Reviewing 1990s: a comparative study of reform transition

1. Reviewing 1990s: a comparative study of reform transition Governor ZHOU Xiaochuan People’s bank of China on April 26, 2004 world bank

2. OUTLINE • Theoretical market economy • The centrally-planned economy • Radical correction Vs Gradual correction • Trade • Banking • Capital market • Summary • What should have?

3. Theoretical market economy • General equilibrium & partial equilibrium • Based on production function: • everybody makes his own money according to fair market prices: • No cross-sector transfer of interest • No cross-sector subsidy • Specific development strategy and income distribution are realized by fiscal policies

4. The centrally-planned Economy • Top priority was the industrialization (including military industry) • prices were tools to mobilize resources for industrialization. • The industrialization strategy realized via: • Farmers subsidized industries • consumer-goods industries subsides heavy industries • Exporters subsidized importers, ( especially heavy industries importers) • Other controls : hurdles to the free movements of resources: capital, labor

5. Radical Correction • Unemployment ↑ • Per capita income↓ • Savings rate ↓ • Opportunity of restructuring: low • qualified companies as borrowers: few • Redistribution may cause instability

6. Gradual correction • Reducing the repression on agriculture, consumer goods industries or exporters • Find some other resources to subsidize, giving room and time for restructuring • Need additional resources to undertake the reform • Banks were needed to play intermediary roles in relatively low standard

7. GATT & CMEA • Some idea about labor division, comparative advantage and trade • GATT was based on market rules • CMEA was based on plan & negotiation rules • Negative sentiment: USSR was a superpower with Chauvinism • Small economies wanted to escape

8. Changing trade partners • From CMEA to EC • Many sectors could not swiftly follow to change the production • Many consumers were somewhere between sky and ground • There should not be the same standards

9. Typical CMEA Foreign Trade: Romania: Exports/ GDP

10. Czech External Trade

11. Russia: External Trade

12. Poland External Trade

15. CIS Unemployment Rates

16. Central & east Europe: Unemployment Rates

19. Border Trade Debate in Early 90s • Reality: • Goods: low quality, low brand • Trade : barter trade, contertrade,normal trade • Customs: concessionary • Payments: any currency or no hard currency • Western dream • Goods: high quality, high brand • Hard currency payments • Bank settlement and finance • Formal customs inspection or tariff • Difficulty: • who can afford? • Who was in shortage of FX • What banks were incapable? • What the custom did? • Result: GDP down, western dream UP

20. Gradual Correction: financial resources needs • Liberalized the prices of agricultural goods, meanwhile subsidies to the wholesale and industrialization • Encouraged exporters, meanwhile subsidies to specific importers • Liberalized the prices of consumer goods, meanwhile subsidies to heavy industries • Thus to bring immediate benefit, to maintain reform momentum • Sequencing the reform with finance constraint

21. Did China have the fiscal resources? • Subsidy↑ • Tax exemption and tax reduction↑ • Poor financial discipline, low accounting standards, slow tax reform and legislation, corruption in tax collectors→tax revenue↓ • China had to use other resources • No capital to undertake the needed reform at all fronts

22. Tax Revenue/GDP China:1979-2003 • Data sources: IFS

23. What other resources to use? • Commercial bank: Policy loans • Allowed undercapitalized companies to borrow at very high leverage • Supported SOEs surviving in production • Supported SOEs renewing the technologies • Supported SOEs slowing down the layoffs • Supported SOEs training new skilled workers • Directly supported the fiscal overdraw and expenditures in industries • Supported the restructuring and welfare program

24. What other resources? • Stock market • Allowed low standards of accounting, disclosure during IPO and secondary offering • Allowed low quality companies to issue bonds • In favor of SOEs • Relieve of inflation pressure

25. Possible outcomes • Easier balance among development, stability and reform • Create bank NPL for disposing in the future • Create task to rebuild the discipline and confidence in capital market • It depends on how much Pareto improvement it could gain • It depends on whether saving rate could be maintained at good level

26. Observed results after 1990s • Positive: • Economic growth maintained • Export growth maintained • Employment and Workers income maintained • Savings rate maintained • Reform momentum maintained • Negative: • Banks NPL • Capital market distortion • with low standard • scandals in capital markets • Tension between government and investors • Slow openness

27. What happened to SOEs in restructuring • 1/3 succeeded • partially privatized or turned to Joint ventures→ went public→ state equity enhances however, they did not pay much to the banks! • 1/3 failed →Bank NPL →Default of pension liability • 1/3:still remain to be seen • Low standards in product, low end of market • Some are good, but pension burden is high • Labor market rigidity and low mobility

28. Value-added output by sector: 1994-2002

29. Exports and Savings in Banks

30. Pareto Improvement: slow but ahead

31. Comparison with shock therapy in banking sector • Quick raise all standard→can bank staff catch up quickly? • Close insolvent banks → may lower the depositors confidence → lower saving rate in GDP • Few customers are qualified borrowers →declined role of intermediary →less financing for reform and development • Broad money/GDP remains low even declines • Foreign banks did not fill the gap as expected

32. CIS Broad Money/ GDP

33. Central and east Europe: Broad Money/GDP

34. Financial Resources: M2/GDP in Transition Economies in 2002

35. Does China have the capacity to solve NPL • CONDITIONS • Industrial restructuring and policy loans coming to the end • Thanks to Asian financial crises • Changed banks’ credit culture • Basically stopped the government interventions • After 1998, NPL ratio reduced 50% • Pareto improvement can be clearly identified • fiscal revenue↑ • reserves↑ • Broad money ↑ • saving↑

36. It is affordable to solve the remaining 50% NPL • Fiscal resources • Future fiscal resources by growing economy • Foreign exchange reserves and gold reserves • Moderate inflation • Reasonable interest rate spread • Good enthusiasm of foreign investors to join in

37. Stock market grew up from 0 • China set up 2 stock exchanges in 1991 • All precondition were not met • Rules first or practice first? • Equity financing were badly needed. • Some central and east European countries also started in early 1990s.

38. Preconditions • Standard • Accounting • Disclosure • Corporate governance • Supervision • Professionalism • Fraud IPO • Price manipulation • Institutional investors • Maturity of individual investors • Capital market services • Accounting firms • Law firms • Rating agencies • Evaluation agencies

39. Preconditions • Legislation & regulations • Company law • Bankruptcy law • Security law • Fund law • Having good companies for listing? • Doing wrong, government has to compensate the innocent investors→need resources

40. China reached • Total capitalization • Domestic 2 exchanges: 40-50% GDP • Overseas market: 20-30% GDP • Equity financing > 5 trillion RMB • Listing companies> 1300 • Daily trade volume ≈ 2.5 billion USD • Substantially improve corporate governance and corporate culture • Substantially help SOE reform

41. The liability remains • Investor claim compensations because of : • Low standard • Poor supervision • Man-made distortion • Corporate scandal • The Pareto improvement done by developing stock market ﹥﹥ total claim of compensation. However, • China need to find a channel and avoid moral hazard

42. Some transition economies • Started early • Voucher privatization

43. Market capitalization/GDP

44. Some other transition economies • Romania • Ukraine • Bulgaria • Central Asian economies

45. Tentative conclusions • Gradual corrections + financing reforms + Pareto improvement + ex post clearance + final transition • Realistic development of trade • Not textbook type banking reform • Emphasize equity capital market function • Solve problems with growing strength based on economic development

46. Tentative conclusions • The path of China in 1990s: half designed, half compromised • Very few economists officers had position of designning • Many officers disliked shock therapy, undermined financial problem, believed in SOEs • If the path could be better: • A bettr and earlier round fo tax reform • A stronger banking reform after Asia financial crisis • A better negotiation with CIS and Central and east Europe about trade

47. Remaining Burden: Pension Liability • Postponed reform, easy up the current fiscal balance • Demographic trend: aging population • Implicit fiscal deficit liability • Does economy future provide enough resources to meet the liability? • Reconsider the sustainability of PAYG

48. What should we have done or should have never done in 1990s? • 50% NPL for bail-out other sectors • 10% NPL caused by low standard of law enforcement • Pension reform before realizing aging trend • 15% NPL caused by poor internal control based on mistaken decentralization • 15% NPL by real estate bubble

49. Thanks for attention