The U.S. Senate will almost surely approve permanent normal trade relations (PNTR) this summer, paving the way for President Clinton to cast a favorable U.S. vote for China’s entry to the World Trade Organization before the end of the year.
Both China and the United States will benefit from more Open trade. New wealth will be created as firms, investors and workers profit from their comparative advantages and as consumers are better served. Along with the increased volume of trade will be an increased demand for financial and other services.
Western banks and non‐bank financial institutions stand to benefit handsomely from their specialized knowledge and technological advantages. And, since every market exchange is two‐sided and requires consent, gains for Western firms imply gains for China. PNTR and WTO accession, therefore, are good for China and for its trading partners.
If the PRC meets investors’ expectations about greater market access and more secure property rights, foreign investment in China will continue to expand, and the flow of new capital will create opportunities for millions of Chinese to increase their standard of living. The Chinese people will demand banking, investment, insurance and other financial services‐from both foreign and domestic firms‐and they will become increasingly intolerant of government policies that limit their investment choices and “cannibalize” their savings.
The dismal condition of China’s state‐owned banks, which Are burdened with the nonperforming loans made to state‐owned enterprises (SOEs), cannot be improved without the discipline of foreign competition. Just as non‐state industrial firms have been allowed to grow spontaneously, private banks and financial institutions must have the freedom to develop if China is to improve its allocation of scarce capital and achieve healthy long‐term growth.
What China needs is not “socialist capital markets” but Real capital markets with private owners who can specialize in Risk taking, who can freely capitalize expected future profits Into their present values by selling shares on organized stock exchanges and who are held fully responsible for losses. That means prices, including interest rates, must be determined by the free market, not by the Chinese Communist Party (CCP).
If the mainland is to become a major player in the global economy, it must stand by its commitment to liberalize its financial sector upon accession to the WTO. That means, according to the Accession Agreement, that, within five years after China accedes to the WTO, U.S. and foreign banks should have full access to the local currency market: They should be able to deal directly with Chinese citizens and business firms in renminbi, they should be able to establish branches throughout China, and they should receive national treatment (i.e., the same treatment as domestic banks).
Any backsliding from those commitments will send a signal to the global financial community that China is not to be trusted. Capital will leave the mainland and flow to places where it is protected by the rule of law.
Granting China PNTR and bringing it into the WTO will encourage Beijing to conform to international norms and move closer to the rule of law. But no one should be under the illusion that the adjustment process will be easy or fast.
Hong Kong and Taiwan can show China the way toward the free market and a more open society, and the Internet and international trade can show the Chinese people that freedom is valuable in its own right, in addition to being a means to greater wealth. But, in the end, the Chinese people themselves must determine the course of their nation by the choices they make.
China’s financial future will depend on the steps that are taken in the next several years to restructure state‐owned banks and enterprises. Allowing greater foreign competition will play an important role in transforming the financial landscape, but ultimately the only way to efficiently allocate capital and de‐politicize investment decisions is to privatize banks and SOEs.
The growing enthusiasm of Chinese President Jiang Zemin For equity markets should not be misconstrued. He and his supporters have not suddenly become capitalists. They simply recognize that tax revenues are not sufficient to bail out insolvent banks and firms. Oddly, they see equity markets as a socialist tool for raising capital to “revitalize” state‐owned banks and SOEs.
The plan is to allow some islands of private ownership in A sea of state ownership. The state would retain majority ownership and control of the key financial and industrial firms it puts on the market. Those who invest in such firms will have attenuated private property rights and trade in pseudo, not real, financial markets.
Nevertheless, getting China’s leaders to start thinking in terms of equity markets, talking about the need for more flexible interest rates and allowing some private ownership are steps in the right direction.
Once West meets East in the global capital markets, things will start to change‐perhaps faster than anyone can imagine. Stock exchanges in Shanghai and Shenzhen will be expanded to include index funds, Chinese citizens will eventually be allowed to move their savings into a portfolio of international investments and Chinese capitalists will be trading over the Internet 24 hours a day. The pace of change, of course, will depend on the extent of competition that the CCP allows and, hence, on the political climate. If the global market proves more powerful than the party, change will accelerate.
The reality is that China’s current financial markets are strictly limited, the renminbi is not convertible on the capital account, SOEs are crowding out the non‐state sector in the quest for investment funds, and foreign banks and non‐bank financial firms are still waiting patiently to enter the Middle Kingdom.
Those constraints on capital freedom have led to rampant corruption. Below‐market pricing of loans by state‐owned banks has created opportunities for side payments as a means of deciding who gets the scarce state funds; exchange and capital controls have led to attempts to circumvent the law by bribery and favors. The success of those attempts is revealed by the fact that, from 1991 through 1998, more than US$100 billion illegally left the mainland for safe havens in Hong Kong and elsewhere. That figure shows up in the errors and omissions component of China’s balance of payments, according to Dong Fu, an economist at the Federal Reserve Bank of Dallas, and amounted to nearly 40 percent of total foreign direct investment in China during that period.
If China wants capital to freely come and stay, it must be free to leave. More importantly, Beijing must establish sound constitutional protection for private investors. That is the challenge for the next decade. By granting China PNTR and by allowing it to enter the WTO, the U.S. Congress will help China meet that challenge and help create real, not pseudo, financial markets for the future.