Thursday, January 10, 2008

Dear All,

Here is a new review of my book, Factions and Finance in China, from Bradley Gardner at the China International Business Magazine blog called The Yuan Also Rises. He did a great job summarizing my argument, and the review is quite kind. And yes, there is a soap opera aspect to elite Chinese politics, but that is why we love it!

Factions and Finance in China: Elite Conflict and Inflation
January 8, 2008 – 8:25 pm

Victor Shih tries to answer the elusive question: how does Chinese monetary policy work?

Factions and Finance in China, though an academic work both in price (USD 85) and structure (it was based on Northwestern University professor Victor Shih’s doctoral dissertation), reads like a soap opera.
Shih argues that the peculiar nature of inflationary cycles in China, which feature sudden run-away inflation followed by quick returns to normalcy along with the absence of credible monetary policy, is a result of conflict and cooperation between two segments of the ruling Chinese Communist Party (CCP) – the leading generalist faction and economic technocrats. The interaction between these two groups, Shih argues, is key to China’s continued economic and political stability.

The three generalist factions that feature prominently in Shih’s narrative are those led by Deng Xiaoping, Jiang Zemin and Hu Jintao. The support base for these factions largely comes from provincial leaders, who require high rates of growth in order to advance their careers. Shih argues that it is not only preferable, but a political necessity, that the leaders of generalist factions push resources towards their provincial followers in order to shore up support. The decentralized monetary policy quickly leads to expansion of the money supply and high inflation, which can only be solved by the technocrat factions.

The technocrat factions, led by Chen Yun, Zhu Rongji and Wen Jiabao, advocate centralization of monetary policy, because they need large financial resources in order to accomplish the major economic goals which are necessary for their advancement. According to Shih, when inflation is taking over the economy and creating a political risk for the leading generalist faction, they hand over control of monetary policy to the technocrats, who are not powerful enough to wrest political control of the country out of the hands of the generalists, but are more effective than the generalists at stopping competing factions from excess spending. Once the crisis is over, this cooperation stops as well, as the generalists fight once more to wrest control of the economy from the technocrats.

Shih renders the dynamic between the two groups dramatically: when Deng Xiaoping is calling for faster growth at one point, Chen Yun snipes from the sidelines “five percent growth is neither small nor simple;” Deng follower Zhao Ziyang at one point calls Brazilian-style inflation (over 100% yearly) “acceptable;” Chen Yun makes ample use of corruption investigations to increase his political strength, and the technocrats let the generalists run the economy to the brink of economic collapse in order to gain full control over monetary policy. Three of the nine chapters are completely dedicated to describing the melodrama that is Chinese monetary policy, and provide more inside information on the decision making processes of the Chinese government than you will find almost anywhere else. The book will help anyone who has been struggling to understand how Chinese monetary policy with only a knowledge of conventional central banking.

Though Shih seems to have a grudging respect for the way CCP infighting has succeeded in controlling runaway inflation, he warns that it has wreaked havoc on the banking system and is largely unsustainable. Both the generalists and the technocrats have used the banking system for their own political purposes, leading to a continual problem with non-performing loans. Shih is not optimistic either about successful reform in the coming years, arguing that control over the banks will most likely only leave state hands in the case of a severe economic shock.

Though the thesis is convincing, and Shih provides overwhelming evidence that the political dynamic he describes has existed in the past and has reason to exist in the future, the time period under investigation is too short to provide enough evidence to fully support his largely pessimistic conclusions. Shih admits that thus far Hu Jintao and Wen Jiabao have cooperated rather extensively, as Hu needs to protect his position from the followers of Jiang Zemin, which leaves the only evidence for the consistency of this dynamic Jiang’s switch from a more moderate position to a strong supporter of decentralization once he needed to consolidate his power in the regions. Shih argues that Hu and Wen will replicate the pattern of the previous two generations (Deng vs. Chen, Jiang vs. Zhu), and his model strongly supports this argument, but there are plenty of reasons to suppose Hu and Wen would find a reason to continue cooperating (such as a continued threat from Jiang), and likewise continued hope that leadership would see the benefit of continued economic reform.

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