Likonomics: Can it work? Will it last?

By He Qinglian on July 22, 2013.
Source article in Chinese: “李克强经济学”的制度基础何在?

Since its coinage by Barclays Capital in a research report in June this year, the term "Likonomics" became a smash hit in the international investment banking sector, the media responded to it was so zealous that they interpreted the concept  in almost a free-wheeling manner.

On July 3, the establishment of Shanghai Free Trade Zone got an approval from the State Council.

At the Group of Twenty (G20) Finance Ministers and Central Bank Governors Meeting, Chinese Finance Minister Lou Jiwei stressed in his speech that the Chinese government would not launch again massive economic stimulus policies.

On July 19, the People's Bank of China announced the liberalization of lending rates.

All these are seen as "Likonomics" in practice.

What is Likonomics?

Like “Abenomics”, “Likonomics” does not refer to the contribution the head of the Chinese government has made on the development of economic theories; it is instead a summary of the characteristics of his economic policies.

Being the only PRC Premier with a doctorate in economics to date, Li Keqiang had, when he governed Liaoning, said to former US Ambassador to China Clark T. Randt that he did not believe in the Chinese GDP figures, he made judgment of the macroeconomics using his own method.

International media thus considered Li an expert in managing economy. Economist, for example, created a “Keqiang Index” basing on the three indicators that Li mentioned—the railway cargo volume, electricity consumption and loans disbursed by banks, and attempted to use that to read the Chinese economy.

Barclays Capital has, months after Li assumed office as Premier, summed up his key policies in three parts: 1. No stimulus; 2. Deleveraging; and 3. Structural reform and called it “Likonomics”.

Since its creation, the term instantly caught on in the international investment banking sector. Those who analyze the Chinese investment market would appear to be behind the bandwagon if they make no mention of “Likonomics”.

“Likonomics”, as summarized by the Barclays report, carries the general ideas of restricting government actions, and correcting the over expansion of government investment and state-owned economy in the wake of the economic crisis in 2008. “No Stimulus”, for instance, is to gradually reduce investment action led by the government; “deleveraging” is essentially to curb the growth of credit and a substantial reduction in debts; and “structural reform” conveys even more content, including financial liberalization, and reform to the financial system, the production factor prices, land use, administrative control, monopoly, income distribution, the household registration system and other areas.

The objective of the policy is using short-term pain to exchange for long-term sustainable economic development potential.

Then, in today's China, which parts of "Likonomics" are good for pilot implementation, and which parts are totally impossible to put into practice?

Limits of Likonomics.

First let's look the part that is already implementing.

Regarding “No Stimulus”, the Central government learned the lesson of massive government investment to stimulate the economy after 2009 and is worried that the economy would collapse because of the staggering local debts.

Focusing on the long term, it wants to put an end to the old model of stimulating the economy with government investment, a model that involves great risk and is low in efficiency.

However, facing numerous difficulties, a slowing economy and troubles in finance, taxation and revenue generation, the local governments prefer to continue increasing government investment to stimulate the economy.

Recently, many places held meetings to analyze the economic situation and stressed that industrial restructuring and expansion of investment would be top priorities in local economic work for the second half of this year. It is said that 16 provinces and 2 municipalities issued statements commending the importance of investment projects in advancing growth and instructing lower levels of government to use all sorts of means to speed up planning and implementation of such projects in the next few months.

According to reports by Chinese media, a number of provincial and municipal leaders went to Beijing to meet with the Minister of Finance and other senior officials, pointed out to them that the economic foundation of their respective provinces or cities is weak and expressed wishes that the Central government could provide greater support in finance.

The stresses of support these leaders asked of the Ministry of Finance differ between one another, yet there is one thing in common: more financial support from the Central Government. 

Under the huge pressure from the local governments, how long can the Central Government's “no stimulus” policy last is open to question.

Another policy that is being tested is “deleveraging”, that is, a reduction of excessive monetary investment. The People's Bank of China (PBOC) announced on July 19 that it will fully liberalize the regulation of lending rates of financial institutions, lower the financing costs of enterprises, and optimize the allocation of financial resources.

Many English media took these as steps of a significant financial reform and held high hope for it.

Quite a number of commentators thought that raising interest rates would increase the borrowing costs and thus constrain the behaviors of borrowers.

However, I believe that these are not the right solutions to the problems.

In credit economy such as that of the US, the interest rate lever works well and could constrain behaviors of borrowers. Yet China’s financial market is no US financial market, it has a chronic illness that is difficult to cure: because of excessive government intervention, there is too much bad debts in the banking sector, and currently there is an accumulation of massive bad debts, a third round in the past 20 years.

Liberalizing interest rates will not solve the following two questions: first, local governments being the predominant users of bank loans (at the end of 2012, the sum of local debts totaled 14.8 trillion yuan); second, all borrowers, local governments and private capitals alike, are irresponsible agents.

Of the approximately 6.24 trillion yuan of local government debt that reach maturity in 2013, the vast majority has not been repaid, and a small part is serviced by borrowing new debt. In recent years, many of the private capital borrowers obtained loans to speculate in real estate and simply ran away if they lost money.

It could be said that these two categories of borrowers are not normal.

In spite of the rising borrowing costs due to high interest rates, these borrowers are able to get free loans by bilking their creditors.

In his article “Signs of actual economic crisis in China emerged (中国已存在事实上的经济危机现象)”, head of the Research Institute of Finance, Development Research Center of the State Council Xia Bin mentioned a set of data when he discussed the relationship between financing volume and GDP: In 2012, the income rate of industrial and corporate assets was 8.88% prior to interest deduction. However, the weighted interest rate of general loans of bank was 7.07%, and if the various financial and high interest rate of shadow banking factors are counted, the income rate of corporate assets only slightly exceeded their financing cost; a sizeable number of corporations saw their asset income rate fell below the financing cost.

Data in May 2013 revealed that the situation has worsened: corporate asset income rate barely covered the financing cost; worse, the income rate couldn't even catch up with the financing cost.

This set of data showed that China’s financial environment has become extremely unusual, and corporations could not become normal borrowers that are trustworthy. As demonstrated in the past few years, most of the private enterprises did not engage in proper business. The majority of private enterprises in Jiangsu, Zhejiang speculated in real estate after they borrowed money; and they would just run away if they lost their game.

It is not difficult to examine the validity of the “deleveraging” policy. The result would by and large be available a half year later.

Institutional Flaws of Likonomics.

The most important idea of “Likonomics” is constraint on government actions and emphasis that economic agents must take responsibility for their own actions. For this to work, however, it is necessary that the effect power has on the market be restricted.

The problem is, the three monopolies of the CPC on politics, resources and media would inevitably lead to irresponsible politics. Whatever the mistakes that have been made, the Central government (including the head of government) does not have to step down; despite being immersed in debt, local governments (including Chief Executives) would not need to resign collectively. It is precisely this that takes from “Likonomics” its institutional foundation.

To discuss the detail, of the three aspects of Likonomics, the first two are after all in the economic policy domain and could be tried. The last aspect, “structural reform”, is too broad in scope and is close to shaking the foundation of the CPC regime: land policy affects the way the Chinese government control crucial resources of the state; administrative control touches upon the relationship between the government and the market—at present, the Chinese government is simultaneously the controller and distributor of national resources; it is also a rule maker of the market, a judge, and a game player (of the monopolized sectors in particular).

If the Chinese government is to relinquish the state’s administrative control over the economy and acts, like its Western counterparts do, as a night watcher of the market economy, then that is tantamount to giving up the material foundation of CPC monopolies in politics and media. How an institutional foundation for “Likonomics” could be created is something that goes beyond the capability of Premier Li and has to be considered by Xi Jinping, the General Secretary who controls the whole situation.

And if we look deeper, we would see that Xi Jinping is nothing more than a housekeeper of the CPC interest group. The reality of China is that between the Central and local governments, and between the various high level interest cliques, a mutual support structure and a delicate equilibrium is formed, in politics and economy alike. It is very difficult to move even one thing.

A few days back, the South China Morning Post published a story quoting an insider as saying that when Li Keqiang was formulating the plan for a free trade zone in Shanghai, he intended to open the financial services industry of Shanghai to foreign investors.

It turned out that the idea was openly objected by the China Banking Regulatory Commission and China Securities Regulatory Commission. To make a small change in the financial sector is already so difficult, how much harder would it be to recreate an institutional foundation?

My presumption is that, although "Likonomics" is trending at the moment, its course would change quietly after awhile.