Is it difficult to hit the bullseye of economic issues?

The Leaning Tower of Pisa in Italy is world-famous. It is said that Galileo's free fall experiment was conducted on this tower.

Pisa is located between two large rivers, with its soil mainly composed of sand, clay, and shells, and a shallow water table. The construction of the Leaning Tower of Pisa began in 1173, led by the renowned architect, Nono Pisano. The builders believed that a foundation depth of 3 meters would be sufficient to support this tower, which stands over 50 meters tall.

However, building taller structures on such unstable soil naturally results in uneven forces at the base. Five years into construction, due to foundation settling, the tower began to lean from the third floor. Subsequently, Pisa and neighboring city-states, such as Genoa, were embroiled in long wars, leading to the project being halted. It was nearly 100 years later that construction resumed on top of the original third floor. The new architects believed the tower was leaning northward, so they attempted to correct it by raising the south side of the tower. However, this corrective action went too far, and by the time it was completed in 1372, the Leaning Tower of Pisa had a banana-like shape.

Over the centuries, as the tower continued to sink, the tilt angle reached a staggering 5 degrees. In 1838, engineers dug a passageway around the foundation to investigate the sinking base, but removing the supporting sand caused even more severe leaning. This attempt clearly did not consider the complexity and fragility of the foundation.

In 1935, Italian engineers injected 80 tons of mortar into the base to reinforce it, but the uneven solidification of the mortar led to another round of sinking and leaning. This demonstrated that simple reinforcement measures were not sufficient to address the complex leaning issues of the tower. In order to prevent the tower from collapsing, engineers poured another layer of concrete in 1990 and added 600 tons of lead blocks to the north side, partially correcting the tilt.

Due to the unsightliness of the lead blocks, they decided to use steel cables to hold the tower in place and remove the lead blocks. During the installation of the steel cables, the ground needed to be frozen with liquid nitrogen, which not only froze the ground but also the groundwater below one meter. When water turns into ice, it expands in volume. This caused the tower to start leaning southward at a rate of 4 arc seconds per day, leading to the termination of this repair project.

After several failed attempts, engineers finally used the foundation stress relief method to repair the Leaning Tower. By excavating soil below the north side of the base, they gradually adjusted the center of gravity of the tower, slowing down its leaning speed. This solution ultimately succeeded in significantly reducing the tower's tilt angle.

By excavating soil on the north side to correct the tilt

Simultaneously, they established an underground water drainage system to alleviate the soft foundation issue. After this maintenance, the top of the tower miraculously moved back over 50 centimeters. In 2001, the Leaning Tower of Pisa finally reopened to the public.

In summary, the restoration project of the Leaning Tower of Pisa lasted nearly 700 years, with four repair attempts proving to be counterproductive. It was originally thought that facing a visible and touchable structure like the Leaning Tower of Pisa, a repair team composed of top engineers applying basic physics or architectural knowledge would easily find the correct repair solution. However, reality proved that unexpected events always occur This leads to the question of how to find the right solution to current economic problems. There are many schools of economics, and several economists are awarded the Nobel Prize in Economics every year for their significant contributions to the field. Their theories are supported by rich case studies to prove their correctness. However, the challenge of economics lies in studying human behavior, whereas fixing the Leaning Tower of Pisa does not require studying human behavior. Therefore, finding the right solution to economic problems is much more difficult than repairing the Leaning Tower of Pisa, and it requires a sense of awe.

Dealing with Deflation: Why Does Japan Keep Making Mistakes?

After the burst of the real estate bubble in 1991, Japan fell into a long period of economic stagnation, often referred to as the "Lost 30 Years." Why did the Japanese government spare no effort in implementing numerous measures but still fail to lead Japan out of the deflationary trap? It is generally believed that there were at least three major mistakes in the policies adopted by the Japanese government at that time.

Firstly, they underestimated the impact of the burst of the real estate bubble on the economy. For example, the "Economic White Paper" issued by the Japanese Ministry of Economy, Trade and Industry in 1991 and 1992 believed that the negative impact of the collapse of the bubble economy on personal consumption and corporate investment was very limited and would disappear after 1993, without paying enough attention to the risks to financial institutions.

Similarly, the Bank of Japan was hesitant in lowering interest rates. Starting from August 1990, the Bank of Japan maintained the official discount rate at 6%, and it was not until July 1991, after the stock market fell for 18 months, that the Bank of Japan finally began to lower interest rates, taking 6 years to reduce it to 0.5%. The slow interest rate cuts by the Bank of Japan were one of the reasons why Japan could not overcome deflation in the long term.

Secondly, there was inconsistency in macroeconomic policies due to frequent changes in prime ministers and lack of policy continuity. From 1991 to 1998, Japan changed prime ministers 7 times, each with different approaches. The Japanese government oscillated between expanding expenditure and fiscal consolidation (raising taxes), leading to weak coordination between fiscal and monetary policies. For instance, in 1997, the consumption tax rate was raised from 3% to 5%, some tax reduction measures were terminated, and the proportion of personal medical expenses was increased.

Thirdly, the fiscal policy lacked specificity, with low actual fiscal expenditure in the early stages and low efficiency. During the initial phase of fiscal expansion, the focus was on production-oriented investments, with a large amount of public funds invested in infrastructure in remote areas, failing to stimulate private consumption and investment, and not generating significant multiplier effects. In early 1996, the Hashimoto government, in response to the massive fiscal deficit and public debt issues, proposed the "Six Major Reform Policies," which essentially implemented fiscal contraction policies.

Proportion of public investment in total investment by the Japanese government

Learn from the Past: Paying High Attention to the "Aftermath" of Economic Contraction

Since the burst of the real estate bubble in the 1990s, the Japanese economy has been stuck in long-term deflation. At the end of 1991, the CPI index was 93.1, and by the end of 2021, it had only risen to 100.1, with a cumulative increase of only 7.5% over 30 years Despite experiencing a brief increase in CPI during the East Asian financial crisis and the US subprime mortgage crisis, Japan's CPI has been hovering around zero for the past 30 years since the bursting of the bubble.

Comparison of CPI trends in Japan and the United States from 1991 to 2021

Looking at Japan's per capita GDP level, it reached $40,000 per capita in 1994, but by 2023, if calculated at constant 1994 prices, it will only be $25,000, which is also related to the depreciation of the yen. In comparison, the per capita GDP in the United States was $28,000 in 1994, and by 2023, at constant 1994 prices, the per capita GDP will reach $56,000, doubling from 1994.

Comparison of per capita GDP between Japan and the United States (at constant 1994 prices)

In November last year, I pointed out that although China's GDP is still growing at a moderate pace of around 5%, the growth rate of residents' income is basically synchronous with GDP, but precautions need to be taken. For example, it is expected that China's general budget revenue will experience negative growth in 2024, and the total profits of listed companies may decline for two consecutive years since 2023 (data from the State-owned Assets Supervision and Administration Commission, with a 2.1% decrease in total profits of state-owned enterprises from January to August 2024).

It is important to pay close attention to and even fear the multiplier effect of economic contraction, just as with the multiplier effect of economic expansion. For example, from 1992 to 2022, China's share of global GDP increased from 2% to 18%, a remarkable achievement driven by demographic dividends and reform dividends accelerating industrialization and urbanization. Now, the total population has been declining for two years, the aging rate has increased to 15.4%, and it is estimated that by 2031, China will enter a super-aged society. Real estate investment and sales have also been declining for three years.

Global GDP share of China, the United States, and Europe (in USD)

Therefore, China is facing a long-term downturn in the real estate market similar to the background of Japan's real estate bubble burst years ago, accelerated by aging. Japan entered a deep aging society in 1994, while China did so in 2021. Moreover, China's total population peaked in 2021, the same year as the peak in real estate, while Japan's total population peaked in 2010, the 19th year after the burst of the real estate bubble.

Some may argue that China's urbanization rate is only at 65%, leaving 15% room for improvement, so the real estate market will not enter a long-term downturn cycle. This may be a reason, but the future increase in urbanization rate does not necessarily have to be achieved through the transfer of rural population to cities; it can also be achieved by reducing the denominator, a process that may not significantly increase the demand for real estate Or the demand for real estate in third-, fourth-, and fifth-tier cities will continue to decline in the future.

In the first three quarters of 2024, the revenue from the transfer of state-owned land use rights decreased by 24.6% compared to the same period in 2023, a 56.6% decrease compared to the same period in 2021, indicating a significant and accelerating decline. The substantial decrease in land sales amounts indicates a significant contraction in demand, which has a negative impact on the entire real estate industry chain, known as the multiplier effect or "residual strength," and must be highly valued.

Can fiscal spending find the right direction?

To make up for the investment decline caused by the bursting of the real estate bubble, Japan expanded the scale of public investment, with infrastructure budgets from 1995 to 2007 reaching as high as 650 trillion yen, exceeding that of the United States by 3 to 5 times during the same period. For example, in 1998, industrial workers in public construction accounted for 10% of the total workforce, reaching 6.9 million people.

Japan is an island nation with over 6,800 large and small islands, most of which are connected by bridges and roads, and the vast coastline is mostly covered with concrete. However, after 2010, Japan's population began to decline, with over 90% of the islands no longer inhabited. According to a report from the United Nations Population Division, Japan's population is projected to decrease to around 75 million by 2100, which means a large amount of Japan's infrastructure will be left idle.

Public engineering expenditure and growth rate in Japan

Twenty-two years ago, Alex Kerr, a long-term resident scholar in Japan, published a sensational book called "Dogs and Demons." The seemingly strange title actually comes from a well-known Chinese allusion (Han Feizi's "Wai Chu Shuo Zuo Shang"): A painter was asked by the King of Qi, "What is the most difficult thing to paint?" The painter replied, "Dogs and horses are the most difficult." "What is the easiest?" The painter said, "Ghosts and spirits are the easiest." He used this allusion to allude to the problems Japan was facing—finding a panacea to solve existing problems is difficult, but spending huge sums on demonstration projects is easy.

Clearly, Japan did not address the persistent deflation problem head-on, did not vigorously stimulate consumption, but instead became obsessed with infrastructure, which was counterproductive. Therefore, do not think that increasing fiscal investment and engaging in large-scale infrastructure projects can solve all problems. Just like in 1935, Italian engineers injected 80 tons of mortar into the base of the Leaning Tower of Pisa to reinforce it, but ended up making things worse, causing the tower to lean even more.

From January to September, the growth rate of China's total retail sales of consumer goods was 3.3%, with a CPI of 0.4% in September, confirming one of the difficulties identified at the Central Economic Work Conference in 2023—insufficient effective demand this year. The interpretation of insufficient effective demand should not be understood as "insufficient effective investment demand," because investment demand is not the final demand, but should be understood mainly as "insufficient effective consumption demand," as the Central Economic Work Conference identified the second major difficulty as "excess capacity in some industries." Many people do not quite understand the logic behind expanding domestic demand. While domestic demand includes both consumer demand and investment demand, investment ultimately leads to "capital formation", which increases total social supply. If the total supply of goods and services increases while consumer demand does not, the supply and demand will become more imbalanced, leading to continued price declines.

China's manufacturing value-added accounts for 31% of the global total, while its population accounts for 17.6% of the global population, indicating the extent of China's reliance on exports. In addition, there is relatively little attention paid to the issue of "excess capacity". For example, by 2023, China's high-speed rail network accounts for 70% of the global total; the total length of expressways is 177,000 kilometers, ranking first globally and accounting for approximately 40% of the global total; and the total length of subways accounts for 48.60% of the global total. Furthermore, as of May 2024, China has built a total of 3.84 million 5G base stations, accounting for 60% globally, despite China's urbanization level being far behind developed countries.

In other words, compared to China's global population share, most industries in China have significantly advanced production capacity or operational capacity. Moreover, the maintenance costs of infrastructure are very high, and in the context of a declining total population and reduced population mobility, long-term and prudent investment should be considered. It is estimated that the median return on investment capital (ROIC) in China's infrastructure investment has decreased from 3.1% in 2010 to 0.46% in 2023.

Whether learning from Japan's experience in the 1990s or deducing from the current economic situation in China, it is not difficult to conclude that the immediate priority should be to benefit the people, stimulate consumption, and avoid a situation where the Consumer Price Index (CPI) lingers near zero for a long time.

Percentage of final consumption in GDP by country (%)

How to Target Current Economic Issues: Is Stable Growth Equal to Stable Employment?

There is a widely accepted belief that GDP must maintain a certain growth rate to avoid employment issues, known as "stable growth leads to stable employment". However, taking an extreme example, if 70% of fiscal expenditure is used for equipment upgrades, AI research and development, etc., and the remaining 30% is used for daily expenses, the result may be a significant increase in labor productivity in the industrial sector after several years, leading to a significant decrease in the number of laborers employed. Other sectors, lacking additional investment, may not have the capacity to create new jobs, resulting in a decrease in the total employment population, even though GDP growth is not declining due to investment driving it.

Therefore, stable growth does not necessarily guarantee increased employment. In fact, due to population aging and the continuous decline in China's birth rate, the number of working-age population has been decreasing since 2012, and the total employment population has been declining since 2018, with a reduction of 36 million by 2023. This indicates that with the improvement of labor productivity, a unit of employed population can generate more GDP Secondly, due to the difference in labor productivity levels across different sectors, the employment created by the same scale of capital investment varies in different sectors. For example, after 2013, the total number of employed population in the secondary industry began to decline, and the proportion of the total employed population in the country also decreased.

Changes in the number and proportion of employed population in the secondary industry

In 2023, the number of employed population in the secondary industry decreased by 17.06 million compared to 2012, looking at the manufacturing investment growth rate of 9.2% from January to September this year, the reduction in the number of employed population in the manufacturing industry is expected to continue in the future. Western countries usually focus on developing the service industry after entering the post-industrial era because the service industry can absorb more employment. Currently, the proportion of employed population in the service industry in the United States accounts for 84% of the total employed population, while Germany and Japan's proportion is around 70%.

Germany and Japan, known as industrial countries, have such a high proportion of employment in the service industry. Therefore, should China also increase investment in the service industry, even though the employment in the service industry only accounts for around 50% of the total employed population? This is not contradictory to the goal of becoming a manufacturing powerhouse because being a manufacturing powerhouse is a quality indicator. With the improvement in labor productivity in the manufacturing industry, surplus employees can naturally transition to the service industry. The key is to increase the scale of financial investment in the service industry, increase residents' income, and strengthen investment in social security such as education, healthcare, and elderly care, which are the greatest support for the development of the service industry.

Looking at actual expenditure data, after 2021, with a significant decrease in real estate investment growth rate, the substantial increase in manufacturing investment has maintained China's investment contribution to GDP at twice the global average contribution rate.

Contribution of investment to GDP has not declined after 2021

Because investment is a fast variable, as long as the physical workload increases, it can quickly turn into GDP. Economic transformation, on the other hand, is a slow variable with many uncontrollable factors, such as institutional obstacles. However, the annual GDP growth target is an objective existence, leading to a prioritization choice.

As we enter the AI era, the level of labor productivity will continue to increase, leading to increased employment pressure. Data released by the National Bureau of Statistics shows that the unemployment rate for the 16-24 age group in urban areas, excluding students, was 17.6% in September, significantly higher compared to previous years, despite the overall surveyed unemployment rate being 5.1%. This indicates the need to create more job opportunities for young people.

Therefore, among various macroeconomic indicators, full employment should be given greater importance, and relevant industrial policies should be implemented around employment. If the contribution of final consumption to GDP can be increased to over 60%, the country's surveyed unemployment rate will definitely decrease again, CPI will also rise, and the economic transformation will begin to show signs of progress. In fact, the National People's Congress has long set the increase in employment as a binding target that must be achieved And GDP growth rate has always been an expected target, not an absolute must to achieve.

In conclusion, solving economic problems correctly is much more challenging than fixing the Leaning Tower of Pisa, which is a purely technical issue in the natural sciences, while the former involves various constraints and the intertwining of multiple interests in the humanities