Chinese government attempts to stimulate economy

The United States sneezes and the rest of the world catches a cold. So the saying goes. So what happens these days when China's economic engine slows down? The immediate effect is for the global economy to respond similarly. So the whole world is waiting to see what effect a massive stimulus package that the Chinese government announced earlier today will have.

Economists note that China's current slowdown has eased the demand for materials such as steel and concrete (in great demand by the wind energy industry). Wouldn't this be an opportune time for the U.S. to stimulate the national economy with a works program based in large measure on the construction of a renewable energy infrastructure?

China Announces Major Stimulus Plan

Spending on Projects And Other Measures May Hit $586 Billion

By Andrew Batson
Wall Street Journal
November 10, 2008

BEIJING -- China announced a stimulus program that could exceed half a trillion dollars, its biggest move yet to rebuild rapidly weakening confidence and unleash domestic demand to counter the prospect of global economic recession.

The package of infrastructure investment and other stimulus measures is to be spread over the next two years and appears to include some measures that were already announced. Still, the huge scale of the planned response -- potentially 4 trillion yuan ($586 billion) -- underscores how rapidly the outlook for China's once-booming economy has worsened and how the country remains comparatively well-placed to deal with such a slowdown.

The boom years have been kind to China, allowing it to clean up its banking system, return state enterprises to profitability and shore up government finances. Now the state is putting its significant financial resources -- including a budget that for the moment is still in surplus -- into play to shore up the economy.

Growth has already slowed to the weakest pace in five years, with output expanding just 9% in the third quarter from a year earlier after gaining nearly 12% in 2007. That is still fast by the standards of any other country and helps show why China is important to maintaining a decent pace of global economic expansion.

But China's government has long held that growth of at least 8% is needed to provide the improvement of jobs and incomes that it relies on for political support. And, while China's financial system remains largely unscathed so far by the global credit squeeze, prospects for the country's continued growth at that kind of pace have deteriorated rapidly.

Export orders from the U.S., Europe and Japan are weakening, causing factories around China to trim workforces or shut down entirely. Spooked urban consumers are pulling back from China's housing market, causing new construction to collapse to its worst level in a decade.

With construction weak, support for other key industries such as cement and steel has eroded, and they are cutting output and canceling orders for raw materials -- moves that are being felt by commodities firms around the world. The downward spiral in confidence is likely to depress growth even further.

China's leaders "realize this is really about sentiment and confidence, which needs a very fast and strong policy response," said Wang Qing, an economist with Morgan Stanley.

The stimulus program was announced Sunday night in Beijing, just before the scheduled release of economic data for October that are expected to show a further sharp deterioration in activity.

Mr. Wang said that based on recent trends and without a policy response, China could have seen 5% to 6% growth next year. With the stimulus measures -- including previous moves to cut interest rates and end caps on bank lending -- he said China now has good odds of achieving the 8% to 9% growth in 2009 that officials still say they expect.

Foreign suppliers of metals and machinery for infrastructure construction and companies that target Chinese consumers will be closely watching the effects of the stimulus program.

Other governments around the world are also considering fiscal stimulus plans to boost their economies, something the International Monetary Fund has encouraged. U.S. lawmakers, during their lame-duck session next week, are expected to consider a stimulus package focused on aid to local governments and extended unemployment benefits.

U.S. House Speaker Nancy Pelosi is pushing for a two-step plan with as much as $100 billion this month followed by a companion measure early next year that would include a tax cut. Outside economists are urging Democratic congressional leaders to move a much larger package -- as much as $300 billion, or 2% of U.S. economic output -- as the U.S. economy faces one of its worst recessions since the 1930s.

China's plan appears to be comparable in size. In a statement announcing the plan, China's State Council said it would deliver 120 billion yuan ($18 billion) of new spending in the last quarter of this year alone. The State Council -- effectively China's cabinet -- estimated that would drive an additional increase of 400 billion yuan in local and private-sector investment throughout the economy.

China's government is also making plans for new spending in areas such as low-cost housing, road and rail infrastructure, agricultural subsidies, health care and social welfare over the next two years.

However, the total new investment could be less than the headline figure of 4 trillion yuan, since the plan does appear, for instance, to incorporate rebuilding programs for the areas affected by May's massive earthquake. Those have already been allocated 1 trillion yuan in funds.

Nonetheless, the figure for the stimulus is enormous and clearly designed to impress. The sum represents about 16% of China's total economic output last year, and is roughly equivalent to the total of all central and local government spending in 2006. China's original budget for this year had called for about 6 trillion yuan in spending.

The rapidity of the response underscored the government's concern about the growing risks of a real downturn. Although Chinese officials have been meeting daily on the financial crisis, most observers hadn't expected leaders to reach final consensus on a stimulus plan until an annual economic-policy meeting scheduled for the end of this month.

China has also joined in international calls to revamp international financial oversight and address faltering business and consumer confidence. President Hu Jintao will visit Washington later this month to meet other world leaders, including U.S. President-elect Barack Obama. On Saturday, in their first telephone conversation since last week's election, Mr. Hu told Mr. Obama that China "attaches great importance" to that summit, and called for efforts to strengthen international financial regulation, China's official Xinhua news agency reported.

Economists said China's new stimulus plan represented an even more dramatic policy response than China adopted in 1998 during the Asian financial crisis, when Beijing spent heavily to counter a similarly worrisome combination of an external financial crisis and a sharp domestic slowdown.

"As the global economic and financial crisis has become more severe in the last two months, China must take flexible and prudent macroeconomic policies to resist the negative impact of the international situation and deal with these complicated and ever-changing trends," the State Council said in its statement.

The new measures include an expected revamping of China's value-added tax system to allow all companies operating in China to deduct spending on capital equipment. The government estimated the new system, which is already in place in some provinces, would save companies a total of 120 billion yuan when fully rolled out. The government has recently been phasing out tax breaks specifically for foreign companies to invest in China and didn't mention any such measures as part of the stimulus.

Economists have pointed out that the change to the tax system is unlikely to encourage businesses to invest if they are doubtful about the economic outlook, which is likely one reason why the stimulus program puts more emphasis on new spending.

Another question is how quickly the effects of the stimulus package will be felt in the real economy. While the government's statement included language urging local officials to rapidly put new money to work, some lag is unavoidable. And since infrastructure spending has already been growing by about 20% annually for the last couple of decades, there may be physical and logistical limitations to how much spending can be further accelerated. Economists expect, at a minimum, one or two more quarters of slowing growth before a rebound can take hold.

"I don't doubt the government's ability to support growth. However the timing is challenging, as the speed of domestic demand may correct faster than fiscal policy can be eased," Ben Simpfendorfer, an economist for Royal Bank of Scotland, wrote in a report last week.

The government is presenting the program as an opportunity to do many things that would be worth doing anyway. Those include helping companies upgrade to higher-tech equipment, improving irrigation in rural areas, raising pensions and social-security payments, and improving water and waste treatment in crowded cities.

"Although we face many difficulties, our nation's domestic demand has great potential, our financial system is sound, and our companies are well able to respond to market changes. This adjustment in the world economy is a new opportunity for our nation to accelerate structural improvements and attract international technology and talent," the State Council statement said.

China's government can afford to spend. With tax revenue surging by more than 30% last year, central and local governments ran a combined surplus equivalent to 0.7% of the year's gross domestic product. That gives China a better starting point to deliver a fiscal push to the economy, compared to places such as the U.S. which already have large budget deficits.

Beijing was already planning a return to deficit spending this year, with March's budget forecasts implying a gap that would be 0.8% of GDP, though the final figure is now certain to be larger. China is also expected to sell large quantities of government bonds next year to finance new spending, and has room to do so: Government debt is relatively low, estimated around 17% of this year's economic output.

—Sudeep Reddy in Washington and James T. Areddy in Shanghai contributed to this article.