Lu Ting Argues Against Broad-Based Direct Subsidies for Resident
Nomura Securities Chief Economist in China argues against providing massive direct subsidies to citizens: What's his rationale and policy suggestions?
In the previous episode, I introduced the People's Bank of China's Monetary Policy Committee member Huang Yiping’s analysis of the Chinese economy and his reason for supporting the government to provide subsidies to citizens directly. To give my readers a more comprehensive and balanced picture of this argument, I bring the counterargument from Lu Ting(陆挺) today. He gave his reason for not implementing cash handout policies in his opinion pieces published on Yicai.
Link to the article: https://m.yicai.com/news/102219257.html
Lu Ting is the chief economist at Nomura Securities in China. He previously served in Huatai Securities as the head of the research department and institutional sales and trading department, chief economist, and managing director. He has also worked as a consultant for the East Asia Department of the International Finance Corporation and the Research Department of the World Bank.
In short, Lu believes that the ideal time for providing universal cash handouts or consumption vouchers has passed, and it should no longer be a primary strategy for the central government. If financial assistance is to be given, it should be targeted at specific demographics, primarily to promote childbirth and ensure basic social security and healthcare for underprivileged groups. Such targeted subsidies can simultaneously stimulate consumption, foster social equity, and boost long-term economic growth potential.
While it is crucial to address local governments' soft budget constraints and excessive borrowing, from a macroeconomic standpoint, it is equally important to intensify the implementation of expansionary fiscal policies to stabilize economic growth. Presently, one of the most effective ways for the government to allocate funds may be to prioritize the clearance of the real estate market by guaranteeing the delivery of presold properties. This approach would rebuild trust in developers, restore confidence in government oversight, safeguard the fundamental rights of homebuyers, and stimulate domestic demand.
Lu believes there are six pre-conditions for effective cash handout policies.
The economy and society are suffering from an extremely severe external shock. Whether from a humanitarian perspective or from the standpoint of maintaining overall demand, it is reasonable for the government to provide cash subsidies to residents who are severely impacted.
These shocks are exogenous and not inherent internal problems. Such shocks are generally temporary and will not persist for too long.
When these exogenous events occur suddenly, the government needs to quickly distribute cash or provide essential goods to residents to ensure basic livelihoods and maintain basic economic operations, preventing a spiral decline in supply and demand caused by the sudden shock, which could lead to secondary damage to the macroeconomy.
The public understands that cash distribution is an occasional act under special circumstances, and the economy will return to its normal state after the shock. Therefore, they will not expect regular cash handouts.
When facing such external shocks, the government only needs to focus on relief and maintaining stability and does not need to rush to solve inherent internal problems.
From the perspective of stabilizing demand, under sudden shocks, the proportion of cash distributed that is used in the current period is also relatively high.
Why does he not support massive cash or voucher subsidies?
First, if domestic demand is weak without external shocks, it must be due to internal factors. Giving money to everyone may stimulate short-term consumption, but it may not be enough to alleviate, let alone solve the deep-seated problems causing the economic downturn. For example, the primary factor currently causing sluggish domestic demand is the huge contraction of the real estate industry over the past three years. Housing prices are still falling, the delivery of pre-sold houses is still a long way off, and local government finances are very tight. In this situation, giving everyone a few thousand yuan nationwide will have a negligible effect on stabilizing the real estate market. Even if this method boosts certain consumption in the short term, the chronic issues in the economy will not disappear as external shocks do. Once the government stops giving money, a "fiscal cliff" situation will occur, with consumption and economic growth plummeting, forcing the government to continuously increase the amount of money given out to avoid a further economic downturn.
Giving money may delay the resolution of actual problems. Some argue that as long as no inflation is generated, money should be given out continuously until the economy recovers. However, the real-world economy and society are much more complex. Giving money itself is a complicated process. Indiscriminately giving money to everyone may seem to save some screening costs, but efficiently and cleanly delivering cash to every citizen is not that simple. Not every citizen has a bank account, especially the elderly in rural areas. According to the 7th National Population Census, in 2020, China had 376 million migrants, with 125 million migrating across provinces and 251 million migrating within provinces. Delivering cash to these groups without any leakage is a complex systems engineering project that will consume a lot of administrative resources. This process may also lead to some degree of corruption and rent-seeking, consuming additional social resources. We also need to consider the crowding-out effect. Even with seemingly unlimited financial resources through money printing, the government's overall capacity and energy are limited. Once embarking on the path of continuously giving money to everyone, it is very likely to delay other matters, including critical issues that urgently need to be addressed, and may also hinder efforts to advance structural reforms. In the end, giving money may fail to sustainably increase demand and allow the economy to enter a virtuous cycle, and it may delay necessary reforms and market clearing, causing the economy to enter a vicious cycle to some extent.
Giving money, especially consumer vouchers, may also increase government monopoly. Continuously giving money to everyone will greatly increase government spending and deficits, expand the size of government, and lead to further nationalization and private sector retreat. Even if local governments can cleanly and efficiently give out money, they have a strong incentive to limit the use of funds, especially consumer vouchers, to their own regions, which will impact the formation of a unified national market and may even lead to some degree of reversal in marketization. Local governments may also try to guide the use of the funds or consumer vouchers they issue to platforms and enterprises they own, thereby eroding the space for private enterprises.
Finally, the inflation risk of giving money to everyone cannot be completely ignored. When inflation is extremely low or even deflationary, continuously giving out money may not lead to immediate inflation. But if more and more of a society's resources are used for distribution and rent-seeking, once public expectations change and people think the government is just using money printing to deal with the current economic predicament, inflation may suddenly erupt. In fact, there are countless examples of developing countries in Asia, Africa, and Latin America that have experienced hyperinflation in recent decades due to large-scale increases in government spending accompanied by money printing. Developed countries also have lessons in this regard. A recent example is the post-pandemic inflation in the U.S. The $2 trillion relief plan launched by the U.S. government when the pandemic broke out in 2020 can be said to be reasonable and appropriate, and the high deficit rate of 14.9% that year was also excusable. But after the Biden administration took office in early 2021, it launched another $1.9 trillion stimulus plan, leading to a deficit rate of 12.4% that year, while U.S. GDP growth had already rebounded to 1.6% in the first quarter and soared to 12.0% in the second quarter. The excessive stimulus without timely pullback directly led to the high inflation that followed.
In short, the government must carefully consider before giving money to all citizens, and it should not be a policy option to boost the economy unless it is in response to a sudden and severe exogenous shock. Scholars who suggest that the central government give money to everyone should also be cautious. Scholars can cite examples of successful cash transfers during the pandemic, but they need to recognize that these examples almost all occurred in developed countries or economies and were special policies under the very unique circumstances of the pandemic. Even with these successful examples, some countries faced high inflation starting in the second half of 2021 because they did not reduce the scale of fiscal spending in a timely manner after the pandemic. Outside of the pandemic, there have not been many examples of large-scale cash transfers to everyone in the past few decades. Some developing countries have done similar things, increasing welfare spending through money printing and large-scale deficits, and the result was nothing but vicious inflation, economic collapse, and even national disintegration.
China's economy currently does not face severe external shocks. It has been a year and a half since the end of the pandemic; there are natural disasters, but they are localized. The global economy is performing well, with China's export growth at 3.6% year-on-year in the first half of the year and as high as 8.6% in June, indicating stable or even strong external demand. The challenges facing China's economy now clearly come from domestic demand, especially the huge decline in real estate in recent years. The contraction of real estate and other factors have led to weak consumption, with retail sales in June growing by only 2% year-on-year. Investment in the new three items, which grew rapidly in the previous two years, has started to decline this year. The significant increase in taxation and confiscation by local governments may also lead to insufficient confidence among entrepreneurs, thus affecting private investment. The decline in the stock market has led to a sharp drop in stock market financing, which in turn hurts primary market financing. China's market interest rates have fallen sharply, with the 10-year government bond yield falling to around 2.1% and financing rates for state-owned enterprises hitting new lows, leaving little room to stimulate credit demand by lowering benchmark interest rates.
Lu also provided his policy suggestion:
While strictly controlling excessive borrowing in some provinces and cities, the overall fiscal stimulus should be increased.
Fiscal reform: While stabilizing the real estate sector, considering the huge impact of the shrinking real estate industry on local finances, it is necessary to promote tax reforms such as consumption tax, moderately increase the tax sharing ratio of local governments, optimize the transfer payment system, and closely link transfer payments with indicators such as local population inflow, number of registered households, and number of students.
Real estate market: Focus on the real estate sector as the "bull's nose." The core is to protect the basic interests of homebuyers as creditors, concentrate central financial resources to ensure the delivery of pre-sold housing, allow the real estate market to clear, restore basic market confidence and order, and ensure the supply of affordable housing during the process of ensuring the delivery of pre-sold housing. (He also suggested the central government set up a 30,000 billion yuan fund in two years to ensure the delivery of pre-sold housing)
Selective cash subsidies:
a. Optimize the social security and medical insurance system, significantly increase the level of basic pension insurance for urban and rural residents, and pay a higher proportion of basic medical insurance expenses for some groups. This can not only increase the income of nearly 170 million low-income elderly people but also ease the worries of 290 million migrant workers, thus enhancing their willingness and ability to consume. For migrant workers, if their pension increased by 300 yuan, the central government's annual fiscal expenditure would increase by 6,000 billion yuan, which is approximately 0.5% of GDP. If each person's monthly pension is increased by 600 yuan, bringing the monthly pension income to 866 yuan, then the central government's additional expenditure would be 12,000 billion yuan, which is close to 1% of GDP.If the central government exempts urban and rural residents under 20 and over 60 years old from paying medical insurance premiums, it would increase annual expenditure by approximately 230 billion yuan.
b. The central government should directly subsidize childbirth through cash payments. Lu asked for 10,000 billion yuan in childbirth subsidies.