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@ U S T . H K
The emergence of China as a major
source of capital for developed countries
is a phenomenon that has caught
economists and politcal leaders by
surprise. Research at HKUST offers
novel perspectives on the flows of
capital in and out of China and its
massive trade imbalance with the West,
with economist Prof Pengfei Wang
and his collaborators becoming the first
to quantify this data and use it to
develop a new theory to explain the
dynamics involved.
Classic economic theory has long
suggested that capital normally flows
from developed countries, where it is
abundant, to the developing. However,
economists have been perplexed as
to why the reverse now appears to be
true. This is particularly the case for
China, which by the end of March 2017
was holding US$3 trillion in foreign
reserves, mostly US government bonds.
Prof Wang explained that this is an
outcome of China’s immature financial
system. Due to the underdeveloped
banking-credit-financial system, house-
holds have limited investment options.
At the same time, households and
firms have borrowing constraints. This
gap creates financial frictions: house-
holds save excessively to self-insure
against unpredictable shocks. However,
their huge financial capital cannot be
effectively channeled to firms.
Prof Wang observed that financial
capital in China yields a lower rate of
return compared with the US. This
drives domestic household savings to
flow to the US for higher returns,
despite government-imposed currency
restrictions, and the rise of informal
financing platforms. He also noted that
Analyses are difficult
if we assume people
are irrational
because irrationality
has limited use in
making predictions
PROF PENGFEI WANG
Professor of Economics
INS AND OUTS
OF CAPITAL
FLOWS AND
ASSET BUBBLES
