Chinese economy embraces supply-side reform
- By Zhou Lin
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E-mail China Today, June 1, 2016
Supply-side reform
The debut of supply-side reform was a main feature of the first year of the 13th Five-Year Plan (2016-2020) period.
The term has indeed become a buzzword among top leaders since November 2015, especially after President Xi Jinping's keynote speeches at the 11th meeting of the Leading Group for Financial and Economic Affairs and the 2015 APEC CEO Summit, when he emphasized the importance of supply-side structural reform. Premier Li Keqiang stated at the planning meeting of the 13th Five-Year Plan, "Efforts should be made from both the supply-and demand-sides to promote the industry's development towards medium and high end.
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"Supply-side structural reform is a major innovation through which the country may adapt to and maneuver the economic ‘new normal.' It is also China's conscious choice to respond to a new comprehensive national power competition after the global financial crisis," the latest Central Economic Work Conference concluded. It declared, "In the coming years, in addition to moderate enlargement of total demand, we should also strengthen supply-side structural reform." The year 2016 was thus earmarked as crucial to reform.
"Recognizing, adapting to, and leading the new normal" is and will be the development logic of China's economy, and supply-side reform has been described as a major innovation in this regard.
As an economic term, supply-side is the antithesis of demand-side.
On the side of demand are investment, consumption, and export, which determine the short-term economic growth rate. On the side of supply, four main elements – labor force, land, capital, and innovation – can generate medium- and long-term potential economic growth in an optimal allocation circumstance. The newly proposed supply-side structural reform aims at readjusting the economic structure to optimize allocation of production elements, thus to improve the quality and quantity of economic growth.
According to Keynesianism, economic recession is mainly the result of low demand. The best course, therefore, is to stimulate demand and adopt active fiscal and monetary policies to counteract the crisis.
The supply school of thought holds that supply, rather than depending on large-scale stimulus policies, spontaneously creates demand. Enhancement of productivity to achieve a higher production level is the main means of boosting economic growth. More efficient supply, therefore, requires promotion of potential production, thus promoting economic growth.
High expectations
On the one hand we have downward economic pressure; on the other, blowout consumption demand; on the one hand we have severe overcapacity of traditional industry; on the other, burgeoning emerging industry and high-end manufacturing; on the one hand we have low efficiency of certain government agencies and institutions; on the other, unsatisfied demands of the people as regards public administration and service industry.
It has been proved that demand-side economy has been over-explored, and that if the government hopes to solve the current problem it must coordinate both the supply- and demand-side. Only then can an effective supply capability be promoted, so creating new supplies, enhancing production quality, enlarging consumption demand, and promoting economic growth.
How can this reform be put into practice? Four key measures must be considered. They include resolving superfluous capacity, reducing the costs of enterprises, dissolving estate inventory, and preventing financial risks. To be successful in these areas, supply-side reform must be pushed forward on four fronts – labor force, capital, innovation, and government.
One factor that has considerable influence on the total supply level is that of the economy's production investment and ratio of combo investment, encompassing the country's level of technology and management efficiency. Production investment compromises human resources and capital investment. Relaxing the family planning policy is a significant measure by the Chinese government to handle the pressure generated by the disappearance of China's demographic dividend.
In addition to these measures, supply-side reform aims at promoting the Chinese economy's productivity – a crucial test of economic reform. Indeed, the reform and opening-up policy adopted last century demonstrates the benefits of liberating a huge productive force.
How can total factor productivity be promoted? First, we should establish a system of incentives that inspires innovative aspirations, and that also relies on development of the capital market and direct financing. Second, we should create a more relaxed environment that facilitates commercialization of innovative products through integration and collaboration of manufacturing and teaching and researching resources, and by providing capital access and tax incentives.
Supply-side reform holds that an excessively high tax rate not only reduces government revenues but also exerts huge negative impact on economic activities. It is clear that by imposing an excessively high tax rate, the government expropriates enterprises and individuals' revenues. The rational choice, therefore, is to automatically reduce economic activities, so bringing about reduction of the tax base as well as of government revenues. On the contrary, tax reductions may proactively inspire economic activities, so increasing economic output and government revenue.
The government should bring supply-side reform into effect in two ways: first by reducing the institutional cost of economic activities, including anti-corruption, monopoly breaking, streamlining administration, and delegating power; and second, by providing a driving force for the economy through the state-owned enterprise reforms of consolidation and regrouping.
At the beginning of the 13th Five-Year Plan period, the Chinese economy will transform potential into motivation, thus generating new vitality in the process of carrying out supply-side structural reform.
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