Financial deregulation, credit allocation across sectors, and economic growth: evidence from China

Abstract

This paper investigates whether financial deregulation causes economic growth through financial development. Financial development is measured by two channels: (1) changes in the allocation of credit across sectors, and (2) changes in savings and investment rates. We measure financial deregulation in China at the provincial level from 1981 to 1998. Our results suggest that financial reform causes economic growth in China. Further, its effect largely comes through the reallocation of credit across sectors, rather than changes in savings and investment rates.

Keywords:

• sectoral allocation of credit
• financial deregulation
• economic growth

JEL Classifications :

• O41
• O16
• C23
• O53

Acknowledgements

I am grateful to the editor Judith Clifton and anonymous referees for comments that substantially improved this paper. I also thank seminar participants at the University of British Columbia, HKUST, University of Manitoba, the Canadian Economics Association Annual Meeting in Montreal, All China Economics International Conference in Hong Kong, the UBC TARGET Student Workshop. I am especially grateful to Paul Beaudry, Michael Devereux, Patrick Francois, Nicole Fortin, David Green, Richard Harris, Keith Head, Carsten Holz, Ashok Kotwal, James Kai-sing Kung, Amartya Lahiri, Thomas Lemieux, Anji Redish, and Kai Yuen Tsui for valuable comments. I also wish to thank the China Academy of Sciences for the provincial financial system data, and TARGET at UBC for generous financial support.

Notes

1. One historical example is Mississippi’s ‘Balance agriculture with industry plan’ that favored industry over agriculture for rapid industrialization in the 1930s (Teaford 2002).

2. See Levine (2005) for a thorough survey of the literature on the finance-growth nexus. Because of his excellent discussion of it, we shall omit detailed references to the literature.

3. China’s average annual growth rate of real GDP per worker stands at 8% for the period 1981–2004.

4. See Lin and Rosenblatt (2012) and Chen and Jameson (2012) for discussions on Chinese reform.

5. Financial reform may spur growth via capital accumulation. McKinnon (1973) and Shaw (1973) show that financial reform mobilizes saving. Loayza et al. (2000) find that financial liberalization affects national savings. Some argue that financial reform promotes growth by more efficiently allocating financial resources (Demetriades and Luintel 1996), which has no solid supporting empirical evidence.

6. Merlevede and Schoors (2007) discuss the speed of economic reform. Chami et al. (2010) propose a framework for financial market development. Sobhee (2009) studies the economic reforms in Mauritius.

7. For China, the term ‘financial system’ appeared in provincial statistical yearbooks after 1997. However, only half of the provinces have data on financial systems since 1992.

8. There are other books documenting financial reform policies in China. The main financial reform policies are quite similar across these books.

9. The yearbooks after 1986 are not available, and the data from 1986 are used for 1981 to 1986.

10. Some studies on Chinese provincial conditional convergence have adopted this approach. There are others (Young 2003, Perkins and Rawski 2008) providing alternative deflators for investment. We follow the former approach and leave the use of alternative deflators to future analysis.

11. In China, out of the 31 provincial governments, four are municipalities and four are autonomous regions. This paper uses ‘province’ for all.

12. For example, if the data on 1991 and 1992 are missing, we use the data on 1990 and 1993 (denoted by D₁₉₉₀ and D₁₉₉₃) and impose [D₁₉₉₀+((D₁₉₉₃-D₁₉₉₀)/3)] for 1991 and [D₁₉₉₀+(2/3)(D₁₉₉₃-D₁₉₉₀)] for 1992.

13. We examined whether financial deregulation impacts growth through savings or a component of savings such as fiscal savings and household savings. The results show that they do not function as a channel.