Fan has published eight books and more than 100 academic papers. He has been an advocate of tight monetary policy coupled with expansionist macroeconomic policy to compensate for still-inadequate private investment in areas like infrastructure. He recently discussed his views on China's economic future with BusinessWeek Senior Writer Pete Engardio. Edited excerpts of their conversation follow:
Q: What is China's basic challenge?
A: China has two big issues. First, it is an emerging economy, and second it is an economy in transition. The first challenge requires development. The second requires reform at the same time. Plus, it has the world's biggest population. And China is the only really large country with only one coastline. That translates into big regional disparity. This is why China is full of problems.
Q: What's the role of the state sector vs. the private sector?
A: The major reform achievement has been in privatizing state enterprises. The private sector accounts for 70% of gross domestic product. There are 200 large state companies -- basically, they are in utilities, some in heavy industries, some in resource industries. Traditionally, this is where governments have invested.
China Mobil and China Telecom are huge, but these are natural monopolies. Even France and Britain had those large state companies for a long time. If you take these away, China is a private-sector economy. In the financial sector, reform has been much delayed. Banking is still a state monopoly, and a concentrated monopoly.
In heavy industries, there are many private steel companies and chemical companies. Private companies have been behind the recent boom in capacity. They hired managers from state companies, then started up in a very efficient, competitive way. In terms of competitiveness, they are better than Taiwanese companies. The have the newest equipment, along with some local equipment. However the private sector is hard to document. There is a lot that is not on the table.
Q: How would you characterize China's financial markets?
A: The capital markets and securites markets still are underdeveloped, because 70% of shares of almost all listed companies are not tradable. So there can't be takeovers -- only when the management wants to sell, which is usually when the business is nothing to them. Just a few months ago, an experimental program was announced to make the nontradable shares tradable. This should be good news in the long run.
Q: What about bank reform?
A: There has been some progress in the banking sector. There still is political interference, but control of the banks has been centralized [away from local governments]. As a result, the whole system is more independent of the local politicians. The managements of local branches aren't appointed by local governments any more.
The reform has started -- but maybe too late. The government has injected money into the banks to float shares. To improve the capital market, 20% to 30% of their shares have to be sold to the public. But [more state injections are likely].
Q: Will foreign banks be able to compete in China?
A: The government still controls the pace of liberalization. By the end of 2006, the market will open. But banks still need licenses.
The real issue is that when foreign banks come into the Chinese market, they will find it is very difficult to compete with the retail networks of the state banks. Chinese banks have thousands and thousands of branches to collect local deposits. It will take years for foreign banks to make an impact. To do business in yuan, [foreign banks] will have to borrow from the Chinese banks.
Also, Chinese deposit rates have not been liberalized. So the banks' margins are big. They can invest a lot in ATMS, bank cards, the Internet, on so on. And they don't charge depositors for these services.
Q: Will China's current-account surplus abate?
A: Trade has essentially been in balance, except recently. The current account is high basically because of capital inflows. But how much is Chinese money? Many companies are just moving funds in commercial bank foreign currency accounts, [and those funds] don't count in reserves.
Before, the market speculated that the yuan would devalue. Now, [companies] are moving their money back into China through trade channels. They can wait, and they know the loopholes.
Q: What should China do with the yuan?
A: I believe that it is a good idea to let the yuan trade in a bigger range. Small steps will invite speculation. My main argument is that this is a global issue. What worries me most is the fiscal deficit of the U.S. That is the whole reason for these imbalances. The U.S. dollar is international money, and the real problems will be borne by everybody. A dollar devaluation will become our revaluation problem.