BUS243 Chinese Business Unit Information and Lear.docx

BUS243
Chinese Business
Unit Information and Learning Guide
TMA, 2017
Professor Malcolm Tull
Ms Sreeparna Saha
School of Business and Governance
© Published by Murdoch University, Perth, Western Australia,
January 2017.
This publication is copyright. Except as permitted by the
Copyright Act no part of it may in any form or by
any electronic, mechanical, photocopying, recording or any

other means be reproduced, stored in a
retrieval system or be broadcast or transmitted without the prior
written permission of the publisher.
CONTENTS
UNIT INFORMATION
ONE Introduction 3
TWO Resources for the Unit 7
THREE Assessment 9
LEARNING GUIDE
Topic ONE Introduction: Why Chinese Business? 16
Topic TWO History and Culture of China 17
Topic THREE China’s Socialist Market Economy 18
Topic FOUR China’s Foreign Trade Regime 19
Topic FIVE Chinese Business Structure 20
Topic SIX Chinese Management Systems 21
Topic SEVEN Market Entry Strategies into China 22
Topic EIGHT Negotiating with the Chinese 24
Topic NINE Chinese Competitiveness 25
Topic TEN Intellectual Property Rights in China 26
Topic ELEVEN China’s Financial System 27

Topic TWELVE Overview and Revision 29
Workshop Program 30
Appendix 33
BUS243 Chinese Business
BUS243
Chinese Business
Unit Information

2 Unit code Unit information
ONE
Introduction
How to use this Learning Guide
This Learning Guide contains topic by topic information
including:
• Objectives and introductory notes to each topic
• List of required readings
• Key concepts
• Workshop/discussion topics
• Written activities
• Other learning activities
This information is designed to help you move through the unit
in a way which will lead
to thorough, critical and reflective learning.
Unit overview
This Unit will introduce the students to the business culture of
China that has emerged after the end of the
Mao Era, and will provide an essential tool-kit to establish

productive business relationships with the
Chinese, be it outside or inside the People's Republic of China.
The unit will teach students how to
establish, negotiate and manage business enterprises,
particularly joint ventures, in China. It is designed to
equip students with the necessary cross-cultural skills to operate
efficiently when doing business in China,
or travelling in China. Also, the Chinese legal and regulatory
system, together with conciliation and
arbitration procedures in case of business disputes will be other
areas of learning in this unit. All this will be
approached within the corpus of a borderless economic and
commercial world. The first three lectures will
introduce students to the broader issues of Chinese history,
culture and political economy. This historical,
cultural, and socio-political background is essential to any
foreign entrepreneur or negotiator to conduct
business in China successfully.
Welcome to BUS243: Chinese Business!
Acting Unit Coordinator
The acting coordinator for this unit is Ms Sreeparna Saha.
Mob: +61 415951527
Email: [email protected]
This unit guide was originally written by Dr Ameer Ali. It was
revised by Professor Malcolm Tull, January
2017.

Aims and Learning Objectives
The broad aims of this unit are to:
• Develop a robust understanding of Chinese cross-cultural
issues and business negotiation practices.
• Equip students with the theoretical tools and knowledge to
operate with confidence in the Chinese
business environment.
• Make students understand the uniqueness of Chinese business
behavior so that they are made aware
of the limitations of existing theoretical knowledge about
commercial enterprises.
The learning outcomes/acquired skills of this unit are:
• A concise knowledge about Chinese business culture.
• Lessons of success and failures by foreign companies that
have ventured into China
• Familiarity with the Chinese hierarchical structures, its
decision making and approval processes and
officialdom
• Knowledge about the Chinese Joint Venture and other business
related legislations impacting upon

Chinese Business Enterprise Development
• Awareness of the principles of trust and interpersonal
relations that lay the foundations for the
ultimate success of business ventures in China.
Students in this unit will be required to actively participate and
demonstrate the capacity of critical
thinking, both during class time and in their written assignment
work.
Graduate attributes
This unit will contribute to the development of the following
Graduate Attributes:
1. Communication: The ability to communicate effectively and
appropriately in a range of contexts using
communication, literacy, numeracy and information technology
skills.
2. Critical and creative thinking: The ability to collect, analyse
and evaluate information and ideas and
solve problems by thinking clearly, critically and creatively.
3. Social interaction: A capacity to relate to and collaborate
with others to exchange views and ideas and
to achieve desired outcomes through teamwork, negotiation and
conflict resolution.
4. Ethics: An awareness of and sensitivity to ethics and ethical
standards on interpersonal and social levels,

and within a field of study and/or profession.
5. Global perspective: An awareness of and respect for the
social, biological, cultural and economic
interdependence of global life.
6. In-depth knowledge of a field of study: A comprehensive
and in-depth knowledge of a field of study
and defined professional skills where appropriate
Prerequisites
Nil.
How to study this unit
The lecture topics are set in a sequence starting with an
overview of China’s history, geography, culture and
economy. Topics relating to contemporary Chinese business
structures and practices follow the historical
overview. Printed lecture notes are provided for each topic and
should be read before each workshop.
It is recommended that students keep abreast of current global
trade and financial developments
published in the relevant newspapers and journals as these
relate to China.
Learning activities
There is a two-hour workshop in each of the teaching weeks.

All students are required to give a workshop presentation.
Topics will be allocated at the first workshop.
The workshop topics are listed at the end of reach topic.
Time commitment
As this is a 4 credit point unit, we expect you to spend on
average 13 hours per week for the total weeks of
this teaching period (or 200 hours overall) working on this unit.
Attendance requirements
Students are expected to actively participate in their own
learning. Attendance at all workshops is
expected. Workshop participation and presentations are
assessed.
Unit changes in response to student feedback
This unit is updated each year to take account of changing
economic issues and policies and student
feedback.
Study schedule

Session Topic Assessment
items
Due
1. Introduction: Why Chinese
Business? Chinese Business in
Regional and Global Contexts
2. History and Culture of China
3. China’s Socialist market
Economy
4. China’s Foreign Trade Regime
5. China’s Business Structure
6. Chinese Management System
7. Market Entry Strategies into
China
8. Negotiating with Chinese Mid-semester
test
Week 8
Date TBA
9. Chinese Business
Competitiveness

10. Intellectual Property Rights Essay Week 10
11. China’s Financial Structure
12. Overview and Revision
TWO
Resources for the unit
Unit materials
To undertake study in this unit, you will need:
Essential
textbook
Liu, Hong (2009) Chinese Business: Landscapes and Strategies
Routledge, New York.
Roger A. Philips, Eugene P. Kim (2016), (eds.) Business in

Contemporary China
Routledge, New York.
You are expected to purchase these texts. Business in
Contemporary China is,
however, available online via My Unit Readings. There are also
hard copies of both
texts in the Library.
Other references
Other recommended texts are:
Min Ding and Jie Xu, The Chinese Way, Routledge, 2015.
Barry Naughton, The Chinese Economy, The MIT Press, 2007.
Min Chen, Asian Management Systems, Thompson, 2004, 2nd
edition.
Ambler, Tim and Morgen Witzel (2004) Doing Business In
China, 2nd edition,
RoutledgeCurzon, London.
Story, Jonathon (2003) China: the race to market, Prentice Hall,
London.
Tian, Xiaowen (2007) Managing International Business in
China, Cambridge
University Press, Cambridge.
Tubilewicz, C. (2006) Critical issues in Contemporary China,
Routledge, Abingdon,

UK.
Wu, Jinglian (2005) Understanding and Interpreting Chinese
Economic Reform,
Thomson, Mason, Ohio, USA.
Zheng, YongNian (2004) Globalization and State
Transformation in China,
Cambridge University Press, Cambridge, UK.
Online resources
including web
pages
The Unit Welcome Page, Online Unit and lecture notes can all
be accessed from
your My Units page. Please note that the lecture notes are meant
to provide only a
guide to your own reading and do not cover in detail every
aspect of this unit.
There a large number of useful resources on the internet. A few
are listed below:

The following monograph, available online, is a useful general
reference for this
unit:
World Bank and the Development Research Center of the State
Council, P. R. China.
2013. China 2030: Building a Modern, Harmonious, and
Creative Society.
Washington, DC: World Bank. DOI: 10.1596/978-0-8213-9545-
5.
World Bank, Ease of Doing Business in China
http://www.doingbusiness.org/data/exploreeconomies/china/
World Economic Forum, Global Competitiveness Report
http://reports.weforum.org/global-competitiveness-report-2015-
2016/economies/#economy=CHN
The Ten Principles For Doing Business In China - Forbes
http://www.forbes.com/sites/insead/2012/03/06/the-ten-
principles-for-doing-
business-in-china/#46544fa31176
Library resources
Electronic Course Material & Reserve information:
All essential readings are available on My Unit Readings
https://murdoch.rl.talis.com/index.html.
Past Exam papers:
These may be accessed via the Library’s database.

http://www.doingbusiness.org/data/exploreeconomies/china/
2016/economies/%23economy=CHN
2016/economies/%23economy=CHN
THREE
Assessment
Assessment for this unit is conducted in accordance with the
Assessment Policy.
The Assessment Policy can be found at:
http://www.murdoch.edu.au/index/atoz/A#assessment.
Schedule of assessment items
You will be assessed on the basis of:
Assignment Mark Due Date
1. Mid-semester test 15% Week 8
Date TBA by
Kaplan PM
Team
2.

3.
Essay
Workshop
discussion and
participation
25%
10%
Monday of
Week 10
4. Examination (two
hours)
50% Date TBA
Assessment details
Workshop Presentation/Participation
Internal students will have a weekly workshop session
beginning in session 2 of the unit.
All students are required to give a workshop presentation.
Topics will be allocated at the first workshop.
The workshop topics are listed after Session 12.
Assessment Criteria

Workshop presentations should be 10-15 minutes long.
Students need to explain the topic they have been
studying, why it is important and how the topic has been
examined in the references they have read. In
order to facilitate discussion, students must distribute a one or
two page handout to all members of class.
Students may wish to provide tables and/or graphs as part of
their handouts. The use of PowerPoint is
encouraged but not required. After each presentation there will
be a general class discussion. Everyone in
the class should be prepared to offer constructive comments and
criticisms. At a minimum it is important
that all students read the essential references for each topic.
See the Appendix for a marking guide.
Mid-Semester Test
This test will take place during Week 8 at a time to be advised.
The test will cover material from sessions 1
to 7 of the semester. You will be required to write concise notes
on FIVE of TEN topics. In your answer you
should:
(a) Show that you understand the meaning of the topic
(b) Briefly illustrate the use/importance of the topic to Chinese
Business
The time allowed to complete the test is 1 hour and 10 minutes.
Kaplan will advise on the timing and venue

for the test. If you have any questions about the test please
contact your lecturer.
If you miss the mid-semester test for a legitimate reason such as
illness, the weight of the test will be
added onto the weight of the final exam. There will be no
make-up for this test.
The Essay
Internal students are required to complete one essay of 2,000
words.
These word limits exclude footnotes, graphs, tables and
bibliography and should be regarded as an
absolute maximum.
Assessment Criteria
The essay is intended to test your ability to critically analyse
arguments and issues in Chinese Business.
When marking the essay your tutor will be looking for evidence
of wide reading and an ability to present a
cogent, reasoned argument. A concise essay directly answering
the question will score higher marks than a
lengthy one containing a large number of irrelevancies.
The essay must be fully referenced using the Chicago system.
For details of this style of referencing
see http://libguides.murdoch.edu.au/Chicago.
The essay will be assessed using the standard Kaplan individual
essay paper mark sheet.
Essay Topics
Students can choose either of the following topics:

Topic 1: Outline the main features of the ‘new normal’ phase
of China’s economic growth.
OR
Topic 2: What is ‘shadow banking’? Does it pose a threat to the
stability of China’s financial system?
http://libguides.murdoch.edu.au/Chicago
The following apply to all students.
• Extensions of time to submit assignments will normally be
granted only to those students whose
work has been significantly affected by illness and who apply
for an extension BEFORE the
scheduled submission date.
• Please note reasons which are insufficient to warrant an
extension include: computer failures; car
failures or other transportation difficulties; work conflicts and
other study commitments. “Losing”
work through “computer failure” is not accepted as a reason for
late submission of an assignment;
students using a computer should know to frequently save and
backup, and always have done so.

• The deadline for submission is 5 pm on the due date. Late
submission will be penalised at 5 per
cent per day or part thereof.
• No essays will be accepted two weeks after the due date as
assignment return will have begun.
• For your own protection, students should keep a copy of all
submitted work.
• Students are encouraged to use the Urkund plagiarism-
checking software prior to submission of
their essay. Urkund is a pattern-matching system designed to
compare work submitted by students
with other sources from the internet, journals/periodicals, and
previous submissions. Its primary
purpose is to detect any submitted work that is not original and
provide a thorough comparison
between the submitted document and the original sources.
• Urkund replaces Turnitin (the previous pattern-matching
software used by Murdoch) in 2016.
• More information about how to avoid plagiarism is contained
within the Murdoch Academic
Passport (MAP) unit
https://moodleprod.murdoch.edu.au/course/view.php?id=2684.
• University policies on academic integrity can be accessed

here:
http://our.murdoch.edu.au/Educational-technologies/What-you-
need-to-know/
Electronic Assignment Submission - all students - LMS online
• When submitting assignments electronically, please use the
Electronic Cover Sheet available at:
Murdoch website via Search function type in Assignment
Coversheet
• All assignment submission is online via the 'Assignments Tab'
in LMS. Please note the date and
time of the online submission is Perth Western Australian time
and students are responsible to
allow for any time difference. The BUS243 assignment box
will be closed at the time and date
specified of the session it is due and after that time the
assignments are then to be submitted into
the late box. Therefore, unless students have already negotiated
an extension, any assignment is
late after the specified time and date and is subject to a late
penalty per 24 hours that it is late (this
includes weekends and public holidays).
• All assignments are to be submitted in Microsoft Word. The
coversheet and assignment should be
submitted as a single file.

https://moodleprod.murdoch.edu.au/course/view.php?id=2684
• So your work does not get mixed up with that of other students
use a file name which follows the
following convention: unit code, assignment number, the first
three characters of your surname,
your first initial and your student number e.g.,
BUS243Assign1ChoJ12345678 for student Jun
Chong.
• You must wait for confirmation from LMS that your upload
has been successful and you should
keep a copy of both your assignment and the confirmation from
LMS. It is suggested that you log
out and log in again to make sure it is there. A Guide to LMS
online assignment submission is
located on the Murdoch web.
Final Examination
The final examination is designed to provide you with an
opportunity to consolidate what you have learned
in this unit. The exam marker will be looking for evidence of
wide reading and an ability to present cogent
arguments on aspects of Chinese Business.
The mechanics of the exercise are such that you must answer 4
essay questions in two hours. You will be
given ten minutes to read the paper before the exam starts. Past

exam papers are available on the
Library’s Website.
For those of you not used to taking exams the following points
may be helpful:
• Read the question carefully. A concise essay directly
answering the question will score higher
marks than a lengthy one containing a large number of
irrelevancies.
• Plan your answers. Make a note of all the points which seem
to be relevant to the question.
Remember to give your essay an introduction and a conclusion.
• Allocate your time. You are required to answer four essay
questions in two hours which means
that you should spend approximately 30 minutes on each essay.
If you are short of time, finish an
answer in note form.
• Try and leave time to read your answers. This is so that you
can correct any errors.
If you have any questions about the examination please do not
hesitate to contact the Unit Coordinator or
your tutor.
The examination will be held during the normal University
assessment period. For further information

about examinations refer to http://our.murdoch.edu.au/Student-
life/Get-organised/About-exams/Exam-
help-and-support/.
Determination of the final grade
Assessment is continuous and students are not required to pass
the final exam to pass the unit. Your final
result will be reported by the following letter grades. In order to
achieve a particular grade you will need to
attain the corresponding percentages listed in this Guide.
Seethe Assessment Policy regarding grades.
Notation Grade Percentage Range
HD High Distinction 80-100
D Distinction 70-79
C Credit 60-69
P Pass 50-59
N Fail 0-49
DNS Fail Fail. The student failed to participate
in assessment components that had a
combined weighting of 50% or more
of the final mark.
SA Supplementary Assessment 40 – 49%*
*The award of the grade of SA shall
be at the discretion of the Unit
Coordinator except where clause

11.8 applies.
SX Supplementary Exam 40 – 49%*
*The award of the grade of SA shall
be at the discretion of the Unit
Coordinator except where clause
11.8 applies.
There is a possibility of marks being moderated to ensure equity
of marking by different tutors on the same
unit and/or to ensure consistency across assessments and
examinations on different offerings of a unit.
Academic Integrity
Murdoch University encourages its students and staff to pursue
the highest standards of integrity in all
academic activity. Academic integrity involves behaving
ethically and honestly in scholarship and relies on
respect for others’work and ideas. Lack of academic integrity,
including the examples listed below, can lead
to serious penalties.
Find out more about how to reference properly and avoid
plagiarism at:
http://www.murdoch.edu.au/teach/plagiarism
Plagiarism Inappropriate or inadequate acknowledgement of

original work
including:
• Material copied word for word without any acknowledgement
of its source
• Material paraphrased without appropriate acknowledgement
of its source
• Images, designs, experimental results, computer code etc
used or adapted without acknowledgement of the source.
Ghost writing An assignment written by a third party and
represented by a
student as her or his own work.
Collusion Material copied from another student’s assignment
with her or his
knowledge.
Purloining Material copied from another student’s assignment
or work
without that person’s knowledge.
Adapted from the Assessment Policy, Plagiarism and Collusion
http://www.murdoch.edu.au/admin/policies/assessment.html

http://www.murdoch.edu.au/admin/policies/assessmentlinks.htm
l%239.
Chinese Business
BUS243
Learning Guide
Introduction
This Learning Guide contains information on how to study each
topic, including:
• Introductory information
• How the topic contributes to the unit’s learning outcomes
• Resources required for the topic
• Learning activities/tasks
This information is designed to help you move through the unit
in a way that will lead to through, critical and
reflective learning. The study questions will help consolidate
your learning and assist you to become an
independent learner. The learning outcomes help to pinpoint
what you need to understand from your
readings.

The detailed information about the learning activities and
readings is available on the LMS site. The LMS site
presents information on a session-by-session basis. This session
structure corresponds with the study schedule
in the unit guide. Students are expected to visit the LMS site
regularly for updates and instructions.
15 Unit code Learning Guide
SESSION ONE
Introduction:
Why Chinese Business? Chinese Business in Regional and
Global Contexts
After an overview of the Unit, together with an explanation of
the objectives to be achieved during the
semester, the lecture will begin by answering the question why
China and Chinese business have become
topics for international dialogue and discussion today? To place
the study of Chinese business in historical and
contemporary contexts the regional and global economic and
commercial development over the last one
hundred years or so will be discussed. To understand the
Chinese economy and business environment of 2016,
it is necessary to see how it has reached its current status, and
consider the role of the main players who have
shaped China’s recent history.
Concepts to Learn

Eurocentricism; sinocentricism; regionalism; globalization;
Maoism; planned economy; unequal treaties;
national humiliation of China; Cultural Revolution; The Great
Leap Forward; Mandate of Heaven; the ‘new
normal’.
Learning Objectives
After studying this section you should be able to:
• identify major landmarks in the history of modern China
• understand how the Chinese economic system evolved after
1978
• understand the impact of globalisation on China’s economy
Essential Readings
Set Text (Liu): Chapter 1
Set Text (Philips and Kim): Chapter 1, esp.pp.11-18.
Recommended Readings
One cannot study contemporary China comprehensively without
learning about Mao Zedong and his role in
shaping the history of that country and society. There are
number of books on Mao’s life and achievements. I
recommend all students read the book below; it is short and
easy reading. A copy of this book will be placed
in close reserve at the Murdoch University Library.
Rebecca E. Karl, Mao Zedong and China in the 21st Century
World, London: Duke University Press, 2010.
For an overview of China’s growth see ‘China’s Path: 1978–
2030’, pp.4-14. In World Bank and the
Development Research Center of the State Council, P. R. China.

2013. China 2030: Building a Modern,
Harmonious, and Creative Society. Washington, DC: World
Bank. DOI: 10.1596/978-0-8213-9545-5.
Audio-visual media
2017 China Macroeconomic Outlook: Goldman Sachs
Research's Andrew
Tilton. https://youtu.be/MlV5dqeGrAg
https://youtu.be/MlV5dqeGrAg
SESSION TWO
History and Culture of China
Although this lecture covers the history of China from the
ancient past to the present the main focus of the
lecture will be on the significance of history to the Chinese
people and their leaders, including business
entrepreneurs. China is one nation that feels proud of its history
and its leaders expect foreigners to have
some knowledge and understanding of the Chinese past. The
same applies to Chinese culture. The lecture will
discuss the Confucian foundations of Chinese culture and will
relate it to the broader issue of ‘Asian Values’. It
will be shown that familiarity with and an understanding of
these values will become handy for foreigners
when negotiating business deals in China.
Concepts to Learn

Right Historian; Left Historian; Grand Historian; Confucianism;
Asian Values; capitalist spirit; Guanxi, Mianz;
Ren; Li.
Learning Objectives
• understand the main features of the Asian cultural doctrines of
Confucianism, Japanese communalism and
Buddhism
• Identify key Asian values
• Explain Chinese business culture and guanxi
Essential Readings
Set Text (Liu): Chapters 1 and 2; Chapter 4 pp.184-187;
Chapter 6, p.255.
Set Text (Philips and Kim): Chapter 1, esp.pp.11-18 and
Chapter 3, esp.pp.113-117 and pp.134-151.
S. Rosefielde, Asian Economic Systems (Singapore, 2013),
Chap 3, pp.48-60. http://0-
lib.myilibrary.com.prospero.murdoch.edu.au/Open.aspx?id=486
888.
‘Timeline: South China Sea dispute’, Financial Times July 12,
2016
Available on My Unit Readings.
Ding and Xu, The Chinese Way, 2015, parts I – VII
Jonathan Fenby, The Penguin History of Modern China, 2009

Frederick Wakeman, Jr., The Fall of Imperial China, London:
Macmillan Press, 1975.pp1-3,pp 65-69, pp 111-
129, pp225-255.
Edward Moise, Modern China: A History, New York: Longman,
1986. ppviii-xv, pp 1-27.
Audio-visual media
20 Tips on Chinese Culture for Successful Business.
https://youtu.be/H6g7tUcoF3I
SESSION THREE
China’s Socialist Market Economy
This lecture covers the current political and economic structure.
The reforms of Dang Xioping will be the
particular focus of this topic. The changing economic and
political scenario in the world in general and in the
Asian region in particular will be highlighted. How China
exited from a planned economy will be discussed in
light of the experience of Russia. The final part of the lecture
will deal in detail on the decline of “Washington
Consensus” and the rise of “Beijing Consensus”.
Concepts to Learn

Market Socialism; Bird-cage economy; Big-Bang approach;
gradualism and pragmatism; Washington
consensus; Beijing consensus; Janus-faced state-led growth;
Newly Industrialized Economies (NIEs); open-door
economic policy.
Learning Objectives
• understand the contribution of the state to China’s economic
development
• explain the main features of Chinese market communism
• understand the Washington Consensus and the Beijing
Consensus
Essential Readings
Set Text (Liu): Chapter 5.
Chapter 2, esp.pp.39-46.
Williamson, J. ‘Is the “Beijing Consensus” Now Dominant?’
Asia Policy, number 13 (January 2012), 1–16.
Stefan Halper, The Beijing Consensus, New York: Basic Books,
2010
Scott Kennedy, ‘The myth of the Beijing Consensus’ in S.

Phillip Hsu et. Al., (ed) In Search of China’s
Development Model, Routledge Contemporary China Series,
London, New York: Routledge, 2011, pp. 27-44.
Audio-visual media
http://video.ft.com/4791614289001/The-end-of-the-Chinese-
miracle/World?cat=china-
slowdown&connectionsapac=y
miracle/World?cat=china-slowdown&connectionsapac=y
miracle/World?cat=china-slowdown&connectionsapac=y
SESSION FOUR
FDI and China’s Foreign Trade Regime
When China opened its economy to the world one of its main
objectives was to attract foreign investment and
modern technology. FDI and foreign trade are inseparable and
this topic covers the recent history of China’s
foreign trade and FDI, from the ‘lean to the East’ policy of the
post-liberation period to the ‘open door policy’
after 1976. The role of foreign investment and the significance
of Special Economic Zones will also be analysed.
In discussing FDI the crucial position of Hong Kong and the
role of the Chinese Diaspora will be highlighted.

Concepts to Learn
Foreign Direct Investment; portfolio investment; flexible, fixed,
and managed exchange rates; Special
Economic Zones; technology transfer; dumping; bilateral and
multilateral trade; current account balance;
comparative advantage.
Learning Objectives
• define FDI
• understand the contribution of FDI to China’s economic
development
• explain the role of Special Economic Zones
• understand the role of the Chinese Diaspora
Essential Readings
Set Text (Philips and Kim): Chapter 2, esp.pp.68-79.
Barry Naughton, The Chinese Economy, chapters 16 and 17.
Lida Yueh, The Economy of China, Cheltenham UK,
Northampton MA, USA, 2010, pp.206-229.
Jun Zhang et al., Transformation of the Chinese Enterprises,
Gale*Asia, 2010, chapter 7.

Audio-visual media
Sens, A., University of British Columbia, Multinational
Corporations
http://www.youtube.com/watch?v=FCojpFwWuG0
What can the iPhone tell us about China's Trade? - RES
2016.Arie Lewin, Duke University's Fuqua School of
Business, China's Innovation Challenge: Overcoming the
Middle-Income Trap.
https://www.youtube.com/watch?v=7ePl91A42M4
http://www.youtube.com/watch?v=FCojpFwWuG0
SESSION FIVE
Chinese Business Structure
The categorization of Chinese enterprises and the impact of the
reforms in transforming those enterprises will
be the chief focus of this topic. The emergence of Township and
Village Enterprises (TVEs), Joint Ventures of
various sorts, and some indigenous innovations in Chinese
private enterprises will also be discussed.
Concepts to Learn

Contractual Joint Ventures; Equity Joint Ventures; Wholly
Foreign-owned Enterprises; Township and Village
Enterprises; State Owned Enterprises (SOEs).
Learning Objectives
• understand the contribution of SOEs to China’s economic
development
• explain the main features of Township enterprises
• explain the main features of foreign-invested enterprises
• explain the main characteristics of joint ventures and the
reasons for their popularity
Essential Reading
Set Text (Philips and Kim): Chapter 2, esp.pp.73-79 and pp.96-
107-107; Chapter 7.
Recommended Reading
‘Dealing with zombie enterprises in China’,
http://www.eastasiaforum.org/2016/11/20/dealing-with-zombie-
enterprises-in-
china/?utm_source=newsletter&utm_medium=email&utm_camp
aign=newsletter2016-11-20
Ding and Xu, The Chinese Way, Part XI.
Jun Zhang et al, Transformation of the Chinese Enterprises,
Gale Asia, 2010.

Audio-visual media
CGTN America, A look at China's state owned enterprises.
https://youtu.be/TrR_oTmdEaE
enterprises-in-
enterprises-in-
SESSION SIX
Chinese Management Systems
One of the objectives of the post-1992 reforms was to bring the
Chinese public and private enterprises under
modern management systems. Companies can be divided into
three categories: state-owned enterprises
(SOEs), people-managed companies (PMCs) and foreign capital
companies (FCCs). One aim of allowing FDI into
China was to learn from foreigners how to manage an enterprise
efficiently. This lecture will deal with this
issue in the context of some of the modern theories on

management.
Concepts to Learn
M-form and U-form organizations; S&T Administration in
China; R&D investment; patents; investment in
human capital; ren.
Learning Objectives
• have a broad understanding of Chinese management systems
• explain the differences between the state-owned enterprises
(SOEs), people-managed companies
(PMCs) and foreign capital companies (FCCs)
• understand the role of FDI and SEZs in bringing in modern
management techniques to China
• assess the benefits of modern management techniques system
in advancing science and
technology in China
Essential Readings
Set text (Liu): Chapter 7
Chapter 5 pp.214-219 and pp.237-239.

"Made in China: three ways Chinese business has evolved from
imitation to
innovation", http://theconversation.com/made-in-china-three-
ways-chinese-business-has-evolved-from-
imitation-to-innovation-67236
Lu De-ming, Development of China in the Modern World
System, Gale*Asia, 2010, chapter 7.
Chen, Min (2004). Asian Management Systems. 2nd ed,
Thomson, London, chapters 1, 8 & 9.
Audiovisual media
The Open University, East-West Management - Management in
Chinese Cultures (3/6).
https://youtu.be/zjGWYNvr9ZE
http://theconversation.com/made-in-china-three-ways-chinese-
business-has-evolved-from-imitation-to-innovation-67236
http://theconversation.com/made-in-china-three-ways-chinese-
business-has-evolved-from-imitation-to-innovation-67236
SESSION SEVEN
Market Entry Strategies into China
Introduction
Chinese and Foreign joint venture enterprises have become very
popular over the past 25 years. While some

foreign companies regretted the day they ever ventured into
China, others are beginning to reap the rich
rewards they expected when teaming up with China.
This lecture investigates the types of agreements and China's
fairly recent Joint Venture (JV) legislation. We
will investigate the tedious process of finding the right partner,
the right site from which to operate and the
long drawn out process of obtaining all the approvals at the
various levels of Chinese bureaucracy.
Infrastructure costs are of vital importance for cost/revenue
projections of JV enterprises and the SEZ's
(Special Economic Zones) have gradually outpriced themselves
to all but the big multi-national corporations.
We will also examine why joint management is the preferred
modus operandi for a JVC (Joint Venture
Company). We will ask the question if and when a foreign joint
venture partner may expect to get returns on
the invested capital and what issues are involved with the
repatriation of capital. Lastly, we will examine the
Chinese taxation system in relation to JVC's and their foreign
investors.
Concepts to Learn
Market research; communication barriers; letter of intent; Sino-
foreign JV-law; feasibility study; partner
compatibility; China-specific cultural skill; legal registration
and license; exit clause.
Learning Objectives
After studying this section you should be able to understand:

• The conditions required to make the establishment of a JV
enterprise in China a feasible proposition.
• Infrastructure requirements for the establishment of a JV
enterprise in China
• Staff management requirements and problems JVC's might
encounter.
• Joint venture and other Chinese laws that impact upon a JVC.
• Chinese taxation system and how it affects JVC's and their
staff and management.
• Advantages and disadvantages of basing your JVC in a
Chinese SEZ (Special Economic Zone) or SAR
(Special administrative region).
Essential Readings
Set text (Liu): Chapters 6 and 9
Set Text (Philips and Kim): Chapter 7
Further Reading
Ahmad Bashawir A. Ghani; Muhammad Subhan; Malcolm Tull,
‘An empirical study of foreign direct
investments of Malaysian multinationals: wholly-owned
subsidiaries and international joint ventures’, Int.
Audiovisual media
UK Trade & Investment, 5 steps for building a marketing plan
for successful market entry to China.

https://youtu.be/VBsqAa_FyOg
J. of Strategic Business Alliances, 2011 Vol.2, No.4, pp.287-
306.
Bath, Vivienne (et al.); editor Duncan Freeman (1993). The Life
and Death of a Joint Venture in China. Hong
Kong: Asia Law and Practice.
Liu, Geng (1995). Joint Venture Laws and Practice in the PRC
(late 1979 to 1992). PhD Thesis, Murdoch
Library
Lee, Fook Hong (1999). Investment and Taxation in China.
Singapore: Federal Publications.
Tian: Chapters 4 & 5
SESSION EIGHT
Negotiating with the Chinese
Successful business managers are usually effective
communicators. Effective communication and cross-cultural
skills are essential for successful business negotiations.
When we deal with others we are engaging in some level of

relationship, and conflict is almost inevitable, and
even potentially beneficial. How we, and others, handle conflict
will determine whether it is constructive or
destructive, but handle it we must. Being aware of personal
styles of handling conflict may increase the
likelihood that conflict can be used positively. This dictum
certainly applies to business negotiations with the
Chinese, where students need to be aware of the Chinese style
of communication and negotiation.
We will now investigate how the Chinese use the time factor in
their favour and as a major bargaining chip
when squeezing out ever greater concessions from their western
business partners. There is nothing
dishonest about this practice; it is simply the style in which the
Chinese have transacted business negotiations
for millennia.
Learning Objectives
• Outline specific communications strategies that can be used to
successfully negotiate a business or
joint venture deal.
• Describe the types of conflicts, which may arise, when
conducting preliminary and final negotiations
with Chinese business partners.
• Determine what bargaining margins you require and how to
skillfully play your trump cards during
negotiations.
• Clearly identify the laws, rules and regulations that China has
in place and is planning to implement in
the future in relation to setting up international business in

China, including JVs.
The arrest in 2016 of employees of Crown Casinos in China
raises some interesting issues regarding the
rule of law in China. See ‘Crown employee arrests show danger
of assumptions about China’ —
http://theconversation.com/crown-employee-arrests-show-
danger-of-assumptions-about-china-67148
‘Businessman seeks pardon for China conviction’, Weekend
Australian 09 July 2016: 4.
Available on My Unit Readings.
Blackman, Carolyn (1997). Negotiating China. Sydney: Allen
& Unwin.
McNeilly, Mark (1996). Sun Tzu and the Art of Business. New
York: Oxford University Press.
Mann, Jim (1989). Beijing Jeep: The Short Unhappy Romance
of American Business in China. New York:
Simon & Schuster.
Wee, Chow-Hou and Lan, Luh-Luh (1998). The 36 Strategies of
the Chinese. Singapore: Addison Wesley.
Audio-visual media
Cultural difference in business | Valerie Hoeks | TEDxHaarlem.
https://youtu.be/VMwjscSCcf0
Essential Readings
Chapter 7 pp.304-331.

SESSION NINE
Chinese Competitiveness
This topic covers the various strategies that the Chinese
government and private enterprises are adopting to
maintain their competitiveness in the world stage. Multi-
dimensional measures of competiveness will be
discussed. Chinese industrial policy will be discussed in
connection with Chinese foreign policy. An important
section of this topic will be devoted to China’s overseas direct
investment and foreign economic assistance. It
will be shown that the historically famous principle of
comparative advantage that determines international
competitiveness plays somewhat of a subsidiary role to Chinese
principles of competitive advantage.
Concepts to Learn:
Industrial policy; competitive advantage; energy-driven and
security-driven economic aids; undervalued and
overvalued currency; US-China trade rivalry; string of pearls
strategy; 21st Century ‘maritime silk road’; ‘soft
power’.
Learning Objectives
After studying this section you should gain knowledge about:
• Comparative and competitive advantages
• Chinese Industrial policy
• Chinese economic assistance to foreign countries
• Link between Chinese foreign policy and economic aid

• International tensions arising from Chinese competitiveness
Essential Reading
Set Text (Philips and Kim): Chapter 3, esp.pp.113--147.
For a brief introduction to soft power see Nye, Joseph S. Jr.,
‘The Rise of China's Soft Power’, Wall Street
Journal Asia, December 29,
2005.
http://belfercenter.hks.harvard.edu/publication/1499/rise_of_chi
nas_soft_power.html. Availab
le on My Unit Readings.
Steffan Halper, The Beijing Consensus, New York: Basic
Books, 2020.
Eva Paus et al., Global Giant: Is China Changing the Rules of
the Game? New York: Palgrave Macmillan, 2009,
chapters, 6, 7, &8.
Audio-visual media
China: Global Competitiveness Report 2014-2015.
https://youtu.be/EOhKE5KlbAY
Asian View, How rising wages affect China's competitiveness.
https://youtu.be/jnqRsqqEccc
http://belfercenter.hks.harvard.edu/publication/1499/rise_of_chi

nas_soft_power.html
https://youtu.be/EOhKE5KlbAY
SESSION TEN
Intellectual Property Rights in China
Introduction
This topic is generally seen as an area impeding trade and
business with China. Infringements of copyright still
remain a concern for international business. The first section of
this lecture will deal with the clash between
post-1976 and pre-1976 legal systems. The cultural aspects of
China’s traditional legal system will be discussed
in depth. The legal challenges to China after joining WTO and
the nature of Chinese legal reforms will also be
considered.
Concepts to Learn
TRIPs and TRIMs; private property and public property rights;
intellectual piracy; legal reforms; legal
convergence.
Learning Objectives
• Understand the history of IPR in China
• Understand the measures taken by China to conform to
international law on IPR

Essential Readings
Set text (Liu): Chapters 7 and 8
Set Text (Philips and Kim): Chapter 7, esp. pp.304-312 and
pp.318-331.
Hunter, Kate Colpitts “Here There be Pirates: How China is
Meeting Its IP Enforcement
Obligations Under TRIPS”, San Diego International Law
Journal, Vol 523, 2006-2007.
(available via HeinOnline)
Audio-visual media
PBS NewsHour, Intellectual Piracy in China.
https://youtu.be/33sI-Z1A9og
SESSION ELEVEN
China’s Financial System
The financial system plays a key role in China’s development
by promoting monetisation, mobilising savings,
allocating investment, distributing risks and managing economic
stability. Under WTO membership
requirements China has introduced major reforms of its
financial and stock markets including greater
liberalisation of interest rates, reforming the state-owned banks,

easing entry restrictions on financial
institutions and capital flows, and upgrading corporate
governance. Nevertheless, despite these reforms, the
system “remains repressed, unbalanced, costly to maintain and
potentially unstable” (World Bank, China
2030). The Asian Financial Crisis and the Global Financial
Crisis focussed attention on the risks of liberalising
financial markets and the global need for improvements in
systems of corporate governance. In the case of
China, further reforms are needed to create an efficient and
sound financial system.
Concepts to Learn
Financial broadening, financial deepening and financial
repression; stock-market; bad debt; currency issue and
credit control; recapitalization; shadow banking; financial
reform.
Learning Objectives
• Understand the development of China’s financial system
• Identify the main institutions in China’s financial system
• Understand what reforms are needed to create a more efficient
and stable financial sector
• Appreciate the dilemmas facing China in reforming its
financial system as well as conforming to WTO
entry requirements.

Essential Readings
Set text (Liu): pp.113-118 and Chapter 8.
Set Text (Philips and Kim): Chapter 2, esp.pp.58-68 and pp.79-
96.
‘Financial System Reforms’, pp.115-127. In World Bank and
the Development Research Center of the State
Council, P. R. China. 2013. China 2030: Building a Modern,
Harmonious, and Creative Society. Washington, DC:
World Bank. DOI: 10.1596/978-0-8213-9545-5.
Special Report, ‘Finance in China’, Economist May 7th 2016
(several articles from this report are available on
My Unit Readings).
Joshua Aizenman, Hiro Ito, ‘East Asian economies and financial
globalisation in the post-crisis world’, 23 June
2016.
http://www.voxeu.org/article/east-asia-s-financial-
future#.V4YEWuQuB64.
Kaiji Chen, Jue Ren, Tao Zha, ‘Unintended consequences of
monetary and regulatory policies on banks’ risk-
taking behaviour: A closer examination of China’s shadow
banking’
http://www.voxeu.org/article/causes-and-consequences-china-s-
shadow-banking’, 24 March 2016. Available
on My Unit Readings.
Barry Naughton, The Chinese Economy, 2007, ch. 19.

Wu, Jianglian Understanding and Interpreting Chinese
Economic Reform (2005), Thomson South Western,
Ohio, USA. (Chapter 6).
Audio-visual media
The Financial Crisis in Historical Perspective: An Interview
with James Boughton,October 11, 2008
http://www.imf.org/external/mmedia/view.aspx?vid=791609740
01
Tng Boon Hwa, Senior Economist at Bank Negara Malaysia,
Preventing a Financial Crisis
http://www.worldbank.org/en/news/video/2016/05/27/preventin
g-a-financial-crisis
http://www.voxeu.org/article/causes-and-consequences-china-s-
shadow-banking
SESSION TWELVE
Overview and Revision
Introduction
The final session revises what has been covered in this unit by
reviewing the topics studied, and considering
what students have learned about the process of economic
development in Asia.

You should prepare for the final exam by going back over your
notes, and reviewing the advice on the exam
given earlier in this Unit Guide.
Workshop Program
NOTE: In order to answer these questions it is necessary for
you to have read all of the Essential
Readings.
Week 1: Workshop Questions
1. Why should we study about China and about its economy
and business?
2. What was the nature of the global and regional economic
environment when China opened its doors for
business in 1976?
3. What were the impacts on Chinese businesses of the 2008
global financial crisis? How did the Chinese
government react to that crisis?
4 What is the ‘new normal’?

1. How does China’s Confucianism differ from Japanese
Communalism and Theravada Buddhism?
2. How do Asian and western cultural systems differ?
3. Is culture relevant to do business? How does the Chinese
culture promote or impede its business
activities?
4. Is an understanding of China’s culture useful in gaining
insight into contemporary Chinese behaviour?
Discuss with reference to the China South Sea dispute
1. Compare and contrast Russia’s exit from its planned
economic model with that of China’s experience.
2. How do you define a socialist market economy? What are the
Chinese characteristics of the socialist
market economy?
3. Is the Beijing Consensus an alternative to the Washington

Consensus?
1. What made China become the main attraction for foreign
investment after 1978?
2. What difficulties do foreign investors face in China?
3. China has had significant growth in foreign trade since the
1980s. Provide some explanations for this
growth. Do you think that it is sustainable?
1. Explain the reasons for the early success and the eventual
failure of the TVEs in Chinese business
structure?
2. What are salient the features of China’s SOE reforms?
3. ‘Grab the big and let the small slip away’. What does this
imply in the Chinese style of reforming State
Owned Enterprises?
4. How private are the Chinese private enterprises?

1. What is so unique about the Chinese management system?
2. List two approaches to get closer to your Chinese business
contact. Use examples to illustrate your
answer(s).
3. What do you consider to be taboo when attending a Chinese
banquet hosted by your Chinese business
contacts?
4. What will you observe, when giving gifts to /or receiving
gifts from your Chinese business contacts
(partners).
1. What do you understand by industrial policy?
2. What do you think are the main reasons for Chinese success
in international business competitiveness?
3. Can China sustain its business competitiveness?
4. Is there a link between China’s foreign policy and its
business competition policy?
5. Why is the world so nervous about China’s business success?
Week 8: Mid-trimester Test

1. Is there a clash between the Western legal system and the
Chinese legal system?
2. How is the rule of law being implemented in China today?
3. What specific problems do foreign investors face in China
with regard to legal matters? How can they
overcome these problems?
1. What are Intellectual Property Rights (IPRs)? Why are they
important?
2. What are the main IPR rules imposed on China as a result of
joining the WTO?
3. To what extent is China’s enforcement of IPRs a matter of
“The Emperor is Far Away”?
1. Why does a modern economy need a sound financial system?

2. Explain the main characteristics of the Chinese stock
exchange.
3. Examine some of the banking reforms that were introduced
by the Chinese government and discuss their
relative success or failures.
4. Do you think that the Chinese Yuan will become the global
currency this century?
Week 12: Revision
Appendix
BUS 243 Marking guide for Student Presentations
Student Name:
Objective/Criteria Needs

Improvement
Met
Expectations
Excellent Exceptional Marks
Allocated
Delivery (voice)-
Communicates well,
keeps audience
attention, talks with
confidence (no
reading)
1 2 2.5 3
Delivery (visual)-
Good ‘eye contact’,
confident posture and
appropriate attire
1 2 2.5 3
Audio Visual Aids and
Props, PPP-
Clear logical
progression,
imaginative
1 1 1.5 2
Handling of Q and A
session
1 1 1.5 2

Total Possible Marks 4 6.0 8 10
How to use this Learning GuideUnit overviewThis Unit will
introduce the students to the business culture of China that has
emerged after the end of the Mao Era, and will provide an
essential tool-kit to establish productive business relationships
with the Chinese, be it outside or inside the ...Acting Unit
CoordinatorGraduate attributesThis unit will contribute to the
development of the following Graduate
Attributes:PrerequisitesHow to study this unitStudy
scheduleUnit materialsEssential textbookOther referencesOnline
resources including web pagesLibrary resourcesAssessment for
this unit is conducted in accordance with the Assessment
Policy.The Assessment Policy can be found at:
http://www.murdoch.edu.au/index/atoz/A#assessment.Schedule
of assessment itemsYou will be assessed on the basis
of:Electronic Assignment Submission - all students - LMS
onlineFinal ExaminationThere is a possibility of marks being
moderated to ensure equity of marking by different tutors on the
same unit and/or to ensure consistency across assessments and
examinations on different offerings of a unit. Academic
IntegrityIntroductionAudio-visual mediaEssential
ReadingsAudio-visual mediaPercentage RangeGradeNotation80-
100High DistinctionHD70-79DistinctionD60-69CreditC50-
59PassP0-49FailNFailDNSEssential ReadingsEssential
ReadingsAudio-visual mediaWhen China opened its economy to
the world one of its main objectives was to attract foreign
investment and modern technology. FDI and foreign trade are
inseparable and this topic covers the recent history of China’s
foreign trade and FDI, from the ‘l...Audio-visual mediaLearning
ObjectivesEssential ReadingsEssential ReadingsRecommended
ReadingsEssential ReadingsFurther ReadingEssential

ReadingsIntroductionConcepts to LearnLearning
ObjectivesEssential ReadingsAudio-visual mediaLearning
ObjectivesEssential Readings‘Financial System Reforms’,
pp.115-127. In World Bank and the Development Research
Center of the State Council, P. R. China. 2013. China 2030:
Building a Modern, Harmonious, and Creative Society.
Washington, DC: World Bank. DOI: 10.1596/978-0-8213-954...
QUESTION 1
1. Coconut Producers' balance sheets:
· Total Revenues = $20
· Wages = $5
· Taxes = $1.5
· Interest on Loans $0.5
What is the Coconut Producer contribution’s to GDP using the
Value Added Approach?
(omit the $-sign in your answer)
10 points
QUESTION 2
· Wages = $5
· Taxes = $1.5
Expenditure Approach?
10 points
QUESTION 3
· Wages = $5

· Taxes = $1.5
Income Approach?
10 points
QUESTION 4
1.
Car Producers' balance sheets:
1. Total Revenues = $100
1. Steel Purchases = $30
1. Wages = $35
1. Taxes = $10
1. Interest on Loans $2
What is the Car Producers' contribution’s to GDP using the
Income Approach?
10 points
QUESTION 5
1. Car Producers' balance sheets:
1. Wages = $35
1. Taxes = $10
Value Added Approach?

10 points
QUESTION 6
1. Car Producers' balance sheets:
1. Wages = $35
1. Taxes = $10
Expenditure Approach?
10 points
QUESTION 7
1. Consider the following Economy in which only cars and
bananas are produced
Year 1
Quantity
Price
Cars
1000
$100
Bananas
7000
$1
Year 2
Quantity
Price
Cars
980
$110

Bananas
9000
$0.9
Nominal GDP Year 1 =
Nominal GDP Year 2 =
(Omit any $-sign in your answer)
10 points
QUESTION 8
1. Consider the following Economy in which only cars and
bananas are produced
Year 1
Quantity
Price
Cars
1000
$100
Bananas
7000
$1
Year 2
Quantity
Price
Cars
980
$110
Bananas
9000
$0.9
Real GDP Year 1 = (Using Year 1's prices)
Real GDP Year 2 = (Using Year 1's prices)

Inflation Rate between Year 2 and Year 1 = (using Chain-
Weighting, your answer has to be a percentage - for example
+5.2%. Stop at the first decimal sign!)
(Omit any $-sign in your answer)
20 points
QUESTION 9
1. Consider the following diagram representing GDP per
capita's Cyclical Component as % of Trend:
If you focus on the great recession, you notice that...
GDP per capita growth has been negative since 2008
The Great Recession is similar to what happened in the 60s
Growth has not been sufficient to bring the GDP per capita back
to its trend level before the great recession
The Great Recession is similar to what happened in the 80s
SHADOW BANKING, CHINESE STYLE
Shalendra D. Sharma*
Abstract
Shadow banks are broadly defined as entities which conduct

credit intermediation outside the formal banking system.
Poorly regulated, engaging in opaque forms of intermediation,
deeply interconnected with the official banking system, and
operating with implicit government guarantees, they pose a
major source of systemic risk. Yet shadow banks provide an
important service by channeling credit to excluded investors,
and can complement the formal banking sector. What
explains the rapid proliferation of shadow banks in China? How
large are they and what forms do they take? What types
of risks do they pose to the financial system? And how best can
China utilise the services of shadow banks while at the
same time ensuring that they do not create systemic risks for the
financial system?
JEL codes: G23, G28.
Keywords: credit intermediation; People’s Bank; securitisation;
shadow banking.
1. Introduction
In early January 2014, one of China’s largest ‘trust’ companies,
China Credit Trust (CCT),
announced that it was about to default on its top-grade ‘wealth
management product’ (WMP),
seductively named ‘Credit Equals Gold No.1’.1 CCT first began
structuring (that is, securitising)
this WMP in early 2011. It was then marketed and sold by the
Industrial and Commercial Bank
of China (ICBC), the country’s largest bank. CCT’s prime
purpose in creating the new product
was to raise money for an unlisted coal mining company, the
Shanxi Zhenfu Energy
Corporation. For this it guaranteed investors a huge 10 per cent
annual return (at a time when
the benchmark bank rate was 3 per cent) on maturity on 31

January 2014. However, in early
January 2014 it became public knowledge that Zhenfu Energy
had filed for bankruptcy soon
after receiving the loan and that CTT was just days away from
defaulting as it could not
honour the obligations it incurred on its once blue-chip Credit
Equals Gold No.1 product –
now valued at some RMB3 billion (US$490 million). Zhenfu’s
total debt stood at RMB5.9
billion, but its total assets were worth less than RMB500
million. With the issuer (CCT) unable
to redeem Zhenfu Energy’s debt, and the seller (ICBC) denying
any responsibility, CCT was
saved from imminent collapse at the eleventh hour by an
‘unidentified entity’ (widely believed
to be the Shanxi government), which bailed out the investors’
principal and a percentage of
their interest.
CCT’s very public woes drew attention to a hitherto hidden
problem in China’s financial
sector: the unregulated shadow banking sector. The realisation
that CCT’s problems were not
exceptional but endemic to the country’s vast shadow banking
system was underscored when,
*Professor of politics, University of San Francisco, and Lee
Shau Kee Foundation Chair Professor of Political Science,
Lingnan University, Hong Kong. Email: [email protected] The
author thanks two anonymous reviewers of this
journal and colleagues Baohui Zhang, Marcus Chu, Ling Pin
and Liangliang Jiang for their useful comments and
suggestions, but accepts responsibility for all remaining errors.
© 2014 Institute of Economic Affairs

in early February 2014, it was reported that ‘six Chinese trust
firms have lent more than 5
billion yuan ($824.6 million) to a delinquent coal company . . .
raising the prospect of further
defaults’ (Wildau 2014). Given its burgeoning and uncontrolled
growth, deep interconnections
with the formal financial system and the opacity of its
operations, China’s shadow banking
sector is a source of instability with the potential to trigger a
catastrophic meltdown of the
financial sector reminiscent of the 2008 subprime-mortgage
crisis in the United States – also
triggered by opaque, poorly regulated and over-extended
shadow banks. Not surprisingly, to
some observers China’s shadow banking sector could prove to
trigger the country’s ‘Lehman
moment’ (Boone and Johnson 2014).2
What is shadow banking? What is the nature of shadow banking
in China? What explains its
proliferation? What risks does it pose for the Chinese economy?
And how best can the
authorities mitigate its negative effects? The following sections
address these interrelated issues.
2. What is shadow banking?
Broadly, the term ‘shadow banking’ refers to non-bank entities
which engage in bank-like
activities.3 Ghosh, Gonzalez del Mazo and Ötker-Robe (2012,
p. 1) define shadow banking as
comprising ‘a set of activities, markets, contracts, and
institutions that operate partially (or fully)
outside the traditional commercial banking sector, and, as such,

are either lightly regulated
or not regulated at all’. According to Pozsar et al. (2012),
shadow banks are ‘financial
intermediaries that conduct maturity, credit and liquidity
transformation without explicit access
to central bank liquidity or public sector credit guarantees’. In
November 2011, at the request
of the G-20, the Financial Stability Board (FSB 2012, p. 1)
formally defined shadow banking as
‘credit intermediation involving entities and activities outside
the regular banking system’. Thus,
like traditional banks, shadow banks function as middlemen by
issuing liabilities and holding
assets (Claessens and Ratnovski 2014; FSB 2011). However,
unlike formal banks, they lack the
security provided by a lender of last resort – for example, in the
United States, the Federal
Reserve’s discount window or insurance provided by the
Federal Deposit Insurance
Corporation.
Gorton (2009) points out (with reference to the United States)
that the shadow banking
system emerged gradually from the 1970s as traditional banking
became less profitable.
Specifically, banks were prevented from paying interest on
demand deposits, including
insurance and securities underwriting services, and faced
increasing competition from
interest-bearing services offered by non-banks such as money
market mutual funds. As a result,
banks began to shift their activities towards the more profitable
activities that the shadow
banking sector offered (see also Basel Committee on Bank
Supervision 2010). Gorton (2009,
2010) and Gorton and Metrick (2010) point out that, although

shadow banking performs a role
similar to that of traditional banks, the lenders and borrowers
using shadow banking are large
businesses, broker–dealers and institutional investors who
invest and lend millions or billions of
dollars at a time. However, much of the credit intermediation in
the shadow banking system
takes the form of maturity transformation by the issue of short-
term, liquid liabilities against
longer-term, less liquid assets. This makes shadow banks
inherently fragile and more vulnerable
to runs. As Pozsar et al. (2013, p. 2) note, ‘The emergence of
shadow banking thus shifted the
systemic risk–return trade-off toward cheaper credit
intermediation during booms, at the cost of
more severe crises and more expensive intermediation during
downturns’.
341economic affairs volume 34, number 3
3. Shadow banking in China
As their name implies, shadow banks do business in the
shadows by engaging in off-balance
sheet operations. Hence, it is impossible to know with certainty
the precise reach, scope and
depth of China’s shadow banking sector. As Table 1 shows,
estimates of the size and exposure
of China’s shadow banking sector vary considerably. However,
there is a broad consensus that
the expansion of credit outside the formal banking system has
been so massive that it currently

equals about 40 per cent of China’s GDP and 16 per cent of its
total banking assets – or
roughly RMB20.5 trillion (US$3.35 trillion) (Caijing 2013).4
Table 2, by aggregating all possible
shadow banking activities in China (trust funds, wealth
management products, the broker-asset
management products, among others) puts the total size at
RMB22.8 trillion or 44 per cent of
GDP in 2012.
The Chinese shadow banking system is a complex, byzantine
network of unregulated
lenders made up of investment and finance companies, ‘trust
companies’, credit guarantee
companies, insurance firms, microcredit firms, brokerages, and
online finance vendors. It
comprises informal lenders such as pawnbrokers, including the
so-called ‘kerb-side bankers’ and
loan sharks who charge exorbitant rates to meet the country’s
insatiable credit needs.5 Usually
operating underground, outside formal channels yet more often
than not with government
connivance, shadow banks, usually with all the trappings of
regular banks, raise funds (often by
non-transparent means) to provide loans to businesses and local
governments at high interest
rates. It has been estimated that loans from the formal banking
system ‘which used to account
Table 1: Estimates of the size of China’s shadow banking
system
Source Date
RMB
(trillions)

USD
(trillions)
% of 2012
GDP
% bank assets*
year-end 2012
GF Securities 17 Dec. 2012 30.0 4.8 57 31
Citi Research 11 Jan. 2013 28.0 4.5 54 29
Barclays Dec. 2012 25.6 4.1 49 27
Hua Tai Securities 14 Dec. 2012 25.0 4.0 48 26
UBS 16 Oct. 2012 13.7–24.4 2.2–3.9 26–46 14–25
ANZ Bank Dec. 2012 15.0–17.0 2.4–2.7 29–33 16–18
Bank of America Merrill Lynch 6 July 2012 14.5 2.3 28 15
*Total assets of large state-owned commercial banks, joint-
stock commercial banks and city commercial banks.
Source: Li (2013, p. 1).
Table 2: Size of shadow banking activities in China, 2012
Activity RMB (trillions)
Trust funds 7.5
Bank wealth management products 7.6
Broker asset management 1.9
Underground lending 4.0
LGFV corporate bonds outstanding 1.8
TOTAL 22.8
% GDP 43.9
Source: Credit Suisse (2013, p. 2).
342 s. d. sharma

for more than 90 percent of total credit, fell to little more than
half of new financing last year
[2012]. Lending by shadow banks now totals RMB47 trillion, or
84 percent of gross domestic
product’ (Rabinovitch 2014).
Unlike advanced economies, such as the United States, shadow
banks in China offer basic
if not simple financial products. Since complex securitisation
(or the repackaging of an array
of loans into a single loan before they are sold) is still new and
limited in scope, high-risk
derivatives and collateralised debt obligations are also scarce.6
This makes the sector relatively
immune from problems associated with counterparty risks and
contagion. Nevertheless, the
proliferation of shadow banks offering a wide array of higher-
yielding products has placed
tremendous competitive pressure on China’s formal commercial
banking sector. Specifically, it
has forced the formal banking sector to forge deeper and deeper
links with the shadow banks –
with the unregulated shadow banks obliging as they are not
licensed to raise deposits or make
loans. Indeed, the formal banking sector has conspicuously
utilised and created shadow banking
services by exploiting loopholes in the regulatory and
supervisory frameworks which limit their
activities – as illustrated by the example of commercial banks
acting as agents for the shadow
banks by selling WMPs (for hefty transaction fees) to raise
funds for Zhenfu Energy. For their

part, official banks are also happy to channel or ‘outsource’
funds to trust companies, which in
turn lend to small enterprises and businesses that generally have
difficulty obtaining credit from
commercial banks. In fact, securitising their risky loans into
unguaranteed WMPs enables the
formal banking sector to keep these loans off their own balance
sheets, and in the process
overcomes the constraints imposed by the loan-deposit rates and
loan quotas (Xia, Schwartz
and Herrero 2013).
As Ghosh, Gonzalez del Mazo and Ötker-Robe (2012, p. 5)
point out,
Banks are involved with shadow banking entities and products,
primarily through the letters of credit
they issue and the role they play in entrusted loans. Banks have
also used off-balance sheet wealth
management products to attract deposits – short-term products
to savers that pay high interest rates
but allow the banks to bring the deposits back on their balance
sheets at the end of each month to
meet their regulatory requirements . . . commercial lenders
issued RMB8.5 trillion in wealth
management products in the first half of 2011, compared to
RMB7.0 trillion for the whole of 2010.
Problems in the shadow banking system would hence affect
banks directly through these links.
However, the collusion between the formal and the shadow
banks has spawned speculative
(indeed reckless) lending, resulting in the official banking
sector being burdened with large
exposure to shadow banking. This systemic problem has the
potential to set off a destructive

chain reaction of defaults triggering a wider financial crisis. In
fact, this was precisely the
concern expressed by Fitch Ratings (Xiaotian 2012). When in
April 2013 China’s total credit
reached 200 per cent of GDP, the agency downgraded China’s
long-term local currency debt
rating by one notch to A-plus (from AA-minus).
Joe Zhang (2013, p. 17), drawing on years of experiences as a
shadow banker in Guangdong
province, compellingly argues that the proliferation of shadow
banking in China is ‘more a
symptom than the disease itself’. First, the disease, he argues, is
pervasive ‘financial repression’:
commercial banking in China is still dominated by state-owned
banks which tend to favour
large state-owned enterprises and other state monopolies at the
expense of medium-sized and
small private enterprises. This is because the Chinese
government, through the central bank, the
People’s Bank of China (PBoC), which is responsible for the
implementation of monetary
policy, maintains tight control over the formal banking system.
The government can control
bank liquidity as it has the power to decide the banks’ loan-to-
capital ratio and yearly loan
quotas by industry and sectors. This enables the PBoC to limit
or restrict the availability of
credit and to maintain artificially low interest rates, ostensibly

to provide cheap loans to
favoured state-owned enterprises (in particular the large state-
owned enterprises, SOEs) and
also those with good connections.7 Indeed, the PBoC’s policy
of maintaining negative real
deposit interest rates by setting an upper limit to the rate of
interest paid on deposits has
meant that real (inflation-adjusted) deposit rates have been
much lower than inflation. In fact,
investors actually lose money and purchasing power given the
negative real interest rates on
bank deposits. Second, the maintenance of stringent capital
controls has meant that there are
limited investment opportunities for individual Chinese
investors, including private businesses,
beyond those offered by the stock and real estate markets. Third
(and as discussed below), the
low (indeed negative) real interest rate environment resulting
from the massive government
stimulus to mitigate the negative effects of the 2008 global
financial crisis forced private
investors, including small depositors with fresh disposable
incomes, to seek funds and yield
elsewhere, especially among the high-yield financial products
offered by shadow banks. Finally,
exacerbating this effect, the new restrictions placed on China’s
formal banking system in 2010
to curb rapid credit growth and reduce inflationary pressures
sharply reduced credit availability,
especially to small to medium-sized companies. This forced
many to turn to shadow banks for
credit.
4. The global financial crisis and shadow banking
However, the meteoric expansion of shadow banking in China is

one of the unintended
consequences of the policies Beijing introduced to combat the
negative effects of the 2008
global financial crisis. Specifically, in early 2008 Beijing
implemented a massive RMB4 trillion
(about US$600 billion) stimulus package to boost the economy.
The central government’s total
funding was around RMB1.18 trillion, with the rest funded by
the local governments via local
government financing vehicles (Sharma 2012). Monetary policy
also played a key role in
supporting the stimulus programme. To this effect, the PBoC
cut the policy rate four times,
from 7.5 per cent in August 2008 to 5.3 per cent in December
2008, and maintained the rate
until September 2010. Moreover, the PBoC lowered the required
reserve ratio on RMB
deposits from 17.5 per cent in August 2008 to 13.5 per cent in
December 2008, while relaxing
bank loan quotas and lifting broad money (M2) growth targets
until end-2010 (see Table 3).
Yang (2014) notes that broad money (M2) ‘ballooned to 110.7
trillion yuan (HK$140 trillion) –
almost twice the country’s gross domestic product’ by end-
2013.
Because the programme was mainly a credit (rather than a
fiscal) stimulus, financed mainly
through new bank lending, stimulus spending drastically
increased bank lending, with
Table 3: Broad money growth in China (% GDP), 2004–2012
2004 2007 2008 2009 2010 2011 2012
151.6 151.8 151.3 179.0 180.8 180.0 187.6
Source: Broad Money (% of GDP), World Bank Open Data.8

344 s. d. sharma
traditional banks issuing new financial products in order to
capitalise on the credit bonanza.
Predictably, this only added to the money supply. According to
Pei (2012),9 between 2009 and
June 2012,
Chinese banks have issued roughly 35 trillion yuan ($5.4
trillion) in new loans, equal to 73 percent of
China’s GDP in 2011. About two-thirds of these loans were
made in 2009 and 2010, as part of
Beijing’s stimulus package. Unlike deficit-financed stimulus
packages in the West, China’s colossal
stimulus package of 2009 was funded mainly by bank credit (at
least 60 percent, to be exact), not
government borrowing.
Although this large-scale injection of liquidity helped the
Chinese economy to withstand the
adverse contagion effects stemming from the global financial
crisis, such an excessive volume
of loose money also fueled a credit and real estate bubble,
besides triggering a spending spree
by local governments.10 Although local governments are
expected to deliver the bulk of
social services, they have limited revenue sources as the central
government collects (and
discretionally distributes) tax revenues.11 In fact, since the
introduction of the 1994 Budget Law,
‘the central government has rapidly centralised the most

lucrative sources of revenue, including
value-added tax (VAT), resource tax, and personal and
enterprise income tax. In 2002, the
central government further ordered local governments to
channel 50 percent of personal and
enterprise income tax to the central government’ (Lu and Sun
2013, p. 6). On the other hand,
although their spending burdens have increased, local
governments are statutorily prohibited
from borrowing from the formal banking system, and until
recently were not even allowed to
issue municipal bonds.12
To square the mismatch between their revenues and
expenditures, local governments have
had to find ways around the prohibitions on borrowing (Shih
2010). Specifically, local
governments, with the tacit approval of central authorities, have
created ‘local government
financing vehicles’ (LGFVs; sometimes also called ‘local
government financing platforms’,
LGFPs), as well as urban development and investment
companies (UDICs) to serve as their
principal financing agents to facilitate borrowing as well as to
tap the stimulus largesse by
issuing bonds.13 By the end of 2010, over 6,500 LGFV’s had
been set up (IMF 2013). Indeed,
Zhang and Barnett (2014, p. 6) aptly note that ‘many local
government financing vehicles were
established as intermediaries to channel funding from the
financial market, mostly banks’.
Because local governments are responsible for implementing the
infrastructure investments
funded by the stimulus, they enjoyed a free rein when it came to
borrowing – and they
borrowed heavily via the LGFVs. As their responsibilities, not

to mention their outsize
ambitions, have far outstripped their revenues, local
governments have accumulated massive
debts. The heart of the problem is that the LGFVs have built up
huge mismatches between
their short-term borrowing and the long-term investments they
have been (and still are)
financing. Investments in infrastructure and real estate may not
generate sufficient cash flow to
service the debts, since the majority of the LGFVs are
dependent on land sales and high
property prices to meet their obligations. Moreover, the
significant misallocation of resources at
the local level resulting from politically motivated lending to
wasteful ‘white elephant’ ventures,
including funds ‘missing’ through corruption, has only
exacerbated the debt problem (Shih
2010). In short, the majority of local governments lack a
sufficient cash flow to service their
debt and related obligations. Lu and Sun (2013, p. 3) aptly point
out that ‘since the receipts
from the sale of land lease rights are the main sources for debt
repayment, a correction in real
estate prices could hurt the debt servicing ability of local
governments and LGFPs, and impair
banks’ asset quality. In the worst case scenario, it may trigger
contagion between the financial
sector and the sovereign.’

Since LGFV debts are not explicitly guaranteed by local
governments, the Beijing
government may have to pay for a bail-out in case of insolvency
– and the debt bill keeps
growing. Pei (2012) notes that ‘the National Audit Office of
China acknowledged in June 2011
that local government debt totaled 10.7 trillion yuan (US$1.7
trillion) at the end of 2010’,
though other estimates put ‘the real amount of local government
debt at between 15.4 and 20.1
trillion yuan, or between 40 and 50% of China’s GDP. Of this
amount. . . . the local government
financing vehicles (LGFVs), which are financial entities
established by local governments to
invest in infrastructure and other projects, owed between 9.7
and 14.4 trillion yuan at the end
of 2010.’14 Indeed, a report released on 30 December 2013 by
China’s National Audit Office
puts the total ‘borrowing by provinces, counties and townships
at 17.9 trillion yuan (about $2.96
trillion) as of June 2013’. In other words, ‘local debt has grown
63 percent since the end of 2010,
much faster than the 40 percent expansion of the economy’
(Roberts 2014).
Seemingly alarmed by the rapid and uncontrolled growth of
credit (and poor- quality
credit), and by the potential risks of uncontrolled shadow bank
lending posed to the wider
economy, the PBoC, along with China’s key regulatory agency,
the China Banking Regulatory
Commission (CBRC), in August 2010 sprang into action and
implemented a series of measures
to restrict the activities of the banking sector, especially the
shadow banks.15 Most notably, in
June 2011 the PBoC raised the bank reserve requirement ratios

to an unprecedented 21.5 per
cent for large institutions; imposed deposit reserve requirements
on collateral deposits; made it
mandatory for banks to bring their high-risk off-balance-sheet
activities back on to their books;
and imposed new capital requirements on trust companies (see
World Bank 2013).
Yet not only were these measures too little and too late (as a
large debt build-up and the
overall poor credit quality of many of the new loans already
posed a huge problem); the
authorities’ half-hearted attempts to cool the economy by
limiting the money supply and
tightening the regulation and supervision of commercial and
shadow banks also backfired. It
created a huge demand for credit outside the formal banking
system. As credit dried up, the
need of individual investors, real-estate developers, private and
state-owned enterprises, and
local governments for financing grew even more desperate. In
their search for badly needed
cash infusions they turned to the shadow banks. The shadow
banks were only too happy to
oblige, raising cash by floating all manner of products – with
the WMPs being the most
ubiquitous.
Predictably, in a short period of time shadow banks had fuelled
an alarming build-up in the
debt owed by private businesses, property developers, state-
owned and private enterprises and
local governments, which at the same time were carrying
liabilities they could not possibly
honour. For example, local governments have invested
massively in infrastructure and, in

collusion with property developers, in real estate projects.
There are already growing numbers
of ‘ghost cities’ or blocks of empty units – a costly testament to
excessive construction –
alongside an under-supply of affordable housing. Similarly,
investments in infrastructure have
not been commensurate with either need or budgetary
wherewithal. As China’s growth slows
the returns will decline still further, but debt burdens will
explode – with serious ramifications
for the already weak local government fiscal base. Thus, the
concern voiced by Joe Zhang and
346 s. d. sharma
others that unsustainable local government debt has the
potential to trigger a financial tsunami
reminiscent of the US subprime mortgage crisis is not as far-
fetched as it is sometimes made
out to be. As Rabinovitch (2014) notes, ‘in all, there are about
$660 billion of trust products up
for repayment or refinancing this year. . . . Chinese shadow
banks, by definition, have been
focused on customers – miners, property developers and local
governments – that regulators
have deemed too risky for banks, so more problem loans are a
certainty.’ If China’s real-estate
bubble bursts, local governments default on their debts, and the
balance sheets of Chinese
banks deteriorate and non-performing loans pile up, the Beijing
government will face an
unprecedented crisis.

5. Conclusion: what Beijing can do
At first sight, China’s financial position remains sound. As
noted (Roberts 2014), according to
China’s National Audit Office, local government debt stood at
RMB17.9 trillion (31 per cent of
GDP) in June 2013. Central government debt stands at around
RMB12.4 trillion. Cumulatively,
China’s government debt stood at around 53 per cent of GDP in
mid-2013 (PBoC 2013;
Roberts 2014) – much lower than the debt levels of many
advanced economies, including
several whose debt-to-GDP ratios are excess of 100 per cent.
Second, the bulk of government
debt is denominated in renminbi and held domestically. Third,
China’s very high national
savings rate (totalling about half of GDP) more or less
guarantees that the banking sector’s
deposit base will remain healthy. Coupled with $3.8 trillion in
foreign-exchange reserves and a
banking sector whose overall health remains robust (the average
capital adequacy ratio for
China’s 17 major banks is around 13 per cent), the Chinese
economy can certainly absorb a
significant volume of bad debt without serious repercussion.16
At worst, defaults seem likely
only to erode the quality of the official banking sector’s loan
portfolios. Finally, the risk of
contagion is small as shadow banks offer only relatively simple
financial products consisting
mostly of direct credit, not complex securitised products.
And yet the unchecked proliferation of shadow banks is an acute
worry for Beijing, largely
because the shadow banks are deeply interconnected with the

formal banking system. The
marketing of shadow bank products like WMPs through the
official banking sector gives the
impression to market participants that their investments are
safe. Of course, in order to sell
their products, both the formal and the shadow banking sectors
do little to avoid giving the
impression that their products carry implicit government
guarantees. The danger is that, if
investors were told otherwise, their confidence in products like
WMPs would greatly diminish –
and, if they refused to roll over their existing investments, the
entire banking system could face
a massive liquidity risk. The resultant credit crunch and the
growing mountain of bad loans that
shadow banks (and their official banks partners) have piled up
could trigger a financial
meltdown like the US subprime mortgage crisis in 2008. All this
makes China’s banking and
financial sectors vulnerable to adverse shocks, besides being a
potential source of systemic risk.
Arguably as a warning to shadow bankers (and their formal
banking partners) that the era
of easy money was over, the PBoC did nothing to alleviate a
liquidity squeeze that China’s
interbank market experienced in June 2013. In fact, the liquidity
shortage began in May when
the benchmark overnight and seven-day repo rates rose to 5 per
cent after staying in the 2–3
per cent range over the previous several months. These rates
jumped close to 10 per cent in
mid-June and then skyrocketed to a record high of 30 per cent
on 20 June before dropping to 8

per cent on 25 June. The PBoC, by allowing the interbank
lending rates to rise to such record
highs (with the seven-day repo rate reaching 25 per cent) before
intervening to provide the
much-needed liquidity and lower rates, underscores the Chinese
government’s concern and
desire to rein in the shadow banking sector (Hong 2013).
Yet deterring (or disciplining) shadow banking by ad hoc
methods such as the use of
short-term interbank funding is not only woefully ineffective
but also potentially destabilising.
For example, too severe a credit tightening which prevents
banks and related entities from
rolling over their financing could trigger a chain reaction of
defaults and bankruptcies with
adverse consequences for the wider financial system and
economic growth. After all, shadow
banks provide desperately needed credit to companies and
businesses such as small and
medium-sized enterprises which have difficulty in obtaining
loans despite being important
generators of employment. Therefore, a punitive crackdown to
restrict access to credit could
further slow economic growth. Similarly, abrupt monetary and
fiscal tightening designed to limit
credit growth has the potential to undermine GDP growth.
Rather, what Beijing needs to do is
better regulate the off-balance sheet activities of the
commercial banks and ensure more
efficient credit allocation.

To mitigate these risks, policymakers must address a number of
core problem areas facing
the Chinese economy. First, in order to rein in credit growth,
Beijing must rebalance the
Chinese economy away from its current investment-led growth
model to one based more on
domestic demand and services. Second is the problem of moral
hazard. As long as individuals
and businesses believe (even implicitly) that their investments
are guaranteed by the
government and the formal banking system, funds will continue
to flow into the shadow
banking sector because investors will continue to buy products
promising lucrative returns.
Indeed, the bail-out of CCT only confirmed the widespread
belief among investors that the
government and the big banks would come to their rescue if
their investments went sour.
Sending a clear message that the government will no longer
provide future bail-outs for
unregulated and insured investments and that investors will
have to take a ‘haircut’ for their
poor and irresponsible decisions would go a long way to curb
speculative and risky activities by
forcing both the official and the shadow banking sectors to
price risk more realistically.
Third, since China’s partly deregulated financial sector creates
opportunities for regulatory
arbitrage, drastically reducing (if not altogether eliminating)
this problem through better
supervision of the official banking sector’s interbank business
and requiring shadow banks to
maintain sufficient net capital reserves could help alleviate the
problem of leverage. Specifically,

greater oversight of the various WMPs through tighter
disclosure of their off-balance-sheet
activities is essential. Most important is interest rate
liberalisation. Specifically, although the
Chinese government has over the years adopted measures to
liberalise interest rates, it has to
date refused to remove deposit rate ceilings, ostensibly to
prevent instability to the financial
system (Liu 2013). This is understandable as the correct timing
and sequencing of liberalisation
is essential to limit market volatility and instability.
However, as is well known, interest rate controls invariably
result in an inefficient allocation
of financial resources, besides punishing savers by imposing a
hidden tax, while rewarding
borrowers and spenders with cheaper credit. Inevitably, interest
rate distortions result in the
unproductive use of credit – a fact vividly underscored in China
by high levels of non-
performing loans in the banking system and frequent
recapitalisation of banks by the Beijing
government. Therefore, market-determined interest rates would
not only generate greater
348 s. d. sharma
competition and better and fairer pricing options for depositors
and borrowers, but also force
banks with highly leveraged deposit bases to undertake
necessary reforms.17 After all, shadow
banks thrive in China because both interest rates and the cost of

money are kept artificially
low. If these controls were removed there would really be no
need for shadow banks – at least,
not to the current extent.
Finally, the Chinese government should impose hard budget
constraints on local
governments to rein in uncontrolled spending and limit the
current diversion of credit to
speculative borrowers. In this regard, the CBRC’s decision to
impose a ban on guarantees for
LGFV bonds is a good start as it provides banks with some
degree of protection from
contingent liabilities. On the other hand, the decision to allow
local governments to issue bonds
as a way of rolling over their debt postpones the inevitable
deleveraging, even though local
governments are thereby given a breathing space to improve
their finances.
Notes
1. WMPs are generally higher-yielding notes issued by trust
companies. They are usually sold through banks’ retail
channels and the funds are then used to issue loans. WMPs are
not guaranteed by the banks, even though individual
investors assume they are implicitly guaranteed (see IMF 2010,
2011). As Das (2014) notes, WMPs come ‘with a
variety of seductive monikers – Easy Heaven Investments,
Quick Profits and Treasure Beautiful Gold Credit’.
2. Indeed, The Economist (2014) notes that ‘over $400 billion-
worth of trust products are due to mature this year
[2014] – and borrowers will want to roll over many of those
loans. Many observers worry that investors will lose
faith in trusts, prompting a run, which may, in turn, blight

certain industries and other parts of the financial system.
No country, pessimists point out, has seen credit in all its forms
grow as quickly as China has of late without
suffering a financial crisis.’
3. The Financial Stability Board (FSB 2013) estimates that the
global shadow banking sector accounted for $71.2
trillion of assets at the end of 2012 – a dramatic increase from
$26.1 trillion in 2002. The FSB’s report also notes
that the shadow banking system is mainly concentrated in the
advanced economies, which account for 85 per cent
of the sector. In 2012 the US held $26 trillion in assets, the
Eurozone held $22 trillion, the UK $9 trillion and
Japan $4 trillion. Emerging economies which saw their shadow
banking sector grow by over 20 per cent in 2012
include China, India, Argentina and South Africa.
4. Similarly, Moody’s Investor Service (2013) ‘estimates that
core Chinese shadow banking products – those that are
relatively non-transparent, loosely regulated, and carry elevated
credit risk – totaled a large RMB21 trillion at
end-2012, or 39% of 2012 GDP’. Similar figures are reported by
Wei and McMahon (2012).
5. In China’s Wenzhou district, it was reported that over a six-
month period in 2012 some 80 businessmen declared
bankruptcy, some committing suicide because they could not
meet the high payments on their shadow bank loans.
See Bloomberg News (2013).
6. At best, China’s shadow banking system is involved in
‘informal’ securitisation as it plays a key role in pooling
funds provided by the formal banks. The official banks also
help distribute the financial products pooled by the
shadow banks.

7. Lu, Thangavelu and Hu (2005), using a panel data set of
public listing companies in China, show not only that
SOEs get more loans than other firms, but SOEs with high
default risks are also able to borrow more than
low-risk SOEs and non-SOEs. They note that this suggests that
Chinese banks have a systemic lending bias in
favour of SOEs. On the other hand, according to the People’s
Bank the artificially low interest rate is designed to
prevent ‘hot money’ from flowing into China and to prevent
speculation through interest rate arbitrage.
8. Available at
http://data.worldbank.org/indicator/FM.LBL.BMNY.GD.ZS
(accessed 22 May 2014).
9. See also Walter and Howie (2011).
10. In China ‘local governments’ cover a broad range of
entities, including provinces, prefectures, cities, counties,
townships and villages.
11. The major source of income for local governments has been
the sale of land under their jurisdiction as altogether
they received about 25 per cent of the VAT revenue.
12. However, a pilot project in 2011 approved by the central
Chinese government in Beijing now allows Shanghai,
Shenzhen, Guangdong and Zhejiang to issue bonds.
13. According to a recent report, ‘Regional governments set up
more than 10,000 local financing units to fund
construction projects after they were barred from directly
issuing bonds under a 1994 budget law.
Local-government debt swelled to 17.9 trillion yuan ($2.96
trillion) as of June, compared with 10.7 trillion yuan at
the end of 2010, according to data compiled by the National
Audit Office’ (Bloomberg News 2014).

14. According to the IMF (2013), China’s general government
debt might be close to 45 per cent if ‘government debt’
also includes local government infrastructure spending. See also
National Audit Office of the People’s Republic of
China (2011).
15. The CBRC was established in 2003 and is responsible for
regulation and supervision of the banking sector. Its
functions are separate from those of the PBoC, which is
responsible for monetary policy and financial system
stability. To its credit the CBRC has help to strengthen
prudential standards and overall improvements in bank
governance. The five large state-controlled banks include the
Industrial and Commercial Bank of China (ICBC);
China Construction Bank (CCB); Bank of China (BOC);
Agricultural Bank of China (ABC or AgBank); and the
Bank of Communications (BoCom). China also has three state-
controlled ‘Policy Banks’: the Agricultural
Development Bank of China (ADBC); China Development Bank
(CDB); and the Export–Import Bank of China.
Altogether, the five state-controlled banks account for about 50
per cent of Chinese banking assets and deposits
and are majority-owned by the Chinese state, though they do
have private shareholders.
16. Boone and Johnson (2014) note that ‘China luckily has
substantial scope for absorbing losses. For example, the
Industrial and Commercial Bank of China, one of China’s
largest banks, reported $59 billion of operating profit

(before loan loss provisions) over the last 12 reporting months .
. . It can use that profit to offset losses on its $1.5
trillion loan book (over and above the $38 billion that it has
already provisioned). Even if 10 percent of loans
were to eventually default, with 50 percent recovery on those
loans, the losses to equity capital could be offset
with just two years of profits. Share issuance (already priced
into equity markets) could raise further capital if
needed. This high profitability of Chinese banks makes them far
more resilient than American and European
banks. For example, Washington Mutual, which eventually was
taken over by the Federal Deposit Insurance
Corporation, reported roughly half the profitability of the
Chinese banks in the boom years before it collapsed.’
17. That is, savers will earn higher interest incomes, while
borrowers will pay a higher (fairer) rate for borrowing.
References
Basel Committee on Bank Supervision (2010) Guidance for
National Authorities Operating the
Countercyclical Capital Buffer. Basel: Bank for International
Settlements.
Bloomberg News (2013) ‘Shadow Loans Hard to Squelch in
China City Hit by Suicide’, 27 March.
Available at http://www.bloomberg.com/news/2013-03-
26/shadow-loans-hard-to-squelch-in-china-
city-hit-by-suicide.html (accessed 27 October 2013).
Bloomberg News (2014) ‘China LGFV Sells First Dollar Bond
as Yuan Borrowing Costs Rise’, 2 January.
Available at http://www.bloomberg.com/news/print/2014-01-
02/china-lgfv-sells-first-dollar-bond-as-
yuan-borrowing-costs-rise.html (accessed 3 April 2014).

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