Infrastructure Creation- Fiscal Deficit led Investment & Demand Creation by China

Chinese growth, Industrial production and fixed asset investment has cooled down significantly.  

Coming at a time when the entire global economy is facing a demand deficit, adding more gloom is this Chinese tale of woe - couldn't have been timed worse.

China has been the most important growth engine for the world over the last 2 decades. Its export led growth story scripted by Deng's far sighted reforms , coupled with fortuitously concurrent technological advances in Information technology and supply chain management have taken China far - thus far.

But now the script has changed. There is an urgent need to re- engineer strategy now that advanced economies have simultaneously launched an FX war on developing countries using zero lower bound interest rates and unconventional monetary policy. Developing economies cannot afford to join this zero sum game because their per capita incomes are very low compared to the developed economies. Ideally , all Governments in developed economies should use their prevalent low interest rates to borrow and supplement collapse in private demand by spending on infrastructure-both greenfield and maintenance of depreciating works. But these geniuses refuse to even consider such a policy relook and instead continue to debase their currencies in the hope of exporting their way out of deflation. The Nash equilibrium is very simple-Developing economies ape the same strategem and world spirals down a never ending FX war.

But there's a way out -There's another solution with superior payoffs as compared to the suboptimal Nash equilibrium above. Suppose developing countries that have the fiscal and inflationary room to increase government involvement in infrastructure spending, do so, then the resultant demand generation there can reinvigorate demand slowly elsewhere(especially in the developed world). This can serve a very useful purpose-Developed nations trying to export there way out of deflation will eventually export the deflation to developing countries if the latter fall into the Nash trap. Hence it is now in the interest of developing countries to search for demand generation internally. China best fits the bill with very healthy government finances and an Imminent deflation it wants to desperately avoid.

So here's the latest brief for Multilateral Development agencies. Help developing economies,especially China to avoid the deflation trap at this critical time by enhancing fiscal participation in the domestic demand regeneration. China is key. If China falls, the western world will follow suit kicking and screaming into a bottomless pit. If the West wants to derisk their China sensitivity then they must themselves adopt healthy fiscal policies. There's no use parroting ZLB and UMP any longer now- no marginal long term benefit on output from UMP is feasible.