Abstract: China should set its GDP growth target at as high as possible so long as it can keep inflation and financial risks under control. To prevent the growth from further decline and maintain macroeconomic stability, China should focus on boosting infrastructure investment in order to drive investment in manufacturing and stimulate consumption. The major bottleneck stemming infrastructure investment at the moment is lack of financing, and issuing government bonds is the key to breaking it. In 2022, China should implement more expansive and well-coordinated fiscal and monetary policies, but the expansion must keep a proper pace.
OBSERVATION 1: We should view China’s economic growth in 2021 objectively.
China recorded a GDP growth of 8.1% in 2021. How should we interpret the number? Does it mean that China has managed to deliver fast economic growth in the year? Let’s compare it with the pre-pandemic figure in 2019. To adjust for the difference in basis, we compare the quarter-on-quarter (q-o-q) growth in 2019 and 2020 here instead of the year-on-year (y-o-y) results. China’s q-o-q growth in the four quarters in 2019 stood at 1.6%, 1.2%, 1.3% and 1.6%, or 6.6%, 4.9%, 5.3% and 6.6% on an annualized basis, respectively; however, the annualized results for three out of the four quarters in 2021 were lower than in 2019 (except for Q4). In other words, the Chinese economy in 2021 grew at a de facto rate that was below the 2019 level of 6%. Had the economy remained on track in 2020 without the pandemic, the growth rate in 2021 may have fallen below 5%. Thus, we should remain sober about the 8%-plus rate and the fact that the Chinese economy has been running and still runs below potential. This is a safe conclusion to draw, in view of the capacity utilization, price and employment situations in China, even if no one knows exactly what the potential rate is.
OBSERVATION 2: The Chinese economy has long been characterized by low inflation, if not deflation.
The Producer Price Index (PPI) growth in China remained in the negative territory for 54 consecutive months starting from March 2012. Neither the CPI or the PPI had been high until Q3, 2021, and the CPI on average rose by less than 2% over the past decade. In 2H21, price levels in China, especially the PPI, increased sharply, but latest data suggest that the PPI has already begun to fall back, while the CPI remains low.
The fact that China does not have inflation or even risks deflation shows that its economic growth could further pick up pace. As Deng Xiaoping famously said, development is of overriding importance. Growth is not everything, but without growth there is nothing.
It’s correct to focus on the quality of growth, but any talk of quality would be a castle in the air without a reasonable level of quantitative growth. With a sluggish economy, it would be very difficult to press ahead with structural reforms, technological innovations or common prosperity efforts. Theoretically, there is no “high-quality” GDP or “l(fā)ow-quality” GDP. Numbers are absolute. A GDP of RMB 100 trillion yuan is what it is. At the macro level, we must assume all GDP records are of the same “quality”, or it wouldn’t make sense to compare the numbers at different times or among countries. It’s true that at the product and project levels, quality has sometimes been placed second to quantity, and such economic activities may not even create value at all. If these activities and their products are taken into account in GDP calculation, then there are problems. However, these problems may not be necessarily solved by slowing GDP growth.
OBSERVATION 3: We have made many methodological mistakes when discussing whether China should strive to achieve a relatively high growth.
Some hold that a relatively high growth is unrealistic since China still faces a whole train of structural problems. This argument makes some sense. But how high is “relatively high”? Is it 10%, 8%, 7%, 6%, or 5%? The 12.2% growth rate in Q1 2010 is certainly too high. GDP growth was 6% in 2019, and we aim at 5.5% in 2022, are these numbers too high? Structural problems are at most part of the reason why China’s GDP growth is declining, but they don’t offer any clue as to what is a reasonable level of GDP growth.
And if we take a step back, there isn’t even a clear definition of structural problems. We usually put everything that’s not a macroeconomic issue under the category of “structural problems”, including population ageing, the balance among investment, consumption and export as a share of GDP, private versus state-owned enterprises, income inequality, the underdeveloped capital market, lack of independent innovation, regional imbalance, lagged urbanization, the low proportion of the service sector, insufficient intellectual property right protection, environmental pollution, resource exhaustion, and falling economy of scale, among a lot others. Using such an all-encompassing, ambiguous concept to explain the growth rate of a specific year or even a specific quarter or why China should set the growth target at 7%, 6% or 5% is logically unsound. Structural factors can explain long-term growth trend, but they can’t explain fluctuations in annual or quarterly growth.
China’s GDP growth has been sliding almost every quarter from 12.2% back in Q1, 2010. If structural problems can explain the decline from 12% to 10%, what about later when it further dipped to 9%, 8%, 7% and 6% or now when it is heading below 5%? Don’t any of the macroeconomic policies implemented take some blame?
Structural factors do affect economic growth, but they don’t explain fluctuations in annual or quarterly growth. I have four comments in this regard.
First, structural factors are slow variables, reshaping growth in a progressive manner. They don’t play much of a role determining annual or quarterly growth, just as population ageing can’t explain the decline of economic growth in a specific year or quarter.
Second, although there are a large number of structural factors affecting growth in various ways, in a given period, any one of them hardly has any major effect on GDP growth—with some exceptions of course, such as the external shock of the COVID-19 pandemic.
Third, some of the structural factors offset each other. For example, while population ageing lowers the growth potential, technological advances improve it. The boom in AI and robotics can offset some of the negative impact of population ageing. True, China’s working-age population started to fall in 2012, but such fall does not necessarily explain why its GDP growth slumped to 7.9% in 2012 from 9.6% a year ago. It also doesn’t make sense to assert that China’s GDP growth is bound to fall below 6% or 5% just because of population ageing.
Fourth, to identify the immediate impact of a structural factor on annual growth, we have to form a complete causal chain, which may not even be linear, and different chains could crisscross and intertwine. Directly shaping annual or quarterly growth are short-term macroeconomic variables such as consumption, investment, government spending, and import and export. When growth is mainly hindered by the supply side, for example, we should examine the factors determining current supply. In comparison, a structural factor usually cannot act on the above-mentioned variables with immediate impacts on GDP growth until it “goes through” a long causal chain. To justify that a structural factor determines that GDP growth cannot exceed 6%, one has to string all key points along the causal chain into a flow of logic, such as how population ageing (quantitatively gauged) affects A, and A affects B which then affects C…until it reaches immediate factors like consumption, investment or net export. No single point can be missing, or the conclusion would be logically untenable.
Macroeconomic discussions and policies usually focus on the near term, on an annual, quarterly or monthly basis, with structural factors presumed. Such short-term analyses tend to take into account immediate factors such as consumption, investment and net export, including their fluctuations and the causes which could include long-term, structural problems. Identifying these factors can help predict the future trend and make policies to reshape the trend.
OBSERVATION 4: On stimulating consumption.
In early 2020 when COVID-19 just broke out, many scholars believed consumer spending could be boosted by government subsidies. It certainly makes sense to try to stimulate growth by boosting spending, but if consumers expect their fixed income in the long term would decline and are pessimistic about the growth prospect, they wouldn’t spend the subsidies anyway but would save them. Later, with lockdowns lifted, some were expecting a “retaliatory growth” in consumption, which has not happened even until today. Theoretically, consumption is affected by income and income expectation. If we can’t boost economic growth and household income and improve expectations, it would be hard to increase spending. Of course, subsidies for the hardest-hit low-income groups remain necessary, but that is more of a sort of social support than a macroeconomic policy.
OBSERVATION 5: How to set a reasonable target for economic growth?
The Chinese government’s recent reiteration of “stabilizing growth” was timely. In light of the circumstances, I interpret it as “preventing further fall of economic growth.” What is a reasonable growth target for China? There is now the consensus that we should first figure out China’s potential growth rate, and based on which determine a growth target. For long I shared this view. But now I realize that with calculation models over-reliant on rigid assumptions and a lack of basic data, it’s hard to reach an accurate growth potential anyway.
I have met many economists known for a perfect prediction of economic growth or growth trend for a certain period of time. But they mostly got right for only once throughout their career. Though we need to figure out the growth potential which can serve as a meaningful reference, we need not take it as the starting point for determining the GDP growth target.
I can’t agree more with Deng Xiaoping’s philosophy that one could cross the river by feeling for stones. When no one can be certain with future results, people should never be afraid of trying as long as they are heading for the right direction. This kind of open thinking proved to be rather successful. The fact is some of the policymakers may know little about economics, but they can do a better job managing the economy than those with more knowledge. Despite all kinds of problems, China had maintained a growth rate of around 10% for 40 years. Before the launch of reform and opening-up in 1978, the Chinese economy ranked 18th in the world with a GDP smaller than that of the Netherlands and less than 1/4 of Japan's. China caught up with Japan in 2010 and now now the economy is three times that of Japan. Practice is the only criterion of truth. We can know whether a policy is successful only after it is tried out.
On the first day I joined the Chinese Academy of Social Sciences in late 1970s, I heard people talk about currency overissue, inflation and economic crisis. There were sayings that the money overissued is like the tiger in the cage, and it will devour people when it comes out of the cage. I have waited for the tiger to come out for over 40 years, and now my hair has turned grey. Had the policymakers performed as prudent as our scholars wished, we wouldn’t have seen the rapid growth and today’s economy. Economics is not a science where everything is certain, and to a certain extent, it is art. I have always held that it’s good that the government had not taken the conventional advice from the economists; otherwise, the average growth rate of 10% in the following 40 years would not have been possible.
The World Bank released many reports predicting China's economic development in the 1980s. Now if people read those reports again, they will find that most of the predictions are far from China’s actual development, and some may even be "diametrically opposed". Experts at the World Bank who wrote those reports were some of the world’s best economists at the time. Why is this? The world is too complicated to predict, so is China. Economic growth features huge uncertainty. We must admit that we know very little about the laws of economic development, and must always be prepared to correct mistakes and make adjustments when formulating and executing economic policies.
OBSERVATION 6: Economic growth goals should be based on experiences and trial.
When expansionary fiscal and monetary policies lead to runaway inflation and increased financial vulnerabilities, policymakers have to lower growth goals. If inflation is under control and financial fragility is not that serious, more expansionary fiscal and monetary policies should be adopted to help achieve the highest possible growth rate. In 2019, I brought up the view that China had to maintain a growth rate of 6%, which was symbolic as I repeatedly emphasized. China's economic growth had basically declined quarter by quarter since 2010, and fell to 6% in 2019. My key point is that we should not allow this situation to continue. In fact, inflation in China was fairly low at the time; the financial system on the whole was healthy despite the relatively high leverage.
China still has ample room for policy maneuver, so why don’t we aim for a higher growth target? It would be a mistake to hold that China has to slow down its growth without even trying. Long term decline of economic growth can produce the so-called hysteresis effect: the long-term and continuous decline will make it hard to speed up growth, as workers unemployed for a long time have trouble returning to work, and disbanded teams are hard to regroup. If we allow economic growth and investment growth to decline freely, the potential growth will inevitably be impaired. In this sense, growth fails not because it has to, but because people expect it to.
In short, as long as there is no danger of runaway inflation and no risk of systemic financial crisis, China should set its growth target as high as possible.
At present, the market's expectation that inflation may get out of control has weakened significantly, but there is still serious worry about financial risks. I think for a long time, people around the world have overestimated the possibility of a financial crisis in China. Before the Chinse New year in 2012, I visited the New York Stock Exchange with colleagues from Peking University. At that time, many in the US believed that China's real estate market was about to collapse, that Wenzhou's underground banking would bring down China's entire financial system, and that China still faced the shadow banking problem. We responded by saying that these problems did exist, but they were not possible to trigger a financial crisis in China. For example, the scale of Wenzhou's underground banking is just a drop in the bucket compared to China's entire economy. We should pay attention to the problem and not ignore it, but it will not cause the crisis as some people imagined.
OBSERVATION 7: Maintaining a certain growth rate is not only an economic issue, but also a geopolitical one.
The growth rate of the US has risen, and that of China fallen, so the growth gap between the two countries has narrowed; India's growth rate has surpassed China's for the second year in a row. We should never ignore such issues. We can see from recent articles and speeches that some US scholars, especially those in geopolitics, are happy to see a further decline in China's growth rate. In fact, China has the potential and the ability to curb further decline of the growth rate, and keep it at a high level.
OBSERVATION 8: The Chinese government should set an economic growth target for 2022.
This target can be directive, not prescriptive. It is difficult to formulate specific policies without a target. In fact, departments and governments at all levels have implicit goals which are not made public. That being the case, why not set targets explicitly? Without a unified and clear growth target, it is difficult for various departments and different levels of governments to coordinate their actions. After setting a goal, governments can then make attempts to achieve it. If they find the goal unattainable, they can always set a new goal.
OBSERVATION 9: Maintaining a certain growth rate of infrastructure investment is an important means to achieve the growth target.
It is possible to formulate a specific growth target based on historical data and experience, and the growth rates that China needs to achieve in consumption, investment, and exports. Most of the macroeconomic variables are endogenous, and their growth rates can only be predicted based on certain assumptions. However, China's infrastructure investment can be largely controlled by the government. Therefore, according to different assumptions about the growth rates of consumption, investment (excluding infrastructure investment), and export, we can work out the growth rate that infrastructure investment should maintain in order to achieve a given growth target. The calculation may require multiple iterations. In any case, it is possible to work out a set of the most likely, self-consistent growth rates that infrastructure investment needs to achieve in order to realize a given GDP growth rate.
The y-o-y growth of China's infrastructure investment was only 0.4% in 2021. Before the outbreak of the global financial crisis, China's infrastructure investment growth generally remained at around 20%. In June 2009, the cumulative y-o-y growth of infrastructure investment was as high as 50.7%. Later, the growth rate fell all the way, and entered the negative territory in February 2012. In 2013, it once rebounded to more than 20%, and then began to decline continuously. Infrastructure investment in 2021 increased by 0.4% from the previous year, far below the 3.8% annual growth rate before the outbreak of the COVID pandemic, and even less than the growth rate of 0.9% in 2020. In the past, infrastructure investment growth has always been counter-cyclical and remained an important factor in maintaining macroeconomic stability. In 2021, infrastructure investment declined pro-cyclically, so how can it not drag down GDP growth?
In the case of a continuous economic downturn and sluggish expectations, economic growth relies mainly on infrastructure investment growth which can create a "crowding-in" effect, drive manufacturing investment, and increase consumer demand growth by stimulating economic development.
Is China's infrastructure construction ahead of its time so that there are no more projects to build? Not at all. Infrastructure construction is a broad concept. It is by no means limited to traditional infrastructure projects such as railways, roads and airports, but also includes "new infrastructure" and the provision of public goods. Even in traditional infrastructure, we are still facing a huge task of making up for shortcomings, as amply shown by the 380 people dead or missing in the heavy rain in Zhengzhou on July 20, 2021.
It is also incorrect to say that infrastructure investment is not profitable. While tackling existing problems and improving investment efficiency, we must see that, based on the function and nature of infrastructures, the success of infrastructure investment should not be measured solely or mainly by commercial returns.
China has institutional advantages in controlling infrastructure investment and it is an advantage that other countries (including the United States) cannot copy. Giving up this advantage is equal to cooking one’s goose.
In addition, as real estate investment plays an important role in China's economy, the slowdown in its growth can put a drag on the country’s economic growth. Under such circumstances, it is even more necessary to boost infrastructure investment growth so as to hedge against the adverse impact of the slowdown in real estate investment.
OBSERVATION 10: Real estate investment plays a particularly important role in China's economic growth.
The proportion of China's real estate investment in GDP is the highest among the world's major countries, and the growth of China's housing prices is one of the fastest in the world. The main problem of China's real estate sector is one of resource allocation, and it is difficult to predict whether there is a serious bubble. China's monetary authority has long been in a dilemma. On the one hand, it hopes to curb the rapid rise in housing prices. Once a rapid increase in housing prices is noticed, policy measures always come out to put a curb on it, and the monetary authority has to change policy direction. On the other hand, a decline in housing prices or the growth rate of housing prices can lead to a decline in the growth of real estate investment, as well as the entire economy. In this case, policy measures to curb housing prices will be put on hold, monetary policy shifts toward a more easing stance, and housing prices rebound in a retaliatory manner. In fact, we've seen several of these cycles so far.
Houses are for living in, not for speculation. Indeed, the housing prices in China’s first-tier cities are too high and have risen too fast, which is not conducive to people's livelihood and long-term economic development. But curbing housing prices should not be the goal of monetary policy and it can be realized mainly through non-monetary means such as building national networks of property registration and taxation.
There are serious structural problems in China’s housing construction. On the one hand, there are loads of vacant high-end residences; on the other hand, low- and middle-income groups, especially young people, find it difficult to pay for houses and some are under heavy mortgage burdens. China should increase the supply of low-rent housing, improve the rental market, and gradually sell off the stock in third- and fourth-tier cities.
This round of real estate regulation does have problems such as improper timing and the one-size-fits-all approach. There must be adjustment, but it is also necessary to avoid sudden changes in policy direction and not cause market shocks.
OBSERVATION 11: To accelerate infrastructure investment, financing must be addressed.
The four trillion stimulus program in 2008-09 taught us an important lesson: infrastructure investment should be financed primarily through government bonds rather than bank loans by local financing platforms. At the moment, China's local governments are in financial difficulty, but there is plenty of room for government bonds, so issuing government bonds may be China’s only way out of its current economic difficulties. The associated problems such as rising interest rates are completely solvable. Moreover, the expansion of government bond issuance has an irreplaceable role to play in the development of China's capital market. Details of issuance—such as how local bonds should be issued and whether special bonds should be converted into general public bonds—can be studied further.
China's tight fiscal policy in 2021 was not conducive to economic recovery. At the macro policy level, fiscal policy should be significantly expanded in 2022. The government need not be bound by the 3% deficit rule, which has no solid theoretical basis. In many cases, experience has shown that the most effective way to reduce the deficit ratio is to accelerate economic growth, even if this means adding to the deficit in the short term. This was demonstrated by Japan’s failure as a result of fiscal austerity in 1996-97 and China’s success with fiscal expansions in the late 1990s and early 2000s.
OBSERVATION 12: In 2022, China should implement a more expansionary monetary policy and improve the coordination and coherence of fiscal and monetary policies.
Monetary policy can function effectively during times of economic overheating. During the downturn, its effectiveness will be severely limited by issues such as the "liquidity trap", though the central bank can and should lower interest rates to alleviate the financial difficulties of businesses and residents and stimulate economic growth. But even with increased credit and lower interest rates, the demand for businesses and personal loans may not increase significantly. Monetary policy can help in this case by supporting expansionary fiscal policy.
A surge in the issuance of government bonds is bound to push up the yield rates and, as a result, cause varying degrees of interest rates rises across the financial system. At this point, expansionary monetary policy measures such as interest rate cuts can reduce the cost of bond issuance while supporting the function of expansionary fiscal policy. If demand for government bonds is weak, the central bank may as well enter the (secondary) market for government bonds purchases, thus activating the market and lowering the cost. China has adequate policy space in this regard.
OBSERVATION 13: Because of the worsening inflation situation, in 2022 the US will start to exit from the extremely expansionary monetary policy that has been in place for 12 years.
The US policy shift is bad news for China's balance of payments, putting a depreciation pressure on RMB exchange rate and calling China's monetary policy independence into question. But since the adjustment will be gradual, I don’t expect a drastic change in China's external economic environment. The change should have little impact on the formulation and implementation of China's macroeconomic policies as long as China allows sufficiently flexible RMB exchange rates and regulates cross-border capital flows.
OBSERVATION 14: The market appears to be in agreement that the growth rate for 2022 should be 5.5%. I agree with it.
On the one hand, we have been, after all, severely hit by the pandemic, so it is natural to grow slower than in 2019. On the other hand, there is room for more expansionary fiscal and monetary policy, particularly fiscal policy, to achieve a higher growth rate. But fiscal expansion need certain conditions. The first is whether or not there are sufficient project reserves. There may be no projects if no preparation is made. The other question is whether local governments are mentally and organizationally prepared. If not, it will be difficult for them to undertake large-scale infrastructure investment. Drawing on the lessons learned from the four trillion stimulus program in 2008, we should not move hastily.
Needless to say, the success or failure of macroeconomic policies lies not only in the design, but also in the institutional environment and political ecology in which they are implemented. Given that the central government has proposed the general direction of "stabilizing growth", there is reason to be optimistic about China's economic growth in 2022.
This article was first published on CF40’s WeChat blog on January 25, 2022. It is translated by CF40 and has not been reviewed by the author himself. The views expressed herein are the author’s own and do not represent those of CF40 or other organizations.
