Reform and appropriate policies can support growth

Misperceptions about how economy is performing: growth and reform are not mutually exclusive

In the face of the tangible slowdown in national economic growth that began last year, it is necessary the government introduces some proactive fiscal and monetary policies to deal with looming deflation.

After fast growth for decades, the world's second-largest economy can accept its natural deceleration in a moderate manner, but when the growth is far below its potential, appropriate fiscal and monetary stimulation measures are needed. This requires correcting three misperceptions about the Chinese economy.

The first is to see the country's economic growth as the antithesis of its reforms: that the country must accept the inevitable slowing of economic growth as it advances needed reforms. However, the fact is almost all reforms can contribute to economic growth. For example, the substantial changes the country has made in the financial sector, which have basically created a market-based pricing regime for interest rates, removed entry barriers to the financial market, and introduced financial innovations, have spurred the development of high-tech enterprises.

Despite unavoidable short-term fluctuations, financial reforms are sure to more effectively bolster economic growth in the medium and long term.

Another example is reform of the hukou, or household registration system, which can not only raise the welfare of a large number of people, but also stimulate consumption and drive national economic growth. And a recent pricing reform program worked out by the State Council, if implemented in a comprehensive manner, will inject more vigor into the economy. Therefore, reforms propel growth rather than hinder it.

The second misperception about China's economy is that once the country adopts a proactive fiscal approach, it will return to an investment-dependent path as in the past. The reason for this misperception is that some confuse counter-cyclical fiscal measures with structural adjustments. It is known that the current proactive fiscal measures the government has embraced are counter-cyclical and temporary while structural adjustments are a long process that cannot be achieved overnight. China's savings rate, for instance, has dropped 4 percentage points over the past five years. Such a decline is rapid and we can expect a further decline.

Against the backdrop of its obvious economic slowdown, the implementation of proactive fiscal policies and increased investment will serve as the most direct means to push up the country's economic growth. Many believe that the efficiency of China's investment has been on the decrease and thus more investment is wasteful. Such an argument is essentially based on a wrong causal relationship. The declining rate of return on investment is a result rather than a cause of the decline in the economic growth rate. Capital is not fully utilized in economic downturn, so it is natural to find its returns decline.

A review of the past three decades shows the efficiency of investment is pro-cyclical. Any time economic growth is booming, the country's investment efficiency will rise; and vice versa. The current decline in investment efficiency is actually a byproduct of the country's economic downturn. And the use of a declining efficiency of investment to object to proactive fiscal policy is simply putting the cart before the horse.

The third misperception about China's economy is that monetary policy can be used to promote economic structural adjustments. Actually, the goal of a country's monetary policy is to keep its economic growth in line with its potential growth rate while keeping inflation down. In other words, monetary policy aims to iron out economic fluctuations. Given that, monetary policy has to be universal so it is applied equally to all sectors of the economy. Their use for economic structural adjustments will inevitably lead to economic distortion.

The author is head of the National School of Development, Peking University. The views do not necessarily reflect those of China Daily.

(China Daily Africa Weekly 11/13/2015 page12)