Regardless of whether we admit it or not, the financial crisis is deeply related to global economic imbalances. Currently, the world seems to have weathered the crisis and people envisage a new, post-crisis world order. If global imbalances are to be blamed for the crisis, then it is of little significance to discuss a new world order before identifying the causes of imbalances.

It is generally believed that the overspending spree in countries with huge trade deficits and the excessive savings in trade-surplus states caused global economic imbalances. Outwardly, this argument is reasonable and has been accepted by academicians and policymakers. Based on the assumption, economists wrote a "prescription" for avoiding crises: Increase consumption in trade-surplus countries and savings in trade-deficit countries. Indeed, since the beginning of this year, some positive signs seem to be emerging in countries with trade deficit, such as increasing savings in the US. So, people began to suspect that with the decline of the US spending, whether the export-oriented growth pattern in trade-surplus countries, with China as the representative, could keep up.

Unfortunately, the rising deposit in the US is very likely to be temporary and irrespective of people's will, and trade-surplus countries will still maintain the export-oriented growth model. I believe that it is the long-term factors that influenced the international division of labor, causing imbalances that could not be avoided through readjusting short-dated factors.

In order to reduce external imbalance, China must engage in structural adjustment, especially in speeding up the process of urbanization and financial system reform. The goal of urbanization is to boost domestic consumption while reforming the financial system aiming at better utilizing the savings provided by current account surpluses.

The direct effect of improving the rate of urbanization is to increase domestic spending. Once a rural resident comes to the cities, his or her income would increase without much training or learning. Because in rural areas, farmers' income improvement is constrained by the fixed factor - land, while in cities their labor is based on capital, which could be expanded. In other words, urbanization could raise the income of migrant workers at "zero cost" as well as per capita income countrywide. At present, urban per capita consumer spending is 2.57 times that in rural areas. Therefore, urbanization will boost domestic consumption level.

On the other hand, China's backward financial system led to the waste of national savings. If we have a well-established financial system, the large amount of foreign exchange brought by exporting could become bank loans or financing in capital market, which can enable enterprises and residents to buy imported products, and our trade surplus will not be so huge. Even if holding tremendous trade surplus, a developed financial system still could transfer the capital into domestic or offshore fund and reduce current account surplus.

One of the problems facing China's financial system is the absence of small- and medium-sized banks. At present, there are only 18 major commercial banks and more than 110 city commercial banks in China. Although the number of rural credit cooperatives is huge, most of them are not in good shape. While in the US, there are 7,500 commercial banks, 886 savings and loan associations, 400 mutual savings banks and 9,900 credit cooperatives nationwide.

Erecting more small- and medium-sized banks would be conducive to relieving China's economic imbalance. First, these banks prefer to issue loans to small- and medium-sized enterprises (SMEs), which have financing difficulties for a long time. China's savings rate has surpassed 50 percent in recent years while domestic investment rate is about 42 percent, which means that savings equivalent to nearly 10 percent of the GDP have not been used each year. In a financial system dominated by large banks, the problem of loan difficulties facing SMEs cannot be solved effectively. With abundant funds, big banks would like to issue loans on a big scale to large enterprises, which could bring stable returns and lower their cost. While, small- and medium-sized banks with a few funds can operate flexibly and would like to issue loans to SMEs. So boosting the development of small- and medium-sized banks could increase domestic investment and improve the utilization rate of savings.

Second, SMEs can promote employment. The same amount of capital invested in SMEs would bring more job opportunities than that in large enterprises. With more employment, the labor payment ratio of the GDP will rise, which would change the current income allocation pattern so as to increase domestic spending and reduce dependence on export.

Another major flaw of China's financial system is the lack of regional capital markets. The population and acreage of each Chinese province is equivalent to a medium- or large-scale country, but there are only two stock markets and only about 1,500 listed enterprises. Even considering the newly launched Growth Enterprise Market, the scale of China's capital market is still relatively small. Moreover, China basically has no enterprise bond market and very few other financing channels. The consequence of lacking regional capital markets is the frequent recourse to illegal funds. We should, however, be aware that the large scale illegal fund raising signals SMEs' high demand for capital and people's desire to deploy spare capital.

Financial markets should not only play a role as an intermediate agent but also as a means for ordinary residents to share the fruit of the current high-speed economic growth. In the current allocation structure of China's GDP, the ratio of labor income is declining while capital income rising. Reforming the financial system could raise the proportion of labor income and could increase the ratio of capital income possessing by residents through encouraging private investment.

The author is deputy dean of the School of National Development, Peking University.

(China Daily 11/06/2009 page8)