Finance professors rush to China

2006 seems to be a Year of China for economics and finance professors. Although many professors already realized the importance of China very early on, it is in this year that people start to think that the next research frontier has to be China, and you better start working on some China-related topics before others publish them. Professors are no different from multinational corporations that rush to China to seek for profits.

A keystone is that the Financial Intermediation Research Society, a prestigious association of U.S. and European finance professors, headed by Wharton Professor Franklin Allen, decided to host its biennial conference in Shanghai, China.

Here I recommend two papers by Franklin Allen that I think can help you better understand the past, present and future of China’s financial system. They are not very technical papers, so you shouldn’t need any academic background to understand them.

China's Financial System: Past, Present, and Future  (pdf file) (by Franklin Allen, Jun "QJ" Qian, and Meijun Qian)

Abstract:  We examine and compare the role of China's financial system in supporting the growth of firms and the economy with that in other countries, and explore directions of future development. First, we find that the current financial system is dominated by a large but inefficient banking sector, and reducing the amount of non-performing loans among the major banks to normal levels is the most important objective for reforming the financial system in the short run. Second, despite the fast growth of the stock market, its role of resource allocation in the economy has been both limited and ineffective. Further development of China's financial markets is the most important long-term objective. Third, we find that the most successful part of the financial system, in terms of supporting the growth of the overall economy, is a non-standard sector that consists of alternative financing channels, governance mechanisms, coalitions, and institutions. This sector should co-exist with banking and markets in the future in order to continue to support the growth of the Hybrid Sector (non-state, non-listed firms). Finally, in order to sustain stable economic growth, China should aim to prevent and halt damaging financial crises, including a banking sector crisis, a real estate or stock market crash, and a "twin crisis" in the currency market and banking sector.

Law, Finance, and Economic Growth in China  (pdf file)

Abstract:      China is an important counterexample to the findings in the law, institutions, finance, and growth literature: neither its legal nor financial system is well developed by existing standards, yet it has one of the fastest growing economies. We examine 3 sectors of the economy: the State Sector (state-owned firms), the Listed Sector (publicly listed firms), and the Private Sector (all other firms with various types of private and local government ownership). The law-finance-growth nexus established by existing literature applies to the State and Listed Sectors: with poor legal protections of minority and outside investors, external markets are weak, and the growth of these firms is slow or negative. However, with arguably poorer applicable legal and financial mechanisms, the Private Sector grows much faster than the State and Listed Sectors, and provides most of the economy’s growth. This suggests that there exist effective alternative financing channels and governance mechanisms, such as those based on reputation and relationships, to support this growth.