Why (Officially) Communist China Is Looking for Answers in Reaganomics

You’ve got to give the communist party of china an A for effort. As part of a new rollout of reforms designed to bolster falling growth, the party PR team has launched a rap song that puts policy to a backbeat. “Reform the supply side, upgrade the economy,” it runs. Maybe it loses something in translation, but the real question is whether it makes any economic sense. “Supply side” economics, a term most associated with the tax cuts and deregulation of the Reagan years in the U.S., seems an unlikely reform slogan for China’s state-led economy. After all, the Reagan revolution represented the kind of naked free-marketism that Karl Marx bemoaned and the Chinese revolution once claimed it would obstruct.

But a species of supply-side economics is what’s being pushed at the National People’s Congress in Beijing as leaders acknowledge the existence of “zombie firms” that may require “bankruptcy liquidations.” Translation: policymakers are talking about the fact that large swaths of China’s economy are in trouble, and more than a trillion dollars of government stimulus has done nothing to offset the fact.

Can supply-side economics with Chinese characteristics help the world’s second largest economy? It depends on how the strategy is implemented. Though supply-side theory has become synonymous with laissez-faire, trickle-down capitalism—which in an age of rising inequality has been largely discredited—the core idea was developed by the 19th century French economist Jean-Baptiste Say. He argued that supply—the production of new goods, products and services—created its own demand, dispersing money into the economy in the form of wages and profits, which could be spent by a rising consumer class. You can see why the concept might appeal to China, a country with production prowess to spare, and one desperately in need of boosting domestic demand for goods.

The key (and often forgotten) caveat is that Say believed there could be supply-and-demand mismatches, where powerful institutions like the state or large financial firms could distort the rules of the game. Wealth, in effect, doesn’t always trickle down if it is funneled off the side by vested interests.

That’s exactly what’s happening in China now. The Chinese economy has slowed because its outdated economic model, which is predicated on cheap capital and cheaper labor, has stalled. When the U.S. and Europe stopped spending in the wake of the 2008 crisis, China’s export economy tanked, and the government stepped in to prop things up with a massive stimulus plan. This resulted in a debt bubble that grew three times as fast as the ruinous American subprime bubble. There’s so much debt in the Chinese economy now that about half of new loans are going to pay off the interest on existing ones. This creates a snowball effect of slower growth, which the government has desperately tried to buffer with more credit. The “self-reinforcing relationship” is what has caused the “large disruptions in the financial markets” recently, says Peking University economist Michael Pettis, a highly regarded China observer.

To the extent that supply siders acknowledge that powerful forces can distort the natural laws of supply and demand, they are on to something. The Chinese state needs to move its economy away from a state-led model in which the cheap capital of consumers gets funneled into unproductive infrastructure projects. Instead, the country needs to find a way to boost household wages and consumer spending.

That is happening, but slowly. As Pettis points out, consumption has been rising as a percentage of the Chinese economy only since 2012. It will have to rise much further to offset China’s massive debt.

This means China’s policymakers could indeed stand to learn some lessons from the Reagan years. Despite all the political rhetoric about a smaller state and less spending, debt—both government and consumer—actually rose during the 1980s in the U.S.

China is going through much the same thing now. (Indeed, the government has actually started repackaging subprime-type loans to try to offload some of its bad debts.) And so far, it’s unclear what “supply side” reform will really mean in the Chinese context. The government has called for policy proposals from think tanks, which run the gamut from closing down old coal-fired power plants to liberalizing financial markets to focusing on creating more upscale goods and services.

None of them are bad ideas, but they will only work in the context of fixing the real problem by shifting more of society’s wealth from the government and state-run corporations to individuals. Which is a change Reagan himself would no doubt appreciate.