In early 2022, hopes were growing that the Chinese economy, and thus the global economy, was poised to take off. After three years of strict travel restrictions, mandatory mass testing, and endless lockdowns, the Chinese government has suddenly decided to abandon its “zero COVID” policy, which has stifled demand, hampered production, rattled supply chains, and caused the country’s economy to slow significantly since market reforms began at the end of 70s.
In the weeks following the policy change, world prices for oil, copper and other commodities rose on expectations that Chinese demand for them would rise sharply. In March, then-Chinese Prime Minister Li Keqiang announced expectations for real GDP growth of around 5%. And many external analysts predicted that it would be much higher.
At first, some sectors of the Chinese economy did grow: pent-up demand for domestic tourism, hospitality and retail trade made a significant contribution to the recovery. Exports surged in the first few months of 2023, and even the relentlessly falling residential real estate market seemed to finally bounce off the bottom.
“But at the end of the second quarter, the latest GDP data showed a very different picture: overall growth was weak and appeared to be on a downward trend. Cautious foreign investors and tight-lipped local governments in China decided not to sustain the initial momentumAdam Posehn, president of the Peterson Institute for International Economics, writes in an article for Foreign Affairs.
He notes that the first quarter of 2020, which saw the onset of COVID, marked a point of no return for Chinese economic behavior, which began to change as early as 2015 as the state expanded its control. Since then, household savings as a share of GDP have risen by a whopping 50% and have remained at that high level ever since. Consumption of durable goods in the private sector has fallen by about a third since the beginning of 2015, continuing to decline since the lifting of restrictions.
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“Private investment is even weaker, down a historic two-thirds from the first quarter of 2015, including a 25% drop since the start of the pandemic. And both of these key forms of private sector investment continue to show further downward trends. The financial markets, and probably even the Chinese government itself, have ignored the severity of these weaknesses, which are likely to drag economic growth down for several more years.”the author writes, calling this state of affairs the “economic long COVID”.
Like a patient suffering from this chronic disease, China’s economy has not regained its vitality and remains sluggish even now that the acute phase of lockdowns has passed. Posehn writes that since the 1970s, when Deng Xiaoping launched his reforms to open up the Chinese economy, Beijing has tried to avoid intervening in the private sector. And he managed to do it longer than expected. But under Xi Jinping, China finally succumbed to the temptation and began to act according to a pattern familiar enough to autocratic regimes.
As a rule, such regimes begin with a social contract in the spirit of “no politics – no problems.” He promises the opportunity to freely conduct business for those who “keep a low profile.” But after being re-elected for a second, and often a third term in office, leaders begin to ignore commercial interests and pursue interventionist policies when it suits their short-term goals. They showcase their crackdown on several political rivals or international companies.
«Over time, the threat of state control over everyday commerce spreads to an ever larger segment of the population. At various times, Hugo Chavez and Nicolas Maduro in Venezuela, Recep Tayyip Erdogan in Turkey, Viktor Orban in Hungary, and Vladimir Putin in Russia have turned onto this already well-trodden path.” – the article says.
When an ingrained authoritarian regime violates the social contract in the spirit of “no politics, no problems,” the economic consequences become all-encompassing. Faced with uncertainty beyond their control, people try to hedge. They are holding on to cash, investing and spending less than before, especially on illiquid assets like cars, small business equipment and real estate.
«Their heightened risk aversion and large savings act as a deterrent to growth, similar to what happens after the financial crisis.“, – explains the author.
Meanwhile, the government’s ability to manage the economy and protect it from macroeconomic shocks is diminishing. Because people know that certain policies are arbitrary, that they can be extended one day and dropped the next, they become less sensitive to stimulus plans and similar initiatives. This is also a familiar pattern.
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In Turkey, for example, Erdogan has been pressuring the central bank in recent years to cut interest rates, which he hoped would fuel an investment boom. Instead, it caused inflation to skyrocket. In Hungary, a large fiscal and monetary stimulus package failed to dampen the economic impact of the pandemic, despite the success of similar measures in neighboring countries.
A similar trend is already being seen in China, as Xi Jinping succeeded in strengthening the Chinese private sector’s “immune response” to government intervention. Stimulus packages introduced after the end of the “Zero COVID” policy, which aimed to increase consumer spending on cars and other durable goods, have not been widely adopted. And in the first half of this year, the share of Chinese companies applying for bank loans remained about as weak as it was in 2021, about half the pre-COVID average. This is despite efforts by the Central Bank and the Finance Ministry to encourage borrowing at low interest rates. Low appetite for illiquid investments and low response to supportive macroeconomic policies – this is the “economic long COVID”.
«Once an authoritarian regime has lost the trust of the average household and business, it is difficult to regain it. A return to good economic performance alone is not enough, as it does not eliminate the risk of impending disruptions or expropriations. The Achilles heel of the autocrat is an innate inability to self-restraint“, the article says.
To seriously commit to such abstention would be to recognize the potential for abuse of power. It is because of these commitment issues that more democratic countries adopt constitutions and their legislatures oversee budgets.
Consciously or not, the Chinese Communist Party has gone even further in the wrong direction. In March, the National People’s Congress changed its legislative procedures to make it easier, not harder, to pass emergency laws. Now such laws require the approval of only the Congressional Standing Committee, made up of a minority of high-ranking party loyalists. Many outside observers have not grasped the significance of this change. But its practical impact on economic policy will not go unnoticed among households and businesses, which will become even more vulnerable to party fiat.
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In recent months, Bank of America, Economist Intelligence Unit Goldman Sachs have adjusted their forecasts for Chinese GDP growth in 2023 downward by at least 0.4%. But with the “protracted economic COVID” still unabated, and with many forecasts erroneously assuming Beijing’s stimulus programs will be effective, China watchers are still reassessing growth prospects next year and beyond. .
«Forecasts of annual GDP growth in 2024 of the Organization for Economic Cooperation and Development (5.1%) and the International Monetary Fund (more modest 4.5%) may be overestimated by 0.5% or more. The need for a downward correction will only increase over time“, – says Posen.
China’s private sector will save more, invest less and risk less than it did before the economic crisis hit, not to mention Xi Jinping’s second term. Durable goods consumption and private sector investment will become even less sensitive to stimulus policies. The likely consequences are a more unstable economy and higher public debt (because more fiscal stimulus will be needed to achieve the desired effect). This, in turn, will lead to a slowdown in average economic growth over time due to lower labor productivity growth, as well as a reduction in private investment in the near term.
However, Xi Jinping and other Communist Party leaders may simply take this as confirmation of their belief that the country’s economic future depends not so much on the private sector as on state-owned enterprises. Even before the pandemic, government pressure was forcing banks and investment funds to favor state-owned enterprises when lending, while investment in the private sector declined.
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A study by economist Nicholas Lardy found that the share of annual investment directed to Chinese private sector firms peaked in 2015, while the share of state-owned enterprises has risen markedly year on year since then. “Prolonged economic COVID” will exacerbate this trend for two reasons.
«First, private investors and small businesses will be careful to maintain liquidity instead of making big bets financed by loans. Second, any tax cuts or stimulus programs targeted at the private sector will have a slower return than investments in the public sector.‘ explains Posehn.
Added to this, he believes, is Xi Jinping’s constant pursuit of self-sufficiency in cutting-edge technology, which is causing an increasing proportion of investment decisions to fall under increasingly arbitrary party control. In such an environment, the prospects for growth in productivity and capital returns only dim.
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