China's stock market reforms
Page 2
A historical background
Why did the government decide to sell the
non-tradable shares on the open market? The answer requires a brief history
lesson. Prior to the mid-1990s, official China had a different mentality: it
was believed that holding a controlling stake in large companies would ensure
the government's continued control over these enterprises. This is the reason
why 90% of the listed companies are still state-owned.
In fact, between the mid-1950s, when virtually all
industrial companies were nationalized, and 1978, when the economic reforms
began, essentially all economic activities were government-run. Following the
Soviet model, government bureaucrats ran all factories, mines, and shops, with
the minor exception of shoe and bike repair shops. Government power expanded
along with state economic control, reaching heights unparalleled in China's
long history. The stagnation inadvertently created by the state-dominated
approach caused China's economy and society to become stuck in the mud for
more than 25 years.
It is less well appreciated, however, that the
government monopoly created vast problems for the government itself. Power
carries responsibility, and Chinese officialdom inevitably faced the quandary
that the greater their power became, the more troublesome their
responsibilities. Providing life's essentials, jobs, and happiness for 1.3
billion people would be a tall order for even the most efficient organization
imaginable, and in the 1970s, China's creaking bureaucracy showed clear signs
that it was beginning to buckle under the weight of this self-imposed burden.
The market reform policies that began in 1978 were
partly motivated by the need to address this problem, and the dramatic changes
that resulted are well known. One of the most noticeable changes was that
foreign capitalists and Chinese businessmen were encouraged to play a
significant part in the economy, along with the state companies, which
continued to exist. The introduction of a stock market in 1992 was widely
regarded as a sign that the reforms had become irreversible.
To be sure, there has been enormous economic progress
achieved in the reform era; the vast wealth destroyed by the Soviet economic
model is quickly being restored. But unresolved issues remain. The most basic
issue is this: how to completely transform a government-run economy into a
market-oriented one. That issue has brought one fundamental conflict to the
fore: the double role being played by the government, as it attempts to be
both a "player" and a "referee" in the economy at the same
time. This basic conflict of interest tempts countless government officials to
utilize excessive government power, left over from the Mao era, for personal
gain - and many have failed to rise above the temptation. Nowhere are the
effects of the player-referee conflict more visible than in the stock markets.
China's stock market woes - and their cause
Building a stock market with 1,400 listings in a
short time is an impressive achievement. But the market has had built-in flaws
since day one. In theory, stock markets follow a competitive principle:
investors put money into good companies, and not into bad ones, which allows
the good companies to grow with the help of investors, while the bad ones die
out. In the end, wealth is created. But the Chinese stock markets have hardly
followed this rational path so far. In reality, they have run into all sorts
of nightmares, with one common cause: continued government domination.
To begin with, the number of companies that want to
be listed is hundreds of times greater than the number of listing slots
available. Listing rights are controlled by multiple government units, at
central, provincial and local levels. This arrangement presents ample
opportunities for corruption, and it is hardly surprising that listing rights
frequently go to companies whose business qualifications may be less than
sound. Furthermore, companies frequently fudge their financial numbers in
order to meet listing requirements. While regulatory bodies exist that are
theoretically empowered to stop such abuses, in practice they have been too
weak to do so.
Once a company is listed, the reward mechanism that
should operate is greatly weakened by the prevalence of manipulative
practices. There are many sources of "hot money" in the Chinese
markets: state-owned banks and state sector companies, for one. "Pumping
and dumping" happens in China also: hot-money investors push up weak
stocks to sky-high prices by buying in massive quantities, then sell quickly
for a fat profit, leaving small investors holding the bag. Regrettably,
various investment brokerages have become involved in such practices by making
short-term loans to such speculators. Worse still, they sometimes play the
game with their clients' money, by promising fat profits to the clients.
The lack of effective regulation has created an
"anything-goes" atmosphere around the Chinese financial markets. The
manipulators have done well for a long time without getting punished,
attracting even more abusers. One "Chinese Enron", De Long, founded
by four brothers, was active for many years in this manner: it borrowed
heavily and tried to manipulate the stock market. The founders were convinced
that their company was "too big to fail", but they were wrong, and
De Long collapsed recently, leaving huge uncollectable debts - believed to
billions of dollars - for various Chinese banks.
The greatest damage done by the stock market excesses
is that they are impeding China's critical goal of transforming and
modernizing Chinese companies, both state and private. With capital flowing so
freely, the listed companies have little incentive to introduce modern,
professional management, to say nothing of transparency and accountability.
This problem is exacerbated by the fact that 90% of the listed companies are
still controlled by various government entities, making them directly
responsible to government officials - not to the market or to investors.
Indeed, government officials, being controlling shareholders, can effectively
control these businesses through such means as the appointment of key
managers. The net effect is to turn market transactions into bureaucratic
transactions.
Naturally, financial wrongdoing, in all its multiple
forms, is hardly exclusive to China; every country with a stock market has
witnessed a certain amount of manipulation and sleaze. Behind the bursting of
the Japanese stock bubble, for example, was the widespread practice of
cross-holding among banks and their corporate clients, which helped to prevent
Japan Inc from having professional, merit-based management. China Inc's key
problem - bureaucratic meddling - may be different, but escaping the traps
created by past practices will be easy for neither country.
Go to
NEXT PAGE
