GUATEMALA CITY — As Beijing develops a reliance on fiscal spending to boost economic growth, a mushrooming fiscal deficit and ballooning public-sector debt will weaken China’s long-term economic prospects. This is because economic growth bought with increased government spending is unsustainable and creates distortions that will cause imbalances in production structures.
It is bad enough that this will bring low-quality growth due to the inefficiency and corruption associated with government spending. All this pump-priming has also been ineffective as evident with the return of deflation.
Although the State Statistics Bureau indicates that fixed-asset spending was up by almost 26 percent for the first five months of the year, most of the spending on fixed assets reflects capital expenditures by the government and state-owned enterprises, or SOEs. Consequently, the central government or its supplicants account for more than two-thirds of investment in the country and such spending outpaces gross domestic product growth by a factor of three.
In this fifth year of continued fiscal stimulus and growing budget deficits, a record budget buster was been announced that would come to 310 billion yuan ($37.5 billion) for the coming year. Ignoring the question over the accuracy of official GDP figures, China has an annual public-sector deficit that exceeds 3 percent of GDP.
Then there are problems on the revenue side that will mean that Beijing will face increasing strains on its finances. After substantial gains over recent years, central government finances have begun to deteriorate. While government expenditures experienced a year-on-year increase of 23.9 percent in the first quarter of 2002, tax revenues rose by just over 3 percent.
These large and growing deficits add to existing public-sector debt. When contingent liabilities that include recapitalizing the banks and fulfilling pension obligations are added to existing government debt and total bad debts held by SOEs, the total is around 70 percent of GDP.
It appears that China’s leaders are embarking on a dangerous gamble. They are undertaking a typical political ploy of inflicting long-term costs to capture short-term gains that will prove to be illusory. Public-sector deficit spending imposes a burden on future generations of taxpayers that will be required to pay for today’s follies.
Beijing’s tendency for spending beyond their means reflects a range of new pressures, including the hopes of smoothing the political transitions in the Communist Party leadership expected later this year. Public spending is also motivated by an attempt to break a nagging deflationary cycle and avoid further slowdowns in growth. At the same time, there is an intention to provide high-cost social-welfare programs and a need to address obligations arising from reform of the banking sector.
In all events, economic theory suggests that it might work if the problems at hand are cyclical and temporary in nature. Even casual observation reveals that China’s economy is suffering from long-term and structural problems that require radical and massive restructuring. Clearly Beijing has made a misdiagnosis and is attempting to apply an incorrect antidote.
How effective is deficit spending in reviving economic growth? A recent test case of mistakenly applying cyclical cures to resolve structural problems can be seen in Japan. Since the end of its “bubble economy,” most of Japan’s additional public-sector expenditures have been financed by deficits. With government spending during the 1990s exceeding 800 trillion yen, it was five times greater than fiscal expenditures in the United States. during its restructuring in the 1980s. Despite these massive expenditures that were combined with expansionary credit policies, Japan’s average economic growth in the 1990s was about 1.1 percent.
It turns out that Tokyo’s outstanding debt rose from 56 percent of GDP at the beginning of the 1990s to around 130 percent. Many credit-rating agencies put the figure at a much higher level.
All this bad news in Japan is the outcome of a government too stubborn or afraid to implement the necessary policies to force radical restructuring of the economy. By following this same path of timidity and lack of resolve, Chinese leaders are likely to have a hand in further deterioration in their economy.
Some similarities exist in the necessary restructuring for these two economies. In both Japan and China, small and medium-size enterprises were starved of capital while some industrial behemoths were kept alive. Rising incomes and lower unemployment rates for both countries will await policy changes that allow a new entrepreneurial class to provide the basis of future growth.
Despite high levels of personal savings in both countries, the allocation of these funds is grotesquely inefficient. Neither Japan nor China has a well-functioning domestic capital market with most borrowing directed through the banking system.
An obvious problem with bank lending is its vulnerability to political pressures. Indeed, the politicization of decisions on capital formation is at the core of the problems in China and Japan. Both countries need domestic stock and bond markets that are wider and deeper. Since capital markets require greater transparency and accountability, massive failures tend to be less likely.
Restructuring in China and Japan needs to be aimed at more than merely cutting costs. Cost reductions can only resolve temporary difficulties. Proper restructuring requires a dynamic perspective that involves deep reform of management practices and government involvement in the economy. China and Japan need nothing less than changes in their corporate and political cultures to encourage the kind of entrepreneurial initiatives that can resolve their economic woes.
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