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.