Published Friday May 1st 2015 HKT 22:00
On assuming office Li Keqiang said that “Reform is China’s greatest economic dividend”. Although the past ten years have been labelled as “reform’s lost decade”, it at least presents the current administration with greater scope for reform. Unless they launch substantial system reform, economic policy will continue to suffer from short term ‘firefighting’. This round of reform will be at the heart of the key battles that will shape the nation’s fate over the next ten years.
Yet there’s no need to feel too optimistic, because the greatest obstacles to reform are government officials, whom are responsible for implementing reform, but unwilling to relinquish their powers. So how to break this deadlock? First is to rely on politicians to be single minded and bold enough to shake up the self-interest groups. Second is to rely on the people, especially encouraging participation by the elite in society. These two combined can become a formidable force for shaping reform.
So far this century it’s evident that China’s monetary supply increase has been excessive. China’s GDP has not yet reached half of American GDP, yet its M2 supply has already surpassed that of the United States. After the 2008 global financial crisis, China made up around half of the world’s increase in M2 supply. This sharp increase in money supply brought with it the risk of inflation; hence in the latter half of 2011, China increased the bank reserve requirement 12 times, causing the economy’s growth rate to slow.
China is therefore faced with two problems: Continue with fiscal and monetary stimulus and risk inflation and an asset bubble. Or halt such stimulus measures, which could cause a hard landing for the economy. In response to this, Li Keqiang clearly stated “Under the current conditions of large monetary reserves, and a relatively fast increase in broad money supply, there’s little room left to achieve this year’s growth target by relying on stimulus policy and government direct investment. Instead we must rely on the market system”. And “Direct more monetary reserves and credit to support real economic growth”. From this it can be seen that at the very least there should be no more increase in leverage, making this the current administration’s “medium to long term mission”.
Although deleveraging needs to occur, it doesn’t come without its risks. It can be seen from international experience that deleveraging, risks sparking a financial crisis. The only way to ‘hedge’ against this is to utilise the growth benefits to be found from unleashing system reform.
Upgrade the economy
In the old China economic model, the government played the leading role, relying on the crude approach of high investment and high consumption of resources to drive economic growth. This author believes that in order to upgrade China’s economy, it must incorporate the following: A market led economy using consumption and innovation to drive growth and development.
In order to transition from investment to consumption driven growth, there must be a major overhaul of the income distribution system, halting household incomes declining share of GDP. For innovation to prosper, there must be rule of law, a fair market, encouragement of entrepreneurship, and a reversal of the situation which forces entrepreneurs to form relations with government officials in order to do business.
The real economy is depressed, inventory and accounts receivables are increasing, and debt risk is rising to the surface. Thus Li Keqiang stated “The economy must not slip below the bottom line”.
Maintaining stable growth is easy but one needs to consider which tools to use, and at what cost? There are three options available. Firstly fiscal stimulus. This is a well-trodden path, the results are effective, but the side-effects great. Secondly, reap the benefits of unleashing system reform. This is still the core policy, but system reform requires detailed planning, careful steps, and takes time to be effective. Thirdly, relax the excessive real estate market controls. Facing the reality of excessive money supply, it doesn’t seem logical that sliding house prices would be a policy objective.
Land sales and property tax make up over half of local government revenues, to heap further pressure on the property market would result in dire consequences. Real estate has already taken in huge amounts of capital, and has a positive effect on the economy. Considering that property contributes around 20% to China’s GDP growth, removing these unreasonable property restrictions, is the first step to safeguarding economic growth.
Given that China’s investment rate is at an historic high of almost 50%, and local government debt is at unsustainable levels, China must find a new source of growth. Premier Li Keqiang said that one bright spot is urbanisation.
This has already been explored vigorously in academic circles, and the central government is already promoting a new form of urbanisation that puts people first. This point needs emphasising, as its designed to prevent local government officials, spurred on by job promotion and rent seeking opportunities, in building grand follies, such as the ‘Ordos ghost town’, and leaving behind mountains of debt.
This author feels that the key driver for this new type of urbanisation is steadily breaking down the protective screen of the ‘hukou’ system, and at the same time providing new arrivals with adequate social security benefits. And there’s no need to worry at all about some academics concerns regarding the large funding amounts required for investment in education, healthcare and other such social services. Currently there is plenty of private capital waiting to pour into these sectors, all the government needs to do is lower the entry barriers, and ensure fair and safe treatment is accorded to private enterprise.
President Reagan, in office 1981-1989, initiated ‘Reaganomics’, a far-reaching and influential set of economic policies which helped the U.S. economy maintain prosperity after the eighties. In the seventies, prior to Reagan assuming power, the U.S. economy fell into a period of stagflation, where high levels of inflation exist alongside high unemployment levels.
How to move away from Keynesian economics and escape this predicament? Reagan accepted the policy position of ‘supply-side economics’, which is centered on the ‘Laffer curve’. This approach advocates both personal and corporate tax reductions to stimulate the economy, resulting in an overall increase in tax revenues, and thereby a steady growth in fiscal income.
In February 1981 Reagan outlined his plans to Congress, the main points being: 1.) Slash government spending, and reduce fiscal deficits 2.) Extensive tax cuts, reducing personal income tax burdens within three years, and favourable tax treatment and investment incentives for business 3.) Loosen business regulation and reduce government intervention 4.) Control inflation by tightly controlling monetary supply.
Whilst China is not experiencing stagflation, it does however face a dilemma similar to the historic U.S. situation: Choose to dampen inflation but risk an economic downturn, or stimulate the economy and risk exacerbating inflation. One might say that ‘Reaganomics’ acts as a valuable guide for ‘Likonomics’.
The above is a direct translation of an essay from the China Reform Journal, September 2013, titled ‘Conjectures on Likonomics’.
Why translate a past essay? Because many of the recent reports on China’s slowdown neglect to mention the above remedies were prescribed after both Chinese and foreign economists called for a change in China’s economic model towards the end of the Hu-Wen administration. i.e. A need to transition to a more sustainable economic model, which would inevitably result in a slowdown in economic growth.
At the end of the journal article, the author emphasises that the important aspect is whether or not Li Keqiang can implement these policies. Two years on, we can already see new laws and regulations which are designed to achieve the above targets. A previous post on this year’s government work report highlights such new policies.
From Li Keqiang’s perspective there is no paradox, just the pressure from 1.3 billion people to reform the economy, and a long hard fight ahead to deliver change.
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