Premier Li Keqiang delivers the annual government work report at the opening meeting of the fifth plenary session of the 12th National People's Congress at the Great Hall of the People in Beijing, capital of China, March 5, 2017. [Photo/Xinhua]

Chinese Premier Li Keqiang delivered the report on the work of the government at the fifth session of the 12th National People's Congress of the People's Republic of China on March 5, 2017. The report is composed of three parts: the summary of the work of the government in 2016; the overall arrangement of the work in 2017; main tasks of the government in 2017. In this article, we reflect on the economic development of China in 2016 and the economic prospect of China in 2017 on the basis of the Premier's report.

The GDP growth number of China was 6.7 percent in 2016, which is 0.2 percent smaller than 2015. However, this decline in the GDP number is accompanied by an increase in the aggregate profit of the industrial sector. According to the Premier's report, the aggregate profit of the industrial sector declined by 2.3% while it grew by 8.5% in 2016. This is a great improvement compared to previous years. Actually, in the past 36 months, the year-on-year growth rate of the total loss of the firms which suffer losses in China has been always positive until August 2016 when the number turned -3.1 percent. In the whole of 2016, the total loss of the firms which suffer losses in China declined by -9.2 percent. In contrast, the total loss increased by 31.3 in 2015. In 2016, the number of firms which suffer losses increased by only 0.2 % while the same number increased by 20.6 percent in 2015.

The year-on-year producer price inflation had been negative since March 2012 until August 2016. The declining producer price inflation indicated over-capacity in the industrial sector. Without enough consumption and investment demand at a given level of price, firms had to cut prices to attract customers, which led to declines in profits. When the declines in profits were too large, firms suffer losses. The cut of the firms' profits led them to cut investment and production. As a result, investment demand declined. Similarly, income of workers in those firms declined, which cuts their consumption demand, given liquidity constraints. Those things compose of a vicious cycle.

Macroeconomic policies of the Chinese government tackle those issues from both the demand side and the supply side. From the demand side, the government used active fiscal policy. More specifically, tax reforms were taken to cut tax burden of firms. Because the Chinese firms were heavily leveraged, financing new investment with new debt was difficult. By cutting taxes, the firms' disposable income was increased so that their spending could increase. Moreover, the de-leveraging of firms and promotion of direct finance reduced the firms' financing cost, which could also encourage the firms' investment. The government investment in infrastructure not only directly increases aggregate demand but also encourages private investment by supplying infrastructure as a complementary production factor. Furthermore, entry of new firms and new investment projects became easier due to a series of deregulation reforms and simplification of administrative procedures. External demand was also enhanced by closer economic linkages with economies on the "Belt and Road" economic zone, the development of cross-border e-commerce and free trade zones.

From the supply side, excess production capacity was cut in 2016. According to Mr. Premier, the production capacity in the steel industry and coal industry was cut by 65 million and 290 million tons, respectively. Various measures were taken to promote technology progress. By 2016, the number of patent in China has reached 1 million and the total value of technology transaction exceeded 1 trillion yuan. The government also promoted the transformation of the industry structure. More specifically, traditional manufactory sector with low value added is now gradually being replaced by high-tech manufactory sector and service sector.

Altogether, those policies increase effective demand while at the same time cut excess supply. As a result, we see improved economic performance. Recently there is a heavy debate in the international community about the future growth prospect in China. One argument is that China's fast economic growth in the past was due to its long distance from the world technology frontier and the benefits from technology diffusion. Some economists argue that this kind of catching growth has less space now. No matter if this is true or not, China is a big country and there are regions which are far away from the country's technology frontier. Regional development strategies as mentioned in the premier's report are useful to promote catching up within the country. Similarly, we see declined external demand from China's trade partners in recent years. On the one hand, China is looking for other international trade partners; on the other hand, promoting division of labor and trade inside the country can enhance productivity and growth as well.

Therefore, 6.7 percent is a smaller GDP growth number than 6.9 percent of 2015. But it does mean worse economic performance. Importantly, this number was not obtained by creating excess production capacity. In factor, both the economic structure and quality of supply have been improved. Moreover, the 6.7 percent growth was obtained with less pollution and energy consumption. According to the report, energy consumption per unit of GDP declined by 5 percent in 2016. Pollution issues were also relieved. For example, the density of PM2.5 in 74 major cities declined by 9.1 percent in 2016, according to the report.

Looking at the overall arrangement of government work and main tasks in 2017, we can see that the Chinese government is going to keep sustainable economic development with policies and strategies which were proven to be effective. The new GDP growth target is set to 6.5 percent, which is smaller than the growth rate of 2016. However, this is going to be accompanied by a decline in energy consumption by 3.4 percent and reduction in the emission of pollutants. Macroeconomic policy mix will still be a combination of active fiscal policy and prudent monetary policy. There will be further reduction of excess capacity, de-leveraging and cost reduction of firms, upgrade of public services and infrastructures. Industry structural changes and regional development strategies will keep pace.

The author is an associate professor of the School of Money and Finance, Renmin University of China.