Chapter 4 Developing a capital market under weak enforcement
The Chinese Experience
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This chapter attempts to provide an explanation for the development of China’s stock market which is clearly inconsistent with my ‘enforcement matters’ thesis. It contains four sections. Section 1 casts some doubts on the often quoted data on China’s stock market. It takes a second look at the real size of market capitalization and the number of investors. Section 2 raises a critique of the argument by Pistor and Xu (2005). Pistor and Xu (2005) claimed that the fact that China’s stock market avoided the failure of other transition economies should be attributed to its adoption of the quota system to fill the governance vacuum during the initial period. Section 3 provides an alternative explanation. It argues that China’s stock market is driven by four factors: state guarantee, rent seeking, speculation and financial repression. Section 4 draws attention to the inefficiency of the stock market. It points out that although China’s stock market expanded quickly in the absence of effective enforcement, it displays serious deviation from the macro economy and extreme volatility. In Chapter 1, I established the thesis that enforcement is crucial to the development of a capital market. In the absence of any form of effective enforcement, a capital market will not develop. In Chapter 3, I examined the enforcement mechanisms in the Chinese securities market and found that neither formal nor informal enforcement mechanisms are effective. As a result, an under-developed stock market may be observed in China. However, the Chinese stock market seems to present a counter-example.

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