China Takes the Lead

China’s financial markets have enjoyed a remarkable record of stability recently. In fact, the country’s stock market was a bright spot in the global investing landscape in 2001, rising substantially even as many other markets around the world suffered significant losses.

Of course, China’s capital markets — which were introduced on an experimental basis only in the early 1990s — are still in their infancy. Nevertheless, their expansion has been nothing short of spectacular.

The country already has a lively and active shareholder class, and retail investors dominate trading in the two exchanges, Shanghai and Shenzhen.

In sheer numbers, China’s shareholders now surpass Japan’s — which, of course, is not that difficult for a country of 1.2 billion people.

What’s more impressive is that the combined capitalization of China’s stock market — at $486 billion (at the end of February 2002) — is second only to Japan’s in the Asia-Pacific region.

What is the secret to China’s success? China, like many Asian countries, has a large pool of savings. Its personal savings rate is in the range of 40%, compared to an average of just 6.4% in the G-7 countries. Yet, China’s strategy in determining how financial markets put those savings to use is rather different from its Asian partners.

In Japan, policymakers over the years have imposed all sorts of obstacles that essentially prevent financial markets from providing their most important function — the efficient allocation of capital. China has taken note — and is determined not to repeat Japan’s mistake.

Instead of mimicking Japan’s approach, the Chinese want to create efficient markets — with all the consequences that this implies in the need for training and transparency in business, workers and society at large. That makes China unusual in its region — and, quite possibly, more likely to succeed in the long run.

In fact, one of the most impressive signals of the importance of sound financial management to China is the influx of Chinese students to U.S. colleges and universities.

They are now studying business, accounting and finance — and not just science, engineering, mathematics and computer science, as was the case in the past.

In fact, nearly 6% of foreign students in U.S. universities are from China, the largest number of any country, with many of them honing their business skills. These students are training to work for Chinese companies such as the Bank of China, one of the four big state run banks.

The Bank of China is at the forefront of introducing U.S.-style corporate governance. As such, it is a perfect example for the types of troubles state-owned companies face as they make the transition to capitalism.

Far beyond a mere corporate case study, the Bank of China provides a valuable lesson in the long-term thinking of the Chinese government. The Chinese leadership has concluded that good corporate governance is a must for sustainable development — and is acting on it. For all in China is not as rosy as it may seem.

Even though the number of listed companies in China has grown to over 1,100, the stock market is still prone to abuse. As anyone who has ever done business in China will attest, financial transparency in a mainland Chinese company is still consided rare. And that is where Chinese policymakers are making their stand.

To shape up the Bank of China, the government has installed a reformer with strong credentials as chairman, and put in place four tough outside directors who run the all-important audit committee.

This is motivated by the government’s plan to float shares of the bank on the Hong Kong exchange. China’s leaders realize that the more honest the management of the Bank is, the more money they will take away from the share offering.

But for China’s leaders, this is not an end in itself. Their real target is none other than the United States. And the main area of competition they are concentrating on is the one area where the United States clearly dominates internationally.

No, it is not the military. The Chinese have targeted financial markets, plain and simple. They understand that it is the access to broad, liquid and diverse capital markets that underpins America’ s global power more than anything else.

To measure up to the U.S. dominance in this field, the Chinese are determined to put a U.S.-style capital markets infrastructure in place.

Despite serious internal debates, the Chinese leadership is united in their goal of increasing China’s global clout — and realizes that markets and a prospering economy are the best tools to give China more political, financial and military influence as well.

At the same time, the social consensus underpinning this transformation is still fragile. A significant scandal that undermined trust in financial markets could therefore have dangerous political and social ramifications, even to the point of mobilizing popular support against further economic reform.

This, China’s leaders know, they cannot afford — and that is why they are rushing to fill the gaping holes in China’s system of corporate governance.