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The authors would like to thank Ray Brooks, Nick Lardy, Huayong Ge, Albert Keidel, Eswar Prasad, Gang Yi, and participants at an IMF seminar, the inaugural meeting of the National Bureau of Economic Research (NBER) Working Group on the Chinese Economy in October, 2003, and a conference at Hong Kong University for very useful comments. The views expressed are the authors’ own, and do not represent those of the World Bank, the IMF, or their respective policies.
Although the question of financial integration has not been studied, the question of the efficiency of capital allocation in China has been analyzed by Park and Seht (2000); Cull, Shen, and Xu, (2002); and Cull and Xu (2000).
Using data from provincial level input-output tables, Naughton (2000) documented an increase in the inter-provincial shipment of goods in the 1990s relative to their GDP; suggesting that goods market integration is likely have increased. On the other hand, using similar data but embedding it in a gravity-model specification, Poncet (2001) showed that the level of intra-provincial trade in China appears too high relative to the model prediction; suggesting the presence of barriers to goods trade at the province-level.
For a description of local government interference in enterprise mergers, see the excellent institutional review of China’s capital market developments in China since 1949 in Yi, 2003.
As part of China’s open door policy, special areas with special tax incentives (mainly under the form of lower enterprise tax) were created. Tax exemptions were aimed primarily at attracting foreign investment. Domestic enterprises often benefit from these fiscal incentives, either automatically or on a discretionary basis.
More recently, the government has initiated a new policy focusing on the development of the western region as an attempt to re-equilibrate China’s regional development which previously had been overwhelmingly favorable to the coastal region. This new policy launched in 2000 has two main components: the development of infrastructure with the central government investing in the region and the extension of fiscal incentives to the western provinces.
China’s banking system is composed of the People’s Bank of China—China’s central bank; four state-owned commercial banks, established in the early 1980s; three policy banks set up in 1994, ten national joint-stock commercial banks; around 90 regional commercial banks, and about 3,000 urban and 42,000 rural credit cooperatives. Foreign banks have branches or representative offices, but their activities are still limited. The four state-owned commercial banks—dominate the market.7 As of late 2001, they accounted for 63.1 percent of loans outstanding and 61.5 percent of deposits. They also dominate in terms of branches and employees: nearly 2 million people are employed in about 103,000 branches across China.
Park and Sehrt, 2000.
Local interbank markets were permitted between 1986 and 1993. Bank branches were able to lend funds to branches in other provinces. However, it also became a mean for balancing the surplus and shortage of medium and long term funds. For instance, coastal open areas borrowed from inland areas large sums of money for long term financing purpose to make up for local fund shortage (Xie Duo, 2002). It also became a mean for state banks to circumvent credit quota and lend to non-banking financial institutions for speculative purposes (investment in securities and real estate industry), and thereby fueling inflation. Hence, as part of the retrenchment policy implemented in 1993, interbank trading was suspended, with the exception of trading center run by PBC branches in 35 cities.
Starting in 1994, credit ceilings applied only to state banks and more importantly, these ceilings were no longer administratively determined, but based on a maximum ratio between loans and deposits that applied only to total national lending by individual state banks (all branches if a national bank are counted together). In January 1998, the annual credit quota system was officially abolished The central bank now relies mostly on tools such as manipulation of interest rates, required bank reserves and asset-liability ratios, credit assessments, discount rates and, increasingly, open-market operations to control the money supply.
New commercial bank law enacted in 1995.
The People’s Bank China became in 1984 the central bank of China responsible for designing and conducting monetary policy. Lardy (1998) defines “excess lending” as measured by the amount of loans extended above and beyond the amount that would have been extended if the loan to deposit ratio was equal to the national average. According to this measure, excess lending was as much as 8 percent of provincial gross domestic product in Heilongjiang in 1993 and the “under lending” in Guangdong averaged 7.5 percent of provincial GDP in a five year period.
In May 1994, local PBC branches were prohibited from relending to state banks in their locality. The PBC instead directed refinancing to the national headquarter of state banks which redistributed them to local branches based on approved plans. Since July 1993, only the central bank’s headquarters has been permitted to lend to the head offices of banks. Furthermore, at the end of 1998, the PBC was restructured to reduce further the local influence on lending. Its 31 provincial branches were cut back to nine regional ones, which report directly to PBC headquarters.
Source: The People’s Bank of China Quarterly Statistical Bulletin, 2002:4. pp. 78–79. The flow of funds accounts encompass all financial transactions among domestic sectors and between domestic sectors and the rest of the world. The terms “uses” and “sources” reflect the changes in financial assets and financial liabilities of each sector. They are available since 1997 onwards.
Note that local protection in the goods market and current account target are not the same thing.
The provinces of Jianxi, Guangdong and Hainan, Sichuan and Chongqing and Ningxia have been excluded for the pre-reform period because of lack of data.
We have tested for the order of integration of the series using panel unit-root tests (Im, Pesaran, and Shin, 1997). Both investment and saving rates are stationary.
We also investigate the presence of structural breaks in the series over the 1990s.
The data of investment and saving for OECD member countries come from the United Nations National Accounts Statistics and are available from 1960 onwards.
Some of the provinces constitute a non-trivial fraction of national saving and investment. We therefore use rest of the country instead of national aggregates in order to avoid distorting the correlations upwards.
We use HP(100) filtered log(province GDP) minus HP(100) filtered log(national GDP).
For instance, Obstfeld (1994) notes that among the G-7 countries over the period 1951 to 1988 there has been a tendency for domestic consumption to become more closely correlated with the world consumption
The intra-national risk-sharing literature has used regional data within Canada (Crucini (1999) and Bayoumi and McDonald (1995)), Japan (van Wincoop (1995)) and the United States (Atkeson and Bayoumi (1993), Crucini (1999), Hess and Shin (1997), Asdrubali, Sorensen, and Yosha (1996).
Finally, consumption-based tests that do not assume asset market completeness provide a more realistic framework for assessing the degree of financial integration on the basis of risk-sharing theoretical predictions.
Consumption and GDP series come from the 2001 A11 China Marketing Research database (see appendix for a description of the data). Some of the provinces constitute a non-trivial fraction of national output. We therefore use rest of the country instead of national aggregates (e.g. we exclude the province’ contribution) in order to avoid distorting the sample correlations upwards.
Year effects are not included as they would be correlated with the aggregate consumption variable.
As emphasized by Obstfeld, this framework is closely related to the investment-saving test for capital mobility. In addition, we also introduced aggregate output growth as a regressor and obtained very similar results.
See statistical annex for a description of the method used to compute provincial capital stocks and productivity.