Politics will determine China’s economic future during Xi’s third term

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At the Twentieth Congress of the Communist Party of China, Chinese President Xi Jinping secured a third five-year term as party general secretary and made up his seven-member Politburo Standing Committee with his loyalists. These leadership appointments, along with Xi’s speech to congress, indicate that major decisions in China will now focus more on politics, especially loyalty to Xi, rather than economic outcomes.

What do the announcements made at the twentieth party congress mean about China’s economic future?

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Shanghai Party Secretary Li Qiang was promoted second in the Chinese political hierarchy. Li Qiang is known for overseeing Shanghai’s harsh COVID-19 lockdown, which had major economic consequences. His promotion shows that loyalty to Xi now seems more important than competence in economic governance. Party cadres and officials at all levels of government are likely to prioritize loyalty to Xi over the commitment to reform and opening up initiated by China’s last transformational leader, Deng Xiaoping, in 1978. .

Xi’s content speech at the party congress suggests that he is determined to reduce China’s economic vulnerability to global disruptions. Xi stressed strengthening the development of basic research and indigenous innovation to boost China’s economy and protect national security. He referred to China’s “technological autonomy” five times, the need to “strengthen supply chain reliability, resilience and security” three times, and twenty-six times China’s “national security”. None of these narratives appeared so strongly in his report to the Nineteenth Party Congress in 2017. Moreover, this year Xi called for a “diverse and stable international economic system” and reiterated his ambition for China. to exert more influence in the establishment of international rules. and standards.

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Taken together, Xi’s remarks and his choice of appointees indicate that China’s economic prospects depend more and more on politics than on supply and demand dynamics. But the supremacy of politics over market mechanisms is undermining China’s four-decade process of reform and opening up. This will likely exacerbate tensions in China’s relationship with the West and ultimately reduce China’s long-term growth potential.

A blow to the Chinese economy would have wide and deep repercussions on the global economy; China is the world’s second largest economy and the largest trading partner of more than 120 countries. Moreover, the large-scale pandemic stimulus policies that China has been pursuing since May could complicate or even undermine the inflation control measures taken by the major Western central banks.

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What are Xi’s signature economic policies?

Xi’s flagship project during his first two terms was the Belt and Road Initiative (BRI), a world-class infrastructure project. The deployment of the BRI has raised concerns among Western policymakers about China’s growing control over global strategic infrastructure and its expansive naval capability, contributing to Western resistance to Chinese influence. In his speech to the party congress, Xi referred to continued efforts to promote the BRI, but he focused more on strengthening China’s self-sufficiency in technology and supply chains through the strategy. of “dual circulation”.

Chinese President Xi Jinping prepares for a group photo with members of the Politburo Standing Committee in October 2022.
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Xi and his comrades launched the dual circulation strategy in 2020 as China’s relations with the West soured. The dual circulation strategy departs from the “going out” strategy of former Chinese leader Jiang Zemin, who ruled in the late 1990s and early 2000s. “Going out” prioritized the use of global markets to develop China’s economy, while “dual circulation” minimizes the role of global markets, or “external circulation”, and instead prioritizes “inner circulation” by developing the domestic market and consumption in China. Powerful. Xi has increasingly emphasized self-reliance for economic growth and technological innovation.

To promote domestic circulation, in December 2021, Xi proposed to build a “unified national market” and take advantage of the unified market to “agglomerate resources, promote growth, encourage innovation, optimize the division of labor and enhance competition”. In addition, Xi has repeatedly stressed the need to establish and improve a new pan-national system to achieve breakthroughs in core technologies in the face of increasingly stringent U.S. export controls. The goal is to make full use of state power to concentrate resources to enhance China’s capacity for technological development and innovation.

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What are the biggest economic challenges China could face during Xi’s third term?

The Chinese economy is facing two pressing internal challenges: weak domestic demand and ballooning debt, both linked to the difficulties in the real estate market. A slowdown in the real estate and construction market depresses demand in key industrial sectors, such as steel, concrete and chemicals, and suppresses demand for consumer goods, such as household appliances and interior decoration. In addition, the slowdown in real estate development is reducing local government revenue from sales of land use rights, which further strains their fiscal capacity and increases their indebtedness. In addition, a colossal mortgage burden weighs more on household consumption. All of these factors indicate that there will be no easy way to promote domestic circulation during Xi’s third term.

China also risks aging before getting richer in the coming decades. It struggles with low birth rates, an aging population and rising pension and social security costs. However, demographic change is not a crisis in itself; a lack of appropriate policy response is. The Chinese government has responded to demographic change by launching a three-child policy and has pledged to strengthen its childcare and social health care systems. These responses will add budgetary pressure in the future.

The most important external challenge for the Chinese economy is the escalation of geopolitical tensions between China and the West, particularly between China and the United States. China is likely to be slapped with stricter US export controls, which will severely restrict its access to advanced technologies and high-tech manufacturing equipment in strategic industries such as semiconductors, artificial intelligence and quantum computing. The deterioration of relations between China and the European Union could also prevent China from obtaining restricted technologies in European markets.

What’s next for China’s trade relationship with the United States?

The lack of pro-reform minds in the new Politburo Standing Committee suggests that Chinese trade policy and diplomacy are likely to be more assertive and less dovish, raising the risk of escalating trade tensions between the United States and China. China. A less reform-minded Chinese central leadership that prioritizes domestic traffic will likely draw increasing criticism from U.S. lawmakers and cause some U.S. companies to reevaluate their positions in China.

The Joe Biden administration is expected to expand strict export controls to more industries that China considers strategic, which will make it extremely difficult and costly for Xi to develop indigenous innovation capacity in China. Washington may be more inclined to pressure Beijing over unfair trade practices and resort to tariff and non-tariff barriers, especially in areas where China has a comparative advantage, such as the production of solar panels and wind turbines. . Xi and his loyalists are unlikely to make easy compromises. Quick reconciliation in times of trade tension will be less likely.

Certainly, trade with China remains crucial to the US economy and the American people. US exports of goods and services to China supported about 758,000 jobs in the United States in 2019, the last year for which this data is available. China was the third largest trading partner of the United States in 2021. Only 1 percent [PDF] of the $151.1 billion in U.S. exports to China in 2021 were subject to a licensing requirement by the U.S. Department of Commerce’s Bureau of Industry and Security.

Tensions in the U.S.-China trade relationship will likely continue to focus on small but highly sensitive areas. Media attention to these hot spots gives the impression that the United States and China are heading for full-scale trade decoupling. However, in reality, the countries will remain important trading partners for the foreseeable future. Both Beijing and Washington should resist the temptation to play the blame game and escalate tensions.

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