Old and New Growth Engine

By Min Jie and Li Jia

A hybrid engine began to drive China’s economy in 2015. The conventional part, fuelled by labour, land and capital, is losing steam; the new part, fuelled by innovation and entrepreneurship, is developing. This has infused China’s economic future with great uncertainty. In the past few months, China’s central government has established a two-pronged strategy based on both aspects of this engine. While boosting demand to stabilise the former, the country is accelerating structural reform to provide consumers with better goods and services in order to power the latter.

However, the tricky thing is that the efforts of one side may at times offset the effects of the other. According to a statement made after the Communist Party of China Central Committee’s annual meeting on economic affairs at the end of December, five tasks are on the to-do list to improve supply: eliminating industrial overcapacity, reducing excessive inventories (mainly housing), cutting the debt ratio, easing corporate operational burdens and fortifying weak foundations wherever they may be. The first task may mean shutting down factories, which would dampen demand rather than boost it.

Is it possible for China to dump its overcapacity and at the same time keep growth stable? How can the seeds of new dynamics be cultivated?

Wang Yiming, deputy director of the Development Research Centre of the State Council, gives his answers to these questions in an exclusive interview with China Report.

ChinaReport: What is your view on China’s economic situation in 2016?
Wang Yiming: I think China’s economy will experience a steady slow-down in 2016 until it reaches a turning point, when it will begin to pick up again.

If we look at the demand-side troika: exports will continue to grow slightly, with some fluctuations, and consumption growth will remain steady. It is investment that will be the key variable of the three and define the demand matrix.

Investments in both real estate and manufacturing will hit bottom before turning around, while investment in infrastructure will shrink slightly. This moderate downtrend in investment will pave the way for stabilising the whole economy at a certain level.

Systematic reform on the supply side is scheduled to launch in 2016. This means that efforts to eliminate overcapacity and “zombie enterprises” [whose survival relies on government support] will be beefed up considerably to reallocate resources to places where they will produce more efficiently. This is a source of endogenous dynamics within the economy. In the meantime, positive expectations will grow in the market as new technologies, new products and new business models emerge faster than ever and make up for the weakened momentum of conventional forces.

CR: Investment in infrastructure mega projects still underlies current efforts to stabilise growth. Will it really stop the slowdown?
WY: Huge investment in this sector has not only fundamentally rebuilt China’s infrastructure, but has also contributed to the growth of the economy. It is true that the improved condition of China’s infrastructure means fewer investment opportunities and returns in this sector [in the future]. However, it is necessary to take advantage of lowered costs [in raw materials and capital] and invest in infrastructure projects that will improve consumption and living standards, such as broadband networks, subways, underground duct systems, parking lots, tourist sites and charging stations for electric vehicles. The key is to make investment more efficient at a reasonable scale so that it can benefit the whole economy.

CR: What do you think is the biggest obstacle in solving industrial overcapacity?
WY: Debts, unemployment and asset liquidations are intense pressures. For example, local governments, short of either strong determination or effective tools, are inclined to rescue struggling enterprises out of fear of massive unemployment, social unrest and their own GDPoriented political careers. Corporate debts will immediately become bad loans once bankruptcy is filed. This is the last thing that State-owned bank officials responsible for these loans would ever want. Local courts do not actually have the experience or professionals needed to deal with a surge of corporate restructuring and liquidation. Incumbent officials of State-owned enterprises on the brink of collapse are afraid of being accused of causing losses of State-owned assets if they declare insolvency. Despite all of these pressures, the longer they put off taking action, the more built-up the risk will become, until it’s too late.

CR: What are the differences in the newly launched supply-side reform in comparison with the old concept of demand-side stimulus?
WY: Stimulus on the demand side is more about government-sponsored investment, while reform on the supply side is designed to let the market reallocate resources from low-efficiency areas suffering from overcapacity to more efficient areas with high demand.

A lot needs to be done to realise this. The government has to intervene in the market less, but provide it with better services at the same time. More sectors have to be opened up to private investors. State-owned enterprises need more diversified ownership. Taxes and fees have to be reduced to ease corporate burden. Geographic segmentation and industrial monopolies have to break down to let resources flow effectively between different markets.

Supply-side reform does not mean a complete withdrawal of demandside stimulus. Without an environment of stable, reasonable growth based on releasing consumption and investment potential, conditions for supply-side reform would be closed off and difficult.

CR: Should supply-side reform be focussed on the manufacturing, service or tech sector?
WY: Big changes have already taken place in market demand. People want more diversified, higher-end products and services. They are not satisfied with what they are offered now. Supply-side reform is meant to encourage market competition to provide the kind of supply to meet changing consumer demands. The decision of picking a particular sector, be it manufacturing, service or tech, should be left in the market’s hands, not any individual’s.

CR: As you have mentioned before, the five-year period from 2016 to 2020 is the “window” in which China will flip the switch from the old driving force to the new one [in the country’s hybrid engine]. What impact will this transition process have on China’s economy?
WY: The old and new engines will work together for some time. This is what China’s economic “new normal” basically looks like. The old engine will remain important, though it will no longer be as powerful as it used to be. The cost of labour, land and environment has risen to the point where high-speed growth that relies on sizeable inputs from these three elements is no longer possible. However, the new engine alone is still too small to drive the economy independently. Using the old engine effectively can lay a sound foundation and buy time for the new engine to develop.

In the time to come, higher productivity and investment returns have to be achieved through both the old and new engines to make them work together effectively. In this process, corporate restructuring, capacity reduction and corporate bankruptcy are the biggest challenges. We have to get ready, and have contingency plans for the risky road ahead.

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