The recently concluded Third Plenum of the Chinese Communist Party (CCP) 20th Central Committee did not produce any major surprises or unexpected policy shifts. Rather, the conclave was mostly an exercise in reiterating policy priorities announced in the last three years. These include channeling resources away from highly leveraged, unproductive sectors such as real estate to the industries of the future (“new quality productive forces” in CCP speak); promoting innovation and self-sufficiency in high-tech industries; reducing the debt burden of local governments; and more subtly, the prioritization of national security and common prosperity over short-term GDP growth.
Analysts who had hoped the Third Plenum would deliver a large fiscal stimulus to boost domestic demand, steps to rescue the ailing property sector, or hukou and social security reforms to increase the share of domestic consumption, were disappointed. Despite more than ample evidence that China’s current slowdown is driven by insufficient demand, high savings, debt deflation, and falling property prices and investments, concrete measures to shore up investor confidence and raise household consumption as a share of GDP were conspicuously lacking.
This suggests a mismatch between what the Chinese economy needs to recover quickly and what policymakers are prepared to deliver. Do China’s policymakers understand the near-term threats confronting the Chinese economy and what is needed to spur a recovery?
At one level, their reluctance to pump-prime the Chinese economy is understandable. Chinese policymakers may not have predicted that their crackdown on real estate would induce the sharp and prolonged fall in property prices and investments it did over the last three years. But they can argue that it has, nonetheless, produced the desired results of deleveraging, more affordable housing, and an end to a decades-long, debt-fueled property boom that was clearly unsustainable.
China’s policymakers may also view the deflating property market as a necessary price to pay to catalyze a reallocation of resources to the more productive parts of the economy – advanced manufacturing, renewable energy equipment and infrastructure, and industries that produce or deploy artificial intelligence. Besides, the economy is still growing at nearly 5 percent, exports growth is positive, unemployment (especially youth unemployment) seems to have stabilized, and property prices may soon bottom out.
Chinese leaders may well conclude that not only is there no need to boost domestic demand through fiscal or monetary stimulus, nor rescue the ailing the property sector, but that doing so would undo the progress they have made in correcting the economic imbalances and rising debt levels that have plagued the Chinese economy over the last 15 years.
China’s policymakers probably believe that what the economy needs is not a short-term stimulus but a long-term shift to the industries and technologies of the future. Such a policy intent may well be a correct and desirable one. But the key question is whether the policy means and instruments that are used will produce the intended results. Just because the authorities have the right policy intent does not automatically mean that they would use the right policy instruments or means to achieve it.
There are at least three reasons to doubt that the means currently employed will produce the desired results. The first is that underlying the push into “new quality productive forces” is the belief that supply creates its own demand, that increasing production (naturally) increases consumption. This assumption is quite suspect; the causal relationship probably runs the other way.
Whatever the case, inadequate consideration of where the demand for all the additional supply will come from is already producing quite predictable but unintended consequences: falling prices of electric vehicles and solar panels globally, falling producer prices and the threat of deflation in China, and a backlash in much of the developed world as China’s trade surpluses balloon.
Chinese policymakers would also do well to remind themselves that export competitiveness can easily co-exist with domestic stagnation. During Japan’s lost decades for instance, its export-led manufacturers were still competitive globally. Japan’s problem was never one of sustaining export growth. Instead, its stagnation was caused by weak domestic demand, debt deleveraging, deflation, and slow growth in household incomes – all problems that currently plague the Chinese economy.
In short, even if China’s manufacturers are highly competitive and the country’s export growth remains strong, this is insufficient to offset weak domestic demand. This risk is amplified by the forces pushing toward decoupling – something that Japan did not have to contend with.
The second fallacy that Chinese policymakers subscribe to is that their state-dominated, social-engineering approach to industrial policy will continue to work as well as it has in the past. While industrial targeting and subsidies worked well when China was playing catch-up in manufacturing, they are unlikely to work as well when the economy is near, or already at, the technology frontier. Industrial policy is also more effective if it is combined with market competition to weed out losers (i.e., uncompetitive firms), rather than if it relies on subsidies to prop up companies that would not otherwise survive.
The Chinese economy has also become far more complex in the last decade or so; it is now much less apparent which technologies, industries, or firms are likely to be future winners. This isn’t to suggest that industrial policy is doomed to fail or that policymakers will always pick the wrong horses, but it does mean that the risk of costly policy errors is higher. It also implies that Industrial policymakers must be highly attuned to market signals, cut losses quickly, and make mid-course corrections. But in a policy environment that has become less tolerant of experimentation and learning from mistakes, and more driven by top-down diktats, one doubts whether industrial policies in China would be as adaptable and flexible as they were previously .
The third risk is that when policy is driven by ideologically-motivated directives from the top, rather than by market signals, it tends to lurch from one extreme to another. For example, until 2020, Chinese policy toward the consumer internet industry (e.g., e-commerce, gaming, consumer finance) was largely accommodative, if not highly supportive, even though there were already well-known problems with the industry. Suddenly in late 2020, Chinese regulators received the signal from above that the sector’s growth should be crimped. A heavy-handed regulatory crackdown ensued, resulting in an industry that has since lost more than 60 percent of its market capitalization – and shows no sign of recovering.
The same can be said of how China’s approach to the COVID-19 pandemic lurched from excessive containment to a sudden and abrupt lifting of all pandemic control measures. Not only did this sudden change fail to deliver a big boost to the economy, but it likely traumatized Chinese consumers and raised precautionary savings. Consequently, China never had the post-COVID rebound that almost every other major economy had.
In an environment where the shocks faced by the private sector faces are generated not just by the market, but also by state’s mixed signals and sudden policy changes, it is hard for agents – firms and households – to plan and invest for the long-term. The consequence is an economy where investors’ animal spirits remain depressed, consumer confidence is weak, and small shocks and bad news are all too easily amplified.
Rather than buffer the economy from external shocks and bolster its flexibility and resilience, a more ideologically-oriented, security-obsessed government may be causing uncertainly and volatility, and delaying its recovery.