* China's economy "weathered" the global downturn better than most economies. In fact, the country’s Gross Domestic Product expanded by an average 8.45% in 2009, the fastest in the world. Yet, the astonishing recovery was supported by a vast fiscal stimulus and loose monetary policy. And looking ahead, China’s economy may overheat and bring inflation to elevated levels thus hampering future growth.
Indeed, China’s growth in 2009 was largely a result of 4 trillion yuan stimulus package directed mostly to infrastructure projects and lending. For example, in December only, China's wide M2 measure of money supply and fixed asset investments grew almost 30% year on year. On the ...view middle of the document...
What it did was it took China from having the highest investment rate—probably in recorded history—and significantly increased it. It increased the importance of investment in China and it increased the probability that a lot of this investment wasn’t economically viable. What didn’t go into infrastructure investment went into expanding capacity in a world that doesn’t really need more capacity, it needs less capacity. So it went into expanding shipbuilding, steel production, chemicals, etc.
So from that point of view it hasn’t been very successful. Especially if you consider that there may be a significant increase in non-performing loans and in non-economically viable investment which must be paid for in the future by the household sector, probably in the form of very low interest rates, which means that it will act as a constraint on future household income growth and therefore a constraint on future consumption growth.
In a way, part of the expansion is going to push up production and part of it is going to constrain the growth of consumption. And China already produces more than they consume. So pushing them in the opposite directions is not going to help.
But, if you think the purpose of the fiscal and credit expansion was to address a short-term problem of a surge in unemployment in China, then it has been extremely successful. With the collapse in net exports, we should have seen the economy grind to halt and unemployment soar. The purpose of the fiscal stimulus program was to address specifically that problem.
Unfortunately, you have a conflict between the short-term policy objectives and the long-term policy objectives. The government, perhaps properly, addressed the short-term policy objectives. But that doesn’t mean that it resolved the long-term rebalancing problem—it probably made it worse, and China is going to have to rebalance one way or the other.
How can China rebalance its economy?
In the case of China, rebalancing has a very special meaning. It means that consumption must grow as a share of GDP. To give you an idea, five or six years ago private consumption was around 40 percent of GDP—that is an extraordinarily low number.
Among Asian countries that have traditionally had high savings and low consumption rates, Malaysia had private consumption in the low fifties, and at one point after the crisis it declined to around 45 percent of GDP before climbing back to up around 51, 52 percent. That 45 percent was an anomaly.
China, five or six years ago, was at 40 percent. You need to bear in mind that the larger the country, the less likely it is to be an outlier. 45 percent for China would have been worse than 45 percent for Malaysia. 40 percent for China was much, much lower.
The government at the time decided that it was very important to raise consumption as a share of GDP. But, because I believe they had the wrong model for thinking about it, what happened over the next five years was that consumption as share of...