US Treasury Secretary Paulson is in town again and gave a speech yesterday in Shanghai. What was the point of this two-day visit? Well, in his only speech he urged China to open its financial sector more quickly to foreign investors/service providers.

Paulson stated the need “to speed financial reforms in order to create more balanced economic
growth, encourage innovation and make better use of natural resources –
all objectives that Beijing has itself recently emphasised.” (from the FT story)

The substance here regarding balanced growth and stability, etc. is certainly on target. As the FT points out, though, this is something that Beijing has been working on for some time now, has its own timetable, and (as leaders would no doubt point out) does not need Paulson pushing them to revise their plans.

Here’s the bone of contention, again a quote from Paulson, courtesy of the FT: “The risks for China are greater in moving too slowly than in moving too
quickly toward transparent, liquid, stable capital markets.” Many would agree with Paulson, particularly people working for financial services companies looking to get fat off a new market.

But maybe I’m being too cynical. There are definitely solid reasons for a faster pace of financial reform here. Paulson is also correct when he says that there are insufficient types of investment products here and that there is a “rising volotility in markets bloated with funds chasing too few investment opportunities.” (quote from the AP) Think stock market and real estate.

Here’s the other side of the story, as explained by a professor Yin and Fudan University: “China can’t move too quickly toward transparent, liquid, stable markets
as the U.S expects, because that would cause chaos given the complex
situation here.” In addition to this more conservative planning, there are political concerns, specifically the Party Congress later this year (noted in the AP article by China econ god Nicholas Lardy). I don’t know if I would agree with the term “chaos”; I would rather say that faster liberalization with insufficient institutional reform could cause a lot of problems. Personally I worry that regulators are not yet ready to deal with appropriate levels of risk and that you might actually get more (and dangerous) speculation in the short term.

Perhaps this is simply a straightforward “gimme, gimme” type of trip for Paulson. Gimme something I can take home to my old friends at Goldman Sachs and other firms, and maybe we can calm things down back in Congress about the trade deficit and currency liberalization. Old-style international relations, that, and you certainly cannot begrudge politicians for pushing policies that would benefit the money guys.

On the other hand, and as a final comment, policy does matter. Asian countries in the past ten years have learned the hard way what it means to liberalize too quickly, and China’s development planners are painfully aware of the Asian Financial Crisis just as much as Japan’s ‘Lost Decade’. In their eyes, a conservative pace of liberalization is not just about protectionism, although this certainly plays a role. Making sure that regulatory structures are put into place as liberalization occurs is crucial, because without proper oversight, dumping a lot of new products on this market is a frightening prospect.