Xi’s Plan for China’s Economy Is Doomed to Fail

A staple of governance under Chinese President Xi Jinping is that major policies are introduced with great fanfare only to be abruptly discarded, often without even acknowledging their prior existence. China’s breakneck shift from three years of “zero COVID” policy to zero policy on COVID, following a wave of protests in late 2022, is only the most conspicuous of these reversals, all of which can be ascribed to their role in undermining the credibility of the Chinese Communist Party (CCP) and its leader.

Xi’s prized policy of “common prosperity” was similarly short-lived. After prematurely declaring victory over the pandemic in May 2020, Xi embraced common prosperity as the mantra behind which to rally the economy while making society fairer and more equal. The government launched high-profile antimonopoly and antitrust probes to curb the reach of Big Tech and to assert greater control over the content and distribution of the fruits of innovation. Hundreds of billions of dollars in stock market capitalization vaporized, crushing ventures that elevated meeting private wants over tracking party ideology. At the autumn 2021 CCP meetings, a historic resolution situating Xi beside Mao Zedong in the pantheon of Chinese rulers invoked “common prosperity” eight times.

Yet by the middle of 2022, with the notoriously unproductive state sector in the ascendant, more powerful than it had been in decades, but with the recovery failing, official references to common prosperity all but disappeared. A 17,000-word report on the economy presented at the National People’s Congress by Premier Li Keqiang in March 2022 mentioned common prosperity just once. Two months later, Xi and his top economic adviser, Liu He, reversed course entirely, issuing a series of broad statements supportive of private tech initiatives, cheering the stock market. By December, zero COVID and common prosperity had both been interred in the graveyard of policy dogmas.

But a great leader needs a great policy, and in Xi’s China there is always a new one. In December 2022, the government announced the less flashy but more reassuring “consumption-led growth”—the centerpiece policy of an ambitious new 12-year economic plan. For the first time in modern Chinese history, the country’s planners would prioritize “expanding household consumption” over “effective investment” as a long-term strategy. In practical terms, China’s growth would now be driven mainly by household spending decisions and not by the state directing or subsidizing companies to build and produce according to diktat.

Almost universally, economists have praised consumption-led growth. Indeed, if carried out properly, this policy shift would help China avoid the dreaded middle-income trap—a phenomenon in which declining productivity and falling investment returns in developing nations lead to stagnating living standards.

Sensible though it is, consumption-led growth in Xi’s China is doomed to fail. As Xi has done so often in the past, he will back away from the policy once the inevitable backlash from powerful constituencies, including state-owned enterprises, local governments, and the national security bureaucracy, takes hold. The Chinese people, knowing that the leader will bury the initiative at the first signs of worry from the party, will be reluctant to embrace it. Instead, they will hunker down, saving—in a country with the highest savings rate on earth—yet more of their meager earnings for the expected hard times ahead.

CLASHING PRIORITIES

Consumption-led growth aims to fix a very real problem. China’s household spending accounts for a mere 38 percent of gross domestic product—nearly 30 percentage points below the global average. Investment accounts for a whopping 43 percent of China’s GDP, and under Xi the economy has become increasingly dependent on state spending in sectors he deems “strategic.” To fuel this investment, the government constrains the share of GDP that accrues to households and boosts the share that goes to preferred businesses and sectors. It does so through a raft of seemingly unrelated policies, such as pushing down the exchange rate to reduce net imports, making tax rates regressive, keeping social safety nets weak, curbing the rights of urban migrants, banning unions outside the party-controlled All-China Federation of Trade Unions, forgoing dividends at state-owned enterprises, and capping bank deposit rates.

Because Chinese lenders pay depositors far less than they would in a competitive market, they are able to lend to state-owned and state-favored enterprises at below-market rates. These companies are then shielded from default by policies and interventions that preclude or forestall bankruptcy. In the stock market, government authorities block disfavored sectors from accessing investor capital (using published “red lights”) or warn investors away from such sectors (using “yellow lights”). They also impose arbitrary “rectification” orders on products and services—ranging from fintech to gaming—the consumption of which is deemed to clash with the “maintenance of social order.” The online retailer Alibaba was subjected to such orders, requiring it to change and report regularly on its business practices, after its CEO, Jack Ma, publicly criticized China’s regulatory regime in October 2020.

The most conspicuous result of state-directed investment has been gross overbuilding in housing and infrastructure, accompanied by relentlessly declining productivity and soaring debt levels across the economy. In the short term (which can endure for many years), a country can always increase GDP merely by digging ditches and filling them back in. But eventually, default or inflation is necessary to extinguish the debt, and the finance for ditch digging dries up.

With a new policy regime aimed at boosting private consumption levels, however, one can expect major positive developments. Speculation in real estate, which has wreaked havoc on the economy and which Xi has condemned, will abate. Wages and living standards among the broad base of Chinese citizens will rise. Spending and investment will flow to the more productive economic sectors, particularly services, which are dominated by private firms—rather than politically fostered state-owned ones. Investment returns will increase and the growth of bad debt decline. Imports will rise and the current-account surplus will move toward balance. And finally, economic and political tensions with the world’s market economies will, after years of relentless growth, begin to ease.

China has the highest savings rate on earth.

Yet consumption-led growth will clash with more immediate government economic priorities. First among these is boosting short-term GDP growth. Despite Xi’s condemnations of real estate speculation, he has never allowed GDP numbers—which are juiced by bullish property bets—to be determined by market forces. Consider the way the Chinese housing and corporate loan markets operate. Whereas in the United States home prices and corporate borrowing have historically risen and fallen together with the ups and downs of the business cycle, Beijing has systematically countered falls in home prices by pushing more corporate borrowing and countered falls in corporate borrowing with incentives to boost home buying—all to ensure achievement of the government’s desired GDP.

This time is no different, despite the consumption drive. As the initial signs of post-pandemic recovery have lost steam, Chinese policymakers have reverted to the old playbook of property support measures—on top of the sweeping 16-point rescue package rolled out last November. There is therefore no reason to believe that Xi is willing, now, to leave economic growth and the fortunes of “strategic” sectors to the mercy of consumer whim. Debt levels will, instead, continue to grow, and consumer demand that does not conform to party demand—say, that directed at foreign firms or competitors of state-owned enterprises—will be snuffed out.

There are other reasons for pessimism about consumption-led growth. The political blowback accompanying any significant shift from investment to consumption will be fierce. As more production is devoted to meeting consumer demand, exporters will be hurt. Highly indebted local governments, which through the control and sale of land-use rights have become powerful economic actors in China, will have fewer resources at their disposal as the mammoth Xi-era construction projects cease. Already, many municipalities are failing to meet payrolls and are auctioning off schools and cutting pensions. After years of claiming credit for robust, nationwide, building-bloated urban growth, the central government will not escape the ire of unpaid municipal workers, the businesses catering to them, and the netizens supporting them on social media.

The central government will, meanwhile, under a genuine consumption drive, have far less control over who makes what, in what quantities, and to what end. This reality will collide head-on with new domestic technology promotion schemes and national “security” initiatives aimed at curbing the ability of foreign firms to gather and disseminate market information or to “make a fuss” about government policy on matters ranging from technology to human rights. Indeed, foreign business confidence in China has, notwithstanding the consumption initiative, fallen significantly in the past year. European business confidence in the country has reached a record low.

SPENDING SLUMP

Early signs suggest that Xi’s consumption drive is already failing badly. In March 2023, Chinese exports surged by 14.8 percent and imports declined by 1.4 percent, producing a massive monthly trade surplus of $88.2 billion. These data reflect weak domestic demand and a corresponding need to push goods abroad—the opposite of consumption-led growth. And the government cannot count on a new generation of consumers to rescue its plans. Youth unemployment is running at over 20 percent. It is no surprise that China’s main stock market index is down 20 percent this year. This decline has been accompanied by a steady slump in the prices of copper and iron ore, signaling continued weak demand.

Whereas spring economic numbers showed a much-anticipated post-lockdown bounce back in demand for luxury goods and domestic travel, broader metrics suggest widespread consumer pessimism. Savings, after soaring in 2022, accelerated further after the consumption drive was announced. Yuan bank deposits rose by a remarkable 41 percent in the first quarter of 2023, year-on-year, after reaching a record high $2.6 trillion in 2022. Borrowing plummeted over 50 percent in 2022, reflecting the decline in home sales. Households with excess cash prepaid mortgages instead of buying cars or other discretionary items. According to a quarterly survey by the People’s Bank of China, there has been an enormous rise in the urge to save rather than spend or invest. Fifty-eight percent of Chinese respondents now prefer to save, up from 45.7 percent in the pre-pandemic year of 2019.

Weak domestic demand correlates directly with weakened household spending power and deteriorating balance sheets. Between 2008 and 2022, household debt as a percentage of GDP surged from 18 percent to 62 percent. Meanwhile, the slumping property market, which accounts for an enormous 30 percent of China’s GDP (double the share in the United States) is suppressing demand for industrial materials such as steel, timber, and chemicals, as well as consumer durables such as appliances, furniture, and fixtures. At the same time, local governments have seen revenue from state-owned land-use rights, a primary source of public expenditure, plummet 27 percent year-on-year in the first quarter of 2023, further dampening demand.

Rapid population aging is also suppressing demand. A report published by the Chinese Academy of Social Sciences in 2019 warned that China’s national social security fund would be depleted by 2035. Against the backdrop of declining public confidence in the state’s ability to support the elderly, younger Chinese have been putting money into a newly launched private pension scheme, draining more funds away from current consumption.

PARTY FIRST, CONSUMER SECOND

Despite these financial and demographic headwinds, the Chinese government continues to shower state-owned enterprises with new tax, financing, and regulatory interventions to increase production in state-strategic sectors. Such initiatives, far from aiding consumption, further disadvantage firms looking to satisfy consumer—rather than party—wants.

If China were as serious about building a consumption-led economy as it is about maintaining a one-party state, it would surely not have far to look. Hong Kong is prosperous, with a per capita GDP that ranks 11th in the world (or third according to so-called purchasing power parity). Although it has never been democratically ruled, Hong Kong had, at least until Beijing abandoned its commitment to “one country, two systems,” an independent judiciary, rule of law, and less interference in business operations and consumer sovereignty than any other polity in Asia. Its household consumption as a share of GDP, at 65 percent, is just slightly below that of the United States yet 27 percentage points higher than in mainland China.

But Xi will never allow a consumer-led economy to take hold on the mainland. That is clear from the strife he has stoked in Hong Kong through the imposition of the 2020 national security law, which enabled Beijing to prosecute protesters at will. Partly as a result, the number of American companies with regional bases in Hong Kong fell to an 18-year low in 2021, and the net outflow of residents from Hong Kong more than doubled in 2022, to 60,000. A survey by the European Chamber of Commerce found that nearly half of all European firms in the city were considering full or partial withdrawals this year. And the companies, domestic and foreign, that have been the greatest beneficiaries of consumer demand, most notably in social media, have been those most heavily targeted by the law.

A consumer-led economy requires a high degree of individual autonomy and commercial freedom to respond to citizens’ ever-changing wants—requirements that the CCP under Xi has been increasingly unwilling to accommodate. The policy of consumption-led growth may have been started with the sincerity that typically accompanies ignorance of collateral consequences. But as those consequences become clearer in Beijing, it is destined to suffer the same silent death and unmarked burial as Xi’s previous initiatives.