China, having been the epicentre of the COVID-19 health crisis, experienced crippling disruptions to its economic growth. This is reflected in its first quarter GDP shrinking by 6.8%, with the pandemic crimping domestic demand, slamming production activity and halting the movement of goods and services.
Negative growth has not been witnessed in the nation since 1992. This has triggered policymakers into action as China unveiled the “14th Five-Year plan” which foregrounded a vision to transition toward a high income economy largely underpinned by infrastructure investment.
Economists believe China has a multiplier effect of around three, higher than any other developed economy. In essence this means a one dollar increase in real government spending can raise real GDP immediately by about $3, highlighting the efficacy of government spending in China in reversing economic slowdowns. The new infrastructure projects are heavily focused on seven different areas: 5G networks, industrial internet, inter-city transport, and inner-city rail systems, data centres, artificial intelligence, ultra-high voltage, and new energy vehicle charging stations. Expenditure on these projects are estimated to reach 2 trillion each year, unlocking at least 10 trillion yuan worth of direct investment and 17 trillion indirect investment by 2025.
Forecasting for such high expenditure in the future, Beijing has to make tough decisions on the proposed 10 trillion dollar yuan infrastructure spending for 2020, an investment package equal to 10% of China’s GDP in 2019. Macroeconomic data suggests that China is already beginning to make a striking recovery, with second year GDP growth turning positive, and figures for industry, investment and consumption all looking strong.
China, through its substantial infrastructure spending, is attempting to increase the ‘Government Expenditure’ component of Aggregate Demand, and therefore attain higher economic growth. Aggregate demand is a measure of the total level of expenditure in the economy. This is the sum of consumption, investment, government expenditure and net exports.
As mentioned previously, China believes that government spending will have a particularly large and favourable impact on its economic growth due to the multiplier effect. The multiplier effect is a process that causes an initial increase in AD to result in a multiplied final impact on output. Any increase in expenditure in the economy will also increase another individual’s income, some of which will be re-spent in the economy, further adding to AD. The process will repeat itself, generating successive waves of spending. The multiplier is given by:
K = 1/1-MPC
K = 1/MPS
MPC → marginal propensity to consume
MPS → marginal propensity to save
Note that the two equations are equivalent since MPC + MPS = 1
Note how this equation suggests that the multiplier is higher when MPS is lower.
Economic growth is measured by changes in Real GDP. Real GDP measures the value of all goods and services produced in an economy over a period of time, adjusted for changes in the price level (inflation).
How to calculate growth given real GDP:
Economic Growth = Real GDP current year - Real GDP previous year/Real GDP previous year * 100
China’s sizeable increase to its infrastructure spending in an effort to resuscitate the economy, is a form of fiscal policy. This describes the use of the government’s budget (government expenditure and revenue) in order to achieve certain economic goals.
More specifically it would be categorised under discretionary fiscal policy. This is where the government makes deliberate changes to spending and revenue in pursuit of a certain objective. Discretionary policy is often used to shift the allocation of resources, to where it is most efficient. China has identified 7 infrastructure products that provide an avenue for immense growth, and therefore are directing large amounts of expenditure toward this.
Discretionary fiscal policy differs from automatic fiscal stabilisers. Automatic stabilisers are designed to offset fluctuations in a nation’s economic activity through their normal cooperation, without additional intervention from the government. The progressive tax system is an example of this.