Ways to Boost Fiscal Policy Further

Abstract

In the second half of the financial cycle, the contradiction of insufficient demand becomes prominent. At the end of September this year, the State Council Information Office released a series of policies, and the Politburo meeting further sent a positive policy signal, which was positively received by the market. We believe that there is still room for monetary policy to ease, but against the backdrop of deleveraging in the private sector, the necessity for fiscal policy to step up significantly increases. We argue that, while strictly regulating new debt, accelerating the replacement of local existing debt and addressing the issue of corporate debt arrears can help reduce the burden on related entities and stimulate economic vitality. The "Decision" of the Third Plenary Session of the 20th Central Committee of the Communist Party of China states, "Ensuring and improving people's livelihoods in development is a significant task of Chinese-style modernization." We believe that, against the backdrop of the reduction of traditional infrastructure space, shifting the focus of fiscal expenditure from infrastructure investment ("hard infrastructure") to people's livelihoods ("soft infrastructure") can help improve the quality and efficiency of fiscal policy.

The scope of people's livelihoods is broad, and we mainly consider education, health, and social security. One scenario is to refer to the situation of other countries (such as the United States and South Korea) during their period of reaching medium-developed status and the so-called "Wagner acceleration period." Another scenario is to refer to the fitting situation of about 30 economies with existing data. There is a certain difference in the results of the two scenarios, but overall, there is still a large space for "soft infrastructure." The multipliers of livelihood expenditure in different fields on economic growth vary significantly. In the short term, the multipliers for the three major livelihoods are generally expected to be between 0.7 and 0.9, but the long-term multipliers are greater than 1. In detail, the short-term multiplier for education is greater than 1, while the short-term multipliers for health and social security are less than 1, which may be due to the more significant rigidity of the former's expenditure.

Main Text

In the second half of the financial cycle, the contradiction of insufficient demand becomes prominent, and prices continue to operate at a low level, indicating that the output gap remains large. Although there is still room for monetary policy to ease, the effectiveness of monetary policy gradually weakens against the backdrop of deleveraging in the private sector. On the morning of September 24th, the State Council Information Office held a press conference on the financial support for high-quality economic development, and the central bank, the China Securities Regulatory Commission, and the Financial Regulatory General Administration issued a series of policies. The adjustment of interest rate reduction and loan renewal policies has effectively reduced the debt repayment burden on the real sector and mitigated potential cash flow risks. For the first time, the central bank created a structural monetary policy tool to support the stock market, stating that there is no clear limit on the quota. The monetary policy effort, combined with financial regulatory and capital market reform measures, has had a positive impact on stock market expectations. The Politburo meeting on September 26th further sent a positive policy signal. If subsequent fiscal policies can expand significantly and the expenditure direction can be more efficient, we expect that the confidence of the real economy will be further boosted. In fact, in the second half of the financial cycle, fiscal expansion is very important for boosting growth and alleviating financial risks, and its necessity has recently increased significantly.

So, against the backdrop of traditional infrastructure experiencing years of high growth, how can fiscal policy be further strengthened? We believe that, while strictly regulating new debt, accelerating the replacement of local existing debt and addressing the issue of corporate debt arrears can help reduce the burden on related entities and stimulate economic vitality. In addition, the mainstream view in recent times also believes that it is necessary for the direction of fiscal expansion to shift more from focusing on investment to people's livelihoods. The "Decision" of the Third Plenary Session of the 20th Central Committee of the Communist Party of China states, "Ensuring and improving people's livelihoods in development is a significant task of Chinese-style modernization." Our research shows that in recent years, the return on government investment in our country has shown a weakening trend. Shifting the focus of fiscal expenditure from infrastructure investment to people's livelihoods can help improve the quality and efficiency of fiscal policy, enhance market confidence, promote short-term growth, and also improve human capital, and increase medium to long-term growth. So, how much space is there in terms of people's livelihoods? What are the differences in fiscal multipliers in different fields of people's livelihoods? These are the questions we will answer next.

Learning from Others: Shifting from Investment to People's Livelihoods in Fiscal Policy

Looking at the cross-country data over the past fifty years, as per capita GDP increases, the proportion of economic construction expenditure in total fiscal expenditure has declined, while the proportion of people's livelihood expenditure in total fiscal expenditure has generally increased; during the period when per capita GDP rises from $10,000 to about $25,000 (measured in 2015 constant US dollars), the increase in the proportion of people's livelihood expenditure is particularly evident. We might call this range the "Wagner acceleration period." The economic construction expenditure mentioned here refers to some items under the International Monetary Fund's (IMF) GFS database that are comparable across countries, mainly including fiscal expenditures on agriculture, forestry, water conservancy, transportation, communication, energy, industry, and other aspects.

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This phenomenon can be understood from both the demand side and the supply side. From the demand side, compared to basic survival needs such as food, clothing, and safety, the income elasticity of demand for public goods such as education, health, and social security may be greater than 1. As income levels rise, the public's demand for such public goods will also expand rapidly. From the supply side, a country's economic output depends on total factor productivity, physical capital, and human resources. Capital public goods provided by the government (such as various infrastructures) become part of the capital stock, while current public goods (such as transfer payments) affect human resources; fiscal expenditures targeting non-employed personnel, such as infant and toddler care, can also indirectly affect the total economic output by increasing the labor supply of employed personnel. Within this analytical framework, the marginal output of capital and the marginal output of human resources will both decrease with increased input, but their relative sizes vary at different stages of economic development.

In the early stages of economic development, physical capital used for industrial production is relatively scarcer than human resources, with low per capita capital stock, hence the marginal output of capital is high, and the marginal output of human resources is low. Both the private sector and the government are motivated to increase the input of physical capital. As per capita income grows, capital continues to accumulate and deepen, and the rise in per capita capital stock may cause the marginal output of capital to be lower than that of human resources. Reducing fiscal input into physical capital accumulation (construction investment) and increasing fiscal input into human resource accumulation (livelihood security) can help improve the role of fiscal policy in promoting economic development.The scatter plot of per capita livelihood expenditure and pension insurance revenue for various countries is as follows. Based on estimates from the public data of the Ministry of Human Resources and Social Security [13], there is a certain difference between the average annual income of basic pension insurance for urban workers and the average annual income of basic pension insurance for urban and rural residents in our country. In addition, compared with developed countries such as the United States, the United Kingdom, and Japan, as well as a few developing countries, there is room for improvement in the ratio of our country's total livelihood fiscal expenditure, including pensions and social relief, to GDP. There is also room for improvement in the coverage rates of workers' compensation insurance, unemployment insurance, and child and maternity welfare.

The "Decision" of the Third Plenary Session of the 20th Central Committee and the "Five-Year Action Plan for Deeply Implementing the People-Oriented New Urbanization Strategy" issued by the State Council in July, which proposed to promote the urbanization of agricultural transfer population and the equalization of public services, are also quite important. By the end of 2023, there were about 177 million migrant workers in our country. If all these migrant workers obtained urban household registration, the urbanization rate of our country's registered population would rise from the current 48% to 60%, and the gap with the urbanization rate of the permanent population would be significantly narrowed.

Livelihood Expenditure Multiplier

The above analysis discussed the space for livelihood expenditure, so how large is the multiplier of livelihood expenditure? The multiplier can help us analyze the role of changes in livelihood expenditure in boosting economic growth. Referring to the mainstream analysis methods in academia, we use the structural vector autoregression method (SVAR) that includes financial conditions and monetary policy to measure the fiscal multiplier of China's livelihood expenditure (sample interval 1993-2022). We estimate that the average short-term fiscal multiplier of China's three major livelihood expenditures is about 0.9, and the long-term multiplier is about 1.2. That is to say, the increase in GDP brought by livelihood expenditure within one year is equivalent to 0.9 times the total expenditure, and the cumulative increase in GDP brought by the cumulative expenditure of livelihood within five years is equivalent to 1.2 times the cumulative expenditure of livelihood. Looking at it in detail, the multiplier of education and health expenditure is higher than that of social security expenditure, which may be related to the difference in the mechanism of education, health expenditure and social security expenditure. The rigidity of education expenditure may be more significant than that of social security, leading to a higher expenditure multiplier than social security. In addition, there is a large difference in pension benefits among people in social security expenditure, and the marginal propensity to consume of those with higher pension income may be lower, and their social security expenditure multiplier may be correspondingly smaller.

We compare the fiscal multiplier of China's livelihood expenditure with that of the United States, which is measured by the same method. Among the three major livelihood expenditures in the United States, the expenditure multiplier of social security is also smaller than that of education and medical and health. The overall fiscal multiplier of China's livelihood expenditure is smaller than that of the United States. How to understand the difference in the fiscal multiplier of livelihood expenditure between China and the United States? We believe that the reason may lie in the fact that the marginal propensity to consume of Chinese residents is lower than that of the United States (about 0.63 in China and about 0.88 in the United States), and the difference in the conversion of the same scale of personal transfer payments into consumption and economic total between China and the United States is quite large.

It is worth mentioning that the marginal propensity to consume is not exogenous, and it is also related to the level of livelihood protection. The higher the level of livelihood protection, the weaker the motivation for precautionary savings, and the larger the multiplier of livelihood expenditure. In addition, due to the higher savings tendency of high-income groups than low-income groups, income disparity also affects the savings rate. Improving livelihood protection can reduce the disparity of disposable income, thereby affecting the propensity to consume and the multiplier of livelihood expenditure.

Academic research has also found that the role of China's personal income tax in regulating income distribution is weaker than that of social security transfer payments. Therefore, the redistributive function of livelihood expenditure needs to be fully exerted to narrow the gap in residents' income and increase the propensity to consume. Data show that for every 1 percentage point increase in the proportion of China's livelihood expenditure in GDP, the average propensity to consume of residents can be increased by 0.54 percentage points. In addition to increasing the propensity to consume, increasing the intensity of livelihood expenditure is also conducive to improving inflation expectations, promoting the downward movement of real interest rates when nominal interest rates are relatively stable, reducing the actual financing costs and debt costs of enterprises and residents, and further promoting investment and consumption. In addition, the multiplier of China's livelihood expenditure in Figure 15 is calculated based on the quarterly data from 2007 to 2022, which is difficult to reflect the situation of weak macro environment and insufficient effective demand in recent years. Based on the relevant data of the National Bureau of Statistics and the Federal Reserve Bank of Atlanta in the United States, we estimate that the current marginal propensity to consume of residents is low, and the overall short-term expenditure multiplier of the three major livelihoods may be between 0.6 and 0.9.