Political Hierarchy and Finance: The Politics of China's Financial Development

Abstract

This chapter presents a political explanation for China’s financial development since it initiated market reforms in 1978. The argument focuses on the implications that arise from party officials’ incentive to meet specific economic growth targets for their jurisdiction (village, town, city, provincial, or national) in order to be promoted. This promotion incentive leads political officials to exploit the financial system to generate higher growth for their specific jurisdiction while diffusely spreading the costs onto the broader Chinese society. As the jurisdiction of a Chinese Communist Party leader increases from the local to the national level, the ease of achieving economic growth by passing costs off onto others diminishes. In other words, distributive welfare calculations give way to aggregate welfare calculations. Thus, when total costs generated by local political incentives reach crisis levels, national leaders must act before a genuine economic crisis ensues, creating the possibility for dramatic financial reforms which tend to occur in conjunction with leadership transitions.