Sustainable growth, legal reforms key to Chinese-style modernization

In China, an important goal today and going forward is to achieve Chinese-style modernization. There are two crucial points to be stressed during the process of achieving Chinese-style modernization.

First, it is important to maintain sustainable economic growth. In order to achieve modernization, China must first become a developed, high-income and prosperous country. We must then consider what kind of institutions, mechanisms, policies and talent can promote sustainable economic growth.

I believe that adhering to the path of developing a socialist market economy with Chinese characteristics and making an unwavering commitment to China's reform and opening-up policies are important institutional foundations for maintaining sustainable economic growth. At the same time, we should also promote technological progress and foster talent.

Second, Chinese-style modernization must include the modernization of the Chinese legal system. A market economy and a sound legal system are two fundamental pillars for achieving Chinese-style modernization.

The current reality is that China's economy is undergoing a structural transformation and iterative upgrading of industries. It is hard for resource-based enterprises and traditional manufacturing industries to become dominant industries in the process of achieving Chinese-style modernization. The most important driving force behind China's modernization is promoting industrial upgrading and iteration through technological progress and innovation.

However, the transition from new technologies to new industries does not happen naturally and requires business incubation through financial means. The reason is that the transformation from new technologies to new industries is full of uncertainties and represents a significant leap. The risks arising from the uncertainties exceed risk tolerance limits of individual capital and even those of entrepreneurs. Therefore, the society as a whole and the financial system should continuously innovate and develop new financial models that can incubate high-tech enterprises.

For this reason, innovation is the most important task for China's financial sector. We need to properly handle the relationship between financial innovation and financial regulation, and firmly guard the bottom line of avoiding systemic financial risks while promoting financial reform, development and opening-up. Striking a balance in this dynamic relationship is absolutely essential.

In the new era we are currently in, the role of technology is becoming increasingly important. It is wrong to assume that new technology will naturally transform into higher productivity or transition into new industries or products without risks. The transformation process involves business incubation and risk diversification, and this process relies on the role of finance. Without financial innovation, traditional finance cannot accomplish these functional changes.

Many key technological advancements often lead to new industrial revolutions, which spawn changes in the financial sector and related reforms, with calls for financial innovation. Since the first industrial revolution in the mid-1700s, the human society has undergone three industrial revolutions and is now in a critical period of the fourth industrial revolution.

Through studying the history of industrial revolutions spanning over 200 years, we have discovered that finance has also undergone tremendous changes during these epochal transformations. The changes in finance drive economic growth and propel the human society toward higher civilization. The adjustment of China's economic structure and the upgrading of industries constitute the most important tasks we face in the foreseeable future and form an essential foundation for sustaining economic growth.

Therefore, finance must fully meet the needs of the real economy. Here, the "real economy "encompasses the economic structural adjustments brought about by technological advances, while "finance" primarily refers to modern finance, which can meet the financial demands of traditional industries and also play a role in the incubation and promotion of new industries.

The mission of finance is not to replicate history but to create the future. Finance can only find the direction of reform and innovation by focusing on the future. Financial innovation does not necessarily increase risks because changes in the landscape of the financial sector will eliminate traditional financial risk and lead to adjustments in risk structures.

We should not hinder financial innovation just because the new landscape of the financial industry comes with certain new risks. On the contrary, financial innovation will bring new and more diversified financial functions, which can cover the additional risks they bring and, to some extent, mitigate traditional financial risks. Therefore, we need to have a scientific, comprehensive and systematic understanding of financial innovation.

We should not try to bring China's financial practices back to a single form of business in the financial sector because such a strategy will be unable to keep up with the pace of the times and lacks competitiveness and vitality. This kind of financing may appear to get risks under control but in fact, it is not the case.

At the core of China's financial sector reform is the need to promote risk flow, which enables risk allocation. The flow of risk depends on the flow of assets, and only assets with liquidity can be allocated. Financial marketization creates predictable mechanisms, and financing without predictable mechanisms is counterproductive.

We need to understand the precise meaning of making finance serve the real economy and where the focus lies. Modern finance primarily serves industries and companies that will be competitive in the future. At the same time, finance must also meet diverse financial needs, including wealth management.

The Chinese society is currently in the process of moving toward modernization. Generally speaking, the basic criterion for a country to be considered developed is to have an annual per capita GDP of at least $25,000. China aims to become a moderately developed economy by 2035 and a great modern socialist country in the future.

During the process of continuously improving income levels, people pay much attention to wealth management. We should not expect that as income levels rise, people will continue to convert their surplus income into bank deposits. The returns obtained from bank deposits are not investment returns because they do not include a risk premium. They are just compensation for deferred consumption.

We must create a wealth management market that matches returns with risks for increasingly prosperous individuals. This is an important task of China's financial reform campaign. Therefore, developing capital markets is a strategic goal of China's financial reform, not just a stopgap measure. We need to ensure that the value of existing wealth can be preserved and increased, especially by continuously reducing the proportion of real estate in stock assets in the future.

In a normal society, a first home purchase meets people's basic housing needs, and a second home may satisfy greater leisure needs, which is reasonable. From the perspective of wealth management, owning more than two real estate properties as investment may not be rational.

If household assets are primarily allocated to real estate, it indicates that finance is backward in the country. Residents in a modernized country do not have 65 percent of their assets invested in real estate. If the proportion remains the same in the future, it can only suggest that the financial system is lagging behind and has not created diversified financial assets that match returns with risks. Therefore, it is necessary to promote structural reforms in China's financial sector.

The driving force behind financial development comes from technological progress. Without technological advancement and the emergence of new industries, existing assets will struggle to grow.

The future allocation of Chinese people's existing assets should be in the capital market, and equity assets in the market should have growth potential.

The article has been compiled from his speech at a recent forum.

The writer is a professor of finance and former vice-president of Renmin University of China.

The views don't necessarily reflect those of China Daily.