Solve Macroeconomic Problems & Promote Real Economy Development

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Written by: Zenghui Zhao, Haili Wang, Yanjun Guo

Edited by:Wilbur Zhu(WeChat ID: aotokuer), Anna HU

The government should take the initiative to employ fiscal policies and promote Public-Private Partnership (PPP) developing pattern, which is regarded as a key to solve the problems facing China’s economy.

Professor Zhang, Dean of the School of Economics, Fudan University, gave a speech onChina’s economic transformation and its long-run growthat the plenary session of FBIF 2017. His speech touched on problems facing China’s economy, like the over-rising leverage ratio, the over-issuing of the currency, and the lack of assets worth investing. Professor Zhang ended his speech by suggesting that the government should employ fiscal policies and promote the PPP developing pattern.

Potential Risks Behind the High-speed Increasing of the Credit

In the past few years, the M2/GDP ratio has been in a high level, which was caused by the over issuing of the Chinese currency. This, thereby, directly resulted in the high rising of the leverage ratio, which means that too much money is needed to generate per unit GDP growth. Meanwhile, the over-issuing didn’t bring inflation, which can be proved by the fact that the CPI growth rate was only 1.5% in the first quarter of 2017. The money issued by the central bank flew into the stock market and real estate market since the real economy cannot absorb them. This can be observed by the soaring house prices in first-tier cities last year.

The over-issued money actually cannot help the core productivity grow, which means that the real estate investment can only increase gross demand in short run. But from the long-run perspective, the economic bubble existing in the real-estate market will harm the core economic growth.

Problems Facing China’s Micro Economy

The decrease of the total demand

According to the National Income Equation, The GDP growth rate is decided by three factors, namely consuming, investing, and net export. The China’s economy downturn in recent years is mainly caused by the slowing down of the investment and export. Though we still have a positive net export, its growth rate was lower than expectation in the first quarter. Meanwhile, investment, which is regarded as the key driving force of China’s economy, is also slowing down, especially in real-estate market and infrastructure.

The over-rising leverage ratio

Resulted from the over-issuing of the currency, the leverage ratio of the china’s economy, whether for the business sector or the household sector, is over-rising. For the household sector, the government can curb this phenomenon by a series of real estate regulatory policies. Therefore the main challenge lies in the business sector. However, the Chinese government is facing a dilemma when solving this problem. For one thing, according to the supply-side structural reform, the leverage ratio must be decreased. For another, the decreasing of leverage ratio is bound to reduce company’s investment demand, including intermediate goods and consuming goods. What’s worth mentioning is that middle and small-sized enterprises have been already facing financing difficulties for a long time. So the efforts to decrease leverage ratio will be likely to worsen their financial situation, considering the fact that China’s direct financial system is still yet to be established and perfected.

The lack of assets worth investing

The purchasing power of Chinese citizen has long been strong. This is further enlarged by the economic leverage in household sector. This phenomenon is contrasted by the lack of assets worth investing. This means that Chinese citizens cannot find high-quality asset to invest. This situation was worsened by the intensive real estate regulatory policies.

Currency over-issuing

The debt-GDP ratio in China is around 2.5% to 2.7%, this is obviously higher than normal level. The issued debt is twice as much as the GDP, which causes a serious problem: intensifying debt interest burden. China’s GDP has grown by about 5 trillion yuan but we have paid about 11 trillion yuan for debt interest. This is a typical debt-driven economic growth, which is unsustainable. Because once the economy slows down, the existing debt will impose an extremely intensive burden on the economy. China’s economic situation is like that of Japan in the last century.

The over-issuing of the currency means that more debt is needed to generate per unit GDP. And this cannot help China to increase its core economic growth rate.

This chart illustrates why the core economic growth rate is decreasing. As we all know, China’s economy is export-oriented. In the past few decades, china has been exporting manufacturing goods by costing natural resources and employing cheap labors. This requires Chinese government to manage its exchange rate, or change the real exchange rate by export rebates to stimulate its export and therefore promote China’s economy. This is a typical extensive economic growth pattern.

Meanwhile, China’s high-speed export resulted in the long-time current account deficit of America. In order to reduce this deficit and increase the domestic employment rate, the US government has been asking China to appreciate its currency and threatened to accuse China of manipulating the exchange rate. Unable to be distracted from the issue rising in North Korea, the US didn’t take actions this time, but the trade friction between the two countries will persist long. In the future, a large amount of money will flow into China if the Chinese yuan is forced to appreciate. And this will lead to the domestic asset bubble.

The over-issuing of the money will lead the Chinese yuan to depreciate and harm the connotative development. However, if the Chinese yuan appreciates, it will stimulate the domestic demand and result in the over prosperity of real estate and infrastructure and therefore causes asset bubble.

From this chart we can see the trend of exchange rate between Chinese yuan and US dollars. This rate was relatively stable before 2005. But after the exchange rate reform in 2005, Chinese yuan was appreciating for a decade because of the “double surpluses” (namely current account and financial account.)

Opportunities amid Transformation

In this year’s NPC and CPPCC, the GDP growth goal set by our government is 6.5%. To realize this goal, our government should focus more on fiscal policies when still properly employing monetary policies. In fact, the effect of monetary policies is not desirable around the world. The Chinese government has room for fiscal policies since the ratio of debt and GDP is only 50% while that of many economic entities in the world is 100%. This can been seen as a big advantage for the Chinese government.

The Chinese government can increase the demand by expanding its spending. A feasible program is PPP, through which private fund can be absorbed into the government’s investing plan. By doing so, the government can enlarge the effect of its fund. This joint force can help to better increase the demand and promote the economic growth. This program has actually been successfully practiced in many western countries.

Usually, government tends to borrow money from banks. But if the government can finance programs by issuing bonds to public and private sectors, its default risk and leverage rate can be decreased. Furthermore, state-owned enterprises should play its leading role. For a long time, state-owned enterprises get more loans from banks than small businesses but they cannot use the money effectively because of the property owner absence phenomenon. The government should use fiscal policies in a flexible way by instructing state-owned enterprises to invest in some areas and then attract private companies to join in. This can help to better increase domestic demand and promote economic growth.

The good performance of China’s economy can guide the public expectation and thus form a virtuous circle. However, this requires a more active role of the government in fiscal policies.