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China and stimulus packages: the best way to respond to more bad news?

Louis Kuijs's picture

A few days ago, our country director David Dollar blogged about the two-sided picture we see when we look at China's economic growth. The economy saw very weak export demand, which partly carried over into weak investment in manufacturing and other "market-based" sectors. Continued growth in other parts of the domestic economy was supported by policy stimulus.

China has weathered the crisis better than many other countries because it does not rely on external financing, its banks have been largely unscathed by the international financial turmoil, and it has the fiscal and macroeconomic space to implement forceful stimulus measures. China’s government has made use of this policy space by pursuing pretty forceful fiscal and monetary stimulus. From early November last year onwards, the government's 10-point plan ("RMB 4 trillion package") is being implemented. This plan emphasizes infrastructure and other investment, financed in part by government budget spending, and in part by bank lending. And the government has taken some additional, more consumption-oriented measures.

The forceful stimulus policies have been key in dampening the downturn. Largely as a result of these measures, we think China can grow at 6.5% this year, even though the world economy as a whole is expected to shrink by 1.5% – with as much as three-fourth of growth coming from government-influenced spending.

With the economic environment weak and global growth prospects grim, what is the best way to respond to new bad news that makes the economic targets difficult to reach?

  • First, while it is true that more government stimulus money may help dampen the global downturn's impact on growth, employment and people's livelihood are equally important. The number of jobs created by growth depends on not just the rate of growth, but also the pattern. China's growth has been capital-intensive in the recent decade, meaning that a lot of new investment is needed to create new jobs.
  • Second, as more marginal projects are considered, the quality of the new projects and growth is likely to go down, and there may be limits to how much investment can be expanded efficiently. Moreover, not all of the investment-oriented stimulus is helpful in meeting the objective of China's 11th Five Year Plan to rebalance the pattern of growth, making it more sustainable economically, socially, and environmentally. By and large, rebalancing requires less industry and investment, and more services and consumption.

Thus, the government has rightly added more consumption-oriented stimulus measures recently, such as a health care reform and spending plan, steps to improve the social safety net, and initiatives to boost rural consumption. There is room for a further shift in this direction, especially for more measures with a lasting impact, such as increasing the presence of the government in health, education, and social safety.

Moreover, I think it might make sense to limit additional general stimulus measures, regardless of the orientation.

  • First, somewhat lower overall growth is not likely to jeopardize China’s economy or social stability, especially not if the adverse consequences of dislocation and lay-offs are alleviated by using and expanding the social safety net. I think that China will be able to ride out the storm this year, whether its economy grows by 6.5 or 8 percent. Thus, there is room to shift emphasis from additional short term stimulus to rebalancing and reform.
  • Second, the global slowdown may well extend into 2010. If so, it is good to have some fiscal ammunition left. Since there are limits to the size of fiscal deficits, it would be prudent to preserve room to increase the fiscal deficit further in 2010 if needed.

Thus, building on what has been done so far, I think the consequences of further downward revisions to the outlook can just as well be alleviated by using and expanding the social safety net, preferably combined with education and training. Using and expanding the social safety net is not universally popular. However, it has two advantages. It is much less costly for the government than additional general stimulus. Meanwhile, the advantage of using the social safety net over labor market measures (see box in page 15 of the China Quarterly Report – pdf) such as "job creation" and "job protection" policies is that it combines protecting income of workers with efficient allocation and flexibility on the labor market. Most of the other labor market measures run the risk of locking up labor in inefficient firms or making the labor market less flexible.

David Dollar and I will answer questions and discuss China's economy in an online chat this week. Submit questions now or join us live on Thursday, March 26, at 9:30 a.m. in Washington, D.C., (9:30 p.m. in Beijing, China). Click here for the site.

Comments

Louis, It seems, from the distance at least, that the Chinese government tries to capitalise on the weakness of many - resource rich - developing economies by providing them with financial buffers they badly need. This means that in practice the Chinese help can appear as a competitor to the IMF/EU/ADB/EBRD etc. packages. Of course, such policy would make a lot of sense for both sides, but not necessarily without long term consequences. 1. Do you think this is a policy as opposed to happenstance (and is it there at all, in your view)? 2. What is the future trajectory in long global recession scenario? Cheers, Tamas

Hi Tamas, China's companies had already become more active in recent years in resource related deals abroad, as part of a wider "going global" policy. As the global financial and economic crisis is unfolding, China's government and senior leaders have advised government entities and large companies to be wary of buying up financial sector assets, but have remained an encouraging stance on resource related deals. So, can we call this a policy? Maybe. As you say, this seems to make sense for both sides. Your second question is on the future trajectory in a long global recession scenario. Well, that will not look pretty, definitely not abroad, but neither in China. At the moment, China can keep on growing significantly because of a large policy stimulus. That stimulus can be maintained for a while, but not forever. Repeated fiscal stimulus means continuing to raise the fiscal deficit, and there is a limit to how high fiscal deficits can and should be (indeed, this is one of the reasons why we think it may not be appropriate, upon bad news, to add more general stimulus measures this year). Moreover, a prolonged global recession will create increasingly large problems with spare capacity in manufacturing, leading to more of the kinds of issues we discuss in this area in our latest quarterly. Thus, in all, and not surprisingly, a prolonged global recession will not look pretty, anywhere, in my view.

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