China's economic success: evidence regarding the role of fiscal policy

Abstract

The Chinese economy has achieved great success in both stability and sustained growth since the market economy was established. This paper seeks to explain that success by evaluating China's fiscal policy. It starts by testing two hypotheses derived from Keynesian economics. First, it seeks to determine whether China's economic regulations act against the business cycle. Second, it aims to understand whether China stimulates economic growth through a deficit policy and strong government fixed-asset investment. Based on a Hodrick–Prescott filter technique combined with cross-correlation analysis and a Granger causality test, we suggest that fiscal policy in China is generally counter-cyclical and achieves its desired effects. Further analyses using a co-integration model and the impulse response function confirm that government fixed-asset investment enhances China's economic growth. These empirical findings indicate that China's fiscal policy matches the basic policy orientation of Keynesian economics and is closely associated with its economic success. We also identify some new findings that contradict Keynesian claims: China's economic growth responds positively to taxation, which we attribute to taxation's function in promoting appropriate resource allocation. We believe our study provides empirical support vindicating China's fiscal policy.