Fiscal consolidation in China: a dynamic computable general equilibrium analysis

ABSTRACT

Inflation and overcapacity caused by fiscal expansion have begun to plague China’s economy. The surge in public debt caused by the perennial high deficit rate has led to accumulated debt risk. The lessons of the European debt crisis have forced China to re-examine its debt sustainability. A larger and more systematic fiscal consolidation is urgent. Based on China’s multiple fiscal accounts, this paper constructs a dynamic computable general equilibrium (CGE) model suitable for China’s scenario. By simulation, we evaluated the economic effects of revenue-based and spending-based fiscal consolidation and mixed consolidation and drew the following conclusions: (1) The success of fiscal consolidation requires paying a certain economic price. The industrial sectors closely related to the government bear more pressure from consolidation, which makes spending-based consolidation measures more advantageous in terms of cost because of their lower negative externalities. (2) China’s social security system has mitigated the effect on households during periods of fiscal consolidation, but the social insurance fund bears greater losses. (3) The mixed strategy of combining revenue and spending balance the contradiction between economic development and industrial structure in consolidation. While protecting the industrial structure, this strategy can complete the consolidation goal at a small economic cost.

KEYWORDS:

• Fiscal consolidation
• fiscal deficit
• public debt
• China’s multiple fiscal accounts
• dynamic CGE model

Acknowledgements

The authors thank Mr. Bowen Xiao for his great contributions to the early draft of this manuscript and they also acknowledge the financial supports from the National Natural Science Foundation of China with grant numbers 72033001 and 72003160.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ The measures for the administration of social insurance fund investment stipulate that the proportion of social insurance fund savings used for private investment shall not exceed 30%. The Interim Measures for the administration of national social security fund investment stipulate that the proportion of social security fund savings used for public investment shall not be less than 50%..