Source: Economic Information Daily

When mentioning developing a modernized economy, Xi Jinping used two key phrases in his report to the 19th National Congress of the CPC, i.e. “getting through the critical transition” and the “pivotal stage”. How shall we interpret the two key phrases?

First, the report made it clearer that China’s economy, built on entering the new normal, moves from the stage of fast growth to the stage of quality-oriented development. Second, we’re in a pivotal stage that features the transformation of the mode of economic growth, the optimization of the economic structure, and the change of the driver behind economic growth. To achieve the goal, we need to complete three reforms, i.e. the quality reform, efficiency reform, and the reform in growth drivers, and ultimately develop an economic mechanism with effective market mechanisms, active players at the micro level, and proper regulation at the macro level.

The report didn’t provide a timetable for the pivotal stage and for getting through the critical transition, but in my view, the period will last for only three years. That is, we should get through the critical transition and complete the pivotal stage while finishing the building of a moderately prosperous society in all respects by 2020. When deploying the task of comprehensively deepening the reform, the 3rd plenary session of the 18th CPC National Congress also mentioned that China will have more mature and fixed reform systems in 2020.

The report proposed to improve the total factor productivity, the first time the Party did so at a national congress. The total factor productivity is directly related to realizing more equitable and more sustainable development of higher quality and higher efficiency, as well as to developing a modernized economy. It is both a standard used to measure innovation and a means of innovation. It fundamentally comes from the reallocation of resources.

First, China’s 30-year development process shows that improvements in productivity are owed to the reallocation of resources. In the early years of China’s reform and opening-up, 70%-80% of the Chinese people were farmers and produced 20% of the output values. That indicates the productivity was quite low at that time. The reform has diverted some of them to non-agricultural sectors, leading to improved efficiency due to reallocation of resources at the macro level.

Second, the Schumpeterian effect works. The economist Schumpeter put forward the theory of creative destruction, which means higher productivity and stronger competitiveness are mostly achieved through destruction. An industry sees new comers and dropouts as well. Research shows that the improvement of productivity in the process accounts for one third to a half of the total improvement in productivity. That is the reallocation among enterprises.

Third, technological progress and innovation is the fundamental approach to improving the total factor productivity. In reality, enterprises are not in step with each other in making technological progress. Those who introduce innovation and new technologies first can monopolize resources and control their pace as they want. So, technological progress, in nature, is about reallocation of resources.

China’s future economic growth will rely on total factor productivity, and reforms are the key to improving total factor productivity.

First, we call the tapping of population potential through reforms reform dividends. The experience of either developed countries or countries with income slightly higher than China, shows that many rural laborers in China can be transferred to other sectors. What prevents us from tapping the potential of population is a series of institutional obstacles, and the core lies in the household registration system, which is still restricting the steady transfer of rural laborers. So, advancing the reform in household registration and urbanizing rural migrant workers can not only enhance productivity and reallocate resources, but also increase the supply of labor, slow the rise in labor cost, and boost domestic consumer demand.

Second, backward production facilities may exist in the forms of sunset industries, sick enterprises, or even zombie enterprises. They occupy limited resources and scarce production factors, but lower the total factor productivity of the entire economy, distort the prices of factors like capital and labor, and push up enterprise and growth costs to sustain the traditional mode of economic development. To improve total factor productivity, we must eliminate industries and production facilities with low productivity.

Third, creative destruction cannot protect backward production facilities or backward posts, but it must protect laborers. Ensuring and improving people’s wellbeing amid development is the successful experience of China’s reform and opening-up, as well as the requirement imposed by the 19th National Congress of the CPC. The stronger the policy support is, the braver we will be in the withdrawal.

（The author is the Vice President of CASS and a member of the Academic Board of Shanghai Academy)