As previous growth momentum is rapidly diminishing due to the demographic transition, China ought to find new sources of growth. The new reform agenda can create these. But there are challenges facing reform in China that need to be tackled urgently.

First, reform has entered a new phase where there is little room for Pareto improvements — namely, benefiting some groups of people without hurting any other groups. Stronger political determination and wiser reform tactics are required to break resistance from vested interests and potential losers by splitting the costs and sharing the dividends of reform.

Second, as reform enters a deep-water zone, it is no longer sufficient for policymakers to feel for a purchase as they make their way across the river. This may have once been an effective approach, but going forward, policymakers should consolidate a roadmap for reform with clear goals and blueprints.

Finally, unlike early reforms, which tended to break laws and regulations in order to promote market development — for example, farmers’ adoption of the household responsibility system had spontaneously abandoned the people’s commune before the latter was officially abolished — new reforms should be undertaken on the premise of amending existing laws and making new ones.

Important progress has been made in recent reforms, such as ensuring a level playing field among enterprises of all ownerships, transforming the government’s role in resource allocation and improving the property rights protection system. The next step of reform — officially called supply-side structural reform — focuses on two objectives. China needs to maintain its traditional growth momentum by tapping into the potential of production factors, especially the potential supply of labour, to extend the demographic dividend. And China needs to foster new driving forces for economic growth through human capital accumulation and productivity improvements.

There are four key areas of reform where new sources of growth can be explored.

First, almost all the factors causing China’s economic slowdown can be attributed to China’s diminishing demographic dividend. In particular, the decline in the working age population will reduce the labour force as well as slow the improvement of human capital. In response, further efforts should be made to improve the labour force participation rate through reforming the household registration (hukou) system to spur urbanisation. That requires reasonably sharing the costs of the hukou reform between the central and local governments to align incentives.

Second, population policies should be relaxed further to increase the fertility rate and establish a balanced population age structure in the future. Recent reforms to the country’s population policy, especially allowing all couples to have two children, can be expected to have a significant effect on raising fertility. To some extent, it is hoped that this fertility policy adjustment will increase the fertility rate, or at least delay its decrease.

It is worth noting that allowing families to have more children alone is inadequate to increase fertility in the short run and balance China’s population structure in the long run. Complementary policies in the provision of public services are also needed to mitigate the burdens shouldered by families in raising children. They also need more maternity services, maternity leave, day care and compulsory education.

Third, there is an urgent need to maintain the momentum of education and training development. During the high growth period, the human capital accumulation of Chinese workers was mainly attributable to the popularisation of nine-year compulsory education, expanded higher education enrolment and mass entry into the labour force of new labourers holding more years of schooling. As the effects of traditional measures of human capital accumulation diminish, new policies such as extending compulsory education from nine to twelve years, training workers on the job and improving education quality and equality are needed.

Finally, a policy environment that allows creative destruction needs to be created. Labour productivity was one of the most important factors that drove China’s rapid growth over the past three decades. It was improved mainly through resource reallocation — namely, labour migration from rural to urban sectors. As the effect of such resource reallocation diminishes as a result of demographic transition, China has to exploit new sources for increasing labour productivity.

Perhaps the most important such source is encouraging enterprises to enter and exit in accordance with their productivity performance. Such a policy environment requires both strengthening competition among producers and social protection for workers.

China may be facing a bumpy ride as it enters its ‘new normal’, but a new reform agenda focused on exploring new sources of growth could provide the roadmap Beijing needs.

Cai Fang is Vice President of the Chinese Academy of Social Sciences (CASS) in Beijing. Zhang Xiaojing is Deputy Director-General of the National Institution for Finance and Development at CASS.

This article is a digest of the authors’ chapter from the publication for the latest China Update. A free e-book is available here.