Money, finance and economic development in China: A case study of the financial repression model

There have been a large number of theoretical and empirical studies designed to apply and extend the financial repression model to underdeveloped market economies since publication of the seminal works of McKinnon (1973) and Shaw (1973). However, most studies tend simply to regard financial repression as government control of interest rates, and use the real interest rate as a proxy for the degree of financial repression. The social, economic and political background behind the practice of financial repression have been largely ignored. These highly generalized studies have thus far failed to reach a consensus concerning the optimal path of financial development. Case by case country studies seem to be the more appropriate and perhaps more fruitful approach for further research.; In this paper I use the framework of McKinnon and Shaw and the historical-institutional approach to analyze the financial and economic development in China during the period 1952-1990. I then investigate some empirical issues that are closely related to the financial repression model.; First, based on historical and institutional analyses, I hypothesize that the Chinese financial sector has gradually increased its role in economic development since 1978. Granger-causality F-tests indicate that the demand-following financial development is dominant for the entire period of 1952-1990 but that the supply-leading hypothesis is moderately supported for the period 1978-1990.; Second, instead of using the official price index, I use an index P, derived on the basis of the equation of exchange, MV = PY, to measure the total inflationary pressure in the presence of commodity rationing. This index is then used to derive the implied real interest rate.; Third, using the implied real interest rate, I estimate functions of household money demand and financial savings and examine the interest elasticity of saving. The results moderately support the hypothesis that the real interest rate plays an important role in the Chinese economy. McKinnon's complementarity hypothesis is rejected in this study.; Finally, I estimate a growth-model regression for the Chinese economy. The results confirm that financial development is one of the necessary conditions for economic development. The test also supports the hypothesis of a structural change in 1978.