The efficacy of China capital control : an empirical investigation


Student thesis: Master's Thesis

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  • Sze Sze LO

Related Research Unit(s)


Awarding Institution
  • Kenneth Shun-yuen CHAN (Supervisor)
Award date2 Oct 2009


From 1978 onwards, China embarked on an economic reform program, instead of imposing reform on the entire Chinese economy at one time, the Chinese government preferred economic reform as a gradual process. The reform’s process was much like crossing a river by groping stones and helped China enjoy a very high rate of GDP growth in the last two decades. The reason why capital liberalization has been emphasized over the past two decades, as suggested by Fischer (1992) and Lardy (1998), is the belief that capital account liberalization should be treated as an integral part of economic reform programs because the liberalization of capital control was not only a question of economics but also one of politics. Understanding the importance of capital control could help the economy to develop and prevent certain economic shocks. As Groombridge (2001) and Han (2002) have pointed out, capital control protected China from the Asian financial crisis likely as a result of closed capital accounts in China. This paper first extracted yearly time series data, measuring the capital flow of China from Philip Lane’s data and then compared the results of the traditional ADF test procedure, which consists of a unit root test without a structure break, with those found with the IO and AO model, which consists of a unit root test with a single structure break (Perron 1989, 1997), and Recursive Least Squares , which consisted of recursive residuals test and one-step forecast test to detect multiple structural changes, to have a better understanding of capital control in China from 1980 to 2004. By applying the IO procedure in the presence of a single structural break, we found the interesting result that most of the variables under investigation became stationary at the 5% significance level after allowing an existence of structural break, it suggested that the policies did have some effect on capital flow of China. Our analysis also applied Recursive Least Squares to highlight the existence of multiple potential structural breaks found in the data due to key policy changes in Chinese capital control. Although there is still considerable risk that China may face in the future, this study, based on statistical criteria, could help us determine how different kinds of capital controls, including control over direct foreign investment, control over portfolio equity and control over portfolio debts and other investment, were introduced in China and this might help Chinese policymakers in making future adjustments of capital controls.

    Research areas

  • Government policy, Capital movements, China