Continuing supply side reforms - China’s 14th, Five-Year Plan

11/4/2020

China’s 14th, Five-Year Plan is a refreshing reiteration of conventional supply side policies, at a time when Developed Markets are in the grip of very unorthodox economic policies.

Orthodox supply side structural reforms amidst a world of unconventional economic policies. China’s emphasis, in its latest Five-Year Plan, on further opening the economy, boosting domestic demand, technological innovation and environmental improvement are logical extensions of the “supply side structural reforms” that started in 2015. They are sensible responses to the challenges of the day.

Over the past decade, the United States has gone from one unconventional policy to another – quantitative easing, “QE infinity”, and now Modern Monetary Theory. Other Developed Market economies – Japan and Australia notably – have added “yield curve control” to the list of unconventional policies.

Arguably, these policies have distorted market pricing and resource allocation but with not much self-sustaining economic growth to show for all that. Market players who can access to “free money” hitched rides on whatever the Federal Reserve bought, and on “second derivatives” (other assets that were secondary beneficiaries of Fed purchases).

But for all of that, economic growth in the US suffered a secular decline. The periods after successive recessions have seen lower average economic growth rates, that is, 3.8 per cent in the period 1992-2000, 2.8 per cent in 2002-2007, and 2.3 per cent in 2010-2019. US non-farm productivity growth has fallen from an annual average of 2.7 per cent in the period 2000-2007 to 1.4 per cent in the period 2007-2019.    

While China’s labor productivity growth rate is still much higher at over 6 per cent, it has decelerated significantly over the past 10 years.

This is one of the contexts through which we view the 14th Five-Year Plan.

Redressing the imbalances of an earlier period. China’s economic growth of past decades have been criticized for being “imbalanced” – with too much reliance on net exports and fixed asset investment. The upshot of this was erosion of the private consumption share of GDP from over 70 per cent in the early 1960s to around 35 per cent by 2010, vulnerability to the global trade cycle, high “credit-intensivity” of growth (with the amount of new credit required to raise nominal GDP by US$1 rising from US$1.3 in 2007-2008 to US$4 by 2015-2016), oversupply in some industries and environmental degradation.

Following through on the Supply Side Structural Reforms of recent years. Given the acronym SSSR by economists, Supply Side Structural Reforms were first mentioned by President Xi in late 2015 and involved reducing excess industrial capacity, lowering leverage in the corporate sector, and reducing the costs of doing business.

Having significantly reduced the growth of fixed asset investment and total social financing over the past 6-7 years, the latest Five-Year Plan takes SSSR to the next stage of reconfiguring the engines of GDP growth.

Boosting productivity for growth in the face of a declining population in coming decades. So, the emphasis in the 14th Five-Year Plan on “quality growth”, with focus on technological upgrading is about boosting the productivity contribution to GDP growth. This is also recognition that China could see a peak in its population at around 1.4 billion within this decade. China cannot rely on the demographic dividend to drive the economy for much longer.

Raising the household share of GDP to drive growth with less credit. So, the focus on developing private consumption expenditure is as much about reducing the “credit-intensivity” of growth as it is about a more equitable share of the GDP going to households. Income will likely rise at a faster rate than in the past and there will be a lot more middle-class spending.

Environmental focus, with carbon neutrality by 2060 the target. The references to “ecology” and the “environment” are acknowledgements of the need to redress the environmental degradation caused by previous decades of lower value-added industrialization. It is supplemented by China’s commitment to be carbon neutral by 2060. Beyond just repairing environmental damage, environmental control/abatement is likely to be an engine of economic growth in itself.

Implications of the Five-Year Plan. The Plan’s objectives will require massive investments in technology, ranging from just pushing higher up in the value chain, to industrial automation, to research and development in semiconductors. These will likely boost the long-term prospects of companies in these areas.

The market has already lifted the prices of green energy stocks ahead of the Plan. China has just committed itself to carbon neutrality by 2060. It has a long way to go before it gets there and a lot more investments will be required.

Lifting the share of personal consumption expenditure in GDP will require raising household incomes. Companies exposed to middle-class consumption will be long-term beneficiaries of this.