By Chen Changsheng & Xu Wei

Research Report Vol.19 No.4, 2017

The new round of economic adjustment has lasted more than seven years. During this period, great changes have taken place in the relations between macroeconomic growth and microstructure, the pace of replacing old engines of growth with new ones has accelerated, China’s interactions with the rest of the world have been strengthened, stock-related issues and new risks have been interwoven more closely, and the traditional macro-management framework has faced severe challenges. To balance speed, quality and risks, we should accurately identify the characteristics and challenges in the phase of economic transformation, systematically evaluate the space of macro-policy, constantly upgrade the approach to macro-regulation, foster a relatively stable macro-environment for economic transformation, promote the adjustment of economic structure, and foster new engines of growth, so as to achieve economic rebalance under the constraints of high leverage, multiple risks and limited policy space.

I. Six Challenges facing Macro-regulation in the Transformation Phase

The shift from high-speed growth to medium to high-speed growth is generally accompanied by some major structural changes. Technological advances, industrial structure, urban-rural structure, and the extent of openness all show distinctive characteristics that are different from in the past. The interwoven periodic issues and structural issues, short-term issues and long-term issues, as well as domestic issues and international issues in economic operation pose great challenges to macro-regulation, and make the situation more complicated.

1. The space of hedging against stock issues with growth has narrowed

From 1980 to 2010, China’s total factor productivity grew at an average annual rate of about 3.6%. After 2010, the annual growth rate declined to less than 2%. With the decrease in the contribution of cross-sectoral allocation of resources to total factor productivity, productivity gains have depended more on the improvement of internal efficiency of sectors. Even if there is room for further cross-sectoral allocation of factors, it is still a great challenge to take the quality of economic growth to a higher level. For example, the institutional requirements for the development of producer services vary greatly from those for manufacturing, and the same is true of higher level of opening up. In the past, stabilizing growth was equivalent to stabilizing investment, but with the decline in the growth rate of total factor productivity, the expansion of investment featuring the increase in quantity, scale and space will be constrained by the decline in investment efficiency. In addition, with the gradual end of the high-speed growth and the deepening of economic restructuring, the interests of some groups will be affected, the gaps in income and wealth may widen, and it will be more difficult to balance interests. Therefore, macro-regulation during the transformation phase must take into account the impacts of loose monetary policy or expansionary fiscal policy on the promotion of debt leverage and the redistribution of wealth.

2. The administrative modes of resource allocation need transformation

During the period of high-speed growth, the directions of industrial and consumption upgrading were relatively clear. Drawing on the experiences and lessons of other economies and relying on our institutional advantages in building large-scale infrastructure and improving basic public services, China successfully coped with the Asian financial crisis in 1998 and the international financial crisis in 2008, and maintained generally steady economic growth. However, after entering the period featuring innovation-driven growth and factor-based efficiency improvement, the uncertainties in economic operation have increased markedly, the path of industrial upgrading has become unclear, and the demand for consumption has become more diversified and individualized. The development space for tangible public services has narrowed, while there is still plenty of room for the improvement of intangible public services. Therefore, macroeconomic regulation should rely more on market-based and legal measures, and shift from stabilizing investment in the past to ensuring consumer confidence, and from investment in material capital to investment in human capital.

3. The focus of creating new balance is being shifted to the supply side

The transition of China’s economic growth stage, on the surface, is the change of economic growth rate. But in essence, it entails changes in many aspects such as industrial structure, enterprises, society, culture, concepts and systems. Some of them are fast variables, and others are slow variables. Economic restructuring and institutional adjustments do not always go hand in hand. Overcapacity and high leverage and stocks can sometimes coexist with the lack of effective supply and the inability of supply to meet demand. The slight fluctuations in the economic downturn since 2012 show that intensifying demand management can only temporarily stabilize the economy but will not change the downward trend of economic growth. To achieve smooth transition from high rate of growth to sustainable medium-high rate of growth, we must focus on the supply side, establish a set of institutional mechanisms that can adapt to the medium-high rate of growth, and promote China’s economy to achieve new balance at a higher level. To this end, macroeconomic regulation should provide a good environment for the supply-side reform.

4. The economy is prone to risks with economic slowdown interwoven with structural imbalance

In the transformation phase, due to the slowdown of technological progress and the decline of investment efficiency, the original mode of growth is difficult to sustain while the new growth points and space are still in their infancy. Meanwhile, the adjustment of different variables is not at the same place. When the original stable structure was shaken up and the new balance has not been established, social expectations are not stable either. In this stage, risks such as overcapacity, corporate debts and local government debts accumulated during the period of high-speed growth become more prominent. After more than 30 years of rapid growth, the household sector has also accumulated an enormous amount of wealth. With the decline in returns on investment in the real economy and an increase in the demand for reallocation of assets, more funds may flow into the real estate sector, stock markets, and the bond market. In the case of inappropriate macro-policy and ineffective supervision, there may be an economy-wide asset bubble. Despite our policy space and institutional advantages in concentrating on dealing with risks, we need to pay close attention to risks and especially, strive to prevent one bubble from covering up another.

5. The importance of expectation management is rising

With the advances in the market economy, market players become more diversified and are more sensitive to policy signals, placing higher demand onmarket expectation management. Especially in the transformation phase, the economic structure is undergoing significant changes, and wide fluctuations may occur in the real estate market, stock market, foreign exchange market, bond market and elsewhere, and spread from one sector to another. Market expectations are more vulnerable, and if not properly guided, there may be chaos or even panic, which may trigger risks in the financial sector. Therefore, we must put greater emphasize on communication with market players when conducting macroeconomic regulation, increase policy transparency, and strengthen our ability to guide expectations and manage risks under complicated circumstances.

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