Opinion | The Real Problem With China’s Economy: Xi Jinping’s Government

China's Economy: Top-Level Issues

On the morning of August 26, 2023, at 7:00 a.m. Eastern Time.

Mr. Prasad works as an academic at Cornell University's Dyson School.

China is currently facing a critical and dangerous point. The statistics indicate that the economy is stalling, but there is a much greater worry. The people and companies in China are becoming less confident in their government's capability to acknowledge and rectify the underlying issues within the economy. Without addressing this fundamental problem, any other actions taken will have minimal effect in stopping the worsening situation.

The government of Mr. Xi has given more importance to state-owned enterprises, which closely follow the ideals of the Chinese Communist Party and are under direct government supervision, rather than the private sector. Technology companies, including successful fintech businesses like Ant Group, that were considered too large and influential have been required to split into smaller divisions and are now subjected to greater control from the state. This crackdown, which has become more severe since Mr. Xi increased his power last year through changes to the Constitution, allowing him to extend his leadership, has also affected private companies in the education and other industries. Additionally, the government's apparent unfriendliness towards foreign businesses in the midst of rising geopolitical and economic tensions with the United States and other Western nations - which could impact China's access to global markets and technology - is further exacerbating the loss of trust.

The government's refusal to change its unsustainable "zero Covid" strategy, followed by the sudden change of that strategy in December, has eroded trust in the decision-making process. This lack of confidence is evident in the sluggish private investments and feeble household spending observed throughout the past year. As individuals are concerned about the economic outlook, they are putting away more money and cutting back on major purchases such as automobiles. China's currency, the renminbi, is losing value as capital exits the country and foreign investors grow less inclined to invest in China.

During a recent visit to China, I noticed a clear contradiction between the government and business owners, which raised concerns. It was remarkable how officials in Beijing appeared relatively calm about the economy and claimed that they had taken sufficient measures to assure entrepreneurs that their contributions to the economy were recognized. However, entrepreneurs held a different perspective. They believed that the government's actions spoke louder than their words and interpreted measures taken to undermine thriving businesses as a direct display of hostility towards private enterprise.

Beijing appears to reluctantly recognize that the private sector plays a vital role in maintaining the economy's momentum. With a dwindling labor force, growth largely hinges on productivity. Private businesses, renowned for spearheading digital payment advancements and other innovations, have consistently outperformed sluggish state enterprises in terms of ingenuity and efficiency. Thus, the government's ambition to foster domestic innovation and transition the economy towards higher-tech and environmentally friendly industries cannot solely depend on massive state-run enterprises.

Companies of smaller and medium scale, especially in the services industry where more manual labor is involved, play a vital role in job creation. Although China's gross domestic product has experienced substantial growth in the past few decades, it has struggled to generate a significant number of employment opportunities. This can be attributed to the fact that a large portion of this growth stems from investments in manufacturing, whereas the government has been actively reducing the workforce in oversized state-owned enterprises. This issue becomes especially worrisome during times of economic slowdown, as highlighted by the increasing rate of unemployment among the youth population, which poses threats to social harmony and stability.

The growing concentration and sometimes careless manner of decision-making led by Mr. Xi have also damaged trust. One instance can be found in the real estate industry, which Beijing has traditionally depended on for significant economic expansion, but has faced issues due to risky investments triggered by government policies aimed at boosting mortgage lending. The Chinese authorities have appropriately taken measures to deflate this bubble, such as curbing financial support for individuals buying multiple homes and enforcing stricter criteria for eligibility.

A few real estate developers have expressed their comprehension of the government's reasoning for taking action, but they find fault with the sudden implementation of certain policy changes. This lack of preparation time has resulted in a significant decline in housing costs and construction projects, prompting the government to backtrack on some of the imposed restrictions in an attempt to balance the situation. These sudden alterations in policy do not instill much trust or confidence. Some believe that officials in Beijing are disconnected from reality and fail to grasp the impact their attitudes and policies have on businesses.

Businesses in the private sector are increasingly concerned about the rhetoric being used, as it could lead to real-world implications. China's leader, Mr. Xi, unveiled the "common prosperity" campaign last year, presenting it as a way to address public concerns about the widening wealth gap. However, successful entrepreneurs believe that this initiative specifically targets them. The campaign has led to a series of strict regulations and anti-corruption measures, which have been used to suppress private businesses, banks, and even government officials who deviate from the party's expectations.

The government's reaction to the increasing worries about the growing number of unemployed young people was to cancel the release of that information. In doing so, it seems to believe that spreading negative news is the reason behind the loss of trust. Similarly, even though it is becoming clear that prices of goods and services are dropping due to weak demand and surplus capacity in certain industries, the government is resisting the notion of deflation. Investors and analysts from other countries have stated that they have recently been denied entry to certain services offered by Wind Information, a private database that contains corporate and financial data which was previously used to highlight concerns about China's financial markets.

Although the Chinese government hasn't openly admitted the gravity of the economic predicament, there are indications that they are cognizant of the fact that the combination of internal and external obstacles is leading to a deflationary trend that will progressively pose more difficulties to tackle.

The national bank has recently decreased interest rates, however, reduced and more abundant borrowing will not encourage individuals or privately-owned companies to increase their spending if they are worried about what lies ahead. This action may also worsen the decline in currency value and the outflow of capital. Implementing strategies to minimize income taxes and increase investments in healthcare and education could slightly improve household consumption. Nonetheless, these strategies may only serve as temporary solutions.

The actual obstacle lies in the government's acknowledgment that it is impossible to turn the economy into a highly technological one with increased productivity and employment growth without establishing a strong connection with the private sector. To validate this recognition, the government needs to implement practical initiatives that aid the private sector, such as liberalizing the financial sector to channel resources towards private enterprises instead of state-owned ones. Being open about information and the policymaking process will greatly benefit the government.

President Xi may have a preference for a system where commands and controls prevail, however, he is realizing that it is extremely challenging to regulate the confidence of the private sector. Nevertheless, this confidence is of utmost importance in order to achieve his visions for the Chinese economy.

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Eswar Prasad is an esteemed faculty member at Cornell University's Dyson School, a distinguished scholar at the prestigious Brookings Institution, and the writer behind the highly acclaimed book, "The Future of Money."

Photograph credit goes to Phill Magakoe of Agence France-Presse, as showcased on Getty Images.

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