China’s soft budget constraint on the demand-side undermines its supply-side structural reforms


China’s growth rate has been declining every year since 2010, from 10.6% to 6.7% in 2016, and the IMF expects it to drop further, to 5.8% in 2021. Expert opinion on what to do has ranged widely. The optimists view cyclical factors to be the cause of the downturn, and suggest macro-stimulus as the cure. The pessimists identify supply-side distortions to be the cause, and recommends comprehensive structural reform. We argue that the existence of the soft-budget constraint guarantees the creation of excess capacity and zombie firms, and that the correct demand-side supplement to supply-side structural reform should be the termination of the soft-budget constraint and not the implementation of macro-stimulus. Correction of the distortion in the composition and size of investment will render the composition of output to match the composition of consumer demand, and put the economy on a sustainable growth path that is more consumption-oriented.

To see the full article, please visit here.


Related JCI Publications