Home' Trinidad and Tobago Guardian : May 23rd 2013 Contents MAY 2013 • WEEK FOUR www.guardian.co.tt BUSINESS GUARDIAN
THE ECONOMIST | BG25
Every economy, like every story, has two sides: supply and
The supply side of China s economy is the stuff of legend: 767
million workers, perhaps US$20 trillions worth of machinery,
buildings and other kinds of capital, combined with rapidly advanc-
ing techniques and technologies, many of them assimilated from
abroad. This combination of labor, capital and know-how dictates
how much the economy can produce.
Whether it actually does produce all it can, however, depends
on the other side of the economy, the demand side, which reflects
the spending decisions of consumers and investors. The supply
side sets the scene, the demand side provides the drama.
Sadly, demand is recovering more slowly than expected. Figures
released this week suggested somewhat disappointing growth in
fixed-asset investment and industrial production last month, fol-
lowing a similarly underwhelming first quarter. Economists who
were expecting growth of as much as 8.5 per cent this year are
now projecting something closer to 7.5 per cent.
As the drama darkens, however, the scene also may be shifting.
A May 6 meeting of the State Council, China s cabinet, outlined
a long list of structural reforms designed to improve the supply
side of the economy. Some of the reforms, such as extending the
value-added tax to services, are already under way. Others, such
as liberalising capital flows, will reach fruition only gradually.
The reforms also are in keeping with pronouncements by former
leaders such as Wen Jiabao, who liked to talk reform, but didn t
walk the talk. However, the new agenda "goes far beyond Wen-
era platitudes in its boldness and specificity," according to Andrew
Batson of Gavekal Dragonomics, a consultancy in Beijing. The
"walk-to-talk" ratio is improving, he believes.
Walking the reform-talk would help sustain the growth of pro-
ductive capacity, improving the allocation of both capital and
labor. Cutting red tape and other regulatory barriers to entry
would help private firms invest in industries now dominated by
state-owned enterprises. By strengthening land rights and reforming
the hukou (household registration) system, China would make it
easier for workers to leave the land and settle in the cities. The
reforms could, therefore, have a big effect on the supply side of
That is not all, though. The reforms also might have side-
effects on consumption and investment. Even supply-side reforms
can have demand-side consequences. Some tend to boost spending,
others depress it. Helen Qiao of Morgan Stanley worries that
some of the measures outlined on May 6 will slow demand at
a time when the economy is already weak.
One example is higher utility prices. They may be necessary
to conserve water, electricity and gas, but they also will discourage
spending. The same is true of higher taxes on natural resources
such as coal.
Efforts to get a grip on local-government finances are a trickier
case. Provinces have borrowed indirectly, and excessively, through
financing vehicles. The central government now wants localities
to borrow more directly by issuing their own bonds.
Lou Jiwei, the new finance minister, has talked of closing the
back door and opening the front door. Whether that helps or
hurts demand depends on timing. If the government opens the
front door before closing the back, it will encourage extra borrowing,
boosting demand, Qiao says. If it closes the back before opening
the front, the opposite will happen.
A similar ambiguity surrounds capital flows. China s capital
account is not entirely closed. Foreign direct investment is welcome,
and short-term financial investment also is permitted, within
limits, by "qualified" investors. Even many unqualified investors
succeed in moving money in and out, although not without delay,
subterfuge and inconvenience.
Moreover, even if the government does liberalise flows, it is
unlikely to leave the capital account entirely open. It probably will
replace bureaucratic impediments to capital mobility with price-
based deterrents, such as taxes on foreign holdings. The net effect
on the exchange rate, on the cost of capital and, therefore, on
demand might be modest.
Liberalising the exchange rate and the interest rate are both
necessary reforms, Qiao says, but they would depress demand.
China now imposes a ceiling on the interest rate paid to depositors.
Removing it would raise banks funding costs. If banks raised their
loan rates in response, it would discourage borrowing. If they did
not, it would hurt their margins and discourage lending. Either
way, demand would be affected.
What about the exchange rate? China has attracted a strong
inflow of capital in recent months, some of it disguised as export
earnings. This has pushed up the yuan, which so far this year has
risen by 1.4 per cent against the dollar and by 20 per cent against
the yen. Speculators again see the yuan as a one-way bet. If the
exchange rate were liberalised, they would push it up further,
hurting exports and depressing demand.
Fortunately, many of the reforms outlined this month will both
improve supply and boost demand. In replacing a crude turnover
tax on services with a value-added tax, the government has sought
to lighten the fiscal burden on services. Cutting red tape should
also boost investment. And allowing rural folk both to sell their
land and use public services in the cities would help them spend
more freely as urban consumers.
As structural reforms have implications for demand, so the
converse also is true: Efforts to boost demand can affect the course
of structural reform. China s 2009 stimulus lending was successful
in reviving demand, but it also had some damaging structural
side-effects. It further skewed the economy in favour of investment,
especially property construction, it made a mess of local-gov-
ernment finances and it forced China s banks to serve government
ends, thus delaying their evolution into commercial lenders.
The stimulus had one other damaging side-effect, on China s
economic philosophy. Many analysts now seem to believe that
all stimulus measures delay reform, if only because they ease the
economic pain without which policy-makers will not act.
That is a mistake. Stimulus does not need to be at odds with
reform. Cutting taxes or increasing social spending would both
stimulate the economy and help rebalance it toward consumption
and services. Likewise many structural reforms, such as removing
barriers to entry into industries now dominated by state-owned
enterprises, would also simultaneously help to boost spending.
The Chinese economy clearly needs reform and may soon need
revival. There is no reason why the leadership cannot do both.
@2013 Economist Newspaper Ltd. (Distributed by the New York Times
off against reform
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