Should The Proud Dragon Repent? A Relative Theory for China’s State Capitalist Banking Sector Based On East Asia’s Experience

Abstract

Amidst the U.S.-China trade war, China’s banking sector, the backbone of China’s economy, plays a key role in this battle. China’s banking sector, however, poses a puzzle to contemporary studies of state-owned banks (“SBs”). According to the property right theory, the mainstream SB theory, SBs are negative for the financial and economic development of an economy because it is susceptible to more serious agency problems, excessive political intervention, and conflict of interest between state regulators and state owners. That said, the economic success of China, whose banks are mostly owned and controlled by the Chinese party-state supports the development theory, a minority theory that highlights the development function of SBs in mobilizing domestic investible funds to support strategic industries.

To have a clearer understanding of China’s banking sector, I engage in the debate between the property right theory and the development theory by comparing the experience of four East Asian developmental states, Japan, South Korea, Taiwan, and Singapore. After comprehensively reviewing the banking evolution in these economies, I put forward a “relative theory” to account for SBs. I argue that the relative success and failure depends on the relative efficiency of the state sector vis-à-vis the private sector in promoting development. In the early stage of an economy’s development, the private sector might have collective action problems to come up with a coherent development policy for the economy; hence, the state sector is relatively better positioned in allocating the investible fund, and its ownership of banks thus promotes development. Nevertheless, as an economy develops and the corresponding institutions mature, the private sector might become relatively more efficient in allocating the investible fund, which demands the state to reduce its intervention in the banking sector. According to this relative theory, the success of China’s SBs in promoting economic development might not be sustainable. At some point, the Chinese party-state would need to readjust its role. That said, this does not necessarily lead to the privatization of SBs in China. As East Asia’s experience suggests, there may be a variety of ways for China to transition to a banking system that is less dominated by the party-state. The current trade war might offer this turning point as it evolves into a finance war.

Keywords: state-owned banks, property right theory, development theory, developmental states, China, East Asia