Insights from China for the United States: Shadow Banking, Economic Development, and Financial Systems

Abstract

The growth of China’s shadow banking industry has been a recent source of serious concern for the US-China Economic and Security Review Commission. US shadow banking practices contributed to the 2008 financial crisis. The proliferation of these practices in China potentially threatens not only China but also economies that are intimately tied to China through trade, investment, and financial relationships such as the United States’ economy. An investigation of Chinese shadow banking, in the context of China’s post-1978 debt financing experience, reveals that China poses a challenge to the established theory that strong, formal financial systems are required for economic growth. Contrary to expectation, China’s outstanding economic growth in the last thirty-five years took place without a strong formal financial system that was easily accessible to private entrepreneurs. This article examines the remarkable story of how China, constrained by political and historical legacies, relied upon informal financing structures to fund Chinese private entrepreneurs who contributed significantly to China’s stellar economic growth. China’s story affirms the work of scholars who have emphasized the importance of sociopolitical structures and who have theorized that law does not necessarily precede economic development but is engaged in a complex relationship with other normative structures. An examination of the sociopolitical underpinnings of China’s informal finance sector also reveals how shadow banking has grown to concerning levels in China and the challenges ahead that China faces as it attempts to use policy and legislative responses. Interestingly, this examination also reveals commonalities between China and the United States and suggests that there is the potential for mutual enlightenment despite the vastly different political systems and histories of these two countries. Thus, China’s shadow banking story advances our understanding on two fronts: (a) China’s example challenges current theoretical understandings of law, finance and economic development and requires us to broaden our inquiry to include political history and informal societal structures and (b) a sociopolitically informed understanding of China also allows us to draw comparisons to the United States to isolate commonalities and differences that may inform future legislative responses and mutual understanding between both countries.