China's 1st half GDP growth should settle the dispute on the correctness of its approach to the financial crisis

On 16 July, as was widely reported, China announced very strong economic growth in the first half of 2009. GDP was up 7.1% year on year for the six months to June. Growth was 7.9% for the second quarter of 2009 compared to the same period in 2008.

Economic acceleration was evident as China's year on year growth rose from 6.1% in the first quarter to 7.9% in the second. Industrial production in June was up 10.7% year on year. In terms of annualised quarter on quarter growth, official figures for which China does not publish as it considers its data on seasonable adjustments are not yet sufficiently accurate, the Wall Street Journal notes private economist estimates of 15% annualised GDP growth in the second quarter.It therefore appears highly likely China will hit its 8% annual growth target this year.

Despite this rapid growth there was no sign of inflationary pressures in consumer or output prices due to overheating - on the contrary year on year consumer prices in June were down 1.7% and the producer prices declined by 7.8%.

These are evidently stellar figures in the context of the international financial crisis - by far the best results of any major economy. They also cast clear light on the debate that has been taking place internationally on the correctness, or otherwise, of the policies being pursued by China in dealing with the international financial crisis. Such first half GDP figures evidently indicate great success, and countries  pursuing objectively guided policies would study China to see carefully what lessons could be learned from this.

This is particularly important as China is not pursuing a course based on running a large budget deficit. Such policies, which are generally mistakenly referred to as 'Keynesian' in the US and Europe, are dominant in those countries' recovery packages - 'mistakenly' because Keynes own views were focused on monetary economics, and based on the priority to reduce interest rates by measures such as quantitative easing, not on expansion of budget deficits, as writers such as Turner and Tily rightly point out. A policy of meeting the financial crisis through large budget deficits might be correct, as Paul Krugman argues, or it may be incorrect. but it is not actually a 'Keynesian' policy in the sense of being the one advocated by Keynes.

Contrary to some mistaken claims in the financial media, China's stimulus package is, however, not based on a large budget deficit. This is clearly confirmed by the figures. China's deficit is projected to expand this year but only modestly, from balance to a deficit of 3% of GDP.

China's stimulus package is instead focused on two measures. The first is direct methods to raise, that is control, investment - thereby avoiding the precipitate fall in investment which is the driving force of an economic downturn.

The largest part of China's $585 billion stimulus package is going into urban fixed investment which rose 33.5% year on year in the first half of 2009 and 35.3% in the year to June. As, in the same period, producer prices were falling sharply it is likely that the real increase in investment in fixed assets approached 40%. China is able to achieve this due to its large state company sector which can be issued with 'administrative' instructions to increase investment, thereby countering any downturn.

The second part of the stimulus package is expansion of bank lending. M2 was up in China by 28.5% year on year in June with bank lending rising by RMB 1.5 trillion ($220 billion) in June and RMB 7.37 trillion ($1.1 trillion) in the first half of 2009. The fact that China's banks are state owned allows them to be instructed to increase lending - whereas in the US and Europe only indirect, so far relatively ineffective, methods can be used to attempt to persuade banks to counter-cyclically expand their lending.

This combination of direct measures to expand investment and rapid increase in bank lending explains the success of the stimulus package and therefore China's rapid economic growth in the first half of the year. This model is evidently quite different to, and far more successful, than the policies based on large scale budget deficits being pursued in the US and Europe.

A number of non-Chinese commentators have accurately judged that the Chinese stimulus package will be successful - the most prominent probably being Jim O'Neill, Goldman Sach's chief economist. In contrast theorists that China is 'oversaving', and must change its economic model, who are given frequent extensive coverage in sections of the the media, such as Martin Wolf of the Financial Times and Michael Pettis, have been proved inaccurate.

It would be hoped that as economic theory has not led writers such as Wolf and Pettis to change their analysis facts might now lead to an acknowledgement their analysis is wrong. As, however, they have maintained views which are false from the point of view of economic analysis, and from the point of view of economic facts, for many years it is probably unlikely there will be any change in light of the latest data. Indeed Pettis in his latest post, commenting on China's GDP figures bizarrely, in the light of the facts, claims: 'I think China will be among the last countries to escape from the effects of the global crisis,'  This is roughly the economic equivalent of continuing to believe that the world is flat despite the fact that all evidence shows it is round.

Fortunately for the health both of China's and the world economies the Chinese authorities have continued to pursue their own policies and ignore such advice from outside. The latest GDP data confirms just how right they were to do so.

Comments

[scoremore]

China is able to achieve this due to its large state company sector which can be issued with 'administrative' instructions to increase investment, thereby countering any downturn,great lens very interesting article will credit this.

[Armando]

Good Job! Mr. John Ross!
Pettis have not answered any of your question at all! He can not reply to any of your points that you have made other than just dismissed outright! I guess that Pettis is just another Gordon Chang but he is smart to never put a date on his prediction!
I believe that you are Austrian economy school!

[Michael Wallace Butterfinger]

First, based on historical inaccuracies in Chinese data during economic downturns, the author would do well to take look at the latest numbers with a skeptical eye. Simply proclaiming triumphantly that official GDP figures validate the government's stimulus package is foolish. The gap between Chinese statistics and reality, historically speaking, is always the widest during times such as these. If total new lending during H1 was 7.8 trillion RMB, and corporate deposits went up by more than 5 trillion RMB, where is the real activity that would produce growth figures as high as those reported this week? Second, neither the OECD nor China have yet addressed the structural issues that precipitated the current state of affairs. It would be better in the medium-term, in fact, if the reported growth figures are bogus, because it would mean that China is not adding capacity at a time when global consumer demand us undergoing an adjustment. If China is, as the numbers imply, adding capacity, then the deflationary trends in the manufacturing sector and consumer economies will continue. This implies that a pernicious debt-deflation cycle awaits China's real economy. People are remiss in their need to make snap judgments about the efficacy of China's stimulus measures. Yes, they have boosted short-term growth, but at what long-term cost? Senior Chinese policy makers have been saying for months that the current policy mix will set back reforms in a range of areas, but people like the author appear unwilling to listen. If any economy pumps as much new credit as China has into the real economy, it will produce strong growth. But I, for one simply don't believe the numbers, becauase if they are true, it means that the medium-term cost of short-term measures will be high. This author has no sense of the forest, and has become lost in it by focussing on just a few trees.

[Duncan]

I'm not sure you're being fair to Pettis.

He fully accepts that China's policies have led to rapid short term growth, he merely questions the sustainability of it.

http://duncanseconomicblog.wordpress.com/2009/07/17/chinas-growth/