Chartbook 234: Whither China? Part III: Policy hubris and the end of infallibility

China’s economy is in trouble because its authoritarian demons are catching up with it and paralyzing the private sector.

China’s economy is in trouble because its growth model exhausted itself and entrenched power structures make it hard to shift gear.

The distinction between the “authoritarian impasse” and “structural Keynesian” interpretations of China’s economic situation is clear enough.

Both are very powerful explanations rooted in well-established social scientific models - institutional economics and Keynesian macro, respectively.

The “authoritarian impasse” model focuses on property rights and the supposed inevitability that at some point an authoritarian regime will succumb to the temptation to abuse them unleashing a downward spiral into a condition Posen compares to that of Russia, Turkey or Venezuela.

In Pettis’s model, based on macroeconomic flows - investment, consumption, government spending - what ultimately sets the limit on growth is the rate at which the economy can productively absorb new physical assets. When that limit is reached, the investment-driven growth model becomes dysfunctional. This too provides a powerful way of understanding China’s current impasse.

What both these strong models also have in common is that neither has a very precise account of the particular recessionary dynamics that China is currently suffering or why they emerged when they did.

Posen waives the real estate crisis aside to focus on the shock impact of the second round of zero COVID measures in 2022, which revealed the fragility of “no politics, no problem” standoff between the regime and the population. He doesn’t offer an account of why zero COVID should have been the moment when the true nature of the regime revealed itself to the Chinese population at large. But on Posen’s reading it was, in any case, only a matter of time. The result, as Pettis points out, is that in Posen’s narrative the slowdown has come abruptly.

Pettis, by contrast, has been bearish about the prospects for China’s growth for many years. The implosion in real estate confirms that pessimism in broad terms. But it also poses questions for the Pettis interpretation, because, contrary to the normally growth-fixated logic of Beijing’s policy - a fixation which is a key element in Pettis’s crisis model - China’s real estate crunch was induced, by the regime opting for stability over growth.

Whether we side with Posen or Pettis, we need a more particular policy narrative to explain how China and Xi’s regime have ended up in the particular impasse they face in the summer of 2023. The key theme of that narrative is not authoritarianism, or fixation on growth, but overconfidence and hubris.

***

Such a narrative might well start with COVID. But it would start not in 2022, but with the first wave in the spring of 2020, which in China, unlike in the rest of the world, was successfully contained.

The victory in the “People’s War” against COVID in the spring of 2020 triumphantly vindicated the improvised policy of zero Covid imposed in late January and February 2020. That comprehensive lockdown policy, of course, suited the particular proclivities and resources of the CCP regime. And it is worth remembering that at the time it seemed to many, not just in China’s leadership, that the emerging conditions of the anthropocene favored solutions that relied on rapid blanket action. Pandemic-reality appeared to have an “authoritarian bias”. The shambles of COVID policy in the West gifted Beijing a huge propaganda victory.

With its mandate from heaven confirmed, Xi’s regime turned bold. In May 2020 Xi’s regime pivoted to address three perceived threats to its undisputed and broadly popular rule - tech oligarchs, Hong Kong, and the giant housing bubble. All of these were issues of longer standing. In what appeared to be the aftermath of the COVID crisis, the summer of 2020 seemed like a good moment to tackle them.

If unfettered political power has an “original sin” problem - it cannot bind itself to behave responsibly and not threaten the conditions of long-term general prosperity - so too does unfettered capitalism. Predatory capitalists cannot credibly commit to behaving like reasonable competitors, even if that is for the good of the economy as a whole, or staying out of politics, even if a clear demarcation between law-making and the economy benefits long-run growth.

Whereas the West lives with the capricious power of Elon Musk, the CCP decided to show Jack Ma who is boss. What Beijing is not going to tolerate is robber baron capitalism - an oligarchy so extreme that some in the West have taken to calling our era one of neo-feudalism (More on that in a future newsletter. More a symptom than a diagnosis in my view).

Clearly, Beijing does not practice the rule of law in the manner of the EU competition authorities, for instance. The crackdown on big tech was a menacing intervention. But, in interpreting it, we should not start with a mom and pop, Jeffersonian model of competitive capitalism. What China’s regime has done is to aggressively reorganize an oligarchic political economy in a highly concentrated sector. That will no doubt cool spirits in China’s platform economy and act as a warning sign to other billionaires, but its long-run impact on overall growth is hard to gauge. It seems implausible to suggest that it will deter Chinese entrepreneurs from hungering after immense wealth and working creatively and furiously hard to attain it. The huge surge of innovation, investment and growth in renewable energy and EVs betokens as much.

The move against the Hong Kong opposition was driven by the prospect of an embarrassing outcome in upcoming elections. As far as its impact on the economy is concerned, the repression had at least the tacit acceptance of major business interests in Hong Kong. Many of those elites are clearly of the view that if opposition and free speech per se are not bad for business, regular clashes between opposition and regime surely are. The crackdown may be odious to liberals everywhere, but it is popular with the majority in the mainland including the Chinese staff of many Western firms that straddle Hong Kong and the mainland. The regime’s bigger project vis a vis Hong Kong is not to stop growth there, but, on the contrary, to bring it up to mainland standards and speed by integrating the city into a vast economic area in the South.

Finally, and most importantly in August 2020, with the Three Red Lines policy, came the decisive turn in housing and real estate. There is MUCH more to be said about this in a future installment in the newsletter series. The point here is simply to locate this turn in relation to the authoritarian impasse (Posen) and structural Keynesian (Pettis) views.

Posen dismisses real estate as nothing more than a sectoral crisis. This is unconvincing in his own terms. Real estate has not only been the biggest single growth-driver in the Chinese economy. If anything embodies the “no politics. no problem” growth bargain for modern Chinese it is property ownership. Owning property is what the Chinese dream promises. If as Posen suggests, the shock that matters is that to the Chinese population at large, not just to big business owners, then real estate is not any-old sector, but the crisis to focus on.

Were the Three Red Line interventions of August 2020 an example of unfettered sovereign power demonstrating the risks of original sin? Hardly. Every analyst around the world had been telling Beijing for years that something needed to be done to deflate the real estate boom. What Beijing is involved in is an exceptionally ambitious macroprudential intervention, trying to reduce systemic risk by allowing the managed collapse of certain over-extended private real estate developers.

The slogan under which Xi authorized the action was telling: “Homes are for living in. Not speculating with.” i.e. Xi claimed to be acting precisely to protect the right to a secure place to live, against the rampant commercialization of real estate. If broad-based incentives and participation in the economy are what you are interested in, then there is a good case to be made that “Homes are for living in” should be your slogan. The opposite logic can be seen at work in the demoralizing excesses of real estate hot spots such as Sydney, Seattle, Seoul, London or the Bay Area.

But what was also always clear, was that Beijing’s decision abruptly to deflate China’s giant housing economy was unprecedented. No other government had ever undertaken a similar preemptive move against a bubble of comparable scale - no one in the West before 2008, for instance. The policy was very risky. In the short-run it was going to inflict large losses on existing stakeholders some of whom were operating with considerable leverage. The fall out, even in the best case, would be protracted. That increased the chance of the property slowdown coinciding with other shocks. And that is what happened.

In 2021, though a slow-motion crisis was unfolding in real estate, China’s economy was doing better than most of the rest of the world. Life in much of China was untouched by COVID. Exports were booming. Compared to the West China’s trajectory through the crisis looked far superior. Then, disaster struck in the form of Omicron.

There is much to be said about the failure of Beijing to prepare adequately for Omicron, notably the failure to vaccinate adequately - an instance of the regime shrinking from coercion when it might have yielded benefits. The important points to make here are twofold:

• First, it was the development of the virus over time that turned Zero Covid from a spectacular success in 2020 into an oppressive debacle two years later. It was the virus that mutated and not Xi’s regime.

• Secondly, the seriousness of the blow to the Chinese economy in 2022 resulted from the coincidence of the desperate effort to uphold zero COVID with the high-risk effort to deflate the real estate bubble.

***

The current acute sense of crisis, which both Posen and Pettis claim as confirming their structural interpretation of China’s problems, in fact resulted not from deep authoritarianism so much as over-confidence and slowness to react to changing circumstances, and it resulted not so much from the relentless pursuit of growth as a bold decision to prioritize medium and long-term stability and security.

If Xi’s regime had not emerged so self-confident from the initial success of its COVID policy in early 2020, if it had deferred its high-risk plan to deflate the housing bubble until after COVD was brought under control around the world, if it had recognized the threat posed by Western COVID variants, vaccinated more comprehensively and prepared the health system, if it had been ready, on that basis, to soften zero COVID at an earlier date, China would not have faced the devastating confluence of recessionary tendencies that have dealt it such a blow in 2022 and 2023.

If you are committed to a structural interpretation, you could, of course, insist that Beijing’s propensity to make such misjudgments reflects the increasingly enclosed system of power around Xi, the lack of good advice etc. It is easy to imagine better policies with more perfect timing. But, if we say that it is authoritarianism that explains clumsy policy on the part of Beijing since 2020, what counterfactual are we invoking? How many governments around the world - democratic, populist or authoritarian - actually have much to be proud of in their COVID response? And consider the unprecedented scale of China’s growth boom since the late 1990s. In light of the track-record of economic policy-makers in Japan, Europe and the US, faced with much smaller real estate booms, why would we jump to the conclusion that China’s main problem is its authoritarianism?

This is not to say that the authoritarian tendencies of Xi’s regime are not oppressive and discouraging to private initiative. This is not to say that the lopsided investment-heavy growth model that China has hitherto pursued is sustainable. But China’s current crisis cannot be understood unless we also allow for the role of overconfidence, risk-taking and, possibly, miscalculation on the part of a regime facing an unprecedented array of challenges.

We do not yet know how the real estate crisis will work itself out. Beijing may yet manage the crisis - more on that in a future installment in this mini-series. But, in the mean time, one important novelty is simply that the CCP regime has lost the nimbus of infallibility that had emerged enhanced by the first phase of the COVID crisis.

***

Thank you for reading Chartbook Newsletter. It is rewarding to write. I love sending it out for free to readers around the world. But it takes a lot of work. What sustains the effort are voluntary subscriptions from paying supporters. If you are enjoying the newsletter and would like to join the group of supporters click below. As a token of appreciation you will receive the full Top Links emails several times per week.