Govt payments, not infra stimulus, may shape recovery

Despite the prevalent view that China will launch a strong infrastructure stimulus package, government payments to low-income individuals and hard-hit businesses may instead hold the key to the post-epidemic economic recovery.

China has pre-approved a total of 2.29 trillion yuan ($323 billion) worth of local government special bonds mainly to fund infrastructure projects and create demand. The market expects that the total quota of the year, which is to be unveiled at the upcoming annual gathering of the nation’s top legislature, may reach 3.5 trillion yuan or more.

Government spending in infrastructure investment is indeed of great efficacy in stimulating demand. Each 100 yuan spent in investment, accompanied by the additional loan funding from banks, could create demand worth more than that 100 yuan.

Otherwise, if the amount is used for cash payments to low-income people, the induced consumer spending should be less than 100 yuan as people tend to save some of the money received.

But let’s see how the COVID-19 pandemic has hurt the economy before finding cures.

COVID-19 has dealt a blow to aggregate demand, while the shock was more overthese whelming for services than for goods. Particularly, it is the lower-end, labor-intensive services sector, which employs less educated and cheaper labor, that bore the brunt, such as offline retail, warehousing, tourism, catering and hospitality.

Data from the National Bureau of Statistics showed that the price rise in home services, provided mostly by lower-end labor force such as plumbers and nannies, slowed down much more quickly than the top-line consumer prices during the first quarter of the year.

As changes in home services prices closely correlate with wages of lower-end labor, the numbers have pointed to a heavier risk of shrinking income of the group than others amid the COVID-19 shock. Demand for lower-end labor has contracted more than the supply.

Owing to the relatively high cash flow pressure on lower-end labor force, the blow to income could swiftly transform into a drastic decline in consumption and inflict a secondary damage on the economy.

Transfer payments from the government to those low-income people will help them maintain their living standards and prevent the contraction in aggregate demand. Indeed, payments to individuals may not be the most efficient way to stimulate demand, but it would reflect society’s intent to care for the hard-hit, ordinary people amid the crisis.

This should also apply to the most-hit sectors and corporates. Although payments to businesses may not shore up demand as strongly as infrastructure investment, society should be responsible for these groups that got hurt.

From the economic perspective, those businesses, particularly small and mediumsized enterprises, hold a great amount of social capital, such as the networks of clients, management skills and brands. Therefore, transfer payments to the hard-hit businesses will help retain the existing social capital, helping the economy to recover swiftly.

Moreover, bailing out the virus-stricken services businesses will also help stabilize employment. Over the past few years, the services sector has been the main source of new job opportunities as employment in the secondary sector shrank. The services sector employed more than 350 million as of the end of 2018, or almost half of total employment.

Compared with infrastructure investment that forms new capital, the transfer payments to individuals and businesses have the advantages of not distorting the allocation of resources and are reversible once the economic fallout from the pandemic ends.

It also should be noted that any over-reliance on macro adjustments that focus on stimulating demand, like expanding infrastructure investment, can have non-negligible side-effects, especially when restrictions on supply recovery linger due to the continued infection risk.

China’s GDP took a record deep plunge during the first quarter of the year, yet the slowdown in the general price rise over the same period was very modest. In normal times, the change in the first-quarter CPI corresponds to only less than 0.5 percentage point of GDP slowdown.

The sharp contrast between output and price level indicates that the aggregate supply was disrupted almost as heavily as the aggregate demand, which cast a long shadow over the suggestions to restart and stimulate the economy from the demand side.

Before completely removing the limits on supply caused by the pandemic, policies that merely stimulate demand may not work as well as expected but brew up inflation.

Domestic demand in China has been gradually recovering and will likely offset the shock from dropping external demand, leading to less economic downside pressure for the second quarter of the year than the previous one.

The economy is expected to start a mild and slow recovery after the second quarter and finally reach a post-pandemic balance. Output at the new balance may be a bit lower than the level prior to the pandemic as long as infection risks linger.

Against this backdrop, the government is expected to be flexible and realistic when it comes to setting this year’s goal of economic growth. For instance, the government may consider setting GDP growth target for the third and fourth quarters of the year but forgo the target of the whole year.

In short, there is still a long way to go for economic activities in China to rebalance after the epidemic. During this process, economic policies should flexibly act in accordance with changes in the supply-demand relationship; and transfer payments to hard-hit businesses and low-income people should become extremely important policy moves.

Domestic demand in China has been gradually recovering and will likely offset the shock from dropping external demand, leading to less economic downside pressure for the second quarter of the year than the previous one. The economy is expected to start a mild and slow recovery after the second quarter and finally reach a postpandemic balance.