China’s Visionary Stimulus

SHANGHAI – In March of last year, the first session of China’s 12th National People’s Congress began with then-Premier Wen Jiabao delivering his tenth and final When he had finished, the 3,000 representatives in attendance gave him a resounding ovation that was surely a response to more than the report; it was a display of praise and respect for his achievements as the head of China’s government.

Since then, however, assessments of Wen’s leadership – particularly his stewardship of the economy – have varied widely. Whereas Wen’s supporters remain adamant that he fundamentally supported a shift toward democracy and a market economy for China, his critics lambast him for failing to fulfill his promises of political and economic reform. As Wen’s successor, Li Keqiang, attempts to engineer deep systemic reforms, understanding Wen’s policy decisions could not be more relevant.

Wen’s most contentious economic policy was the CN¥4 trillion ($586 billion) stimulus package that his government launched in response to the 2008 financial crisis. Though the policy succeeded in buttressing China’s economic growth, it was widely criticized as an overreaction – one that led to excessive monetary expansion.

Indeed, the surge in bank loans caused (a broad measure of the money supply) to soar, from 150% of GDP in 2008 to some 200%, or more than CN¥100 trillion, today. The massive injection of liquidity into China’s economy has contributed to rising debt, especially among local governments and firms, while fueling massive real-estate bubbles, and resulting in significant excess capacity.

Over the last 18 months, Li’s government has been attempting to address these challenges, by overhauling China’s industrial structure, reducing excess production capacity, restricting lending, containing the shadow banking sector, and curbing real-estate investment. And he has had some success – at the expense of economic growth. Though the current rate of 7% is comfortable, it is far lower than the double-digit rates that prevailed prior to 2008.

Given the need for further economic restructuring – and in view of long-term demographic trends, which will reduce the labor supply – pre-2008 growth rates are unlikely to be restored. This is fine with Li, who recognizes that structural transformation and industrial upgrading – not an unsustainable credit-led growth model – is the key to achieving high-income status.

But there is more to assessing Wen’s stimulus than the growth/reform trade-off. The policy also helped to expand China’s foreign trade and boost its external financial strength (with a robust balance-of-payments position, large international reserves, and a stable currency), thereby creating space for Li to carry out his ambitious reform agenda.

At the same time, the global financial crisis triggered a shift in the relative price of assets worldwide. As developed countries were plunged into debt crises, with shrinking asset values and declining exchange rates, China’s international purchasing power grew. This, together with Wen’s stimulus, bolstered China’s investment and financing capabilities considerably.

Countries like New Zealand and Peru, unable to depend on developed countries for export demand, signed bilateral free-trade agreements with China. Likewise, when developed countries cut back on their foreign investment, China stepped in to inject much-needed capital into the global economy.

In fact, many countries began to pursue improved bilateral relations with China, in order to gain access to its capital. For example, in 2009, Jamaica was faced with a plummeting currency, surging unemployment, and considerable banking-sector risks stemming from exposure to government debt. When its traditional allies, the United States and the United Kingdom, rejected its pleas for help, it turned to China, which provided $138 million in loans to prop up the economy.

By next year, China’s outward investment is likely to reach over $100 billion annually – bringing it close to parity with inflows. It will not be long before China undergoes an historic shift from net merchandise exporter to net capital exporter.

And China’s external financing activities do not end there. In 2009-2010, China also invested heavily in the International Monetary Fund, with the People’s Bank of China announcing in 2009 that it would buy up to (the IMF’s quasi-currency) – the equivalent of about $50 billion. Over the same period, China signed multiple bilateral currency-swap agreements, offered policy loans and special assistance, and contributed to regional investment funds.