The Politics of Lending: Prospectus and Preliminary Investigation

Is a state ever truly insulated from interest group influence, or is state insulation conditional under the best of circumstances? While Huang (1995) attributes relatively low inflation in China to political discipline of the Chinese communists, the banking sector has slowly fallen into quagmire. While harsh retrenchments succeeded in lowering inflation, each monetary expansion brought the Chinese banking sector closer to bankruptcy. The central government controls the overall amount of lending and is therefore responsible for the current banking crisis. If politics is responsible for low inflation, how does it influence lending? My research, in addition to rigorously testing the conventional wisdom that state controlled finance itself leads to sub-optimal allocation of capital, also investigates political pressure groups, informal factions, and electoral incentives as possible explanations of the irrational lending problem. Irrational lending here is defined as lending without assessing the commercial risk of the borrower. For the field of Chinese studies, my work will provide more empirical evidence to the debate on " reciprocal accountability, " which will shed light on the political origins of policies in China. It also hopes to provide a causal theory of how politics influences economic outcome in China. In the field of comparative politics, my work seeks to generate a new framework of analysis for state intervention in the economy that provides more fine-tuned predictions about the economy than previous approaches. It also seeks to explore whether different institutions give rise to different configurations of economic interest groups. Ultimately, this research also tries to increase our ability to predict future developments in China. On the one hand, if the Chinese banking system lends now purely due to technocratic considerations for social stability or other developmental goals, technocratic reformers will more likely be able to carry out the current batch of reforms aimed at bringing the banking system to Victor Shih 2 international standards in time for its entrance into the WTO. On the other hand, if bank lending currently serves as an instrument of elite political struggle, commercialization of lending and other reforms are likely to face more difficulties as the political leadership would be reluctant to give up this powerful tool of political struggle. As Nelson notes about the general likelihood of reform, " …[leaders who] depend on their control over allocation of resources to maintain the loyalty of faction-ridden or personally ambitious lieutenants " are less likely to delegate power over …