(Amazon) This timely book by Lardy explains: 1) the intermingling of China’s gradualist reform, the inefficiency of SOE and the evolving banking system; 2) the structure and practise of the banking system of China; 3) some of the implications of the looming financial crisis in China. It thus serves as a critical and timely piece for readers to gauge what has been wrong for China and why are the policy implications. There are a few points worth highlighting. First, the cost of the gradualist reform approach is the resulting inefficiency in SOE and the related banking crisis, a cost which is usually forgot in the debate on the pace of reform for emerging economy. Second, the relative size of SOE in China, despite all the measures to stimulate private sectors for the past two decades, is still large, particularly from the perspective of bank lending. This has been reducing the strength of the banks and limiting the availability of funds to private enterprises. Third, due to the lack of other forms of investment, Chinese banking system has absorbed most of the saving from the private sector. However, because of the fragile banking system, deposit rate has been politically controlled at a very low level. This is effective taxing the Chinese household and subsidising the borrowers, i.e. the inefficient SOE. Forth, related to the third point, liberalisation of capital market will post a serious threat to the banking system because it will take away the funding source from the banking system. Fifth, the Asian flu would post limited short term threat to the Chinese system primarily because it is still a closed system. However, long term implication is clear and the Chinese leaders are aware of the similarity of the Chinese symptoms to those of the Asian flu. The only problem from this reader perspective is the level of theoretical underpinning. The piece is full of details in most of the aspects it is addressing. The missing piece however is that it fails to put the banking crisis into a larger perspective of the transformation of socialist system. Although a full discussion in this aspect may perhaps require an entire book itself, a brief discussion seems appropriate given that Lardy commented on some of the more theoretical aspect of the study in Chapter 5.
Firstly, let me say the research Nicholas Lardy has conducted is commendable and a welcome addition to the existing literature. His data sources are vast and highly informative. The major limitation of this publication is that the central argument is biased. Lardy selects those data and pieces of existing literature which support his own view. As a result, major sections of the literature concerning financial reform in transitional economies are simply ignored or brushed over. Lardy’s view is the typical Western, dare I say “American” argument. Primarily he uses financial criteria to evaluate the economic performance of China’s state banks. This methodoloy is extremely poor – particularly in the context of China’s trannsitional economy. Financial criteria are a horrible guide to both internal and allocative economic efficiency. If anyone would like elaboration on this point feel free to email me. In summary, Lardy’s book is informative and makes for interesting reading. However as a piece of economic analysis, its usefulness is limited. The major reason for this is a total lack of economic theory(as indicated by the previous reviewer) which has resulted in a poor methodology.