Lu Feng: The imbalance of "strong supply and weak demand" is still the main contradiction in macroeconomic operation, and targeted structural reforms need to be promoted.

In an exclusive interview with Red Star Capital Bureau, Lu Feng, an economist and professor at the National School of Development at Peking University, suggested that a combination of policies be implemented to make various market entities “visible and tangible” to boost confidence and thereby significantly improve the problem of insufficient demand. “It is necessary and possible to promote China’s economic development through structural reforms focusing on the institutional and systemic levels.” Regarding boosting the private economy, Lu Feng suggested that enterprises should play a role as the main drivers of innovation, with private enterprises still taking the lead. He also emphasized that important regulatory measures must be legal and transparent to stabilize the expectations of market entities. Addressing "insufficient demand" will also help resolve "overcapacity,” and targeted structural reforms need to be promoted. Red Star Capital Bureau: What do you think of the current performance of the traditional troika (consumption, investment, and exports)? Lu Feng: Judging from the first three quarters of last year, the overall year-on-year growth of the troika was relatively fast, and the recovery in the first year after the domestic epidemic was quite apparent. Preliminary estimates indicate that the actual growth rate of consumption may be around 7%, and the actual growth rate of investment may be close to 6%. The export growth rate has indeed dropped, and the role of external demand in economic growth has been negative. As a result, our GDP in the first three quarters was 5.2%. However, these data are also due to the low base of the previous year. Overall, the economic growth rate is still low. A significant issue in the current economic situation is that aggregate demand remains weak. The Central Economic Work Conference also recently mentioned that "mainly effective insufficient demand" is the main contradiction in macroeconomic operation. In general, the vitality of my country's economic supply suggests that China has bright prospects for catching up with the United States in the long term. However, continued weak demand has become a constraint, which is a very real problem. To solve this problem, we need to increase the intensity of active macro-control and promote structural reforms, continuing to seek truth from facts and pool wisdom. Macroeconomic control policies need to be appropriately strengthened, and implementation strategies need to be adjusted based on experience. As for the most important monetary and fiscal policies, in response to the weak overall demand situation, monetary policy needs to moderately increase the amount of active adjustment and make full use of aggregate and price instruments, especially interest rate tools. In terms of fiscal policy, the central government has been emphasizing in the past two years the need to "appropriately increase efforts and improve quality and efficiency." In my opinion, "appropriate increase in efforts" means increasing the total amount, and "improving quality and efficiency" means a reasonable structure. Although the fiscal deficit ratio and debt ratio have increased in recent years, our debt ratio is still relatively low among large countries, and the debt risk is within a controllable range, providing good policy space. Therefore, the overall intensity of fiscal policy needs to be increased, providing more structural support to areas significantly affected by the epidemic, such as the household sector. Red Star Capital Bureau: For some time, some industries have been discussing "overcapacity." How can this problem be alleviated? Lu Feng: Production capacity is supply capacity, so in terms of supply and demand, "overcapacity" and "insufficient demand" generally mean the same thing. Only when supply exceeds demand will there be overcapacity. Therefore, resolving the problem of overcapacity is addressing the issue of insufficient demand. However, due to the different technical possibilities for quantifying production in different industries, the overcapacity discussed in reality sometimes refers to excess production capacity or insufficient demand in manufacturing and industry. For example, Xinsanxiang faces a situation of "overcapacity." Its impressive export performance puts pressure on local industries, leading them to resort to trade disputes to protect their interests. After the U.S. economy declines and inflation falls in 2024, similar actions may occur. Strong exports mean we have strong competitiveness and supply, but it also indicates varying degrees of weak domestic demand. As a country with rapid industrial upgrading, China will inevitably face the problem of structural overcapacity. However, from the perspective of overall supply and demand, it is possible and necessary to boost demand through policy intervention, thereby alleviating the problems of weak demand and overcapacity. In such a market environment, once China's industry takes off, it will be very complex. The downside is high competition pressure, but the upside is reduced costs, leading to significant changes globally. This competitiveness is advantageous for China, but it may cause tension in foreign economic and trade relations. Last year, we discussed these issues with relevant parties in the United States. They mentioned "small courtyards and high walls" to restrict China, with new energy being one of the areas of concern. The United States is conflicted about China's investment in the country, fearing that not letting China in will inhibit the development of its new energy industry. This highlights that the U.S. suppression of China in the high-tech field may bring short-term difficulties to China but cannot prevent China from maintaining an open pattern and catching up through its own efforts. There are institutional reasons for weak demand and low prosperity. With visible and tangible policy packages, I believe confidence in China's economic development will increase significantly, improving the problem of insufficient demand. Opportunities still exist to promote China's economic development through structural reforms. Recently, academic circles have discussed possible options: accelerating the deregulation of household registration, increasing the transformation and support of public finance, providing equal treatment to new residents, treating private and state-owned enterprises equally, fully implementing competitive neutrality principles, and allowing private enterprises to receive the same treatment as state-owned enterprises in terms of laws and policies. Regulatory measures need to pay more attention to the rule of law and transparency. Red Star Capital Bureau: Do you think our domestic demand potential has been fully tapped, and what is left to be released? Where exactly is China’s consumption growth? Lu Feng: From an economic perspective, consumption is mainly determined by factors such as income and expectations. In recent years, affected by the impact of the epidemic and other factors, residents' income growth has been low. For example, in 2022, the actual growth rate of my country's residents' income was only 2.9%. The confidence and expectations of market entities during the epidemic are still recovering. Expanding domestic demand involves both investment and consumption. Last year, investment in manufacturing and infrastructure grew relatively quickly, while real estate investment showed significant negative growth. This reflects the "strong supply and weak demand" we mentioned earlier. Manufacturing and infrastructure investment are strong, increasing supply capacity, while weak real estate investment illustrates less active consumer demand for housing. Expanding domestic demand has been a key policy for us for a long time, but the extent of domestic demand depends on several key factors. From 2018 to now, we have been emphasizing downward pressure on the economy and insufficient effective demand. There are many reasons behind this, some short-term, such as macro-control during the epidemic. We focused on the supply side, with tax cuts and fee reductions providing many subsidies, which makes sense; but on the consumer side, direct subsidies were relatively small. Although the epidemic has passed, many of its impacts will not disappear immediately. The long-term impact on economic operation will take time to repair, and the "scarring effect" will continue to affect income growth and confidence recovery. Additionally, regulatory policies in recent years, while necessary for high-quality development, have had some impact on demand. Changes in the external environment will also have an impact. As these factors improve, demand may gradually increase. Recent policy adjustments are moving in this direction, but solving the problem will take time. Red Star Capital Bureau: For some time, our country has introduced many measures for the private economy. Do you think they can effectively stimulate the "entrepreneurial spirit"? In what other aspects do we need to boost entrepreneurs’ expectations? Lu Feng: Marginal effects can be improved. Current policy guidelines emphasize equal treatment for all enterprises. Adjustments and repairs to some policies are producing marginal positive effects, but it may take time to see a complete change. To improve, important regulatory measures must be legalized and transparent to stabilize market entities' expectations. We must be determined to improve our country's socialist market economic system through "systematic, holistic, and coordinated" reform breakthroughs. From the perspective of "potential growth rate dependent on reform," several rises in economic growth in the past were inseparable from emancipating the mind and reform breakthroughs. Deepening reforms is still essential to fully unleash growth potential. It is necessary to comprehensively implement market-oriented reforms, significantly reduce the direct allocation of resources by the government, and promote resource allocation based on market rules, market prices, and market competition to maximize benefits and optimize efficiency. Efforts must be accelerated to address the "problems of an imperfect market system, excessive government intervention, and inadequate supervision." Supervision of industry departments needs to be improved and strengthened according to high-quality economic development needs. It is important to advance orderly based on legal principles and procedures, coordinating regulatory dynamics to strengthen the relationship between improvement, development expectations, and stability. In areas where the supply side performs well, state-owned enterprises are already very strong, but private enterprises are leading the way in most cases. Innovations in areas like new energy initially developed abroad and were later adopted and improved by us. Enterprises must play their role as the main drivers of innovation, with private enterprises taking the lead. We must emancipate our minds and dare to make breakthroughs. Many outstanding private enterprises in China have experienced baptism, laying the foundation for the open economy to catch up beyond expectations. Red Star Capital Bureau: The service industry has played an increasing role in driving the economy in recent years. Do you think there is still room for us to develop in the service industry? Is the breakthrough point for our economic growth the service industry or the manufacturing industry? How do we view the role and relationship between the two? Lu Feng: The service industry will definitely be an important engine for future modern economic development. Although China's service industry has already improved significantly, its proportion still needs to increase to develop into a modern moderately developed country. Growth points in the service industry depend on consumer needs, such as education, healthcare, elderly care, and tourism. The manufacturing industry also needs to develop, but as output increases and production efficiency improves, its proportion of GDP will generally stop rising after reaching a peak. In 2022, the added value of China's manufacturing industry accounted for 27.7% of GDP. It is difficult to make a significant rise after that, as efficiency improves quickly and the overall output ratio decreases. The service industry's proportion of GDP will increase during development. People's demand for manufactured goods is limited, and income demand elasticity is relatively low. The proportion of manufacturing may decline, and its contribution to employment will also be limited. Consumers will spend more of their income in the service industry, a common rule in developed countries. Red Star Capital Bureau: According to the latest OECD forecast, global economic growth will slow to 2.7% in 2024, making it the lowest global economic growth year since 2020. What difficulties and challenges do you think our economy will face in 2024? Lu Feng: The economic recovery post-epidemic will be in two steps: first, economic growth will recover to a level consistent with pre-epidemic levels, and second, the economic aggregate will return to the pre-epidemic trend line level. From this perspective, 2023 marks the first step in our recovery, expected to continue into 2024. Demand-side policies need a more powerful configuration, and the Central Economic Work Conference mentioned strengthening macro policies in 2024, including monetary and fiscal policies. There are uncertainties in the external environment. The recent stabilization of Sino-US relations is positively significant for the Chinese economy. However, the 2024 US election and future developments bring uncertainty. The global economy's weakness in 2024 will impact China's economic growth from a trade perspective, with falling external demand needing attention but being relatively controllable for China. The most important factor is domestic policy. We believe that a relatively loose regulatory environment will likely continue in 2024, benefiting short-term Chinese economic growth. There will also be positive increases in macroeconomic policies on the margins. If there is a major breakthrough in deepening reforms, China's economic growth prospects remain very encouraging. Source: Red Star News