China’s Stimulus Will Work
Global markets have cheered the stimulus plan Beijing announced Sunday, and with good reason. At $586 billion, it’s ambitious. And although it might take some time to take effect, it could help usher in important changes in China’s economy. If China is going to “rescue the world” from economic crisis, this kind of stimulus package is the way to do it.
Some have advocated a rescue of a different sort, calling for China to use its foreign reserves to bail out the U.S. financial system. But that is not the ticket to global recovery. The bulk of China’s official reserves are held in low-risk U.S. dollar assets and that is where prudence dictates they should remain.
Rather than buying more assets, China could better pump up the world economy by buying more goods. The reason China’s reserves are so large in the first place is that the country exports a lot more than it imports. In 2007, China’s trade surplus accounted for nearly 2% of world GDP. China’s industrial development has been driven by U.S. consumer demand while U.S. consumption has in turn been fueled by Chinese lending that kept interest rates low and asset values rising. But this symbiosis has fallen apart as the U.S. economy has softened and Chinese consumers are failing to fill the gap.
To reinvigorate its economy, China must rely on homegrown consumption. China’s national saving rate in 2007 reached a phenomenal 51.2% of GDP, up 13.5 percentage points from the 37.7% rate of 2000. In counterpoint to this rising saving rate, the investment rate flattened out at around 43% of GDP from 2004 onward. The resulting excess of saving over investment finds its counterpart in a trade surplus as export revenues not spent on imports are absorbed as a savings outflow.
The main driver of the increase in the saving rate has been a very high rate of GDP growth. A rapid increase in saving rates is common among developing countries in their growth take-offs. But growth is not the only factor influencing saving, and even with growth sustained at a goodly pace there are many avenues for government policy to alter the saving versus consumption choice.
The stimulus plan just announced by Beijing contains a mix of consumption- and investment-boosting elements. With investment spending already extremely high by any standard, elevating this source of demand does not hold much promise for sustaining growth. More railroad construction will not help to rebalance the Chinese economy. But other elements of the plan appear well conceived to stimulate consumption either directly or indirectly. Even where the immediate fiscal outlays are of an investment nature, if the spending feeds quickly into income growth or productivity gains, consumption can be promoted. This is true, for example, for such elements of the package as rural water conservancy and electrification and reconstruction in earthquake devastated areas.
The real potential for fiscal spending to have an impact on consumption, though, is through social spending. One element of the policy package focuses on health and education spending; another captures social security, pensions and income support. Spending in these areas not only supports public consumption directly, it stimulates private consumption as well by relieving households of the need to save to finance retirement or self-insure against mishap.
Strengthening the social welfare system has been an avowed goal of the current administration since it came to power six years ago. Yet budgetary allocations to social welfare purposes remain woefully low. Understandably, health and education are not as easy to throw money at as a railroad, especially in a country that is largely rural and poor. Funds have to be disbursed at the local level, and much capacity development must take place before this can be done effectively. The last six years have seen important progress in the way social spending is administered. Responsibility for service delivery has been shifted from the village and township levels upward to the counties where personnel are better trained and monitoring systems are more readily implemented.
Across the country, experiments in fashioning health-care delivery systems have gone forward. As of 2007, Rural Cooperative Medical Schemes were established in 86% of rural counties. While these have not been ambitious in terms of the dollar amounts — the level of coverage is typically under $10 per person per year — they’ve contributed importantly to administrative capacity building. The upshot is that with an institutional framework in place but with funding as yet only nominal, there is both need and opportunity to ramp up fiscal flows. Similar situations exist with regard to education and social insurance programs.
The Chinese government has the fiscal space to undertake a massive stimulus program. Last year the fiscal budget was in surplus, and the cumulative level of debt-to-GDP is modest. Avenues for productive spending are readily available. A redirecting of the economy toward consumption-based growth will ensure the tax base continues to expand and a healthy fiscal position is maintained.
China’s stimulus package is good news for the world at large. More Chinese consumption means more demand for foreign goods and less export competition for producers abroad. As China’s growth is driven more by absorbing domestic resources into the provision of social services not only are incomes generated, but human capital formation takes place contributing to productivity gains and income growth into the future. That means a growing consumer market to be tapped in the years ahead.
Ms. Wiemer is a visiting scholar at the University of California-Los Angeles Center for Chinese Studies.