November 9, 2008, and every newspaper, TV and radio broadcast in mainland China is leading with the news of President Hu Jintao’s announcement. In the face of the global financial crisis, and just days before the G20 summit in Washington DC, Hu has just pledged economic stimulus measures worth RMB4 trillion (US$586 billion), a package comparable in size with that subsequently put together by the United States from an economy with a GDP only a third as large.
China’s largesse was in one way plausible. Incoming US President Barack Obama would find himself with little recourse but to issue Treasury debt to fund the US stimulus measures, which have since come to exceed US$1 trillion. In stark contrast, President Hu could have paid for his package out of China’s gargantuan foreign exchange reserves, and still have enough left over to send his counterpart at 1600 Pennsylvania Avenue a cheque to cover the entire cost of the initial US measures.
Just over a year later, there’s some indication of the impact of China’s stimulus measures on its economy. But experts diverge on what’s coming, with some forecasting a bright new decade and others predicting disaster.
Learning Lessons
The Asian financial crisis began in July 1997, when the Thai government removed the baht’s peg to the US dollar. Months later, a number of the region’s economies were ravaged. China’s economy fared dramatically better than those of South Korea, Thailand and Indonesia-the Chinese currency and financial system were much more insulated, and foreign investment in China was overwhelmingly in hard assets like factories, rather than securities, so even those investors who wanted to spirit their capital out of the country had difficulty doing so. But the Chinese government also took some key steps to bolster its economy, increasing liquidity, investing in infrastructure and accelerating deregulation of the property and healthcare markets. The property deregulation alone has transformed China, with urban home ownership climbing from less than 35 percent in 1997 to more than 70 percent today. Home ownership has created a stakeholder society and fuelled an explosion in household goods consumption-the Ms. Zhangs and Mr. Lius walking the city streets in China these days would be unrecognizable to their parents in terms of their relationship to the economy.
The experience of the 1990s gave Beijing policymakers in 2008 some valuable lessons to draw on, and the stimulus measures introduced in the wake of the Lehman Brothers failure bore a strong resemblance to those from a decade earlier. First, they emphasized infrastructure investment: more than 50 percent of the entire RMB4 trillion in the initial package (including the RMB1 trillion ear-marked for helping Sichuan Province rebuild after the May 2008 earthquake that killed more than 65,000 people and left millions injured). Second, they included a massive increase in liquidity. Policy statements emanating from the PRC’s annual Economic Work Conference, held in December 2008, revealed that funds from the national government would not exceed 30 percent of the designated RMB4 trillion, and that 40 percent of the amount would be provided by bank lending. The government subsequently reduced reserve requirements and cut interest rates. Third, the measures included substantial regulatory change, including a lowering of down payments required for mortgages, reduction or elimination of VAT, lower fuel prices and subsidies for smaller cars (fuel efficiency) and an expansion of subsidies for consumer goods purchases in rural areas.
Reaction to China’s November 2008 announcement of the initial package was largely positive. In comments carried on the World Bank’s website a few days after the announcement, President Robert Zoellick said, ‘China is well positioned given its current account surplus and budget position to have fiscal expansion. I am delighted . . .’
After a closer look, though, many macroeconomists began to express concerns about the structure of the package. One popular criticism: the share of the package aimed at major infrastructure projects, as opposed to direct stimulus of consumption, which is widely reckoned to be far lower as a percentage of GDP than the percentage in industrialized economies.
As 2009 unfolded, another criticism gained traction: the government’s pledged direct funding was insufficient, and using debt to prop up the economy would create risk of non-performing loans and inflation. In its mid-2009 review of the measures, The Economist said, ‘The so-called RMB4 trillion stimulus package is more a policy than a package.’
Nonetheless, recovery seemed a reality by the second half 2009. Companies were hiring again, restaurants were filling up and consumption statistics had turned northward. Still, the recovery continued to feature Chinese characteristics that regularly evade the attention of, or just baffle, offshore observers.
One of the more obvious effects of the stimulus-driven recovery is China’s infrastructure building frenzy. While a number of the projects seen all over the country these days were already planned by November 2008 (Shanghai’s frenetic pre-Expo face-lift is a good example: the metro/subway system will boast 16 lines and extensions by April, up from only a few at the beginning of the decade), the trillions of RMB being spent on new infrastructure is evident in every corner of the country, from wastewater treatment facilities to bridges to schools, with relatively poorer regions, notably the West and the Northeast, gaining funding beyond their per-capita share of the country’s population.
Critics suggest that, because so many of these projects are government mandated and run, China is experiencing what Japan did late in the last century: horrifically wasteful public-works projects that generate nowhere near the economic value needed to justify their cost. (The risk of governmental mismanagement is real, the comparison with Japan, which already had a highly developed economy and infrastructure by the mid 1980s, is less so.)
Another obvious effect is the level of debt incurred to finance the stimulus initiatives. By the end of 2009, more than RMB10 trillion of loans had been written, ten times the government’s incremental stimulus investment, an increase of 150 percent over the debt levels of 2008. Moreover, because the bulk of the lending has been claimed by state-run entities, for the first time in two decades the state-controlled portion of GDP has risen.
Anti-Keynesians worldwide bemoan the perceived double punch of 1) a debt-laden economy, and 2) loans in the hands of the state-controlled sector, and the concurrent loss of capital available to private, small and medium sized enterprises. Arthur Kroeber, principal at Dragonomics Research & Advisory, refers to ‘a Great Wall of borrowed cash,’ saying that ‘there’s nothing remarkable or spiritual about an economy growing at 8 percent when credit is allowed to expand by 34 percent. . .Ten dollars of new loans were required to generate just one dollar of economic growth. . .China’s first-half [2009] growth shows one thing and one thing only: the existence of a powerful state with the ability to commandeer its citizens’ wealth and plough it into more buildings, bridges and roads, with no regard for the return those investments will bring.’ In a December 2009 Forbes article, Victor Shih of Northwestern University simply referred to the entire Chinese economy as ‘a Ponzi scheme.’
Other respected macroeconomists are more sanguine. Andy Rothman, China macroeconomist for CLSA Asia-Pacific Markets, suggests that the limited direct investment by the central government, as well as the focus on infrastructure vs. direct stimulation of consumption, were well advised.
‘If the government hasn’t invested as much as they first stated they would, that simply reflects a faster than expected private-sector recovery, which is positive,’ he says. ‘And Beijing was clever to focus its stimulus money on infrastructure. It could be spent quickly; it had a significant impact on employment where it was needed the most (low-skilled workers, many of whom had lost low-end export-processing jobs); much of the money found its way to private firms who were subcontractors to the initial state-owned enterprise (SOE) beneficiaries; and it had a huge impact on consumer confidence. This last point is key. Since there was no financial sector meltdown and no credit crunch, and no household debt, consumers were able to resume spending as soon as confidence returned, as is clear in the retail sales and household consumption data.’
Rothman’s comments point to some of the less obvious, yet potentially more telling, effects of the stimulus initiatives. Overseas macroeconomists routinely deride China’s economy for a perceived lack of consumption as a percentage of overall GDP, for flooding the world with exports kept cheap by an unfairly low RMB and a concurrent level of savings that is untenable. Recent evidence indicates that all of these claims are suspect, that Chinese consumers may be spending more, and saving less, than widely believed.
Economists broadly agree that increased consumption in China, especially if it’s broad-based, is good for China and the global economy. The September 2009 issue of the China Retail Quarterly suggests not only that consumption is strengthening, but that consumers outside the marquee cities (Beijing, Shanghai, Guangzhou) are leading the charge. It says: ‘The masses of rural China are the main source of domestic retail growth at present. First half 2009 urban retail sales grew 13.7 percent YOY, whereas rural sales grew by 37.6 percent. The rural appliance rebate scheme and rural chain store network promotion campaign are working, and rural spending is beginning to rise in significance. Why the optimism? There is the continued investment in rural China [in part down to the stimulus measures], driving strong rural sales, for one.’
In a January forum hosted by the Shanghai Foreign Correspondents’ Club, Shaun Rein, head of China Market Research, derided what he calls the ‘myth’ of China as an export-based economy. In the same week, in an article titled ‘Fear of the Dragon,’ The Economist published statistics showing that exports had dropped from 36 percent to 24 percent of GDP in 2 years, that imports have increased by 27 percent in 2009 and that exports from the United States to China increased 13 percent through the past year to November. It added, ‘In other words, rather than being a drain on global demand, China helped pull the world economy along during the course of last year.’
To Save or Not to Save?
These statistics suggest that, both in stores and at the customs desks, consumption in China is increasing. But if the savings rate is so high, where is the money to pay for rising consumption coming from? There are at least three reasons why China’s savings rate may be over-reported. Take, for example, a woman we’ll call Penny, who is in her mid-30s and lives in one of China’s second-tier cities. Penny has an MBA from a well-known foreign university, and a strong career in finance. Her official income is less than US$25,000 per year. The actual value of her compensation totals three times that much, when her housing subsidy, the car she drives and other benefits are included. These benefits are legitimately deducted as a business expense by her employer and Chinese tax law doesn’t require Penny to pay tax on them. So Penny has real income far beyond what official statistics report. The practice of shifting compensation away from salary to non-taxable benefits is, naturally, widespread. Penny is joined by tens of millions of her upper income fellow citizens who are similarly compensated.
In addition to official income levels being lower than actual income (and thereby driving down the actual savings rate as a percentage of this higher income), savings rates vary by age group. While China’s aggregate savings rate is often said to be around 50 percent, a mid-2009 survey conducted by China Market Research concluded that the savings rate of 24 to 32 year old Chinese was virtually zero, and that 25 percent of them were carrying balances on their credit cards. It’s their parents who are doing all the saving-the young have no memory of the Cultural Revolution, or indeed anything other than a booming economy. The same survey revealed an ‘optimism’ rate of 85 percent in the provinces, among the highest demographically and in line with the rural consumption figures cited by China Retail Quarterly and others. The young join the provincial dwellers as among the most optimistic, and so more likely to spend.
Finally, hundreds of billions of US dollars of China’s aggregate savings aren’t individual savings, but government diversion of wealth, a by-product of keeping the currency under control. As James Fallows wrote in The Atlantic in January 2008, ‘Much of China’s national income is ‘saved’ almost invisibly and kept in the form of foreign assets.’ So while the official savings rate may be relatively high, the relevant savings rate (of individuals in the ‘consuming’ age groups and areas) is not. And China’s relatively quick recovery from the financial crisis, a recovery driven in part by the stimulus measures, has bolstered the confidence of the young and the provincial even further.
Policies resulting from the 2009 Economic Work Conference, which ended on December 7, suggest that Beijing sees a strong recovery, and will now take steps to manage it. The conference added ‘managing inflation expectations’ to their list of economic objectives, while maintaining a focus on appropriate housing (more for low-income households) and consumption promotion.
China’s most serious challenges are widely reported, most notably the environment, the transition to a truly globalized market economy, and political reform. Managing them will require focused governance and the right tools. With foreign reserves of more than US$1 trillion, an economy that’s leading the world in growth and a population that’s steadily becoming wealthier, Beijing should at least have the economic foundation it needs to craft and apply those tools. Whether the mandarins are successful in doing so remains to be seen, but their collective performance to date is part of the reason why the citizens are relatively optimistic, and increasingly willing to vote with their wallets.