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«Incomplete financial reform in China is puzzling because Premier Zhu Rongji, a seemingly promarket technocrat, was largely insulated from explicitly ...»

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An additional explanation is that despite the strenuous effort of the technocrats, they simply could not overcome entrenched opposition from ideological conservatives or from antireform interests and thus could not enact comprehensive financial reform. In the ideological sphere, the Fifteenth Party Congress in the autumn of 1997 finally put the stamp of legitimacy on private entrepreneurship, staving off a coordinated ideological attack against Zhu’s policies (Fewsmith, 2001). In terms of rent-seeking interests, Chinese bureaucrats were largely insulated from direct lobbying from societal groups, because the Chinese Communist Party was a nondemocratic regime. During Zhu’s tenure, some 25% of the 1997 SOE workforce, or

27.8 million SOE workers, lost their jobs, often receiving little compensation (Hurst, 2004).

To be sure, insulation from societal pressure did not imply that technocrats were free from all political pressure. Shirk’s (1993) seminal work suggests that reform in China was propelled forward by reformers in the central government making a series of proreform coalitions with members of the Central Committee representing various interests. In the case of financial restructuring, had Zhu been a reform-maximizer, he could have found powerful allies for reform measures, which he ultimately rejected. For example, both interest-rate liberalization and the legalization of private banks enjoyed the fervent support of prosperous and politically powerful coastal provinces. Had Zhu’s sole objective been to form a sufficiently strong coalition to implement these two policies, he could have found strong allies in local leaders. Nonetheless, there is no evidence that Zhu even attempted to form such a coalition. There, instead, is strong evidence that he made a pact with the poor regions of China to provide them with subsidized financing in exchange for their support for banking centralization.1 Furthermore, the delays in financial reform might have been a product of China’s relatively high growth rates, which allowed technocrats to delay fundamental reform. Looking back at the 20 years of reform, China experienced three episodes of economic slowdown: 1980, 1989 to 1992, and Shih / Reform Equilibrium 7

1999. In all three episodes, senior technocrats were perfectly content to concentrate financial power and use the central hoard of resources to spend their way out of a slowdown. Despite continual deflation after Zhu took power, he used both fiscal and monetary resources to launch an expensive and likely wasteful infrastructure, building campaign in western China. Granted, he was able to do so because of China’s repressed financial system, capital control, and high savings rate. Thus, the concentration of savings in China’s state banking sector furnished an important precondition of financial politics among the political elite. Nonetheless, the high savings rate alone does not explain the variation of policy implementation and could have equally furnished a cushion for committed technocrats to enact more fundamental reform.

Politicized Technocrats

The starting point of a political explanation for Zhu’s financial policies is that Chinese politicians and top technocrats, who are also party elites, operate in an environment of great uncertainty. Even if they are relatively insulated from societal political pressure, they can be removed from power at any time without due process by other members of the elite. Thus, according to a rich literature on elite politics, senior Chinese leaders need to maintain their informal political influence to protect themselves against sudden challenges (Nathan & Tsai, 1995). As Huang (2000) puts it succinctly, “Decisions are made according to the vision of those who have prevailed in the power struggles rather than through the due process... ”(p. 5) Even with the increasingly stringent retirement rules in China, top leaders have an incentive to build up informal power both for current expenditure and for postretirement influence through a network of protégés (Huang, 2000).

To ensure against possible challenges to their authority and to maintain influence, top leaders in China mobilize policy tools at their disposal to defend themselves or to unseat a rival. In the 1980s, for example, ideological conservatives launched ideological campaigns to undermine the authority of reformist leaders (Fewsmith, 1994). Because top ideologues had a network of followers in the propaganda apparatus, they mobilized these resources in the elite political struggle. Top technocrats, in contrast, have the most knowledge about economic and financial issues and the densest network of followers in the financial and economic bureaucracy in the central government.

Through the distribution of fiscal subsidies, bank loans, and state fixed-asset investment, senior technocrats and their protégés heading various ministries are able to secure political support for themselves.

8 Comparative Political Studies Given their embeddedness in the finance and economic bureaucracy, the most effective strategies for top technocrats to build up political capital comprise centralizing financial policy power and making oneself the indispensable problem solver. These two strategies complement each other and also apply to ministerial level officials in the top technocrat’s patron–client network. Consolidating financial power to the central level would first enable senior technocrats to more readily use the distribution of financial resource as political bargaining chips at the Politburo level, building a support coalition through disbursing funds to the pet projects of other leaders. In China’s increasingly monetized economy, where money constitutes a powerful and fungible instrument, control over banks and tax revenue becomes much more valuable to senior technocrats. Without financial centralization, provinces would garner control over financial resources themselves and would have less need to lobby their Politburo patrons to bargain for more funds from the technocrats. In Zhu’s case, control over the financial sector allowed the premier to mobilize banking resources to alleviate political setbacks, such as the failed World Trade Organization negotiations and the hastening of the promotion of close protégés. One high-level interviewee (anonymous, personal communication, May 2, 2002) pointedly stated, “(Premier) Zhu values the power to distribute financial resources through loans and stock-listings, and he has used the power as chips in the political game.” Firm control over the financial sector allows senior technocrats and their followers to effectively act in the role of the problem solver, thereby accumulating “administrative accomplishments” (zhengji). As the postreform era experience has shown, the perceived ability to solve pressing problems greatly increases the likelihood of promotion and of retaining power. Zhu himself rose through ranks by repressing inflation in 1993 and by resolving the triangular debt problem in the early 1990s. In contrast, Premier Li Peng’s authorities greatly suffered, because he had failed to rein in inflation in 1993. During his administration, Zhu and his protégés mobilized China’s vast financial resources to tackle a series of problems, ranging from chronic SOE indebtedness to the decline of rural income. Delegating financial authorities to his protégés in various agencies allowed them to resolve problems and increase their chances of promotion. A senior central bank official

explains this incentive in the following terms:

–  –  –

ensure that agriculture receives sufficient funding so that he would look relatively successful. Although this sort of distribution can increase society’s wellbeing, it often does not. (anonymous, personal communication, May 14, 2001) Because central bureaucrats have a strong incentive to deal with politically pressing issues, they tend to ignore longer term structural problems.

Moreover, because their administrative accomplishments are evaluated by short-term results, they tend to concoct short-term solutions to these apparent problems. The premier’s Politburo colleagues also pay little attention to the distant future. In fact, interviewees pointed out that everyone from the premier on down had a strong disincentive to carry out fundamental reforms that could potentially jeopardize short-term stability or prevent solutions to more pressing issues (anonymous, personal communications, October 10, 2000, May 14, 2001, June 23, 2001, May 2, 2002).

Given these two strategies of political survival, we can expect financial policies to take the following shape. First, one would expect the State Council to politicize policy problems to enhance central power. This is more easily accomplished after a crisis or a perceived crisis, as was the case in 1998. After the politicization of a financial problem, one would expect the top bureaucrat to adopt policies that maximize central power and maximize the apparent improvement of the situation without jeopardizing his ability to resolve other pressing issues. One would also expect senior technocrats to implement policies that minimize the short-term cost of solving problems, disregarding the long-term consequences. Policies or policy options that do not fulfill these objectives are likely to be modified or abandoned altogether. In hindsight, these are precisely the financial policies that the Zhu Administration adopted.

Outcomes of the 1998 “Reform”: Four Cases

The favorable conditions at the beginning of the Zhu Administration generated great expectations of significant financial reform. After all, Zhu Rongji was heralded as a tough reformer by everyone from fund managers to the Wall Street Journal to U.S. Secretary of Treasury Lawrence Summers (K. Chen, 1998). With the removal of ideological barriers and a perceived crisis, all the pieces seemed to be in place for a series of long-awaited reforms. At the end of Zhu’s tenure, great changes were made to centralize financial power to the State Council, which Zhu directly controlled. Beyond that, however, most of the banking resources remained in the hands of the giant state banks and were allocated to the state sector.

10 Comparative Political Studies The policy analysis approach here compares the expected outcomes from alternative explanations with actual outcomes. The policy areas examined include financial centralization, policies addressing the enormous NPL problem, interest-rate liberalization, and the legalization of the private banks. All four areas had been under intense discussion by the policy community during or before Zhu’s tenure, but only the first two policies were implemented. These four cases generate both between-case variation and within-case variation. With access to internal government debates about these policies, the analysis below further observes abandoned proposals, creating within-case variation. The political survival framework explains both why some policies were carried out zealously, whereas others languished, and why specific options within a policy area were adopted.

Banking Centralization

Banking centralization was the hallmark of Premier Zhu’s financial policy. Previously, local branch managers of state banks were appointed by the local party secretary, which gave rise to rampant local intervention in the banks. The conventional interpretation at the time was that Zhu implemented further reform as a part of a long-term plan to commercialize the banking sector in China (Lardy, 1998). Yet careful examination reveals that Zhu’s team hastily hobbled together the centralization plan when the political opportunity presented itself. Ironically, the policy with the least intellectual preparation was implemented immediately, whereas other long-anticipated policies were delayed.

As the Fifteenth Party Congress convened in the autumn of 1997, the most dynamic economies neighboring China were toppling in rapid succession. Initially, China seemed unaffected because it had effective foreign exchange control. Yet fewer than a week after the Fifteenth Party Congress at the First Plenum, General Secretary Jiang Zemin declared, “the prevention and resolution of financial risk is an important and urgent task...” (Zhu, 1998). His remarks were by no means empty words.

Bank officials uniformly attributed major changes in banking policies to the shocking lessons from the Asian Financial Crisis. The central leadership was genuinely afraid that China would follow Indonesia’s path of economic collapse and political chaos (anonymous, personal communications, October 8, 2000; October 10, 2000; October 27, 2000; December 13, 2000; April 15, 2001). Although the Politburo had reasonable cause Shih / Reform Equilibrium 11 for alarm, the new premier further manipulated the issue to centralize the banking system.

Before the Asian Financial Crisis, few at the State Council, China’s cabinet, had considered centralizing the appointment authority over local bank managers from the local party committees to the central government.

Instead, State Council technocrats proposed numerous alternative policy measures to deal with the growing NPL problem, including the establishment of a central commission to coordinating lending, a national system to monitor the asset-to-liability ratio of all financial institutions, and even a scheme to simply forgive interest payment owed by SOEs (Industry and Commerce Bank of China Research Group on Problems of Enterprise Bankruptcy, 1998).

But before these policies could be tested, the Asian Financial Crisis catapulted the NPL problem from a minor technical problem to the center of the regime’s focus. The newly appointed premier, along with State Council technocrats, created the crisis mentality by circulating a flood of alarming internal reports on the Asian Financial Crisis among the leadership (e.g., Guangdong Branch of the People’s Bank of China, 1998). In October 1997, the Central Committee and the State Council abruptly issued a stern decree to remove local branches of the state banks and the central bank from local Party committees’ jurisdiction and to place them under the newly formed Central Finance Work Committee (Heilmann, 2005).

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