China's New Deal

The Chinese government has unveiled a boost to its slowing economy that is worth almost $600bn. Sean O'Grady reports on China's plans to spend its way out of the global slowdown
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The Independent Online

The Chinese have been called many things in recent years, but until now no one has tried to pin the label "Keynesian" on them. Like most things in China – the Beijing Olympics, industrialisation, cultural revolutions – when they decide they want to do something, they do it big. So it is with their Keynesian boost to the economy: some 4 trillion yuan, over $500bn. It is the equivalent of 7 per cent of China's GDP; adjusting for the size of our relative economies, it would be as if Alistair Darling was to get up in the House of Commons and announce that he had abolished VAT and stamp duty in the name of getting the economy moving.

The reasons for the Chinese government's initiative are not difficult to find. Although growth is still impressive by the standards of the advanced economies, it is faltering by comparison with the recent cracking pace set by the Chinese themselves. The International Monetary Fund last week downgraded its growth forecast to 8.5 per cent for 2009, only about two thirds of the rate achieved in 2007, and down by 0.8 per cent on the forecast made only a month ago in the fund's World Economic Outlook.

That downgrade, in turn, has been caused by two or three fairly obvious factors. The credit crunch, which had previously passed China by, is now beginning to make its baleful effects clear. Quietly, companies in China are going bust and laying off workers. "Decoupling" – the notion that the fast-growing emerging markets such as China could detach themselves from the sluggish West – has proven mistaken.

Exports are 40 per cent of China's GDP, and a fifth of those are sent to the US, its biggest national trading partner. Add in the still larger slice accounted for by the 27 members of the also stumbling economies of the EU, and a further 8 per cent accounted for by stagnant Japan, and it is clear to see what must be going on in all those factories making our shirts, pet food, toys and DVD players. It was never very likely that as open an economy as China now is could escape the credit crunch, and so it has proved.

Recent weeks have seen another benefit of globalisation switch into reverse. Rather than a wave of western inward investment firing Chinese stock markets, all the emerging economies have seen a flight of capital that has destabilised their financial markets and shredded many of their currencies.

China has also had to cope with the steady deflation of her stock market and real estate bubbles that predated the latest turmoil. China's vast foreign currency reserves – they will reach $2 trillion before long – have helped her withstand the pummelling that has seen smaller, weaker nations run to the IMF for help. But it has been a sobering experience.

So if the new emphasis on rebalancing China's economy towards domestic rather than export-led growth is followed up, the world as a whole may breathe a sigh of relief.

China's insistence on export-led growth is, on one level, understandable. The markets of North America, Europe and developed Asia are extremely tempting; the purchasing power of their citizens so far ahead of the average Chinese as to make the comparison meaningless. A Chinese peasant might labour for weeks to be able to pay for just one shirt, something that could be earned by most Americans within an hour of arriving at work.

Yet the large surpluses that China has built up have caused geopolitical resentments and, at least to some degree, did much to fuel the credit boom that has now turned to bust and dust. US Senators – Barack Obama among them, as well as successive EU trade commissioners and WTO officials, have long remonstrated with the Chinese to revalue their yuan, which remains undervalued. The Chinese have shown themselves slow to respond. Now perhaps they have decided be a little less dependent on the exchange rate for their success. Inflation in China has eased lately, which adds to the attractions of a public spending binge.

The downside to the Chinese authorities' new enthusiasm for the wisdom of John Maynard Keynes – we might call it in this case "spending your way out of single digit growth" rather than a slump as we understand it – is that it will reinforce one of the Chinese economy's most serious yet least remarked-upon weaknesses; its huge overinvestment. Yet more "prestige" infrastructure projects and public works are likely to make that worse. The semi-planned Chinese economy simply invests far too much – something like 50 per cent of national income, far more than western societies did at similar stages in their industrial revolutions a century or more ago. In terms of inputs – manpower and energy – much is wasted.

Such inefficiencies are especially dangerous in an economy that needs to generate 25 million jobs a year – roughly the size of the entire UK workforce – just to stay still and absorb China's rising generations.

The promise of more public spending is in part also an attempt to spread China's new prosperity to the countryside and urban poor. Some call it China's "New Deal", just as the original New Deal launched by President Roosevelt in the US during the Great Depression was focused on especially depressed areas such as Tennessee and Alabama.

For social and political reasons as well as economic ones, China too cannot afford to stay still. Next year marks the 60th anniversary of the founding of the People's Republic by Chairman Mao. Senior Chinese officials say it will be a time for thought as much as parades. One pressing worry is the growing divide in China between a poorer, more rural west China and the arc of westernised prosperity that stretches along the eastern seaboard, from Beijing, Shanghai, Hangzhou and Nanjing through to Shenzen and Hong Kong.

It is why the Communist Party fears multiparty democracy so much. Poverty breeds division; division begets weakness; weakness brings national humiliation, as it did for so much of China's story in the 20th century. China's leaders will be very happy to spend their way out of that particular problem.