Promote Supply-Side Structural Reform*

January 18, 2016

At last year's Central Conference on Economic Work, I emphasized supply-side structural reform. This caused a lively debate and won some recognition both domestically and internationally. Some colleagues later told me that they were not quite clear about the concept and the related discussions. Here I would like to explain it in more detail.

First, I want to make it clear that the supply-side structural reform we have raised is different from that of conventional Western supply-side economics. We cannot see it as another version of the latter. We must prevent people from using it to advocate neoliberalism or to disseminate negative press reports.

Western supply-side economics emerged in the 1970s. At the time, the demand management policies of Keynesian economics were failing, resulting in the stagnation of Western economies. Supply-side economics emphasizes that supply creates its own demand, so supply is the key to economic development – to increase production and supply, tax cuts are a must to improve savings, investment capacity, and initiative. This is the Laffer Curve invented by the leading supply-side economist Arthur Laffer. Moreover, supply-side economics holds that tax cuts demand two conditions – first, reducing government expenditure to balance budgets; second, restricting monetary supply to stabilize prices. Supply-side economics emphasizes tax cuts and overstates the role of tax rates. This theory is too definitive, emphasizing supply while ignoring demand, emphasizing market functions while ignoring government intervention.

What we have raised is "supply-side structural reform". As I mentioned at the 2015 Central Conference on Economic Work, the word "structural" is critical to the full expression, although we can call it "supply-side reform" for short. The key to our supply-side structural reform is to release and develop productive forces, to adjust structures through reform, to reduce ineffective and lower-end supply while increasing effective and medium- and high-end supply, to make supply structure more adaptive and flexible to changes in demand, and to increase total factor productivity. This is not only about taxation and tax rates; it is a strategy designed to resolve China's supply-side problems through a string of policy measures, in particular by promoting innovation in technology, by developing the real economy, and by improving the standard of living of ordinary people. Our supply-side structural reform emphasizes both supply and demand, aims both to develop productive forces and to improve relations of production, allows the market to play its decisive role in resource allocation and government to fulfill its functions, and looks to both present and future. From the perspective of political economics, the fundamental goal of our supply-side structural reform is to improve the country's supply capacity, so as to meet the people's material, cultural, and ecological needs, which are becoming more extensive, more sophisticated, and more individualized, and ultimately realize the purpose of socialist production.

Supply and demand are the two basics of the inner relationships of the market economy. They are opposite and unified, interdependent, and mutually conditional. New demand generates new supply while new supply creates new demand.

Supply side and demand side are the two basic means of macroeconomic regulation. Demand-side management addresses economic aggregate problems, focuses on short-term macro regulation, and propels growth mainly by adjusting taxation, fiscal expenditure, and money supply to stimulate or restrain demand. Supply-side management tackles structural problems, creates growth drivers, and boosts growth mainly by optimizing the allocation of production factors and by adjusting the structure of production to improve the quality and efficiency of the supply system.

Reviewing world economic development, we can see that whether a country focuses its economic policies on supply side or demand side depends on its macroeconomic situation. It is a one-sided perspective to ignore either of them. Supply side and demand side do not replace each other but coordinate with each other.

Now and in the future, China's economic development is facing and will encounter problems on both the supply side and the demand side, while major problems exist in the former. For example, some industries have severe overcapacity problems, however we are still relying on the import of key equipment, core technology, and high-end products, and the vast domestic market is not in our own hands. For example, agricultural growth has maintained good momentum, but the supply of agricultural produce is not adaptive to changes in demand – milk has not met the demand for quality and won public trust; there is a shortage of soybean while corn is overproduced; agricultural produce in general is overstocked. For example, despite great purchasing power, our consumption demand cannot be met by domestic supply; much money is spent on outbound shopping tours and overseas online shopping, for goods ranging from jewelry, cosmetics, brand handbags, watches, clothes, and other luxuries to electric cookers, toilet lids, milk powder, feeding bottles, and other daily necessities. Statistics indicate that in 2014 China's outbound travel expenditure exceeded RMB1 trillion.

These facts prove that China is not short of demand, but the supply of quality products and services fails to keep up with changing demand. Inadequate effective supply has caused spillover in demand and a severe outflow of consumption. To resolve these structural problems, we must promote supply-side reform.

Profound changes are afoot in the international economic structure. The global financial crisis broke the global economic circulation in which developed economies in Europe and the US relied on borrowing-driven consumption; East Asia provided high savings rates, and a cheap labor force and products, while Russia, the Middle East, and Latin America provided energy and resources. As a result, effective demand in the international market has fallen sharply, and economic growth lags far behind potential production capacity. In major countries, the problem of population ageing has become more severe; the growth rate of the working population is decreasing; social costs and production costs have risen rapidly; traditional industries and their growth have declined; and emerging industries have not gathered sufficient size and growth momentum. Against this background, we need to start with the reform on the supply side to clarify our position in the world supply market.

Domestically, China's economy is facing four problems, namely, a slowdown in the growth rate, falling prices of industrial products, falling business profits, falling fiscal revenues, and rising economic risks. The major causes of these problems are not periodic but structural – the supply structural mismatch is severe. As the marginal benefit of demand management falls, overcapacity and other structural problems cannot be resolved simply by stimulating domestic demand. Therefore, we must concentrate our efforts on improving the supply structure, so as to push the supply-demand balance to a higher level.

To promote supply-side structural reform, we should start with production. The key is to resolve overcapacity effectively, promote industrial restructuring, reduce enterprise costs, develop strategic emerging industries and modern service industries, increase the supply of public goods and services, and ensure that the supply structure is more adaptive and flexible to changes in demand. In short, measures are required to cut overcapacity and excess inventory, deleverage, reduce costs, and strengthen points of weakness.

In recent years, a number of Chinese enterprises have succeeded in promoting experimental supply-side structural reform. For example, various cellphone brands have competed fiercely in the domestic market, both foreign brands like Motorola and Nokia and domestic brands, pushing some to the edge of bankruptcy. In response to the situation, domestic cellphone enterprises upgraded production, promoted original innovation, aimed at the high-end market, and launched high-end smartphones. These smartphones have met the demand for more functions, higher speed, clearer images, and more fashionable appearance, thus seizing an increasing market share in both domestic and international markets. The international cellphone market also features fierce competition. Once monopolistic brands such as Motorola, Nokia, and Ericsson no longer hold sway – some no longer even exist. After New Year, I visited a company in Chongqing. The thin-film-transistor liquid crystal display they produce is a successful example of supply-side reform. In recent years Chongqing has developed the industries of laptops and other intelligent terminal products, as well as Chinese brand automobiles, forming the world's biggest electronic information industrial cluster and the country's biggest automobile industrial cluster. One of every three laptops in the world was made in Chongqing. This proves that as long as we advance supply-side reform aimed at the market, industrial upgrading can be achieved.

Based on international experience, a country's development is fundamentally driven by the supply side. Time after time technology and industrial revolution have improved the productive forces, creating unimaginable supply capacity. Nowadays socialized mass production has a distinctive feature: Once historic innovation has been achieved on supply side, the market will respond with immense trade volume. According to one article, at the Meta-Council on Emerging Technologies, 2015 World Economic Forum, a panel of 18 experts compiled the list of the top 10 emerging technologies of 2015; these were fuel cell vehicles, next-generation robotics, recyclable thermoset plastics, precise genetic engineering techniques, additive manufacturing, emergent artificial intelligence, distributed manufacturing, "sense and avoid" drones, neuromorphic technology, and digital genome. Last year during my visit to the UK, Professor Konstantin Novoselov and Professor Andre Geim from the National Graphene Institute of University of Manchester, co-winners of the 2010 Nobel Prize in Physics, told me about the R&D of graphene and its application prospects. Graphene is a promising new material that is winning forceful support from the British government and the European Foundation for Research and Development. Technology innovation has brought scientific progress, and will add impetus to economic growth. Therefore, to push forward supply-side reform, we must uphold the new development concepts and vigorously develop new technologies, industries, and forms of business, so as to continuously provide endogenous impetus for sound and sustained economic development.

* Part of the speech at a study session on implementing the decisions of the Fifth Plenary Session of the 18th CPC Central Committee, attended by officials at the provincial/ministerial level.

(Not to be republished for any commercial or other purposes.)