PKU National Development dean on Chinese economy

YAO Yang second-guesses supply-side incentives, calls for consumption stimulation

On March 15, 2022, the National School of Development (NSD) of Peking University held the 60th China Economic Observation (CEO). The Dean of NSD, Professor YAO Yang, gave a speech, on which the article is based - a translation of 《姚洋：振兴消费仍然是中国经济的重大挑战》Yao Yang: Vitalizing Consumption Remains Major Challenge to Chinese Economy on the web of the NSD, originally published on March 23, 2022.

YAO is a professor at the China Center for Economic Research (CCER) and NSD, Peking University. He currently serves as the director of CCER and the dean of NSD.

YAO has a Ph.D. in development economics from the department of agricultural and applied economics at the University of Wisconsin–Madison in 1996.

YAO was awarded the 2008 and 2014 Sun Yefang Award in Economic Science, considered the top economics award in the People’s Republic of China.

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Three Highlights of the Government Work Report

In this year’s government work report [ENG], I noted many new highlights rarely seen in previous years.

The first highlight is that the strength of monetary and fiscal policies to stabilize growth is remarkable. “Stabilize economic growth” was the main goal prioritized in last year's Central Economic Work Conference [Pekingnology], and was clearly underlined in this year's government work report given by Premier LI Keqiang.

To be specific, monetary and fiscal policies are both very strong. In terms of monetary policy, the People's Bank of China expanded its balance sheet by more than 740 billion yuan in the first quarter this year, exceeding the whole of last year.

Fiscal policy is even stronger. The special-purpose bonds to boost local governments’ investment this year will total 3.65 trillion yuan, on top of which 2.5 trillion yuan in tax relief has been proposed. This is a particularly large figure. Compared to the country's annual general fiscal revenue of about 20 trillion yuan, 2.5 trillion yuan is more than 10%, indicating the central government's great determination and exceptional efforts [Pekingnology] to protect market entities.

The second highlight lies in the updated statement on the “dual carbon” path [China will strive to peak carbon dioxide emissions before 2030 and achieve carbon neutrality before 2060]. In this year's policy objectives, the “dual carbon goal needs to be practical and feasible” is clearly proposed.

My personal understanding is that this is a necessary and timely adjustment to the campaign-style emission reduction during the implementation of the “dual carbon” goal in some places over the past few years.

PKU NSD develops a large report every year, and the theme for this year's is China's “dual carbon” path. In this report, we assess China's achievement of the “dual carbon” goal. It turns out that, according to the 14th Five-Year Plan [Georgetown CSET original translation], even if we steadily reduce carbon emissions, we can still achieve the "carbon peak" target before 2030. Given an assumed [nominal] economic growth rate of 5.5% (the growth rate in real terms may not actually achieve that) in the future, coal currently accounts for 60% of energy consumption and 80% of total carbon emissions in China.

According to the 14th Five-Year Plan, our energy efficiency should be improved by 3% per year, and the proportion of coal in total energy consumption should be reduced by 10%, translating into a 1.65% decrease in carbon emissions per year. 1.65% plus 3% equals 4.65%, the percentage points by which carbon emissions can be reduced.

In addition, there is potential for upgrading emission technologies so that carbon emissions can be reduced to an even lower level. If emissions efficiency increases by another 0.8%-0.9% annually, then basically the carbon emissions generated by 5.5% economic growth can be offset.

The new expressions [Shuang Tan] with regard to “dual carbon” in the government work report this year also indicated the future for the coal industry. The General Secretary, when attending the deliberation of the Inner Mongolia delegation during Two Sessions, said [Pekingnology] that China is still a country with coal as the "mainstay" of the energy mix.

Coal makes up the lion’s share of the nation's total energy consumption. Even if coal consumption can be reduced by 10% during the 14th Five-Year Plan period [2021-2025] and by 12.5% during the 15th Five-Year Plan period [2026-2030], its proportion will remain as high as 50% and 37% respectively. This means that by 2030, coal will still maintain a relatively high proportion of China's energy mix.

Then how to utilize coal in an efficient manner? I think clean coal technologies such as coal-to-gas and coal-to-oil are essential. These technologies, which now seems less cost-effective, with further investment could develop as new energy did, and their prices could go down, maybe in the same way that solar energy’s cost declined below that of thermal power.

The third highlight lies in a new expression with regards to regulation over real estate. Data show that real estate contracted in the second half of last year. Real estate has such a long industry chain that its impact goes beyond just house sales and construction. Building materials and home appliances go with real estate. If real estate contracts, the whole consumption follows down. Our economic growth deceleration last year could largely be explained by the contraction of real estate.

Premier Li, in this year's government work report, proposed developing the long-term housing rental market in real estate. But how? It seems that we used to fail in coming up with a practical solution. It’s actually not that difficult from my point of view. The government may, for example, require the developers which get a plot of land to set aside a quarter for long-term rentals. If the developers can't do that themselves, they may seek partners, and the market always takes care of the rest.

Premier Li noted in the government work report that "city-specific measures" should be adopted on the basis of ensuring that "houses are for living in, not for speculation". Now we have seen many cities start to take action [Reuters], with some cities lowering the down payment to 20%.

But in fact, I am a bit worried that the real estate industry will overheat in the second half of this year. From the outbreak of the pandemic till the end of 2021, real estate played a critical role in the economic recovery. However, the industry was severely hit by the “three red lines” [Bloomberg], issued by the central government in response to overheating. It is therefore still necessary to establish a long-term mechanism for regulation over real estate to avoid the fluctuations in policy like last year.

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The key to safeguarding growth lies in promoting consumption

What is the priority in reaching this year’s goal of growth of 5.5%? It will not be easy. According to my own measurement, the potential growth rate of China's economy is at 4.65%-6.5%, with a median of just under 5.5%. The actual growth rate for the past two years has averaged 5.2%, so it will be difficult to reach 5.5% this year. Judging from the situation in January-February, the macro policies we have adopted so far have played a big role in stabilizing growth. But will the effect be sustainable? It should be viewed with caution.

Fiscal policy

Infrastructure investment is the largest part of the government's financial support, but since 2018, the contribution of infrastructure investment to economic growth has been all the way down. Government support for infrastructure remained very strong over the past two years, but the growth rate of infrastructure is only 2-3% per year, which already translates into a small number in economic growth.

Can this year's infrastructure growth rate reach 7-8% or even 10%? I think there is the difficulty for two main reasons.

First, after more than 20 years of high-speed development of infrastructure, local governments can find fewer and fewer good projects. The central government also issued a new policy [Caixin via Nikkei] that stipulates high-speed rail can no longer be developed [as massively] as before, and many high-speed rail lines are not profitable. Local governments feel the same way about infrastructure, I'm afraid.

Second, since 2018, the central government's increasing requirement for local governments to deleverage has led to a dilemma for them.

On the one hand, the central government needs them to invest, but not enough money is given. In previous years, the total amount of infrastructure proposed by local governments is more than 30 trillion. Even if this 30 trillion can be undertaken in several years, it is probably far more than 3.65 trillion per year.

On the other hand, if local governments want to make many big projects happen, they must go to the market for financing and to take up commercial debts, which is contrary to the central government's requirements for deleveraging. Within the dilemma, the local governments' enthusiasm for investment has declined.

Even if local governments are willing to invest, we need to watch out for debt problems, especially the commercial debt of local governments. Urban investment bonds increased by more than 4 trillion yuan in 2020 and another 6-8 trillion yuan last year, showing a rapid growth rate. these commercial debts have a very short repayment period, local governments will soon face repayment problems and finally have to come back to a debt swap. This is not sustainable.

Monetary policy

The effect of monetary policy is getting worse. An important reason is that private enterprises are not benefiting from the extra money issued and lower interest rates. The People’s Bank of China, for example, issued more money to push interest rates to go down from 3.5% to 3%, from which state-owned enterprises benefit more. The interest rate for private enterprises is usually 7%-8% or higher - even above 10%. The little variation in interest rate passed on to private enterprises is thus almost negligible.

Meanwhile, private enterprises are also reluctant to take out loans amid weakened expectations and insufficient demand. We hope that by giving companies tax exemptions thus reducing financial burdens, they will be prompted to keep their operations afloat and keep their workers - through loans. However, it is not in line with how business works, since it is a unilateral attempt by the government to get enterprises to borrow money to preserve employment.

Within our current monetary policy, there is a problem with the transmission mechanism. The superficial and short-term reason is that expectations have weakened but the deeper reason is the persistent discrimination against private enterprises.

On the Supply Side

In summary, I think that we need a second thought about our supply-oriented policies in the past two years.

Over the past two years, we have seen a rapid export growth rate, with last year’s reaching over 20%, which returned to the ultra-high level in the first decade of this century. This year, the growth of export, even in the optimistic estimation, may stand at 10%-15% and contributes to GDP growth of only 1.5%-2%. Therefore, it's the domestic demand that has to be the drive behind GDP growth.

The current policy puts its focus on the supply side but now we are facing nationwide overcapacity and lagging sales. We need to know that the economy is a closed loop, and total production should equal total demand each year. If producers are encouraged to produce more when there is overcapacity, it is obviously against the principles of economics.

On the Demand Side

We have to boost domestic consumption since investment is constrained by the declining expectation on the demand side.

The general view is if you want to boost consumption, income must go up, otherwise, consumption increase is impossible. However, John Maynard Keynes taught us a hundred years ago that there is a way to boost consumption, namely to promote "autonomous consumption", that is, the part of consumption that is not dependent on income. Therefore, when the economic growth rate fails to reach the potential growth rate, demand management should be carried out to stimulate consumption. And the policy should focus on enhancing people's capacity to spend.

How? Induced consumption, driven by income growth, couldn’t cut it. I insist on what I have been calling for these two years - giving the people cash to promote consumption. For instance, from the 3.65 trillion dollars of special bonds to promote local investment this year, we can take one third to stimulate consumption, giving each person in the country about 1,000 yuan on average, in the form of electronic money for everyone to use within a limited period of time [the money expires if people don't spend it in that period]. If the multiplier is 3 or 5, about 1,000 yuan per person translates to 4.5 trillion to 6 trillion dollars of consumption, which is significant.

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COVID-19 prevention and control must be both precise and open

In addition, our epidemic prevention and control should be "both precise and open". We are now in the fourth wave of the global epidemic, and given the severity of the current epidemic in Hong Kong, it is necessary for us to continue to implement strict prevention and control measures.

But once this wave is suppressed, we should try to avoid controlling the epidemic in the future by locking down communities and restricting inter-city travel, because domestic consumption and travel are inseparable, and once the business activities in the whole society are at a standstill, economic recovery will pay a huge price.

Our technologies should enable precise epidemic prevention and control, and now there is a nucleic acid test that can produce results right away. Research and development like this should be accelerated and the scope of application can be expanded to every airport, restaurant, and hotel in the future.

There are so many smart people in China that we should be able to quickly find a “both precise and open” path for epidemic prevention and control that will allow us to fight the epidemic without significantly cutting down on consumption.

In a word, there's a lot to watch in this year's government work report, but we also face huge challenges. Promoting consumption remains a pressing priority.

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Lin (Lynn) Liu, a student pursuing a Master's degree in international journalism at Tsinghua University, contributed to the translation.

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Near-full transcript of Premier Li Keqiang's Press Conference

Liu He in November: "Macroeconomic stability is a rare resource"

Central Economic Work Conference readout & notes