Ting Lu advises against common "cash handouts" proposal for China's economic slump
Ting Lu advises against common "cash handouts" proposal for China's economic slump
Nomura's Chief China Economist cites the vicious cycle of rising subsidies, advocating instead for targeted support for vulnerable groups.
Despite Beijing's hesitation, leading Chinese economists continue to advocate for direct cash handouts or consumption vouchers to revive slumping consumption and address high savings rates. At the forefront of this push is David Daokui Li, a professor at Tsinghua University, who proposes the issuance of one trillion RMB [$139 billion] in consumption vouchers during the upcoming seven-day National Day holiday in October to stimulate spending and invigorate the economy.
Ting Lu, Chief China Economist at Nomura, though, recently argued that the opportunity for broad cash handouts has passed and they should not be a primary tool for economic recovery. Lu believes that such handouts are most effective during severe external shocks, like the COVID-19 pandemic, to stabilize livelihoods and maintain aggregate demand. In contrast, China's current economic challenges stem from internal structural problems, such as the real estate sector contraction and weak domestic demand, which, he argues, require targeted, long-term reforms rather than temporary consumption boosts.
And the risks are real, says Lu. "Some developing countries that attempted similar measures—increasing welfare spending through money printing and large deficits—ultimately experienced severe outcomes such as hyperinflation, economic collapse, or even national disintegration," he warns.
Instead, Lu advocates for more targeted financial assistance, including subsidies for vulnerable groups, support for childbirth, and ensuring the completion of unfinished housing projects. He highlights the need to significantly increase pensions for China's nearly 300 million migrant workers, who have dedicated their youth to urban development but live frugally to secure their future. Additionally, Lu advises subsidizing basic medical insurance, as rising premiums for the scheme, which covers 68% of the population—primarily farmers and minors—have increasingly burdened the rural elderly, leading many to drop out due to the high costs.
Mr. Lu has kindly proofread our translation.
慎谈“发钱”
Cash Handouts Should be Approached with Discretion
Regarding the current situation of the Chinese economy, two seemingly indisputable consensuses have emerged among economists: interest rate cuts and direct cash handouts. Some scholars argue that significant and sustained interest rate cuts can solve all economic problems, while others firmly believe that distributing money or consumption vouchers to the entire population can stimulate consumption and boost domestic demand, ultimately curing economic malaise and revitalizing the economy.
This essay will discuss interest rate cuts separately later. First, it will explore the topic of direct cash handouts. The best opportunity for issuing cash or consumption vouchers to the Chinese population has passed, and it should not be considered a primary option for the central government. If cash handouts are to be implemented, they should target specific groups, primarily to encourage childbirth and provide basic social security and healthcare for vulnerable groups. Such subsidies can stimulate consumption, promote equity, and enhance future economic growth potential simultaneously.
Addressing the soft budget constraints and excessive borrowing of local governments is indeed necessary. However, from a macroeconomic perspective, it is also crucial to more rigorously implement expansionary fiscal policies to stabilize economic growth. Currently, one of the most effective ways for government spending is to ensure that unfinished housing projects are completed and delivered. This would promote the clearing of the real estate market, rebuild developers' credibility, and restore confidence in government regulation, protecting the basic rights of homebuyers while stimulating domestic demand.
Types of Cash Handouts and Their Preconditions for Effectiveness
The policy calls for "cash handouts" can be divided into two categories: one is to distribute money equally to the entire population, and the other is to provide cash to specific groups, with current suggestions primarily focusing on encouraging childbirth. Issuing consumption vouchers is similar to cash handouts, as they come with specific expiration dates and conditions for use. Recently, some scholars have proposed issuing one trillion RMB [$139 billion] in consumption vouchers during the seven-day National Day holiday in October, while others have suggested distributing ten trillion RMB in consumption vouchers to the entire population in installments, both falling into this category.
Whether cash handouts are effective depends on specific conditions and cannot be generalized. I believe distributing money to the entire population or all residents of a specific region is warranted only under one critical condition: when the economy and society face severe external shocks. From both a humanitarian perspective and the need to maintain aggregate demand, it is reasonable for governments to provide financial support to residents impacted by severe shocks.
During the COVID-19 pandemic outbreak in 2020, I also advocated for indiscriminate cash subsidies for residents in Wuhan and certain areas of Hubei under lockdown. Between 2020 and 2022, Hong Kong issued direct cash handouts to adults and provided additional subsidies to employers for wage payments. In March 2020, the U.S. implemented its largest-ever stimulus package, amounting to $2 trillion, which included $1,200 payments to individuals earning less than $75,000 annually and support for small business employees. In April of the same year, Japan announced a 100,000 yen [$684] cash payment to every resident, including non-Japanese residents, regardless of income. These cash distributions played a crucial role in stabilizing employment and consumption, addressing livelihoods, and contributing significantly to economic stability and recovery in the post-pandemic period.
Why are cash handouts effective in such exceptional circumstances? This is because these shocks are external, not inherently internal; they are generally temporary and not long-lasting. For the government, it is essential to quickly distribute money or necessities to residents in response to these external events to ensure basic livelihoods and maintain economic stability. This prevents a downward spiral in supply and demand, which could lead to secondary macroeconomic damage.
The public is likely to understand that cash handouts are an exceptional measure in response to specific crises. They will expect the economy to return to normal once the shock has passed and thus will not anticipate cash handouts becoming a norm. The government should focus on alleviating the immediate impact and maintaining stability rather than rushing to address inherent internal problems when facing such external shocks. Furthermore, from the perspective of stabilizing demand, cash distributions are more likely to be used in the immediate period.
Without severe external shocks, a cautious approach to "national cash handouts" is essential for several reasons:
First, if domestic demand is weak without external shocks, it is likely due to internal factors. While national cash handouts might stimulate consumption to some extent in the short term, they are unlikely to alleviate, let alone solve the underlying issues that caused the economic slump. For example, the primary factor behind weak domestic demand currently is the significant contraction of the real estate sector over the past three years. With ongoing declines in housing prices, challenges in ensuring the delivery of housing projects, and tight local finances, distributing a few thousand RMB to each person nationwide would have minimal impact on clearing the real estate market. Even if such handouts temporarily boost certain types of consumption, the deep-seated issues in the economy will not disappear of their own accord as external shocks would. A halt in the handouts will lead to a "fiscal cliff," where consumption and economic growth could plummet sharply, forcing the government to increase the scale of handouts continually to prevent a second economic plunge.
Cash handouts might delay the resolution of underlying issues. Some argue that as long as inflation is avoided, cash handouts should continue until the economy is on track. However, the real economic and societal operations are much more complex. Distributing cash is complex enough; distributing it indiscriminately to everyone may reduce some administrative costs, but ensuring that it is delivered efficiently, transparently, and promptly to every citizen is even more challenging. Not every citizen has a bank account, especially elderly people in rural areas.
According to the Seventh National Population Census of China, in 2020, 376 million people lived outside their household registration areas. Of these, 125 million lived outside their registered provinces, while 251 million lived in places other than their household registration but still in the same province. Distributing cash effectively to these groups without errors is a complex systematic challenge that would consume significant administrative resources. This process could also lead to corruption and rent-seeking, further draining societal resources.
Moreover, there is the issue of the crowding out effect. Even with seemingly unlimited financial resources from printing money, the government's capacity and focus are limited. A sustained national cash handout approach could delay addressing other urgent issues and undermine efforts to advance structural reforms. Ultimately, cash handouts may not sustainably boost demand or foster a virtuous economic cycle. Instead, they could hinder necessary reforms and market clearing, leading to a vicious cycle.
Cash handouts, especially in the form of consumption vouchers, could also enhance government monopolies. Continued national cash distributions would significantly increase government spending and deficits, enlarging the scale of the government, and potentially leading to further "advance of the state, retreat of the private sector." Even if local governments manage to distribute cash efficiently and transparently, they may have strong incentives to confine the use of funds, especially consumption vouchers, to their own regions and "keep the goodies within the family". This could undermine the development of a unified national market and even lead to some regression in marketization. Local governments might also steer the use of funds or vouchers toward local platforms and businesses as much as they can, thus crowding out private enterprises.
Lastly, the inflation risk associated with national cash handouts cannot be ignored. In periods of very low inflation or even deflation, continuous cash distributions may not immediately lead to inflation. However, if societal resources are increasingly directed towards distribution and rent-seeking, and once public expectations shift to believe that the government is merely resorting to printing money to address current economic troubles, inflation could suddenly surge.
In fact, numerous historical examples abound in developing countries across Africa, Asia, and Latin America, where excessive money printing to fund increased government spending has led to hyperinflation. Developed countries have also faced similar lessons. A recent example is the post-pandemic inflation in the United States. In 2020, the U.S. government's $2 trillion relief package was deemed appropriate and reasonable, with a deficit rate of 14.9% that year being understandable. However, after the Biden administration introduced an additional $1.9 trillion stimulus package in early 2021, the deficit remained high at 12.4% that year, even as GDP growth rebounded to 1.6% in Q1 and surged to 12.0% in Q2. This excessive stimulus, not scaled back in time, directly contributed to the subsequent high inflation.
In summary, national cash handouts warrant careful deliberation by the government. They should only be considered as a policy option in response to severe and sudden external shocks, rather than as a general economic stimulus. Scholars advocating national cash handouts should also exercise caution. While there are examples of successful cash handouts during the pandemic, these cases were primarily in developed countries or economies, implemented as exceptional measures in response to a unique external shock.
Even in these successful instances, some countries faced high inflation in the latter half of 2021 because they did not promptly reduce fiscal spending after the pandemic. Outside of the pandemic, there have been few examples of large-scale cash distributions in recent decades. Some developing countries that attempted similar measures—increasing welfare spending through money printing and large deficits—ultimately experienced severe outcomes such as hyperinflation, economic collapse, or even national disintegration.
Currently, the Chinese economy is not facing a severe external shock. The pandemic ended over a year and a half ago; while natural disasters are occurring, they are regional. The global economic performance is decent, with China's exports showing a year-on-year growth of 3.6% in the first half of the year, and 8.6% in June alone, indicating stable and even strong external demand.
The challenges China faces today are clearly related to domestic demand, particularly the significant downturn in the real estate sector in recent years. The real estate contraction and other factors have also led to weak consumption, with retail sales growing only 2% year-on-year in June. Investment in the "new trio" [photovoltaics, lithium-ion batteries, and new energy vehicles], having experienced high-speed growth in recent years, has begun to decline in 2024. Additionally, increased taxation and fines by local governments may suppress entrepreneurial confidence, subsequently affecting private investment. The stock market tumble has led to a sharp decline in equity financing, impacting primary market financing. Interest rates have already fallen significantly, with the 10-year government bond yield dropping to around 2.1% and interest rates on business loans for state-owned enterprises hitting new lows. The space for stimulating credit demand through lowering benchmark lending rates is fairly limited.
In this situation, what kinds of policies could effectively boost the economy?
How to Stimulate the Economy and Implement Cash Handouts
Given the current situation and China's status as a middle-income country in transition, I propose the following measures to balance short-term stimulus with long-term structural adjustments from a fiscal and financial perspective:
Consider a balanced approach. While strictly controlling excessive borrowing in certain provinces and cities, it is important to intensify the stimulus through loose fiscal policies.
In addition to tightening budget constraints, commit to advancing tax reforms including consumption taxes, reasonably increase the share of local government in total tax revenues, and optimize the transfer payment system by linking transfer payments closely to indicators such as population inflow, household registration numbers, and school enrollment. While stabilizing the real estate sector, it is essential to consider the significant impact of real estate contraction on local finances.
Focus on the key issue of stabilizing the real estate sector, prioritizing the basic interests of homebuyers as creditors. Concentrate central fiscal resources to ensure the delivery of unfinished housing projects, clear the real estate market, restore fundamental market confidence and order, and ensure the supply of government-subsidized housing throughout this process.
Hand out direct subsidies on a selective basis. The first focus is to improve the social security and healthcare insurance systems. Increase basic pension insurance significantly and increase the proportion of healthcare costs covered by basic medical insurance for certain groups. This approach will boost the income of nearly 170 million low-income elderly people and alleviate concerns for 290 million migrant workers, increasing their willingness and ability to consume. Another key focus is for the central government to subsidize childbirth with direct cash payments.
Since this essay discusses "cash handouts," the focus will primarily be on the latter two points. The contraction of the real estate sector is currently the most significant challenge facing China's economy. The sector is already oversold, and its full impact on the economy, finance, and fiscal situation has not yet fully manifested; some risks remain hidden and may still emerge. Therefore, it is essential to take proactive measures to prevent the real estate sector from falling into a downward spiral.
Ensuring the delivery of unfinished housing projects is fundamental to stabilizing the real estate sector and serves as a practical starting point. Resolving this issue is quintessential for revitalizing the entire real estate market. In China, real estate sales are primarily driven by new home sales, with pre-sold houses dominating the market. These pre-sold houses function as a futures market, where delivery is essential for normal operations. Effectively addressing the delivery of unfinished housing projects is critical for rebuilding market confidence and government credibility, and it is a prerequisite for stabilizing and expanding domestic demand.
The Chinese central government should accelerate the investigation and survey of unfinished housing projects across different regions. Given the severe fiscal situation of local governments, commercial banks may face significant difficulties in advancing the whitelist program [which involves local governments identifying eligible ongoing real estate projects and recommending them to banks, who must ensure prompt and adequate financing to meet their needs]. Developers are also struggling to raise funds to ensure the delivery of housing projects on their own. Therefore, the central government should directly provide special funds for ensuring the delivery of unfinished housing projects and establish dedicated agencies to promote related efforts. According to a conservative estimate from last year, the funding gap for ensuring housing delivery is approximately 3 trillion RMB [$418 billion]. Additional central government spending in this area is the most optimal economic policy at present, whether from the perspective of protecting homebuyers’ basic interests as creditors, maintaining social equity and justice, accelerating market clearing, or stabilizing economic growth.
The optimal time window for national cash handouts has passed, but providing targeted financial assistance to specific groups remains necessary, which should be understood as policy adjustments and structural reforms.
Increase basic pension insurance for vulnerable populations. China's pension system comprises three tiers. According to data from 2022, the top tier consists of retirees from government and public institutions, totaling 21.13 million, with an average monthly pension of 7,320 RMB [$1,019]. The middle tier includes enterprise employees, with 115.31 million retirees receiving an average monthly pension of 3,778 RMB [$526]. At the base are people categorized as residents, primarily farmers, with 164.64 million recipients, far more than the total of the previous two tiers, receiving an average monthly pension of only 246 RMB [$34]. Notably, in this year's Two Sessions, the State Council increased the pension for this group by 20 RMB [$2.79] per month. Rural elderly also have some income from land, but it is minimal.
Nearly 300 million migrant workers in China must live frugally and are hesitant to spend to ensure financial security for their future elderly lives. Therefore, to encourage consumption among more than half the population, the most efficient and equitable approach is to significantly increase pensions for this group. Historically, China's farmers have made substantial contributions to the country due to "price scissors," and during the reform and opening up, generations of migrant workers have dedicated their youth to urban development. Increasing their pensions would also contribute to common prosperity and promote social equity. According to calculations, if each person's pension is increased by 300 RMB [$42.8] per month, the central government would incur an additional annual spending of 600 billion RMB [$83.6 billion], roughly 0.5% of GDP. If the increase is 600 RMB [$83.5] per month, raising the monthly pension to 866 RMB [$120.6], the additional spending would be 1.2 trillion RMB [$167 billion], nearly 1% of GDP.
Subsidize basic medical insurance for vulnerable groups. China's medical insurance system is divided into employee and resident categories. In 2023, 962.93 million people participated in the basic medical insurance scheme for residents [which offers significantly fewer benefits than the employee scheme], accounting for 68% of the 1.4 billion population, including the vast majority of farmers and minors. In recent years, premiums for the basic medical insurance scheme have steadily increased across various regions, placing a significant burden on the rural elderly and leading many to drop out due to the high costs.
It is estimated that if the central government were to exempt residents under the age of 20 and over the age of 60 from medical insurance contributions, it would result in an annual additional spending of approximately 230 billion RMB [$32 billion].
Provide cash subsidies to encourage childbirth. In 2022, China's population decreased for the first time in sixty years by 850,000, which expanded to 2.08 million in 2023. The number of newborns has sharply declined since 2018, reaching only 9.02 million in 2023—a 45% drop compared to the annual average of 16.36 million from 2003 to 2017, and a 9.4% average annual decline since 2018. Currently, China's total fertility rate may have fallen to 1.0, well below the 2.1 needed to maintain population replacement. The decline in the total population and the proportion of young people is a significant factor inhibiting domestic demand. From a supply-side perspective, it also reduces the overall vitality of Chinese society and suppresses the potential growth rate of the Chinese economy.
There has been extensive discussion and controversy in academic and policy-making circles regarding how to subsidize childbirth, including whether there should be distinctions between subsidies for first, second, and third births, or whether subsidies should be provided for already-born infants and minors. The policy design will undoubtedly be complex. However, it is clear that targeted childbirth subsidies are preferable to indiscriminate cash handouts given limited overall financial resources. It is advisable to consider an annual additional expenditure of approximately 1 trillion RMB [$139 billion] for childbirth subsidies over the coming years.
In summary, over the next two years, if the Chinese central government allocates 1.5 trillion RMB [$209 billion] annually for ensuring housing delivery (totaling 3 trillion RMB or $418 billion), 600 billion RMB [$84 billion] annually for resident pension subsidies, 230 billion RMB [$32 billion] annually for resident medical insurance subsidies, and 1 trillion RMB [$139 billion] annually for childbirth subsidies, the total additional government spending would amount to 3.33 trillion RMB [$464 billion], approximately 2.5% of GDP.
After two years, once the unfinished housing projects are completed and economic growth stabilizes, this expenditure will cease. By then, the annual resident pension subsidies would have increased to 1.2 trillion RMB [$167 billion], medical insurance subsidies would have risen to 400 billion [$56 billion] RMB, and childbirth subsidies would have been elevated to 1.4 trillion RMB [$195 billion], totaling 3 trillion RMB [$418 billion]. Considering GDP growth, these three types of subsidies would represent about 2% of GDP.
This targeted approach to direct subsidies can effectively stimulate current domestic demand, clear the market, stabilize demand, promote fairness, and enhance future economic growth potential.
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