Supply-side cutbacks in China—real or a red herring?
China’s overcapacity is leading to global price deflation as the country exports subsidized goods. The government has discussed supply-side reform—but how real is this? Does China have the political capacity to reduce production enough to change global supply dynamics?
Supply-side reform is not impossible but politically difficult. National state firms, particularly the large ones in key sectors, are politically protected due to their contribution to growth and employment. In addition, China’s prioritizes the industrial sector over consumption. Nonetheless, supply-side reform may be forced on China. Local government revenue is declining sharply, and the central government is going to have growing problems transferring tax revenue to the provinces. Local officials will have to make difficult decisions about where to allocate scarce capital—to inefficient local state firms or to paying salaries. Smaller, often private, firms are not protected by the state but may confront capital constraints and global trade barriers and thus will have to reduce output.
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