Sometime very soon China must make major efforts to stimulate its economy. That may seem to contradict concerns about inflation and excessive money-supply growth, but the situation is complicated.
China’s rising money supply can be blamed on inflows that have swelled the foreign exchange reserves and raised prices of imported commodities, notably energy. Simultaneously, its manufactured export boom has been continuing, albeit at a gradually moderating pace.
So why stimulate? It boils down to the proposition that Beijing needs to encourage domestic consumption so that the country can continue to grow at around 8% almost regardless of what happens in the rest of the world.
China’s problem is that it has come to believe that export growth is the most visible sign of a dynamic economy. This has been the case for the past decade, which has been unusually favorable for export-led growth, but the next decade will most likely not be.
The prescription
New circumstances demand new policies and perceptions. These include the following:
It should be recognized now that exchange rate appreciation can add more to domestic demand than it detracts from export demand. Simply put, it increases the buying power of Chinese people at the expense of foreigners who buy Chinese-made goods. Although export growth has led the economy in the past, the developed-world buyers of Chinese goods are no longer in a position to buy more.
Exchange rate appreciation increases the returns to Chinese workers at the expense of manufacturers and (most importantly) the foreign buyers whose markups are very large in relation to labor costs in China. The losers will be more the foreign buyers and factory owners, less so the workers.
Domestically, China is suffering from excessive fixed-asset investment in areas that do not correspond to consumer demand. This is keeping consumer spending at an absurdly low 36% of GDP. These investment excesses have been partly the result of money inflows leading to excess lending, but also to a belief that investment is “good” and consumption “bad.” That most liberal of all economists, Adam Smith, had the common sense view that investment was pointless unless it was the way to increase consumption.
Raise interest rates. Strongly negative real interest rates have hurt household incomes and encouraged unproductive investment. Higher rates would hurt overblown real estate but help incomes and consumption.
The government can take a lead in pushing up wages, especially for the lower income groups that have a higher propensity to spend.
Increase government spending on economic infrastructure outside the favored coastal regions, and on health and education. The former will increase demand in the interior, the latter will reduce the pressure on households to save against a rainy day. The government deficit and debt-to-GDP ratio are both low; revenues have been buoyant and there is plenty of room for increased spending.
The benefits
If China implements the above agenda it will earn the rest of the world’s thanks by acting as a growth engine when most other regions are unable to do so. It will also encourage other Asian economies, which have the capacity to allow more growth, but are hesitant because they fear being dragged down by a major US slump.
Indeed, China should actually welcome the gradual elimination of its trade surplus in the knowledge that this will itself be a boost to world trade and do more for the welfare of Chinese people than hanging on to US bonds paying negative real interest.
Unfortunately, there is a mindset in China, as elsewhere, that endless trade surpluses and rising foreign exchange reserves are an indication of national strength. To some degree that is true – and those who remember the 1997-1998 Asian crisis are aware of the dangers of inadequate reserves.
But China has come a long way in the ensuing decade. Now is the time to focus on the new challenge of maintaining high growth when export demand becomes a drag factor, not the leader.
While there will be losers – particularly the low value-added exporters from the coastal regions – this strategy can deliver sustainable growth and reduced regional imbalances, a constant concern in Beijing but one better addressed at the macro-economic level than by micro interventions.
