China’s focus on stability over growth may haunt it moving forward

January 17, 2022, 12:12 PM UTC

Former Chinese leader Deng Xiaoping, whose “opening and reform” drive lifted China out of grinding poverty, was fond of defending his policies with an aphorism: if you open the window to let in fresh air, he observed, don’t be surprised if a few “flies come in” too. Deng was a pragmatist. To him, what China needed above all was growth, even it if came with buzzing annoyances.

China’s current leader has zero-tolerance for flies. Xi Jinping is a perfectionist whose watchword is stability, even if it threatens to slow the rate of economic expansion. Over the past ten years, that shift in emphasis has served Xi well, putting him in a position to claim an unprecedented third term as China’s president at a crucial Communist Party congress expected to be held later this year.

And yet, as his moment of political triumph approaches, the economic trade-offs of Xi’s focus on order and control over risk and dynamism are becoming increasingly apparent. Xi’s careful policies seem certain to assure him another five years in power. But they also seem likely to create new perils for him—and China—in that third term.

There was fresh evidence of those tradeoffs Monday as China’s National Bureau of Statistics announced that China’s economic output rose 4% from October to December compared to the same three months in the previous year. That was enough to bring China’s full-year growth rate for 2021 to 8.1%—slightly better than most economists expected and easily exceeding the government’s 6% annual target. But the fourth-quarter figure confirmed that China’s economy is weak and has continued to decelerate from the July-to-September quarter, in which it managed 4.9% year-on-year growth.

Economists attributed China’s sluggish growth over the past two quarters to three of Xi’s signature “stabilizing” initiatives: a government campaign to squeeze speculation out of the nation’s residential property market that has forced the default of several developers and unnerved Chinese homeowners; citywide lockdowns and strict travel restrictions that have succeeded in containing COVID but battered consumer confidence; and an ongoing regulatory crackdown on dozens of China’s largest Internet companies that has wiped out more than $1.5 trillion in market capitalization and put hundreds of thousands of people employed by those companies out of work.

Those measures dragged China’s growth rate lower in the latter part of last year even as recovery in other economies created huge new demand for Chinese products, pushing China’s monthly trade surplus with the rest of the world to an all-time high of $94.5 billion in December, shattering the previous record of $84.5 billion set in October.

Ning Jizhe, head of the NBS, boasted that in 2021, China “sustained the continuous and steady recovery of the national economy and maintained the leading position in economic growth and epidemic prevention and control in the world.” But he conceded that “the domestic economy is under the triple pressure of demand contractions, supply shock and weakening expectations.”

Those pressures aren’t likely to subside any time soon. The consensus among Western economists is that China’s economy will grow only around 5% this year. Analysts at Goldman Sachs last week lowered their forecast for China’s 2022 GDP growth rate to 4.3%, down from 4.8%.

Over the longer term, China must grapple with the challenge of an aging, shrinking labor force. The NBS also reported on Monday that China’s birth rate fell for a fifth straight year in 2021 to the lowest in modern history. The bureau said last year’s 10.62 million births barely exceeded the 10.14 million deaths.

Over the past six months, China’s economy has been buffeted by many factors beyond its control, including soaring commodity prices, chaos in global supply chains, and a worldwide shortage in semiconductors. And China is hardly the only nation to be blindsided by Delta and Omicron, the new and more infectious variants of COVID-19.

But China’s “COVID-zero” response to the pandemic—which calls for Draconian lockdowns, massive testing campaigns, and near-total travel limits in cities where even a few cases of the virus are discovered—has put an enormous dent in consumer sentiment.

In locked-down cities, residents aren’t able to visit shops or restaurants or even leave their homes; in the northwestern city of Xi’an, which is gradually lifting restrictions after three weeks of lockdown, residents complained that they couldn’t even have access to food deliveries. In December, China’s retail sales rose just 1.7% from a year earlier.

So far China has had astonishing success in limiting the spread of the virus. The nation has reported fewer than 105,000 cases since the beginning of the pandemic—a fraction of the more than 933,000 cases reported in the U.S. on Jan. 14 alone. But in recent weeks China has reported small Omicron outbreaks in Beijing, Shanghai, Dalian, and several cities in the southern province of Guangdong. China’s inactivated vaccines seem to have little effect against Omicron, and in the absence of more powerful remedies, most experts expect Xi to stick to his COVID-zero policy until well after the conclusion of the party congress in October or November. It remains unclear how, even after that gathering, China will be able to reopen.

The squeeze on property developers is also taking a toll. The sector was flying high until 2020, when the central government announced a “Three Red Lines” policy setting strict limits on property developers’ ratios for liability to assets, debt to equity, and cash to short-term debt. The goal was to create a more stable financial system and reduce the gap between China’s rich and poor. But in recent months, the measures have pushed some of China’s largest property giants—including China Evergrande Group, Kaisa Group Holdings, Shimao Group Holdings—over the brink of default. New housing starts are falling as developers scramble to conserve cash, and home sales have slowed as Chinese families wonder whether developers can stay solvent.

The contagion now threatens Country Garden Holdings, the nation’s biggest developer by contracted sales. The company had been considered one of the property sector’s most resilient players. But last week, reports that the firm is struggling to win investor support for a convertible bond deal sent its offshore bonds tumbling. On Monday China’s central bank trimmed by a tenth of a percentage point its interest rate benchmarks for one-week and one-year lending, signaling that it stands ready to pump more money into China’s financial system if the crisis escalates.

The economic impact of Beijing’s regulatory blitzkrieg on the nation’s Internet giants is difficult to measure. Defenders of the crackdown have argued that its primary targets—large, consumer-facing Internet platforms like e-commerce giant Alibaba Group Holding, video game purveyor Tencent Group Holdings, or ride-hailing leader Didi Global—benefitted unfairly from monopolistic behavior and were “soft” technologies inessential to innovation and growth in China’s broader economy. Optimists predict investors, who have retreated from those companies in droves, will return to place their bets instead on truly innovative technology companies in “hard” sectors like semiconductors, advanced robotics, electric vehicles, or nanotechnology.

That remains to be seen. The danger is that the state’s harsh treatment of the technology firms and their founders has dampened the unpredictable and often chaotic entrepreneurial zeal that has been the hallmark of China’s spectacular economic rise. Another of Deng’s famous aphorisms holds that “it doesn’t matter whether the cat is black or white as long as it catches mice.” In Xi’s China, the cats are learning that color does matter—and that all felines are much safer if they are the proper shade of red.

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