Zheng Yongnian breaks down China's path to economic revival (Part II)
Rule of law, fiscal & financial power, and a deregulation push to transform China's economy
Today’s newsletter brings you the second part of Zheng Yongnian’s opinion on China’s economic revival. The first part is available below.
IV. Clarifying the logic of the "Three Policies"
The "Three Policies" - monetary, fiscal, and deregulation - are tools and methods for addressing the question of "how to drive development."
Monetary and fiscal policies are unlikely to be overlooked, as both are the most widely used tools for adjusting economic activities worldwide. In China’s current economic context, these policies have primarily focused on addressing existing problems. The primary goal of monetary policy is to stimulate economic momentum among actors - whether individuals or institutions (often described by Ray Dalio as the "animal spirit"). For instance, quantitative easing can be deployed to "unclog" economic transactions, resolving challenges like "triangle debt." Meanwhile, fiscal policy offers relief for local government debt, reducing their financial burdens and enabling a fresh start. Additionally, fiscal measures ensure that local governments continue providing essential public services, thereby maintaining social stability.
Among the "Three Policies," deregulation is often overlooked. In reality, regardless of how robust monetary and fiscal policies may be, if economic actors remain "tied down," it will be challenging to achieve substantial outcomes. Currently, monetary policy has primarily unlocked the potential of individuals (notably retail investors), while the debt-relief effects of fiscal policy on local governments have yet to be fully realized. However, the "untying" of enterprises and local governments - the two most important economic actors - has not yet begun. Without "untying" these actors, it is difficult to establish a transmission mechanism between them and actual economic activities. In other words, for monetary and fiscal policies to drive real economic growth, these actors must channel the energy of these policies into the real economy. Genuine growth will occur only when the real economy recovers; otherwise, monetary and fiscal policies risk fueling asset bubbles or creating superficial prosperity.
Therefore, both in theory and practice, it is essential to clarify the relationship and logic between monetary, fiscal, and deregulation policies. Without this clarity, an accommodative monetary policy and proactive fiscal policy could lead to unintended or even counterproductive results. In monetary policy, injecting large amounts of capital is like raising the level of a river: the waters rise, spilling over into smaller streams. However, without stable embankments, once the dikes are breached, not only will the river water escape, but the waters from these smaller streams will also drain away. This, inevitably, leads to the very “cutting of leeks” that people fear — a scenario where investors face substantial losses. China’s financial market is still in its early stages, with regulatory systems and mechanisms yet to be fully developed, and much experience still to be gained. Given the complexity of the financial system, sound financial operations require a deep understanding and carefully crafted strategies. Fiscal policy operates in a similar way. Merely reducing burdens on local governments can be seen as a passive approach to fiscal policy. A truly proactive fiscal policy, however, must drive economic growth. When fiscal policies are primarily focused on alleviating local government burdens or sustaining public services, they risk fueling “policy rent-seeking” behaviors, deepening local dependence on central support. The real strength of fiscal policy lies in its tangible contributions to economic growth. Ultimately, the core challenge is how to foster genuine growth in the real economy.
The core of the economy is development, and the core of development is growth.
While economics and broader economic theories may seem complex, they can essentially be boiled down to a single concept: "development." Achieving development requires certain conditions, known as factors要素, which must be efficiently allocated - a task that falls to either the market or the government. Development yields outcomes; some, like wealth creation, help lift society out of poverty, while others, such as social divides caused by significant income inequality, can hinder economic sustainability, thus requiring government intervention.
The concept of "development" is a modern one. In traditional societies, many civilizations had the idea of "economic management," but the notion of "economic development" did not exist. This concept emerged during the European Enlightenment when humanity realized that rationality could be harnessed to achieve a better life. For thousands of years, productivity in traditional agrarian societies was low, and people lived in a "subsistence economy." However, the introduction of the concept of "development" changed how people viewed economic life. From that point on, the pursuit of wealth through the efficient combination of various factors became the central focus of economic activity.
In modern times, the concept of "development" was introduced to China. China’s defeat by Western imperialism was fundamentally due to its "backwardness" and "lack of development," captured in the idea that "backwardness proves vulnerable to attack." Sun Yat-sen’s "Three Principles of the People," particularly the "the livelihood of the people," is seen as one of the earliest foundations of modern development economics in China.
Deng Xiaoping's theory did not present complex economic theories, but instead focused on the core of economic theory: "development." This led Deng to propose the idea that "development is the absolute principle." From Deng Xiaoping's "development is the absolute principle" to today's emphasis on "high-quality development is the absolute principle", there has been a consistent guiding principle.
Many of today's "economic phenomena" or "economic problems" that China faces are related to insufficient development, or are the inevitable consequences of insufficient development. At its core, the key to all economies is "development" - the bedrock of economics. When the economy grows, challenges become easier to address; when growth stalls, solutions become elusive. Since the reform and opening-up, China’s greatest success has been reframing all issues as development challenges. These "problems in development" suggest that instead of addressing economic issues in isolation, growth itself absorbs and resolves many of the challenges it produces. Empirically, while some issues can be consciously tackled, this often leads to new problems. Ideally, development should naturally resolve these challenges over time. From this perspective, although there has been more discussion on "distribution" in recent years, the goal is still "development." For example, the core of the debate on the policy of "three distributions" is how to create a more equitable and just society, thus providing a favorable social environment for sustainable economic development. Similarly, the central-local fiscal relationship debate revolves around how to empower local governments to pursue regional development.
From the perspective of development, it is not difficult to understand the problems facing China’s economy today, nor is it hard to identify new drivers of growth. When we emphasize that reform and opening-up is the "top priority," we mean creating an environment and conditions for development through reform and opening-up. One could even say that "internal reform and external opening" is, in itself, development.
V. How can "growth" lead to "development"?
So, how can growth lead to development? Several issues need to be discussed: Where does growth occur? Where are the new areas for growth? Who will drive this growth? And which economic actors will be most effective in achieving growth?
The traditional growth engines - investment, consumption, and trade (often called the "three drivers") - are now either quite limited or increasingly saturated. Today, many sectors of the economy show signs of intense "involution," even in newly emerging fields like renewable energy, making sustainable growth challenging. In this context, establishing new growth areas is essential. For both state-owned enterprises (SOEs) and private businesses, expanding these new growth spaces involves addressing two critical issues.
1. The Relationship Between State-Owned Enterprises and Private Enterprises
This is a longstanding issue, dating back at least to the Han Dynasty (202 BC-AD 220). In recent years, with the rapid rise of state-owned capital (whether central SOEs or local state-owned capital), state capital has had a profound impact on private enterprises. Some foreign observers believe that China’s national economic structure is currently undergoing a "silent revolution," characterized by the large-scale expansion of state-owned capital and the shrinking of the private sector. While similar phenomena have occurred before, private enterprises typically voiced their concerns. This time, however, it seems to be happening "silently." In some regions, private enterprises are not only refraining from complaining but are even welcoming the expansion of state capital. This phenomenon requires careful study. In today's environment, the expansion of state-owned capital is inevitable. Trade tensions and geopolitical factors have led to a decrease in foreign investment, and many private investors, facing an uncertain environment, are taking a more passive stance. Some struggling private enterprises are even seeking support from state capital, with some going as far as transferring their businesses to SOEs. Under these conditions, the growth of state-owned capital may be both necessary and unavoidable. However, in the long run, this trend is concerning.
The "56789" figures are often used to describe China’s private economy: private enterprises contribute more than 50% of tax revenue, over 60% of GDP, more than 70% of technological innovation, over 80% of urban employment, and more than 90% of the total number of enterprises. These numbers highlight the critical importance of the private sector. However, if this "silent revolution" continues, it won’t be long before there is an imbalance between SOEs and private enterprises. Recently, despite emphasis from both the central and local governments on the importance of private capital, the trend of state capital gaining momentum while private capital stagnates - or even "lies flat" - continues. For example, from January to July of this year, state investment grew by 6.3%, while private investment showed no growth.
In the long term, an imbalanced national economic structure will not only severely constrain sustainable economic development but will also affect China’s international environment. From the perspective of domestic development, a shrinking private sector is undoubtedly bad news. People should not forget the economic lessons of the planned economy era. The inactivity of private capital could even affect China's relationship with the global economy. Externally, China’s economic conncections with the world are primarily driven by the private sector. If the private sector shrinks, China’s integration into the global economy will inevitably weaken. In an increasingly ideologically driven international society, state capital's attempts to "go global" will become increasingly challenging.
2. New Economic Spaces
This issue is even more crucial and fundamental. In the past, the large real estate market and infrastructure development served as the most effective conduits for monetary and fiscal policies, driving high growth. However, the situation has changed today - there is limited room for growth in both real estate and infrastructure. Therefore, new economic activities must take on the role of conduits, transforming monetary and fiscal policies into real drivers of growth. In this regard, there is tremendous potential.
China is the only country in the world that possesses all the industrial categories listed under the United Nations' International Standard Industrial Classification (ISIC), but this does not mean that we are the most comprehensive economy in terms of economic activities. In almost every industrial category, there are still significant opportunities for untapped economic development. Recently, both the Pearl River Delta and the Yangtze River Delta have seen a substantial push to develop the "low-altitude economy," with many optimistic about its potential to stimulate broader economic growth. However, the low-altitude economy is not a new concept; it has long existed elsewhere, but was previously restricted by government policies in China. Similar to the low-altitude economy, there are nearly limitless opportunities for new economic spaces. For instance, private boating has yet to develop in China. In all the economies that have evolved from the Mediterranean civilization, private boats are common in coastal regions. In Asia, countries and regions such as Japan, South Korea, Singapore, and Hong Kong, China also have a significant number of families owning private boats. By comparison, China has an extensive coastline, yet private boats are rare, which not only wastes valuable marine resources but also fails to foster a maritime culture among its citizens. If the government were to permit the development of private boating, its contribution to economic growth could far surpass that of the "low-altitude economy." Moreover, China’s shipbuilding industry is among the world’s best, so the technology to build private boats would not be an issue.
(Personally I assume the example of private boats doesn't hold up well in this context — Yuzhe)
When it comes to new economic spaces today, many areas of economic activity are unable to take off due to a lack of institutional reforms. The much-discussed "new quality productivity forces" is undoubtedly the foundation for sustainable, high-quality development. While fostering the growth of new quality productivity forces is crucial, it is even more important to consider how to transform the emerging productivity forces into actual economic activities. Enditem
The newsletter is written by Yuzhe He, the founder of Gen-Z Glimpse. The personal newsletter solely reflects his perspectives, NOT those of others.
Errors may occasionally occur. If you spot any errors or have feedback, please don’t hesitate to respond or send your comments to Yuzhehere # hotmail DOT com.