Friday, April 03, 2009

My new Wall Street Journal Asia editorial

Here it is, comments welcomed:

Asian Wall Street Journal,
April 3, 2009
Victor Shih

Legless Stimulus in China

China's 'Legless' Stimulus

China touted the effects of its $588 billion economic stimulus package at the Group of 20 meeting this week in London. Chinese policy makers, including President Hu Jintao, argued that the stimulus package proves Beijing is playing its part in jumpstarting the global economy. Some investors have been swept up in a wave of optimism about the package's positive impact.

There is considerable evidence, however, that even if the stimulus manages to produce some positive headline numbers, it is likely to fall short on its ultimate aim of creating employment and jump-starting private consumption. This result is the outcome of a political system dominated by state planners, large state corporations and local officials.

More than three-quarters of the stimulus package will be spent on construction, including transportation infrastructure, earthquake reconstruction, welfare housing and rural infrastructure. Much of the money spent on earthquake reconstruction may prove productive. After more than a decade of intensive infrastructure building elsewhere in China, however, it is dubious that additional construction on such a massive scale can generate economic returns beyond boosting short-term employment for a few months.

Furthermore, the central budget finances only around one-quarter of the stimulus package. At least half of the remainder will be financed by banks in China. Banks are eager to finance these government-sponsored projects because they come with implicit government guarantees and thus pose less risk than private borrowers do. In addition to $588 billion in central projects, local governments have also proposed more than $3 trillion in additional investment projects. Not all of these projects can be financed, but local plans could potentially double the size of the central stimulus. Banks may end up financing as much as three-quarters of these local projects because local governments are typically cash-strapped, thus further crowding out private consumption and investment.

Local and central governments are in some cases at an impasse over how much land should be allocated to central projects. Land sales to developers and land mortgaging have been major sources of local discretionary spending in recent years, but the stimulus projects will demand large tracts of land from the local land banks at little compensation. Thus, local governments do not want to "waste" this land on public projects, especially when the central government has set a strict limit on the amount of farmland that can be developed. The Chinese press reports that sometimes local governments are simply stalling on central projects, especially when it comes to welfare housing. In other cases, local governments are resettling residents with little compensation to reduce the cost of obtaining land. The Ministry of Land and Resources apparently deems these problems serious enough that it has organized an internal work group to monitor them.

Of the remainder of the money, the government announced at the March National People's Congress a $54 billion fund for enterprise "innovation and restructuring." Most of this money will go to state-owned corporations. A significant portion of the $31 billion allocated to pollution reduction will also end up in state firms.

These firms may not use the cash effectively. Large state firms' profitability fell 25% at the end of 2008 from the end of 2007. Some state-owned corporations, such as China Eastern Airlines, stay afloat only due to central subsidies after botching deals on commodities futures. In addition, subsidies embedded in the stimulus and bank loans will be used by state firms in the steel, automobile, electricity, and coal industries to buy state-owned and even private competitors, which contradicts at least the spirit if not the letter of the antimonopoly law by creating oligopolies.

From the perspective of building behemoth national champions, rescuing ailing state firms and subsidizing sector consolidation may be a fine strategy. However, from the perspective of generating employment and private consumption, it may not be particularly effective. To be sure, state-owned corporations have been ordered to not fire anyone, but with overcapacity looming over them, they are certainly not doing much hiring. In addition, it is unclear whether the no-firing rule applies to newly acquired subsidiaries of these state behemoths.

The stimulus is thus legless: It looks impressive at the top, full of grandiose plans and ample financing from state banks, but lacks a solid foundation. The epic scale of central expenditure and state bank lending will generate some positive investment and GDP figures. Its impact at the grassroots level, however, is dubious. Beyond the short-term boost in employment and relatively small sums spent on social welfare and health, ordinary Chinese will see few benefits, limiting their capacity to spend.

Already, the People's Bank of China's fourth-quarter monetary report indicates that household propensity to consume declined yet again. Given horrendous export figures in the first quarter of 2009, household propensity to consume is likely to decline again. The central leadership in Beijing has voiced its intention to boost domestic consumption. If they seek to maximize society's welfare over the long term, these leaders may be relied upon to carry out the right policies to boost consumption.

But these are heroic assumptions. In an autocratic regime, generating employment is not the only means of holding on to power. State corporations and local officials demand their large slices of the stimulus package. Even if the current leadership is sincere about its desire to reorient the economy, they are under pressure to address the concerns of powerful rent-seeking interests, who directly influence the leadership's ability to stay in power. Ordinary citizens and small firms are largely absent from the political process, and exert no direct influence on the implementation of the package.

This is not to say the American stimulus will perform any better, but the Chinese political system certainly diminishes the effectiveness of the stimulus. When China claims that it has done enough to jump-start domestic demand, G-20 leaders should take that message with a large grain of salt.


I have a stupid question. You wrote "Already, the People's Bank of China's fourth-quarter monetary report indicates that household propensity to consume declined yet again."

From what statistics do you at the above conclusion? I couldn't find a direct reference to declining consumer spending in PBoC's monetary policy report.
Well, politicians know politicians. What they say, hide or lie about, is just for majority of ordinary people to believe, half-believe at least. You are right about the "legless" of China's stimulus package among "little" people. However, it has long and strong legs among "fat cats" under the autocratic regime. I believe they definitely are "well" spending people's hard-earned money.
Hi, on household propensity to consume was reported on page 50 of the 4Q Monetary Report, where it said "the 4Q national depositor survey reveals that the willingness of residents to spend decreased somewhat....." Also, previous to that, there was a huge discussion on marginal propensity to consumer, which dropped between 2002 and 2008.
Thank you for your response, Xiao Shih.

I asked because the PMI index rose for the third consecutive month, the exports are declining, and so is the consumer spending propensity. I would have to assume that the government is now the primary driving force behind consumption. Otherwise, the overcapacity has not been alleviated, and could lead to dangerously high inventory.
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