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In China, Stimulus and Questions about Global Financial Governance

Authors: Elizabeth C. Economy, C.V. Starr Senior Fellow and Director for Asia Studies, and Adam Segal, Maurice R. Greenberg Senior Fellow for China Studies
November 13, 2008

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Even before the U.S. financial meltdown, the Chinese economy had shown signs of strain, with rising unemployment, falling exports, and a plummeting stock market. Well over sixty thousand factories closed down in the first half of 2008; the stock market has lost more than two-thirds of its value over the past year; and home and auto sales have slowed dramatically. Not surprisingly, unemployment is now a top concern for the government. Laid-off workers are protesting loudly and frequently throughout coastal China. Even China's well-educated are not immune to the country's slowdown: According to one survey, 80 percent of this year's college graduates were still jobless in August. With all this, fourth quarter gross domestic product (GDP) growth may be as low 5.8 percent.

China's leaders are moving quickly to stave off what they now fear could be a significant downturn in their economy. On November 9th, they announced a major stimulus package of 4 trillion yuan (about $586 billion). The funds are slated for investment over the next two years in a number of sectors, including low-income housing, rural infrastructure, water, electricity, transportation, the environment, technological innovation, and earthquake reconstruction. The government has also abolished the credit ceiling on commercial bank lending in the hopes of spurring falling investment levels.

Chinese officials and experts have begun to frame the financial crisis as an opportunity to reform international finance and trade.

This package follows on the heels of several stimulus policies announced over the past few months, including interest rate cuts, lower bank reserve requirement ratios, reform of value-added taxes, and more infrastructure spending. Taken all together, these policies add up to a clear signal from the leadership that the focus is economic growth.

The stimulus package, coupled with the government's other measures, could shorten the length of the downturn and help ensure domestic stability. The large-scale infrastructure projects will be critical for absorbing the millions of out-of-work migrant construction workers, and also will provide a boost to China's steel and cement industries. In addition, these large-scale projects may prevent a rapid drop in Chinese consumption of imported resources, providing a degree of stability to the developing economies that have come to rely on China's commodities consumption to fuel their own economic development.

Yet questions concerning the real value of the package--to both China's economic recovery and that of the rest of the world-remain. It's uncertain how much of this funding is actually "new," with some analysts arguing that well over one-third of the package is simply previously allocated funds that have been rebranded. The extent to which Beijing is not relying on central reserves to fund this effort but rather local governments--who may or may not be supportive--is also in question. The success of the stimulus package will also ultimately depend on when and how funds are actually distributed; systemic corruption in China means that a significant percentage of large infrastructure funds often makes its way into the pockets of officials.

Some economists also believe that the basic thrust of the package is misguided--that continued economic growth in China will depend more on establishing a viable system of social welfare protection than on large stimulus packages.  They argue that the decades of export-led growth have come to an end, and that China must now develop its domestic market by supporting the development of a real social--welfare net-pensions, health care, and education--to enable the Chinese people to become consumers, not just savers. For much of the international community, increased Chinese consumer spending could play a significant role in a financial recovery. Such a transformation is not likely to occur quickly, however. The Chinese people will have to possess a much higher degree of confidence in government programs than they currently do before they are willing to dip into their household savings.

The jury also remains out as to China's ultimate role in resolving the world's financial crisis. Over the past month, Chinese officials and experts have begun to frame the financial crisis as an opportunity to reform international finance and trade. While in Moscow in October 2008, Premier Wen Jiabao stated that developing countries should get a bigger voice in international financial institutions. "The right of emerging and developing countries to know what's going on, have a voice, and the right to set rules should be improved," he said. The chief economist at China Galaxy Securities, Zuo Xiaolei, told the Associated Press, "Let's assume, if China does give money to the IMF [International Monetary Fund], of course China should ask for more rights." Moreover, at the Asia Europe Meeting (ASEM), held in early November in Paris, some Chinese experts proposed moving away from the dollar as the universal trade currency. They argued that trade between Europe and Asia could rely on the euro, the British pound, the yuan, or the Japanese yen through a system of bilateral or multilateral agreements.

The best thing we can do for the world, so China's leaders say, is to take care of things at home.

Still, Chinese leadership in resolving the financial crisis is likely to be constrained. China has generally understood its contribution to global challenges as stemming largely from reform on the home front, rather than leadership on the international stage. The best thing we can do for the world, so China's leaders say, is to take care of things at home.

When President Asif Ali Zardari of Pakistan went to China in October, for example, some may have predicted that China would have provided its longtime ally with much-needed economic assistance. Beijing, however, rejected the appeal for a $3 billion loan to bolster Pakistan's economy. It is clear, too, that China has been uncomfortable with calls for it to "rescue" the United States or to contribute substantially to a global bailout. Beijing feels neither prepared nor obligated to assume such a role.

China will be keeping a close eye on the U.S. economy, worried that a long recession could lead to a rise in protectionist sentiment, greatly complicating the bilateral trade relationship and China's own economic recovery.  To be sure, many in China will be looking for signs of what the financial crisis says about the future of U.S. power: Does the United States show economic and political resilience, or does the financial crisis further hobble Washington's influence?

If the economic downturn is deep and protracted, we might expect some changes in Chinese foreign policy. Beijing's primary objective will still be regional and international stability so that it can focus on economic development. However, slow growth could make it much more difficult for China to offer subsidies, trade agreements, or any of the other economic inducements Beijing has used in its dealings with Southeast Asia, Africa, and Latin America. If, however, China rebounds quickly, it can be expected to trumpet the apparent advantages of state capitalism, and perhaps, with mounting domestic and international pressure, assume a greater leadership role in shaping future global financial arrangements.

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