital could explain 30%-60% of the TFP differences between developing and developed countries, which means that  China and India have low TFP mainly because that resources are not allocated in the most efficient way. Virgiliu and Xu (2014, AER, citation 571) extend the framework to study the role of financial frictions in determining TFP. They focus on one specific type of misallocation, distortion in capital allocation generated by financial frictions. However, they find that this type of misallocation explains only a small part, 5%- 10%, of the TFP differences. However, financial frictions reduces n

What makes China’s reform, started from 1979, successful? Why they are different from those of Eastern Europe and the Soviet Union? In their paper Why China's economic reforms differ: the M-form hierarchy and entry/expansion of the non-state sector (Economics of Transition, 1993 citation 648), Qian and Xu proposed the “M-Form Economy” theory and argued that it is the essential reason. In this blog, I focus more on the part about China (M-form), the counterpart analysis about Eastern Europe and the Soviet Union (U-form) can be found in the paper. Originated in Chandler (1966) – Williamson (1975) “M-Form” and “U-form” firm theory, the authors contract China’s multi-layer-multi-regional hierarchical economy based on territorial principle (the deep M-form, or briefly, the M-form) with Eastern Europe and the Soviet Union’s unitary hierarchical structure based on functional or specialization principles (the U-form). Under the M-form organization in China, interdependence between re

How to explain the cultural and institutional bifurcations between China and Europe? In their paper Cultural and Institutional Bifurcation China and Europe Compared , Avner Greif and Guido Tabellini ( AER  2010 citation:187) demonstrated that initial distribution of values and social heterogeneity themselves alone could be the reason. Two otherwise identical societies can evolve along different self-reinforcing trajectories of both cultural traits and organizational forms. The collapse of the Chinese Han dynasty and the Roman Empire (after 220 CE) were turning points in the cultural and institutional evolution of China and Europe respectively. Large kinship organizations were common in the former but not the latter and this remarks the distinction in initial conditions. In China, the Han dynasty came to power while advocating Confucianism as an alternative to the Legalism of the previous Qin dynasty. Confucianism considers moral obligations among kin as the basis for social order,