The Political Economy of Trade-Financial Liberalization and Financial Underdevelopment: A perspective from China

Although financial development may facilitate economic growth over the long term, financial underdevelopment remains a salient feature of even leading emerging or transition economies. In principle, openness to both international trade and finance may weaken resistance to major financial reforms; however, the apparent failure to consolidate political support for such reforms in practice is not completely understood. This paper develops a simple model of the political economy of trade-financial liberalization that offers insights into this phenomenon. When applied to China, it not only facilitates a better understanding of its approach to financial integration in the global economy and why its relatively fragile state-bank dominated financial system has persisted; but more generally, it raises the question of whether limited de facto political competition in the domestic electoral system may be a binding constraint on the quantity and quality of the policies required to foster financial development.