Of the many paradoxes presented by China's reform-era economy, this book focuses on two: First, how has the country managed to restrain inflation despite countervailing tendencies toward aggressive investment at the local level, and second, why does the financial system allocate credit so inefficiently? At first glance, nonspecialists might wonder why success in constraining inflation is analyzed in the same framework as failure in commercializing the banking system. Indeed, previous studies have examined the two financial outcomes as distinct dependent variables (notably, Yasheng Huang, Inflation and Investment Controls in China, 1996, and Nicholas Lardy, China's Unfinished Economic Reform, 1998). Fortunately, Victor Shih justifies this book's dual explanatory objectives on both empirical and analytical grounds. Empirically, low inflation and banking weaknesses have contrasting implications, respectively. Monetary stability has positive implications for economic growth, while the extraordinarily high level of nonperforming loans in the banking system portends financial crisis. How can these dual tendencies be reconciled? Analytically, Shih traces the coexistence of low inflation and bad banking to the nature of factional politics in contemporary China.
While China scholars have debated extensively about factionalism during the Mao era, Shih brings a fresh lens to the topic by identifying two distinct factional types—generalist and technocratic factions, which are led by the most senior leaders of the Chinese Communist Party and by the state bureaucracy, respectively. On the basis of publicly available data sources, internal government documents, and interviews with about 70 officials and bankers, the book demonstrates, both inductively and quantitatively, how the preferences and strategies of the two factions have shaped the dynamics of five monetary cycles since the late 1970s. Specifically, the generalist faction prefers looser monetary control, which increases the ability of provincial governments to finance local investment projects through bank credit. This preference for decentralized credit policy derives from the generalist leaders' experience and from their networks of political support in the provinces. The generalists' policy preference yields hyperinflationary tendencies as local officials pursue high-growth development strategies to advance their careers. In contrast, the technocratic faction prefers centralized control over policy tools, including financial resources, so that central agencies can carry out large-scale, capital-intensive tasks on behalf of the regime. Relatedly, senior technocrats also seek to enhance the regulatory scope and authority of the central bureaucracy whenever they have the resources to do so. A seesaw dynamic of conflict and cooperation between the factions flows from these conditions. At the beginning of a monetary cycle, the generalist faction is dominant and allows local governments to engage in expansionary bank lending. As inflation threatens to spiral out of control and undermine social stability, however, the generalist faction delegates monetary control to the technocrats who, in turn, use their bureaucratic authority to tame the economy. Once monetary stability is achieved, the generalists wrest control from the technocrats to decentralize credit allocation.
This cyclical model carries a number of perverse incentives in terms of national economic well-being. First, according to Shih's provocative argument, China's technocrats strategically enable economic crises so that generalists will relinquish monetary control to central regulators: “One pernicious implication of this model is that senior technocrats in fact have a disincentive to truly fix the economy, as they gain control over the economy only during a crisis. In the short run, their standing depends on an apparent fix of the economy. In the medium term, however, they need to plant the seeds for the next economic crisis because they know that the generalist factions would soon take their power away” (p. 61). This dynamic is illustrated most vividly in the description of the 1988 and 1993 inflationary cycles.
Second, neither faction is motivated to eliminate practices that contribute to mounting nonperforming loans because both use banks to advance their own short-term political objectives. Local officials in the generalist faction pressure financial institutions to extend soft loans to businesses within their jurisdictions, while technocrats channel bank credit toward pillar industries in the state sector. In this model, the so-called technocrats are more concerned with their immediate political survival and promotion prospects than in implementing reforms that would create a more sustainable, commercially competitive financial system.
A third economically irrational outcome, which receives less direct attention in the book, is the fact that the engine of China's growth—the domestic private sector—is effectively excluded from the banking system. Because state-owned enterprises receive the overwhelming preponderance of bank credit, private businesses rely on informal finance and other unconventional capital-raising strategies. Given all these politically fueled distortions, the prognosis for China's financial health is grim, and Shih brings an impressive mixed-method arsenal of document research, quantitative analysis, and field interviews to justify his claims.
While this is an otherwise admirable book, students of Chinese politics may be left to wonder about the implied permanence of the generalist versus technocratic faction cycle. Shih's elegant factional model provides a novel explanation for the monetary and policy fluctuations under Deng Xiaoping and Jiang Zemin. Under Hu Jintao and Wen Jiabao, however, the lines between the generalist and technocratic factions do not seem as sharp. Indeed, Cheng Li has observed that China is evolving toward a “one party, two factions” system where the primary source of political competition is between an elitist coalition and a populist coalition. Yet this book suggests that the logic of the generalist-technocratic cleavage is unlikely to change. Similarly, the book makes only a brief nod to the potential impact of international factors in influencing the course of monetary policy and banking reforms. Finally, comparativists hoping to learn about the potential applicability of Shih's version of the factional model to other authoritarian regimes will have to wait until the last five pages. Nonetheless, Factions and Finance in China offers an invaluable window into the workings of elite politics in a regime better known for its opacity, and will soon become a staple in the literature on China's contemporary political economy.
