A theoretical framework for understanding financial distortions: With special application to China

We attempt to explore the political roots of financially distorting policies ("FDP") by building a simple demand-supply framework in this study. On the demand side, in many countries, including non-democratic ones but particularly in democratic ones, interest groups are attracted by rents associated with FDP and therefore devote resources to distort financial policies to their advantage. On the supply side, governments, particularly governments in non-democratic regimes, are inclined to adopt FDP to channel financial resources to the key constituents of their regimes in exchange for their loyalty and support. The framework is shown to be useful in understanding financial situations in certain countries, such as China, where a highly distorted financial environment has been maintained for decades.