Western Mistakes, Remade in China
To achieve its goal of joining the world’s high-income countries, China's government has rightly urged for a “decisive role for the market.” But banking is different, as the last seven years of reliance on bank-based capital allocation in China has shown.
SHANGHAI – The Chinese economy faces an enormously challenging transition. To achieve its goal of joining the world’s high-income countries, the government has rightly urged a “decisive role for the market.” But, while market competition works well in many sectors, banking is different. Indeed, over the last seven years, China’s reliance on bank-based capital allocation has led to the same mistakes that caused the 2008 financial crisis in the advanced economies.
Rapid GDP growth requires high savings and investment, and high savings almost never result from free consumer choice. States can directly finance investment, but bank credit creation can achieve the same effect. As Friedrich Hayek put it in 1925, rapid capitalist growth depended on “the ‘forced savings’ effected by the extension of additional bank credit.”
Japan and South Korea both used bank credit to finance high levels of investment in their periods of rapid growth. South Korea’s nationalized banks directly funded export-oriented companies. In Japan, private banks were “guided” toward the tradable sector.