China needs supply-side reforms to boost potential growth

Margit Molnar

In a recent interview with the China Daily website, Margit Molnar, head of the OECDs (Organisation for Economic Cooperation and Development) China Desk, described that China needs three things if it wants to maintain growth – expanding the scope of reforms, a healthier marketing mechanism, and encouraging its people to learn more about finance. The rest of the interview is as follows:

CD: Why did the Chinese choose supply-side reforms now?

M：The Chinese economy has grown fast for the past 20 years so there had been less pressure on the government to implement structural reforms. Now, with the economic downturn, the government can’t rely on the old drivers such as capital and labor input for economic growth, so there’s more urgent need for supply-side reforms to boost the economy’s growth potential.

CD: The main purpose - as the president of the Asian Infrastructure Investment Bank, said at a news conference in Beijing on Sunday - of the reforms is to reduce overproduction and overcapacity. Why do these two things exist?

M: For the past decades, the market role to allocate resources has not been exercised fully, which led to price distortions. For example, interest rates didn’t fully reflect the price of capital and many SOEs got cheap credit and other benefits through preferential policies. It’s common knowledge, for instance, that China lacks energy resources, nevertheless it still became an exporter in energy-intensive industries such as steel or electrolytic aluminum. The key here is that by keeping the price of energy and capital low, many firms became internationally competitive in energy-intensive goods.

CD: Cutting excess inventory in the property market is also an important goal this year. Some suggests encouraging migrant workers to buy property in 3rd-or-4th-tier cities. Could you give some suggestions on how to reach this goal?

M: I heard a very reasonable proposal on encouraging retired migrant workers to buy property in these cities because migrant workers with savings who would like to come back to a city near their hometown could enjoy still better services than in rural areas. This proposal also needs some support measures, like increasing the number of nursing homes and improve elderly health care service in these cities. China is aging rapidly, even faster than Japan and, among OECD countries, only South Korea is aging faster than China.

CD: Apart from cutting taxes, are there any other institutional costs that can be lowered to reduce overall costs of doing business?

M: Structural reforms are much more important than tax cuts, especially those related to setting up new firms. The SAIC (State Administration for Industry and Commerce) began combining business licenses, organization code certificates, and tax registration in one document, and that’s a very positive move. But there’s still room for improvements when it comes to the management process of enterprise registration and enterprise operations. And taxes are a very sensitive issue, cutting taxes could also lead to a decline in fiscal revenues, which means weakening the government capacity to provide support for those who need it.

CD: How would supply-side reforms affect the economic structure and the three main industries?

M: The reform process would speed up this year. Although the size of the service sector now exceeds that of industry, when compared with advanced economies, there still exists ample room for increase. Not only are the service industries of the US and Britain impressive, but also in other advanced countries the service sector typically accounts for around 70 percent of GDP, while in China, the service industry is still at 40 percent, so it’s reasonable to expect it to have a bright growth potential. One reason for China’s service industry’s lagging behind manufacturing is past preferential policies for the manufacturing industry. One recent measure of converting business taxes - levied on the turnover of services firms - into a value-added tax will encourage services outsourcing and very likely stimulate micro-to-small business development.

CD: How long would it take to tie GDP growth to supply-side reforms?

M: It’s important to avoid a hard-landing and to do that broad-scale structural reforms are indispensable. Population aging plays a key role in the slowing of long-term growth potential. We believe that structural reforms can make up for some of the slowing of potential growth. At least it could diminish the impact of slowing growth. As for how long it would take to speed up growth that mainly depends on how broad the reforms are in scale and how effective their implementation is. A rapidly aging China means it will be hard to bring GDP growth back to what it was in the past 20 years, but we could slow the pace of decline, and avoid a hard landing. The aging population causes a decline in growth potential so, innovation and structural adjustments are vital for boosting potential growth.

CD: Could you tell us how the OECD countries use supply-side reforms to adjust their economic structure?

M: We analyze many kinds of indicators, such as those related to the product market or the labor market and compare country policies and performances, then we can see which countries can provide valuable experience for others. For example, in the area of labor protection, if a government uses very strict regulations on labor protection, it can restrict company development as firms are more reluctant to hire new labor if they are more restricted in getting rid of them when they face a downturn, but if the employment protection is weak and there is no relatively good social security system, it can make people feel insecure. We feel that some northern European countries’ policies in this area are exactly right for both people’s well-being and for efficiency.

CD: Could you give some suggestions on dealing with unemployment caused by reduced capacity in industry and economic adjustments?

M: Industrial restructuring usually takes a long period of time but China has gotten used to rapid change whenever it comes to the economic structure or development. To face the challenge, the most important thing is to focus on increasing the training, including professional skills in or outside the company. If a person works in an industry with a not very promising future, for example, industries suffering from excess capacity, then those employees should be provided more training, first of all in basic skills to increase their ability to learn new skills then technical skills to enhance their employability. And the authorities should put more effort to improving training all over one’s working life. This should begin early, because, if layoffs become large scale, it would cost more to respond and adjust. The training development could start with a market-oriented selection of the skills to be taught so as to also reduce skills mismatches in the labor market.

CD: How do you evaluate China’s economic development and its future?

M: We believe that it is not impossible for China’s GDP growth to reach 7 percent given the healthy situation of public finances but it is another question whether it is desirable. It is a natural process for the economy to slow as its population ages and stimulus policies would only delay the adjustment while building up imbalances. So, assuming that the government will increase its structural reforms and come up with more policies to encourage innovation, we predict that its GDP growth could reach over 6 percent in 2 years ahead. We believe that its economy will be on the right track if can stick to supply-side reforms instead of using stimulus measures.

CD: Do you have any suggestions to our current supply-side reforms?

M: First, the authorities could expand the scope of the reforms, instead of small steps, reforming on many fronts simultaneously, for example addressing the issues of aging, simplification of business procedures, upgrading skills and tackling the problem of industrial over-capacity in an effective way. Adopting structural reforms becomes more urgent as the economy slows.

Second, allow the market to play a greater role.

Last but not least, it’s important enhance Chinese people’s basic skills, including financial literacy to make better decisions. For instance, to judge whether currency is weakening or strengthening in general, it is more useful to look at the effective exchange rate, started to be published regularly by the People’s bank of China, instead of looking at only the bilateral rates.

The OECD uses its wealth of country experiences and data on a broad range of topics to help governments grow and prosper and fight poverty through economic growth and financial stability.