Abstract: In this article, the author discusses how China could unleash its growth potential in 2021. He suggested that China make policy adjustments in the following areas: first, economic structural reform, which should focus on better integrating the 300 million migrant workers into urban life; second, aggregate demand management, which will enable standardized policy tools to fully play their role; and third, opening-up, which should focus on breaking foreign monopolies by actively participating in international trade agreements and R&D collaboration.
Despite the unexpected outbreak of COVID-19 which has brought huge challenges to the world economy, the Chinese economy achieved a pretty sound outcome in 2020, which should be mainly attributed to the following three factors.
First, and probably most importantly, China successfully put the virus under control, which was the precondition for economic recovery.
Second, China took prompt, decisive and targeted measures in the first quarter of 2020 when the virus outbreak severely disrupted economic operations, including expansionary monetary and fiscal policies as well as targeted relief measures.
These policy measures helped prevent demand slump and secured supply. Besides, the high savings rate of the household sector kept the balance sheets of residents and enterprises afloat during the pandemic. Most residents and enterprises which were gravely hit by the pandemic have managed to weather the crisis. Once the pandemic was put under control, the economy quickly resumed vitality.
Third, the outperformance of export. China’s comprehensive and flexible industrial system helped fill up the gap in manufacturing production in other countries when they were severely disrupted by the pandemic. This helped boost China’s export and promptly met the demand in foreign markets, which has made great contribution to both the Chinese and global economy.
In 2021, China should make policy adjustment in multiple areas such as economic structural reform, aggregate demand management and opening-up, in order to unleash the country’s growth potential, maintain stable economic operation and enable the whole society to share the benefits of economic growth.
I. Economic structural reform policies should focus on helping the 300 million migrant workers better integrate into urban life
Economic growth sustains its momentum from positive interactions and synergies between each economic sector.
The focus of structural reforms should be improving the weak links in the economy, which can not only help drive the growth of individual sectors, but also form positive interaction among different sectors, thereby driving the development of the entire economy.
However, without a reference it would be hard to identify the weak links. Using the patterns displayed in similar development stages of high-income economies as a reference, and comparing that with the trajectory of China’s economic growth and the changes in the structure of the Chinese economy, we may find the shortcomings.
The development of China’s manufacturing industry has been very successful, far surpassing that of high-income countries in similar development stages. Export is like a mirror which reflects a country’s manufacturing capacity. The sophistication of China’s export products is on par with that of an economy with a per capita income of over $20,000.
Some experts pointed out that the gap between China and developed countries like the US, Japan and Germany is still huge in the manufacturing sector. While this is a fact, it should be noted that the level of development of China’s manufacturing industry is pretty remarkable considering that China is still an economy with a per capita income of $10,000.
More importantly, China’s manufacturing upgrade is still going on as evidenced by the input in research and development, the division of labor in the manufacturing process, sales of products and so on. Given the current development stage of China, manufacturing industry is not a weak link of the Chinese economy.
The weakest link of the Chinese economy at this stage is the failure to assimilate the nearly 300 million migrant workers into urban life. Under the above-mentioned reference framework, the most noticeable issue is the low share of employment in the secondary and tertiary sectors, low urbanization rate and the low share of consumption.
The reason behind this is that nearly 300 million migrant workers have not been able to truly settle in the urban areas. This part of population is not included in the employment statistics, which explains why employment by the industrial and service sectors takes up only a small share of total employment, and partly explains the reason for China’s low urbanization level and low proportion of consumption.
Helping the nearly 300 million migrant workers integrate into urban life should be the top priority of future structural reform. This is not only about social justice, about the welfare of the nearly 300 million migrant workers and their families, but also has much to do with the overall growth potential of the Chinese economy.
With nearly 300 million migrant workers settling in cities, China will see the release of another round of huge growth potential. This will bring enormous market demand, and a huge improvement in human capital accumulation and supply capacity.
Achieving this goal requires breakthroughs in policies concerning social security, urban public services, land, and household registration among other aspects, to ensure the migrant workers can enjoy the same public services and social security as urban citizens. Metropolitan clusters attract and absorb new labor forces like a large magnetic field, and has been recognized as such by the government, but there is still much to be done.
Related reforms pose a huge challenge to cities’ public services capacity and governance capabilities, and will increase public expenditures. But these difficulties are usually partial and won’t last long. From a long-term and overall perspective, that the nearly 300 million migrant workers settle in the urban area will create huge market demand and bring rich human capital, which will provide plenty of room for solving the problems. By making it a must-do task, policymakers will be compelled to come up with appropriate solutions, and these difficulties will be resolved one by one.
II. Demand management policy: give full play to standardized policy tools
We should not underestimate what aggregate demand management can achieve. Normally there are fluctuations and setbacks in economic operations. Severe turbulences such as depressions, severe unemployment, and widespread bankruptcies can bring extensive damage to the market. Successful aggregate demand management can help avoid or reduce such damage, an essential element to sustain economic growth momentum.
China has always attached great importance to macroeconomic stability, and has been quite successful in this aspect. However, it has also learned its fair share of lessons in terms of policy choice. Since 2012, the overall feature of China's economic cycle has been "easy to cool and hard to heat up", and the main task of aggregate demand management is to increase demand.
Regarding the choice of policy tools, standard monetary and fiscal policy instruments such as lowering interest rates and raising government debt to expand expenditures have not fully played their role. Meanwhile, investment through borrowing that is participated and led by local governments, backed by government credit to varying degrees but not reflected on the government budget, and also widely participated by commercial financial institutions, has prevailed. This approach of increasing total demand is costly for the following reasons.
First, it could substantially raise systemic financial risks. A large number of commercial financial institutions and players in the bond markets have widely participated in investment and financing activities led by local governments, and have gained significant benefits from them. However, their participation is based on confidence (in the governments’ implicit guarantee of repayment or yields) instead of business logic. However, if you examine the books of these government-led projects, the returns are not very optimistic. Many local financing platforms can only sustain themselves by borrowing new debt to pay off old ones. Such assets held by financial institutions are huge and the quality is worrying.
Second, local governments have to rely excessively on land finance, which is closely linked to high land and housing prices.
Third, due to the lack of a standardized regulatory mechanism and risk assessment, waste of resources is unavoidable.
The way to get out of this dilemma is to give full play to the standardized monetary and fiscal policy tools.
When the demand is insufficient, lowering interest rates should be the first tool to use. If this is not enough, then it is essential to expand expenditure budget.
These efforts will stem the debt expansion of local financing platforms, and help to fully implement macro-prudential regulatory measures. Adopting strict credit risk assessment and credit lending principles is important for reducing credit risks and improving resource allocation.
Cutting interest rates is the preferred way to boost aggregate demand. Rate cuts can pare down debt costs for businesses and households while increasing the value of the assets they hold, thereby improving their balance sheets and stimulating spending.
This is essentially tapping market force to address insufficient demand. With China’s debt now standing at 260 trillion yuan, every cut by 1 percentage point in the interest rate will translate into reduced costs of over 2 trillion yuan for borrowers; if the consequent increase in asset valuation is taken into account, it’s obvious that rate cuts will play a significant role in improving balance sheets and boosting spending.
Rate cuts tend to spark concerns over greater money supply and higher housing prices. However, this may not necessarily be the case.
Rate cuts can push up credit demand of the private sector, which in turn will boost aggregate demand, relieve the pressure on local governments to maintain economic growth through credit expansions. Private sector borrowing is more efficient in driving demand growth than public sector borrowing.
As a result, lower interest rates may result in slowed expansion of credit and money supply, rather than the opposite. This, combined with reduced dependence of local governments on land finance, would make housing price hikes less likely.
III. Foreign economic policies: monopoly rather than opening poses the biggest threat
China could never have scored miraculous economic growth without opening-up. Opening to the outside has brought a larger market for China’s products, introduced advanced concepts, technologies and management experience, and is an indispensable driver of reforms. Its importance can never be over-emphasized.
After decades of opening-up, China has deeply integrated into the world economy. Its enterprises have already become used to allocating resources globally and benefitted enormously from international division of labor and economy of scale.
For example, the meat we consume on a daily basis comes from livestock fed with imported plant protein sources such as soybeans. It would take over 40 million hectares of land to produce these soybeans in China. A China without the international market is just unimaginable.
A higher level of opening-up and increased dependence on the international market ignite safety concerns. However, it should be made clear that it is not opening-up, but monopolies of all sorts in the international market, that endanger economic security and supply chains.
The competition between China and developed economies in the high-tech territory has escalated in recent years, as evidenced by intensified confrontational moves by countries like the US including administrative interventions. These measures would not have been effective without these countries’ monopolies in certain products and services.
Turning inwards is not an efficient or safe way to break the monopolies, as history demonstrates.
Instead, China should step up its participation in international economic and trade agreements such as the CPTPP, seek to build more consensus with the international community, and boycott monopolies with joint endeavors.
China should also open up wider in scientific research and high-tech development, enhance intellectual property right protection, and fully mobilize market forces to break monopolies.
In addition, China should establish effective incentive mechanisms for basic research, and promote interaction and synergy between research and industrial development.
