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The Sunday Paper – The Effect of the China Connect

Should an Emerging Market economy (like China) allow it’s capital account to be liberalized? You’d think the answer would be obvious. However, like many other financial theory glib conclusions real-world experience suggests the answer is, in fact, complicated.

Researchers are always looking for before-and-after situations to test theories and one was provided in China that addressed this question recently. In 2014 the government allowed certain Chinese stocks to be traded by non-Chinese investors. What the academics wanted to know is would these companies then show more exposure to the global financial cycle, one that is dominated (it just is) by U.S. monetary policy?

The bad news is not only did companies exposed to this more open capital account exhibit greater sensitivity to the global economic cycle but the effect was broadly negative. The most obvious effect was a long-term dampening effect on corporate investment especially pronounced among weaker companies in the study.

The paper supports other recent work that presents an increasingly solid case against the long held (mostly Western it has to be said) orthodoxy that financial liberalization is always and everywhere a good thing. The reality seems to be messier. Sometimes it is and sometimes, it might not be.

The paper, authored by Chang Ma and Sili Zhou of the Fudan University with John H. Rogers of the Board of Governors of the Federal Reserve System, can be accessed via the following link Connect Effect.

Happy Sunday.

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