Not all Chinese ngdp is created equal

Economists are familiar with the use of monetary and fiscal policy to stimulate or restore nominal gdp, or other measures of aggregate demand if you prefer.  But China faces a bigger dilemma.  Part of its earlier pro-growth program overstimulated particular sectors of the economy, for instance construction and a variety of heavy duty state-owned enterprises.  Not coincidentally, those are the same parts of the economy which have experienced excess capacity and decreasing returns.

The more specific dilemma is this: China’s main paths for boosting its nominal gdp path also tend to stimulate or re-stimulate these overextended sectors.  Think for instance of pushing more credit through state-owned banks to favored state-owned firms.  Or consider fiscal policy.  At the margin that could mean municipal governments spending more on what they know best how to do, namely building more physical infrastructure.

Chinese stimulus, in the broad sense of that word, thus worsens previous Chinese malinvestments.  China would like to stay on a smooth ngdp growth path, but they don’t know how to do this without overextending themselves in particular sectors all the more.

It is fine to call for “reform,” but there are two extra problems.  First, most of the best reforms will lower ngdp in the short run and maybe even the medium run.  Second, the ngdp crunch may be coming more quickly than reforms can be instantiated.

Over the next months, you will read many blog posts, from other economists, about China in an aggregate demand framework.  Be wary of them if they do not appreciate this point.

Here are my earlier remarks from 2012.


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