Ensuring the Quality of Economic Growth

A quick implementation of supply-side reforms would provide the necessary institutional and policy environment for China to shift from the rapid growth of the past to medium-speed expansion with a greater focus on the quality of its development. The main area of these supply-side reforms lies in applying market-based principles that can more efficiently channel resources and improve factor productivity.

China has seen important changes in its economic structure and growth momentum since it entered the period that is commonly referred to as a "new normal." There has been much discussion of whether China's economy will have a so-called hard landing and sink into the "middle income trap" as its growth rate continues a decline that has already lasted six years. What are the prospects for growth in the short-term and over the long-term? An analysis with a long-term framework - and benefiting from international comparisons - would help guide us in addressing these questions.

China will not fall into the Latin American style middle income trap. Since the end of World War II,dozens of economies have become industrialized,but their success in development has been limited. Among these industrialized states,only thirteen graduated to high-income societies. Two different types of declines in economic growth can be observed.

The first kind is the decline that occurred after average per capita income reached less than 7,000 international currency units (an average unit for purchasing power comparisons) just after a period of high-speed growth. In these cases,the economy sank into stagnation and in some cases slipped backwards. These economies generally relied on import substitution as their strategy to curb market development,resulting in heavy foreign borrowings and a serious polarization of society. Some countries were swept up in waves of nationalism and were unable to pay for their high welfare costs. This ultimately put a halt to high growth and led to a slide into the middle income trap. Some Latin-American countries were typical of this kind of stagnation.

The second kind experienced a longer period of high growth but then declined once average per capita income reached 11,000 international units. The high-speed growth rate turned into medium speed growth once the society reached a high-income level. This was true of Japan,South Korea,China's Taiwan,China's Hong Hong,and Singapore. These economies enjoyed relatively sound market fundamentals,with strong development-oriented governments and export-oriented developmental strategies,which resulted in relatively competitive industries.

In China,the reform and opening up program set the stage for more than 30 years of high-speed growth. The nation's growth model and growth path has been quite similar to those of the second group of East Asian economies. In recent years,China's economy entered a "new normal" phase of slower growth. From the point of the historical process of industrialization,China is deemed to have successfully exploited its high industrial growth potential. At this juncture,the economic environment faces important changes,including the slow transformation of the nation's agricultural labor force into a non-agricultural labor force,a decline in the size of the overall work force,rising factor prices,and a peaking of demand for major industrial products,among others. Thus,high speed economic growth has given way to medium-speed growth.

Over the longer term,it is unlikely that China will follow the Latin-American economies and find itself stuck in the middle income trap. China's economy faces many difficulties,risks and challenges but the nation is enjoying a much higher degree of development compared to those same Latin-American economies when they fell into that kind of stagnation. If China avoids policy mistakes,it can successfully make the transformation to a high income society.

Medium-Speed Growth

The transformation of China's economy from high-speed growth to medium-speed growth is a process of structural change and balance. On the demand side,high-speed growth stemmed from high levels of investment,but investment probably bottomed out after exports,infrastructure and the property sector all underwent significant adjustments. On the supply side,some sectors - such as chemicals and heavy industry - experienced serious overcapacity. This led to negative growth in factory prices for nearly 50 consecutive months and a decline in profits at big industrial companies for more than a year. If overcapacity could be dealt with properly,prices of industrial goods and revenures of industrial companies would bounce back quickly and there would be an adjustment in the balance of supply and demand. It is expected that,with the help of supply-side reforms,China's economy should successfully touch bottom in one or two years,and then enter a sustainable,medium-speed growth phase featuring higher levels of creativity.

Currently,China's average per capita GDP is about US$8,000 -- still far behind the US$40,000 to US$50,000 of developed countries. During the high-speed growth phase,the focus was on production quantity but that is now shifting to a pursuit of quality growth. In this phase of development,there is a greater emphasis on innovation. Since China is still trying to catch up with other economies,it is important to learn from predecessors and absorb the knowledge they acquired. This requires changes in our developmental conditions as well as our institutions and policy-making environment. Therefore,several questions need to be addressed:

First,it is important to rectify the misallocation of resources. At the moment,there are still obvious discrepancies in industrial productivity,and this stems from inefficient use of resources dispatch,partly as a result of administrative monopolies and the structure of our resource pricing system. The deepening of reforms could help rectify problms with the use of resources,which would allow the exploitation of substantial demand constrained by the "old economy." This would help create more efficient investment as well as boost productivity,increase revenue and address potential risk. This could reduce costs through supply-side reforms.

Second,it is