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Structural reform to speed up transition to innovation-driven development

LI YUE | 2019-04-04
(Chinese Social Sciences Today)

Pictured above is a drone developed by Chinese e-commerce giant JD.com for online purchase delivery. Enhancing enterprises’ innovative capacity is essential for a country to enter the innovation-driven development stage. Photo: FILE


In recent years, as macroeconomic policies on the demand side increasingly restrict the space and efficiency of economic development, growing numbers of economies and international organizations have cast their eyes on structural reform. Alongside the global wave of economic recovery through structural reform, academics have also been discussing structural reform itself in terms of its implications and evaluation systems.


Mainstream view
Academia and international organizations started research on structural reform in the 1990s, when global growth was sluggish and unemployment ran high in the wake of the economic crisis. Together with fiscal and monetary policies, structural reform was regarded as one of the three policy instruments for economic adjustments. After years of discussions, scholars have reached a consensus on the core mechanism of structural reform despite diverse views on its implications and evaluation systems.

The mainstream view on structural reform contends that barriers hindering effective resource allocation are the primary reason for the failure in optimizing the distribution of resources. The barriers are related to the mobility of production factors and market competition.

Mobility barriers hint at the unsmooth flow of production factors between regions, industries, enterprises and countries for reasons like policy design, so it has been difficult to effectively direct the flow of resources to more efficient departments. Production factors include capital, labor and technology, covering such fields as trade, labor and financial markets.

Scholars in favor of structural reform argue that inappropriate policy design in these fields results in the unsmooth flow of factors, so the first mechanism of structural reform is to advance reform in trade, labor and financial markets; reduce barriers hindering the flow of capital, labor and technology; and enhance the efficiency of factor flow and resource allocation, thereby increasing the potential growth rate.

When it comes to competition barriers, enterprises and individuals are unable to realize their full competitiveness due to the regulation of the product market, restrictions upon enterprises, and related policy designs like standards, laws and property rights, thus resulting in inefficient economic operation. In this regard, the product market and institutions are to blame. Hence structural reform should be carried out in the product market and with institutions to boost the competitiveness of enterprises and individuals and promote effective resource allocation, thereby increasing the potential growth rate.

To sum up, the core mechanism of structural reform is to lower policy barriers blocking the mobility of production factors and competition in the economy in order to allocate resources more effectively, eventually raising the potential growth rate.

Generally, excessive government regulation is one of the policy barriers. Mainstream structural reform in the West tries to weaken excessive regulation by the government and loosen its control, while China attempts to advance market-based reform with Chinese characteristics.

Nonetheless, structural reform is not equal to adopting laissez faire approaches. In essence, excessive government regulation is not the only barrier impeding effective resource allocation. Non-government factors like natural monopolies, information asymmetry, moral risks and financial institutional distortions also lead to market failures. The solutions to such problems entail effective government regulation.

Implementing effective government regulation is a significant part of the process of structural reform. Blind laissez faire approaches are not advisable. For example, in the indicator system of structural reform created by the IMF and OECD, economies with better banking regulation systems will obtain higher scores according to the indicator for financial structural reform, though banking regulation is not laissez faire. In this sense, structural reform can be construed as a series of reform policies to dissipate ineffective regulation.


From efficiency to innovation
According to the Global Competitive Report, economies will go through factor-, efficiency- and innovation-driven models sequentially in their development trajectory. The Chinese economy is transitioning from efficiency- to innovation-driven development. Whether it can smoothly complete the transition is vital for the country to sidestep the middle-income trap. Therefore the Chinese government has put forward the major strategy to realize economic transition through structural reform.

Taking as its samples economies that realized the transition or were transitioning from efficiency- to innovation-driven development from 1960 to 2015, an empirical study reveals that the probability of economies realizing the transition exhibits an inverted U-shaped curve, and the turning point takes place in approximately the 19th year after entering the efficiency-driven stage. The 14th to 19th years constitute the peak in the transition, with the probability approaching 50 percent. Thereafter the probability heads downwards, which indicates that if an economy rests in the efficiency-driven stage for too long, its growth mechanism is highly likely to be fixed, adding difficulties to the transition.

Structural reform is an effective strategy to speed up the transition. Empirical studies on the effects of reform show that the structural reform of trade and financial sectors have significant positive effects on economies’ transition from efficiency- to innovation-driven development, while the effects from the structural reform of product and labor markets are vague and insignificant. It can be inferred that the structural reform of product and labor markets is not as pressing as that of other sectors.


Private enterprises essential
Enhancing enterprises’ innovative capacity is essential for a country to enter the innovation-driven development stage. In China, a latecomer economy, enterprises mostly follow the path of technology imitation or import. According to a field investigation into enterprises in Jiangsu and Guangdong provinces in 2018, most enterprises didn’t care about mastering cutting-edge technologies. In order to gain short-term benefits or sustain their operations, they made non-technological innovations, such as on their workflow, market and organization.

However, research shows that workflow innovation helps little in improving enterprises’ total factor productivity, nor will it generate spillover effects as technological innovation does. It is thus crucial to specify the type of innovation and explore relations between structural reform and innovation of enterprises in order to strengthen their technological innovation capacity and willingness.

Empirical studies discover that structural reforms in the five fields of trade, institutions, finance, product and labor markets have different bearings on different types of innovation. Reform plays a positive role in technological, market and organizational innovation at the two ends of the value chain, and its role is negative in the innovation of workflow at the bottom of the value chain.

Meanwhile, the impact of structural reform on different types of innovation varies in enterprises of different types of ownership. The impact is most obvious in private enterprises and less obvious in foreign- and state-owned enterprises. In future structural reform, in-depth investigation should be conducted into private enterprises to know about their real difficulties and needs.


Chart a scientific roadmap
Structural reform includes a series of reform measures. Charting a scientific reform roadmap will not only achieve a “1+1>2” result, but also diminish short-term impacts, effectively improving the efficiency of resource allocation and increasing the potential economic growth rate. During the transition to the innovation-driven development stage, the order of structural reform on different sectors will have different effects.

Related empirical studies generalize two paths to implement structural reform. The first path is to progressively and strategically plan trade, institutional and financial reform, and the second path features reform of trade, the product market and the labor market in sequence to abate the short-term impacts of product and labor market reform on economic development, so that the economy can benefit from structural reform sooner and realize the transition from efficiency- to innovation-driven development.

In practice, the planning and design of the structural reform roadmap should take more factors into consideration. Whether reform is implemented at different levels or unified, whether it targets specific groups or covers all groups, and whether it goes on progressively or radically will bring about different results. Academics should conduct in-depth, systematic and scientific research, China should bear in mind its unique traits as a socialist market economy, and governments at all levels should consider their own development characteristics in their efforts to hammer out a scientific, practical and effective structural reform roadmap with Chinese characteristics.


Li Yue is an associate research fellow from the School of Economics at Nankai University.

edited by CHEN MIRONG