The Sustainability of China's Recovery from the Global Recession

POLICY BRIEF 10-7

The Sustainability of China's Recovery from the Global Recession

by Nicholas R. Lardy, Peterson Institute for International Economics

March 2010

Nicholas R. Lardy China faces major challenges in sustaining its economic growth in a period of weak global recovery, particularly in Europe. In 2009 China's net exports of goods and services dropped precipitously, resulting in a substantial drag on economic growth. To overcome this drag China launched a massive stimulus program, financed largely with bank credit. While it is now widely understood that China was the first globally significant economy to begin to recover from the crisis, critics nonetheless increasingly charge that the stimulus program has substantial flaws and that China's early economic recovery cannot be sustained. One prominent critic has gone so far as to suggest that the stimulus has created a debt-fueled bubble that will collapse, causing China's growth to plunge to only 2 percent.

Nicholas Lardy suggests these criticisms are exaggerated. Contrary to repeated criticisms, this stimulus had a substantial consumption component and focused on investment in infrastructure rather than expanding capacity in traditional industries such as steel. But the stimulus did come at a cost insofar as it led to a substantial increase in the borrowing of local investment companies, which local governments will have to ultimately repay, but the infrastructure provided through these companies likely will contribute to China's sustained economic growth and thus to increasing government tax revenues as well.

The authorities recognize flooding the economy with more credit is not the way forward and that they will have to take strong additional policy initiatives to sustain economic growth. These include raising the prices of inputs such as water, electricity, and other resource products as well as introducing realistic environmental taxes and fees. These reforms, as well as a more flexible exchange rate, would reduce the distortions that for much of the past decade have favored industrial growth and exports over services and consumption and would contribute to sustaining China's impressive long-term economic growth.

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