There are various approaches to studying the progress of China’s financial reform. Some studies focus on changes in China’s social financing data to illustrate the process of financial market liberalization. Others examine the relationship between M2 and GDP to analyze the progress of China’s monetary development, while some explore the capital markets, particularly the valuation and liquidity of the stock market. Over more than four decades since the reform and opening up, China’s financial data show significant disparities when compared to developed countries, and even more so compared to emerging markets. Both public and private sectors currently criticize the relationship between finance and the real economy. The prevalent critique is that the financial sector’s contribution to national GDP is too high, while the financing cost for the real economy remains excessively high, leading to disproportionately high incomes for finance professionals. These viewpoints are steering the next phase of China’s financial reforms.
Several key events stand out in this process: first, the widespread income adjustment in the financial sector, and second, the strengthening of support for real enterprises. The new direction of financial reform is now framed through the “Five Major Articles,” and no longer framed under the terminology of financial market liberalization. Indeed, our understanding of financial market liberalization reform has encountered significant resistance across society—politically unsupported and practically difficult to push forward.
Looking back, there are many representative theories for the progress made over the past 40 years. Domestically, one prominent theory is asset monetization, which primarily explains the relationship between China’s M2 and GDP ratios. Internationally, the theory of financial repression, which posits that the underdevelopment of capital markets in developing countries results in high financing costs, is also frequently discussed. We believe that China’s financial market reform has lagged behind the marketization of the real economy and price reforms. It can be said that the entire process has slowed by more than ten years. Notably, China’s internet and manufacturing sectors are now nearly on par with leading developed countries in terms of innovation. However, China’s financial institutions are still focused on basic lending and channel services, with limited research on complex financial instruments or household investment products. This is largely a result of self-imposed economic reform choices.
There are two key factors driving this economic reform process: first, the control of capital markets’ financial accounts, and second, the regulation of deposit interest rates. These two critical elements are central to financial reform in developing economies. The management of capital account controls determines the extent of capital outflow, which, in turn, affects the gap between China’s financial sector services and international standards. Despite low investment returns in domestic markets, major capital cannot flow into international markets. This explains why China’s overall economic growth aligns closely with global trends, while its capital markets show no correlation with global capital market movements. As often stated, “The world is flat”—but China clearly is not.
Capital account controls are part of a national strategy, offering many benefits to developing countries. However, historically, they have hindered the improvement of the financial sector’s service efficiency. The regulation of deposit interest rates further compels household savings to be deposited, as investment returns are low. By controlling deposit rates, the costs for financial intermediaries are kept in check. The real economy’s returns are globally linked, but financial intermediaries, when benefiting from both domestic and international markets, stand to gain all the rewards of this interaction. These two factors ultimately determine the industrial structure and income distribution of the national economy. This cycle has been sustained primarily because inflation levels in developing countries have been relatively low, so there has been little desire for households to seek alternative financial solutions to combat inflation, allowing most savings to remain in deposits.
If this core factor were to be disrupted, with households beginning to seek ways to protect against inflation, the cycle would likely break, leading to structural issues in the economy. The real economy can secure low-cost financing through both international and domestic markets and tends to favor capital-intensive industries, thus holding most of the production capacity and making supply shortages unlikely. This leads to a surplus of production. Once this production state is disrupted by inflation-protective savings, the price system could become further distorted.
Moreover, while many new developing countries exist in the world, their industrial structures and capital market developments exhibit notable differences. Aside from differing levels of financial account control and interest rate regulation, a key differentiating factor is the proportion of state-owned capital. State-owned capital has two notable characteristics: first, most capital returns are reinvested into the enterprise, rarely flowing into the consumption sector; and second, state-owned enterprises benefit from credit subsidies, allowing them to access household savings at lower rates, further tightening control over deposit interest rates. These features deepen the economy’s shift toward capital- and production-intensive structures.
This is why China’s innovation model from 1 to 100 is unique globally, but innovation from 0 to 1 requires substantial household savings to support it, as well as greater access to returns through financial markets. This leads to a healthier economic cycle. In contrast, some developing countries where state-owned enterprises are fewer, and where state-owned credit has not deepened the economy’s shift toward production, have been able to converge with global trends.
In summary, the slow development of financial market liberalization historically provided low-cost liquidity to production enterprises, accelerating China’s industrialization. At the same time, due to capital account controls, China’s financial market has been less affected by international shocks. Logically speaking, while financial regulation seems to reduce external shocks, it has actually lowered the efficiency of the entire financial sector. For future financial reforms, without changing these three key factors, it will be difficult to develop a healthy capital market purely through enterprise dividends. It is almost impossible to achieve the expansion of consumption and a long-term low inflationary environment solely through central bank monetary policies or fiscal support. To fundamentally advance the above reforms and adapt to our new developmental stage—particularly as the global community challenges China’s production capacity—appropriate adjustments are needed.