China’s 586 billion dollar stimulus plan

Countries all over the world are facing the brunt of the current financial crisis. Everyone is taking measures that suit their economic environment the best. China has also announced a stimulus package to keep its economy going.

The key thing about this plan is that at $586 billion it is as almost as big as the American bailout plan, but primarily focuses on infrastructure development within the country.  The major similarity in the American and Chinese plan is that both try and create an environment  for expansion of consumer credit.

  1. Remove the credit ceilings of commercial banks: There is a certain limit beyond which commercial banks cannot lend in China. The current plan will abolish that ceiling and allow banks to invest more freely in predefined investment areas.
  2. Investment in Infrastructure: The stimulus plan will focus on spending money on ten key areas. These have been identified as low-income housing, rural infrastructure, water, electricity, transportation, the environment, technological innovation and rebuilding from disasters.

Apart from the stimulus plan itself China plans to reform its Value Added Tax (VAT) laws and bring in cost efficiencies to its manufacturers.

Focus on consumption

Much of China’s growth in the the last few decades has come from a sustained focus on exports and investment in factories and industries. In the wake of the financial crisis thousands of factories have closed down in China and many businesses have gone bankrupt.

In this context, China’s focus on consumption and building up its rural infrastructure shows the direction Chinese think the global economy is taking.

They are no longer relying on American and European consumption to fuel export oriented economic growth, but are planning to stimulate internal consumption to fuel future growth. While exports have grown annually at rates as high as 20%, this year the rate of growth is expected to be in the vicinity of 0%.

What it means for the west?

China is going to go the same path the more developed economies have followed since the end of World War – II. Initial thrust through exports (whether arms or cars), then stimulate the economy through massive spending on internal infrastructure and top it up with major expansion in consumer credit.

The economic cycle has changed for both China and the West. While China promotes massive investment in infrastructure and consumer demand the West has to do just the opposite. While China reaps the benefit of years of trade surpluses, the west needs to balance its budgets and control costs in order to let the financial and real economy stabilize. The thrust for the more developed economies need to be spending on capital goods and innovation and not so much on consumer credit.

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