China’s financial system has been highly successful in mobilizing savings, but it has fallen short in its task of allocating capital to the most productive players in the economy.
Savings from households, for example, often are not channeled to the best available investment opportunities.
Nonperforming loans are the most conspicuous outcome of this misallocation. Yet MGI research shows that the much larger volume of loans to underperforming ventures that don’t go bad but yield only negligible returns are potentially more costly to China’s economy.
Increasing the operating efficiency of China’s financial institutions and improving the mix of financing vehicles would boost GDP by $62 billion a year. Reforms that enabled a larger share of funding to go to more productive enterprises would increase investment efficiency, raise GDP further by up to $259 billion.
Two major opportunities for reform remain:
- Improving the allocation of capital to the most productive investment opportunities in the economy
- Addressing the operational inefficiencies in each of the system’s components.
With a more integrated approach to reforms, China’s financial system could lead to an enormous increase in wealth for China’s people.
