【原创】Supply-Side Structural Reforms and China’s Potential ...
Supply-Side Structural Reforms and China’s Potential Economic Growth Rate
Li Ping and Lou Feng
Institute of Quantitative & Technical Economics, Chinese Academy of Social Sciences (CASS), Beijing, China
Abstract: This paper examines the effect of supply-side structural reforms on China’s potential economic growth rate in the coming decade according to the data we have gathered. Under the rapid growth scenario that we currently see with the implementation of supply-side structural reforms, China’s potential economic growth rate will reach an average of 6.5% and 5.8% respectively in the 13th Five-year Plan (2016-2020) and 14th Five-year Plan (2021-2025) periods. The growths are up 0.2 and 0.3 percentage points over the baseline scenario under the inertia of historic trends. In implementing supply-side structural reforms, China must transform governmental functions, break monopolies, create a comprehensive competitive market environment, foster the creation of pro-innovation mechanisms, refocus on quality and efficiency, and raise capital utilization and labor productivity.
Keywords: supply-side structural reforms, potential economic growth rate, TFP, China’s economy
After three decades of rapid growth, China’s economy began to transition from structural acceleration to deceleration. Consistent with the general patterns of global economic growth, this transition also results from domestic influences including an ageing population, overcapacity and pollution, coupled with flagging international demand. Under such a complex situation, the 11th Session of the Central Financial and Economic Steering Group identified the strategy of supply-side structural reforms in November 2015. This strategy is expected to fashion the new mechanism of China’s economic growth in the 13th Five-year Plan period, significantly improve the quality and efficiency of supply system, and bring about new vitality to China’s economy. In this context, discussions on supply-side structural reforms and their effect on economic growth will be of great theoretical and practical relevance.
1. Characteristics of Supply-Side Structural Reforms
Classical economic theories, including both the Marxist theory of political economy and Western mainstream economics, have all elaborated on the structural issues of economy. In Das Kapital, Marx revealed in his theory of average profitability that capital moves from less profitable sectors to more profitable ones, spurring industrial restructuring and upgrades that contribute to growth and prosperity. This highlights the role of factor allocation in economic structures. Adam Smith’s theory (1776) that “The division of labor is a major cause of productivity growth” provides an important theoretical cornerstone for the analysis of structural issues of any economy. The Petty-Clark Theorem discusses the relationship between the output of three major industries and the share of labor between them, which further elucidates the structural issues of economies.
Against the backdrop of China’s current economic and social development, supply-side structural reforms refer to measures taken at the supply and production side to deregulate, improve production, reduce transaction costs and give better play to market mechanisms to unlock total factor productivity (TFP) and enhance the efficiency, competitiveness and sustainability of growth. The primary objectives of supply-side structural reforms are as follows: at the micro level, to give play to the decisive role of market in resource allocation, to inspire dynamic and creative contributions to the market, to improve the responsiveness of resource allocation to fit a growing and ever changing demand, and to transform the previous growth pattern featuring the intensive inputs of resources and factors into one that relies on the endogenous increases in factor allocation efficiency and TFP. At the macro level, efforts must be made to step up government reforms, streamline administration, develop innovative macroeconomic regulation, adopt fiscal and monetary policies to utilize the stock of resources, and create an environment of positive innovation conducive to growth, welfare and competitiveness. Intrinsically, supply-side structural reforms have the following features:
First, supply-side structural reforms aim to enhance the effectiveness of the allocation of resources to match the needs of supply and demand by addressing the issues of production structure, industrial structure, income gaps and regional imbalances. Supply-side structural reforms aims to unleash the intrinsic value of mismatched resources, putting premium on the quality of growth and the coordinated economic, social and environmental development.
Second, supply-side structural reforms are intended to reshape existing systems that impede factor supply, resource allocation and restructuring so as to create new systems of social protection, government administration, socialist market economy, and a pro-growth institutional environment.
Third, supply-side structural reforms reflect the shift of mid- and long-term economic momentum. Given the diminishing demographic dividends, rising factor cost and increasingly rampant pollution, the previous extensive pattern of growth is unsustainable. Under the new normal of China’s economy, the demand pulling approach of growth is losing steam. Besides, this approach only worsens and exposes structural problems such as deficits between supply and demand. In this new chapter of China’s economy, it is imperative to seek out new forms of economic growth. According to many economic theories, economic growth is dependent on the efficient supply of labor, capital and TFP in the long run. Among them, TFP plays a critical role in growth. By putting focus on the quality and efficiency of growth as well as the increase of TFP through technological progress, institutional innovation and structural improvement, with supply-side structural reforms providing enduring and stable growth momentum to the economy. In this sense, supply-side structural reforms will unleash the unremitting potential of China’s economy in the medium and long term.
Fourth, supply-side reforms represent an earnest requirement of China’s development stage and basic national conditions. In 2015, China’s GDP aggregate exceeded US$10 trillion, ranking the second in the world. However, in terms of development stage, China remains and will continue to be in the primary platform of socialism with per capita GDP far behind that of developed countries. Today, many parts of China remain underdeveloped and many social needs remain unaddressed. The key issue facing China’s economy remains long-term development rather than short-term macro regulation. From a long-term perspective, efficient supply is a fundamental assurance for economic development and prosperity. As shown by world history, an economy grows rapidly only when supply efficiency increases with the most rapidity. Without rising TFP, prosperity will be unsustainable and eventually stagnate. In the post-crisis era of the world economy, major nations all agreed to promote the innovation of science and technology and the effective supply of real economy. For instance, the United States has followed the strategy of “reindustrialization”, Germany embraced the new concept of “Industry 4.0” and Japan stepped up its development of new generation smart industry, while China has also announced the Made in China 2025 plan. These initiatives represent various forms of supply-side structural reforms and the quality and efficiency of supply will decide the economic prospects and destinies of countries in the years to come.
However, it should be noted that supply-side structural reforms are not the withdrawal of demand-side management. Supply side and demand side are two sides of the same coin and must be coordinated with each other. Demand side management aims to moderately expand aggregate demand to maintain economic growth within a reasonable range and create a favorable macro environment for supply-side structural reforms. Supply-side structural reforms must enhance effective supply, create new sources of supply, improve the quality of supply and foster new market demand, enhance the endogenous momentum and vitality of the economy, and foster an environment for sustained and healthy growth in the medium and long run. The subsystems of demand-side and supply-side factors must form a synergy to spur growth in an efficient and quality manner.
2. Effect of Supply-Side Structural Reforms on China’s Economic Potential
According to economic theories, mid- and long-term potential economic growth rates are primarily subject to the endowment of labor, capital and environmental resources as well as TFP. The production function consisting of these four factors determines the possibility frontier at supply side. In the past, China’s rapid growth mainly relied on the massive input of factors, especially cheap labor, land, capital and natural resources. However, the endowment of labor and natural resources underlying this model of growth has now changed, making factor-driven growth unsustainable. Therefore, China’s economy must embrace a new model of innovative growth, the key of which is the increase of TFP. Meager growth of TFP and its low contribution to China’s economic growth can be attributed to the following reasons: first, the lack of innovation and technological progress; second, inefficient resource allocation and capacity utilization arising from unreasonable institutional factors. Hence, supply-side structural reforms will focus on resolving the institutional barriers afflicting factor allocation and improving TFP to enhance China’s mid-and long-term growth potentials. In terms of the mechanism of action, supply-side reforms exert the following effects on economic growth:
(1) Technological innovation. Under given input of production factor, TFP is a decisive factor of efficiency, while innovation is a key driver of growth. Reducing overcapacity and improving quality and value addition through innovation and technology progress will not only maintain and expand market shares but offset the diminishing contribution of labor and capital to economic growth. Moreover, supply-side innovation will improve demand, contributing to export and consumption upgrade by enhancing industrial competitiveness. With growing R&D investments over the years, China has achieved rapid progress of R&D and may possibly lead the world in certain areas of advanced technology. Under the strategy of supply-side structural reforms, the contribution of technology progress to China’s economic growth will keep growing.
(2) Institutional innovation. Institutional factor is also a major component of TFP. Good systems can enhance TFP and quality of growth. Supply-side structural reforms are intended to unleash institutional dividends, promote market-based resource allocation, reduce institutional cost, rationalize the relationship between government and market, reforms the systems that impede economic development, inspire innovation and dynamism, increase mobility and allocation efficiency of resource factors, expand the space of optimal resource allocation, and match the risks, benefits, responsibilities and interests of economic development to enhance efficiency and unlock the potentials of productivity.
3. Estimation of China’s Potential Economic Growth Rate under Supply-Side Structural Reforms
3.1 Decomposition of China’s Economic Growth between 1979 and 2015
Given China’s serious overcapacity and rapid growth of pollution abatement investments in recent years, this paper adopts an improved Solow economic growth model to decompose the momentum of China’s economic growth between 1979 and 2015 with the consideration of capacity utilization and pollution abatement investments (see Table 1). As can be observed from Table 1, with capital, labor and TFP as major input factors, China’s economic growth over the past 36 years primarily relied on investment (an average contribution of 61.3%); the contribution of labor to economic growth declined from 12.9% between 1979 and 1985 to 1.9% between 2011 and 2015; the contribution of TFP to economic growth went up from 34.7% between 1979 and 1985 to 44.5% between 2001 and 2005 before gradually declining to 25.3% between 2011 and 2015. In comparison, the contribution of TFP to economic growth in advanced economies generally exceeds 40%. These figures suggest that China will not be able to grow sustainably unless it embraces supply-side structural reforms, enhance TFP and foster new drivers of growth.
In order to shed light on the internal drivers of TFP, this paper creates a model to further decompose TFP into the following six factors in accordance with relevant theories:
(1) Urbanization and labor migration. Considering that the labor productivity of China’s primary industry is far below that in secondary and tertiary industries, a growing number of rural populations will migrate to cities, moving from primary industry to secondary or tertiary industry. In this manner, overall productivity will continue to increase. As shown in Table 2, between 1995 and 2015, urbanization and labor migration contributed to TFP growth by an average of 1.23 percentage points, which is the highest among the six sub-factors.
(3) Expanding human capital. According to the theory of human capital, education is an effective means to improve labor quality and human capital. The share of educational spending in GDP can measure the level of human capital in any one country, which is a significant factor in productivity. Due to the lack of reliable data of household educational spending in China, however, this paper employs the share of fiscal educational spending in GDP to measure the effect of education on TFP. As shown in Table 2, the improvement of human capital has a growing contribution to TFP, particularly after 2011. This is related to the substantial increase of educational spending by the Chinese government over recent years. Between 1995 and 2015, human capital improvement contributed to China’s TFP by an average of 0.58 percentage points.
(4) Technological progress. This variable is measured by the actual growth rate of R&D spending. According to economic theories, R&D investment is an effective means to enhance TFP. As revealed by Table 2, the contribution of technology progress to TFP keeps on the rise and the level of increase is particularly striking over recent few years. This may have to do with China’s growing R&D spending and fiscal incentives to indigenous innovation. Between 1995 and 2015, technology progress contributed to China’s TFP by 0.5 percentage points on average.
(5) Process of market-based operation. According to economic theories, a higher level of market-based operation will spur competition, technological progress and managerial expertise, which are conducive to TFP improvement. This report employs the provincial market-based operation index in China’s Market-Based Operation Index: Relative Process of Market-Based Operation by Region and 2011 Report authored by Fan Gang, Wang Xiaolu and Zhu Hengpeng to estimate China’s national market-based operation index. This index consists of five sub-indices including the relationship between governments and markets, as well as the development of non-state sectors of economy, product and factor markets, intermediary organizations and the rule of law. Covering almost all aspects of market-based operation, this index measures the depth and scope of market-based reforms in various provinces, municipalities and autonomous regions. As can be seen from Table 2, with diminishing dividends of market-based reforms between 1995 and 2015, the contribution of market-based operation to TFP declined, averaging 0.31 percentage points.
(6) Other factors of influence. Additional factors of influence are those that fall outside of the aforementioned five sub-factors, such as the effects of economies of scale, the competence of management and operation systems, foreign patent licensing and acquisition of technology, as well as resource constraints. As shown in Table 2, other factors of influence have contributed to China’s TFP positively or negatively during different periods of time, with an average contribution of -0.56 percentage points between 1995 and 2015. It should be noted that in recent years, other factors of influence have relatively significant negative contributions to China’s TFP in recent few years. This may have to do with the declining economies of scale resulting from serious domestic overcapacity and weakening corporate profitability and return on investment due to the high cost of production factors.
3.2 Scenarios of China’s Economic Growth Potentials in the 13th Five-Year Plan Period (2016-2020) and by 2025
This paper creates the following three scenarios of economic growth according to the approach and planning of supply-side reforms: (1) baseline scenario that reflects historic trend; (2) rapid growth scenario under supply-side structural reforms; (3) slow growth scenario under the assumption of unsuccessful economic transition and supply-side reforms and failure to achieve the objectives set for the 13th Five-year Plan period. In addition, this paper also references the basic pattern of world economic history: when an economy experiences serious
Under the baseline scenario, China’s GDP annual growth rate will reach 6.3% and 5.5% respectively for the two periods between 2016 and 2020 and between 2021 and 2025. Under the rapid growth scenario, if China successfully implements supply-side structural reforms, advances in urbanization, upgrades in manufacturing, enhances international competitiveness of products, further increases the share of fiscal spending on education in GDP, improves the competence of workforce, beefs up R&D investments and the value addition of products, and comprehensively deepens market-based reforms, it is likely for China to maintain fairly rapid annual growth rates of 6.5% and 5.8% between 2016 and 2020 and between 2021 and 2025 respectively, thus achieving the objective of doubling the GDP of both urban and rural household per capita income by 2020 on the basis of 2010 as laid out in the Report of the 18th CPC National Congress. It can be seen from the comparison between baseline scenario and rapid growth scenario that under the rapid growth scenario with the implementation of supply-side structural reforms, the average potential growth rate of China’s economy stands at 6.5% and 5.8% respectively during the periods of the 13th Five-year Plan and the 14th Five-year Plan, up 0.2 and 0.3 percentage points over the average potential economic growth rates under the baseline scenario of development by the inertia of historic trend.
4. Optimization of China’s Economic Growth Mechanism under Supply-Side Structural Reforms and Policy Recommendations
In the chapter of new normal, China’s economy is changing gears from high growth to medium-high growth, moving from a crude pattern to an intensive pattern of efficient growth. The economic structure is undergoing profound adjustment where quantitative expansion is giving way to the adjustment of stock and improvement of increment. Traditional drivers of growth are being replaced by new drivers. In the 13th Five-year Plan and 14th Five-year Plan periods, China’s potential economic growth rate will decline to the level of around 5% and 7% respectively even if supply-side structural reforms are implemented. According to the experiences of both Japan and South Korea, this range of growth rates will coincide with outstanding liability and financial risks and the eruption of crises. Therefore, preparations must be made in advance during the 13th Five-year Plan period, the pace of fiscal income and spending be controlled, local government financing mechanisms be regulated, fiscal spending performance be enhanced, sound and prudent monetary policies be initiated, and excessive loose monetary policies and liabilities in both public and private sectors be prevented. Our specific recommendations are as follows:
(1) Deepen Administrative Reforms and Proactively Transform Government Functions
The key to promoting supply-side reforms, make the market more dynamic and increase business vitality lies in the proper handling of relationship between governments and markets. Given the diminishing return to traditional production factors such as capital and labor, China’s economy must rely on new factors such as information, technology, innovation and management in order to grow sustainably. The new term of government must transform its functions, clarify the boundary between government and market by creating the “list of powers”, “negative list” and “list of responsibilities” to prevent dereliction of responsibility and the arbitrary use of power and minimize government intervention in micro-level affairs. Meanwhile, efforts must be made to improve the check and balance systems for decision-making, executive and supervisory powers, further open up market, give play to market initiative and its decisive role in resource allocation, and create market-based mechanisms of pricing, cost transmission and investment return. Dynamism and consumer potentials should be unlocked by promoting entrepreneurship and innovation, and the abuse of power must be strictly prevented to ensure market integrity.
(2) Break Monopolies, Reforms the System of State-owned Enterprises (SOEs) and Create a Competitive Market Environment
It has been proven in both world history and economic theories that monopoly stifles innovation and leads to social discord, inefficiency and inequities. Monopolies and short-term behavior have severely hampered the R&D of Chinese firms. Firms obsessed with short-term interests are not motivated to invest in R&D for long-term benefits. In addition, incentives for R&D are dwarfed by gains from government-mandated monopoly. Short-term behavior and addiction to monopoly and subsidies are the common ills of Chinese SOEs. Monopolistic industrial policies and exclusivity by service sectors such as telecommunications have deterred private investors, compromising the efficiency of resource allocation, innovation and producer incentives. In order to address these problems, efforts must be made to reform the system of SOEs, eliminate monopolies, introduce competition and modify the mechanisms for the appointment, dismissal and evaluation of SOE cadres. Preventing the short-term behavioral outlook of SOEs and further relaxing the market access of high-end manufacturing and modern services are vital to promoting internal R&D and innovative economy. SOE reforms are among the key priorities for China to avoid the middle income trap and promote internal R&D and innovative economy. Creating a competitive market environment is among the key responsibilities of government. The government should strive to foster a unified, open and competitive market system, ensure fair competition and eliminate regional segmentation and industrial monopolies to unleash the potentials of growth and creativity.
(3) Strengthen Internal Innovation and Build a Positive Innovative Environment
Competitiveness in business boils down to a competition of technologies. Putting premiums on research and innovation is the only way for firms to acquire core technologies which allow companies to build upon as a pattern of growth and innovation, even through difficult periods. Innovation is particularly important for China, a country at a critical juncture of industrial restructuring and upgrading amid a challenging export environment. Taking advantage of supply-side reforms, efforts must be made to ramp up innovation, promote venture investments and institutions, improve laws and regulations on fiscal reforms and corporate R&D, encourage and guide businesses to invest in R&D, and build their confidence in making such investments. Access to financing should be increased by improving investment and financing policies and promoting mortgages, guarantees and insurance and enforcement of intellectual property rights and the issuance of bonds by high-tech development zones, as well as developing venture investment funds. It is also imperative to enhance the protection of intellectual property rights, perfect the necessary support systems, technical service systems and technology trading systems for the dispensation of R&D results. External environment should be created in China to protect the intellectual property rights of firms. R&D personnel should be incentivized by enabling them to share the profits of their work.
(4) Quantity Should Give Way to Quality and Efficiency to Increase Capital Utilization and Labor Productivity
In addition to innovation and TFP, supply-side reforms must improve the efficiency and quality of traditional production factors. First of all, in light of China’s population growth and economic outlook, efforts must be made to enhance human capital investment and improve the competence of the workforce. Create a unified labor market, promote free flow of labor across regions, firms, universities and research institutions, extend the retirement age for R&D and managerial personnel, encourage elders to stay in the workforce, shift the strategy of population growth control to one that focuses on the competence and quality of population, and enhance education and training programs. It is suggested that efforts be made in the 13th Five-year Plan period to extensively roll out 12-year compulsory education programs, build the strategic alliances of industries, universities and research institutions, enhance the competitiveness of industries, and bring about a smooth transition of China’s development stage. China must also accelerate its financial reforms, enhance capital efficiency, break the monopoly of profiteering financial firms, create a multi-tiered financial system compatible with real economy, integrate financial resources, speed up market-based financial reforms, and reduce the cost of access to capital for businesses especially small and medium-sized enterprises.
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