Introduction

The world economy is heading for a “new long-term recession” that is unprecedented. In 2019, the global economy, including the economy of China was slowing down even before the eruption of the novel coronavirus (COVID-19) pandemic, but the COVID-19 pandemic has caused the economy to sink further.

The pandemic is crippling the global economy in many ways. Lockdowns have slashed both demand and supply. Financial markets are tumbling. Lives are cut short. Joblessness has spiked. Revenue losses are forcing many small and medium-sized businesses into bankruptcies. Supply chain and business travel disruptions are rising. The combination of these impacts, none of which is easy to cope with individually, will slow the momentum of the global economy. Kristalina Georgieva, in her World Bank/IMF Spring Meeting’s curtain raiser speech on April 9, warned that the COVID-19 pandemic will turn global economic growth “sharply negative” in 2020, leaving the world to face the worst economic crisis since the Great Depression of the 1930s. This grim outlook is looming large.

1. Economic Situation in the Midst of the Pandemic: Selection of Research Methodology

In investigating the economic situation, it is most important to choose the correct methodology as different methodologies result in different assessments and different policy conclusions. The most appropriate methodology, given the new challenges of the pandemic, is that of pandemic economics. Based on this approach:

First, the pandemic must be contained for all policy initiatives to work. That is to say, all monetary, fiscal and other policies will fail unless the COVID-19 public health crisis is brought under control.

Second, we may infer from the first point that the economic recession results from a public health response to the COVID-19 pandemic. The reason is that all measures that we have taken either impede the flow and aggregation of production factors and thus exacerbate recession on the supply side or slash incomes and consumption, thus aggravating the recession on the demand side. The implication is that economic recession is unavoidable as policy authorities take draconian measures to curb COVID-19. As such, three key factors - medical aid, public health and economic growth - come into play under the same analytical framework.

Third, while some supply chain disruptions can be remedied after the pandemic ends, others may never be restored. Should the pandemic last a long time, there will be more permanent ruptures in the supply chain, dragging the post-pandemic global economic performance to a lower growth track.

Given these considerations, our policy conclusion is that, unlike in normal times, fighting COVID-19 should be at the top of the agenda. Curbing the pandemic should take precedence over all other policy goals. The economic policy can help bring the outbreak under control. The time it takes to achieve this depends on the intensity of the policy and the science behind the COVID-19 outbreak. As such, the economic policy should focus on minimizing the impact of the recession. And the stimulus plans adopted by countries in the aftermath of the COVID-19 pandemic should be protective plans for employees, firms, banks and supply chains intended to reassure people that the economy will ultimately go back to normal, and should provide basic protection to those with difficulties.

In many cities across China, people have started to go back to work. Yet industrial output is far from normal. Some argue that going back to work without meaningful output is worse than ordering people to stay at home. But I believe that as the fight against the pandemic becomes routine, going back to work is necessary, even if the full workload is yet to resume. As long as people go back to work, companies still exist, and so does hope. During the pandemic, the priority of our policy-making is to help companies survive and recruit people, and not just to stimulate the economy. There will be hope as long as businesses survive. That is why we should do everything in our power to help businesses continue to function, restore people’s confidence in the economy, and assist the poor. In my view, this approach should be followed in our current economic situation.

The US Federal Reserve’s policy statement on April 9 helps us make sense of the analytical methodology and policy position based on developments of the pandemic. It says that the current priority is to address the public health crisis, and that the monetary policy is, to the extent of its full authority, responsible for providing rescue and stability during the period of economic constraint. Countermeasures must be “vigorous, proactive and even aggressive” to ensure a robust economic recovery after the pandemic. Obviously, the focus is to maintain stability and restore confidence. With the launch of unprecedented measures to shore up markets since the beginning of March, US fiscal and financial policies have been extended to every facet of the economy, including households, businesses, and states and local governments. The aim of these measures is clear: To survive the pandemic is the first and foremost priority, which is true in all countries. This policy rationale warrants our careful analysis.

2. Employment, Survival and People’s Livelihood Should Top the Policy Agenda

Based on the above approach, three priorities should dominate the policy agenda: employment, survival and people’s livelihood. To achieve these goals, we have seen a swathe of policies introduced, including fiscal policies like tax cuts and subsidies, social policies such as rent exemptions and social relief, as well as monetary and financial policies to extend more loans at reduced interest rates. We believe all these policies are important and ought to be implemented. Rescue initiatives should give utmost importance to assisting micro, small and medium-sized businesses (MSMEs) and implementing large-scale public-interest projects.

2.1 Supporting Micro, Small and Medium-sized Businesses (MSMEs)

In China, MSMEs are vital to creating jobs and maintaining social stability. Their importance cannot be over-emphasized. In the wake of the COVID-19 outbreak, we have seen central and local governments issuing policy measures in quick succession to support MSMEs. Yet the vast majority of small, medium-sized and micro businesses are yet to benefit. In recent years, we have seen numerous good policies introduced but not implemented in earnest. We need to delve into the reasons behind problems regarding policy implementation. One type of problem is related to our systems and ideology. Scholars and officials familiar with the topic of small businesses must know that most MSMEs in China are private companies that face institutional barriers raised against the private economy. They struggle to overcome these high barriers and “glass doors” that are rooted in an obsolete ideology to achieve market entry. Another type of problem has to do with technology. Apart from financial support, we should also extend technical support such as information, technology, credit, management, human resources and market access to MSMEs, which is often more important than financial support. A third type of problem is related to the form of financial support. Most MSMEs need investment rather than loans. When businesses struggle to survive, their chance to succeed is diminished by our misplaced policy that encourages them to be overburdened with loans. In my opinion, our country’s institutional mechanisms for supporting MSMEs must be overhauled without delay. The COVID-19 impact highlights the urgency of this reform.

2.2 Jobs First    

In discussing plans to revitalize the economy during the pandemic, there has been a great deal of interest in infrastructure - both traditional and new types of infrastructure. Beyond doubt, infrastructure is a key part of the solution. Ramping up investment is the only way to shore up economic growth in the foreseeable future. This reality is hard to change in the short run however controversial the investment-driven growth model is. Moreover, investment-driven growth is not at odds with innovation-led growth. For all the differences in their underlying technology, investment is the first step in turning innovations into productivity. With our economy increasingly reliant on investment, two questions stand out: Which parts of our economy should we invest in, and how to raise money?

When prioritizing investments, the core principle is to determine whether priority should be given to economic growth or employment. Over the years, our economic development and planning have always prioritized growth, as manifested in hefty investments in railways, highways, and infrastructure. This approach dominated policy-making in tackling the global financial crisis of 2008-09. Over the years, policymakers have held the view that growth would naturally create jobs, so that employment targets can be covered by growth targets. It is true that economic growth is job-creating during rapid industrialization. When industrialization is more or less complete and the economy is increasingly service-based, however, growth and employment targets cease to reinforce each other. While the economy will grow if new jobs are created, growth may not always boost employment. In the changed circumstances, the central government has written “jobs first” in its official documents as the primary goal of China’s economic development and macroeconomic regulation.

In fighting the pandemic, we must unswervingly adhere to the jobs first principle to ensure that the vast majority of companies will survive and the vast majority of people will not starve. The COVID-19 outbreak reveals a sobering fact that numerous people spend every penny they earn and have no savings to rely on. The vast majority of Chinese people have no income-yielding assets. For them, having no job means no income and no food on the table. These include many salaried urbanites who struggle to make ends meet. This stark reality reminds us that public programs must be carried out as part of our investment strategy to assist those reeling from the pandemic.

2.3 Focusing on Public Programs

Before discussing this topic, let us review President Xi Jinping’s important speeches on overcapacity, land management and urban infrastructure. President Xi said that if we are committed to land management like European countries are, and if we strive to improve urban infrastructure, especially underground infrastructure, investment will continue to drive China’s growth in the coming decades. Industrial products otherwise in excess capacity, such as steel and cement, are the physical materials required for land management and urban infrastructure improvement. In this sense, land management and urban infrastructure improvement, once initiated on a large scale, will unleash a tremendous demand for industrial goods in China, which will no longer be in oversupply. Clearly, the crux of the problem is the incompatibility between our investment and financing systems. The mismatch between supply and demand that exist in the real economy largely stems from limitations in the ways funds are raised and allocated. That helps explain the massive overcapacity that coexists with underdeveloped urban infrastructure and landscapes in many parts of China. After rapid industrialization in the past three decades, it is high time for us to revamp our investment and financing systems to expedite urban and rural integration.

Four priorities of public programs warrant our special attention. First, infrastructure, particularly “new infrastructure,” should become a focus of investment. No effort can be spared when it comes to investment, on which China’s future development and technological prowess rest. The second priority is urban-rural integration and the countryside revitalization strategy as part of China’s land management and infrastructure construction. The key message is to create an integrated urban and rural land market and promote equal access to public services in cities and the countryside. Unlike the traditional concept of urbanization, the goal is to achieve integrated urban and rural development. The third priority is to upgrade urban infrastructure in large- and mega-cities, beginning with public health programs to fight COVID-19. The COVID-19 outbreak has revealed numerous weaknesses of our cities. Not until recently did we know that Singapore had 889 fever clinics for a population of less than 6 million. Sufficient public health facilities allowed Singapore to cope with COVID-19 without a drastic lockdown. With over 20 million people, Shanghai only had 117 fever clinics, which, together with the additional 182 community clinics created during the COVID-19 outbreak, are less than a third of Singapore’s. Beijing also has more than 20 million people but it has even fewer fever clinics than Shanghai. A densely populated city with more than 10 million people is a breeding ground for unforeseeable public health and security issues, including COVID-19 infections. To cope with the risks facing our cities, we must expand and modernize our urban infrastructure. Last but not least, we must bring urban and rural education to new levels on all fronts. In World Development Report 2019: The Changing Nature of Work, the World Bank argues that technology has transformed the form of enterprise and employment, giving rise to the gig economy. The report strongly recommends countries to revamp their educational systems and promote lifelong learning to keep pace with the change. Developing countries should invest in their people, and in particular, invest in their health and education as the two cornerstones of human capital. Without doubt, China still has a long way to go - and broad potential - in both endeavors.

3. Fiscal and Monetary Policies

Coping with the economic fallout from COVID-19 requires a combination of proactive fiscal and monetary policies.

3.1 Fiscal Policy at the Forefront

Public finance serves many goals. Amid the pandemic, there is no doubt that fiscal policy should play a greater role. The Central Politburo meeting on April 17 called for “adopting a more proactive fiscal policy, raising the deficit ratio, issuing special Treasury bonds for fighting the pandemic, increasing local government special bonds, and enhancing efficiency in the use of capital to stabilize the economy.” Among the four priorities listed in this policy statement, three are related to financing: raising the deficit ratio, issuing special Treasury bonds, and raising local government special bonds. The fourth is about efficiency in the use of fiscal capital to stabilize the economy. China’s government fiscal revenue has suffered heavy losses when the country is in dire need of more public spending to boost social and economic development. In 2019, of the 28 provinces, municipalities and autonomous regions surveyed, most posted falling fiscal revenue growth. For February 2020, only Zhejiang and Yunnan provinces reported positive fiscal revenue growth. To make things worse, the fiscal gaps are likely to grow larger in the foreseeable future.

To compensate for the fiscal gaps, government debt will pile up. The Central Politburo meeting on April 17 identified three types of government debt: deficits, pandemic bonds and local government bonds. As a researcher on fiscal and financial issues, I have never argued against government indebtedness. Today, the conclusions have become self-evident. As a researcher, I have shifted my academic interest to debt management as government indebtedness becomes less controversial. Regarding debt financing, there is a great deal of fundamental work to be done in China. Local governments face many institutional challenges to debt financing. China’s local governments are barred by law from running deficits. But even if the deficit ban is lifted, local governments will not be able to afford to take on such a massive debt expansion, not to mention their worrying capacity for fiscal management. Myriad financing options available to the government include both deficit financing and non-deficit financing. Most of China’s local government special bonds are in the latter category of non-deficit financing. While deficit financing compensates for public spending gaps, non-deficit financing serves public investment projects more broadly, this may generate cash flows and assets. Yet public infrastructure investment tends to lack commercial sustainability. The management of such government financing activities poses a grave challenge to China’s fiscal and macroeconomic policy-making. Bond issuance to finance investment appears to be a policy matter. Yet market-based principles still have to be followed even in a socialist market economy. For this reason, all investment and financing activities behind government projects can be defined as “policy finance.” As government investment and financing play an increasingly important role in fighting the pandemic, swelling government bonds are poised to become the largest bond category in financial markets, highlighting the importance of coordinating fiscal and monetary policies. Without a doubt, government bonds have become a critical factor that Chinese policymakers cannot overlook in conducting macroeconomic regulation.

3.2 Monetary Policy: Creating a Conducive Monetary and Financial Environment

Numerous policy initiatives can be undertaken regarding finance, which plays an indispensable role in our economy. I suggest that interest rates be brought down swiftly. There should be fewer types of interest rate and more uniformity. Money and credit supply must increase, too. In China’s financial system, interest rates have long been decoupled from aggregate financial goods and services. Such decoupling must change. Against the backdrop of global low interest rates and quantitative easing, there is no need for us to painstakingly maintain a stance alone, which is neither necessary nor practical. Any such attempt will not yield desirable effects.

We should be sober-minded about the diminishing potency of monetary policy. Then Fed Chairman Alan Greenspan’s famous testimony to the US Congressional Banking Committee in 1991 marks an end of the traditional monetary policy paradigm based on the “single rules” and the beginning of a new era when monetary policy is concerned with regulating interest rates. This shift is widely seen as one from direct to indirect regulation and from quantitative to price regulation. The reality of diminishing monetary policy effects has gone less noticed. Instead of achieving precise quantitative and price regulation, the role of monetary policy is to create suitable monetary and financial conditions for the real economy. After a blitz of policies enacted over the past couple of months, the US Federal Reserve has cut interest rates close to zero and announced unlimited quantitative easing. The message is clear: The monetary authority intends to create an easy environment to facilitate structural adjustment in the real economy during the pandemic. We need to draw upon this policy orientation of creating an enabling environment and its underlying macroeconomic regulatory philosophy.

Regarding the structure of the financial policy, I would like to emphasize three things. First, we should increase equity-generating investments while extending credit support to SMEs. When survival is at stake, easier access to loans won’t help medium-sized, small and micro enterprises (MSMEs). In this case, our reform should strive to create opportunities for MSMEs to raise equity capital. In this regard, experiences from Germany, Japan and the United States can be referenced. Second, we should develop a financial services policy. Since the financial crisis of 2007-2008, financial services policies have gained favor from monetary authorities in various countries, giving rise to the re-emergence of some financial policy institutions. Financial policy seems poised to play a bigger role at least during the pandemic and post-pandemic economic recovery. Only a strong financial policy will support the bulk of the social infrastructure investments required in this pandemic. Third, small and medium-sized financial institutions below Tier-3 cities should be remodeled into inclusive financial institutions to support local economic development and address the demand of MSMEs for investment and debt capital. That means financial services policy will account for a considerable share in the business portfolio of such financial institutions. In this respect, we may draw upon a multitude of institutional arrangements under the US Community Reinvestment Act (CRA) and experiences from other advanced economies. Another important reason for proposing this reform direction is that China’s small and medium-sized financial institutions have amassed hefty non-performing assets to the extent that it threatens their financial stability. While fighting the pandemic, policymakers should nudge small and medium-sized financial institutions towards differentiated development in the interest of China’s post-pandemic economic and financial development.

3.3 Coordination Matters Most

So far, I have discussed fiscal and monetary policies. Now, how to coordinate the two policy systems? In recent years, academics have generally been in favor of separating the two. There has been little research on the correlation between the two policy systems at an institutional level. However, the economic crisis caused by the pandemic has brought before us the urgent question of how to coordinate the fiscal and monetary policies. As we know, social scientists are particularly interested in crisis research. Unlike natural sciences that deal with controlled trials, social scientists delve into crises because the most fundamental factors and correlations in our society and economy may be revealed in the most extreme and devastating way only during a crisis situation. Understanding the anatomy of crises has thus become an essential skill in social science research. In the United States, academic research surrounding the Great Depression of the 1930s has formed a large economic discipline, which is even considered the “holy grail” in the system of economic research. Unremitting crisis research endeavors allowed the US Federal Reserve and Department of the Treasury to take comprehensive, swift and resolute countermeasures during the financial crisis of 2007-2008. Targeted policy responses were made possible by a proper understanding of previous mistakes. In this regard, our paucity of research on previous rounds of economic volatility has led us to stumble twice over the same stone.

This topic is too broad to be discussed in this paper. What I want to explain is that the economic crisis is another reminder that fiscal and financial policies are intertwined. To a great extent, financial policy is dictated by national fiscal priorities. In this sense, the modern money theory (MMT) that has gained international currency is proven right. It reveals the crux of the problem. In a crisis, people start to appreciate its practical relevance and theoretical value. Here, I have no intention to offer any conclusion. What I would like to stress is the importance of investigating the coordination between fiscal and financial policy systems in coping with the crisis. Specifically, the mechanism of debt monetization and risk management issues therein must be placed on the agenda.

3.4 Deepening Debt Crisis

Undeniably, policy initiatives to fight the pandemic will escalate global debt to a new level. As a prominent feature of global finance and economy after the dawn of the new century, high indebtedness stems from the underlying mechanism of the global response to the debt crisis of 2008. The debt crisis of 2008 and the global response took on numerous new traits. Most importantly, it did not lead to a typical economic depression. Nor was it accompanied by a financial contraction. On the contrary, swelling debt and continued financial prosperity trapped the whole world into a big bubble of debt expansion. This phenomenon also warrants analysis. Since the 2008 crisis, global efforts have eased the world economic downturn. Turbulence has abated. This achievement results from increasingly sophisticated market economic regulation by various countries over the past decades and by international coordination to tide over the crisis. But we must be sober-minded that various forms of regulation may only mitigate or smooth out the consequences of crisis without addressing the underlying causes. While wild economic volatility has been averted in the recession, a hefty debt burden looms larger.

In this sense, indebtedness is the price of market bailouts. The crisis of 2008 is obviously a debt crisis. Yet in coping with the crisis, countries did not unwind debts and leverage ratios as they should have done. By the end of 2019, global debt amounted to a staggering 255 trillion US dollars or 33,000 US dollars for each of the 7.7 billion people on earth. The raging pandemic has prodded countries to respond with the same approach as in 2008. In just two months, the world economy is deluged with a money supply with interest rates suppressed to zero or below, posing risks for a liquidity trap.

Monetary easing has far-reaching consequences. First, monetary policy will lose its potency as finance becomes increasingly detached from the real economy. Instead of serving the real economy, the tremendous money supply stays within the financial system. Given this dilemma, monetary and financial policies ought to focus on the secondary goal of creating a conducive environment for the real economy. Second, economic cycles increasingly become pure financial cycles. As financial innovations unfold and lead to “financialization” or “quasi-financialization,” the economy becomes subject to the financial “boom and bust” cycle. Tremendous money and credit flow unremittingly into and stays within the financial system, exacerbating the financial system’s deviation from the real economy, causing financial distortions to precede economic distortions. That means under the modern financial system, a crisis may materialize through asset price instead of traditional commodity price and interest rate, posing a grave challenge to monetary policy, financial regulation and even financial theories. Third, a negative interest rate may last as long as a debt persists. There are certain prerequisites for debt sustainability in the long run. For instance, the payment of interest on debt as a share of the GDP should stay below total debt as a share of the GDP. This goal justifies a negative interest rate. In this analysis, we have identified the inherent consistency between high indebtedness and quantitative easing and negative interest rate, bringing to light a host of new questions to be further researched.

4. Beware of Financial Exclusion of China

The shift away from China has escalated as COVID-19 takes its toll. In 2018, China-US trade spats led some firms to relocate manufacturing outside of China. In the ravages of COVID-19, the trend to move away from China has become more blatant and systematic.

4.1 De-globalization

Some countries have been scapegoating and isolating China amid the pandemic to tilt public opinion against China. Whatever their intentions, lockdowns imposed by countries have disrupted supply chains, which has led to a backlash against globalization and China. Should lockdowns last for about three months, the world is likely to return to an era of “castle economy.”

The international community has expressed strong concerns over de-globalization. In its recent World Economic Outlook, the IMF describes what is happening around the world as a “Great Lockdown,” although some academics refer to it as a “Great Shutdown” to downplay the conspiracy theory. This concept points to the fact that even if policymakers are not motivated to impose lockdowns, the pandemic and collective actions will result in the closure of national borders and industrial chain disruptions, causing the world economy to collapse. After the lockdowns are lifted, some ruptures may become permanent and irreparable, dragging the world economy to a low level amid de-globalization.

4.2 Financial Exclusion of China

Parallel to the shift away from China in the real economy and the trend towards de-globalization, a reverse process appears to be in the making in the monetary and financial realms. That is, the exclusion of China and renminbi from a new round of global monetary and financial integration appears to be relentless, or even accelerate, as can be seen in the following developments:

First, on March 19, 2020, the US Federal Reserve entered into temporary US dollar liquidity swap arrangements worth 450 billion US dollars with the central banks of Australia, Brazil, South Korea, Mexico, Singapore, Sweden, Denmark, Norway and New Zealand. Less than two weeks later, on March 31,  the US Federal Reserve announced the creation of overseas central bank repurchase instruments to ramp up dollar liquidity to the world economy on top of existing dollar swap instruments. It is fair to say that we have seen the emergence of a new international monetary and financial network underpinned by the US dollar and excluding renminbi. In this new network, comprising major world economies, the international status of the US dollar is on the rise amid the scramble for dollars.

Currency swap agreements can be traced back to December 2007. Back then, the impact of the sub-prime mortgage crisis led to a surge in risk premiums across global financial markets. In coping with the liquidity shock, the US Federal Reserve reached currency swap agreements with 14 central banks, those of Australia, Brazil, Canada, Denmark, the UK, Japan, South Korea, Mexico, New Zealand, Norway, Singapore, Sweden and Switzerland and the European Central Bank (ECB), which agreed to swap US dollars back into their home currencies at fixed exchange rates in the future. The central bank currency swap mechanism created in March 2020 is an extension of the currency swap mechanism established in 2007, with the same basis and goals. Yet in this round of central banks’ currency swap arrangements, the status of the US dollar has become even more prominent. A closer look reveals that the COVID-19 pandemic has led to a new US dollar shortage in the international financial sphere, consolidating the unique US position as the world’s savior. At least in the financial sphere, the United States stands to gain relative to other nations.

Second, despite China’s early success in curbing COVID-19, which continues to rage in many other countries, renminbi’s external value has taken a hit. Yet the US dollar remains strong. The implication is that the crisis highlights a currency’s safe-haven status. As we know, safe-haven currencies refer to those whose external values will rise when investors’ risk appetite tumbles or economic outlook is uncertain. It is generally believed that a country must have highly sophisticated financial markets with low interest rates and massive overseas net assets for its currency to become a safe haven. Based on these conditions, the US dollar enjoys unparalleled superiority, followed by the Japanese yen and the Swiss franc. Other currencies, including the euro, are not safe havens. By the same criteria, renminbi is far from a safe haven.

As the world’s largest developing country and the second largest economy, China cannot overlook the fact that a new international monetary system that excludes renminbi is in the making. Another evidence of the trend is Libra, launched in 2019, which also excludes renminbi.

The current pandemic brings a host of challenges that China needs to cope with in the foreseeable future. On April 8 and April 17, the Central Politburo meetings called for “preparing for changing external environment amid the pandemic and world economic woes.” Guided by the principles adopted at the Third Plenum of the 18th CPC Central Committee, we should deepen domestic reforms, and implement the Belt and Road Initiative under the banner of building a community of shared future for mankind. These two strategic priorities should underlie our response to the new challenges.