Abstract: In this paper, the author argues that for any economy, intermittent pandemic shocks and the resulting negative feedback mechanism will cause huge losses, particularly to low-to-middle income groups. Thus China needs to fight an enduring economic battle against the pandemic. Such a battle needs sound institutions to implement four tasks, i.e., targeted pandemic prevention and control, loss compensation, stabilizing demand, and opening the market.
Economic operation in many regions of China still faces pressure from pandemic control, though the degree varies depending on their risk levels. Service industries such as hotels and accommodation, catering, transportation, wholesale and retail sales, sports, culture, and entertainment have been hit the hardest. These industries host the largest share of the self-employed and SMEs, they are also where most low- and medium-income workers are concentrated and where a large number of rural migrant workers are hired.
Since the outbreak of Covid-19 in 2020, Chinese migrant workers have suffered heavy losses in terms of employment and income, both of which have remained below pre-pandemic levels as of the middle of 2021. With another wave of the pandemic in July and August, it remains to be seen how great the loss would be.
The aforementioned industries bear the direct blow of the pandemic, while the pandemic also has ripple effects, first on the whole society’s consumption and investment, and then on fiscal revenue and expenditure.
Among studies on the scarring effect of the pandemic, some claim that pandemic will make people become more risk-averse and prefer saving to consumption, which is not good news for the whole economy.
Some studies hold that the pandemic has forced many companies to shut down, and even if the pandemic is gone, lots of them would not reopen - probably because they worry about a resurgence of the virus, or they don’t have enough money to reopen, or they are so frustrated that they simply walk away from their businesses.
Short-term economic loss is not a big concern, since the loss can be made up over time. The real concern is recurrent outbreaks and the frequent adoption of large-scale control measures. As the virus is constantly mutating, it will continue to spread around the world for a long time. Since it is impossible for China to completely isolate itself, it has to face enduring shocks from intermittent pandemic outbreaks.
Under the intermittent pandemic shocks, economic losses would add together to make a sum greater than its parts. Most self-employed individuals and SMEs might be able to weather the first round of shock but could not survive multiple ones. Consumption willingness and investment confidence will also dampen, forming a negative feedback loop that will amplify the impact of the pandemic on the economy.
For any economy, intermittent pandemic shocks and the resulting negative feedback mechanism will cause huge losses, particularly to low-to-middle income groups. Thus we need to be prepared to engage in an enduring economic battle against the pandemic. Such a battle needs better systems to implement four tasks, i.e., targeted pandemic prevention and control, loss compensation, stabilizing demand, and opening the market.
I. TARGETED PANDEMIC PREVENTION AND CONTROL
The precondition for the normalization of economic activities is to prevent the large-scale spread of the virus. Meanwhile, we should avoid overreaction and public panic so as to minimize damage to the economy.
The solution is targeted prevention and control.
Targeted prevention and control needs scientific methods and effective management. With more than a year of pandemic control, we need to draw lessons from experience, particularly successful experience from regions that have done well in this respect, and set up an effective pandemic control system and toolkit. Local governments can tailor this system to their own conditions based on medical experts’ advice.
Covid-19 pandemic not only brings the virus but also provokes all kinds of anxiety and extreme sentiment. We should rely on expert opinions and scientific knowledge when designing pandemic policies, and avoid being swayed by emotions in decision-making. Only when we give professional knowledge the leading role in policymaking, can we realize targeted prevention and control.
II. LOSS COMPENSATION
For companies and self-employed individuals who have suffered heavy losses from the pandemic, institutional measures to compensate for damage should be adopted and conveyed in advance to stabilize businesses’ expectations. The goal is to assure companies that the government will cover at least some of their losses incurred due to compliance with pandemic control measures to prevent them from going bankrupt.
Compensatory measures should have multiple dimensions, including but not limited to employment subsidies, rent subsidies, tax and fee reductions, interest-free loans, and payment deferral within a specific period.
Because of these subsidies, the government will have to increase spending. But these additional expenditures will reduce bankruptcies and unemployment, lower GDP loss, stabilize expectations and ensure social stability. This is where government spending is needed most and where it matters most. Since pandemic control in every region will influence the whole nation, fiscal expenditure on pandemic control should be coordinated by the central government and included in central government expenditure.
There is no need to worry that such an increase in fiscal expenditures will strain public finance. Pandemic-related expenditure will save companies and jobs that can generate revenues, which will, in turn, save GDP and sources of tax revenue. Without such spending, GDP and tax sources will suffer great losses, which might put more pressure on public finance.
During the pandemic control period, it is natural that the fiscal gap would widen and the government would issue more bonds. The fact that Chinese government bonds are highly attractive in domestic and international markets as an undoubtedly risk-free asset is a vote of confidence from global investors in China’s public finance.
III. STABILIZING DEMAND
Stabilizing demand means stabilizing the purchasing power of the whole society. Only with a steady and continuous growth of purchasing power can companies operate in a sound environment. This is the prerequisite for preventing the economy from being trapped in a vicious cycle and for returning the economy to normalcy.
China’s experience over the past year shows that when pandemic control was tightened, economic activities were constrained, dragging supply and demand into stagnation. As the pandemic gradually receded, supply recovered pretty well whereas demand, especially consumption, struggled to bounce back. Insufficient domestic demand has become the most prominent challenge facing post-pandemic recovery.
To sustain a reasonable growth of demand, we need to set clear goals and adopt strong policies. Two types of indicators are the key to assess whether aggregate demand is in an appropriate range. The first type reflects the general price level of most goods and services. Within this category, core CPI is a more suitable measure than CPI or PPI as it is highly correlated with business performance, prosperity index and employment, whereas CPI and PPI tend to be influenced by cyclical factors of specific goods and external factors and sometimes fail to reflect the real aggregate demand. The second type reflects employment, which should include unemployment rate as well as labor force participation rate and wage growth.
From the standpoint of policy design, macroeconomic policymakers should set clear targets for core CPI and employment, which can help guide market expectations towards the right direction of economic adjustment. In this way, policy and market could aim for the same direction instead of conflicting with each other.
Policy tools to sustain the growth of aggregate demand include monetary policy, budgetary fiscal spending, and off-budget debt financing as well as spending activities led by (local) government. When the demand is weak, monetary policy and budgetary fiscal spending should be proactive to create greater synergy.
From January to June of 2021, cumulative growth of public expenditure reached 4.5%, far below the pre-pandemic level. The risk associated with implicit local government debt is being resolved since its growth has been strictly controlled and the credit spread in local SOE financing has increased significantly. From the perspective of policy combination for stabilizing aggregate demand, growth of government expenditure has stayed at low levels and is unlikely to boost demand. Even if budgetary spending and issuance of special bonds are stepped up in the second half of the year, it is still not enough to stabilize demand. Hence, monetary policy needs to play a more active role in lowering the interest rate to maintain a reasonable growth of aggregate demand.
Now is a favorable time to adopt proactive monetary policy. Currently the Fed’s policy stays extremely loose and will gradually tighten in the future. Before the Fed tightens its monetary policy, adopting a proactive monetary policy in China will not face much pressure of capital outflow and RMB depreciation. On the contrary, such a policy move will help iron out excessive short-term capital inflow and ease the pressure on RMB to appreciate. Once the Fed begins to tighten its policy, adopting proactive monetary policy in China will face greater pressure of capital outflow and RMB depreciation, which means the effect of such policy will be limited.
A proper policy combination for stabilizing demand is active use of monetary policy in the short term and more reliance on fiscal policy after the Fed raises expectations for rate hikes in the next two years.
To stabilize demand, the financial market also needs to remain stable. The pandemic has caused a drop in cash flows for many companies and dragged many to insolvency, thus pushing up the non-performing loan ratio and the bond risk premium. When only a few enterprises and financial institutions meet such problems, the whole financial market will not be harmed too much. However, we need to prevent such liquidity crisis from spreading to stop the diffussion of financial risk.
IV. OPENING THE MARKET
The purpose of opening the market is to create new opportunities for investment and employment. Currently, China is going through a rapid consumption upgrade on the demand side and a shift from capital-driven to knowledge-driven growth on the supply side. During this transition, many weaknesses of the economy need to be addressed. We need to reduce the market entry barriers, create a level playing ground for market participants and allow companies to grow through trials and errors.
China has largely achieved market opening and fair competition in its manufacturing sector over the past several decades and is now moving from a manufacturing giant to a manufacturing powerhouse. In comparison, the service sector has much room to improve in terms of market opening, especially in industries like education, medical care, scientific research, financial services, social security, public administration and services, etc.
Some of these industries can be led by the government, some by the market, and some by both. For sectors led by the government, a sound accountability mechanism is needed to allow the consumers to evaluate the service; for sectors led by the market, fair competition is needed to choose the winners and losers. The government needs to fully exploit the potential of the market in improving the supply of services and give the market more opportunities.
The article first appeared in Chinese on CF40’s WeChat blog on August 25, 2021. The views expressed herewith are the author’s own and do not represent those of CF40 or other organizations. The English version has not been reviewed by the author.
