"The last week has put back financial reform for a decade," said Shaun Rein, founder and managing director of the China Market Research Group. "Rather than 'the omnipotent Chinese government,' they created panic. I'm shocked at what they did."
China's response may also have set back its efforts to attract foreign investors to its mainland markets, where individual retail investors hold most of the shares. Just last month, MSCI said it would consider adding the A-shares traded in Shenzhen and Shanghai markets to its widely followed emerging markets index if China continued to progress on issues such as transparency.
"They indicated they might consider them again, but after this, it would be hard for them to say 'yes, we're going to add their shares into the emerging market index,'" said Peter Donisanu, global research strategist at Wells Fargo Investment Institute.
MSCI did not respond to a request for comment from CNBC.
"There's a tremendous urgency within the Chinese government to move its financial system on par with the world," said Yukon Huang, senior associate of the Asia program at the Carnegie Endowment for International Peace.
The collapse of the stock market follows a rapid surge higher, with an increase of more than 100 percent in less than a year. This was partly driven by the easy access to margin lending, and encouragement from the government that the equities markets were a good place to invest.
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Huang said the government may have moved too quickly in its desire to join the global stage of more developed marketplaces. "The pace of reform was probably too quick. In the U.S. we're still struggling with questions (of risk) in the banking system."
China liberalized the policies on margin lending and short selling but the activities helped exacerbate the bubble that was forming in its markets, analysts said. At the same time, it tightened some rules on real estate holdings that made stocks even more attractive.
The country's efforts to build up its stock market at home coincided with its goals to lure more investors. Last year, China launched the Shanghai-Hong Kong Stock Connect which lets foreign investors with access to the Hong Kong exchange trade a limited amount of mainland A-shares for the first time.
Just a small portion of the Chinese population is part of its burgeoning middle class. A significant amount of the population is relatively poor, and there's a wide disparity between the social classes. China ranks 88th in GDP per capita, according to the World Bank.
Wells Fargo's Donisanu described the government's efforts to encourage equity investment as a form of "social harmony."
"As a ruling one-party system, the reason they've been able to maintain this one-party system, besides by brute force, is by making them happy," he said. "The stock market is one way to make the next generation or even the present generation feel happier."
Huang, however, said China's market cannot be a world player yet. "The politically motivated objectives (connecting markets, internationalizing the yuan) has encouraged the government to liberalize and do things probably faster than it should have," he said.
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"That kind of reform process is a decade-long, generation-long process," he said. "You have the most significant market in the U.S. still having problems."
Last November, the mainland A-shares began rising in anticipation of greater foreign inflows with the symbolic opening of the stock connect. From the program's launch, the Shanghai composite jumped about 110 percent to a peak in June, amid several interest rate cuts by the People's Bank of China.
That A-share rally turned into a bear market in the weeks after MSCI's June decision to delay inclusion of the stocks in its $4 trillion benchmark emerging markets index. The highly anticipated announcement was a blow to China, for which the addition of A-shares would smooth the way for the International Monetary Fund to approve the yuan as a reserve currency.