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Economy must not rely on Keynesian policies

By Zhang Jun: 0 Comment(s)Print E-mail China.org.cn, July 7, 2012

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Zhang Jun, professor of the School of Economics, Fudan University. [File photo]

It has been four years since China launched a 4 trillion yuan stimulus package in late 2008 to counter the economic downturn triggered by the global financial crisis. The government's current policy to maintain economic growth has again called attention to the 2008 stimulus plan.

In the recent couple of years, more economists have started to voice criticisms of the 4 trillion yuan plan, expressing worries that Keynesian polices may disrupt China's economic development process. Keynesianism advocates expanding demand in the very-short-term, they argue, which, in most cases, stabilizes the economy but fails to induce growth. This kind of stimulus, therefore, should not be routine policy, but only used if the economic recession is so severe that the country has no other choice.

Stimulus encouraged deficit spending

After the 4 trillion yuan stimulus package was enacted, local governments resumed their financing platforms. The National Development and Reform Commission then approved a large number of projects which depended on local financing.

However, the liquidity injected into the market has far surpassed expenditures. Only the banking system itself has issued loans of 10 trillion yuan. With more than 10,000 financing platforms all over China, the country has been suffering a storm of debt financing.

However, I don't think the local debts of 10 trillion yuan are terrible, since the governments have spent a lot of money on infrastructure and public welfare projects. According to those balance sheets, while debts have accumulated, the number of assets including railways and bridges has increased.

China has a lot of experience in activating these assets to repay debts to banks. During the tenure of former premier Zhu Rongji, many bad assets from banks were finally repackaged and sold, thus absorbing them into the market. Hence, although risk exists in local debts, it has never reached the extent of a debt crisis.

Nonetheless, how local governments finance economic development has always remained a problem. Some provincial-level governments such as Shanghai, Zhejiang and Guangdong have raised money for development projects on the open market. This is the right idea, but more time is needed before local governments can issue bonds on large scale. Therefore, in the next ten years or possibly longer, local governments will still have to depend on banks to supply credit.

Stimulus aggravated economic concerns

Other critics of the stimulus plan say it has driven up inflation, caused the phenomenon of "the state sector advancing while the private sector retreats" (or "guo jin, min tui" in Chinese), and also caused housing prices to skyrocket. However, these phenomena have not been solely caused by the 4 trillion yuan plan, nor did they emerge after the plan's inception.

China's commodity prices have been rising since 2004. The real exchange rate is also going up. As many goods have become more expensive, wages and production costs have increased.

From 2004 until the onset of the financial crisis, inflation in China can be characterized as cost-push inflation. After 2008, the launch of the stimulus package also contributed to inflation due to the increased demand for raw materials, goods and services.

When local governments invest in projects through local financing platforms, it's always been easier for state-owned enterprises (SOEs) to participate than private companies. Such relationships between state-owned and private enterprises are nothing new, and they are certainly not a by-product of the stimulus plan.

After the 4 trillion yuan stimulus package was launched, credit flowed to SOEs. The public hence had more concern for the widening gap between state-owned and private enterprises. However, the stimulus package is not the cause of this phenomenon; rather, it merely exacerbated the problem.

Moreover, even if without this stimulus policy, housing prices would have still continued to rise. The plan stimulated more funds from banks flowing into the property market; if the plan had not been enacted, real estate would have still grown, albeit at a slower pace.

Also, at that time, stimulating domestic demand to ensure hitting the country's GDP growth target of 8 percent became a politicized task. This immediately inspired enthusiasm of the real estate industry and maintained high expectations for housing prices. All these factors led to a sharp rise.

Economy must be regulated from supply-side perspective

To maintain steady economic growth, we need to learn lessons from the 4 trillion yuan stimulus.

The policy of stimulating demand can help short-term gains if the economy suffers from a sharp slowdown; however, the present Chinese economy has been hurt by increasing costs, so the country should adopt a middle- or long-term macroeconomic policy to ensure continued growth.

In this sense, China needs to regulate its economy from the view of supply side so it can increase productivity.

The only way to offset costs is to raise productivity. The government should break up business monopolies, loosen protection for some industries, and build a competitive environment. Upstream industries should be more open to private enterprises and tax-reduction measures should be taken to encourage competition.

At present, the Chinese government has formulated the "New 36 Clauses", rules that allow private companies to invest in sectors previously monopolized by state-owned enterprises. This policy needs to be fully implemented so that the Chinese economy can achieve vitality again.

The author is a professor from the School of Economics, Fudan University.

(This article was published in Chinese and translated by Wang Wei.)

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