Home> Research> CDI Opinions

What is Supply-Side Reform?

By Prof. FAN Gang

What is supply-side reform? To put it simply, the supply side is the opposite of the demand side. On the demand side, there are 3 stimulating forces of the economy, e.g., investment, consumption and export. These 3 forces determine the short-term economic growth rate. On the supply side there are 4 factors, e.g., the labor force, capital, technologies and regulations. In essence, it takes a long time to improve these 4 factors, which decide the long and mid-term potential growth rate.

In this sense, supply-side reform is a long-term issue which requires in-depth institutional planning and long-term adjustment. Reform is necessary whether or not the economy is good. However, the supply side also has short-term issues such as eliminating the supply surplus. Building a factory is a long-term issue because it only takes 3 years. However, that factory can be closed in an instant.

Quickly eliminating the supply surplus and helping to excise the excessive resources trapped inside it can improve the efficiency of resource use, enhance the quality of growth and promote economic growth, and this captures the essential meaning of supply-side structural reform. “Zombie companies” in some regions rely on subsidies from local governments and continue to waste resources, resulting in the decline of the whole industry's supply capacity. This is the practical meaning of supply-side reform now and in the near future.

For these reasons, supply-side structural reform focuses on the “elimination of excess capacity”. In a broad sense, this means de-stocking, de-leveraging and cost reduction. The capacity would not be released and the next round of growth would not happen if such measures were not taken. Although some doubt that the next round of growth will happen, this author firmly believes it. Sooner or later, the Chinese economy will escape its slow performance, abnormal state and deflation, and we will definitely see the results of this adjustment. If we accept the market economy, we have to accept the whole process of the economic cycle. I hope the next round of economic growth will not be too extreme and will maintain normal development. A 14% growth rate is much too high, and 7% is already a high growth rate.

This adjustment has an active meaning. When the economy is far too hot, the “survival of the fittest” seldom obtains because all enterprises have their orders. However, when the economy is in a downward trend, enterprises have to think about reducing costs, making innovations and improving efficiency. Enterprises that have focused on product innovation and the improvement of technologies in the past few years are presented with greater advantages when the economy is slow, and those enterprises that are not sufficiently professional and always think about speculations and consider business transitions find themselves in the position of possibly being eliminated, merged or regrouped. When good resources go to good enterprises, better benefits will be generated, and the form of direct financing will play a bigger role.

We must now be fully aware of the mistakes that can be made in undertaking supply-side reform. Some people misunderstand reform as adding new industries and new supplies, which might result in a new surplus when the original supply surplus has not yet been eliminated. In our future economic development, we should not use new supply growth to cover past problems.

(April 07,2016)