Twofish's Blog

February 5, 2009

Nature of Chinese stimulus

Filed under: china, finance — twofish @ 9:12 am

Yu: This is where the government needs to do more, as Wen has implied, rather than rely on the banks as quasi-fiscal organs of state.

One problem is that if you rely on direct funding from the government, what tends to get funded are large infrastructure projects which then take on a life of their own. The big problem with Keyesian stimulus is not so much starting big projects, but shutting them down once you have gotten out of trouble. Once you have a large political group that is making money from an infrastructure project, it becomes difficult to shut down. This is less of a problem with health and education, but it can be a big problem with things like roads.

Something that the government has to do is get credit to small and medium enterprises, and at that point the banks play a crucial role since only the banks have the staff to figure out who to lend to. The problem with lending to small and medium enterprises is that it’s something new for the big state banks, and they are likely to do it badly at the beginning. A small increase in NPL’s is not necessarily a bad thing, if it actually does encourage small and medium enterprise formation.

One important point is that when I say that the Chinese economy should be focused on investment and not consumption, I *don’t* support state subsidized capital to heavy industry. What I do support is investment in small and medium businesses. Getting credit to a dim-sum stand is in some ways much, much harder than getting credit to a steel factory.

Flora: have to say I share your concern on China’s longer-term growth outlook. the “expensive bet” on a quick recovery in global trade and economy trade will likely prove miscalculated,

I don’t think that the Chinese government is betting on a recovery in global trade and economy. It needs to create enough demand so that you have reasonable economic performance in China *regardless* of what happens in the rest of the world. It really doesn’t have a choice in the matter. If the government doesn’t get the Chinese economy growing in the next year or so, then the people on the streets will take matters into their own hands.

Flora: The Govt should focus more on helping the private sector in the rational way instead of blindly throwing money into public sector investment mainly initiated by local govts…

It’s not either/or. The problem is getting money into small and medium enterprises is very tough to do. One big problem is that large enterprises are too big to fail, so no one minds loaning them money. Small and medium enterprises can fail, so people are reluctant to lend to them in tough times. Another big problem is corruption. It’s much harder to make sure that money to small and medium enterprises gets to the right people than it is to monitor money to big enterprises.

Flora: a permanent derating of china’s GDP to below 5% beyond this cycle is not totally out of the question just like what happened to Japan after early 1970s.

I don’t think this is likely. Japan’s GDP started to hit limits after it had already reached levels of industrialization that China will not see for decades. Remember that by the 1920’s, Japan was already an industrialized nation with a far more productive economy than China has now.

Chinese GDP growth is not magical. It’s that the country is so underinvested that anything will help. The first freeway that you put in a county will generate huge amounts of economic growth as well the first factory. It doesn’t matter if the freeway or factory are incredibly inefficient. It is less inefficient than what was there before. If you have a poor enough country, then even industrialization through a broken inefficient system will create growth. Look at Russia from 1930 to 1960. Part of the problem with these discussions is that people are so fixiated about Japan and Russia in 1990, that the don’t look at the lessons of Japan and Russia in 1935.



  1. Sure, projects are hard to shut down , just like Shadow Shogun regime in Japan for long time. But it is easier to build roads in the short-term than to fix the shambles of national healthcare regime, or to boost education spending. Social services systems cannot absorb large increases in funding efficiently, but I think what commentor meant was the government needs to boost social spending in addition to more infrastructure. For China economic growth in the future, it may be tough, because although there plenty of areas to spend, income does not trickle down, just back to Party member and their interests, so it is either build lots or slowdown until actual income level reaches point to sustain higher contribution from household consumption. Now political firms get the projects and the loan. The government still does not like SME, despite rhetoric. Show them the money, you are right.

    Comment by Cochin Loco — February 5, 2009 @ 9:54 am

  2. Hi Twofish,

    I totally agree with your analysis of China. The recency bias of human nature makes people overweight its similarity with Japan in 1989 and underweight the experience of Japan in 1960, or even 1930s. Everyone agrees that China’s industrialization has to stop at some point, but they just don’t know whether it’s currently in its 2nd inning or the 8th inning. Based on my study of history and understanding about China, it’s much more likely that it’s in the 2nd inning than in the 8th inning. The 48% urbanization has 2 decades to go before it reaches 60s. The vast supply of cheap labor inland (800 million farmers) can be tapped for at least 2 more decades if industrial base can be built inland. The fact that we can’t turn many more inland farmers into migrant coastal workers doesn’t mean that the world is done tapping the labor pool in China.

    By the way, I recently started a blog after stumbling upon ndk’s inspiring post. I absolutely recommend reading his if you haven’t already. But I also would like to share my ruminations on this inflation/deflation debate with you. I would love to know if you, one of the original thinkers I respected the most, have any thoughts to share with me.

    Comment by CouldMarxBeRight — February 6, 2009 @ 4:39 pm

  3. Social service systems can’t absorb large amounts of funding in a short time, but the Chinese government has spent a few years ramping up a new health care system, and it’s can be more rapidly expanded. In the case of primary and secondary education, there is already a system in place, and funding can be increased. The trouble with using health and education for demand management, is that you can create stimulus by boosting teacher pay, but you really can’t do anti-stimulus. For example, if China boosts teacher salaries by 25% to get out of the recession, it can’t cut pay when times are good. However, a one time bonus might work.

    Political and party officials firms will spend their money in their own interests, but you can arrange things so that their interests are aligned with public interests. Workers end up getting money because of the unspoken but very real threat that if workers don’t get money, they will organize and burn down party headquarters.

    I think within the government there is realization that SME credit is necessary. The problem is that it is really, really hard. It is much harder to give a $1000 loan to a beauty salon than it is to give a $1 billion loan to a steel mill, and it’s even harder to give one million $1000 loans. Another hard problem is how do you integrate SME’s into the Chinese political system? It’s pretty obvious how you integrate large enterprises (i.e. set up a Party branch and hire a party secretary).

    It’s not so obvious how you integrate small and medium enterprises into the Party-State system. I think the system that is developing is that you will have business chambers of commerce which resemble Chinese labor unions, and you will have political interaction between SME’s and local officials, with credit going through banks that are not heavily influenced by local officials.

    Ultimately, the only reason that the government will even do this is the realization that not doing this will put the long term survival of the Party-State at risk, which it will. Part of it is that today’s small companies are part of tomorrow’s big companies.

    Comment by twofish — February 8, 2009 @ 4:51 pm

  4. I don’t think we are near the end of Chinese industrialization, but I do think we are near the end of export driven industrialization. The problem is not that there are too few Chinese, but that there are too few non-Chinese to buy Chinese products. Export industries may and probably will continue to generate employment for 100 million inland migrants, but the next 200 million migrants will have to find something else to do.

    Also industrialization may be the wrong term for what is going on. What is interesting is that the number of Chinese employed in manufacturing hasn’t increased since the 1980’s. What is going on is that as you increase manufacturing productivity, you increase the number of service jobs available. So that people have been going directly from agriculture to services. This is a pattern that is very, very different from what most other countries have gone through.

    So instead of building more factories that build refrigerators, what may happen is that you increase productivity so that you end up building more refrigerators with the same number of people. At this point then you have lots of job openings for refrigerator salesmen, refrigerator delivery people, refrigerator repairmen etc. etc. If you have cheap refrigerators, this also creates new businesses like ice cream parlors, which then creates jobs in advertising, ice cream product research.

    If you look at what I just said, it should be pretty obvious why I think that SME’s are important. You can create a refrigerator factory as a very large company, but it’s difficult to create an ice cream store that way.

    Comment by twofish — February 8, 2009 @ 5:04 pm

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