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Empowering the market remains key to China’s ‘supply-side’ reforms

The central government appears to be determined to reconfigure the economy by forcing businesses in industries with extreme overcapacity to shut down or merge.

By NewsChina Updated Aug.22

To battle China’s continued economic slowdown, the central leadership launched its so-called “supply-side” reform policy earlier this year. The economic campaign aims to curb excessive production capacity and clear overstocked inventories in various industries. 
In the past few months, pundits and officials alike have crossed swords over China’s next move. One camp thinks the country should resort to its old ways and employ massive government stimulus measures to avoid further economic stagnation, while the other wants China to adopt more assertive policies to reduce overcapacity and close down “zombie” enterprises. 
In a Party meeting on May 16, Chinese President Xi Jinping asserted that the ongoing supplyside reforms will focus primarily on reducing “ineffective” supply while increasing “effective” supply so that supply-side infrastructure can become more “adaptable” to the changing dynamics of the demand side. To flesh this concept out, Xi laid out five specific tasks for the reform to accomplish: reduce excessive production capacity, lower inventory levels, decrease business costs, solve the debt problem by reducing leverage and address the sectors where supply has failed to meet demand. 
Xi’s statements seemed aimed toward analysts who have shown confusion over why China’s money supply increased significantly in March and April, which allowed many lagging enterprises to reboot production and even led some to draft plans for expansion as commodity prices rebounded. 
Xi’s plan has been interpreted as a “balanced” approach to pushing forward supply-side reforms. 
Facing a two-pronged challenge of restructuring the economy and preventing its downturn, the Chinese leadership has chosen what it views to be a prudent path. 
While focusing on maintaining a stable economic growth rate and bypassing “shock therapy” policies that could push the economy into a “hard landing,” the leadership is trying to reinstate economic restructuring and overcapacity reduction as its top priorities. 
The central government appears to be determined to reconfigure the economy by forcing businesses in industries with extreme overcapacity, such as steel, coal and metals, to shut down or merge. At the same time, to reduce the impact of this restructuring, it aims to increase investment that will bolster effective supply in areas where supply has failed to meet demand, such as education, medical services, environmental protection and green energy. 
This approach sounds reasonable, but to achieve its goal, the leadership must address the fundamental problem underlying various issues – excessive government interference. In order to prevent the closure of some large enterprises and thus stave off mass layoffs, the government has continued to support these zombie enterprises through various means. If the supply-demand structure remains distorted, loosening monetary policy can only result in higher leverage levels, as capital stays out of the real economy. To solve the supply-demand problem, the key is to allow the market to play a greater role.