Time for China to Move from Macro-Stability to Macro-Sustainability: Making Macro-Stimulus Work and Maintaining its Effects

Abstract

We attribute the success of China’s monetary-fiscal policies in producing 8.7% growth in 2009 to (1) the capital adequacy ratio requirement was not binding because the banks’ capital had not been reduced by losses on assets like subprime mortgages; (2) the initial fiscal position was sound, and this allowed a substantial expansion of the budget deficit; and (3) the state has direct control over the actions of the state-controlled enterprises (SCEs) and the state-controlled banks (SCBs), which dominate large segments of the economy; and so could order SCEs to ramp up investments and the SCBs to ramp up lending. However, these quick decisive actions can be hasty actions that increase the role of the state-controlled firms in the economy, and generate nonperforming loans in the future. Chinese policymakers can eliminate the tradeoff between maintaining sufficient aggregate demand and ensuring economic efficiency by replacing the present macro-stimulus with new market-friendly growth drivers. Small and medium private banks should be legalized and interest rate liberalized to promote the formation of new private businesses. Farm land should be privatized so that the new entrepreneurs would have the collateral to access investment loans. The termination of the household registration system and the adoption of the principle of future home ownership would accelerate high-quality urbanization whereby the state would build public housing for migrants. China’s high economic growth and its integration into the global economy are now threatened by increasing calls in the developed countries, especially in USA, for protectionism against Chinese exports. As these calls have been prompted by China’s chronic trade surplus and by the present deep recession (from the Global Financial Crisis), China should aggressively reduce the trade imbalances (e.g. by removing export rebate, liberalizing imports, and modernizing the financial sector) to forestall protectionism.