TCS Daily


Is Keynes a Good Substitute for Marx?

By Christopher Lingle - September 10, 2004 12:00 AM

China has overcome some of the economic disasters of an obsession of its leaders with Marxist-Leninist communism. Despite abandoning ideology for pragmatism, Beijing has adopted a new but equally discredited set of economic theories and policies. Class struggle and central planning have been traded for tools designed to manage aggregate demand following the ideology of Keynesian economics. Central planning kept China's economy on the brink of collapse, but Keynesian policies may take China's economy over the edge.

After buying into Keynesian economics, Beijing has become addicted to fiscal spending aimed to boost current economic growth. Despite the appearance of promoting growth, it has also brought growing fiscal deficits and ballooning public-sector debt that weaken China's long-term economic prospects.

Economic growth arising from increased government spending is unsustainable and also introduces imbalances in production structures. And corrupt cadres have overseen low-quality growth arising from inefficiency and graft.

Beijing has spent wildly on fixed assets to sustain high economic growth. However, much of these capital expenditures went to state-owned enterprises. Of this total "investment", two-thirds of the spending was directed to the central government or its supplicants and it grew faster than GDP by a factor of three.

Six years of fiscal stimulus and growing budget deficits has brought China's annual public-sector deficit to more than 3 percent of GDP. This may seem small compared to other countries, but it does not include liabilities including the mountain of bad debts in state-owned banks and unfunded pension obligations.

On the revenue side, Beijing also faces increasing strains. While government expenditures experienced a year-on-year increase of almost 24 percent in the first quarter of 2002, tax revenues rose by just over 3 percent.

Beijing's large and growing deficits add to existing public-sector debt. Adding contingent liabilities like recapitalizing banks and fulfilling pension obligations to existing government debt and total bad debts held by SOEs brings the total to around 70 percent of GDP.

China's leaders are embarking on a dangerous gamble whereby long-term costs are imposed in exchange for illusory short-term gains. Public-sector deficit spending is a burden on future generations of taxpayers that must pay higher taxes to finance today's follies.

How effective is deficit spending in reviving economic growth? A recent test case of applying Keynesian-style cyclical cures to resolve structural problems can be seen in Japan. Since the end of its "bubble economy", most of Japan's additional public-sector expenditures were financed by deficits. Tokyo's spending during the 1990s exceeding 800 trillion yen, five times greater than fiscal expenditures in the US during its restructuring in the 1980s. Despite such massive expenditures that were combined with expansionary credit policies, Japan's average economic growth in the 1990s was about 1.1 percent.

And Tokyo's outstanding debt rose from 56 percent of GDP at the beginning of the 1990s to more than 140 percent. Many credit-rating agencies put the figure at higher levels.

All this bad news in Japan is the outcome of a government too stubborn or afraid to implement the necessary policies to force radical restructuring of the economy. By following this same path, Chinese leaders are likely to cause further deterioration in their economy.

Some similarities exist in the necessary restructuring for these two economies. In both Japan and China, small and medium sized enterprises were starved of capital while industrial behemoths were kept alive.

Despite high levels of personal savings in both countries, the allocation of these funds is very inefficient. Both Japan and China lack well-functioning domestic capital market so that most borrowing goes through the banking system.

This is a problem since bank lending is vulnerable to political pressures. Indeed, politicization of the capital formation process is at the core of the serious financial sector problems in China and Japan. Both countries need wider and deeper domestic stock and bond markets.

Restructuring in China and Japan must go beyond cutting costs since such reductions only resolve temporary difficulties. Proper restructuring requires a dynamic perspective with deep reform of management practices and government involvement in the economy. Beijing and Tokyo should force changes in their respective corporate and political cultures to encourage real entrepreneurial initiatives in the private sector to resolve their economic woes.

Christopher Lingle is Professor of Economics at Universidad Francisco MarroquĂ­n in Guatemala and Global Strategist for eConoLytics.com.


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