Repercussions from China’s 2009–10 fiscal stimulus—a widely praised spending program credited with dampening the effects of worldwide recession—are limiting the country’s economic growth today, according to research.

A study by Chong-En Bai of Tsinghua University, Chang-Tai Hsieh of Chicago Booth, and Zheng Michael Song of the Chinese University of Hong Kong demonstrates that off-balance-sheet investments by local governments funded China’s stimulus and obscured a high debt load for the country. The program may have created a permanent decline in the growth rate of China’s aggregate productivity and gross domestic product. The findings explain how China initiated major infrastructure projects without officially raising national debt to alarming levels.

To fund the stimulus, China lifted longtime rules that prohibited local governments from accruing debt or running deficits, the researchers find. Freed from these constraints, local governments transferred land to investment vehicles to use as backing for bank loans or bond issuances. The researchers estimate that about 75 percent of China’s stimulus spending came from transactions through these entities, whose debt is not reflected in official tallies of government accounts.

The local governments continued to invest with off-balance-sheet transactions long after the stimulus ended. Although they continued to make significant investments in infrastructure, they put more of the money toward commercial projects by favored private companies, according to the study. “The aggregate effect is that the overall efficiency in the allocation of capital worsened . . . which lowers the aggregate growth rate,” the researchers write. They illustrate the point with figures that show aggregate growth rates declining significantly after stimulus ended in 2010, even though investment rates rose.

Breaking down the assets in China’s banking sector (all figures given in trillions of Yuan)
Asset Type 2008 2014
Reserve Assets 9.4 23.3
Central Bank Bonds 5.3 9.6
Domestic Government Bonds 4.3 0.7
Lending to the Non-Financial Sector 39.2 127.2
Total Assets 58.2 160.8

Source: Bai et al., 2016

Contributions from local government entities led China to attain one of the highest investment rates of any country in the world. By 2014, China’s investment rate was 48 percent of GDP, the researchers point out. The US, by comparison, had an investment rate of about 20 percent of GDP in 2014, according to Economy Watch, an independent news and economic statistics service.

China’s stimulus package has drawn praise in the past in economic and policy circles, including appreciation from leaders of the International Monetary Fund. But more recently, IMF officials and international economists have warned that China’s high corporate-debt levels could be a threat to economies worldwide.

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