Since 2008, every time there was an economic slowdown in China, its government launched fiscal stimulus, an increased government spending or lower taxes, to bring the economy back on track. It worked not only for China but also for the world. After the global financial crisis, a grateful British foreign secretary, Ed Miliband, quipped, “After 1989 (Tiananmen incident) capitalism saved China, but in 2009 it is China which has saved capitalism.”
Now, as China struggles to recover from the blow dealt by the coronavirus pandemic, many expected its leadership, led by the powerful President Xi Jinping, to intervene with a big stimulus package. They didn’t.
The reluctance of the world’s second-largest economy, which contributes 22% to global GDP, to intervene has triggered a spate of analyses. JP Morgan analysts said China was going through ‘Japanification’, a protracted period of ‘deflation, economic sluggishness, decline in the property market and financial stress for individuals, companies and governments trying to deleverage after a debt binge.’ Some argued that China has reached its peak and will slide in the years to come. Some others are cautiously optimistic and expect China to ‘muddle through’ its current woes and stage a recovery.
Many experts are missing a crucial point. China has been making a big shift in its policy over the past few years. One of the key elements of that policy is to focus on investing in economic and technological modernisation to build self-reliance. By doing so, Chinese leaders believe the country can immunise itself from external shocks like the one it has been subjected to by the Trump administration which introduced measures to disrupt the tech value chains. And importantly, the shift aligns with Xi’s political aim of national rejuvenation and ideological resurrection.
The seeds of the problem
One might argue that China could still pursue its policy of modernisation and self-reliance after first kickstarting the economy through a fiscal stimulus. To understand why China is not doing that, we have to go back to the global financial crisis.
The current woes in the Chinese economy can be traced to the fiscal stimulus package of four trillion RMB in the wake of that crisis. Its economy grew thanks to heavy doses of capital infusions financed through debt. Provincial leaders took out debt to finance infrastructure spending. Households borrowed more to buy more homes. Corporate leaders borrowed from banks to finance ever-ambitious growth plans. There was a surge in economic activities. The country was clearly shifting from growth led by exports to growth driven by domestic consumption.
By the time Xi was elevated to power, the Chinese economy was already overheating. This led to a massive surplus in steel and cement production. Among other things, it led to the wastage of resources, widespread corruption, and an enormous surge in nonperforming loans (NPLs). These developments inspired Xi to launch an anti-corruption crusade and call for a ‘new normal’. The massive surplus of steel and cement remained a sore thumb. To put them to use, Xi unveiled the Belt and Road Initiative (BRI). The BRI was described as an economic development strategy for those inside China and a massive infrastructural project for those outside.
China’s fiscal stimulus strategy continued in practice well beyond the global financial crisis despite the issue of building up debts. Contrary to conventional wisdom, real estate players and other critical stakeholders used to put their bets on high-risk portfolios, knowing well that yet another round of fiscal stimulus package would bail them out of trouble. For instance, real estate developers like Evergrande leveraged on high-yield USD bonds issued in the Hong Kong market, paying a high 12% annual interest for access to overseas liquidity. Large-scale bond issuances led real estate giants to exaggerate their values, with some even being placed on the Fortune Global 500 list.
The writing on the wall
In 2015, the then-Chinese premier Li Keqiang, while presenting the annual report of the state council to the National People’s Congress, stated that using stimulus to generate growth is ‘unsustainable’ and ‘creates new problems.’ He was likely referring to the irresponsible behaviour of key constituencies like real estate giants, local governments, and other investors. Aware of the pitfalls, the Chinese government came up with a deleveraging policy in 2016 to reduce financial risks by reducing the growth of shadow or informal banking. However, despite the measures, real estate players continued to borrow, speculating that property prices were bound to rise over time.
This time the government was clear that it intended to restrict property sector financing and bring down real estate’s impact on the economy. In other words, Beijing sent a clear signal to investors that Beijing should no longer be expected to intervene in irrational and irresponsible economic behaviour. With the government unequivocally stating its intent to restrict financing in the property sector and reduce the industry's impact on the economy, other critical stakeholders like banks and investors pulled back their lending, and the investment in the entire property sector changed. This policy led to a significant drop in the real estate sector's credibility, leading to a contagion effect on Chinese and global financial markets. It is worth pointing out that the real estate sector used to borrow 30-35% of the credit. The collapse of this sector meant a significant blow to other industries fed by the real estate boom till recently.
In the current slowdown, the Chinese government defied the expectations of one and all and sent real estate players like Evergrande, Country Garden, and investors scurrying for cover.
The politics of Xi’s economics
The turnaround in China’s economic development strategy is driven by Xi’s ideological impetus to bring back the party’s focus on reviving its ideological commitments. In today’s China, what constitutes economic success is no longer measured with double-digit growth but rather one that helps China build a ‘strategic focus’ (ding li). Rather than diverting money for fiscal stimulus measures which are unlikely to create national capacities, China will redirect it to develop economic and tech self-reliance. That means slower growth, but it suits Xi’s narrative of the Chinese dream and China’s striving for achievement (fenfa youwei).
Besides, China invests in sectors that will help it graduate from ‘made in China’ to ‘innovate in China’, after the US administration under Donald Trump and later Joe Biden disrupted tech value chains. The fourteenth five-year plan and socialist modernisation plan for 2035 are about building a self-reliant China. Further, economic reforms and modernisation have led to China’s social stratification with rising socioeconomic inequalities. Xi wants to convey that China should be ready to bite the bullet and make tough decisions. It means that if the urban centres are no longer attractive to provide employment, people should go to tier II and III cities and even rural areas to generate work and find avenues for employment. With the transformation in economic policy, there is scepticism regarding its success.
Politics versus economics
The scepticism stems partly from confusion. The change in overall economic policymaking has sent confusing signals to investors who are unsure about what assets Beijing is willing to support and when the previously backed assets and industries will be subject to new policy guidelines. The new policy has also divided the economic and political watchers. The first group contends that Beijing will be forced to step in and rescue real estate players by injecting cash or dividing these big players like Evergrande into smaller units because the property industry is too big to fail.
The second group argues that in the current context, external and internal, Beijing’s priorities have changed, and real estate players and investors should not expect the government to bail them out this time.
First, geopolitical tensions between the US and China are a cause of concern. To revive its sluggish economy, China set out this year to woo foreign investors and stabilise its ties with the West. But these goals are colliding with the government’s paramount priority of protecting national security in a world seen as full of threats. Second, consulting and due diligence firms’ access to data about Chinese industries, including defence, finance and science, triggered alarms in the country’s security apparatus. There has been a crackdown on some consulting firms with international ties. This crackdown inspired by national security considerations has sent confusing signals to foreign investors. As a result, foreign direct investment (FDI) recorded a deficit of $30.2 billion in the first quarter compared with a surplus in 2022.
On the domestic front, it was believed that the major tech firms like Alibaba and Tencent were mainly focused on gains made from e-commerce platforms but they were not adding to China’s national capacity in the form of concrete R&D apparatus. Further, some of these firms were in ruthless pursuit of profits at the cost of exploiting millions of youth. As a result, Xi launched a major crackdown on China’s tech sector to cause a big dent in their profitability. Tech players like Alibaba, JD.com, and Pinduoduo were forced to confront their monopolistic practices. Meituan, a super-app was forced to provide better working conditions like providing better food for their delivery agents. Crackdown on online tutoring and regulation of the online gaming industry caused huge losses to Tencent, but they were also political statements to gain popular support.
However, it’s not yet clear to what extent this will inspire the youth who were so fed up with the growing costs of living in urban centres that they decided to “lay flat” (tang ping). The phrase that’s common among the disillusioned Chinese youth of late is bai lan (translated as ‘let it rot’).
In short, addressing socio-economic inequalities has motivated the current leadership to decide that now it is time to cut the benefits of financial elites to quell inequality within the regime for political stability. However, there is widespread apprehension regarding the possible turnaround in the perception of Chinese youth. Today’s youth comprising the generation of ‘little emperors’ is not inspired by the same kind of ideological zeal that Xi and his comrades exhibited during the Cultural Revolution days to swear by the virtues of ‘socialist consciousness’. They do not share the same ideological sentiment that Xi expects. The disillusioned youth and the demographic disadvantages of having a very highly dependent population pose a significant challenge.
Apart from the tech crackdown, the current leadership is keen to pursue its goals of achieving ‘common prosperity’. For instance, measures have been taken to cut the benefits of financial elites to quell inequality within the regime for political stability. To bridge income disparity, Chinese financial firms have gone on austerity measures by cutting salaries, allowances and perks. Therefore, revival of socialist consciousness, and ideological resurrection merits a high level of importance.
The tech crackdowns in the last two years have led to a science and tech policy aimed at helping China graduate from ‘made in China' to ‘innovate in China’. The focus, thus, is on achieving the goals of the ‘socialist modernisation’ plan by 2035. The various measures taken to attain the goal of ‘common prosperity’ had significantly dampened the enthusiasm of the private sector.
Similarly, the restrictions on the environmental front have translated to high pressure on China’s traditional industries with relatively high energy emissions. Consequently, small businesses have shut down, and sectors like steel, cement, and associated industries find themselves in the firing line.
The problem of bulging debt in local governments was a cause of major concern in centre-province fiscal relations. With provincial governments’ Local Government Finance Vehicles (LGFVs) incurring significant debts, the centre has sent financial experts to help them. LGFVs were started way back in 1998 to fund the construction of highways. These became more powerful after the 2008 stimulus owing to the wealth they amassed due to the property sector boom by selling land use rights to property developers. During the pandemic, these vehicles collapsed due to a surge in Covid-related public spending and the declining sources of revenues owing to the lull in real estate investment. Beijing has explicitly stated that while it will help and counsel the local governments, the latter must find a way to get out of jail. The provinces are crying foul, saying that it is on the centre’s advice that they have pursued a development model to build infrastructure.
According to Nikkei Asia, Chinese leaders are concerned that the financial problems of local governments can have a very significant financial risk. Therefore, it was important for the central leadership to rein in what it perceived as irresponsible economic behaviour by the local authorities. To plug the loopholes of the fiscal stimulus route for economic revival it was indispensable to infuse heavy doses of austerity measures for the provinces.
The upshot is that in Xi’s China realising the China Dream calls for patience and collective sacrifice by the Chinese nation. Further, the party expects the people to reduce their aspirations and stoke their socialist consciousness. In short, it is austerity that has to take priority over prosperity. It wouldn’t be wrong to say that in today’s China austerity is prosperity.
When China sneezes
The Chinese leadership has decided to bite the bullet and opt for consolidation to build economic and tech self-reliance. It will be quite an accomplishment if China can achieve its 5% GDP growth rate as per estimates by the end of 2023. In perspective, a $18 trillion economy growing at 5% translates to adding up to $900 billion in value terms. In isolation, it’s not bad. But if one views from a larger perspective, an economy that invests 40% of its GDP annually, the growth is just not commensurate with its size.
The Chinese slowdown has severely impacted its East Asian neighbours, Japan and South Korea. It has also set alarm bells ringing among the US policymakers who would perhaps welcome an economically weak China. However, the slide should not be too fast too soon. That will mean the Chinese economic woes should not trouble the American economy and the rest of the world. Perhaps China’s internal developments inspired the recent climb down from the Biden administration and the current effort to have some detente. President Biden, who imposed very punishing measures to choke China’s semiconductor industry and was swearing by the policy of containing China, suddenly announced during his recent visit to Vietnam that the US doesn’t ‘want to contain China’. But that’s a story for some other time.
What China’s economic troubles mean for the world (The Economist, behind a paywall)
Xi Jinping and the rise of a new party elite (Founding Fuel)