The communiqué of the Third Plenum of the 18th Central Committee of the Communist Party of China has unveiled a panorama roadmap about China’s new round of reform for the next decade.
The guideline document for a “comprehensively deep-going” reform is abundant with detail. The document makes clear that market will play a decisive role in the allocation of resources and that the government’s role will be improved; it announces that a top-level leading group will be set up to take charge of designing, coordinating and promoting nation-wide reform; and the communiqué says that the country’s governance system will be “modernized” into a complete, standardized and effective one. “Decisive results”, the communiqué says, “should be achieved in the reform of major areas and key links by 2020.” This last point is probably the most significant for China’s future development.
China has entered a new stage of development, and a second round of economic growth. China’s economy is currently sustaining external impacts, which have been strengthened by the economy’s intrinsic structural problems. Under these conditions, we can no longer follow the old way of macro-control. Instead, we should create a new model of macro management to develop an impetus for economic growth.
Economic growth is generally driven by an increase in supply on the micro level, and that of demand on the macro level. Since the onslaught of the international financial crisis in 2008, the global economy has remained sluggish. Countries across the world have generally adopted the method of expanding domestic demand to stimulate economic growth. This is the theory of “demand management” in economics.
Most governments have followed this theory in the past few decades. After the Western countries completed their industrialization in the 1920s and 1930s, the supply became so abundant that it greatly exceeded the demand. The contradiction worsened and led to the Great Depression.
That crisis gave birth to the Keynesian Theory that advocated demand management and government intervention, which US President Franklin Roosevelt promoted in the West and across the world. The transient policy for short-term demand management later became favored by many countries and even grew into a long-term policy. Major nations began to exercise government intervention as a new way of stimulating economic growth. The growth no longer depended only on production promotion and efficiency improvement. Increasing exports, consumption and investment became the main force propelling economic growth.
However, the Keynesian model of demand management does not work in China. The most serious shrinkage in China is not the shrinkage of demand, but that of supply; or a problem caused by the lessening of demographic dividends, the rise of the prices of productive factors and the sluggish growth of total factor productivity (TFP). With the decline of demographic dividends, the high return-on-capital rate China has so far enjoyed from the low cost of production is very much likely to end in the next five years. The low cost-based, extensive growth model is no longer sustainable.
China must change its approach to economic analysis from the “troika” model to a long-term-supply model, because only long-term supply is the decisive factor for a nation’s potential growth. The current theories on “restructuring” are mostly focused on striking a rebalance between exports and investment and consumption. The discussions are all within the concept of general demand, but it was only the substantial shrinkage of supply that restrained China’s economic growth.
In 2008, the Chinese government adopted a stimulus package to cope with the pressures from the global financial crisis. The measures paid off and the economy rebounded powerfully. But the recovery came at a price. The governmental, household, industrial and banking sectors all saw their debt ratios soaring. Statistics from the IMF indicate that the debt to GDP ratios of China’s non-banking sectors (households, non-banking industries and the government) kept rising from 2005 to 2012. The total volume of debts rose from 25.8 trillion yuan to 91.6 trillion yuan and the leverage ratio ascended from 139.3% to 176.3 % during the period, showing a strong momentum of balance sheet expansion.
Traditional expansionary fiscal and monetary policies are all targeted at a rightward shift of the aggregate demand curve by adjusting the commodity or monetary market’s equilibrium condition, so as to attain a higher equilibrium output. The price of which, however, is an ever-rising aggregate price level and even inflation. On the contrary, shifting the aggregate supply curve can also raise the equilibrium output, but the by-product is a fall of prices and improvement of production factors efficiency.
That’s why the Third Plenum suggested, for the first time, establishing a new framework for state governance. China needs to improve its medium and long-term supply capacity by “easing government control, optimizing institutional supply and raising the factors efficiency.”
The next round of reform will focus on an all-round marketization so as to establish an open, unified and orderly market system. More tax incentives, such as tax reduction and system reform, should be devised to enhance producers’ supply ability and encourage technological innovation. The government and market roles should be re-defined, and greater importance should be attached to productivity’s function in raising the aggregate supply. Only by doing so can we break the supply barrier and really liberate productive forces.
Zhang Monan is a fellow of the China Information Center, a fellow of the China Foundation for International Studies, and a researcher at the China Macroeconomic Research Platform.