Abstract: A growth rate of over 5 percent in 2022 needs to be underpinned by boosting domestic demand, as the decline of the real estate market and exports can only be offset by the expansion of domestic consumption and investment. The aim is not to pursue a growth rate of 5 percent for its own sake, but to achieve an increase in household income, corporate profits, and job opportunities as well as industrial and consumption upgrades. Macroeconomic policies should be adjusted to meet the goal.
Based on the estimated growth of 2.3% in 2020 and 8 percent in 2021, China’s average annual growth rate between 2020 and 2021 is around 5.1%, far lower than the pre-pandemic potential growth of about 6%.
Given the impact of pandemic control, a 5.1% growth rate is not easy to achieve. The main growth drivers are stronger-than-expected export expansion and robust increase of real estate investment from the beginning of the pandemic to the first half of 2021, leading to higher prices and profits for the industrial sector, especially the upstream raw material industry. Meanwhile, the recovery of consumption and the service sector has remained sluggish. This has weighed on the labor market where the increase of new jobs and salaries for migrant workers slackens and the number of SMEs and self-employed workers exiting business climbs up.
Since the second half of 2021, growth of sales and investment in the real estate sector has dropped sharply compared with a year earlier, while the high-speed export growth will become hard to sustain after the global economic recovery reached its peak. Consumption and the service sector have yet to witness a rebound, whereas real estate investment and export, the two growth drivers, are losing steam, adding to the pressure on future economic growth.
The latest Blue Book of China’s Economy (2022) released by the Chinese Academy of Social Sciences (CASS) proposed a growth target of 5% for 2022 to maintain economic vitality and stable employment. According to the bluebook, China's potential growth rate should stand at around 5.5%, and given the impact of pandemic control, the growth target can be set at 5%. This is not a high target, but if domestic demand does not pick up, realizing a 5% growth will face great challenges.
A growth rate of over 5% needs to be underpinned by boosting domestic demand. The decline of the real estate market and exports can only be offset by the expansion of domestic consumption and investment. This should be the priority of macroeconomic policy next year, not to pursue a growth rate of 5% for its own sake, but to achieve an increase in household income, corporate profits, and job opportunities as well as industrial and consumption upgrades. Macroeconomic policy should therefore be adjusted to align with the goal. Here, macroeconomic policy refers to policies related to aggregate demand management, including monetary and fiscal policy in the broad sense.
I. HIGH LEVERAGE SHOULD NOT BE A CONSTRAINT ON MACROECONOMIC POLICY. A HIGH LEVERAGE RATIO DOES NOT MEAN ZERO POLICY LEEWAY NOR HIGH FINANCIAL RISKS.
Japanese government’s debt has risen from 11.5% of GDP in the 1970s to over 200% nowadays. The rising leverage ratio has been a concern of Japan’s decision-makers for half a century, but what they have been worried about has never materialized—increasing leverage hasn’t led to weaker yen or inflation. Japan’s high public debt has not threatened the solvency of the government nor the credit rating of Japanese government bonds.
Low leverage does not necessarily mean ample policy leeway or low financial risks. Most low- and middle-income economies and emerging market economies have low leverage ratios but face higher inflation, currency depreciation, and swings in the financial market whenever they adopt slightly expansionary policies.
The reason behind this is that the planned spending of Japan's private sector is always lower than its revenue and the government fills the gap by borrowing for expenditure; given that the government expenditure by borrowing will not exceed the supply, expansion of Japan’s government debt only leads to more demand and output instead of inflation. In contrast, in many low-income countries and emerging markets with low-level industrialization and supply shortages, a modest expansion of government debt will drive total social expenditure above the supply capacity, resulting in higher inflation and chain effects.
If we look at China’s economy more than a decade ago when its supply was always lower than demand, even with a low leverage ratio, a slightly expansionary policy would overheat the economy, and the CPI at that time averaged close to 5%.
Over the past decade, the Chinese economy has become more like an industrialized country, with a supply surplus. Even the leverage ratio is much higher than more than a decade ago, the expansionary policy has not overheated the economy and the inflation rate always hovers around 1-2%. The absence of inflationary pressure indicates that spending increase due to expansionary policy is not excessive and the policy is not too aggressive.
We think that in the current context of quite low inflation and a relatively sluggish labor market, proactive fiscal policy and loose monetary policy will only move the level of aggregate expenditure close to the production capacity, and will not cause significant inflationary pressure while boosting economic growth. China’s fiscal and monetary policies still have a large room for maneuver, and the high leverage ratio should not be a constraint on macroeconomic policy.
II. MONETARY POLICY TAKES THE LEAD WITH THE SUPPORT OF FISCAL POLICY
China has been cautious in the use of traditional monetary, budgetary, and fiscal tools for addressing weak demand.
In terms of fiscal policy, China’s average deficit-to-GDP ratio between 2010 and 2020 is 3.2%, far lower than that of developed countries during the same period. In terms of monetary policy, the decline of interbank rates is much lower than the decline of inflation, and real interest rates have increased, with the 2010-2020 average being 2-3 percentage points higher than that of a decade earlier. This is in sharp contrast to the continued slowdown of economic growth and frequent demand deficiency.
Traditional monetary policy and budgetary fiscal expenditure are not enough to close the aggregate demand gap. Over a long time, China employed a unique tool to expand demand, i.e. debt-fueled investment led by local governments in coordination with local financing platforms, state-owned enterprises, and commercial financial systems, particularly in infrastructure. This approach has the merit of fast implementation and quick effects. However, it also has many weaknesses, the most prominent of which is that these investment projects were mostly financed by commercial financial institutions and frequently lacked solvency, posing hidden dangers of implicit local government debt and financial risks. This is the root cause of all concerns over the stimulus packages in the past. In recent years, China has tightened the governance of shadow banking and local government debt precisely to defuse such risks.
China needs to optimize the macroeconomic policy mix for demand expansion. To address inadequate demand, we should first let the market play its role and then let the government step in when the market cannot close the gap. Correspondingly, interest rate policy should be prioritized among monetary policy tools, to reduce the debt pressure of the private sector through lower interest rates, raise the asset valuation of the private sector, change the relative price of intertemporal spending, and expand the spontaneous investment and consumption in the market.
There is widespread concern about the failure of the interest rate policy. Based on the experience of developed countries, such concerns have not materialized. In a loose monetary policy environment, the US and the Eurozone both realized moderate inflation and employment goals, while Japan also witnessed the longest round of economic boom since the late 1980s even without hitting its inflation target. China’s business and household debts total RMB 210 trillion. Lowering interest rates can significantly reduce the debt burden, and stimulate market demand indirectly.
Another concern is that the use of interest rate policy should be cautious, based on the belief that when interest rates are near zero, there would be no policy leeway. In other words, the question is whether we should maintain sufficient room for monetary policy adjustment. Global monetary policy practice after the GFC demonstrates that in addition to zero interest rates, other tools such as quantitative easing and forward guidance can also be harnessed to add to monetary policy room.
Fiscal spending, especially investment in infrastructure, is also a powerful tool to boost demand. Every new infrastructure project brings an increase in business and household income, leading to spending expansion. What we need to do is to improve the regional distribution of infrastructure investment and project design. More importantly, we should find more suitable financing channels for infrastructure investment projects that lack cash flow, i.e., phasing out high-cost, short-term financing from commercial financial institutions and adopting low-cost government financing in line with the nature of the project. Both monetary and fiscal policies should move away from the narrow focus on ensuring room for maneuver, so as to serve the goal of demand management. If monetary and fiscal policies overstress their respective space, it would be at the expense of demand management, economic welfare, and people’s livelihood behind the economic growth figure.
The article first appeared in Chinese on CF40's WeChat blog on December 13, 2021. The views expressed herewith are the authors' own and do not represent those of CF40 or other organizations. The English version has not been reviewed by the authors.
