Bubble or Not: Why China's Economic Programs are Working

After the Chinese government announced its Beijing-London railway project, the global discussion around its ambitious economic stimulus and infrastructure programs heated up. People have been asking if these represent a recessionary bubble in the making, or whether there is a method to the apparent madness of the Chinese.

Although China’s policies potentially could create a bubble on the long term, a near-term recession is not likely and a number of factors are working in China’s favor, despite recent GDP growth deceleration. These can provide insight into the conditions under which large-scale government projects and economic stimulus programs can succeed.

The first factor is that China is a net exporter, with average monthly trade surpluses of $10B to $15B. This allows the government to keep corporate income tax rates relatively low while generating enough revenue to finance projects without having to print more cash.

China also has adopted business and entrepreneur friendly policies. Under its Unified Corporate Income Tax Law (“New CIT Law”) which took effect from January 1, 2008, foreign owned enterprises and domestic businesses are subject to a unified tax rate of 25%. Additionally according to Rule 28 of New CIT Law, income tax of small low-profit enterprises is subject to a reduced rate of 20%. In some cases businesses that are classified as a “resource multipurpose utilization enterprise” can receive an income tax holiday of a year or more. Compare this to average U.S. corporate tax rates that often exceed 40% when state and local income taxes are factored in.

Innovation also is encouraged by aspects of the government’s five year planning cycle, particularly in its modernization policies. In a recent interview, top policy advisor Hu Angang said, “The 12th five-year plan will not only be China’s first national plan for ‘green development’, but a historical starting point of the nation’s path towards a ‘green modernization’.”

Chinese entrepreneurs and their investors are seeing a greater number of exit strategies, due to both favorable policies and trends towards industry consolidation in infrastructure verticals. China Infrastructure Construction Company (CHNC:OTCBB) is an example of a small company that was able to offer its stock publicly in the United States. As one of the few producers of ready-mix concrete that is “green” (i.e., made in part from recycled materials), its prospects are bolstered by the government’s green modernization efforts.

These factors have been important contributors to the expansion of China’s expanding middle class that continues to demand more domestic products and services. Some estimates show a Chinese middle class of 700 million people by the year 2020.

Could China’s “growth bubble” burst? It could over time, but not in the near term. The emerging middle class will increase its demand for foreign goods, but barring an internal economic shock or banking meltdown, it will be many years before the balance between cash in and cash out shrinks to the point that the country’s ambition drives an economic contraction.