A Stronger China

• Author: Linda Yueh
• Position: Director of the China Growth Centre and Fellow in Economics, St. Edmund Hall, University of Oxford.

IN the West, countries are facing the fallout from a deep recession and financial crisis. Economic growth is at best tenuous in advanced economies, most of which have large levels of national debt. And the euro is under pressure. Meanwhile, China’s growth races ahead. Is China’s seeming resilience to the recession the real deal?

China is in better shape than most countries. It averted a recession, confounding expectations by exceeding its targeted 8 percent growth rate in 2009. If it can adapt to a world economy unlikely to be driven by consumer demand from the West for the next few years, China can emerge from the global crisis stronger than ever.

Surviving the crisis

No country was immune to the global financial crisis that began in the United States in 2007. But because China’s financial sector does not trade extensively in derivatives, it escaped the devastation suffered by the United States and advanced economies in Europe. China did not experience a “credit crunch” nor did it have to contend with the so-called toxic securities that devastated bank balance sheets in advanced economies. Some of China’s large state-owned banks were creditors of the Wall Street investment firm Lehman Brothers, whose failure in September 2008 caused near financial panic. These state-owned banks did experience losses, estimated to be in the billions of dollars, but they avoided ongoing balance sheet impairments, which would have been far more damaging.

Still, China was affected by the second stage of the crisis: a global recession and the first contraction in global trade in 30 years. China’s exports—which account for over 30 percent of its gross domestic product (GDP) and about one-third of its annual economic growth—collapsed in late 2008. The plunge in trade cut the growth rate by about 3 percentage points in 2009 and by about 1 percentage point in the first quarter of this year. An injection of funds from the G-20 group of major economies to support trade financing has helped, but exports have yet to resume their role as a strong growth engine.

Stimulus response

As a result of the crisis and the ensuing drop in trade, China is reconsidering the importance of domestic demand as a driver of its economy, instead of relying on more volatile exports. China therefore responded to the crisis in the spring of 2009 with a $586 billion (Y 4 trillion) stimulus package. The government continued to disburse the stimulus in 2010 in the face of continued weak global demand. The People’s Bank of China (PBOC) acted earlier, beginning to cut the policy interest rate in August 2008 when it was 7.47 percent. Its most recent cut put the rate at 5.31 percent in December 2008, where it remained as of June 2010.

This combination of stimulus package and lower interest rates helped spark pickup in growth by the second quarter of 2009. It had wallowed (for China) at about 6 percent in the final three months of 2008 and the first three months of 2009. Growth recovered to 8.7 percent for 2009 as a whole and in the fourth quarter registered an impressive 10.7 percent year-over-year growth. During the first quarter of 2010 growth spurted to 11.9 percent year over year.

China’s continued growth will depend on the success of the massive fiscal stimulus, focused largely on infrastructure. Infrastructure spending builds on a large-scale transportation project in the 11th Five Year Plan, which began in 2006. The existing plan allowed the spending to be quickly implemented and provided jobs on roads and rail for some of the millions of workers laid off from export-oriented factories. Indeed, job creation does seem to be occurring, validating China’s stimulus spending (Orlik and Rozelle, 2009).

But the social part of the stimulus, representing less than 5 percent of the package, was judged insufficient to stimulate private consumption. It failed to address China’s high level of household saving—a...