[칼럼] World Story 5 - Vision 5  by Atty Jeong-kee Kim

(NewsKorea=Seoul) Digital News Team = World Story 5 - <Vision 5  by Atty Jeong-kee Kim>

● China, a manufacturing powerhouse, is now evolving into a financial powerhouse.

For a nation to become a developed power, a successful transition from a manufacturing powerhouse to a financial superpower is essential. Historically, the world's dominant powers, such as the United Kingdom and the United States, achieved their status by leveraging their manufacturing strengths to build robust financial sectors. China, aiming to become a leading global power, is well aware of this reality. Following high-speed growth since the reform and opening-up policies, China has already become a leader in manufacturing. Now, it is ambitiously planning to solidify its position as a manufacturing powerhouse while transitioning into a financial superpower by 2049.

Becoming a financial superpower cannot happen overnight. It requires a solid foundation based on a market economy and extensive experience. The evolution of manufacturing and financial sectors involves several stages: imitation of advanced societies, adaptation to local conditions, and innovation. In manufacturing, the innovative stage means securing intellectual property rights (IP) to earn royalties. In finance, it involves obtaining dividends from corporate investments and becoming a dominant issuer of a key currency.

To assess China's current stage in finance, we must first review its financial history before and after the reform and opening-up period. Understanding China's journey towards becoming a financial superpower will help neighboring Korea prepare strategies for coexistence and adaptation in this evolving landscape.

◇ Before reform and opening (pre-1978) ◇

Before the reform and opening-up, China's financial industry was characterized by a single-bank system centered around the People's Bank of China (PBOC). Since the establishment of the People's Republic of China in 1949 until 1978, the socialist system focused on nationalizing the means of production, suppressing profit-oriented production activities, and minimizing market exchange and currency use. Consequently, the financial sector was very weak. The PBOC functioned merely as a conduit for central planning, playing a passive role in credit allocation and risk management, while still handling a wide range of banking activities.

The government’s economic departments and the single bank worked together to collect taxes and mobilize deposits, reallocating resources according to national strategic goals. They also managed currency issuance, cash circulation, government account management, and short-term loans for enterprise operations. All enterprises and credit cooperatives were required to open accounts with the PBOC for transaction and accounting purposes, and personal savings were also mobilized through the PBOC.

Founded in 1948, the PBOC expanded to approximately 20,000 branches nationwide by 1957, controlling around 100,000 rural credit cooperatives. The organizational structure mirrored other governmental administrative systems, with vertical relationships between the central office, provincial branches, and municipal branches, which were subject to dual control from the central office in Beijing and local party committees.

Initially, the PBOC's banking operations and the Ministry of Finance's fiscal duties were separately administered with equal administrative status (1949–1958). However, with the onset of the Great Leap Forward in 1958, the PBOC was subordinated to the Ministry of Finance, losing its equal administrative authority.

◇ After reform and opening (post-1978) ◇

After the reform and opening-up, China's financial system experienced remarkable quantitative and qualitative development in tandem with rapid economic growth. By the end of 1978, with the separation of politics and economics and the adoption of a market economy, China's financial industry initially comprised a very simple structure dominated by four state-owned commercial banks. However, from the late 1980s onward, stock commercial banks and various non-bank financial institutions were established, and the opening of stock exchanges in the early 1990s further complicated and refined China's financial system. This marked a significant financial reform for socialist China, which can be further broken down into specific stages.

 <First stage of financial reform (1979~1993)>

Following the launch of the reform and opening-up, while the government's policy focus was on economic development and various reform measures were introduced to enhance production efficiency and living standards, financial reform lagged significantly.

In the industrial structure dominated by state-owned enterprises, the financial sector functioned primarily as a policy tool. Expanding the autonomy of bank management meant increasing the autonomy of credit allocation, which would result in the government losing a significant policy instrument. Hence, meaningful financial reform was virtually impossible.

Nonetheless, as the economy grew rapidly, changes in financial institutions became unavoidable. In January 1984, the State Council established the Industrial and Commercial Bank of China (ICBC) and upgraded the People's Bank of China (PBOC) to a central bank. ICBC took over personal deposit operations, corporate lending, and PBOC’s nationwide branch network, becoming the largest among the four state-owned commercial banks.

Additionally, the Agricultural Bank of China was assigned to handle rural financial operations and policy loans to the agricultural sector, while the Construction Bank of China specialized in long-term investment loans for state-owned enterprises and foreign exchange transactions, marking a significant advancement in the financial sector.

During this period, the development of non-bank financial institutions was crucial. Institutions like rural credit cooperatives, urban credit cooperatives, trust investment companies, and financial companies rapidly expanded, reflecting the quantitative growth of the financial system. The rise of non-bank financial institutions was driven by increasing savings deposits in state-owned banks due to rising incomes among urban and rural populations, coupled with the need for alternative savings instruments amidst income growth and inflationary pressures.

Non-bank financial institutions generally operated with greater independence from government and central bank credit plans, facing fewer regulations and pressures compared to state-owned banks. This relative freedom and leniency in legal environments contributed to a more developed financial system compared to the early 1980s.

One of the most significant financial developments of this era was the establishment of stock exchanges. In the early 1980s, the advent of a personal finance market in rural and urban areas introduced a stock-based system as a new source of funds. However, the lack of regulations regarding trading, stock issuance, and investor protection meant that the stock market's development remained minimal.

Although stock systems inherently represented capitalist elements that conflicted with the socialist ideology of early China, the Chinese government became more supportive of stock systems in the 1990s for two main reasons.

First, to improve the efficiency of state-owned enterprises and clarify property rights, transforming state-owned enterprises into joint-stock companies was deemed necessary. Introducing stock systems was part of this reform process, aiming to separate ownership from management without severely undermining state control.

Second, listing state-owned enterprises and raising capital through stock exchanges were seen as vital for modernizing production facilities and reducing debt. Recognizing this necessity, the Chinese government established stock exchanges in Shenzhen and Shanghai in December 1990.

From 1991, domestic A-shares issued by state-owned enterprises were categorized into state-owned shares, legal person shares, and individual shares, with state-owned and legal person shares largely restricted from trading. In 1992, B-shares for foreign investors were introduced, with shares traded in dollars in Shanghai and Hong Kong dollars in Shenzhen. The distinction between A-shares and B-shares, based on the investor's nationality, was a policy measure to attract foreign investment while maintaining capital and foreign exchange controls.

<Second financial reform phase (1994~2001)>

This stage marks a period of significant measures aimed at establishing a practical financial system that matches China's economic growth. One of the first major reforms was the overhaul of the exchange rate system. Until 1993, China operated a dual exchange rate system with both official and market rates. However, by the end of 1993, the official exchange rate covered only about 20% of foreign exchange transactions, necessitating the unification of exchange rates. On January 1, 1994, the dual exchange rate system was abolished, and a single market exchange rate was applied to all foreign exchange transactions.

In December 1996, China liberalized foreign exchange transactions for the current account, but capital account transactions remained strictly controlled. This control over capital movement and foreign exchange transactions helped China avoid significant impacts from the East Asian financial crisis in 1997.

A large-scale restructuring of state-owned enterprises (SOEs) was also carried out, including their privatization. Under the principle of "holding on to the big and letting go of the small" (大抓大放小), the central government actively promoted the privatization of small and medium-sized SOEs. By the end of 1996, more than half of these enterprises had been privatized, leading to the dismissal of over 20 million workers from SOEs and urban collective enterprises between 1996 and 1997.

To further promote state-led economic development and reform, three policy banks were established in 1994 with specific powers and responsibilities. In 1995, the "Commercial Banking Law" was enacted to facilitate the transformation of state-owned banks into commercial banks and legally strengthen the independence of all commercial banks. This law marked a significant shift from a state-owned bank system to a more market-oriented banking system, encouraging the development of commercial banks.

To address the problem of non-performing loans, asset management companies were established. The "Central Bank Law" was also amended to enhance the independence of the central bank while outlining a compromise between the bank's independence and government development goals. Additionally, the central bank’s branch network was significantly restructured, and the issuance of government bonds was increased to support the development of the bond market.

The development of the stock market during this period was notable. The first experiments with securities trading began in Shenzhen in 1986, and by 1988, securities trading was allowed in almost all major cities nationwide. The range of tradable securities expanded to include stocks, corporate bonds, and financial bonds, with government bonds being the primary focus. From 1990, stock exchanges were established in Shanghai and Shenzhen to unify the fragmented securities market and implement comprehensive policy measures for stock market development. Between 1992 and 2000, the number of listed companies in China grew from 53 to 1,088, an increase of more than 20 times, and the market capitalization surged from 104.8 billion yuan to 4.8091 trillion yuan, a 46-fold increase.

The insurance market also saw substantial growth. In the mid-1990s, the insurance system was restructured, and in 1995, the Insurance Law was formally passed. In 1996, the China People's Insurance Company underwent organizational restructuring, and five new insurance companies (three national and two regional) were approved. The structure of China's insurance market now comprises four major state-owned insurance companies (including reinsurance companies), stock insurance companies, and foreign insurance companies.

◇ Opening and development stage (post-2001) ◇

After China joined the WTO, its financial market underwent developmental changes. There were two main issues: regional restrictions and customer limitations, but these were gradually resolved. The regional restrictions on foreign banks were progressively abolished, and by five years after WTO accession, RMB business was permitted in all regions of China.

The operational restrictions for foreign insurance companies were initially limited to Shanghai, Guangzhou, Dalian, and Shenzhen at the time of WTO accession but were fully opened after three years. Foreign securities firms were allowed to participate directly in B-share operations without Chinese intermediaries, and joint venture fund management companies for securities investment in China were permitted to have up to 33% foreign ownership, increasing to 49% within three years. Other financial sectors were permitted to provide and process financial information, offer software, and provide advisory services for credit and investment analysis.

The securities market in China has also significantly improved, with the market capitalization of the Shanghai and Shenzhen stock exchanges being comparable to the size of China’s GDP. Considering that the U.S. market is 1.5 times the size of its GDP and Japan’s market is similar in size to its GDP, this represents a substantial scale for an emerging stock market. However, since the establishment of the exchanges in the 1990s, over 90% of listed companies were state-owned enterprises, and as of the end of 2006, they still accounted for 80%. Consequently, most shares were non-tradable, with tradable shares constituting only 36.2%. However, by 2005, reforms were introduced to non-tradable shares, allowing for limited sales and circulation. After the unification of the dual exchange rate system in 1994, the exchange rate against the U.S. dollar was maintained under a fixed rate (1 USD ≈ 8.28 RMB) for over ten years, but due to pressures for RMB appreciation, there has been a partial shift towards a floating exchange rate.

Regulations on capital inflow and outflow have also been relaxed. Since joining the IMF in 1996, the exchange of RMB and foreign exchange for current account transactions has been liberalized, but foreign exchange transactions related to capital movements, except for foreign direct investment, were strictly regulated. Foreign direct investment has been progressively liberalized since the 1980s and is now fully liberalized. For foreigners, capital inflows other than direct investment have been strictly regulated under a permit system, but securities investment by foreign financial institutions has been opened.

Capital outflow is generally regulated under a permit system for all forms of investment, but recently, regulatory easing has been rapidly advancing in line with policies encouraging Chinese companies' overseas expansion. As a result, overseas direct investment by Chinese companies has steadily increased, reaching $50 billion in 2009, and foreign securities investment has also been allowed on a limited basis.

Despite this, partial controls and regulations still remain, but China is in the process of building a foundation for developing into a financial superpower. Considering the stages of imitation → integration → innovation, it can be said that China is currently in the early stage of integration. China is diligently preparing for its goal of becoming a financial superpower.

Currently, China's GDP is about $19 trillion, which is slightly more than three-quarters of the U.S.'s $26 trillion. The foreign exchange reserves amount to $3.1 trillion, of which $900 billion is held in U.S. Treasury securities. Including diaspora Chinese capital, China's foreign exchange reserves are estimated to be about $5 trillion.

China faces the situation of having to manage a vast amount of foreign exchange, and currently, it is circulating funds mainly through real estate. In the process of transitioning from a manufacturing powerhouse to a financial superpower, enhancing the competitiveness of the financial sector is essential, and there is a need to circulate the dollars earned from manufacturing.

After the 2008 financial crisis, the Shanghai municipal government attracted 150 foreign financial talents to be placed in investment banks (IBs), and established College of Finance at Shanghai Jiaotong University to build infrastructure for securing and educating high-level financial talent. While China has the capability to acquire representative IB companies, it recognizes the lack of human infrastructure and is focusing on talent acquisition and training as a strategic approach to establish a foundation for future financial dominance.

China's specific goal is to cultivate Shanghai into the world's largest capital market and to make the Shanghai stock exchange the center of global stock exchanges. Additionally, by 2050, China aims to develop the yuan into a major reserve currency and establish a competitive financial system with the U.S. This indicates that China is gradually evolving from a manufacturing giant to a financial superpower.

It is worth noting that the Jewish people, who lead the financial powerhouse of the world in the U.S., cannot be overlooked. While the Puritans, who were key founders of America, valued austerity, Jews leveraged their 2,000-year tradition of usury in Europe to develop private finance in the U.S., becoming the foundation of American financial services.

During the 18th century British Industrial Revolution, the Jewish banker Rothschild began large-scale financial business centered in Frankfurt, Germany, and subsequently expanded to London, Paris, Naples, and Switzerland, and eventually to the U.S. Based on this, Jews gradually took over the American financial sector. This continues to be the case today, with prominent investment banks on Wall Street being controlled by Jews, playing a significant role in maintaining America's superpower status.

In contrast, China’s financial power is emerging through the efforts of Wenzhou merchants. These merchants have created significant wealth in Wenzhou and expanded into major coastal cities and central-western development areas, primarily through real estate, amassing substantial cash reserves. Despite their potential for substantial capital growth, Wenzhou merchants have a shorter history and rely on family and personal networks rather than established financial institutions, leading to challenges in financial transparency and access to capital markets.

However, Wenzhou merchants have a relatively short history compared to their Jewish counterparts and have yet to establish a formalized financial system. Their business operations rely heavily on personal and familial networks, with minimal engagement with formal financial institutions. Consequently, their companies often suffer from weak financial structures and transparency issues, making it challenging for them to list on stock exchanges. This situation mirrors the relatively primitive business practices of Jews in Europe during the 1600s.

As China becomes more integrated into the global financial market, Wenzhou merchants, with their substantial real estate holdings and cash reserves, are expected to increasingly enter the financial sector. Additionally, Taiwan’s robust economic capabilities and the significant capital from overseas Chinese communities, particularly in Southeast Asia, are anticipated to play a crucial role in China’s ascent to a financial superpower.

Although China lags several decades behind the US in financial development, its remarkable economic growth suggests that it might eventually surpass the US. The yuan has the potential to become a major global reserve currency, and China could emerge as a dominant global power.

Korea, having experienced the 1997 Asian financial crisis and the 2008 global financial crisis, has gained valuable insights into international finance. To prepare for the era of becoming a financial powerhouse, Korea needs to enhance its capabilities in the investment banking sector and establish large-scale financial holding companies capable of competing with global investment banks. Despite the challenges facing Hong Kong’s status as a leading financial hub in Asia, Seoul Mayor Oh Se-hoon's proactive efforts to attract global financial firms and establish Seoul as a financial hub for the Asia-Pacific region offer a promising path forward.

☆ Author:  Atty Jeong-kee Kim ☆

● Education
- Bachelor of Arts in Political Science, Summa Cum Laude, State University of New York at Stony Brook
-  Doctor of Jurisprudence, Marquette University Law School
- Senior Executive Program, John F. Kennedy School of Government, Harvard University
- Research Scholar in North Korean Studies, Peking University

● Experience
- Consul General of the Republic of Korea in Shanghai
- Commissioner General for the Korean Pavilion at the 2010 Shanghai Expo
- CEO, Asia-Pacific Local Government Network for Economic and Social Development (CityNet)
- Secretary General, World Smart Sustainable Cities Organization(WeGO)
- Law Clerk, Milwaukee Circuit Court, USA
- Senior Attorney-at-Law, Dr & Aju LLC
- Distinguished Visiting Professor, World Economy Research Institute, Nanjing University
- Research Professor, Institute of Oriental Studies, Peking University
- Distinguished Professor, Graduate School of Political Science, Kookmin University
- Chair Professor, Graduate School of Business, Dongguk University
- First President of Soongsil Cyber University

● Publications
- Georo English Studies Series for College Students [10 volumes] (Georo Publishing)
- I Challenge the Possibility of One Percent (Chosun Ilbo)
- The Art of Negotiation (Cheongnyonneongsin Publishing)
- Korea and the World (Chekmidum Publishing)