Alex's China & the World Economy Part B: Corporate Sector I. Explaining the Chinese Puzzle 1 - The Chinese Puzzle

Question 1

Describe & explain what the Chinese Puzzle is

Answer 1

Using macro data for various countries worldwide, numerous papers have found a positive
relationship between broad measures of financial development and economic growth. Yet,
China is a counterexample to these findings: in spite of a malfunctioning financial system, it
has one of the fastest growing economies (Allen at al., 2005). This can be seen as a puzzle.
* Several authors have tried to find explanations for this puzzle. For instance:
o Allen et al. (2011) show that in fast-growing economies with a weak legal system
such as China, non-market, non-bank finance plays an important role in financing
growth. These alternative forms of finance can be, for example, finance provided by:
➢ various forms of private credit agencies, such as shareholding cooperative
enterprises run by professional money brokers, lenders and middlemen;
➢ credit associations operated by a group of entrepreneurs;
➢ pawnshops;
➢ underground private money houses (Allen et al., 2011).
The advantage of these alternative sources of finance institutions is their flexibility.
o Ayyagari et al. (2010) find that it is finance from the formal financial system that is
associated with faster firm-level growth, while informal finance is not.
o Cull et al. (2009) show that trade credit did not play a significant role in explaining
China’s growth.
* We propose several new explanations to the puzzle, which will be discussed in turn
hereafter