Lessons from China's fiscal stimulus in 2008-09..

A nice paper on China’s fiscal stimulus in 2008-09 by Shahrokh Fardoust, Justin Yifu Lin and Xubei Luo.

They demystify China’s fiscal stimulus and point to several lessons from the stimulus. The Chinese stimulus had two main features. First large part of stimulus was into shovel ready infrastructure projects. This was unlike India which just boosted consumption and fueled subsidies.

Second, even the sub-national governments also did their bit by doing countercyclical fiscal policy. This was unlike US where states were seen as cutting budgets  leading to a lower impact of fiscal stimulus.

China’s government economic stimulus package in 2008-09 appears to have worked well. It seems to have been about the right size, included a number of appropriate components, and was well timed. Its subnational component was designed to maximize the impact of the stimulus package on the economy and minimize the potential procyclical elements that are usually built into subnational fiscal mechanisms in federal countries. Moreover, China’s massive fiscal stimulus played an important role in the overall recovery of the global economy. Using a simple analytical framework, this paper focuses on two key factors behind the success of the stimulus: investments in bottleneck-easing infrastructure projects and countercyclical nature of subnational spending based on the assumption that well-chosen infrastructure projects could improve business climate and thereby crowd in the private investment.

The paper concludes that the expansionary subnational government spending played a key role in strengthening the overall impact of the stimulus and sustaining growth. It also highlights the importance of public investment quality and cautions about the sustainability of local government financing through the domestic banking system and increases in local governments off balance sheet or contingent liabilities. These lessons may be of particular relevance today for China, as well as other countries, in formulating policy response to another global economic slowdown or crisis, possibly as a result of the Eurozone turmoil. For China, investing in urban infrastructure and green economy, as well as in higher quality and better targeted social services, will be crucial for improving income inequality and inducing a more inclusive growth path.

The subnational government expenditure bit is what is creating stress in Chinese economy. The paper points to interesting discussion on China’s federal finances:

While the United States is formally a federal country, the European Union, which has a  monetary union, does not yet have a fiscal union as decisions about taxes and spending remain at the  national level, though some members, such as Germany, have a federal system. China, on the other hand,  is a unitary state, even though in several important ways it behaves as a fiscal federalism and its fiscal  system shares some of the key features of fiscal systems in federal countries (Bahl and Martinez-Vazquez  2003). In particular, fiscal decentralization has been a fundamental aspect of China’s transition to a  market economy, and the country has made substantial progress in moving away from its highly  centralized fiscal management system and tax sharing system, though the current fiscal system requires  further reforms, particularly in the areas of sub-provincial expenditure assignment, dealing with widening  fiscal disparities and intergovernmental transfer system (Shen, Jin and Zou 2012).

Hmm.. Box 2 of the paper has a superb discussion on federal finances.

How was all this financed? Was slightly complex involving banks and govt. guarantees:

China’s central government authorized a special program of bank loans at extra long-term  concessionary interest rates to provide paid-in capital for investment projects and allowed the  issuance of corporate debt under the sponsorship of local governments (Naughton 2009).  Substantial financing was made possible at the subnational level using local land as collateral  with the central government’s permission. Put another way, China’s fiscal stimulus was financed  through local government financial vehicles rather than carried on the central government’s  balance sheet The annual reports from the five largest commercial banks show 17.6 percent  overall growth in the loan categories likely to have been utilized by LGFVs in 2011 (Wolfe 2012). Since local governments’ investments were mainly financed from bank borrowing, one  can conclude that the fiscal stimulus in China was financed to a large extent by the central  government’s expansionary monetary policy, which could lead to inflationary pressures and a  real estate bubble.

So what were the lessons?

• Multipliers Are Larger When Debt Is Lower
• Targeting and the Quality of Spending Matter
• The Need to Stimulate the Economy Should Not Drive Investment
• Fiscal Sustainability Should Not Be Jeopardized
• Lending and Investment Must Be Economically Justified
• The Risks Arising from Worsening Income Distribution and Environmental Problems

Useful paper on Chinese fiscal stimulus. But then issues of  sub-national finances and bank balance sheets remain..

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