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Economic Adjustments Needed for Fast Growth

China will soon enter its 11th Five-Year Plan period (2006-10). Abrupt changes in the macroeconomic environment in the middle of previous such periods have prompted adjustments to economic policies.


In 1996, during the Ninth Five-Year Plan period (1996-2000), the Chinese economy successfully managed a soft landing. Fast growth momentum was expected to resume afterwards. But the sudden impact of the 1997 Asian financial crisis coupled with stagnant domestic demand drove China's economy backwards. It suffered, for the first time, a serious deflation in the middle of that period.


As a result, macroeconomic policy had to shift from being moderately tight, as decided at the start of that period, to being expansionary. The pro-active and unprecedented macro economic policy was put forward to ease deflation, and monetary policy was also made much less stringent.


The 10th Five-Year Plan period (2001-05) has witnessed similar drama. The target for gross domestic product growth was 7 to 8 percent year on year, which was largely growth-oriented although adjustment and restructuring were anticipated.


But in 2003 and 2004, a new round of accelerated economic growth led to overheating in some sectors and regions. Shortages of fuel and electricity, and limitations of transportation networks, posed fresh problems.


Against this backdrop, macroeconomic and monetary policies began to shift from being expansionary, as had been determined, to being more moderate.


Both policy changes were unexpected. They show macroeconomic policy-making needs to be more predictive. On the other hand, this is a sign of the increasing complexity of the macroeconomic environment.


As China remains a transitional economy, charting a macroeconomic path is very challenging.


The start of the coming 2006-10 period may become, as history shows, a time of adjustment and preparation for accelerated growth in the following years. Since the late 1970s, the first year of each five-year period except for the Ninth Five-Year Plan timeframe has been one of adjustment before the economy is let loose on the fast track.


China's new economic situation indicates that next year good preparations for rapid economic growth in the following four years will be made.


Driven by fast-paced urbanization and income growth, the new housing and transportation-based consumption boom is expected to continue, acting as a strong engine behind overall economic growth.


National economic policy still holds economic growth as a major challenge for the new period while social stability, harmony and sustainable development have also been emphasized. Macroeconomic policy will remain relatively active.


Economic adjustments this year and next will naturally dampen investment in some sectors. But the economic cooling-off will make it easier for the national economy to resume its fast growth momentum after 2007.


But despite the bright growth prospects, policy botches or changes in the economic environment could make 2006 the start of a downturn.


In other words, it is still possible that the economy will slow down from the middle of the next five-year plan period.


The main challenges facing policy-makers over the next five years are oversupply and insufficient effective domestic demand. As overall supply continues to exceed demand, deflation may come back to haunt the economy.


The main reason for oversupply is strong investment across the country. Backed up by technological advancement and abundant capital, investment may continue to grow and translate into excessive production in the early years of the next five-year plan period.


Meanwhile, slow growth in consumption puts the economy out of balance. Consumption is restrained by many factors, including insufficient employment and the widening income gaps between regions and among the urban population.


If current investment growth momentum is not held back, the production-demand imbalance will only worsen in the coming years, leading to an economic slowdown in the middle of the next five-year period.


Economic regulation should be applied to both supply and demand to prevent that worst-case scenario from being realized.


Unlike the pro-active policies that have been in place since the late 1990s, policies in the next five years to stimulate domestic demand may not depend on issuing more treasury bonds, but shift to tax cuts to release consumption potential.


Regarding investment, emphasis will be put on improving investment structure, not increasing the volume of investment as in the past.


Taxation reform should be continued to ease tax burdens on individuals and enterprises.


The creation of jobs will play an effective role in expanding domestic demand. More flexible and favorable employment policies would help release public purchasing power.


Growth of house prices should be kept at a reasonable level while consumption of cars should be encouraged. In particular, the consumption taxes on compact cars must be cut and discriminatory policies targeting such vehicles must be scrapped to revitalize consumption.


In the mean time, the supply of inexpensive housing should be increased to expand demand from low-income earners.


A long-time but still important matter is the reform of the split residence system between urban and rural areas. If more rural residents could become permanent urban residents, their released purchasing power would widen the consumption base for the economy to draw on.


Last but not least, China must continue to uphold the policy of stabilizing grain prices to increase the income of farmers.


The State should help farmers improve the structure of the agricultural sector to make their produce cater better to market demand, which would bring them more income.


If grain prices can run at a stable level in the medium and long term, farmers will be better off, which would enable them to consume more and provide funding for the transfer of redundant rural labourers to the cities.


The author is a researcher at the Institute of Macroeconomic Research under the National Development and Reform Commission.


(China Daily December 6, 2005)


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