Was Deng Xiaoping Right? A 40‐Year Assessment of China's Adoption of Western Capital Markets
Authors: Walter Carl E. 
Published: January 2022

In early 1992, Deng Xiaoping opened the way for China to experiment with and then adopt the Anglo‐Saxon style of development through capital markets. With the passage of nearly three decades, perhaps now is a good time to offer at least a preliminary assessment of how successful China's experiment with finance capitalism has proved.

As part of this account of China's alternating embrace of and clampdown on Western‐style capitalism, the author constructs a rough financial balance sheet for China's state sector today that reflects a number of important developments and realities. First and foremost is the ad hoc fiscal system in which Beijing has for decades negotiated with local governments the amount of revenues to be turned over—in return for expected subsidies. The 1994 Budget Law was a compromise with the local governments aiming to codify the practice that Beijing would collect most of the revenues and share part of them with the poorer provinces. But although revenues increased dramatically, they failed to meet the local governments’ aspirations; and because such governments were left with less money and more social spending responsibilities, they ended up creating and relying on a “shadow” fiscal system—one in which the accumulating debts of the local governments do not show up in national income accounts.

But China's entry into the WTO in 2001 changed the entire game. With foreign investment, which was the second critical factor, came related supply chains and an export sector that became the envy of the world. As a consequence of such investment, the principal forms of Chinese savings—corporate and household bank deposits—soared. During the first decade of this century, the country developed a middle class, the first in its history, comprising some 300 million Chinese. Helping to fuel all this activity and growth, stock markets both domestic and international generated tens of billions of U.S. dollars in capital for Chinese state‐owned enterprises.

But then the global financial crisis hit, and China embarked on what has become its now decade‐long financial stimulus program, a program of social spending made possible and effectively funded by the household wealth stored by China's (largely state‐owned) banks. From a balance sheet perspective, the state's net worth has largely disappeared under a mountain of debt that had been extended overwhelmingly to parts of the state sector itself. And on the basis of the most recent available Chinese government data—whose endpoint is 2018—the author suggests that the value of China's state assets today may well be insufficient to meet its obligations to Chinese households—much of them in the form of deposits in (the mainly) state‐owned banks with arguably negative net worth.

In sum, China's government, by introducing and then reversing many of its economic reforms, has sacrificed inefficiency and economic value to preserve what it values the most—control and social stability. The government's legitimacy rests on the support of Heaven's Mandate, an old saw the Chinese people continue to believe. But one thing has clearly changed over the past 30 years: any major loss of confidence in the party's management of limited capital resources would likely have serious consequences for China and the world.