In the winter vacation, I decided to read two classics in the field of economics once again. As I read them, the recent heated discussions about the economic reforms on the supply side, both the theoretical ones and the practical ones, dawned on me. Therefore, I would like to summarize the history of how economics and economic policies developed and give suggestions for the economic reforms on the supply side based on it.

In 1776, Adam Smith, the Father of Economics, published his work The Wealth of Nations, which symbolized the birth of economics. There is a formula in his economic theory, that is, happiness=utility/desire. In this formula, “utility” refers to the satisfaction obtained from the consumption of goods and services (“the supply”). The more various and abundant the goods or services are, the happier the people become. “Desire” refers to demand. The greater the demand and the stronger the desire, the less happy the people become. In the time of Adam Smith, the core issue of the society was “supply”, that is, how to provide more goods and services and tackle the problem that supply exceeded demand. At that time, economists were convinced of the power of market, believing that the “invisible hand” could allocate the resources effectively and increase the production efficiency so that abundant goods and services could be provided and demand could be created autonomously by supply. That is called “Classical Economics”.

After the industrial revolution, the situation where demand exceeded supply was turned around, with the human society stepping into the era when “supply exceeded demand”. The imbalance between supply and demand continued until the outbreak of the Great Depression in the 1930s, which was the first economic crisis in the capitalist world. Afterwards Keynesianism, the core of which is on the demand side, was established. Keynesianism advocated stimulating the effective demand. In the Keynesian view, demand can determine supply and it can spur the economic growth. For Keynesian economists, investment, consumption, and export are three important ways to boost the economic growth. That is called “Neoclassical Economics”.

The 1970s witnessed the oil crisis, which was the second economic crisis in the capitalist world. Stagflation such as high inflation and low employment appeared, and the economy slowed down, which indicated the ineffectiveness of Keynesianism. To deal with this crisis, developed countries in the West, which were represented by the United States and the United Kingdom, abandoned Keynesianism and adopted ideas of the supply school. They took measures such as cutting taxes or reforming the state-owned enterprises, etc. to revitalize the economy. That is called “Reaganomics” and “Thatcherism”.

It can be found from the previous overview that supply and demand are the two main lines in the development of economy and the equilibrium being pursued by all the countries and their economic policies is always the balance between supply and demand. The present problem in the Chinese economy is not only the slowdown of the growth rate at the quantitative level, but also the imbalance between supply and demand at the structural level. The insufficiency of the effective demand coexists with the dislocation of the effective supply. On the one hand, on the demand side, there are two basic factors determining the effective demand: people should have “demand” and “purchasing power” at the same time. Affected by the imbalanced income distribution and the income gap, the low-income groups are facing the problem that they have the “demand” but no “purchasing power”—they have no money for purchases. Such a problem is relatively obvious in the purchase of the properties. Nonetheless, the high-income groups are facing a different problem that they have the “purchasing power” but no “demand” or the goods/services are not supplied in the domestic market — they cannot buy the goods and services in the domestic market. For instance, high-income groups always travel abroad or contact the purchasing agents abroad to purchase the name-brand clothes or the high-end goods. On the other hand, on the supply side, there are two basic factors determining the effective supply: manufacturers can produce the goods and they can sell out of all these goods at the same time. However, now some goods are produced but they cannot be sold, which is called “overcapacity”. This situation mainly exists in the traditional industry. For instance, the ratio of the iron & steel output in China to the iron & steel output in the globe remains high all the time; the iron and steel produced in China alone can meet the demand of the whole world, so some iron and steel enterprises in China are in the state of “zombie”– on the verge of bankruptcy but kept alive by the government support. Besides, some goods can be sold but they cannot be produced, which is called “no productivity”. This situation mainly exists in the high-tech industry, for instance, China’s import of computer chips in 2015 has exceeded 200 billion dollars.

To sum up, the problem in China’s economy is complicated: the insufficiency of the effective demand coexists with the dislocation of the effective supply. Therefore, we should take China’s situation into account, and when we suggest the reforms on the supply side, we should not neglect the management of the demand.

Note: The author is an oriental scholar and professor in the School of Economics and Management and in the Think Tank of Sustainable Development and New-Style Urbanization at Tongji University. The article first appeared on the website of Xinmin Wanbao Newspaper: https://xmwb.xinmin.cn/xmwb/html/2016-02/27/content_2_1.htm