Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday 3 August 2018

How China beat the Global Financial Crisis

If you were hoping for something on yesterday’s interest rate rise, I can only direct you to the leader in the FT today which says: “There is no compelling reason to increase the cost of borrowing in the UK, but there is definitely good cause to wait.” On why nine intelligent people could all make the same mistake, you have to question their mandate, and move to something that focuses on having the right environment for growth, as I do here.

I recently finished reading the latest book by Adam Tooze (of which much more in a subsequent post), and it reminded me of a story that was not told enough in the early days of austerity. Everyone knows about how quickly the Chinese economy has grown over the last few decades, and how strong exports have been an important part of that. In dollar terms the value of Chinese exports more than quadrupled between 2000 and 2007. By 2007 Chinese exports represented 35% of GDP.

An important characteristic of the Global Financial Crisis (GFC) was how quickly world trade collapsed. If we compare the beginnings of Great Recession after the GFC with the start of the Great Depression, while world industrial production moved in a similar fashion, world trade collapsed by much more in the Great Recession than the Great Depression. Here is a chart from Barry Eichengreen and Kevin O'Rourke’s ‘A Tale of Two Depressions Redux’ VoxEU article.

Trade collapsed in the winter of 2008 around the globe, without exception. This was very bad news for China. Whereas exports had been around 35% of GDP in 2007, they fell to around 25% of GDP in 2009. That is a big hole to fill, and if it wasn’t filled, there was a chance that Chinese growth would collapse completely with damaging knock on (multiplier) effects to the rest of the economy. Above all else, China feared the political consequences of the unrest widespread unemployment would bring.

As Tooze recounts, China’s reaction was swift and bold. In November 2008 it announced a stimulus package of public spending worth 12.5% of GDP. (The Obama stimulus package, by comparison, was around 5% of GDP.) “Over the days that followed [the announcement], across China, provincial party meetings were hurriedly convened …” Within a year 50% of the stimulus projects were underway. Some of this stimulus paid for what Tooze describes as “perhaps the most spectacular infrastructure project of the last generation anywhere in the world”, the Chinese high speed rail network. Monetary policy was also relaxed.

In 2008 as a whole, before the stimulus and hardly touched by the collapse in world trade, Chinese GDP grew by 9.6%. In 2009, when GDP in the advanced countries fell by 3.4%, Chinese growth was 9.1%. The stimulus package had filled the whole left by collapsing Chinese exports. (Source)

Basic macroeconomic theory says that a negative shock to GDP, caused for example by falling exports, can be completely offset by a monetary and fiscal stimulus. China is a good example of that idea in action. What about all the naysayers who predicted financial disaster if this was done? Well there was a mini-crisis in China half a dozen years later, but it is hard to connect it back to stimulus spending and it had little impact on Chinese growth. What about the huge burden on future generations that such stimulus spending would create? Thanks to that programme, China now has a high speed rail network and is a global leader in railway construction.

Now of course people will say that China is not like an advanced democracy, and it was not part of the global banking network that caused the GFC. But the US and UK stimulus programmes could and should have been larger. Those close to the action tell me that the UK was running out of things to spend more money on in 2008/9, but I cannot help think this amounts to a failure of imagination: it is not as if UK infrastructure is great, there are no flood defence projects left to do etc. Above all else China’s example tells you what a huge mistake 2010 austerity was.


  1. The GFC was really a western phenomenon. It was a temporary inconvenience, at worst, in East Asia. I am not aware of a single major financial institution from that part of the world that encountered serious difficulties.
    The share of trade as a % of GDP in China did decline in 2008 but it had recovered to around 60% two years later (and that's in the context of a rapidly growing economy, as you mention).

  2. And here in India we have put in place an inflation targeting framework & are actually taking it as some holy rule. But, China already had a pretty strong supply based infrastructure(including human capital) but still pretty far from PPF owing to which it was able to increase productivity easily without increasing inflation after pumping this much amount of liquidity. Here in India our supply chain is somehow broken & government was pretty shy of taking strong decisions owing to which even after pumping ample amount of liquidity projects were not granted permission & now we are suffering from twin balance sheet crisis or secular stagnation from our potential's perspective.As return on savings started to become negative they fell continuously & Fed's rumours of increasing interest rates led to a crisis like situation in 2013 & so inflation targeting was the natural offshoot of those times.

  3. It is telling that ime the most common criticism of the construction boom was that China ended up with too many airports and empty houses. What a problem to have!

  4. Interesting post.
    Should the People's Bank of China move to quantitative easing or helicopter drops?

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  6. I think it’s wrong to say that China beat the financial crisis. It‘s true that China has experienced strong growth this century. But a lot of this was catch up from a very low base; in particular China only joined the WTO in 2000 which set off spectacular export driven growth (and arguably helped the rest of the world reign in inflation, prolonging the great moderation).

    When the GFC struck China responded with stimulus. And never stopped, putting ever more strain on the financial system. When they have tried to clamp down on lending it’s only diversified into other areas, such as P2P lending which is now collapsing. They have little to show for it as it’s been mostly wasted, including a high-speed rail network that has no economic justification.

  7. What we all fail to see is motivation, here in Britain Thatcher outlined how she would shrink the state and privatise all public services including education and health, (1982 Cabinet papers, the longer term options. The Great Financial Crash gave them the opportunity to accelerate that drive, then Brexit was another accelerator to completely finish the job and seal the the real deal with Trump and his cronies.

    It isn't rocket science but we do have to be awake to see how it is all going nicely to plan.


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