TOKYO -- A specter is haunting China -- the specter of Reagonomics. When given this little twist, the opening line of the Communist Manifesto quite aptly describes the economic policy being pursued by Beijing.
On March 5, Premier Li Keqiang delivered a policy address, called a "report on the work of the government," at the start of the annual National People's Congress. Halfway through, Li described the communist state's economic direction for 2017: "Structural reform on the supply side must be the major course. We must stimulate microeconomic agents by simplifying the government, cutting taxes, lowering entry barriers, encouraging innovation ... ."
If those words sound familiar, it is because they are exactly the kind of thing Ronald Reagan said while campaigning for the U.S. presidency in 1980s America on a promise to revive the economy through a business-boosting mix of tax cuts and deregulation. The measures espoused by Li mirrored -- to a surprising degree -- Reagan's supply-side economic policy, known as Reaganomics, laid out over three decades ago.
Bigger demand, bigger debt
The need for structural reform on the supply side was first mentioned by President Xi Jinping in November 2015, and Li included it in the 2016 government work report. This year, Li placed greater emphasis on the topic than last year, explaining it in detail. On the subject of deregulation, for instance, he said the government's discretionary powers will be reduced and licenses and permits will be reviewed. As for monopolies by state enterprises, Li said the government will try to foster competition, and specifically called out the electricity, oil and natural gas industries.
Li also broke down how the government intends to cut taxes. Under the current rules, small businesses that make up to 300,000 yuan ($43,470) in annual taxable income have their corporate taxes cut by half. Li said the upper limit will be raised to 500,000 yuan. Also, small and midsize science and technology companies will receive an additional 75% tax deduction, instead of 50% under the current rules, on their research and development investment. Overall, the changes will save companies about 350 billion yuan in tax payments. The government also plans to abolish or suspend 35 administrative charges for companies at the central government level, and would reduce various de facto tax payments by about 200 billion yuan.
Li promised to support fledgling industries such as new materials, artificial intelligence, integrated circuits, biomedicine and 5G mobile networks. Peppering his speech with new expressions such as "digital homes," the premier also talked about plans to grow the online and consumer services industries. The idea apparently is to spur the kind of startup boom that began in the U.S. in the 1980s thanks to deregulation. "A path will not open unless we rely on reform and innovation," intoned Li.
Ever since the Communist Party of China shifted to a market economy under the "reform and opening-up" initiative, the country has incorporated Western economic principles into its policies. That means despite differences in political systems, the economic phenomena occurring in China are similar to those observed in the West. Reaganomics and Li's proposed supply-side structural reforms are similar in that both came about in reaction to Keynesian economic policy: In the U.S., such policy, which had been in place before the '80s, expanded demand and resulted in a bloated government along with a fiscal deficit and increased tax burdens; China, after two decades of growing demand, is now struggling with mountains of debt.
It started with the Asian financial crisis of 1997. Zhu Rongji, who became premier the following year, weathered the storm by increasing government debt issuance to finance more public works projects. Zhu's successor, Wen Jiabao, continued on this typical Keynesian path to boost demand -- but in a distorted manner.
In 2008, China tried to cope with the effects of the global financial crisis by boosting public investment. This time, local governments, their affiliated companies and state companies borrowed repeatedly to finance construction projects of every kind, giving little thought to how much debt they were accumulating.
Debt held by the government and households as a share of gross domestic product remains relatively low, at just under 50% and around 40%, respectively. However, the ratio for companies stands at around 170%. In total, China's debt-to-GDP ratio is estimated to be somewhere between 250% and 300%.
Though that figure pales in comparison with the roughly 450% for debt-ridden Japan, it is hardly negligible. China's leadership probably realized that the country cannot continue growing with a demand-boosting policy driven by debt-financed investment. Hence the shift in its long-term strategy from the demand side to the supply side.
Enemies of reform
Another important parallel between Reaganomics and China's latest economic policy is an increase in military spending. While Reagan did not expand government spending, he made military expenses an exception. As the U.S. bolstered its military might, the Soviet Union grew weary and eventually collapsed. China today is also spending more on its military -- to a significant degree. This year, it plans to increase military outlays by 7%, or over 1 trillion yuan, while holding increases in other areas, such as railways and other infrastructure, to relatively moderate levels. As far as the military is concerned, China appears determined to keep its hard-line stance toward the U.S., not wanting to back down even a bit.
However, Beijing's proposed supply-side structural reforms have a crucial weakness. The country's political power structure has been underpinned by the meddling in and control of every corner of the economy by the Communist Party and the government, which ultimately benefits party members. If China further relaxes regulations and becomes more of a market economy, those at the bottom of the party's pecking order will be stripped of their special interests, undermining the party's power base. To avoid such a scenario, those in the party who want to cling to their vested interests and maintain the party's political standing will probably try to emasculate the reforms.
The more China tries to maintain political stability, the more its supply-side reforms struggle to make progress. The great irony of a country run by a Communist Party pushing for a small government that counts on private-sector vigor will continue to be a fascinating spectacle.
