The famous economist Lang Xianping was a professor at Wharton School of Business, New York University and University of Chicago in the United States. He is currently a visiting professor of finance at the Chinese University of Hong Kong. "Lang Xianping Said: How to Start Reform Again" is his latest work on interpreting China's reform signals. This article is an excerpt from the core ideas of the book.
The situation China is facing today is an unprecedented difficulty, called stagflation. Stagnation means economic stagnation; inflation means inflation. If you look at the data from the Bureau of Statistics, it seems that this is not the case. The GDP growth rate was 7.8% in 2012 and 7.6% in the first half of 2013, the highest in the world. The inflation rate has been between 2.1% and 2.7%, which is almost the lowest in the world.
If we only look at the data from the Bureau of Statistics, we will feel that we are living in happiness. Whether you believe it or not, I don’t believe it anyway. The "Keqiang Index" named after Premier Li Keqiang shows that GDP growth has reached its lowest point in 2013 – 4.02%. Among them, the growth rate of train transport capacity is particularly outstanding, with 9.3% in 2010 and 8% in 2011. These two growth rates were similar to the GDP growth at that time. Let’s look at the train capacity growth in 2012. For the first time in China’s history, it was negative, minus 0.8%. What about the first half of 2013? Even scarier, negative 2.9%. If China's train capacity growth rate is negative, how can GDP growth be positive? Our train freight is almost the cheapest, far lower than the market price. If it has declined and the economy is still growing, there should be something wrong with our statistics.
As for the inflation rate, how is this figure of 2.1%~2.7% possible? The growth rate of our money printing has averaged 20% in the past five years. You don’t need to understand economics to know that inflation will be as high as the money is printed indiscriminately. So I suspect that the Bureau of Statistics has miscalculated the decimal point. 21% to 27% is relatively credible.
Therefore, today's China: first, GDP may have negative growth and economic development will stagnate; second, the inflation rate may exceed 20%. What does it mean to constitute "stagflation"? It means that China's economy is leading the world into depression, and it is the most terrifying depression – stagflation. This is why from March 2009 to mid-2013, the U.S. stock market rose by 136% and Germany by 121%. Only China’s stock market has fallen for six consecutive years. We are almost the only country in the world whose stock market has fallen continuously. Many people are talking nonsense, saying that our stock market does not reflect the fundamentals. They are wrong. Our stock market completely reflects the fundamentals, which reflects what I mentioned earlier that China has led the world and became the first country to enter depression, and it is the most terrifying depression – stagflation.
Reaganomics
Facing the terrible stagflation, what should the new government do? Moreover, it is impossible to solve two problems at the same time. We can only take care of one, either solving "stagnation" first or solving "expansion" first. To solve "stagnation" first is to continue to stimulate economic growth; to solve "inflation" first is to combat inflation. And you can only do one thing, you can't do two things.
Today's China is like a person who is about to die of thirst in the desert. This person who is about to die of thirst has two choices. The first option is to solve the "stagnation" first and run forward under the bright sun to find water. This is the policy implemented by the government in the past ten years, the policy of ensuring eighty percent; the second option is for the person to quickly find a shady place to wait until the sun goes down and the weather is not so hot, and then go out slowly to find water at night. This is to solve the "bloat" problem first. I once asked many of my friends and students which path do you think our government should choose, and everyone almost unanimously said that we should choose the second path.
Yes, it is possible that the new government will choose the second path. Based on historical experience, the second path is more likely to solve stagflation. This historical experience is "Reaganomics". After Reagan took over as president, he faced the most terrifying depression in the United States, that is, stagflation, the same as China today. He also took the second path and made four major moves to solve stagflation step by step. His original policy is today called "Reagan Economics."
When Reagan took office in 1981, U.S. inflation was as high as 13.5% and the unemployment rate was as high as 7.6%. It was because of this stagflation that President Carter resigned. Reagan's first move was to combat inflation. He unexpectedly raised interest rates to 21%, and even bank lending rates were as high as about 20%. This move is too cruel. After this move, the entire economy becomes even more depressed, because in order to solve the "inflation", the "stagnation" must be worsened, making the economy even worse. So by the end of 1982, the United States was in an unprecedented Great Depression, which was probably even more severe than the Depression of 1929, but inflation came down. In 1982, the inflation rate was 5%, and in 1983, the inflation rate was 3%. This harsh approach did control the "bloating", but it was severely criticized by many people at the time.
But his strategy was successful after 1983. Greenspan gave him the most pertinent evaluation: "President Reagan is the father of economic vitality in the United States in the past 20 years" because the second path he took was very successful. Control inflation first, and then go back to solve the stagnation problem and promote economic growth. So there is the second plan: a major tax cut, which reduces the corporate tax rate from 50% to 28%, almost half, and the personal income tax from 46% to 34%. As a Republican, it is not easy to do this with the House and Senate controlled by Democrats. The tax cuts are so large that the United States may have the lowest tax rate among developed countries. This is the economic miracle created by President Reagan.
Taxes have dropped, companies have made more money, and people have more disposable income. Companies began to hire more employees in the hope of making more money, and people began to increase consumption when they had more money. After the tax cuts, companies and individuals made more money, the tax base expanded, and tax revenues increased. Therefore, tax revenues almost doubled after 1983, exceeding US$1 trillion. So the U.S. economy is slowly starting to grow again.
The third party began to pay more attention to market mechanisms and solve problems through market mechanisms. How did the "inflation" in the United States come about at that time? As the price of oil doubled several times, it led to inflation. As a general rule, what would our government do? It must be to control prices. We like to control the most, such as regulating housing prices, limiting prices, and restricting purchases. We usually block rather than relax, but inflation cannot be suppressed by pressure. This is why if you want to suppress housing prices, the more you suppress them, the more prices will rise, because this completely violates the economic laws of the market.
What Reagan did was to completely return to the market's price adjustment mechanism, liberalizing prices and restrictions to allow oil to rise. American oil companies found that prices had risen so high that they could make greater profits from producing oil, so they began to exploit more oil fields locally or overseas, hoping to make the pie bigger. As more oil fields are exploited and oil production increases, prices fall. Reagan allowed prices to skyrocket. The result was an increase in supply, and prices fell instead. This is called respecting the market mechanism and respecting the price function.
The fourth step is to break the monopoly. To give an example, Reagan abolished price controls and route controls in 1982 and 1983 respectively, which gave many small airlines the opportunity to compete. In the end, competition intensified and ticket prices dropped by 30%. Breaking the monopoly will reduce costs and lower prices, which is more conducive to economic promotion.
These four measures saved the U.S. economy and allowed the U.S. economy to develop in a straight line for more than 20 years, making Reagan one of the greatest presidents in the United States.
Xi and Li’s New Economic Deal
The new policies of Xi and Li represent the significance of the times. They are a change from the crazy way of boosting GDP, which used to be running under the sun in search of water. Regarding this transformation, I think there is at least a successful precedent in the past – Reaganomics. Let me compare President Reagan’s four axes with the four axes of our new administration.
The first step is to control "inflation". President Reagan raised interest rates. As for us, we launched a "money shortage" on June 20, 2013. Through the "money shortage", we found that the inter-bank lending rate was close to 30% on June 20, even higher than Reagan's time. This short-term phenomenon has indeed suppressed the momentum of banks' arbitrary credit granting and local governments' borrowing money. Therefore, total social financing dropped by 43% in June 2013 to only 1.04 trillion. It seems that the new government is considering suppressing inflation first. But when data came out in July, the inflation rate was 2.7%, the highest since 2013. In the first three months, it was 2.1%. Therefore, it is more necessary to suppress inflation, but more efforts are needed.
Compared with Reagan’s second round of tax cuts, we began to try to stimulate economic growth through “replacing business tax with value-added tax”. Changing business tax to value-added tax will generally result in a reduction in tax rates. In July last year, the central government announced that companies with an annual income of less than 20,000 yuan would be tax-free. This tax exemption is not large enough. Our new government should step up its efforts in this regard and significantly reduce tax rates.
Third, respect the market mechanism. Reagan was focused on oil, our new administration is focused on coal. The price of coal has been very low recently, many coal plants have closed down, and some mayors have even taken the lead in selling coal. According to past practices, it is very likely that coal groups will ask the central government to ban coal imports. Coal prices have fallen because foreign coal is particularly cheap, and its imports have impacted domestic coal prices, causing prices to plummet.
Why were coal prices so high before? After our research, we found that there are a total of 88 taxes and fees on our coal. Excessive taxes and fees make China's coal uncompetitive. What has the new government done? Allowing international coal to enter China will impact local governments at low prices, forcing reforms and forcing local governments to cancel taxes and fees. I think this approach is somewhat similar to President Reagan's approach. It is highly worthy of recognition to force reforms through adjustments to the price mechanism and respect the market mechanism.
Fourthly, in terms of breaking down the bureaucracy and monopoly system, the new government has done one thing that is very meaningful, which is to push forward the establishment of the Shanghai Free Trade Zone against all opinions. The real opposition actually comes from the "one bank and three associations". Why? Because the Shanghai Free Trade Zone is about financial reform, it includes four major items: interest rate liberalization, exchange rate liberalization, opening up of banks to competition, and the establishment of futures delivery warehouses.
The thinking of the new government may be as follows: The reason why China's financial reform has stagnated and is so backward is probably the result of disruption by special interest groups. In 2012, the financial reform in the Qianhai area of Shenzhen and the financial reform in Wenzhou failed. I think it was because of the opposition of the "one bank, three committees" and state-owned commercial banks.
But how can such a backward financial system support the long-term economic development of a country? How to change the reform? First of all, we must break the monopoly of the "one bank, three committees" and state-owned commercial banks, but breaking it is not easy. I personally support this kind of reform. I think we need to conduct a pilot to find out whether we have been too strict on finance in the past, and whether too many interest groups have hindered financial reform? Can we develop a better system for the liberalization of interest rates, exchange rates, banks, and futures in this small area without regulatory entities or interest groups? What if it fails? If it fails, we will just revise it. Even if it fails, there won’t be much impact.
To sum up, I think the new government is taking the second path, which is to take a rest first and wait until the sun goes down in the evening before looking for water. And when we compared President Reagan’s four axes, we found that the paths were the same. The global economy entered a major crisis that has not been seen in a century in 2007. The initiators of this crisis were developed countries. They abused their rights in the context of globalization and used money to occupy the resources of other countries for free. No matter who is responsible for the cause, the responsibility for adjustment is shared by the whole world. In this sense, the whole world must reform, that is, whoever has a deeper understanding of its own crisis, whoever takes the most targeted and comprehensive measures, whoever makes the greatest determination and moves fastest will be the world leader in the future, and China is the best among them. If we deepen institutional reform with the determination of a strong man, China will surely rise.
