Expanding domestic demand still requires public investment to play a major role

Editor's note:

Currently, China’s investment trends are closely watched at home and abroad. How do you view the current investment situation, and what are the profound changes in the underlying logic of investment? Sanlihe launches a series of interpretations by authoritative experts to understand the general investment trend and respond to market concerns. A signed article by Zhang Bin, deputy director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, "Public investment still needs to be the mainstay to expand domestic demand" was published today.

The key to expanding domestic demand is to use strong external forces to break the negative cycle between income, expenditure, expectations and credit. Judging from my country's past experience, an effective way is to significantly increase the income of enterprises and residents in the short term by expanding government public investment, successfully breaking the negative cycle and returning the market to normal track. These public investments not only expand domestic demand, but also play a key supporting role in improving people's livelihood, upgrading industries, and protecting the ecological environment in the future. They are an important force in creating China's economic miracle. Today, public investment still has great potential. It can not only play a major role in expanding domestic demand, but also lay a solid foundation for future development. Increasing public investment through borrowing will not amplify debt risks, but will reduce debt risks if used properly.

Public investment is a key external guiding force for expanding domestic demand.

In an environment of insufficient domestic demand, the income growth of enterprises, residents, and governments has slowed down, and they have all reduced expenditures. In this way, a negative cycle can easily be formed: the expenditure saved by one entity corresponds to the decrease in the income of another entity; the expenditure saved by each entity corresponds to the decrease in the income of the whole society, and this situation will form a self-amplifying negative cycle. This is a typical manifestation of market failure, which is difficult to solve by relying on the spontaneous power of the market. The key to expanding domestic demand is to use external guidance to break this negative cycle, help the market return to normal track, and restore market vitality.

Public investment is the key external guiding force to break the negative cycle. In an environment of insufficient demand, public investment has two characteristics that the spontaneous force of the market does not have: First, public investment is independently decided by the government and is not subject to the conventional market logic of reducing expenditures when income drops; second, public investment can form expenditures on a large scale in the short term, thereby significantly increasing the income of enterprises and residents in the short term, and reversing the downward force of the market in a powerful way. Judging from historical experience, in 1998, my country vigorously promoted infrastructure construction represented by the national highway network to help the economy get out of insufficient demand; in 2008, my country adopted a 4 trillion yuan infrastructure investment policy to help the Chinese economy take the lead in achieving a V-shaped rebound during the global financial crisis; in 2015, my country supported the renovation of shantytowns, driving the recovery of real estate and credit, and getting out of insufficient demand.

When public investment increased significantly, the income growth of the whole society rebounded significantly, and workers' income and consumption also increased significantly. Judging from historical experience, public investment and consumption do not wax and wane, but rather drive and promote each other. In an environment of insufficient demand, using public investment to repair market failures and help the market regain its vitality is precisely the most effective prescription for helping workers' income and consumption increase.

There is vast space for public investment in our country, and there is much to be done.

Our country has invested heavily and made great progress in infrastructure such as electricity and gas, railways, highways, airports, ports and terminals. In many areas, it is close to the level of developed countries or even exceeds the level of developed countries. But that doesn’t mean there’s no room for public investment. In order to improve people's livelihood, industrial upgrading and ecological environment protection, our country still has a lot to do in the field of public investment.

On an incremental level, my country still has a lot of room for investment in public areas such as education, culture, sports, underground network management, and urban roads. The average number of libraries, museums, sports venues, etc. owned by one million people in our country lags behind the level of developed countries. There are 110 million floating people in urban areas at or above the prefecture level in my country who find it difficult to settle down in their permanent residences. The local government lacks corresponding affordable housing and various educational and medical supporting services. There is a large public investment gap behind this.

At the stock level, our country has always paid more attention to incremental construction and not enough attention to the maintenance, repair and reconstruction of the stock. After decades of construction, our country has formed a large-scale public infrastructure stock. A considerable number of these facilities have room for great improvement in terms of safety, effectiveness, and convenience, and a large amount of new investment is needed to make these infrastructures function better.

The characteristic of public investment is to solve problems that ordinary people and businesses need but are difficult to solve even if they want to spend money. As long as we observe carefully, there are many such problems in our daily lives. Think about your work with the intention of serving people's livelihood and serving enterprises. You don't have to worry about no projects to invest in and nothing to do.

The government has not borrowed excessively, and borrowing to increase public investment does not mean increasing debt risks.

International experience shows that in the past two decades, new government debt accounted for approximately 49% of the total new debt in developed economies, including 58% in the United States and 74% in Japan. In comparison, the proportion of new government debt in China was approximately 34%. The government debt here adopts the government debt caliber of the Bank for International Settlements (BIS), which includes not only statutory government debt, but also some local government implicit debt. Judging from the popularity of Chinese government debt by the market, domestic and foreign investors have given high evaluations to its safety, indicating that the market is not generally worried about the sustainability of the government's overall debt. The implicit debt of some local governments is unsustainable, but this does not mean that the government as a whole has over-leveraged.

After multiple rounds of replacement and resolution of local government implicit debts, the scale of local government implicit debts has dropped significantly, but the stock is still large. Many places have difficulty repaying debt principal and interest with the help of local government's own financial resources. Through countercyclical policies including increasing public investment and lowering policy interest rates, repairing market failures and restoring the vitality of the market itself can alleviate the debt pressure of local government platform companies through multiple channels such as increasing local government taxation and land transfer revenue, increasing the income of platform companies and the valuation of their assets, and reducing debt financing costs. Over time, at least in areas with population inflows and more developed economies, the hidden debt difficulties of local governments are expected to be alleviated.

Due to concerns about excessive macro-leverage, one idea is to reduce borrowing as much as possible, so as to lower the debt ratio and reduce debt risks. For residents or individual businesses, this is roughly correct, because reducing the scale of debt may not affect income growth and the debt ratio will decrease. But for a country, the situation is completely different. A decline in the debt growth rate of the whole society will generally correspond to a decline in the income growth rate of the whole society, and the debt ratio may not fall but rise. From 2002 to 2025, the correlation coefficient between my country's debt growth rate and debt ratio is -0.49. A decrease in debt growth rate corresponds to an increase in the debt ratio. The same is true for the experience of the United States, the Eurozone and Japan. In recent years, debt in Europe, the United States and Japan has expanded rapidly, but the debt ratio has slowly declined. Debt expansion and debt ratio are also negatively correlated. The enlightenment brought by these experiences is: through government borrowing to increase public investment, thereby driving the income of the whole society to increase, my country's debt ratio will not increase but decrease, the solvency will be improved, and debt risks will be better controlled.

Author: Zhang Bin, deputy director of the Institute of World Economics and Politics, Chinese Academy of Social Sciences