China´s fiscal deficit makes sense – Sara Hsu

China´s fiscal deficit will be the largest in six years. Financial analyst Sara Hsu explains why this is a good move, so it can encourage spending, she writes in the Diplomat.

Sara Hsu:

China’s central government deficit is projected to be the largest in six years. The official government deficit was originally forecast to be around 2.3 percent of GDP, but the actual deficit will likely come close to 2.7 percent, according to Finance Minister Lou Jiwei. This is because China is committed to expanding its fiscal policy in the face of a domestic and global economic slowdown, as well it should be. Moreover, the additional funds come from unspent money allotted in the previous year’s budget.

China’s position in favor of fiscal spending is in line with Keynesian wisdom that government spending can alleviate the worst effects of slowing demand. This wisdom, while rejected in the eighties and nineties, was restored in the wake of the 2008 global crisis: countries all over the world launched fiscal stimulus packages that worked against recessionary tendencies and helped bolster employment. Fiscal stimulus in times of recession has been shown to have a greater impact on the economy than in times of expansion. In fact, researchers at the Inter-American Development Bank found that stimulus carried out in 2009 and 2010 raised China’s GDP by 2.6 percent and 0.6 percent, respectively. Greece, which was forced to cut government spending, by contrast, appears to be trapped in a downward spiral of slow growth. Therefore, while some analysts fear fiscal deficits during periods of financial stress, the proof of the spending “pudding” is in the recovery.

China has been engaging in expansionary fiscal policy on and off since even before the global crisis hit in 2008. Last year, China increased spending in education and public housing, and continued to spend on infrastructure. While China’s spending on infrastructure has to some extent been decried as inefficient, certainly spending on pro-poor sectors such as education, public housing, and social services not only has a positive impact on China’s GDP, but also on inequality. In fact, although the spending efficiency of local governments has declined, studiesof China’s fiscal spending in the earlier 2000s have shown the nation to be one of the most efficient in government spending in Asia.

The biggest concern in China’s fiscal spending agenda is that local governments have not spent wisely. However, they have been taught (and may have learned) their lesson after the national audit on local government debt revealed how careless local governments had become in taking on new projects. Local governments spent massively on unusable infrastructure (including ghost towns) in local regions, but this practice appears to have stopped. While China’s budgeting process remains relatively opaque, we do know that building up sectors outside of local infrastructure investment will boost economic growth. Funds are anticipated to be spent in part on modernizing agriculture and on railway projects.

Finally, China’s government deficit should decline and/or reverse over time, as the tax and budgeting systems are reformed. Increasing the tax base, which is in the works, should increase government revenue. The budgeting process is expected to become more transparent and, over time, subject to fiscal discipline and audits, which will likely streamline spending and reduce waste. Therefore, not only is the 2015 government deficit necessary, it is also sound in the long-run view that takes government debt into account. As China restructures, there is little alternative to make up for lack of demand with high-impact expansionary fiscal policy.