Fan Gang

Getting economic recipe right

By Fan Gang (China Daily)
Updated: 2010-07-02 07:50

China's active counter cyclical policy interventions in boom times has tamed overheating over the past three decades

China's GDP growth this year may approach 10 percent. While some countries are still dealing with economic crisis or its aftermath, China's challenge is - once again - how to manage a boom.

Thanks to decisive policy moves to pre-empt a housing bubble, the real-estate market has stabilized, and further corrections are expected soon. This is good news for China's economy, but disappointing, perhaps, to those who assumed that the government would allow the bubble to grow bigger and bigger, eventually precipitating a crash.

China has sustained rapid economic growth for 30 years without significant fluctuations or interruption - so far. Excluding the 1989-1990 slowdown, average annual growth over this period was 9.45 percent, with a peak of 14.2 percent in 1994 and 2007, and a nadir of 7.6 percent in 1999.

While most major economies in their early stages of growth suffered crises, China's story seems abnormal (or accidental), and has elicited periodic predictions of an "upcoming crash." All such predictions have proved wrong, but the longer the story lasts, the more people will forecast a bad end.

For me, there is nothing more abnormal about China's unbroken pattern of growth than effective macroeconomic intervention in boom times.

To be sure, both economic development and institutional reforms may cause instability. But the central government must be responsible for inflation in times of overheating, lest a bursting bubble fuel unemployment. Local governments and State-owned enterprises do not necessarily have those concerns.

They want high GDP growth, without worrying much about the macroeconomic consequences. They want to borrow as much as possible to finance ambitious investment projects, without worrying much about either repayment or inflation.

Indeed, the main cause of overheating in the early 1990s was over-borrowing by local governments.

Inflation soared to 21 percent in 1994 - its highest level over the past 30 years - and a great deal of local debt ended up as non-performing loans, which amounted to 40 percent of total credit in the state banking sector in the mid-1990s. This source of vulnerability has become less important, owing to tight restrictions imposed since the 1990s on local governments' borrowing capacity.

Now, however, the so-called "animal spirits" of China's first generation of entrepreneurs have become another source of overheating risk. The economy has been booming, income has been rising, and markets have been expanding - all this creates high potential for enterprises to grow; all want to seize new opportunities, and every investor wants to get rich fast.

They have been successful and, so far, have not experienced bad times. So they invest and speculate fiercely without much consideration of risk.