However, when economists looked closer, they saw a more complex picture. There is no denying that the megastimulus was effective in the short term, but it distorted the quality of China’s economic growth and sowed the seeds of many of the problems the country now suffers from. Thus a broad reassessment of the role of the state in economic management was required. As it turns out, if the state has too much control, it tends to do more harm than good.
Of course, state support was not limited to the one stimulus package that China implemented between late 2008 and 2010. By allowing local governments to borrow off-budget (which effectively became a guarantee for local construction company bonds), China provided tremendous support for two industries – infrastructure construction and real estate. This stimulus continued for another decade. As a result, these two industries now account for about a third of China’s total demand, well above the levels of the EU, Japan and the US.
In a paper for a recent Brookings Institution conference, Princeton economist Wei Xiong and his co-authors offered a sobering assessment of the impact of China’s prolonged government stimulus on private sector activity. Analyzing local data, they showed that, contrary to the predictions of standard Keynesian models, provincial GDP growth was strongly correlated with growth in corporate profits and retail sales between 2002 and 2008. Notably, this correlation disappeared completely between 2011 and 2019. The same report finds that city-level productivity growth (including capital and labor inputs) rose steadily before the stimulus, but began to fall markedly in subsequent years.
Western analysts are often frustrated by the Chinese authorities’ reluctance to approve a large stimulus package to boost consumer demand, as America did with its cash bailouts during the Covid-19 pandemic. But they often overlook a key point emphasized by Wei and his co-authors: China has a hybrid economy in which the role of the state is larger than in any developed country.
For years, Chinese authorities were able to maintain the status quo by citing the economy’s rapid growth rate. But today, the weight of this argument has been greatly diminished. The quality of growth is steadily declining, and sooner or later it will become impossible to mask fundamental weaknesses in the economy with accounting tricks and unproductive infrastructure projects. The only sustainable way to revive growth is for the central government (which has been aggressively consolidating power over the past decade) to transfer some of its powers to local governments and, most importantly, to the private sector.
Because of the trade war launched by U.S. President Donald Trump, the task of reviving dynamism in the private sector becomes even more urgent for China. The export sector remains the most dynamic and globally competitive part of China’s economy, and it is the country’s main hope for productivity growth and relief from its current ills. But this engine has gone haywire, so the authorities must look for new sources of growth, and only the private sector can help solve this task.
One can admire China’s economic achievements over the past decades, but the massive stimulus after 2008 has not been an unqualified success, contrary to the claims of many progressive Keynesians. Moreover, this story should be a cautionary tale for all.
One of its results has been an increase in the debt-to-GDP ratio, which further limits the government’s ability to stimulate the economy. The IMF’s Fiscal Monitor predicts that China’s public debt will exceed 100% of GDP by 2027, and when corporate and household debt is included, it will exceed 300%. It may be argued that thanks to low interest rates, China will be able to cope with such a debt burden. But it is worth recalling that the same was once said about the US. Like Japan, China can keep interest rates low for a long time through financial repression, but the likely price will be slower economic growth. Japan’s experience over the past 30 years helps to see where that path might eventually lead.
The Chinese authorities are creative and skillful, but they have created some of their current problems themselves. Whether they will be able to find a way out of this predicament, or whether China will turn into another victim of the middle-income trap, remains to be seen. But what is already known is that hopes for a repeat of 2008 are deeply misguided. Well-designed stimulus aimed at boosting consumer spending could help, but only if private sector demand becomes its main channel.
Kenneth Rogoff,
former chief economist at the International Monetary Fund, now Professor of Economics and Public Policy at Harvard University, winner of the Deutsche Bank Prize in Financial Economics (2011).
© Project Syndicate, 2025.
www.project-syndicate.org
