Exchange rate

Considering first exchange rate effects, the "supply side" is sometimes erroneously conceived of as being purely domestic. But the exchange rate, which links China's domestic economy to the global one, crucially influences China's supply side. Statistical studies show that the most powerful force in economic development is increasing division of labor producing greater economic efficiency. This, in a globalized modern economy, is necessarily international in scope.

China's exchange rate rose strongly after the 2008 financial crisis. Taking into account different countries inflation rates, in October China's real exchange rate was 32 percent above January 2008 levels – compared to the dollar's 15 percent rise, the yen's 3 percent decline and the Euro's 11 percent fall. China disengaging from rises in the dollar, together with controls on its capital account and large foreign exchange reserves, gives China a much greater ability to avoid exchange rate problems than other economies.

Investment

Trump's policies' upward pressures on global interest rates create downward pressure on investment as the latter is financed by borrowing. China's fixed investment growth rate rose to 8.3 percent by January-November from 8.1 percent in July. However, the private investment growth rate while rising was significantly lower at 3.2 percent. Upward pressure on interest rates can negatively affect private fixed investment as this is controlled by profitability and China has not escaped upward pressure on interest rates created by Trump's policies – the yield on China's government bonds rose from 2.77 percent on November 7 to 3.21 percent on December 13.

However, China has two powerful mechanisms to sustain investment that do not exist in other countries. In China, most company borrowing is from banks, not bond markets, while simultaneously January-November saw a strong 20.2 percent growth rate of state investment. Therefore, there is no reason to anticipate a major fall in China's investment.

Logistics and infrastructure

Turning from trade and international division of labor to developing China's domestic division of labor, underdevelopment of China's logistics system and infrastructure remains a major problem for the efficiency of China's supply side compared to advanced economies. Per capita China's electrical power supply, road length and railway length is respectively only 31 percent, 16 percent and 7 percent of U.S. levels. China's supply side cannot function at the level of an advanced economy with underdeveloped logistics and infrastructure.

Therefore, China's policy in the second half of 2016 to increase infrastructure investment should be seen not only as a successful cyclical response to the risk of slower growth but as part of its strategic program of improving China's supply side efficiency.

Innovation and investment

The risk of downward pressure on investment could also threaten the correct emphasis China places on innovation. The lesson of periods of economic development, as illustrated by the latest stage of U.S. internet innovation, is that innovation must be embodied in fixed investment to be successful – as Alan Greenspan who headed the U.S. Federal Reserve through much of the "internet revolution" stressed. In the U.S., the correlation between growth in fixed investment and the increase in labor productivity three years later was 0.86, which is extremely high.

The increase in China's fixed asset investment growth played a key role in stabilizing short term domestic growth in the second half of 2016. But this must be seen as part of a strategic conception that innovation can only be a successful supply side strategy for China if accompanied by a high level of fixed investment. Fortunately, as already analyzed, China has more powerful mechanisms for maintaining investment than other countries.

Conclusion

In summary, China's December Economic Work Conference meets following successful economic performance in 2016 due to "supply side" policies. China, no more than any other country, can evade negative squalls coming out of the U.S. economy due to Trump's proposed policies. But the context of the Work Conference is that, for reasons analyzed above, the same forces which allowed China to record economic success in 2016 give it the tools to deal with negative consequences of Trump's policies.

John Ross is a columnist with China.org.cn. For more information please visit:

http://www.ccgp-fushun.com/opinion/johnross.htm

Opinion articles reflect the views of their authors, not necessarily those of China.org.cn.