China's Trapped Transition_ The Limits of Developmental Autocracy - Minxin Pei [73]
Yet, the paradox of rent protection at the sector level and rent dissipation by insiders means that it is also very costly to maintain an unreformed banking system. Eventually, the combined effects of sectoral inefficiency and rent dissipation would threaten the stability of the entire financial system and demand government action. In China’s case, the government was forced to introduce gradual reforms to slow the deterioration in the banking sector. In the early 1990s, as the SOEs’ financial performance worsened dramatically, action was urgently required. In addition, the overheating in 1992-1993, blamed mainly on the government’s loss of control over bank credit, and the effective takeover of economic policy-making by a reformist leader, Vice Premier Zhu Rongji, precipitated the reform measures adopted in 1994-1995.
But these incremental reforms have made marginal improvements at best. With the exception of the strengthening of the central bank, these reforms have not improved competition or transformed the SCBs into real commercial banks. Indeed, none of the reforms adopted were intended to end the state’s monopoly of credit allocation, and indirectly threaten the regime’s ability to distribute rents. The results of such partial reforms have been all too predictable: the banking system has remained under the control of the state and retains its vital function as a conduit of politically directed credit, and the deterioration of assets has accelerated. Less than a decade after these partial reforms, the government was forced to dip into its last cash reserves—the country’s foreign exchange reserve—to shore up the fragile banking system. Revealingly, the bank bail-out package unveiled in early 2004 gave no sign that the government would relinquish its control over the banking sector. Even after capital injection, corporatization, and stock market listing, the state will retain its majority ownership in the restructured former SCBs. Domestic private entrants still face high hurdles. Even China’s entry into the WTO would have a modest impact on reducing barriers to the entry of foreign banks into the Chinese market.117 In other words, despite the huge economic costs, the government seems as determined as ever to defend the sector to which the CCP’s own security has been inextricably linked.
The Economic Costs of Gradualism
In evaluating gradualism, its proponents tend to overlook and downplay the accumulated costs of partial reforms and reversals and the impact of such reversals on the overall reform process. In the Chinese case, such partial reforms and reversals, two steps forward and one step back, have been the hallmarks of most top-down reforms. When looked at individually and within the political context at the time of adoption, these partial reforms might appear to be positive, albeit small, steps forward. Although their costs, both in terms of residual rents and opportunity costs, were recognized, they were judged to be outweighed by potential gains from the adoption of reform. And in fact, on balance, incremental reform has been better than no reform. However, economic reform is path-dependent: bad initial partial reforms lock decision makers into a certain path and constrain their future choices with the mounting costs of reversing mistakes. Flawed reform measures have high reversal costs not only in terms of opposition from vested interests, but also in terms of reputation loss for reformers. Indeed, reformers cannot afford to suffer such reputation losses too often if they wish to sustain political support.
In addition, the gains from such partial reforms frequently