Rolf J. Langhammer
China’s GDP growth rate target wastes resources and prevents necessary structural adjustments. The target encourages the build-up of overcapacities and forces the government to stimulate demand even if this demand is not sustainable. China should replace growth targets with economic forecasting and assessments of China’s capacity growth potential.
There are many good reasons to criticize China’s obsession with GDP growth targets. Setting such targets for growth – and therefore for total demand – is a relic from the era of Communist planning in a closed-off economy. It is a bad fit for today’s open economy, which owes a considerable part of its growth to external demand, the development of which China’s planners cannot directly influence. In times of double-digit growth rates, growth targeting was not a major issue. It became an issue when China’s boom slowed down and when the government had to find ways to keep growth at a level that was high enough to avoid widespread dissatisfaction. Since then, China has continuously set the target in a range of 6 to 7 percent.
The obvious problem of a demand growth target is that it is set long before the actual macroeconomic data are out. As soon as the data suggest lower growth than the target rate, the government sees itself forced to intervene with fiscal expansion, loose monetary policy, and private demand stimulus. This behavior creates a long-term burden for the economy as it triggers a misallocation of investment in favor of well-established sectors and dangerous increases of corporate and public debt.
GDP growth rate targeting becomes costly when the actual economic development signals a steeper decline of growth than planned by the government, and the price goes up if the government hesitates to revise its own unrealistic expectations. But the most important long-term flaw of GDP growth rate targeting is that it stands in the way of the necessary structural transformation of the Chinese economy. In the aftermath of the 2008 global financial crisis, China had launched the world’s largest fiscal expansion program. Many industries, such as construction-related industries, reacted by expanding their capacities. These industries would now suffer from massive oversupply and job losses once the measures are phased out.
In the absence of a growth rate targeting policy, in a true free-market economy, a time-consuming process of structural adjustment and transformation would occur. Idle capacities would be removed from the market. Jobs would be lost. The value of loan collaterals would have to be adjusted downward. State-owned enterprises burdened with non-performing loans would struggle. In some sectors, companies would be forced to exit the market before new industries would provide new jobs. All these adjustments would have to take their time to materialize.
China’s planners don’t allow time for painful adjustments
During this time of adjustment and restructuring, GDP growth rates would fall significantly. Yet, by defending a growth target, China’s planners allow the Chinese economy no such time to adjust. The easiest and fastest way to raise demand in order to match a given supply level is to stimulate it in already existing sectors, which results in the production of “more of the same.” By financing infrastructure projects abroad, for example through the Belt and Road Initiative, the Chinese government helps its construction industries to export their oversupply, and it stimulates domestic demand by issuing targeted loans to ensure a stable level of output in these sectors.
Postponing structural adjustment by defending a targeted GDP growth rate through new fiscal and monetary impulses for old industries will be wasteful for China in the medium-term as it binds capital in these industries and thus hinders new industries to mobilize capital. A reallocation of capital from old industries towards new industries will be made difficult once the capital is bound in physical assets of the old industries, such as machinery, plants and equipment.
The problem with the current growth targets is that they focus on demand to be raised to a given level of supply. This results in short-term demand management rather than facilitating a change in the supply pattern. Such a change would comprise human capital formation, labor market reforms, bankruptcy laws and state support to smoothen market exits.
China should replace growth targets with forecasts
There are two ways to get out of this trap. First, the government could commission independent research institutes to forecast GDP growth rates and use these forecasts as the basis for its own forecast. This approach would take both the demand and the supply side of the economy into account. This does not mean that the government could no longer intervene in favor of specific sectors. But the shift towards a forecasting system similar to that in most other market economies would move China away from its rigid GDP growth rate targeting.
Second, research institutes and government would additionally estimate the growth of capacity output and communicate the assessment of medium-term productivity developments of labor, capital and institutions to the public. The assessment would include the anticipated effects of a range of China’s industrial policies such as “Made in China 2025” on the trend of capacity growth.
The government would have to step carefully in communicating the policy shift away from a set GDP growth rate target since a sudden change could lead to confusion and uncertainty among economic actors and financial markets. But substituting the target with a forecast would be the only way to stop the waste of resources and to start the painful but necessary process of restructuring.