The short answer, according to a new paper by Fardoust, Lin, and Luo, is that since the Chinese fiscal stimulus in 2008-09 focused on (i) investments in bottleneck-easing infrastructure projects, and (ii) countercyclical nature of expansionary subnational expenditure on well-chosen infrastructure projects that improved business climate, it worked. The latter one had the largest effect.
Chinese stimulus money (US$586 billion—1.25% of China’s GDP in 2008) went to housing guarantees, rural construction, energy conservation and emissions reduction, infrastructure development, social services, industrial restructuring, and post-disaster reconstruction of Wenchuan.
Below is an abstract from their paper:
China's government economic stimulus package in 2008-09 appears to have worked well. It seems to have been about the right size, included a number of appropriate components, and was well timed. Its subnational component was designed to maximize the impact of the stimulus package on the economy and minimize the potential procyclical elements that are usually built into subnational fiscal mechanisms in federal countries. Moreover, China's massive fiscal stimulus played an important role in the overall recovery of the global economy. Using a simple analytical framework, this paper focuses on two key factors behind the success of the stimulus: investments in bottleneck-easing infrastructure projects and countercyclical nature of subnational spending based on the assumption that well-chosen infrastructure projects could improve business climate and thereby crowd in the private investment. The paper concludes that the expansionary subnational government spending played a key role in strengthening the overall impact of the stimulus and sustaining growth. It also highlights the importance of public investment quality and cautions about the sustainability of local government financing through the domestic banking system and increases in local governments off balance sheet or contingent liabilities. These lessons may be of particular relevance today for China, as well as other countries, in formulating policy response to another global economic slowdown or crisis, possibly as a result of the Eurozone turmoil. For China, investing in urban infrastructure and green economy, as well as in higher quality and better targeted social services, will be crucial for improving income inequality and inducing a more inclusive growth path.
It has more to do with the quality of public investment, i.e. the economy should have enough absorption capacities, which will help stimulate economic activities without jeopardizing inflation too much. Also, the source of such stimulus is important as a one-off investment by borrowing from domestic financial institutions or by increasing contingent liabilities of local governments is not going to be sustainable. The public investments have to be such that they exploit idle resources (human and capital) and are sustainable in the sense that the total costs are paid off in due course of time. It offers an important lesson for economies like Nepal that have constrained economic growth in the face of severe shortage of infrastructure (electricity, transport, urban services, etc.). Prudent management of resource allocation, project selection and quality investment (public, private or public private partnership) in these will have significant multiplier effects.