David Daokui Li's case for more government bonds as fiscal relief
Tsinghua economists emphasized central government responsibility, advocating for the issuance of long-term bonds with maturities of 20 to 30 years to bail out local government debts.
David Daokui Li is the Mansfield Freeman Professor of Economics and Director of the Academic Center for Chinese Economic Practice and Thinking (ACCEPT) at Tsinghua University. In a short video uploaded on September 19, Li advocated that "issuing long-term government bonds is the most prudent solution to address the current economic challenges."A transcript was published on ACCEPT's official WeChat blog.
李稻葵:中国经济不需要强刺激,需要发行长期国债重组地方债,打通宏观经济流转的堵点、痛点
No Need for Strong Stimulus: The Case for Long-Term Government Bonds to Restructure Local Debt and Remove Macroeconomic Choke Points
What will be the next moves and adjustments in the Chinese economy? This is a significant question which I will discuss in a straightforward way.
The Economic Slump is Caused by Overlapping Infrastructure and Real Estate Cycles
To begin with, the current slump in the Chinese economy is a result of the overlap of two major cycles that influence and intertwine with each other.
The first factor is the infrastructure cycle. Over the past two decades, China has invested heavily in infrastructure, building bridges, roads, and airports. These investments have been essential and beneficial to the economy. However, once these projects are completed, demand decreases, leading to an economic slump. More importantly, during the infrastructure boom, high expectations led real economy investors to borrow more, often with short-term loans of less than ten years. Now, after nearly two decades of infrastructure investment, many of these loans are coming due. With the real economy weakening, the pressure to repay debt at a time of reduced economic activity has created substantial financial strain. Compounding this issue, banks are holding significant cash reserves that they are unable to lend out, creating a paradox of unmet funding needs.
This phenomenon has also been observed in countries like the United States and the United Kingdom. For instance, before the first major U.S. economic recession—the five-year downturn beginning in 1837—there was significant infrastructure investment, including the construction of canals and roads. During that recession, GDP declined by 30%, a situation far more severe than China's current economic challenges.
The second factor is the real estate cycle. Over the past two decades, urbanization has driven large numbers of people from rural areas to cities, fueling substantial growth in real estate development. However, this cycle has now peaked, with construction and sales volumes in the real estate sector declining by over 40%. It's important to note, though, that both the real estate and infrastructure cycles are long-term in nature and will eventually recover.
The Need for Long-Term Government Bonds to Restructure Local Government Debt and Mitigate Cycle Impacts
China's urbanization remains incomplete, with only about 50% of the population fully integrated into urban life through homeownership in cities. The other half has yet to find employment or purchase property in urban areas. Given this context, what would be the appropriate responses to the current economic slump?
Given the long-term nature of the infrastructure and real estate cycles, local governments lack both the capacity and influence to effectively address these challenges. Enterprises are similarly constrained, and the general public is even less empowered to effect change. The responsibility, therefore, falls on the central government to issue long-term bonds.
Currently, Chinese banks are flush with funds, but there is a lack of willing investors. The state should issue long-term bonds with maturities of 20 to 30 years, which banks can purchase, helping local governments repay portions of their debt and restoring economic vitality. Additionally, state-issued long-term bonds are in high demand as there is a severe shortage of low-risk, highly liquid assets. Central government debt in China currently represents only about 25% of GDP, while developed economies typically have ratios exceeding 70%, 80%, or even 100%. For instance, Japan's debt-to-GDP ratio is over 220%. Therefore, the way forward is for the Chinese central government to implement measures to counteract and address these long-term economic cycles. This approach has been advocated by scholars, including myself, for some time, and I remain optimistic, despite the more pessimistic views held by others.
The Chinese Economy Does Not Need Strong Stimulus, Nor Can It Withstand It
The question now is whether strong stimulus measures are advisable for the Chinese economy. This seems unlikely. The Chinese economy neither requires nor can withstand strong stimulus. It's like a weak patient taking excessive medication, which could lead to unintended consequences rather than the desired outcomes.
Specifically, China's infrastructure is already highly developed, and further investment in this sector is unlikely to do any good; it may even worsen existing issues. While local governments should certainly enhance social services, this must be done cautiously and gradually. Sudden large-scale spending on social welfare and public services could create unsustainable expectations, leading to future fiscal deficits and long-term risks. The current challenges in China's economy stem from choke points in economic circulation, much like blood clots in the human body. On one hand, there is a severe cash flow shortage in the real economy, and on the other, banks are holding substantial amounts of funds.
Issuing long-term government bonds for financial institutions to purchase provides both security and liquidity. The central government can then use these bonds to replace local debt, helping to resolve the current liquidity conundrum by improving economic circulation.
Some have questioned why the central bank cannot simply issue currency to purchase local debt. This could be a short-term fix and better than a do-nothing strategy, but it is not as effective as issuing long-term bonds. The central bank needs to hold highly liquid assets that can be easily converted to cash so that when monetary policy requires tightening in the future, it can sell these standardized financial products—such as government bonds. If the central bank were to print money to buy large amounts of local debt, it would face challenges when inflation rises and it needs to sell assets, as local debt is difficult to offload. Moreover, managing local debt would exceed the central bank's capacity. Thus, issuing long-term government bonds is the most prudent solution to address the current economic challenges.