Ben Bernanke has weighed in with an interesting intervention on China, arguing that fiscal policy targeted at household consumption could offer a way out of the current economic problems:
An alternative worth exploring is targeted fiscal policy, by which I mean government spending and tax measures aimed specifically at aiding the transition in China’s growth model. (Spending on traditional infrastructure like roads and bridges is not what I have in mind; in the Chinese context, that’s part of the old growth model.) For example, as China observers have noted, the lack of a strong social safety net—the fact that Chinese citizens are mostly on their own when it comes to covering costs of health care, education, and retirement—is an important motivation for China’s extraordinarily high household saving rate. Fiscal policies aimed at increasing income security, such as strengthening the pension system, would help to promote consumer confidence and consumer spending. Likewise, tax cuts or credits could be used to enhance households’ disposable income, and government-financed training and relocation programs could help workers transition from slowing to expanding sectors. Whether subsidies to services industries are appropriate would need to be studied; but certainly, unwinding existing subsidies to heavy industry and state-owned enterprises, together with efforts to promote entrepreneurship and a more-level playing field, would be constructive.
There are a few things to say about this. First and to be clear, I agree. It would generally be a good thing to switch fiscal priorities from off-budget spending on infrastructure to on-budget spending that supports consumption. But that’s part of the problem: people have been giving China this particular bit of advice for years. And in fact the government has not ignored this advice, and has steadily raised spending on social programs (universal healthcare coverage was more or less achieved in 2011).
Of course, China could do still more. But it may not be that simple for them to do a lot more than they are already doing. China has a fiscal system that is strongly biased toward delivering investment rather than streams of benefits to consumers. It’s worth stopping to think for a bit about just how unusual this is, as most governments around the world are the exact opposite: they are primarily bureaucracies for delivering social programs, not designing investment projects. The World Bank office a while back made a fascinating comparison of China’s fiscal spending patterns with those of OECD countries. The results are summarized in the excerpt and table below:
A large share of government spending supports capital expenditures in transport, housing, and other economic activities, as gaps in providing core public services remain wide. While the size of government expenditures (public finance budget, government fund budget, and social security budget) remains similar to the OECD average, the composition of expenditures differs substantially. First, spending on general public services is under half the OECD average. It is declining due to continuing efforts to reduce wasteful public outlays: in the first half of 2014 it accounted for only 2.4% of GDP, down from 3.0% in 2013. Second, despite gradual increases, expenditures on social services (health, education, and social protection) are far lower than in the OECD countries. Third, outlays on economic affairs, housing, and community amenities are about three times as high as the OECD average.
Note that this bias toward investment spending is very strong in the official government budget–even before any of local governments’ massive off-budget spending on infrastructure is accounted for. So while I don’t think it’s wrong to urge China to shift the composition of its fiscal spending, I also think it’s important to recognize that this might be difficult to do quickly. They have a set of institutions and priorities that are well established and deeply rooted, and making a big shift in those would require both a different way of thinking and extensive practical changes. It’s certainly not impossible, but it’s also not easy.
A final point is that even if they do move to a consumer-focused fiscal stimulus, it might not deliver that much net impact on growth. This is simply because of the size of existing infrastructure-based fiscal stimulus: the IMF estimates that once off-budget local government spending is included, the annual fiscal deficit is on the order of 10% of GDP (compared to an on-budget deficit of 2-3%). Given the already-huge size of infrastructure spending, it seems more likely that consumer-focused spending would replace it rather than add to it over time. This would be a good way to soften the impact of reducing infrastructure spending; it also seems likely that the multipliers from a consumption stimulus would be higher than infrastructure spending at this point, as infrastructure is probably reaching diminishing returns. But expenditure-switching seems more like a strategy for allowing China to wind down its enormous fiscal deficits than one for delivering a lot of additional fiscal stimulus.