Reluctant Regulators: How the West Created and How China Survived the Financial Crisis
By Leo F. Goodstadt
Hong Kong University Press
The events of last few years would seem to offer ample evidence that markets are not inherently self-regulating. Financial institutions enriched themselves by inflating an asset bubble that, when it popped, destroyed wealth on an unprecedented level. In the US, household net worth fell 18% in 2008, the largest annual drop ever recorded.
But those who never put much faith in regulation in the first place argue that the faster growth of an unregulated market more than offsets these periodic slowdowns, that markets are essentially beyond regulatory control, and that regulation enhances moral hazard – in other words, safeguards often backfire by encouraging risky behavior.
Leo Goodstadt, the former head of the Central Policy Unit in Hong Kong, delivers a somewhat limited but thoughtful critique of this philosophy in Reluctant Regulators, using Hong Kong an example to show that rapid oversight and strict economic growth are not contradictory – in contrast to the tenets of what he calls “Anglo-American regulatory culture.”
Hong Kong discovered that Anglo-American regulatory culture was unsuited to its small, open economy during a series of financial crises in the 1970s and 1980s, Goodstadt writes. In response to popular discontent, Hong Kong stepped up the supervision of its financial markets, while also expanding market opportunities by eliminating cartels and restrictions on foreign banks.
These moves, however heretical to laissez faire purists, obviously did not impede Hong Kong’s growth as an international financial center. In 2010, the International Monetary Fund released a studying indicating that Hong Kong and Singapore faired relatively well during the financial crisis partly due to their regulators’ more activist interventions in the market.
However, Goodstadt goes on to argue that Hong Kong’s regulatory strengths did not translate into financial reform on the mainland. Quite the contrary: Reluctant Regulators suggests that Beijing has been able to resist liberalizing its banking system precisely because it has Hong Kong on its doorstep. Instead, sporadic liberalization campaigns have been offset by internal backlashes.
Just say no
As usual in China, much of the conflict is due to resistance from internal constituencies. Despite a decades-long push by bank regulators to banish policy lending, the country has struggled to abandon the practice; shutting down state-owned enterprises usually threatens labor unrest. While the Asian financial crisis put wind in the sails of financial reformers during the last decade, the recent crisis has had the opposite effect: a return to rampant policy- and relationship-based stimulus lending to local governments.
“Ironically, the economic stimulus package itself was to create a new threat to the stability of the banking industry,” writes Goodstadt. “China’s auditor general, Liu Jiayi, revealed that a mere 9% of local government borrowing in 2009 was spent on projects related to Beijing’s stimulus package.” Because the central government committed to financing only 30% of the total stimulus package, local governments borrowed heavily through special vehicles to help fill the financing gap.
The product of all this waffling – between periods when regulators have more autonomy and when the command economy snaps back into action – has been financial volatility and a massive pool of non-performing loans. “China offers considerable evidence that financial liberalization without professional or independent regulators is a prescription for financial instability,” Goodstadt writes.
Reluctant Regulators makes a strong case for applying greater nuance to our understanding of the relationship between regulation and growth. Unfortunately, Goodstadt is short on prescription. He doesn’t discuss which aspects of a policy template based on a small, open economy would be appropriate for a giant, hybrid economy in a state of explosive growth. As a policy advisor to the Hong Kong government for nearly a decade, Goodstadt could surely have shared valuable information about the specifics that anchor Hong Kong’s regulatory framework, and how they could be reused by regulators elsewhere. The book would have been more useful had he bitten the bullet and made some recommendations.