By Peter Navarro 

Asia Times

13th November, 2008

Years from now, China’s embrace of a massive fiscal stimulus, announced this week, will be seen as a far more important marker of the country’s emergence as an economic superpower than even the successful hosting of the 2008 Summer Olympic Games.

This two-year, US$600 billion fiscal stimulus – equal to a stunning one-sixth of China’s entire gross domestic product – focuses primarily on the construction of economically critical infrastructure, such as rail and energy networks and politically critical infrastructure, like low-income housing and healthcare. The historic importance of China’s “New Deal” is evident in at least five factors. 

First, China’s swift action aptly illustrates how this putatively communist country can flexibly embrace the kind of mainstream

Keynesian economics that has kept the capitalist world (mostly) in prosperity since the end of the Great Depression. It’s pitch-perfect fiscal policy. 

Second, in a supreme irony, China has acted far more quickly and decisively than the United States, with the students now teaching their former mentors. Indeed, Chinese officials, many of them schooled in US universities, seemed to have grasped far more quickly than US officials like Federal Reserve chairman Ben Bernanke the futility of relying solely on interest rate cuts for rapid recovery. 

In particular, businesses won’t invest, no matter how low interest rates go, if the recession remains. Nor will lower interest rates entice consumers to buy big-ticket items such as cars and houses if they are worried about their jobs and shrinking stock portfolios. Chinese officials have grasped this point, even as European officials have thus far rejected fiscal stimulus and US officials continue to quibble over the size and timing of any package. 

Third, China’s fiscal stimulus package puts a powerful exclamation point on the tightly woven interconnectedness of the world’s major economies. While China continues to run large trade surpluses with the US and Europe, it is equally true that exports to China by American, European and even Asian countries constitute an ever-increasing component of economic growth. 

In this global trade, countries like Germany, Japan and the US provide sophisticated capital equipment for China’s “factory floor”. As China expands its infrastructure, companies like Hitachi and Caterpillar likewise benefit from increased sales to China. 

Fourth, the focus of China’s fiscal stimulus particularly on infrastructure illustrates a sophisticated understanding – seemingly lacking in the United States – of what is necessary to build a strong economy. In its next stage of development, China’s rail system must far better serve the inland areas of China where large pockets of rural poverty and high unemployment persist, despite three decades of robust growth. In fact, while the coastal areas from the Pearl River Delta up to Dalian have prospered, much of inland China remains impoverished. Swiftly developing better roads and rail and a more reliable and extensive electricity grid and water system is just what the country needs. 

Fifth, China’s New Deal will act as a powerful stimulus for domestic demand. Today, the Chinese economy is far too heavily dependent on export-driven growth. By stimulating domestic demand, China will not only better insulate itself from the vagaries of global trade. Rising domestic demand should also help reduce trade frictions that have arisen because of the large trade surpluses China runs with Europe and the US. 

Finally, China’s fiscal stimulus may also prove to be the beginning of the end of China’s willingness to finance the budget and trade deficits of the United States. 

For almost a decade, China has recycled many of the dollars it has earned through its export trade back into the US bond market. This has kept interest rates low in America and allowed the American consumer to spend far beyond his or her means. 

Now, however, China is going to need its foreign reserves and export earnings for domestic purposes. That should certainly mean fewer dollars available for recycling back to the US. In this way, China’s fiscal stimulus may act as a significant constraint on America’s own ability to successfully implement its own fiscal stimulus – even as China uses Keynesian policies to eclipse the US as the world’s reigning economic superpower. 

Peter Navarro is a professor at The Paul Merage School of Business at the University of California-Irvine, a CNBC contributor and author of The Coming China Wars. http://www.peternavarro.com. 

(Copyright 2008 Peter Navarro.)