The road back to growth in China

BEIJING — According to China’s National Bureau of Statistics, the economy grew by 4.5 per cent year on year in the first quarter of 2023. While that hardly matches the robust growth of the pre-pandemic period, it did exceed market expectations. And with the right policies, China can do even better.

There is plenty of pessimism about China’s economic prospects nowadays, with many warning, not without reason, that China has entered a deflationary period. In the first quarter of 2023, China’s consumer price index (CPI) rose by only 1.3 per cent year on year, down from 1.8 per cent in the previous quarter. More striking, China’s producer price index (PPI) fell by 2.5 per cent year on year in March, its sixth consecutive month of decline.

This is not a new trend. In fact, China’s PPI has been negative for the better part of the last decade. Beginning in March 2012, China’s PPI was in negative territory for 54 consecutive months. In January 2019, it turned negative again, and remained so for 17 months. While CPI has remained positive, it has grown by less than 2 per cent annually, on average, for a decade.

While claims that China has entered a deflationary period are excessive, the data indicate that China’s economy continues to be hamstrung by low effective demand. Official figures also support the claim that China’s GDP growth has been below potential for some time.

This may not have been surprising when the zero-COVID policy was triggering regular lockdowns, including in economic hubs like Shanghai. But the abandonment of strict pandemic-containment policies in December was widely expected to unleash pent-up demand, leading to a robust recovery. Some even warned that inflation could spike, as supply struggled to keep up.

None of this came to pass. Non-economic factors — linked, for example, to global geopolitical tensions — bear some of the blame. But, in my view, one of the most important reasons for China’s weaker-than-expected economic performance since December is the government’s overly cautious approach to macroeconomic policy, particularly fiscal policy.

China’s government has set a growth target of “around 5 per cent” for 2023. For an economy that grew by 6.7 per cent, 6 per cent, 2.2 per cent, and 8.1 per cent in 2018-21, that is simply too low. A better approach would aim for 6 per cent growth, an entirely feasible target, given China’s recent performance. While the government’s reluctance to aim for a higher growth rate is understandable, a conservative target can create a self-fulfilling prophecy, by weakening confidence and failing to exploit growth potential fully.

Some policy interventions, such as cash transfers, would provide a direct and immediate boost to consumption, which accounted for 54.3 per cent of GDP in 2021 and had been the main contributor to GDP growth for years before 2022. But, as China’s government well knows, consumption is a function of income; a sustained, broad-based increase in incomes depends on economic growth; and infrastructure investment is traditionally the state’s most effective instrument for boosting growth when effective demand is weak. Despite past investments, China still has a large infrastructure gap that urgently needs to be closed.

There are risks to this approach. As China learned when it implemented a CN¥4 trillion ($578 billion) stimulus package during the 2008 global economic crisis, large-scale public investment in infrastructure can lead to an increase in local-government debts, ultimately undermining financial stability.

But rather than discourage state-led infrastructure investment, this experience should motivate policymakers to engage in more careful planning that avoids creating additional “white elephants”. It should also spur changes to how the government finances its investments.

China’s authorities have historically been very reluctant to run budget deficits. As a result, the vast majority of funding for past infrastructure investments has been raised by local governments on capital markets at high interest rates. Spending by the central government accounted for perhaps less than 1 per cent of total infrastructure investment in 2021. Small wonder local governments are weighed down by debt.

For the next round of infrastructure investment, the central government should contribute a significantly larger share of funding. At the same time, it should step in to help local governments resolve their debt problems. This will require the central government both to increase its budget deficit (as a share of GDP) and to sell more government bonds to the public in 2023.

Barring a “black swan” event, China can achieve 6 per cent GDP growth this year, thereby ending a 12-year slowdown. But this will not happen on its own. Carefully planned and prudently funded infrastructure investment, supported by expansionary fiscal policy, is essential.

Yu Yongding, a former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, served on the Monetary Policy Committee of the People’s Bank of China from 2004 to 2006. Copyright: Project Syndicate, 2023. 

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