CAI FANG. A trade war will only hasten China’s structural reforms (East Asia Forum)

Jul 10, 2019

On 22 March 2018, the United States, invoking Section 301 of the Trade Act, increased tariffs on imported goods from China. Since then, the trade war has severely harmed both the Chinese and US economies. Yet despite 11 rounds of high-level negotiations between the two sides, the Trump administration has continued to escalate the trade conflict. The result has been an increase in tariffs on Chinese imports from 10 per cent to 25 per cent on 10 May 2019. China certainly did not want a trade war, it was launched unilaterally by the United States. But China was prepared for its escalation.

Early in 2019, President Xi Jinping talked to Chinese policymakers about carefully addressing major risks in the Chinese economy. Although he did not directly name the China–US trade dispute, the risks that he mentioned logically included its potentially damaging effects. President Xi cited two well known metaphors: the black swan for highly improbable but neglected events and the grey rhino for seemingly obvious yet poorly handled events. The trade war and its escalation have had elements of both.

What has happened in trade relations between the two countries is not going to alter the course of Chinese policymakers, and there is no reason to expect a holding back or reversal of China’s reform agenda. As the escalation of the trade war is expected to negatively impact growth, the sense of urgency to carry out reforms will only intensify. Experience over the past 40 years has assured Chinese policymakers that reform and opening-up deliver immediate gains for growth.

In recent years, the government has implemented reforms aimed at streamlining administration, delegating powers and improving government services, all of which have significantly helped increase the potential growth rate.

Simultaneously, policy makers have become more and more aware of the diminishing benefit from stimulus measures on growth. Understanding the supply-side component of the growth slowdown, the Chinese government has been determined not to rely on stimulus measures to lift the actual growth rate above the potential growth rate.

A major concern is the disappearance of the demographic dividend, which fuelled China’s rapid growth over the 30-year period before 2010. The negative growth in China’s working age population has led to labour shortages, slower improvements in human capital, diminishing returns to capital and narrowed room for resource reallocation efficiency. As a result, China’s actual growth rate has been decreasing since 2012.

In lieu of stimulus measures, the government has tried to increase the potential growth rate itself by carrying out supply-side structural reforms aimed at increasing labour supply and improving productivity.

As the trade conflict between China and the United States deepens, reform measures have been deployed in areas where the reform dividends are expected to be big. The reform of the household registration (hukou) system is an example. Hukou reform could significantly enhance the economy’s potential growth rate by transforming migrant workers from guest labourers into legitimate residents in cities, thereby increasing labour supply and improving the efficiency of resource reallocation.

But though this reform has attracted broad consensus and has long been on the central government agenda, progress was delayed until 15 April 2019 when the Central Committee and the State Council released guidelines to promote integrated urban–rural development. The guidelines laid down a deadline for the long-scheduled hukou reform by announcing that restrictions on rural-to-urban settlement will be gradually eliminated by 2022.

There may be questions about other supply-side structural reforms that could be delayed, including those centering on de-leveraging, reducing overcapacity, lessening burdens on enterprises and clearing up zombie firms. These reforms may be put on hold as policymakers prioritise coping with demand-side shocks that could result from setbacks in China–US trade talks. Organising the reform agenda is the key to solving all of these problems and overcoming any difficulties.

From 2019, the supply-side structural reform agenda has been updated along four dimensions: consolidatingachievements made so far in priority structural reform areas, strengthening the dynamism of micro-entities in the market, upgrading industrial chains and ensuring unimpeded flows in the economy.

All these priorities aim to move the Chinese economy from high-speed growth towards high-quality development. The escalating trade war between China and the United States will only accelerate the pace of China’s structural reform, not reverse it.

Cai Fang is Vice President at the Chinese Academy of Social Sciences, Beijing.

Thisarticle was published by East Asia Forum

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