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The Sunday Paper – The Effect of the China Connect

Do capital controls work? There’s a long answer to that question with many subjective clauses but the short answer is, nobody really knows.

There are so many moving parts to an economy and separating short, medium and long term effects not to mention the highly partisan nature of the question means juries remain out on the question.

Writing in a Finance and Economics Discussion Series [Paper from the] Divisions of Research & Statistics and Monetary Affairs [Of the] Federal Reserve Board Washington though a group of researchers made findings, albeit situationally specific, that contribute usefully to the debate.

They use the Shanghai (Shenzhen)-Hong Kong Stock Connect program as a natural experiment because this program, kicked off in 2014, represents a de facto hole-in-the-wall of China’s broader capital account controls.

What’s especially useful about this event is that only certain stocks have been allowed to participate so there’s a natural control experiment with those left out (before you start with the obvious ‘Ah but…’..the researchers have tried to filter out the suggestion that only ‘good’ stocks got included).

The research found as follows:

  1. When there was a negative monetary shock in the U.S. system Chinese stocks in the connect suffered negative consequences. However, ..
  2. Stocks in the connect had observably lower financing costs which seems to have allowed them to invest more and achieve higher profitability.

The Chinese government appear then to have created a situation where China Inc. suffers the occasional, small, negative setback (which, given the ever interconnected world they well may have suffered anyhow?) but benefits way more over the long term.

You can therefore have, at least a bit, of your cake AND eat it. The argument for limited capital account opening is thus settled. It’s a good thing.

The issue of whether or not broader exposure to global capital flows and opening up would be to China’s (or other tightly controlled economies) advantage though remains, still, moot.

You can access the paper in full via this link The Effect of the China Connect.

Happy Sunday.

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