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Yu Yongding calls on Beijing to stimulate growth via fiscal expansion, believes 6% growth achievable
The former adviser to China's central bank laments policy was influenced by supply-siders and the Maastricht criteria.
In late September, at the 30th-anniversary celebration and academic symposium of the Shanghai Development Research Foundation (SDRF), Yu Yongding, of the Chinese Academy of Social Sciences (CASS) and chairman of the academic committee of the SDRF, delivered a keynote speech titled "Some Thoughts on China's Macroeconomic Issues."
Yu was formerly president of the China Society of World Economics and director of the Institute of World Economics and Politics at CASS. He served on the Monetary Policy Committee of the People’s Bank of China from 2004 to 2006.
He believes that the Chinese government should quickly dispel various concerns, stimulate economic growth through expansionary fiscal and monetary policies and that China has ample policy space to stabilize economic growth and address the issues of sudden financial collapse faced by real estate companies and the debt issues of local governments. The following are the main points of his speech:
Different Macroeconomic Policies and Economic Performance between China and the U.S. after the Global Financial Crisis
After the global financial crisis, the U.S. macroeconomic policy was primarily characterized by Quantitative Easing (QE) combined with zero interest rates. This policy was widely criticized at one point, but the actual outcome was that the U.S. experienced the longest period of positive economic growth since 1850, lasting 120 months.
As for our policy, the official documents describe it as a proactive fiscal policy paired with a prudent monetary policy. Over the past 10 years, China's economic growth rate has continued to decline, dropping from 12.2% in the first quarter of 2010 (due to the base effect) to 6% in the fourth quarter of 2019. During the pandemic, the average growth rate was 4.67%. The first quarter of this year was decent, but the second quarter did not perform well, failing to achieve higher economic growth despite a low base. Since 2012, the basic situation in China has been characterized on the one hand by a very low Consumer Price Index (CPI) growth rate (around 2%), and negative growth in the Producer Price Index (PPI). On the other hand, there's a consistent decline in the GDP growth rate.
Reflections on China's Past Macroeconomic Policies
Since the outbreak of the global financial crisis in 2008, the Chinese government's macroeconomic policies and control have achieved significant results. However, in hindsight, I feel that there are areas that can be improved.
Firstly, there was an inability to accurately distinguish the different natures of "overcapacity". One type of overcapacity is structural, where companies invest blindly, resulting in industry-wide overcapacity. However, in some situations, overcapacity arises because of excessive contraction [of fiscal spending]. In 2008, our fiscal deficit was 2.8%, which was reduced to 1.1% by 2011. In 2009, our new credit increased by 9.6 trillion RMB($1.44 trillion USD), which was indeed too high. The following year, it was reduced to 7.9 trillion ($1.185 trillion USD) and 7.5 trillion ($1.125 trillion USD) the year after. From a significant expansion, there was a sudden shift, leading to overcapacity. For different types of overcapacities, the policy response should be different. Structural overcapacity should be left to the market and can be resolved through the price mechanism. Overcapacity resulting from excessive policy contraction should be resolved by adjusting the overall demand through macroeconomic policies.
Secondly, the goal of stabilizing housing prices interferes with macroeconomic policies aimed at maintaining growth. If we consider real estate prices as a regulatory target, then the cumulative effects of monetary policies and some price restrictions, loan restrictions, and purchase restriction policies will exert a downward shock on the economy. The international economic community is divided on whether asset prices should be included in macroeconomic policies and serve as one of the central bank's monetary policy targets. The more consensus view is that financial stability relies on macro-prudential policies. I am skeptical of making stable asset prices or preventing asset bubbles a final goal of monetary policy. The asset price cycle may not be in sync with the macroeconomic cycle; a period with rising asset prices could also be a period with economic decline. The goal of controlling asset prices might conflict with the goal of stabilizing economic growth. The fluctuations in China's real estate prices have caused significant disruption to China's macroeconomic policies. Further reflection is needed on how to address this issue.
It should be pointed out that, on the one hand, it is hard to determine whether there is a severe real estate bubble in China (it undoubtedly exists in some areas). On the other hand, compared to other countries, China's real estate investment as a proportion of GDP is too high, presenting a resource allocation issue. In the long run, the Chinese government should guide funds more towards high-end manufacturing and technology services. There are also significant structural issues with real estate investment itself. Developers should be encouraged to build more affordable housing to serve urbanization.
Thirdly, there's an excessive emphasis on fiscal balance. In 2013, the economy was under "downward pressure," but the government insisted on not expanding the fiscal deficit. In 2017, the GDP growth rate "broke 7" (6.9%), and although the "economic downward pressure continued to increase," the fiscal deficit rate was reduced by 0.4 percentage points in 2018. Due to strict control of local government debt, infrastructure investment plummeted, with a growth rate of only 1.79% for the entire year of 2018.
China highly values the provisions of the Maastricht Treaty that the fiscal deficit to GDP ratio should not exceed 3%, and the national debt to GDP ratio should not exceed 60%. In reality, these stipulations have no theoretical basis and were merely proposed to limit Southern European countries from excessive spending. Western countries have long abandoned these two standards.
Fourthly, fiscal policy places too much emphasis on tax reductions and fee cuts. The stimulative effect of fiscal policy on the economy mainly comes from increased expenditure rather than tax cuts. This suggests that our fiscal policy might be unconsciously influenced by the supply-side economics. The propositions of this school have not been accepted by any mainstream economists, but they are quite popular in China. While tax cuts do stimulate economic growth, the focus of short-term expansionary fiscal policy should be on increasing fiscal expenditure rather than tax reductions.
Fifthly, the government's public budget provides too little support for infrastructure investment. During the 4 trillion RMB (600 billion USD) stimulus [in the aftermath of the 2008 credit crunch], the government contributed 1.18 trillion (177 billion USD), and the rest was sourced by local governments by various means. Later, the central general budget's support for infrastructure investment became less and less, only around 0.1% in 2021. Under such circumstances, it is inevitable for local governments to fall into a debt predicament (of course, local governments have their own issues). The central government should bear more responsibility for infrastructure investment. This means that the central government should issue more national bonds. If we can establish a large and highly liquid national bond market, the level and ability of China's macroeconomic policies will see a significant enhancement.
Sixthly, there's an excessive emphasis on leaving leeway for maneuver and preserving policy space. In 2011, the actual GDP growth rate was 9.1%, yet the growth target for 2012's GDP was set at 7.5%. It's perplexing why, when the previous year's growth was 9.1% and the inflation rate had already fallen to 3%, the economic growth target was reduced. This trend continued for many years after, always setting the target a few basis points lower. The purported reason for this was to "guide all parties to focus on accelerating the transformation of the economic development mode and genuinely improving the quality and efficiency of economic development." Whether reducing economic growth speed benefits achieving the aforementioned objectives remains uncertain.
Conclusion and Recommendations
We should promptly dispel various concerns and stimulate economic growth through expansionary fiscal policies. China possesses ample policy space to stabilize economic growth and address the issues of sudden financial collapse faced by real estate companies and the debt issues of local governments. In resolving the crises of real estate companies, there are numerous precedents worldwide. Apart from bankruptcy restructuring, the potential solutions that we can consider include firstly, employing various measures to prevent further decline in the asset prices of these companies; secondly, providing these companies with adequate liquidity so they don't default or go bankrupt due to liquidity issues; and thirdly, implementing temporary nationalization.
Regarding local government debt, debt restructuring, and bond swaps are among the available solutions. The crux lies in whether we possess sufficient policy space. Unlike Western countries such as the United States, we currently don't face the dilemma of choosing between inflation and economic growth. Our concern is the continuous decline in the GDP growth rate and the fear of deflation. Such circumstances suggest that we have ample fiscal and monetary policy space, which, if fully utilized, can completely resolve our present issues. I believe that China can maintain a relatively high economic growth rate of 6% for several years; it's at least worth trying. If we allow the growth rate to keep declining, due to the so-called "hysteresis effect" in economics, the cumulative effects of factors like population aging, or due to external shocks leading to a rise in the inflation rate, the window of opportunity will close permanently.
Lastly, I'd like to emphasize that implementing expansionary fiscal and monetary policies is merely one of the necessary conditions to maintain stable and relatively high economic growth - it is not sufficient. Reforms and structural adjustments are also essential, but that's a separate issue that won't be discussed further here.
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