Download China: what are supply-side structural reforms

CN: What are supply-side structural reforms? 7 Apr 2016
Economics
China: What are supply-side structural reforms?
DBS Group Research
7 Apr 2016
• China’s “supply-side structural reforms” differ from Western “supplyside economics” in terms of theory, application and objective
• In China, the temptation to resort to demand-side stimulus will remain
high
Xi Jinping discussed China’s “supply-side structural reforms” in a speech at the
12th meeting of the Central Leading Group for Financial and Economic Affairs
on Jan 26, 2016. He emphasized that the fundamental objective of the reforms
was to increase ‘social productivity’ and to put in place a people-centered development approach. Appropriate demand expansion should be complemented
by trimming overcapacity, inventory destocking, deleveraging, cost reduction
and improving weak links in the economy. In addition, in the field of production, there is a need to enhance high-quality supply, increase effective supply,
improve the adaptability and flexibility of the supply structure, and increase
total factor productivity to make the supply-side more adaptable to changes in
the evolving structure of the economy.
Western supply-side economics primarily focus on
lowering tax rates
In the Western context, supply-side economics emphasizes economic growth
achieved by tax and fiscal policy that creates incentives to produce goods and
services. In some instances, supply-side economics has focused on lowering
marginal tax rates [1]. The idea is that tax reductions may increase the after-tax
rate of return from work and investment, bringing more supply. This is important because increased supply brings lower prices with it, whereas increasing
aggregate demand does the reverse. As such, supply-siders shun demand-side
expansion to prop up the economy, and urge monetary restraint to cap inflation. Supply-side policies were often debated in America in the 1970s to address stagflation.
China’s supply-side structural reforms have little in common with Western supply-side economics
It is clear from the above definitions and descriptions that China’s supply-side
structural reforms are not the same as Western supply-side economics. Their
only similarities are: 1) That tax cuts, central to Western supply-side economics,
are also being proposed in China (tax cuts fall under “cost reduction”, mentioned in Xi’s speech). However, it is only one of the many means to address
structural problems facing China, and cannot be deemed as central to China’s
supply-side reform concept; 2) The supply of goods and services, as well as improvements in productivity are being emphasized.
Beyond these similarities, however, lie many differences:
1.
Theoretical differences
The Laffer curve hypothesized a tradeoff between tax rates and the total tax
revenues collected by the government. It was argued that tax reductions in-
Chris Leung • (852) 3668 5694 • [email protected]
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CN: What are supply-side structural reforms? China’s emphasis is on
cutting overcapacity and
increasing effective supply
7 Apr 2016
crease supply / GDP while lowering prices and/or inflation. There is no singleeconomic theory or theorem behind China’s supply-side structural reforms. In
terms of production, the focus in China is less about increasing supply of goods
and services than it is about increasing “effective” supply, i.e., supply that better matches consumer demand. In addition, China’s supply-side policies are not
premised on a vertical or nearly vertical supply curve, and as such the inflationary impacts of expansionary demand-side polices are also not emphasized.
With respect to tax cuts, the tradeoff between tax rates and tax revenues does
not seem to be the Chinese government’s key concern at the moment. The
government has acknowledged that tax revenues will fall and the budget deficit will widen in 2016. What’s important is incentivizing (effective) production
and improving company profitability, and rebalancing its economic structure
through tax cuts. For example, as part of tax reform, services industries such as
real estate, financial services and insurance, and lifestyle services (hospitality,
food and beverage, healthcare and entertainment) will all be subject to VAT
with effect from 1 May 2016. The services industry is expected to reap tax savings after transitioning to VAT from business tax. This important move should
help China transition towards a more service-based economy.
2.
While Western supply-side
proponents shun demandside management, China is
actively employing it
The application of Western supply-side economics is characterized by the means
by which economic problems are solved, primarily through “supply-side” measures. These measures are namely: 1) Tax reduction, in particular marginal taxes
and capital gains taxes; 2) Deregulation and minimizing the role of government; 3) Exercising monetary restraint by linking money supply to GDP. Accordingly, Western supply-side proponents shun demand-side management,
claiming such policies create little or no economic value.
The application of China’s supply-side structural reforms is characterized by solving economic problems – many of them on the supply-side – using whichever
means are most appropriate under China’s current institutional and macroeconomic context. This means that demand-side expansionary policies – both monetary and fiscal – are to be employed to maintain a reasonable pace of growth
and stability in China. China is planning to increase the intensity of its proactive
fiscal policy, increasing the deficit-to-GDP ratio to 3% in 2016 from 2.4% in
2015. The enlarged deficit will allow the government to “increase government
spending and central budgetary investment by an appropriate amount” [2]. In
particular, it is expected that more government spending would be directed to
targeted industries in the upgrading of China’s industrial structure, and to support urbanization efforts.
3.
China’s supply-side reforms
entail heavy government
intervention
Application differences
Ideological differences
The essence of Western supply-side policy is to allow markets to work more
efficiently by lessening government intervention, with the belief that markets
will correct any imbalances itself. In other words, less government is called for.
The supply-side polices that the Chinese government is pursuing require government guidance on all fronts and levels. In China, major reforms are often
initiated through government controlled pilot schemes. In SOE reforms, the
government decides which firms to reform first, as well as the method and
extent of reform. As for the task of trimming overcapacity, the government’s
hand is also very visible. According to a report by the Ministry of Finance, “The
market should serve as a check, enterprises should be the major actors, local governments should play a coordinating role and the central government
should provide due support, while the responsibility for making sure that overcapacity reductions happen in a locality will be on the relevant provincial-level
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CN: What are supply-side structural reforms? 7 Apr 2016
government.”[3] Because political institutions are completely different in the
West and China, divergence of reform ideologies can only be expected.
An umbrella term
In sum, “supply-side structural reforms” is an umbrella term for China’s pragmatic approach to solving its structural problems. Without a solid theoretical
foundation as an anchor, it could mean different things at different times, and
the temptation to rely on demand-side management remains overwhelming.
Bound by existing political institutions, the leadership’s approach to solving
economic problems has not fundamentally changed. Bold institutional reforms
are required to effectively push through the structural reforms that China urgently needs.
Sources:
[1] “The Laffer Curve,” The Laffer Center, http://www.laffercenter.com/supplyside-economics/laffer-curve/
[2] Report on China’s Economic, Social Development Plan, delivered at the Fourth
Session of the Twelfth National People’s Congress on March 5, 2016
[3] Report on the Execution of the Central and Local Budgets for 2015 and on the
Central and Local Draft Budgets for 2016, Ministry of Finance, P.20-21
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CN: What are supply-side structural reforms? 7 Apr 2016
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