September 22nd, 2015 Bridge Cafe (Wudaokou)
JIANG Guohua 姜国华, Professor of Accounting, Guanghua School of Management; Director of Operations, Yenching Academy, Peking University.
China’s ability to recover from the 2008 global recession came from its readiness to break every rule in the economic textbook. Yet, as illustrated by Prof. Jiang Guohua from Peking University’s Guanghua School of Management, surviving a global crisis doesn’t necessarily mean being able to tackle domestic financial challenges with the same ease.
Today, the PRC financial sector is faced with pressing issues such as ’policy uncertainty’ and what Nobel Prize winner Finn Kydland called ‘the disease of time-inconsistency’ – a governmental tendency to design policies that are only effective in the short term.
Bearing these conundrums in mind, how can we then make better sense of China’s stock market volatility, and what should we be expecting from the economy in years to come?
In a brief historical overview, Prof. Jiang traced the roots of China’s recent stock market turmoil. From 1949 to 1990, the top-down approach typical of central planning allowed the PRC government to set commodity prices in a tightly regulated market. Production and distribution were also planned: there was no need for marketing sales, and no plan to establish a market economy of supply and demand. Resources were allocated, consumption measured. Existing enterprises were either State Owned (SOEs) and fully financed by the central government, or collectives, mostly concentrated in rural areas.
The life of Chinese society was also subject to central planning. To this day, issues such as the confinement of human movement and the formal division between urban and rural areas lie at the very core of a possible reform on residential rights.
From 1978 onwards, the overall situation appeared to be taking a new turn. China’s closed economy underwent the so-called period of reform and opening up (改革开放, gaige kaifang), while market-oriented reforms gave new momentum to the country’s overall development. Yet, mechanisms of central planning and capital allocation still lived on, and the economy remained SOE-dominated. In the years following 1978, low SOE efficiency, lack of innovation and poor economic performances inevitably called for the implementation of a new set of reforms.
Within a few years, the government transferred control and residual claim rights to local authorities, at the same time implementing managerial responsibility systems that recognized greater autonomy to SOE managers. During the final stages of the reform path, private firms were allowed to enter the newly established market, while in the early 1990s SOEs were eventually restructured into shareholding companies, and the stock market was created. For the first time in the history of the PRC, the government started distancing itself from SOE ownership, no longer acting as a market regulator, but also as a shareholder.
In the early 2000s, what economists ridiculed as “state meddling” started to look like a thing of the past. Commentators worldwide began praising China for its economic management strategies, and the studying of financial markets “with Chinese characteristics” gained new popularity. Yet, when China’s economy started being hit by the repercussions of a financial crisis that was global in scope, it remained unclear how central authorities could have not prevented this situation from occurring.
In cases like this, as explained in detail by Prof. Jiang, the one main factor to blame is policy uncertainty, which in turn leads to strategy shortsightedness (also defined as the “short horizon problem”). Financial market policymaking in China is in fact tainted by an inherent lack of transparency, regulations remain vague, and the sudden changes that the central government can afford to make at SOE managerial levels generate uncertainty and mistrust among investors.
According to Prof. Jiang, if we were to search for the underlining causes of such instabilities, we would find them by looking back at the history of China’s economy. The legacy of central planning and state ownership, in fact, seems to be playing a determining role in China’s economy to this day.
First of all, state-ownership over most enterprises gives the central government power to achieve its priorities at all costs; secondly, State interest in China is still considered superior to the rights of the individual, causing investors to be more exposed to substantial risk; lastly, feelings of instability and uncertainty lead shareholders (including the government) to make short-sighted decisions, generally incompatible with business planning.
Within this context of uncertainty, China’s minor investors prefer to not become long-term shareholders (either of an SOE or of a private firm). In fact, “holding shares for longer time periods and waiting for firms to grow and expand appears riskier, and the frantic buying and selling of shares generates greater stock market volatility”, Prof. Jiang concluded.
For the future, China might have to find ways to fight against the so-called “time-inconsistency disease”, striving to design more far-sighted economic and financial policies that can ultimately prove to be efficient in the longer run.
Addressing a question about the existing similarities between China’s current economy and that of the United States in the years preceding the 1929 stock market crash, Prof. Jiang argued that even if investment in China is currently driven by speculation, Chinese investors have nothing to fear from a purely financial perspective. Alongside having learned their lessons from historical stock market crashes, in fact, Chinese investors are constantly learning from each other’s mistakes, and know exactly how to deal with market fluctuation without running too many risks at once.
Further elaborating on the implications of an ever-increasing government intervention in China’s economy, Prof. Jiang affirmed that China is indeed determined to continue moving along the path of openness and reform that it has been following for almost 40 years, and does not intend to turn back to greater central planning and government ownership of the market.
Asked to further illustrate what could be the inherent value of a Chinese stock, Prof. Jiang said that SOE and listed firms’ stocks are both greatly valuable. Yet, the stock market opened in China only in 1991: for many years, buying and selling shares was something entirely new to Chinese citizens, who often didn’t want to own any stocks by means of uncertainty and lack of trust. Central authorities thus decided to forcibly allocate shares between government workers, and people became motivated to buy shares only after those stocks yielded considerable returns. Today, the inherent value of Chinese stocks and profitable opportunities are the two main factors that have given investors renewed confidence in the market.
Responding to a question on whether China’s market volatility needs to be seen as the outcome of policy uncertainty, Prof. Jiang explained that we need to consider the Chinese government not just as a shareholder, but also as a market regulator. In the first quarter of this year, central authorities hoped to stimulate the economy by strengthening the confidence of investors in stock prices, attracting private money and channelling it into SOE and listed firms. Yet, the May 27th market crash was linked to insider trading operations orchestrated by market regulators and CEOs. Sure, policy unpredictability may as well be an investor’s worst enemy. Yet, the Shanghai stock market crash was indicative of how economists often need to take other factors into account when looking at China’s market volatility.
Report by Carlotta Clivio