A tale of two (China vs US) stimuli

It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness … we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way. – Charles Dickens, A Tale of Two Cities

Economists, like Dickens, can’t figure out if the world is headed for economic renewal or if the global economy is “going directly the other way” in a hand-basket.

Exhibit A is the great Chinese stimulus of 2008-09, a US$586 billion shot of infrastructure spending that, as a percentage of gross domestic product, dwarfed the US effort by a factor of four. The example of China has acquired heightened relevance as the global economy falters once again and a fierce, and fiercely ideological, battle has broken out over the need for further stimulus in the Western economies and inside China.

The Chinese stimulus is credited with saving the world from a global recession. The US stimulus for the same period is unanimously dismissed as a damp squib. To the American right, stimulus doesn’t work; to the left, the reason for America’s prolonged woes is not enough stimulus, thanks to President Barack Obama’s excessively cautious and conciliatory approach to governing during his first months in office. Its cure: more stimulus. (On Thursday this week, Federal Reserve chairman Ben Bernanke did his bit, announcing that the Fed will make open-ended purchases of $40 billion of mortgage debt a month and hold the federal funds rate near zero “at least through mid-2015”.)

Even so, the Chinese stimulus gets little love from Western economists, many of whom deride it as little more than a wasteful, inflationary, bubble-fueling misallocation of resources on a heroic scale. Doubts about the stimulus cast a grim shadow over the world and the Chinese economy. Economic growth is faltering and the only nostrum with a near-term prospect of success, both in China and in the West, “more stimulus”, is viewed with suspicion.

For anti-Keynesian economists in the West, bad-mouthing the 2008 Chinese stimulus is a matter of faith, ideology, and politics. Western governments are locked in a debate as to whether they should increase taxes or sell more debt now to fund further stimulus of their economies, or whether austerity, with its immediate and concrete benefits to the well-to-do and theoretical long-term benefits to the human race, should prevail.

The opponents of stimulus point to the Chinese experience as evidence of the catastrophic consequences of government spending. Keynesian economists, who apparently recoil at the concept of a successful economic initiative growing out of China’s manifestly corrupt, neo-mercantilist state capitalist regime, apparently find the 2008 Chinese stimulus difficult to defend.

Gordon Chang, who, like Minxin Pei, has a very well-aged bottle of champagne ready to uncork when the Chinese economy finally collapses, tried to taunt Nobel economics laureate and newspaper columnist Paul Krugman into defending stimulus in an article for Forbes titled “Hey, Krugman, ask China if the stimulus is a good deal”. [1]

Krugman, among the most vociferous advocates of additional stimulus in the United States, has primly declined to defend the Chinese stimulus. In a December 2011 column, he wrote:

I’ve been reluctant to weigh in on the Chinese situation, in part because it’s so hard to know what’s really happening. All economic statistics are best seen as a peculiarly boring form of science fiction, but China’s numbers are more fictional than most. I’d turn to real China experts for guidance, but no two experts seem to be telling the same story. [2]

Fortunately, Chinese China experts seem to have a relatively clear and circumstantial understanding of what happened with the stimulus. That understanding appears to be fundamentally Keynesian. Some major stimulus was necessary. However, there are profound doubts concerning the wisdom of the stimulus in conception, execution, and the handling of its messy aftermath.

Bad news, great and small, has served to concentrate attention on the shortcomings of the Chinese stimulus. The recent collapse of a Harbin bridge segment – built on a rush schedule as part of the stimulus package – serves as a symbol of out-of-control spending and shoddy results. On the macro scale, Chen Zhilong, an economic journalist of reformist views, provided an indictment of Chinese stimulus policies on his blog:

A province might have seven or eight airports, but 80% can continue to exist only through government subsidies. In the central region, eight out of 10 or so high-speed rail lines aren’t making money; in coastal areas without resources or markets, “poor counties also want to build big ports”, and are dredging deepwater berths, but there isn’t a single money-marking berth, leaving a pile of debts for posterity. This brings with it financial difficulty, low investment efficiency [and] bad bank debt, [and] exacerbates overcapacity and encourages corruption.

For an extended period, almost all increased investment has been concentrated in industries with overcapacity. In 2008, iron and steel annual capacity had already reached 500 million tonnes. There was a chance to restructure the industry but instead in 2009 there was a burst of additional capacity, the nationwide capacity of big iron and steel facilities increased to 700 million tonnes, a situation of severe overcapacity and wide-scale losses. At the beginning of this year, Zhanjiang [in Guangdong province] received approval for another large-scale iron and steel project. Cement manufacturing capacity is over 300 million tonnes. Utilization of aluminum-smelting capacity is only 65%; the photovoltaic industry has become a black hole for money. [3]

Massive over-investment on the industrial and civil-works side translates into dismal if not negative returns on investment. From a Keynesian perspective, that’s not a mortal sin. Even under the most favorable circumstances, it may take decades for large civil-works projects to justify their investment.

Stimulus spending is not supposed to be the implementation of targeted government investment aka industrial policy, or what conservatives would characterize as stealth socialism. It is merely an emergency measure to sustain demand temporarily while the private sector gets out of its funk, banks resume lending, businesses start investing again and so on and so on.

However, persistent, massive over-investment in a favored sector that crowds out other investment and drags down the economy, with few effective mechanisms for restructuring and rationalization after the worst damage has been done, is bad.

An important metric for the success of a stimulus program is how quickly and effectively it can be wound down – the lumps and bumps it made in the economy smoothed out, as it were – in case another stimulus program is desired. The Chinese regime’s record in this regard is not good.

During the stimulus period, banks were encouraged to lend promiscuously, and a lot of that money showed up in real estate, inflating a bubble of world-historic proportions. The government has been gingerly attempting to pop the bubble for the past year or so, but success in bringing down prices has also brought real-estate developers to their knees. It is suspected that banks and financiers are colluding with strapped real-estate companies and one another in shadow financing vehicles that are little more than Ponzi schemes to keep non-performing real-estate loans from showing up on their books.

Local governments, which became addicted to income from real-estate development, are facing massive budget shortfalls as the market deflates. The central government has not come up with a compelling formula either to deal with these shortfalls or to force the local governments to cut back on spending and borrowing and bingeing.

The overcapacity of the manufacturing industry is almost comical in its magnitude. China, once a steel importer, now has 100 million tonnes of excess capacity and is roiling export markets and balance sheets around the world. Inside China, a Chase analyst estimates that mills and middlemen are holding 100 million tonnes in unsold inventory. Some mills took advantage of their borrowing power to swill at the stimulus trough and pour money into unproductive real-estate investments as well as unnecessary capacity. [4]

Crucially, the Chinese economy is not being given the opportunity to grow out of its problems. Lagging economic growth in the West means reduced exports, more excess capacity, more bad loans.

Trying to duplicate the 2008-09 stimulus in an environment of dodgy bank balance sheets, massive overcapacity, and continued weakness in global demand would not be an effective emergency measure; it would be a recipe for economic suicide.

The Chinese government has responded to the dire overall slackening of export and domestic growth with a modest stimulus package estimated at $157 billion, one-quarter of the magnitude of the 2008 stimulus and – ironically or, perhaps, tellingly – roughly equivalent in percentage of GDP to the underwhelming stimulus enacted by the US after President Obama’s election.

In fact, the Chinese government doesn’t even seem to want to call it “stimulus”. A September 12 commentary by Xinhua was titled “China’s economy: Less speed but no more stimulus” and stated: “A massive stimulus plan to boost the economy is not only unlikely, but would be detrimental to the country’s sustainable growth.” [5]

This op-ed can be taken as a message to foreign investors – who have been blithely optimistic that the central government will uncork the money spigot, pronto – that they should temper their expectations of a sizable, rather desperate stimulus that will pump up demand, the real-estate market and stock prices, thereby boosting their sales and valuations, at least for the time being.

Instead, the government’s policy response to the 2011 crisis is restructuring of the economy to achieve – the key buzzword – “sustainability”.

When President Hu Jintao reiterated at the Asia Pacific Economic Cooperation meeting in Vladivostok that China’s main challenges are “lack of balance, coordination and sustainability” – thereby demonstrating that the restructuring policy is not merely a hobbyhorse for reformist liberals surrounding Premier Wen Jiabao – the international investment community’s disappointment was palpable:

Hu’s standing with international investors has suffered ahead of the leadership change later this year. In a quarterly Bloomberg Global Poll published [September 7], two in five voiced pessimism about the impact of his policies on the investment climate in China. That’s up from less than one in three in May and is the highest negative reading since the poll began asking that question two years ago. [6]

The central government has also been fighting off the real-estate, materials, and local-government constituencies that have been lobbying shortsightedly for a loosening of credit and re-inflation of the property bubble to solve their problems.

For the time being at least, there is a consensus at the center that dumping massive amounts of more money into the hands of reckless bankers and desperate investors is not going to turn out well for the People’s Republic of China.

A closer examination of the precedent of the China stimulus indicates that the PRC and the US can and should draw diametrically opposite lessons from the China stimulus of 2008-09. For the PRC, with its rickety economic system, it pushed stimulus to the safety limit – and perhaps beyond. The United States, with a stimulus a fraction of China’s, didn’t go far enough. Therefore, as the economy slows, China can’t do another great stimulus.

But it looks as if the United States can.

The question is, does either nation have the political will to do what’s good for itself and the world economy?

Writing in May, before China’s economic problems were anywhere near as dire as they are now, Krugman was not optimistic about the PRC:

Some commentators say not to worry, that China has strong, smart leaders who will do whatever is necessary to cope with a downturn. Implied though not often stated is the thought that China can do what it takes because it doesn’t have to worry about democratic niceties.

To me, however, these sound like famous last words. After all, I remember very well getting similar assurances about Japan in the 1980s, where the brilliant bureaucrats at the Ministry of Finance supposedly had everything under control …

For what it’s worth, statements about economic policy from Chinese officials don’t strike me as being especially clear-headed. In particular, the way China has been lashing out at foreigners … does not sound like a mature government that knows what it’s doing.

And anecdotal evidence suggests that while China’s government may not be constrained by rule of law, it is constrained by pervasive corruption, which means that what actually happens at the local level may bear little resemblance to what is ordered in Beijing. [7]

However, it is a pretty good political bet that given the political gridlock in the United States, there isn’t going to be any significant US stimulus in the near term, even if the economy could benefit significantly. More quantitative easing – money sneaked out the back door of the Treasury building into the hands of banks that, it is hoped, will lend it for something useful – is the most viable possibility (vide the Fed’s annnouncement on Thursday).

In the PRC, on the other hand, there exists a consensus, albeit fragile and under stress, to eschew the easy choice of reckless stimulus and brace for a bumpy economic landing. Whether or not the PRC can make sustainable lemonade out of slow-growth lemons is another matter.

In the reformer’s perfect world, unproductive speculation in stocks and real estate would be replaced by market-driven investments in worthy manufacturing and service industries, ie, “sustainability”, economic growth and diversification that rely less on government intervention and more on market forces.

Reformers in China are staking their hopes on stimulating consumer demand and mobilizing private capital to restructure the economy both to generate growth and direct it into more rational and profitable sectors. One initiative is to try to pry open investment opportunities in profitable state-dominated sectors such as telecommunications to make the corporations more responsive to markets and investors than to bureaucrats and their bespoke bankers. [8]

Some of the proposals appear somewhat quixotic, albeit echoing some progressive lines of thinking in the United States.

Chen Zhilong, the Chinese economic journalist quoted above, proposed that any stimulus be distributed as grants to individual families. He argued that consumers could exercise “economic democracy” and vote for the best products, thereby compensating for the distorted and corrupt investment choices that the government has been making.

Chen asserted that giving 3,000 yuan (US$474) to a family of three would generate 15,000 yuan in internal demand. One trillion yuan distributed nationwide – roughly equivalent to the current “stimulus”
 would create 5 trillion yuan in demand. And the stimulus would get a head start of 20% – the losses suffered by government investments out of the gate thanks to corruption and inefficiency.

His proposal echoes calls on the left wing of the Democratic Party in the US for the Federal Reserve chairman Ben to reinvent himself as “Helicopter Ben” and indiscriminately shower money (as if from a helicopter) on consumers, instead of propping up money-center banks with preferential access to liquidity.

We are unlikely to see a money rain on China. And it is very likely that hopes and dreams of significant reform will fall victim to inertia, corruption, and the grim bonfire of bankruptcies, strikes, public anger, and unrest fueled by economic decline. And the central government will just take the easy way out: opening its pocketbook to underwrite the failures of the big banks and the state-owned enterprises once again.

However, if the Chinese leadership can weather the unfolding crisis without recapitulating the errors of the first stimulus, and incrementally weakening instead of further entrenching the forces arrayed against economic restructuring, then 2012-13 might be remembered as something other than “the worst of times”.

Notes

1. Hey, Krugman, ask China if stimulus is a good idea, Forbes, May 20, 2012.

2. Will China break?, The New York Times, Dec 18, 2012.

3. Click Here for his weibo (mini-blog).

4. China stimulus won’t work this time, says Citigroup, The Wall Street Journal, Sep 12, 2012.

5. China’s economy: Less speed, but no more stimulus, Xinhua, Sep 12, 2012.

6. Click Here to read more.

7. Will China break?, The New York Times, Dec 18, 2012.

8. China may allow more private investment in state-owned companies, Los Angeles Times, May 28, 2012.

Peter Lee writes on East and South Asian affairs and their intersection with US foreign policy.

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