This paper argues that the tradtitional way of gauging a country's fiscal policy stance by looking at government budget deficit or cyclically adjusted budget deficits is misleading in the case of China, since a lot of what usually would be considered fiscal policy is conducted via investment by state owned enterprises. The paper therefore proposes a different indicator for the fiscal policy stance, constructed from government consumption, government expenditure, the state-owned- enterprises' investments and tax revenue. Using this indicator, it can be shown that fiscal policy has been strongly counter-cyclical in China over the past two decades.Fiscal Policy, China, State-Owned Enterprises, Statistics

Sebastian Dullien

English

Research Papers in Economics

Measuring China's Fiscal Policy Stance 
By Sebastian Dullien
1 
June 2004, corrected version 2006 
 
Abstract: 
This paper argues that the tradtitional way of gauging a country's fiscal policy stance 
by looking at government budget deficit or cyclically adjusted budget deficits is 
misleading in the case of China, since a lot of what usually would be considered fiscal 
policy is conducted via investment by state owned enterprises. The paper therefore 
proposes a different indicator for the fiscal policy stance, constructed from 
government consumption, government expenditure, the state-owned-enterprises' 
investments and tax revenue. Using this indicator, it can be shown that fiscal policy 
has been strongly counter-cyclical in China over the past two decades. 
Keywords: Fiscal Policy, China, State-Owned Enterprises, Statistics 
JEL-Classification: E62 
 
1. Introduction 
It is widely agreed that China used active fiscal policy in order to stimulate the 
economy after the Asian crisis in 1998 (e.g. Jia 2002). However, if one looks at 
traditional measures of fiscal policy stance such as the general government deficit, 
hardly any impulse can be seen. Instead, the changes from year to year are only 
minimal and seem to be much too small to have any significant effect on the business 
cycle. 
This paper therefore tries to construct a different indicator for fiscal policy in China. It 
is argued that fiscal policy in the People's Republic is different from traditional fiscal 
policies in industrialized or traditionally more market-oriented economies. As in 
                                                 
1 Financial Times Deutschland, Friedrichstr. 60, 10117 Berlin, +49 30 22074-170, dullien@web.de China, state-owned enterprises (SOE) are to a large extent used to reach policy goals, 
their actions have to be taken into account for judging the overall fiscal policy stance. 
From an economic point of view, the SOEs' credit financed investments which are to 
a large extent conducted under the influence of politicians and the loans for which are 
often also handed out after political influence, have a similar effect as an credit 
financed government investment. Thus, they have to be taken into account when 
judging the PRC's fiscal policy stance. 
The further paper is structured as follows: Section 2 gives a short overview of what 
fiscal policy appears to have been like given traditional indicators such as the overall 
budget deficit. Section 3 explains what might be wrong with the official indicators for 
judging China's fiscal policy. Section 4 proposes a different indicator and explains 
how expansionary or restrictive fiscal policy has been according to this alternative 
indicator. Section 5 concludes. 
2. Policy stance according to official data 
Taking the official budget deficit both as measured by the International Monetary 
Funds (IMF) or the national statistical office, fiscal policy does not seem to have been 
very active over the past two decades except for short periods around 1989 and 2000. 
According to national statistics, the budget deficit hovered most the time around one 
percent of GDP; according to the IMF data, it was most the time around two percent 
of GDP (see table 1). The two instances in which the deficit widened sharply were the 
1989/90 recession and – curiously – the global New Economy boom of the late 90s. 
Both occurrences are odd: The 1989/90 recession has usually been interpreted as the 
government slowing down the economy sharply after the events of June 4, 1989 
(Lin/Schramm 2003, p. 256), while the New Economy boom usually is interpreted as 
a period where strong export demand provided the Chinese economy with a strong 
demand stimulus, so that the economy did not really need an additional policy 
stimulus. The 1994 slowdown when the government managed to cool the overheating 
economy without raising interest rates much, at the same time, does not turn up in 
overall deficit figures. 
[Table 1: Traditional measures for fiscal policy stance: budget deficits relative to 
GDP] The picture even becomes more obscure when one tries to use some business cycle 
adjusted measure for the traditional budget deficits. Columns (4) to (7) in Table 1 
show cyclically adjusted measures for the Chinese budget deficit, derived both from 
the IMF and the national budget figures. These structural deficits are computed using 
a Hodrick-Prescott-Filter
2 and under the assumption of an elasticity of the deficit 
towards GDP deviations from trend of alternatively 0.15 or 0.3.
3 Of course, 
computing business cycle adjusted deficits already is problematical for developed 
economies as in reality, demand and supply cannot be seen as independent from each 
other and the filter therefore might not include feed-back-effects of fiscal policy to 
current output and thereby to measured potential output. For a developing country like 
China with high and – sometimes very – volatile growth rates, it is even more of a 
problem. Therefore these figures should only be used here for the sake of illustration. 
According to all measures of the cyclically-adjusted figures, there was indeed a sharp 
restriction of fiscal policy in 1989, as common wisdom has perceived. However, in 
1994, when another slow-down occurred which was widely perceived as policy-
induced, the figures show a strongly expansionary fiscal policy stance. Moreover, in 
1998, when China avoided falling into a recession even though the Asian crisis 
brought a sharp fall in regional demand and Chinese manufacturing employment 
slumped sharply (10 percent of manufacturing jobs got lost within one year), fiscal 
policy appears to have been only slightly expansionary. Instead, the cyclically 
adjusted data shows a large expansionary impulse in 1999 and 2000 when the world 
economy was booming anyway and Asian countries were already recovering from the 
Asian crisis. 
So, the headline and cyclically-adjusted data do not well go together with either the 
common sense about Chinese fiscal policy in the 1990s, nor with the other GDP 
                                                 
2 For details, see Hodrick/Prescott (1997). 
3 For industrialized countries, often elasticities between 0.25 to 0.5 are used. See e.g. van den Noord 
(2000). However, more developed countries usually have more sophisticated automatic fiscal 
stabilizers, especially those with an extensive social security system and high replacement payments. 
The value of 0.15 for China would imply no automatic reaction of expenditure and a roughly linear 
reaction of tax revenue to GDP fluctuations. 0.3 could be interpreted as a linear reaction both of 
expenditure and tax revenue to GDP.  figures. Why, for example, should the running hot Chinese economy have slowed 
beginning in 1994 had fiscal policy been expansionary given that monetary policy 
was still rather loose with real interest rates still negative? Or why did the Chinese 
economy get so smoothly over the Asian crisis which hit important trade partners 
heftily if the government did not provide any additional stimulus? I will argue in the 
following section that the reason is that the measured budget deficit is a very 
insufficient measure for Chinese fiscal policy. 
3. Problems with standard data 
So what is wrong with taking China's measured government budget deficit as a gauge 
for the fiscal policy stance? The problem is that in China's government budget, only a 
small share of government activities and borrowing related to these activities really 
shows up. Government expenditure as reported in the national hovered around only 
12 percent most of the 1990s, incredibly low for a transition country in which most 
state assets have not been yet privatized. The reason for this very low figure is that 
most economic activity of the state (which works through its state-owned-enterprises) 
does not turn up in the national accounts.  
Especially on local levels, but also on the national level, SOEs are often used to reach 
policy objectives by (local) politicians using their influence over the management. For 
example, their investments are often used to shore up aggregate demand. They are not 
free to lay off workers as they wish in order to prevent social tensions. Finally, they 
are not faced with a hard budget constraint: Many of the SOEs are not able to service 
their debts, but still get new loans from the banks, either because the banks want to 
prevent an insolvency of their debtor and the subsequent write-off of the loan, or 
because local politicians push local bank branches into handing out new loans. The 
banks can hand out the loans as they are not really confronted with hard budget 
constraint either: The government has injected capital into the banking sector by 
taking over non-performing-loans from the banks several times over recent years and 
is widely expected to do so again. 
From an economic point of view, this is not much different from traditional fiscal 
policy: Investments are decided upon for political reasons, the governments' (implicit 
or explicit) liabilities increase and the economy gets a demand impulse. However, this 
debt-financed policy impulse is neglected in the traditional analysis of fiscal policy. The relevance of SOE investments must not be underestimated (Figure 1): In 2002, 
when private investment for the first time overtook SOE investment, it amounted to 
43.3 percent of total gross capital formation in the economy (or 18 percent of GDP), 
while the state's infrastructure investment (which is included in the national accounts) 
only amounted to 7.2 percent of capital formation (or 3 percent of GDP). When we 
take a look at the SOEs' investment compared to the private sectors', we also see 
clearly that their investment is in fact used to manage the economy as its pattern often 
leads the private sectors' investment pattern (Figure 2). In 1987/88 when the 
government was faced with a external deficit and it wanted to slow the economy, the 
SOEs' investment was cut back while private investment was booming. A similar 
pattern could be observed in 1993/94. SOEs' investment slowed already in 1993, 
while private investment soared. Finally, in 1998, in the midst of a regional crisis and 
an increased competition by main competitors which had just devalued their exchange 
rates, SOE investment picked up much stronger than the private sectors' investment.  
[Figure 1:  Gross Fixed Capital Formation by type] 
[Figure 2: Private and SOE investment in China, change on previous year] 
Of course, part of the SOEs' activities are profit-orientated and driven by sound 
business calculation and similar consideration as for the private sector. Table 2 gives 
an hint how much influence both the political and the business objectives might have. 
The table shows the correlations for the shares of the three kinds of investment 
(government infrastructure, SOE investment and private investment) of GDP. If SOE 
investment were driven exactly by the same considerations as private sector 
investment, their correlation coefficient should be 1. However, as we can see, this 
coefficient is not even 0.1. Thus, we can conclude that SOE investment is to a large 
part driven by different considerations than private investment. At the same time, the 
coefficient between government infrastructure investment and SOE investment is 0.1, 
larger than that between SOE and private investment. This hints that both SOE and 
government infrastructure investment are sometimes used at the same time, possibly 
to reach the same objectives. 
[Table 2: Correlation Coefficient between different investments' share of GDP, 1986 
to 2002] 4. Alternative Measure 
So how can we get the SOEs' activities together with other measures of state activity 
into an indicator showing the overall fiscal stance of the public sector, including 
SOEs? The correct thing would be to add all SOEs' expenditures and revenues to the 
state sector and compute a financing deficit for the whole sector. However, data on 
SOEs' revenue is not available, nor is data on their total expenditure. Thus, we will 
not be able to construct a precise indicator.  
However, we can construct a proxy. To this end, we add government consumption, 
government investment in infrastructure and SOE investment. From this measure we 
substract tax revenue and put this number into relation to GDP. Thus, we get some 
kind of measure of public sector expenditure less tax receipts. By looking at the 
changes relative to one year earlier, we now have an indicator showing whether fiscal 
policy has been expansionary or restrictive. Of course, this indicator has caveats. For 
example, it will not be able to track changes in the SOEs' revenues from changes in 
demand for their goods. Thus, it might underestimate net fiscal stance in an upturn 
and overestimate net fiscal stance in a downturn. However, given the large weight of 
SOE investment in GDP, this indicator should still be a large improvement over 
standard budget deficit data. 
 
Table 3 shows the details of the calculation and the results. Column (1) gives GDP in 
current prices, column (2) government consumption. Column (3) gives government 
capital investment and column (4) SOE investment. Column (5) shows tax receipts. 
Column (6) finally shows the sum and (7) that sum in relation to GDP. Column (8) 
finally gives the annual change in the public sectors expenditure less tax receipts in 
percentage points of GDP. This is the indicator which most likely shows the fiscal 
stance of fiscal policy: Positive Values mean an expansionary fiscal policy while 
negative values indicate a fiscal contraction. 
[ 
Table 3: Details for alternative fiscal policy indicator] 
The picture from this indicator now gives a strong picture of a contra-cyclical fiscal 
policy over most of the period: In 1989, fiscal policy was strongly contractionary, just 
as it is perceived by common wisdom. Again, 1994 and 1995, fiscal policy contributed strongly to the slow-down with a contraction of 1.4 percent of GDP each 
year, respectively. When the Asian crisis hit in 1998, fiscal policy was strongly 
expansionary with a shift of 1.7 percent of GDP. These results are even more 
remarkably as the indicator – as above remarked – should rather err at understating 
counter-cyclical fiscal policy. 
5. Conclusion 
This paper has shown that the plain budget deficit data for China most likely draws a 
wrong picture of actual fiscal policy during the past two decades. Instead of being 
rather passively in the fiscal policy domain as those standard indicators propose, 
China has actively been using fiscal policy. Starting in 1989, fiscal policy in China 
has instead been strongly counter-cyclical, with cooling the economy strongly in the 
mid-90s and given it a significant boost during the Asian crisis. 
Bibliography 
Hodrick, R. J. and E. C. Prescott (1997), Postwar U.S. Business Cycles: An Empirical 
Investigation, Journal of Money, Credit, and Banking 29 (1), 1-16. 
Jia, K. (2002), Pro-active fiscal policy in China since 1998: backgrounds and its 
emphases in practice, Journal of Asian Economics 13, 615-622. 
Lin, G. and R. M. Schramm (2003), China's Foreign Exchange Policies since 1979: A 
review of Developments and an Assessment, China Economic Review, 14,  
246-280. 
Van den Noord, P. (2000), The Size and Role of Automatic Fiscal Stabilizers in the 
1990s and Beyond, OECD Economics Department Working Papers No. 230. 
Data used 
Budget Deficit (IMF), International Financial Statistics, Series 92480...ZF... divided 
by 92499B..ZF... 
Budget Deficit (National Statistics): Datastream series CHGOVBAL 
GDP Deviation from Trend: Own Calculation using HP-Filter, lambda=100. 
Government Consumption (National Statistics): Datastream series CHCNGOV. 
Gross Fixed Asset Formation (National Statistics): Datastream series CHIFATOT 
Government Expenditure: Capital Constructuction (National Statistics): Datastream 
series CHGECPCO SOE investment (National Statistics): Gross fixed investment by state owned 
enterprises; Datastream Series CHINVFXS 
Private Investment: Gross Fixed Asset Formation minus Government Infrastructure 
Investment minus SOE investment 
Tax Revenue (National Statistics): Datastream series: CHGRTAX. Graphs and Tables 
Table 1: Traditional measures for fiscal policy stance: budget deficits relative to GDP 
      
Assumed elasticity of 
deficit to GDP =0.15 
Assumed elasticity of 
deficit to GDP =0.3 
 
According 
to IMF 
(1) 
According 
to national 
statistics 
(2) 
GDP 
Deviation 
From 
Trend 
(3) 
(1) 
adjusted 
for 
business 
cycle 
effects 
(4) 
(2) 
adjusted 
for 
business 
cycle 
effects 
(5) 
(1) 
adjusted 
for 
business 
cycle 
effects 
(6) 
(2) 
adjusted 
for 
business 
cycle 
effects 
(7) 
1984  -0.6% -0.8%  1.5% -0.8% -1.0% -1.1% -1.3%
1985  0.2% 0.0% 4.3% -0.4% -0.6% -1.0%  -1.3%
1986  -0.8% -0.8%  2.7% -1.2% -1.2% -1.6% -1.6%
1987  -0.5% -0.5%  3.9% -1.1% -1.1% -1.7% -1.7%
1988  -0.9% -0.9%  5.2% -1.7% -1.7% -2.5% -2.5%
1989  -1.0% -0.9% -0.8% -0.8% -0.8% -0.7% -0.7%
1990  -4.0% -0.8% -7.1% -2.9% 0.3% -1.8%  1.3%
1991  -3.5% -1.1% -7.7% -2.4% 0.1% -1.2%  1.2%
1992  -2.7% -1.0% -5.0% -2.0% -0.2% -1.2%  0.5%
1993  -2.0% -0.8% -2.0% -1.7% -0.5% -1.4% -0.2%
1994  -2.0% -1.2%  0.1% -2.0% -1.2% -2.1% -1.3%
1995  -1.6% -1.0%  0.7% -1.7% -1.1% -1.8% -1.2%
1996  -1.3% -0.8%  0.8% -1.4% -0.9% -1.5% -1.0%
1997  -1.2% -0.8%  0.8% -1.4% -0.9% -1.5% -1.0%
1998  -1.6% -1.2%  0.0% -1.6% -1.2% -1.6% -1.2%
1999  -2.5% -2.1% -0.9% -2.3% -2.0% -2.2% -1.9%
2000  -3.1% -2.8% -0.5% -3.0% -2.7% -2.9% -2.6%
2001  -4.4% -2.6% -0.4% -4.4% -2.5% -4.3% -2.5%
2002  -3.0% -3.0%  0.7% -3.1% -3.1% -3.2% -3.2%
Gross Fixed Capital Formation by Sector, 2002
7.2%
43.4%
49.4%
Government Infrastructure
State Owned Enterprises
Private Sector
 
Figure 1:  Gross Fixed Capital Formation by type Private and SOE investment, % change on year earlier
-20.0%
-10.0%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
1
9
8
6
1
9
8
8
1
9
9
0
1
9
9
2
1
9
9
4
1
9
9
6
1
9
9
8
2
0
0
0
2
0
0
2
SOE 
Private
 
Figure 2: Private and SOE investment in China, change on previous year 
Table 2: Correlation Coefficient between different investments' share of GDP, 1986 to 2002 
Government 
Investment in 
Infrastructure 
SOE 
Investment 
Private 
Investment 
Government Investment in 
Infrastructure 1 0.109 -0.681
SOE Investment 0.109 1 0.075
Private Investment -0.681 0.075 1
 
Table 3: Details for alternative fiscal policy indicator 
GDP, in 
bn RMB 
(1) 
Government 
Consumption, 
in bn RMB 
(2) 
Government 
Capital 
Investment, 
in bn RMB
(3) 
State-
Owned-
Units, in 
bn RMB
(4) 
Tax 
Receipts
(5) 
(2)+(3)+(4)-
(5) 
(6) 
(5) as 
share of 
(1) 
(7) 
yoy 
change 
of (5) 
(8) 
1985 896 12 55 168 204 31 3,5%
1986 1020 14 60 208 209 72 7,1% 3,6%
1987 1200 15 52 245 214 98 8,2% 1,1%
1988 1490 17 49 302 239 130 8,7% 0,5%
1989 1690 20 48 281 273 77 4,5% -4,2%
1990 1850 23 55 299 282 94 5,1% 0,5%
1991 2160 28 56 371 299 157 7,3% 2,2%
1992 2660 35 56 550 330 311 11,7% 4,4%
1993 3460 45 59 793 426 471 13,6% 1,9%
1994 4680 60 64 962 513 573 12,2% -1,4%
1995 5850 67 79 1090 604 632 10,8% -1,4%
1996 6790 79 91 1201 691 679 10,0% -0,8%
1997 7450 87 102 1309 823 675 9,1% -0,9%
1998 7830 95 139 1537 926 844 10,8% 1,7%
1999 8210 104 212 1595 1068 842 10,3% -0,5%
2000 8940 117 209 1650 1258 719 8,0% -2,2%
2001 9731 130 251 1761 1530 612 6,3% -1,8%
2002 10479 138 314 1888 1764 577 5,5% -0,8% 

China's Foreign Exchange Policies since 1979: A review of Developments and an Assessment,

Postwar U.S. Business Cycles: An Empirical Investigation,

Pro-active fiscal policy in China since 1998: backgrounds and its emphases in practice,

Measuring China's Fiscal Policy Stance

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Measuring China's Fiscal Policy Stance

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