The latest research work of Associate Professor Yang Guochao (Director of the Big Data Research Centre for Finance, IIDPF) and his co-authors Li Xiaoxi and Gong Qiang, Long Pains or Short Pains?——Long-term and Short-term Effects of Economic Stimulus Policies During the Financial Crisis has been published in China Economic Quarterly, an authoritative journal in China.
Whether governments should introduce economic stimulus during economic downturns is the central difference between the Keynesian and Austrian schools of thought. This paper examines the impact of macroeconomic stimulus policies on the profitability of micro enterprises, taking advantage of the impact of the "four trillion" economic stimulus policy implemented by the Chinese government at the end of 2008 in response to the international financial crisis. Research found that although the economic stimulus policy lead to a large amount of bank credits flow into state-owned enterprises (SOEs), the profitability of state-owned firms during and after the stimulus period performed poor than non-state-owned firms. Further, the credit inflation caused by the economic stimulus policy has flowed into the state-owned enterprises with the worst profitability, and even the enterprises that cannot repay the principal and interest of the loans on time. The resources misallocation also caused state-owned enterprises to hire excess labour during the economic stimulus period. Sales growth were achieved by lowering sales prices and providing more relaxed commercial credit rather than through innovative activities. Substantial increase in real estate investment was accordingly realized. Finally, the paper also finds that the 'long pain' and 'short pain' caused by economic stimulus policies are mainly found in provinces where there is more pressure for local government officials in terms of promotion, a higher proportion of state-owned enterprises, a higher rate of regional unemployment growth and a larger local debt. In general, when there are market frictions, the stimulus has not only failed to clear inefficient SOEs during the economic crisis, but has also led to a large number of SOEs being turned into zombie enterprises as a result of government bailouts due to "soft budget constraints", making it difficult to achieve the objectives of the stimulus.
The findings of this paper have important theoretical contributions and practical implications: Firstly, the findings of this paper help us to reconceptualise the solutions proposed by the Austrian and Keynesian schools for the economic crisis. The Austrian school argues that the introduction of economic stimulus during a downturn will stimulate demand and boost the economy in the short term, but will lead to a longer-term recession. The Keynesian school argues that economic downturns are caused by a lack of effective demand, therefore, the introduction of economic stimulus policies will not only boost the economy in the short term, but will also lead to a positive feedback loop in the long term. The findings of this paper instead find that the economic stimulus led to large credit capital flows to SOEs, however, the performance of SOEs declined significantly both during the stimulus period and after the withdrawal of the economic stimulus. This suggests that government stimulus policies distort the allocation of resources when there are market frictions. As a result, the inefficient state-owned enterprises did not receive clearing during the economic crisis, but were turned into zombie enterprises due to "soft budget constraints", making it impossible to achieve the objectives of the economic stimulus policy. This article suggests that, rather than debating the rights and wrongs of different academic schools of thought, it is better to examine the premises of the applicability of each theory to different economic systems.
Secondly, the findings of this paper also help to rethink the role of state ownership of banks and enterprises in special situations. The 'political view' of the state system assumes that SOEs have a political mission. As a result, the allocation of capital in SOEs is not entirely based on value maximisation, which can lead to inefficiencies in SOEs. The 'social view' of the state system, however, argues that in extreme cases, state-owned banks and SOEs can play a role in addressing market failures. For example, Liang & Yu (2014) study the impact of the Asian financial crisis and the global subprime crisis on firm investment in 11 Asian countries or regions. The study found that capital investment by SOEs fell less in the financial crisis. The more nationalised the banks where the firms are located, the less the financial crisis hit them. That is, state equity has acted as an "economic stabiliser" in times of financial crisis. This paper does not deny the positive role of the state system in stimulating business investments. However, if the stimulus policies implemented to alleviate the financial crisis create distortions in the incentives of state-owned banks and SOEs, they will not be able to truly address market failures in times of economic crisis, but will simply use the accelerated growth in investment to mask the decline in real corporate performance.
Thirdly, this paper has important practical implications for how to curb China's economic downturn. A healthy economy should ensure optimal capital allocation efficiency by allocating scarce capital to firms or individuals that can maximise value, while reducing investment in value-destroying projects (Schumpeter, 1942；Aghion and Howitt, 1997；Restuccia and Rogerson, 2008). Song et al.（2011）found that, the continued flow of economic resources from inefficient state-owned enterprises to efficient private enterprises is the fundamental reason why China's economy continued to achieve high growth rates from the end of the 20th century to the beginning of the 21st century. However, this study finds that the economic stimulus policies introduced in later 2008 have concentrated a large amount of economic resources in SOEs, especially the loss-making ones. This grim fact reflects the serious problem of "soft budget constraints" that still exists in SOEs in China. Therefore, there is an urgent need for the government to achieve a rational allocation of economic resources by hardening the budgetary constraints of enterprises themselves, to truly establish a level playing field and to fundamentally stimulate the vitality of our economic growth.