Enough already, the pump is primed

It’s one thing to run big budget deficits going into a recession, or after the WTC attack; it’s quite another to be running deficits when your economy is growing around 10% a year. Yet that’s what China has been doing. Even today, the Chinese economy continues to run a sizeable deficit, 2-2.5% of GDP. The Chinese budget for 2005 is $392 billion, up almost 14% from the prior year. The good news for China is that its tax and other revenues have been increasing smartly in recent years, from what appears from the chart below to be a low of around 11% of GDP to 20% today. The Economist produced an article and a chart on the situation which badly explain it; the chart is particularly incomprehensible:

The budget includes a demand for a reduction in the deficit—a 6% cut to 300 billion yuan ($36 billion). This would represent a deficit of about 2% of GDP, down from last year’s 2.5% (see chart). It signals a winding down of the pump-priming policy brought in to maintain high economic growth in the wake of the Asian financial crisis of 1997. This policy has involved billions of dollars of government spending on infrastructure, much of it in less prosperous areas.

The chart above is hard to understand. The deficit is coming down, but there is no convergence yet of revenues and expenditures, which the chart falsely implies.

Rather, the situation would appear to be that China is running a deficit during a time of astounding growth, when economic orthodoxy is that governments should run surpluses. Moreover, a 14% increase in the budget during the boom time seems counterintuitive. Prudent fiscal and monetary policy would be leaning into the wind during a great boom time. China is doing only a little of it, like the weak palliatives of a 5.5% capital gains tax on Shanghai real estate held for less than a year (!), and a 0.2% increase in mortgage rates.

Running fiscal, monetary, credit, and industrial policy all in the same expansionary direction during a boom time is a classic recipe for a hard landing. What are we missing in our analysis that would indicate otherwise?

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