With the ever-present sound of jackhammers in the background, large construction cranes place large beams and other infrastructure carefully in place at a new building site as workers scurry back and forth in the process of construction. These are the signs of a bustling capitalistic economy with growth and development driving employment and living standards to new and higher levels. In this case, however, the activity is taking place in Guangzhou, China, an area that shows signs of being caught halfway between Communism and Capitalism.

The signs of capitalism are present, with much investment spending provided by the banking industry with money provided by citizens. Banks are awash in funds because most savers have few investment options, except for banks, so the supply of loanable funds is constantly replenished. In fact, recent reports indicate that Chinese banks have made more loans already this year than they made in all of last year. Stock markets are developing in China, although they remain small and risky. A bond market is also developing, but at this point remains small and underdeveloped. The Chinese are acting like capitalists, while still espousing many of the tenants of Communism.

The banking industry is owned by the government, except for small stakeholders in some small and midsize institutions in larger cities. With state control of the banking system, banks often lend money to politically connected customers without adapting rates to account for the risks that projects entail. Borrowers have defaulted on nearly half of all bank loans made in China, according to Standard & Poor's. Investigations of banking practices have found evidence of conflicts of interest between bankers and borrowers. As a result of banking practices, unfettered by legal and regulatory safeguards, the Chinese government has had to bail out the banking industry to keep banks open.

Factors favorable to China's transition to a capitalistic economy include its vast natural resources, the potential release of resources from the military and the entrepreneurship that is evident from the workings of a thriving underground economy. The transition could be assisted further with private investment by foreign firms. Yet, current fears that the economy is overheating, along with continuing bureaucratic resistance, keeps foreign money out. The final transition will require a smoother-running bureaucracy and a limited and reoriented role for the Chinese government.

(Updated October 1, 2003)