By: Phillip Orchard
For all the pressure weighing on the Chinese economy, and for all the warnings exhorting the Communist Party of China faithful to prepare for pain, Beijing has not exactly been acting like it’s a crisis.
Gross domestic product growth is quite likely to fall below 6 percent next year for the first time since the CPC took power. Yet senior officials have been telling anyone who will listen that the government will not throw open the stimulus floodgates anytime soon.
Chinese exports are dropping, particularly to the United States. Yet Beijing has shown near-zero willingness to make major concessions on structural issues in trade talks with the Trump administration.
Private firms are defaulting on dollar bonds at a record pace, and a string of bank failures over the summer has authorities scrambling to prevent online rumors from triggering bank runs. Yet Beijing’s bailout packages have been cautious, at best, and for the first time, Beijing has been signaling a real willingness to let some investors and bankers pay the price for their imprudent decisions. The closely watched recent plenum produced no hints that Beijing is planning to change course.
This underscores three things: One, China fears shocks to the system more than a gradual loss of growth or economic dynamism. Two, its tools for staving off economic pain have become less effective, while the risks of using them have soared. Three, the worse conditions get, the more tightly the CPC will try to micromanage its way through the coming storm – inevitable trade-offs be damned.
China Fears Shock, Not Stagnation
To be clear, Beijing isn’t exactly letting a natural, cleansing recession take root. To goose growth, it’s implemented 2 trillion yuan ($284 billion) in tax cuts and pushed local governments to accelerate infrastructure spending. It’s doled out state support to more than 300 listed private companies facing a risk of default.
This summer, it orchestrated a series of takeovers of ailing banks. And it’s expected to set a growth target just slightly lower than this year’s 6-6.5 percent window, despite deteriorating conditions at home and abroad. GDP figures in China are notoriously unreliable as a measure of real output. But such targets tell us quite a bit about how much economic activity Beijing expects local and provincial governments to generate – and how much it’s willing to let them binge on debt to get there.
Still, Beijing appears to be serious about breaking its habit of overreacting to the first sign of trouble, discarding painful reforms and deleveraging efforts en masse and flinging itself on the altar of debt-fueled growth. Its fiscal stimulus this year, for example, has amounted to a small fraction of the trillions of dollars in spending it unleashed after 2008. Its monetary easing measures, meanwhile, have been aimed solely at staving off the liquidity crunch that has resulted from its crackdowns on systemic risks like shadow banking, not on turbocharging growth or staving off its inexorable structural slowdown.
The most obvious explanation for Beijing’s restraint is the fact that external conditions may very well get a lot worse in the next two years. The global slowdown currently underway is not the same thing as a 2008-style global crisis. Naturally, China is loath to use up too much stimulus firepower now – especially since it’s still cleaning up the mountain of debt and financial risk it created with its response to 2008.
To the extent that Beijing has been willing to kick-start certain sectors, it’s mostly been to ensure enough growth to allow its sweeping deleveraging agenda and other painful reforms to continue. And Beijing thinks these reforms must continue.
What Beijing cares about most is stability. It cannot avoid a structural slowdown, as its investment-led growth model will inevitably require ever-higher levels of credit to achieve returns. (This reality is also making its stimulus less effective). But with some pluck and some luck, it thinks it may just be able to guide the economy to a soft landing.
And so long as the slowdown happens gradually, it thinks it has the tools to handle the political risks of stagnation. In other words, it can intervene selectively to rescue firms or banks that are “too big to fail,” use state-owned enterprises and pressure on factory owners to soak up excess labor, use state banks to metabolize toxic assets and shift debt around, and intervene selectively to stabilize property markets. And where it deems it prudent to let economic forces run their course, it can crack down on any social unrest that may result from layoffs, declining property values and so forth.
What Beijing fears most is a shock – whether triggered by an external bubble or by a rupturing of any one of its interconnected internal socioeconomic fault lines – that sows panic, overwhelms its ability to respond, and exposes the inherent rigidity and clumsiness of its tightly centralized system. This is why it can’t abandon growth-sapping deleveraging measures.
It’s why Beijing is desperately trying to deal with its moral hazard problem in the financial sector by forcing banks and investors to think twice before assuming the state will guarantee any losses. Most important, it’s why China is refusing to liberalize the economy or its political system – whether at the behest of U.S. trade negotiators or centuries of economic and political science theory.
Xi Jinping’s Foremost Focus
This approach may sound reasonable enough on paper. But the problem for the CPC is it’s trying to micromanage a vastly complicated country of 1.4 billion people. The beauty of the market, of course, is it allocates resources in many economic sectors more efficiently than a relatively small number of distant, politically motivated policymakers ever could. In an ideal system, the risk-tolerance of banks or investors wouldn’t really be Beijing’s problem.
Beijing presumably recognizes the trade-offs of centralization. But since the party can’t tolerate the risks of instability that come with liberalization without jeopardizing its control – and, in its view, risking a return to China’s historical vulnerability to disintegration – perhaps the only option is to focus on implementing a highly responsive state-led system of governance that operates as close to market efficiency as possible.
Thus, as illustrated at the recent plenum, “reform and opening” has tilted heavily toward the former. Indeed, improving governance and eliminating systemic risk have been President Xi Jinping’s foremost focus since taking power. This was a major driver of his sweeping anti-corruption campaign, which in turn paved the way for his staggering reorganization of the Chinese government a year ago. The widespread conclusion among party elites that a strongman was needed to push through these sorts of reforms is why Xi was able to consolidate power in the first place – and why any hints of major dissent in Beijing can be so alarming.
It’s clearly still a work in progress. Xi is constantly griping about “entrenched interests” blocking reform, the need to enforce political discipline and the importance of ideological purity. In July, he said China’s main problems were not structural economic woes or, say, imperialist U.S. trade tactics. Rather, according to the president, the biggest issue is that “rules are not followed and implementation is ineffective.”
This may sound like an overmatched college football coach blaming his players – humans who are prone to exhaustion and the temptation to take shortcuts or put personal interest ahead of the good of the team – for struggling to execute a convoluted scheme that works only with infallible players.
Maybe, with the right amount of technocratic tinkering, disciplinary tools and ideological indoctrination, Xi really can implement the sort of efficient, corruption-free, stability-ensuring system of governance that has eluded every country in the region save for Singapore (a geographically blessed city-state that doesn’t have an existential fear of recessions) and Japan (a socially cohesive rich country that doesn’t have an existential fear of recessions).
It’s a tall order, especially given that Xi’s own grip on power is not guaranteed.
Just as likely, China will end up lacking the market-bred dynamism and/or the flawless governance needed to fulfill the extraordinary pledges the party had made to the Chinese people. Either way, to Xi, throwing out the playbook at this point isn’t really an option.
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