Learning from China’s economic philosophy and policy —IV

Here, it makes sense to also see how this overall economic philosophy of China translated in terms of directing finance, and its efficient utilization towards overall sustainable economy. A couple of distinguishing factors quickly come to the fore even at a cursory look at China’s financial system, which has played a crucial role in directing the economy onto a sustainable path, highlighting the conscious, purpose-driven policy direction enabled by the non-neoliberal underpinnings of China’s economic philosophy.

Compared to countries like Pakistan, which have faced ongoing shock therapy, neoliberal reforms, and austerity with a limited government role, China has reaped deep economic dividends by doing the opposite.

A greater role for the public sector—which includes using mission-oriented incentives to drive inclusive and green growth—has shaped the economy over the years. This approach relies on tools like taxation, subsidies, and high levels of public investment.

The public sector works actively with private individuals and organizations to shape real and financial markets with a clear purpose. It uses strong regulation and public finance to support economic directions that improve both productive and allocative efficiency.

READ MORE: Learning from China’s economic philosophy and policy — III

A 2020 ‘Princeton University Press’ published edited book ‘The handbook of China’s financial system’ has highlighted the concerted, purpose-driven role of finance, employed by government through involving financial actors, primarily banks, and through them financing of mission-oriented endeavours, involving private sector in a supportive way in the process, tapping bonds markets to this end, while incentivizing stock markets to align better with economic goals in a significant way.

This certainly has not been the case in countries like Pakistan, where under years of neoliberal and austerity, both inside or outside of the IMF programmes, given similar minded ‘Chicago boys’ seem to be influencing policy in a majority way, which then also lays a strong basis of these policymakers apparently for enjoying support from politico-economic elites in policy circles, which benefit from these policies to pursue extractive institutional design.

They influence both directly when in government, but also indirectly as colluding vested interest groups, in turn employing neoliberal/austerity policies. Here, with lesser footprint of public sector in directing economy in an inclusive way, and profit signal feeding the main purpose of private sector and markets, and not what brings much-needed greater productive and allocative efficiencies. This, in turn, also weakens political voice over time, which otherwise works as a strong lever in functionally strong democracies as safeguards against extractive politico-economic institutional design.

On the contrary, an overall active role played by government in China – which they continue to improve by keeping the door for learning from experience wide open – in involving economic levers in the real and financial sectors, with better orientation of finance to generate, for instance, momentum towards achieving larger economic goals in an inclusive, and over time, green, and high technological direction, like AI, has been nothing less than impressive.

READ MORE: Learning from China’s economic philosophy and policy — II

The handbook, for instance, points out in this regard: ‘China’s financial system has served indispensable roles in China’s spectacular economic growth over the past 40 years. …This system builds around a dominant banking sector, a quickly growing bond market, and a widely followed stock market.

Each of these markets in already among the largest in the global system… The loans made by banking institutions accounted for 92 percent of the Aggregate Financing to the Real Economy (AFRE) in 2002. While this ratio came down in recent years, it remained at a very high level of 76 percent in 2018.’

This is in stark contrast to the increasingly practiced phenomenon in neoliberal/austerity-oriented economies, like Pakistan, where investment, gained from real and financial sectors, gets significantly recycled in the financial sector in terms of share-buybacks, rather than being invested in the real sector in a significant way.

This favours, in turn, a narrow base of the economy represented as big performers – agriculturists, industrialists, among others – in the economy receiving disproportionately high level of finance in rounds, and presenting as safe havens as compared to the real sector receiving very little public investment, incentivization, and regulation to create a favourable ecosystem to meaningfully attract private sector to invest in the real sector, not to mention a lack of appropriate taxation in the financial sector and loose capital controls under the neoliberal mantra all create wrong incentivization in terms of disproportionately high level of investment in the financial sector, mostly staying in a narrow band of economic agents, and away from creating benefits in the real sector in terms of overall enhancing aggregate supply, and generating inclusivity, resilience, and higher social spending in the economy.

READ MORE: Learning from China’s economic philosophy and policy – I

Moreover, the same handbook pointed out the following: ‘Even more impressively, banking institutions owned more than 97 percent of the total assets in China’s financial system in 2018, reflecting the fact that banks not only make loans but also serve as the main source of funding for the bond markets, for shadow banking products (such as trust loans and entrusted loans), and for even the asset management industry. This dominance is bolstered by the high saving rate of households and firms throughout China.’

It is important to note that better price management, strong capital controls, and increased economic incentives for investment serve two main purposes. First, they improve price discovery to generate domestic savings, while tighter financial regulations keep those savings within the country. Second, this improved price discovery makes the real sector much more attractive for investment—including agriculture, domestic and export industries, green energy, and advanced technologies like artificial intelligence.

In addition, highlighting the purpose-driven role of government in creating an effective bridge between finance, and economic outcomes serving major country-level economic goals, the same handbook pointed out: ‘Different from other countries, where savings are mostly absorbed by direct investment in bond and equity markets, in China the banking system captures a large share of these savings. This empowers the banking sector as the key channel for funding China’s financial and monetary policies, as well as for developing other financial sectors, particularly the bond market.’

A July 11, Business Recorder (BR) published news report ‘PM advocates for greater lending to SMEs’ where the PM called upon ‘banks to substantially expand lending to priority sectors, with a particular focus on small and medium enterprises (SMEs)’ yet it may make sense to learn from China in this regard to meaningfully augment the effort of bank finance, and to enlarge the scope of overall finance in terms of availability for the private sector. Unlike Pakistan - where the private sector, especially small farmers and small and medium-sized enterprises, receives a limited amount of bank financing — China has introduced “dual-track” interest rates to help provide affordable loans to the private sector. The People’s Bank of China (PBC) only removed this dual-track pricing in 2015, after supporting the economy for many years.

The same handbook pointed out in this regard ‘…the PBC gradually focussed more on interest rate instruments. On the one hand, it pushed ahead the interest rate liberalizations and granted commercial banks greater degrees of freedom in setting their deposit and lending rates by widening the allowed bands. By the end of 2015, the PBC had abolished all the restrictions on commercial banks’ interest rates.’

It is important to note that the ‘dual-track’ interest rate was abolished in 2015, PBC still continues to influence commercial banks to provide more supportive interest rates in an overall effort to enhance investment regarding which the same handbook indicated the following: ‘Officially, China’s interest rate liberalization was complete as of 2015… In reality, banks still priced off the benchmark deposit and lending rates set by the PBC as of mid-2019, and have had limited scope to raise deposit rates on their own.’

Moreover, the large extent of support to real sector, especially farmers, and small business from China – especially during the formative years for the economy – and which should be a strong learning curve for Pakistan, which seriously lacks policy consistency, the same handbook indicated: ‘The PBC quotes a range of benchmark policy rates on direct monetary operations, including a policy lending and discount rate.

The PBC lending and rediscount windows were important sources of base money supply during the 1990s; however, since the early 2000s, they have ceased to be major liquidity channels. In recent years, they mainly act as a channel to support commercial banks’ lending to rural and small businesses, and these rates haven’t been changed between 2010 and 2019.’

Moreover, People’s Bank of China (PBC), which works under the State Council, and has more objectives than price stability, has introduced the concept of Aggregate Financing to the Real Economy (AFRE), serving as an important feature to learn from.

The same handbook pointed out in this regard: ‘From 2011, the PBC introduced a new indicator, Aggregate Financing to the Real Economy (AFRE) which converts renminbi and foreign currency loans, trusted loans, undisclosed banks’ acceptance bills, corporate bonds, nonfinancial institutions’ domestic equity financing, and others.’ This, in turn, also calls on the government to employ fiscal-monetary policy coordination in a more effective way to have a greater alignment, and say of State Bank of Pakistan (SBP) to policy objectives beyond price stability in a more meaningful way, along with greater creativity of SBP – for instance, learning from China’s AFRE indicator – to enhance bank credit, and from government side, lesser reliance on bank borrowing.

In fact, AFRE is also being used as an intermediate target, in addition to other targets, about which the same handbook indicated: ‘Bank loans and money supply pretty much reflect financing conditions of the economy. Various economic studies confirmed the high relevance of these quantitative intermediate targets to the monetary policy objectives, particularly inflation and growth… In recent years, however, the correlations between these quantitative intermediate targets and monetary policy objectives decline visibly.

This is probably because non-bank financing grew rapidly. In addition to the government’s efforts to promote development of multi-layer capital markets, bank’s off-balance-sheet transactions, or the shadow banking businesses, also expanded quickly. …As bank credit became a smaller portion of total finance, its relevance to monetary policy objectives declined. …AFRE has become a more important intermediate target, at least partially replacing the newly increased bank loans… which are only one of several components of AFRE and that its share has been relatively declining, especially since 2008. …In the past, the PBC mainly used money supply and bank credit as the intermediate targets. In recent years, the central banks even introduced the new target of aggregate financing to the real economy (AFRE).’

Here, it needs to be pointed out that high government borrowing from banks for interest payments has weakened the impact of broad money (M2) growth on the real economy. Instead, this borrowing allows commercial banks and the SBP to earn higher profits. Banks make more money by investing in financial assets, while the government uses funds to pay high interest rates.

(To be continued)

Copyright Business Recorder, 2026