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May We Learn from Mistakes of '08
Summary:If China's only responds to the economic slowdown with big investment projects and huge capital injections, then it will be quenching a thirst by drinking poison.

By EO Editorial Board
Issue 571, May 28, 2012
News, cover
Translated by Gao Xin
Original article [Chinese]

Should we be glad to see signs of an economic stimulus package? Last week, the standing committee of the State Council said that there needs to be a “greater emphasis on growth,” and it issued a set of supportive policies, which had been anticipated over the last few weeks.

It’s obvious that the decision makers are worried about a hard landing for the Chinese economy, and have already taken action to avoid this outcome.

The market was broadly expecting a new economic stimulus, and the signals from the standing committee of the State Council are in line with those expectations. The new stimulus for 2012 has already been arranged, and more measures will follow, but the response from economists has been closer to alarm rather than enthusiasm.

For example, Wu Jinglian has said that “the government must endure its loneliness”. Some others even believe that the new policy is exactly the same as the stimulus package from 2008 and that we shouldn’t underestimate its negative consequences.

When the global financial crisis stuck in 2008, China’s economy was suffering from excessive government control. The instant four trillion yuan stimulus arrested the economic downturn with an efficacy that has never been seen in any other economy. However, the huge amount of credit injected during that period led to two years of rampant inflation.

To this day, the country is still suffering from the “advance of the state and the retreat of private enterprise”. Not only are we seeing delays to the rebalancing of the China’s economy, we’re also witnessing  a decline in overall economic vitality and debt risks for local government financing platforms along with the potential for the growth of bad loans in the banking industry. Therefore, even though the argument that “the top priority is to rescue the economy” can be used to defend today’s policy, we should be careful to learn the lessons of our past mistakes.

Of course, we ought to pay attention to rescuing the economy. Recently, for political and economic reasons, the vitality of businesses has fallen suddenly, and macro data shows that there’s a danger that the economy might experience a rapid slowdown. We’re glad to see policy responses in these circumstances, but there are some differences between this time and 2008. For instance, structural tax reduction has been set as a top priority, as has private investment in railways, municipal affairs, energy, telecom, education and health care. This shows that the government expects to raise the level of investment from actors in the market in order to push policies to boost the economy. The four trillion yuan stimulus in 2008 was mainly targeted at huge investment projects run by the government and state-owned companies, with banks coordinating the financing effort that rescued the economy.

However, whether it’s about reducing the tax burden or opening up the market, it’s hard for those measures in these areas to drive economic growth in the short term. As a result of weak foreign demand, exports are low this year and it’s hard for the government to boost domestic demand when reforms to equalize income distribution have been implemented so slowly. If we’re measuring by the speed and effectiveness of the results, then the key is getting loans flowing so that work can get started on a batch of major projects.

Therefore, we don’t think it’s amiss to look back at the experiences and lessons from 2008. Decision makers should make sure that the stimulus plan is of an appropriate scale and steers clear of negative effects. If the central government acts as though big investment projects and huge capital injections are the only stimulus that matters, then it’s trying to quench a thirst by drinking poison. This is just like using strong antibiotics to treat an infection - they can save the patient from an emergency, but once he began to shows a dependence or resistance on the pills, he might be incurable if the illness reappears.

Therefore, decision makers should pay attention to mid- and long-term policy adjustments as well as the implementation of the short term ones. Making structural tax reductions, reforming income distribution reform and breaking the monopoly of state-owned enterprises is at the core of these adjustments. Those measures take courage.

Tax reductions are often offset by new taxes created on a whim; no progress was made on income distribution reforms after they were proposed eight years ago; the State Council’s Several Opinions on Encouraging and Guiding the Healthy Development of Private Investment are rolled out only when the economy is weak are people are prepared to listen.

Needless to say, changing policy will affect the incomes of the government and state-owned enterprises, so of course it’s a difficult knot to untie. However, unless we push forward with the reform, China’s economy won’t have a foundation for sustainable growth. And if China doesn’t have the courage to promote reform, any crisis that we face in the future won’t simply be an economic one.

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