The writer is a professor at Cornell University, a senior fellow at Brookings, and author of “The future of money‘
The mood in China is gloomy. Sentiment indicators at home and abroad – private consumption, private investment and foreign capital inflows – are weak. Real estate prices continue to fall and the stock market is in the doldrums. Both reflect and reinforce the feeling that the economy is rudderless and that the government either does not understand the seriousness of the situation or has no plan to stop the decline. Or both.
The third plenum of the Communist Party of China Central Committee, a key meeting that typically sets out an economic policy roadmap for each five-year cycle, is due to take place next week. The government had been expected to put forward a clear policy agenda and concrete reforms, and offer short-term stimulus to support growth, but those hopes may be dashed.
Chinese Premier Li Qiang recently spoke of addressing the symptoms and root causes of current problems, but he offered few remedies. The plenary will no doubt produce rote statements about further reform and opening-up, but these will be a fiasco if the government fails to revive market-oriented reforms.
The government has resisted calls for monetary and fiscal stimulus, fearing financial risks and an increase in its debt burden. To boost the economy after the pandemic, Beijing has issued a significant amount of long-term government bonds to finance infrastructure and other spending. The central bank has eased monetary policy moderately, but credit growth remains weak. Private companies are not eager to invest in an uncertain environment.
The government has also boosted production in selected industries – something that planned economies are usually good at. The support has boosted sectors such as green energy and electric vehicles, which is in line with the goal of technologically upgrading manufacturing.
It has proved more difficult to get households to spend more when their confidence is at a low and they see their homes and equity investments falling in value. The focus on large-scale, capital-intensive manufacturing has limited employment growth and further slowed consumption. With consumption lagging behind the increase in productive capacity, deflationary pressures remain. As China tries to solve its problems through exports, trade tensions with other countries are worsening, adding to the gloom.
The government’s ambivalence toward the private sector and open hostility toward successful entrepreneurs have also dented confidence. Entrepreneurs are willing to take risks for the prospect of high profits. But this equation is turned on its head when profits are capped, reducing private sector dynamism and dampening innovation.
The banking system appears to be sound, but it is not channelling its resources to the more productive parts of the economy. Banks have little incentive to lend to small and medium-sized enterprises, including those in the services sector. Creating incentives and broader development of capital markets are top priorities.
Local governments are under financial pressure. They bear a large share of overall spending, while the central government collects most of the tax revenues. This model, which had already failed, is no longer sustainable as the decline in property values reduces local governments’ income from land sales. At the same time, the central government has expanded local responsibilities, including dealing with the consequences of real estate developer bankruptcies.
China’s current problems are both cyclical and structural in nature, and action is needed on several fronts. Stimulus is not a panacea, but it can be an important part of the solution. The transition away from traditional growth engines such as real estate investment will take time, and the economy needs support during this process.
Fiscal support for poorer households and measures to strengthen the social safety net would be a good start. However, economic stimulus without a plan for more comprehensive fiscal and financial reforms and steps to restore private sector confidence will not make much difference.
The Chinese government appears to have clear economic goals, including reorienting the economy towards services and more productive manufacturing, moving away from the real estate sector as the main growth driver, and increasing private consumption. It now needs to develop a concrete plan to achieve these goals, make a down payment in the form of some specific reform measures, and lubricate the process with targeted economic stimulus. Only then will the mood in the country improve.
