Farewell to Surplus Dependence: Fiscal Plans for China's Economic Rebalancing | Yu Yongding Interprets Witnessing Imbalance 3

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The Macroeconomic Roots of the Current Account Surplus

China’s longstanding current account surplus helps stimulate economic growth and maintain employment in the short term, but is unsustainable in the long run and intensifies international political and economic friction. Keynes once pointed out that the experience between the two World Wars showed that long-term trade imbalances and competitive currency devaluation are not just economic issues, but also a threat to peace. Today, with the rise of right-wing populism in Western countries, some factions exploit trade imbalances to incite anti-China sentiment, playing into their hands. At the same time, with increasing weaponization of the US dollar, the persistent twin deficits in the US, and mounting security concerns over holding dollar assets, China is required to take the initiative in adjusting external imbalances.

Figure: Changes in China’s Current Account Surplus/GDP Since 2000

On a macro level, the current account surplus equals private savings minus private investment, minus the fiscal deficit, and further minus the investment income deficit. China’s current account surplus exists mainly because the gap between savings and investment is too large. Ways to balance the current account include increasing consumption, boosting investment, or expanding the fiscal deficit—in short, stepping up expansionary macro policies and using domestic demand expansion to absorb excess savings.

At the policy level, expanding domestic demand has been clearly established as the strategic foundation, promoting a shift in the economic development model towards domestic demand dominance. The 15th Five-Year Plan highlights the increasing role of domestic demand as the main driver of economic growth, forming a more domestic demand-led, consumption-driven, endogenously growing pattern. At the same time, it calls for optimizing industrial layout, promoting orderly domestic transfer of key industries, innovating in trade, improving foreign trade quality and efficiency, and accelerating building a strong trading nation. Notably, the plan no longer mentions stabilizing foreign trade, reflecting central awareness of trade imbalance issues and a policy shift from relying on external demand to tapping internal demand potential.

Fiscal Policy Space and Debt Sustainability

China has significant room to implement expansionary fiscal policy, with government debt levels relatively low internationally. By the end of 2023, China’s total government debt stood at 85 trillion yuan, with a debt/GDP ratio of 67.5%, far lower than most major world economies. In comparison: Japan 249.7%, Italy 134.6%, USA 118.7%, France 109.9%, Canada 107.5%, UK 100.0%, Brazil 84.7%, India 83.0%, Germany 62.7%, G20 average 118.2%, G7 average 123.4%.

China’s debt carrying capacity is much greater than other countries, supported by: a high national savings rate, extensive state-owned assets, substantial net foreign assets, and being in a deflationary rather than inflationary environment. These features mean the boundaries of debt expansion sustainability in China are much broader than most developed nations. On November 8, 2024, Minister of Finance Lan Fo'an emphasized fiscal space over fiscal risk, reflecting a significant change in fiscal thinking.

Theoretical Framework for Fiscal Sustainability

In assessing fiscal health, the key is not whether there is fiscal balance, but whether any imbalance is sustainable. Yu Yongding, citing a 2000 simulation on China’s fiscal sustainability, noted that even with large implicit debt and non-performing loans, China should pursue expansionary fiscal policy. The core meaning of fiscal sustainability is that the debt-to-GDP ratio will tend toward some limit, at which point the government can repay principal and interest. The limit equals the deficit ratio divided by nominal GDP growth rate; the critical repayment condition is that GDP growth exceeds the interest rate (n>r). For example, if the deficit ratio is 3% and GDP growth is 5%, then the debt limit is 60%.

The debt dynamic can be described by a differential equation: changes in the debt ratio depend on the deficit ratio, interest rate, and growth rate. When economic growth exceeds the interest rate, the debt ratio converges to a finite value; when growth is below the interest rate, the debt ratio diverges. This math shows the boundary for fiscal expansion lies not in the static debt ratio, but whether growth can sustainably cover debt costs.

International experience confirms this law. When Japan faced fiscal crisis worries in 1996, it pursued fiscal tightening, raising consumption tax and cutting government spending in 1997 to reduce its debt ratio. But this tightened policy caused economic growth to drop; the denominator shrank faster than the numerator, and leverage actually rose, ultimately forcing Prime Minister Hashimoto to resign in July 1998 in a failed fiscal reconstruction. Today, Japan’s national debt ratio is 250%, but sustained low interest rates make the debt sustainable. The US took the opposite route, using fiscal deficit monetization to spur recovery; while problems remain, its recovery is visibly stronger than Japan’s.

China faced a similar choice in 2020 and adopted expansionary fiscal and monetary policy. After economic growth resumed, bank NPLs and other issues eased. This success was predicated on learning from Japan’s failures. Fiscal expansion’s sustainability depends on whether growth can cover debt costs, not the static level of debt.

In 1942, Bank of Shaanxi-Gansu-Ningxia border region president Zhu Lizhi faced a fiscal crisis. Even including debt income, there was still a funding gap of 75%. As Tsinghua Economics’ first graduate student, Zhu decided to issue currency to close the gap. He knew this could spark inflation, but if currency was not issued, soldiers couldn’t be paid and major production campaigns would be impossible. After currency was issued, the regional economy actually revived. This case shows that in deflation or severe demand shortage, fiscal and monetary expansion is not only feasible, but necessary; the sole constraint is inflation.

Origins and Solutions to Local Government Debt

The root of China’s local government debt lies in the mismatch of central and local fiscal responsibility for infrastructure investment, and overly conservative fiscal discipline. In the 2009 four-trillion-yuan stimulus, the central government paid 1.18 trillion, but local projects totaled 20 trillion. To match funds, the central bank in 2009 encouraged local financing vehicles, and local governments raised funds via land sales and financing platforms. By 2021, central government contribution for local infrastructure was down to 0.1%, with nearly all funding self-raised at the local level, causing rapid debt accumulation when land sales dried up.

The local debt problem stems from conservative fiscal policy. Infrastructure is foundational, public, and long-term, thus lacking commercial returns and mainly the government’s burden. If the central government’s share is too low, locals must borrow via platforms, leading to unavoidable debt buildup. Yu Yongding argues that resolving local debt requires breaking the dogma of balanced budgets. Without national aid, local government urban investment bonds risk default. He suggests writing off unpayable debt—while holding those responsible to account. Debt write-offs are not unprecedented; the key is to build a sustainable fiscal framework, preventing local governments from bearing undue commercial finance burdens for public, foundational, long-term projects.

Coordination of Monetary and Fiscal Policy

In the current macroeconomic pattern, fiscal policy should play the leading role, with monetary policy mainly supportive. China now faces an asset shortage, financial institutions lack effective borrowing demand, and loosening monetary policy alone has limited impact. Lowering interest rates can cut borrowing costs but squeezes deposit rates, affecting ordinary people who depend on interest income, and reduced spreads also hurt bank profits. The wealthy tend to buy wealth management products, while depositors are usually ordinary citizens, so excessively low deposit rates can cause social problems.

Space for More Government Bonds: 10-Year Treasury Yield—1.6% with Strong Demand

The effective point of monetary policy is to act in tandem when fiscal stimulus is greatly ramped up. When treasury supply increases and yields rise, the central bank can buy treasuries in open market operations to press yields lower and reduce fiscal financing costs. China’s 10-year treasury yield is now about 1.6–1.7%, with strong demand and no issuance difficulty. If yields are too high, the central bank can further step in. At present, the PBoC does not need to intervene massively; in an asset shortage, treasuries sell themselves.

2000 Simulation of China’s Fiscal Sustainability: Faced with High Implicit Debt (NPLs), Should China Have Expansionary Fiscal Policy

Yu Yongding argues that the order of policy releases should also be optimized: first the NDRC defines project reserves, then the Ministry of Finance publishes funding, and finally the PBoC explains liquidity support. On September 24, 2025, PBoC Governor Pan Gongsheng announced monetary policy at a press conference; on September 26, the Politburo formally decided on expansionary fiscal policy. This sequence could be improved; ideally, plans are announced by the NDRC, Treasury follows with funding, and the central bank provides liquidity last, forming a complete policy loop.

The meaning of “moderately loose” policy remains unchanged. Currently, monetary policy has limited effectiveness, and the key is a strong fiscal push. Fiscal policy must be backed by concrete projects and plans. Local governments need to raise their enthusiasm for implementation, forming rolling project balance mechanisms at both provincial and central levels. When fiscal stimulus is greatly strengthened and bond yields rise, the central bank can buy up bonds to help lower yields. At this stage, clarity and planning in fiscal policy and increased local initiative are required.

Reflections on Economic Research

China’s economics teaching and research faces deep issues of conceptual fuzziness and disconnect between theory and practice, holding back the quality of policy debates. Yu Yongding noted while head of a research institute that even elite university students showed notable gaps in grasping core economic concepts. For instance, asked why the IS curve slopes downward and the LM curve upward in the IS-LM model, students would start from formulas and not from the logic of economic equilibrium. This stems from miscasting goods market and money market equilibrium conditions as behavioral equations, reflecting inadequate teaching about conceptual essence.

Both IS and LM in the IS-LM model are equilibrium conditions, not behavioral equations. The IS curve shows the interest rate-output pairs for goods market equilibrium; the LM curve does so for the money market. The opposite slopes reflect different market equilibrium logic, not opposing behavioral responses. Interpreting equilibrium as behavioral equations is plainly wrong, and if not corrected in education, will lead to repeated mistakes in research and policy.

Theory-practice disconnect is also prevalent. Some “armchair” academics make out-of-touch arguments that influence policy. University instructors bear heavy responsibility—if teaching lags behind reality, students who go into policy or finance will find it hard to handle complex economic challenges. Half-jokingly, Yu suggests hedge fund practitioners should join fiscal advisors to boost market sensitivity and practical relevance in policymaking. The Fed has also criticized US university teaching as detached from reality—China faces a similar issue.

Hypothetical-Deductive Method and Philosophical Methodology

The methodological foundation of economic research lies in precise grasp of basic concepts and skilled use of the hypothetical-deductive method. Citing Einstein’s framework: a scientific system is made of three parts—basic definitions and concepts, propositions based on those concepts, and the hypothetical-deductive process connecting propositions to phenomena. Economics follows the same path: clarify concepts, distinguishing between identities, definitions, equilibrium conditions, and behavioral equations, then deduce conclusions. Conclusions should not be intuitive judgments, but reached through strict logic.

For philosophy study, Yu recommends Russell’s History of Western Philosophy (preferably the original English). He himself studied Hegel’s Logic, Marx’s Capital, and Reichenbach’s Rise of Scientific Philosophy, but found these cost a lot of time—and Hegel’s philosophy in particular is such that when you think you understand it, you surely do not. For today’s economics students, he advises focusing on basic economics works and math/natural science, and developing interdisciplinary interests. Marx’s Capital aimed to prove capitalism’s demise; current tasks are to find concrete ways to ensure China’s stable economic development and people’s improved living. Study should be practical, continually adjusting and refining theory through practice, and gradually forming one’s own views.

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