Factions and Finance in China: Elite Conflict and Inflation [Hardcover]

Victor C. Shih (Author)

Book Description

Publication Date: December 3, 2007 | ISBN-10: 052187257X | ISBN-13: 978-0521872577 | Edition: 1

How does the Chinese banking sector really work? Nearly all financial institutions in China are managed by members of the Communist Party, yet economists and even those who engage the Chinese banking sector simply do not have a framework with which to analyze the links between banking and politics. Drawing from interviews, statistical analysis, and archival research, this book is the first to develop a framework with which to analyze how elite politics impact both monetary and banking policies. This book serves as an important reference point for all subsequent work on Chinese banking.

Editorial Reviews

Review

"This impressive new book makes several important contributions: the case studies provide never before available accounts of elite politics, with vivid details of the personal and political differences among top leaders; the model of inflationary cycles provides new insights into how financial policy changed to cool an over-heating economy. It is both a fascinating portrait of elite politics in China and a rigorous test of an analytical model. Most scholars are good at one approach or the other. Shih shows he is equally gifted at both."
Bruce Dickson, George Washington University

"Shih offers a political-economic explanation of a dual feature of the post-reform Chinese financial system-an inflationary cycle and a large amount of non-performing loans. This book will make a valuable contribution to understanding the Chinese financial system and the reasons for the lack of reform thereof."
Chung Lee, University of Hawaii at Manoa

"In this forthcoming book, Northwestern University Professor Victor Shih presents a compelling alternate framework for a key slice of Chinese politics-economic and financial policy making. He argues that rather than a duel between conservatives and reformists, Chinese policy making represents a series of compromises between a "generalist" faction that derives support from local provincial authorities vying with a "technocrat" faction supported by central government bureaucrats seeking to consolidate control in Beijing...Prof. Shih presents a statistical model that aims to prove his theory, but the book comes to life when he launches into a narrative depicting the post-1978 struggles among China's political elite...As China's role in buoying the global economy continues to deepen, building a proper framework for understanding that push and pull in elite politics-and using those tools to foresee possible outcomes of Chinese policy becomes essential. Prof. Shih's work makes an important contribution to that effort."
Rick Carew, Dow Jones Newswires, Far Eastern Economic Review

"Shih's elegant factional model provides a novel explanation for the monetary and policy fluctuations under Deng Xiaoping and Jiang Zemin...Factions and Finance in China offers an invaluable window into the workings of elite politics in a regime better known for its opacity, and will soon become a staple in literature on China's contemporary political economy."
Kellee S. Tsai, Johns Hopkins University, Perspectives on Politics

Book Description

Nearly all financial institutions in China are managed by members of the Communist Party, yet economists do not have a framework with which to analyze the links between banking and politics. This book is the first to develop a framework with which to analyze how elite politics impact both monetary and banking policies.

See all Editorial Reviews

Product Details

• Hardcover: 268 pages
• Publisher: Cambridge University Press; 1 edition (December 3, 2007)
• Language: English
• ISBN-10: 052187257X
• ISBN-13: 978-0521872577
• Product Dimensions: 9.5 x 6.4 x 0.8 inches
• Shipping Weight: 1.2 pounds (View shipping rates and policies)
• Average Customer Review: 4.3 out of 5 stars  See all reviews (6 customer reviews)
• Amazon Best Sellers Rank: #2,436,644 in Books (See Top 100 in Books)

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Most Helpful Customer Reviews

19 of 19 people found the following review helpful

5.0 out of 5 stars Engaging and thorough January 1, 2008

By katiek

Format:Hardcover

As someone with some knowledge of China, I picked up this book because the title sounded interesting. Also, I wanted to know more about the financial system in China. It was kind of a whim, but I am so glad I got the book. Dr. Shih provides an insightful and poignant analysis unveiling the deep interdependencies between Chinese banking policy of the last two decades and the evolving political landscape of the Chinese Communist Party. First of all, I learned a LOT about the banking system in China, probably more than I ever needed to know. It's really stunning how much the Communist Party in China still controls the banks. Although parts of the book are too theoretical and pedantic (all the stats!), the book as a whole is nuanced, elegant, and backed by a rich set of primary data, including really detailed accounts of high-level intrigue. I was really impressed that Dr. Shih used classified Chinese government sources to construct behind-the-scene accounts. For example, top level technocrats used anti-corruption campaigns to stop inflation! That's not something you read in the Wall Street Journal. In sum, this book offers experts and laypersons alike a compelling framework for understanding financial policy decisions in China and their longer-term implications. Once you get past all the theory and stats (chapters 4 and 5), it's an engaging read that offers a lot of useful and interesting information about the financial sector and elite politics.

5 of 5 people found the following review helpful

5.0 out of 5 stars Brilliant June 9, 2010

By Awolfe

Format:Kindle Edition

Shih's model is simple and brilliant. Though it complicates the normal factional model that I've seen elsewhere, Shih is convincing in his historical rooting of the actors. The only thing I wish he had explored with a bit more gusto would have been the role that institutionalization of power in China has weakened factional competition, and whether or not this could lead to reform of the financial sector. But even without this, I have to give Shih 5 stars.

4 of 5 people found the following review helpful

5.0 out of 5 stars fascinating! August 1, 2010

By Law student

Format:Hardcover|Amazon Verified Purchase

great look into China's politics and banking, actually explains quite about about China's inability to switch from an export based, dollar propping up economy to a consumer society. This, combined with the more recent articles coming out of China really put to lie the idea that the Communist Party is some cool, calculating entity that is able to think 10 moves ahead of the decadent and shortsighted West.

1 of 1 people found the following review helpful

5.0 out of 5 stars Mancur Olson would be proud May 13, 2011

By AlexT

Format:Paperback|Amazon Verified Purchase

Factions and Finance is a fascinating bridge from understanding politics in China to understanding monetary and fiscal policy. The two could not be more closely linked in China as they are in most countries: ultimately, Central Bankers get appointed by politicians, have dual or convoluted mandates and tend to have a strong sense of where their bread is buttered. To that end they are pretty responsive to politics and Central Bank independence really depends upon the political pressure being manageable. This was a controversial idea when I was in university but its abundantly clear now with negative real rates in the US, troubles in Europe and the like.

Vic Shih draws upon extensive work on factional allegiances and policies in China to explain the core dialectic of Chinese monetary and fiscal policy: local government leaders get promoted and occasionally paid for growth in their region and do not care about inflation or fiscal solvency that much. The central government and central bank does, and the fate of provincial mayors is not their concern. Factional allegiances are drawn up accordingly and the ebb and flow of these groups' priorities and patronage networks drive most of policy.

Mancur Olson's Rise and Decline of Nations explains how interest groups ultimately become important, stagnate and then impair policy. I think there are lessons for this in China today and to get a full grip on them there really isn't anything else out there as good as this book.

5.0 out of 5 stars The Foundations of a Planned Chinese Monetary System April 1, 2013

By James R. Maclean

Format:Paperback

Shih's book is a very clear, well-researched explanation of the dynamic driving China's reforms. It is especially good as a companion to Yasheng Huang, Capitalism with Chinese Characteristics, Cambridge University Press, (2008). Where Huang laments that China's reforms imploded in an orgy of statist meddling, Shih allows us to see the compelling motivations for why reform took the path it did.

According to Shih, the many committees of China are naturally divided into factions. There are many of these, but we are interested in two categories of factions, the "generalist" and the "technocratic" (both of which are, after a fashion, reformers). The generalists belong to regional groupings, such as first secretaries in provincial governments (1) or the mayor of Shanghai. The generalists favor an aggressive developmentalist agenda, with decentralized control over the money supply; the technocrats, represented by members of the State Council, favor centralized control over the money supply. Until quite recently, the contest was over control of the People's Bank of China (PBoC), the central bank and one-time universal bank (2). The PBoC, like the early Federal Reserve (1913-1933), was decentralized, with provinces having considerable influence over the money-creating powers of their branch.

During the first phase of the reform period, the two leading reformers were Deng Xiaoping and Chen Yun; both were major figures of the Chinese Civil War (1947-1949) and architects of the planned economy (1949-1957), and both were purged in the Cultural Revolution (Deng, twice).... Deng led the largest faction of market reformers in the Central Committee, while Chen led the main technocratic faction. The two were in agreement on many issues, but beginning in 1980, Deng waged a struggle within the Central Committee for more investment, while Chen warned that the PBoC had lost control of the money supply. Initially, Deng won the stuggle, but in November, severe inflation struck and Deng had to capitulate to Chen.

Additional non-victories for Deng were his appointment of ally Hu Yaobang and later Zhao Ziyang to leadership of the party. Both Hu, and later Zhao, broke with Deng while serving as premiers. Western observers like Ezra Vogel (Deng Xiaoping and the Transformation of China, p.578) cast the rupture as arising from Hu and then Zhao's support for political liberalization--which Deng vehemently opposed. Shih argues that the real reason was that Hu had failed to impose fiscal discipline on the provincial governments, and Zhao had flooded Guangdong Province with all manner of local control over central government subsidies. Hu's, and more urgently, Zhao's, fiscal and monetary recklessness were extremely dangerous to the integrity of CCP rule, not to mention price stability. And in fact, China did suffer an episode of galloping inflation that culminated in the Tienanmen Square incident (June 1989) and a three year recession.

The main development was the final apparent victory of Deng, in getting his next protégé Jiang Zemin (mayor of Shanghai) chosen as General Secretary of the CCP. Soon after, Jiang succeeded Yang Shangkun as President. But Zemin would prove to be much more ideologically aligned with Chen Yun, to the point of practically restoring central planning. At the same time, his government used skillful PR to create the illusion of continued reform (3).

In the years since then, the Chinese authorities have vigorously strengthened centralized control over the money supply and the issuance of securities. One could argue that this consolidation of CCP Politburo control has paved the way for future Chinese financial hegemony.

ADDITIONAL NOTE: WHY CHINA STERILIZES ITS RESERVES

Allegations that the PRC manipulates the renminbi's exchange rate are a staple of political punditry. In point of fact, the real effective exchange rate (REER) of the RMB has risen, while the REER for the USD has fallen in recent years. As with any pair of currencies, there is a large gap between the purchasing power parity (PPP) and the exchange rate; as of this writing, the gap for the RMB:USD was actually not huge, so this has practically become a moot point (4).

China's currency is managed by the People's Bank of China (PBoC). Generally speaking, deposits of US dollars in the Chinese banking system (or, indeed, any banking system) can serve as reserves for the bank, allowing it to lend more money. Over the last 35 years, China has suffered about five distinct inflationary episodes, all short, and all arising from decentralized money creation (i.e., the provincial branches of the PBoC responded to pressure from provincial governments to create ample money for developmental projects). Monetizing foreign currency reserves would flood the banking system with cheap money and trigger the worst inflationary episode yet.

The alternative strategy, used by the PBoC, is to repeatedly increase the reserve requirement for banks. In a Western banking system, the reserve requirement is usually around 3% of deposits, or a bit less. In China it reached a high of 21.5% in June 2011. However, this could only go so far in restricting inflation. The PBoC issued bonded debt in itself (central bank bills) to soak up the liquidity in the system, then used the money raised by the bills to recapitalize the Big Four Banks--which suffer from an amazingly large portfolio of non-performing loans (NPLs).

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NOTES

(1) China has a State Council, analogous to the executive branch of the US government; and it has the Chinese Communist Party (CCP), with a bureaucratic system of leadership (i.e., the top leaders appoint subordinates and replacements for themselves when they retire/die.) All State Council are also members of the Central Committee, the 180-200 member body that formally controls the CCP. However, only 25 members of the Central Committee are members of the Politburo, and only 7 of those are members of the Standing Committee of the Politburo. The 1st Member of the Standing Committee is also the President of the PRC. The 2nd member of the Standing Committee is also the Premier of the Republic, i.e., head of the State Council. Source: People's Daily website

Apart from the topmost positions, there is less overlap. Two of the 7 Standing Committee Members hold no position in the state government; two more are legislative officers. Conversely, Wang Yi, the Foreign Minister of China (and high-ranking member of the State Council) is not a member of the CCP Politburo, although he is a member of the CCP Central Committee. Governors of provinces correspond to minsters in the State Council in rank, although it is rare for a governor to be a Politburo member. Source: China Vitae website.

(2) After 1978, the PBoC was reorganized to serve as a central bank, rather than the one single bank of China. The banking system of China is dominated by the four state-owned banks (Bank of China, ABC, CCB, and ICBC) and their asset management corporations (AMCs). As late as 2004, the Big Four accounted for 60% of lending (Shih-2008, p.39-45).

(3) Walter and Howie (2011) , pp.176-184, explain how this was done with the assistance of Western investment banks:

(Quote)

Red Capitalism, p. 178: In October 1997, and despite the evolving Asian Financial Crisis, China Mobile (HK) Co., LTD, completed its dual New York/Hong Kong IPO raising US$4.5 billion--some 25 times the average size of the 47 overseas-listed companies that had gone before. This kind of money made everyone sit up and pay attention: underwriting fees alone were said to be over US$200 million. If China was, in fact, full of [only unsuitably] small companies, as the earlier international and domestic listings show, there where had this one come from? [...] China Mobile represented the consolidation of provincially owned and run industrial assets into what is now commonly called a "National Champion." This transaction demonstrated to Beijing how it could overcome the regional fragmentation of its industrial sector and, with huge amounts of cash raised internationally, create powerful companies with national markets.

(Endquote)

In effect, the Chinese industrial sector received a makeover that preserved the state control and patronage, but adopted the trappings of modern financial capitalism.

(4) According to the IMF, the PPP is RMB 4.28 per US dollar, instead of the current RMB 6.21:USD ratio in forex markets. See 2012 World Economic Outlook Database, purchasing power parities data. As of this writing, the RMB exchanges at a 31% discount to the USD, which is actually not at all unusual for a developing economy. India's rupee trades at a 58% discount. The USD trades at a 10% discount to the euro. Read more ›