Editorial: Chinese Government Must Define Goal of Expanding Domestic Demand

As Chinese economic growth is clouded by deceleration in exports growth, the importance of the domestic market has once again become apparent. The Politburo suggested at its April 23 meeting that China should accelerate its structural reform while simultaneously expanding domestic demand.

This call from the top decision-making body drew a great deal of market attention and was seen as an important signal. However, the interpretations were different. Three questions need to be clarified to understand this new rhetoric: Why does China need to continue to expand domestic demand? What domestic demand needs to be expanded? And how should it be expanded?

Authorities need to share their authoritative voice on what “continuing to expand domestic demand” means in order to guide the market.

But before that, we think that the central government’s call to expand domestic demand implies that China will underpin its high-quality growth by encouraging individual consumption and private investment, focusing on technology and business innovation and deepening supply-side structural reform. It by no means implies that old stimuli, such as easing monetary policy or government-led infrastructure investment sprees, will be tried again.

The Politburo meeting pointed out in a statement that the Chinese economy has stabilized and has shown some signs of improvement since the beginning of this year. This being said, there is no need for China to make radical changes to its prudent and neutral monetary and fiscal policies.

Indeed, structural and deep-rooted problems remained, and more effort is needed to fight the “three tough battles” — controlling risks, reducing poverty and fighting pollution. In addition, the world economic and political situation had become “even more complicated.” Against that backdrop, there is an increased need to be ready to deal with unexpected developments, and efforts should be made to tackle and resolve outstanding problems, the statement said.

During the first quarter of this year, Chinese exports’ net contribution to economic growth turned negative again. Coupled with the increasing spat over trade between China and the U.S and a weakening economic recovery in the EU, the outlook on China’s exports doesn’t look promising.

Strenuous efforts must be made to achieve the goals the government has set for the economy this year, according to the statement. Against this backdrop, the central government’s emphasis on “expanding domestic demand” while at the same time “accelerating supply-side reform” seems very preparatory, which is designated to respond to short-term flagging external demand facing the Chinese economy and to support high-quality growth in the long term.

Shoring up the economy with huge investments and easy money have resulted in few positive results, and decision-making leaders are fully aware that these approaches are no longer an option.

In recent years, China pressed ahead with supply-side structural reform, with major achievements being made in top five priorities — cutting overcapacity, reducing excess inventory, deleveraging, lowering costs and strengthening areas of weakness.

Several provincial-level governments, including Hunan, Xinjiang and Fujian, issued documents that required the local governments in their respective jurisdictions to reduce government investment projects, reflecting the central government’s resolve to rein in local governments’ debt risks brought on by reckless borrowing.

Infrastructure-related stocks jumped on the call of expanding domestic demand. This opportunistic mindset should be abandoned.

Expanding domestic demand should focus on individual spending and private investment. In the past, government measures to help consumption and private investment expand produced few results. That’s why the government this time should prepare for the levels of difficulties in increasing domestic demand and shouldn’t look forward to any immediate effects on the economy compared with stimulus policies.

The government should speed up individual tax reform and social security reform in order to continue to increase people’s incomes and reduce the income gap. It should also create a more consumer-friendly environment by strengthening its protection of consumers and stepping up oversight of the market.

It should also give more protection to all types of properties, including intellectual ones, and help channel more credit/financial resources into private firms and small businesses in order to prop up confidence in private entrepreneurs and stabilize their expectations on investment.

The government must press ahead with programs such as state-owned-enterprise reform and tax reform in order to create a level playing field for all types of ownerships and to improve a market-orientated system. It should open sectors like financial services to foreign capital and increase government spending on basic public services to improve people’s livelihoods.

In all these aspects, the central government has already laid out plans. Local governments and relevant departments need to implement them sooner rather than later in order to gain benefits from these plans.

Currently, the Chinese economy has already pivoted to high-quality growth from the high-speed growth in the past. To accommodate this change, expanding domestic demand requires new measures. As the Politburo pointed out at its April 23 meeting, expanding domestic demand and structural reform should be done at the same time and converge if possible. It means achieving the upgrade of the manufacturing industry and expanding the services sector by shaking up industry and trade in order to expand effective domestic demand.

In the next stage, the government should use more market-orientated methods to reduce excessive production capacity and increase research on key technologies in order to support new industries and new business models. Authorities should continue to cut red tape and reduce the tax burden and costs of firms in financing, energy and logistics.

Under the background of changing government functions and containing local debt risks, efforts should be made to improve the quality and efficiency of government investments. Central government financial support should be used to promote major projects that are of overall importance to reform and opening-up, and local governments at all levels should also aim at important sectors such as poverty alleviation, rural revitalization and high-tech research and development.

In the course of expanding domestic demand, fiscal policy can be an important tool. However, to make good use of fiscal policy, the government should not give its approval to projects that fail to meet investment standards. Otherwise, the debts risks at both the central and local government levels will be on the rise, posing threats to the stability of entire financial system.

China should draw lessons from the 2008 stimulus package of 4 trillion yuan (about $586 billion at the time).

Large countries mainly depend on domestic demand for economic growth. However, expanding domestic demand does not contradict full-scale opening-up to the outside world. Effective exploration of both domestic and international markets will enable China’s economy to truly achieve high-quality development.

Translated by Pan Che (chepan@caixin.com)