China is trying to increase demand, but provincial austerity is making it hard.

China is changing from its standard growth model to a more expansionary one that aims to boost demand in order to get its economy going again. But the austerity measures that local governments have put in place are a big problem for the central government’s plans. There is a gap between Beijing’s economic plan and the regions’ actual budget situations. This could make it harder to reach the country’s big 5% growth goal.

Beijing’s Move to Growth Driven by Demand

China’s economic growth has been driven by huge building projects in the past. Provincial governments have led the way by investing in roads, railroads, and industrial parks. In a departure from custom, Beijing has used a large portion of the money from this year’s special sales of national bonds to help people and businesses buy new equipment. This is a change from only focusing on measures to boost supply to also focusing on measures to boost demand.

An analyst at Goldman Sachs Group Inc. named Lisheng Wang said, “It’s a sign that policymakers’ focus of easing has been shifted a little more to the demand side.” He also said that the usual link between government spending and building up infrastructure seems to have become weaker.

A lot of experts have been calling for this change for a long time, saying that China can only get out of its current deflationary problems by increasing deficit spending on consumption instead of industry investment. People think this plan is important for making sure the economy grows at the rate planned.

The Problem with Austerity at the Local Level

Beijing is trying out economic policies that are more flexible, but measures of cutbacks being put in place at the provincial level are working against most of the central government’s efforts. Regional governments used to be important for growth because they built infrastructure, but now they are focusing on paying off their debts instead of growing the economy.

It’s taking longer than ever for provinces to sell new special bonds because many people don’t want to spend more money without a promise of a return. The real estate crash and the slowing economy have made it hard for local governments to get the money they need to pay their employees and meet their other daily financial responsibilities. Some governments have put off paying contractors and sending businesses backdated tax bills to make up for the gap. This has made the private sector’s financial situation even worse.

Economists at Nomura Holdings Inc. say that these actions are part of a larger trend in which local governments are “grabbing hands” in the economy and using punishing measures to make money instead of encouraging growth. This trend could possibly cause a second wave of economic shocks, which would weaken China’s economic success even more.

The Heavy Debt in the Provinces

The war on “hidden debt,” which President Xi Jinping has taken very seriously, is a major cause of austerity in the provinces. Local governments used to set up financial vehicles to borrow money that wasn’t recorded on their books, which got around official debt limits. However, these local government financing companies have had net financing losses for three quarters in a row. This is because regions have had to deal with unmanageable debt loads.

In Yueyang, a city in Hunan province, for example, officials have planned to “compress” the sale of assets and the issue of special bonds in order to follow Xi’s orders. Cities like Yueyang are having to take economic steps that show how tight their budgets are for many local governments.

Xiangrong Yu and other economists at Citigroup Inc. are warning of a coming “fiscal-confidence spiral” in which falling tax earnings could lead to stricter tax collection efforts, which would hurt economic confidence and growth even more. They think China needs to act quickly to get out of this budget trap, since the economy is starting to slow down.

Beijing’s Power to Spend

Even with these problems, Beijing has taken steps to take on more of the growth-related work. In July, the central government used almost a third of the money from the sale of a special bond worth 1 trillion yuan ($141 billion) to help pay for the purchase of cleaner, more advanced equipment. The government also raised the incentives for buying new electric cars, giving each buyer up to 20,000 yuan.

These steps are already beginning to pay off. In the second part of August, the number of applications for electric car subsidies went up by 24%. This shows that the central government’s efforts are starting to pay off. According to Bloomberg Economics, these steps could increase investment and spending by about 1.5% of China’s GDP.

Even though Beijing’s efforts are showing promise, many experts think that a more long-term solution is needed to increase demand. As China tries to deal with an aging population, some of the ideas being put forward are to improve the social safety net, make public services better for migrant workers, and offer cash incentives to urge people to have children.

Different Goals: Central and Local Governments

The fact that central and provincial governments have different goals shows a bigger problem: it’s hard to get national and local interests to work together. Beijing is trying to boost economic growth through policies that increase demand, but many provinces are still focused on keeping their debt levels in check and following Xi Jinping’s instructions on how to be fiscally responsible.

There are signs, though, that Beijing might be loosening some of its rules on how much the provinces can borrow. One idea being thought about is letting local governments sell special bonds to buy unsold homes. This would help the country’s struggling real estate market.

Some experts say that Beijing should give local governments more of its own money to help them with their budget problems. They say that this method would help local governments get their finances back on track without having to use harsh tax laws or wasteful spending on infrastructure.

Jacqueline Rong, chief China economist at BNP Paribas SA, said that the situation is very complicated and that China’s leaders need to find a balance between economic growth and other issues like national security and avoiding risks. Rong said, “It’s hard to find a balance between the three.”

The End: A Careful Balancing Act

China is trying to increase demand, which is a big change in the country’s economic policy. But a big part of how well these efforts work will depend on how well local governments can match their budget policies with Beijing’s goals. China’s economy is facing more and more problems, such as an aging population, deflationary pressures, and a real estate crisis. The country’s economic future will depend on how well the central government can balance growth with budget control.