What Is Supply-Side Structural Reform? Five Questions Explained at Once
As the Central Economic Work Conference drew to a close in Beijing on December 21, 2015, “supply-side structural reform” became the hottest term in China's current political and economic discourse.
From the fading of the “three main drivers” of investment, consumption and exports to the proposal of “supply-side structural reform,” this change conveys a clear signal: China's approach to macro-control is undergoing a major shift, from a previous emphasis on demand-side regulation to an emphasis on supply-side regulation.
Beyond the directional shift in macro-control, the Central Economic Work Conference also made key arrangements for supply-side structural reform, specifying the five major tasks for economic work in 2016: cutting overcapacity, reducing inventory, deleveraging, lowering costs, and shoring up weak links.
2016 is the opening year of the decisive phase in building a moderately prosperous society in all respects, and also a year of tackling tough issues in advancing structural reform. For leading officials at all levels, whether they can get off to a good start and make a good beginning during the “13th Five-Year Plan” period depends on whether they can carry out and firmly implement the major task of advancing supply-side structural reform.
How to “view” and how to “carry out” supply-side structural reform has become a key focus of thought and exploration across the whole country.
Question One
What Is “Supply-Side Structural Reform”?
What is the supply side? The familiar “three main drivers” of investment, consumption and exports belong, from an economics perspective, to the three major demands of the demand side; the corresponding supply side focuses on the supply and effective utilization of factors of production.
Where there is demand, there will be supply; the “supply side” and the “demand side” are like two sides of the same coin. For a long time, China's macro-control has leaned more toward the “demand side.” Now the central government has made it clear that the focus of regulation should shift to the supply side, that is, while moderately expanding aggregate demand, efforts should be concentrated on strengthening supply-side structural reform.
Yang Weimin, deputy director of the Office of the Central Leading Group for Financial and Economic Affairs and an important drafter of the documents of the Central Economic Work Conference, said that supply-side structural reform should include three aspects: policy goals, policy targets and policy instruments:
Policy goals are to reduce ineffective supply, expand effective supply, improve the adaptability and flexibility of the supply structure, raise total factor productivity, and ultimately improve the efficiency of resource allocation.
Policy targets: the core problem to be solved by supply-side structural reform is to correct distortions in factor allocation. “I think there are three levels of distortion in factor allocation: first, the allocation and combination of factors within an enterprise, which mainly depends on entrepreneurship and is achieved through sound corporate management. For example, the household responsibility system at the beginning of reform and opening up changed the way labor and land were combined, mobilized the enthusiasm of hundreds of millions of farmers, and raised output; this is the most micro-level. Second, the structure of factor allocation among enterprises, meaning resources should be allocated more to high-quality enterprises, competitive enterprises and innovative enterprises, so that the efficiency of the whole society can improve. The strategic restructuring of state-owned enterprises in the 1990s actually addressed the issue of efficiency in resource allocation among enterprises. What is now called solving the problem of zombie enterprises is in fact still about solving this kind of problem. Third, the structure of factor allocation among industries, that is, what is usually called the adjustment and optimization of industrial structure, so that resources flow more to industries and economic forms with demand, prospects and high returns, for example from agriculture to non-agricultural industries, from industry to services, from traditional industries to emerging industries, and so on. Since reform and opening up, the transfer of hundreds of millions of farmers away from the land to non-agricultural industries has in fact been the greatest practice of supply-side structural reform.”
Policy instruments: the policy instruments of supply-side structural reform differ somewhat from those for expanding demand; they are mainly no longer about expanding investment, expanding fiscal spending or expanding money issuance. The instruments of structural reform are mainly to stimulate the vitality of micro-level actors, encourage innovation, resolve excess capacity, lower enterprise costs, reduce the tax and fee burden on enterprises, improve the flexibility of the labor market, encourage competition, break monopolies, relax market entry, and reduce improper government intervention, and so on. In this sense, structural reform means using reform methods to solve structural problems. For example, lowering institutional transaction costs requires continuing to advance reform of the administrative management system and streamlining administration and delegating power; lowering electricity prices requires reform of the power system; and reducing the tax and fee burden on enterprises requires reform of the fiscal and tax systems and the old-age insurance system, and so on.
Zhang Yansheng, secretary-general of the Academic Committee of the National Development and Reform Commission, believes that supply-side structural reform means using reform methods to correct mismatches in the supply and demand structure and distortions in factor allocation, to address the problem that effective supply does not adapt to changes in market demand, and to enable supply and demand to achieve a new balance at a higher level. “For example, how to improve the efficiency of resource allocation, how to raise total factor productivity, how to maintain low-carbon green development, how to enhance the role of innovation-driven growth, and so on, all of these are the supply side.”
From demand to supply, this change has its own profound background. “The reason is not complicated, because practice in recent years has shown that demand management relying solely on economic stimulus can hardly help the Chinese economy move toward its intended goals,” Zhang Yansheng said.
Question Two
How Important Is “Supply-Side Structural Reform”?
The 2015 Central Economic Work Conference stressed that advancing supply-side structural reform is a major innovation for adapting to and guiding the new normal of economic development, a proactive choice for adapting to the new situation of competition in overall national strength after the international financial crisis, and an inevitable requirement for adapting to the new normal of China's economic development.
Yang Weimin, deputy director of the Office of the Central Leading Group for Financial and Economic Affairs and an important drafter of the documents of the Central Economic Work Conference, said that this year's Central Economic Work Conference can be called a historic meeting, not only making comprehensive arrangements for economic work in 2016, but more importantly making key arrangements for supply-side structural reform. “The theme of the meeting was supply-side structural reform. General Secretary Xi Jinping systematically expounded the thinking on supply-side reform, and from the judgment of the situation, the diagnosis of problems, the approach to work, key tasks, reform measures and major principles, put forward a package of plans that is logically rigorous, systematic and complete, clear in direction and highly operational.”
Yang Weimin said that supply-side structural reform is another major strategic decision made by the Party Central Committee with Comrade Xi Jinping as General Secretary, upholding the ideological line of emancipating the mind and seeking truth from facts and the problem-oriented way of thinking. It is an inevitable requirement for adapting to and guiding the new normal of economic development, and also another major theoretical innovation of our Party. It is of great significance not only for doing a good job in economic work in 2016, but also for promoting sustained and healthy economic development for a period to come. It is not only crucial to China's economic development, but will also have an important impact on the world economy.
In fact, since the Politburo meeting in November 2015 first proposed “supply-side reform,” this term has continuously appeared in various central meetings.
On November 10, 2015, General Secretary Xi Jinping stressed at a meeting of the Central Leading Group for Financial and Economic Affairs that while moderately expanding aggregate demand, efforts should be concentrated on strengthening supply-side structural reform, improving the quality and efficiency of the supply system, enhancing the momentum for sustained economic growth, and promoting an overall leap in China's social productivity. This was the first time the central government proposed “supply-side reform.”
On November 11, 2015, the State Council executive meeting once again stressed “cultivating new supply and new momentum to expand domestic demand”; on November 15, Xi Jinping stressed at the G20 Antalya summit the need to “attach importance to the coordinated efforts of both the supply side and the demand side”; on November 17, Premier Li Keqiang, when presiding over a meeting on the drafting of the “13th Five-Year Plan” outline, again pointed out that efforts should be made on both the supply side and the demand side to promote industry toward the medium-high end; on November 18, Xi Jinping once again raised “supply-side” reform at the APEC meeting.
Question Three
Why Emphasize “Supply-Side Structural Reform” Now?
China's rapid economic growth is there for all to see. Before 2007, China's economy maintained a relatively high growth rate, and in 2007 the GDP growth rate hit a 13-year high, reaching 14.2%, matching the highest value since 1992.
What was the secret of China's rapid economic growth? In the view of Zhang Shixian, a researcher at the Institute of Industrial Economics of the Chinese Academy of Social Sciences, the reason China's economy was able to maintain rapid growth was mainly reliance on the pull of investment demand. Put plainly, it relied on the demand side.
However, while continuously expanding investment drove sustained rapid economic growth, it also brought about an imbalance between supply and demand, namely structural contradictions.
As for qualitative and quantitative scientific evaluation criteria for overcapacity, European and American countries generally use capacity utilization or equipment utilization as the evaluation indicator for whether capacity is excessive. The normal value of equipment utilization is 79%-83%; above 90% is considered insufficient capacity, with equipment being overstretched. If equipment operation falls below 79%, it indicates that overcapacity may exist.
Zhang Yansheng, secretary-general of the Academic Committee of the National Development and Reform Commission, believes that judging overcapacity in China's industries is reflected in three aspects: first, the product price index declines relatively; second, corporate profitability falls sharply and loss-making enterprises increase; third, industry supply seriously exceeds industry demand.
Public data show that in the first 10 months of 2015, the total profits of industrial enterprises above designated size nationwide fell 2% year on year, with profits in oil extraction, steel, coal and other mining and raw material industries declining markedly. As for the steel industry, data from the Ministry of Industry and Information Technology show that in 2014 China's crude steel output was 820 million tons, while crude steel capacity that year was 1.16 billion tons, and the crude steel capacity utilization rate was 70.69%, meaning about 30% overcapacity.
The most direct consequence of overcapacity is severe losses in the steel industry. Statistics from the China Iron and Steel Association show that from January to October 2015, large and medium-sized steel enterprises suffered a loss of 72 billion yuan in their main business, with 47.52% of them operating at a loss.