China needs tax curbs to aid real growth

• Source: Global Times
• [21:42 July 06 2009]
• Comments

Editor’s Note:
The following is an interview by Global Times (GT) reporter Li Yanjie with Zhiwu Chen (Chen), a professor of finance at the School of Management, Yale University, on how China can change its economic development model.

Zhiwu Chen

GT: To deal with the economic downturn and boost domestic demand, the Chinese government released a 4 trillion yuan ($570 billion) stimulus package, much of it to be spent on infrastructure construction. What problems are there with the stimulus package?
 
Chen: China’s stimulus package is dominated by infrastructure projects and also industrial projects. This focus on tangible projects is in line with the usual biases in Chinese government spending policies, so the spending structure and nature of the stimulus is not a surprise. It is true that the stimulus efforts in China have helped boost confidence and allowed economic growth to continue in the short run. The government’s short-term goals of sustaining growth in 2009 and 2010 may be achieved.

However, the investment orientation of the stimulus package is not going to help transform China’s economic structure, making it even more dependent on investments and on exports. China’s heavy, unsustainable dependence on investment and export growth has emerged precisely because of this type of bias that has been characteristic of China’s economic policies over the past decades. In this sense, the stimulus package is pushing China’s economy in this direction even further. Thus, the package is not helpful in the long run.

GT: What adjustments you would suggest to the stimulus package?

Chen: It would have been different if China had, for example, used the money to give mid- to small-sized companies a year free of taxes in 2009. Since these businesses provide about three-quarters of non-agricultural employment in China, such a tax break would create new employment and save existing jobs, better protecting China’s economy from being dragged down by the financial crisis.

First, these businesses have had difficulty accessing capital to begin with. Such a tax holiday would give them the needed capital in a straightforward way.

As long as they don’t have to shut down and lay off workers, the financial crisis’ impact can stop right there. The Chinese banking system has always favored large enterprises, especially State-owned ones, and it still does even though they don’t contribute as much to employment.

Second and more importantly, economic growth has largely come from these mid-to small-sized companies over the past 30 years.

Putting more resources into them will not only protect employment in the short run, but also promote healthy structural changes in China’s economy, favoring the private sector by allocating more resources away from the State-owned sector.

Such a structural shift would improve the long-term health of the economy. It would also increase the income share of the household sector in the national economy, promoting domestic household consumption and hence helping reduce the dependence on the export market.

Stimulus efforts by China should target more households and private mid-to small-sized businesses, as opposed to the State sector. Such efforts would be better for both the short-term and the long-term effects.