Balance stimulus and supply-side reform

Since last November economists and the media alike have been hailing supply-side structural reform as a groundbreaking solution to China's economic woes. The logic goes, demand-side policies, in the form of Keynesian stimulus measures, are useful only for resolving short-term and aggregate problems. But since China's problems are long term and structural, the country should focus on supply-side structural reform, even if it means accepting slower GDP growth. Is this the right approach?

GDP growth is generated via the interaction between the supply side and the demand side of the economy. For example, investment in human capital enables innovation, the products of which create demand and, in turn, economic growth. Demand-side policy and structural adjustment are not mutually exclusive. In aggregate terms, growth of supply determines growth potential, and growth of demand determines the use of that potential. To change the economic structure and growth pattern, first the structure of demand must be changed.

For China, the supply side should be driven more by innovation and creation, rather than by increasing inputs. On the demand side, it should be driven more by domestic consumption, instead of investment (especially in real estate) and exports. But this shift is proving difficult, as structural factors cause China's long-term potential growth rate to fall; the economy now seems set to fall below that lower rate this year.