Understanding Capital Reforms In China And Some Lessons For India

Greater acceptance of foreign capital and cultivating a culture of entrepreneurship is what India should learn from China.

Currently, China is the second largest economy in the world sustaining about 20 percent of the world’s population. A large part of the credit to foster such growth goes to the reforms in capital allocation that started taking place since 1978, two years after the death of Mao Zedong.

China first moved to empower its rural economy by improving accessibility to credit for rural entrepreneurs. Thus, we saw ‘Township and village enterprises (TVEs)’ sprout tremendously. The ownership of  TVEs was at the public/village level which, according to Stiglitz (2006), ‘aligned the interest of the central government with those of local governments effectively preventing private stealing of public assets.’

This sprouting of TVEs was complemented by three major reforms in rural areas:

1. Allowing the depositors of rural credit co-operatives to select their staff and determine the lending criteria of their branches, which were earlier vested with the Agricultural Bank of China – a state bank. Thus, government control was reduced, and the founding principles of rural credit co-operatives were restored.

2. Entry of private lenders led to formalizing the ‘informal finance’ and increasing free lending and borrowing in the rural areas. This also helped increase competitiveness and forced state-owned banks to improve.

3. Easing access to credit for rural entrepreneurs by allowing interest rates to float and waving collateral requirements leaving it to the co-operatives to decide their needs. This financial decentralization gave ‘finance entrepreneurs’ more room to invest and grow.

In early-to-mid 1990s, however, we saw a complete reversal in the economic reforms that were enacted in the previous decade. All informal finance was declared illegal, rural credit co-operatives were abolished, and collateral requirements were reinstated, even tightened. We see that the shareholder equity of rural credit went down from 62.5 billion yuan in 1995 to -8.5 billion yuan in 1999.

In this period, China made various other changes. They introduced labor-incentive schemes, privatized state-owned enterprises, and improved worker mobility. But, the government continued to favor state firms over private enterprises by allowing them low-interest rates of borrowing, suppressing wage increases and granting additional state benefits.

So, private firms worked toward increasing their functional efficiency. They didn’t distribute their profits to the workers or owners but increased their savings because they had to finance themselves as the banks were biased to state-owned enterprises.

Rural-urban migration led to workers moving from rural areas to urban ones thus slowing the urban wage growth. This in-turn led to a high corporate savings rate in China. This high savings rate maintained by firms, governments and households drove China’s growth over the 1990s and the 2000s. Joining WTO in 2001 further led to an increase in savings due to a rise in foreign direct investments and exports alike.

The fiscal tax reform of 1994 led to a rise in the disposable income of the government. The revenues of the central government quadrupled from 1.8 trillion yuan in 2000 to 6.7 trillion yuan in 2008. This was used to finance domestic investments in state-owned enterprises, which continued to rely on government savings.

We thus notice a boost in productivity of firms in China which met the expanding external demand arising from its entry to the WTO. Dependence on imports also reduced as the capacity to produce goods domestically increased.

India lacked a coherent approach to capital reforms and development. The noisy political system is to be blamed to some extent. Historically, both countries have looked up at the State as the primary driver of growth due to fear of foreign domination.

Even though India tried to modernize, the process was largely agriculture driven, fostering profound overhauls like the green revolution; while China modernized through industrialization. China implemented capital reforms to a far greater extent than India, and those directly led to the deepening of capital in the economy which bolstered labor participation and technological progress.

The Chinese have shifted the reforms from “each according to his need” to “each according to his work” and India needs to do exactly that. Access to capital – rural and urban – has been at the center of China’s growth story. Reforms are needed in India to make it easier for labor to move out of agriculture into higher productivity sectors. Greater acceptance of foreign capital and cultivating a culture of entrepreneurship is what India should learn from China.