Chinese Economic Reform

In 1978, China formally recognized the deficiencies of Soviet-style planning and adopted a policy to reform its economy (Chow). Through its financial reform, China has embraced a market-based financial system by establishing financial institutions and markets (Ito). The financial reform has aimed to develop the economy by acquiring funds necessary for investment, while simultaneously improving the efficiency of investments by allocating capital effectively (Gen-you). By establishing a central bank, developing a financial market system, and opening the financial market to the global community, China’s financial reform has played an important role in the country’s economic growth.

The establishment of the People’s Bank of China as the central bank has allowed China to conduct effective monetary policy. In the first half of the 1990’s, the Chinese economy experienced impressive growth, averaging a 12 percent growth rate over the five-year period. However, this success was overshadowed by an average inflation rate of 12.9 percent for the period (Gen-you). Inflation coupled with exchange rate fluctuations prompted the People’s Bank to implement a tightening of monetary policy. By adjusting the reserve requirement, the central bank lending rate, and by conducting open market operations, the People’s Bank began targeting money supply (Chow). The result was a Chinese economy with a rapid growth rate and a healthy inflation rate: “Moreover, the retail price and the consumer price plunged to 0.8 percent and 2.8 percent respectively in 1997. Yet China still maintained an 8.8 percent economic growth rate that year (Gen-you).” The ability of the People’s Bank to successfully curtail inflation illustrates that monetary policy has impacted China’s real economic growth.

The financial market system that was developed through the financial reform plays an important role in efficiently allocating capital. China’s capital market has flourished since the 1990 founding of the Shanghai and Shenzhen stock exchanges: “The issuance of government securities, corporate shares and bonds has greatly increased, enterprises have become more dependent on direct financing (Ruogu).” It was estimated into year 2000 that nearly 50 million Chinese invest in stocks and that the market value of the 1121 Chinese companies listed in exchanges worldwide was RMB4.8 trillion. This figure constitutes about 57 percent of that year’s gross domestic product (Ruogu). The increasing importance of the capital markets implies an increase in economic efficiency. Money is transferred from lender-savers to those institutions that have real productive opportunities (T. P. Wong, class notes, Fall 2006). As these opportunities are actualized, the economy grows as a result of the allocation of capital provided by the financial market system.

The financial reform has stressed openness to foreign institutions, a policy that has contributed to China’s economic growth by bringing foreign assets to China. The “opening up” the Chinese economy has encouraged foreign investment and trade (Ruogu). Foreign investment has provided “capital, new technology, managerial skill, and training for labor to China (Chow).” For example, by 2000, 87 foreign financial institutions from 22 countries were present in China. About 70 percent of the capital these banks use originates