Published in the Wall Street Journal on 24 September 2020
China is the only major world economy reporting any economic growth today. It went first into Covid-19 and was first out, grinding out 3.2% growth in the most recent quarter while the U.S. shrank 9.5% and other advanced economies endured double-digit declines. High-tech monitoring, comprehensive testing and aggressive top-down containment measures enabled China to get the virus under control while others struggled. The Middle Kingdom may even deliver a modest year-over-year economic expansion in 2020.
This rebound is real, but behind the short-term numbers the economic restart is dubious. China’s growth spurt isn’t the beginning of a robust recovery but an uneven bounce fueled by infrastructure construction. Second-quarter data showed the same imbalance other nations are wrestling with: Investment contributed 5 percentage points to growth, while consumption fell, subtracting 2.3 points.
Since 2017, the China Dashboard, a joint project of Rhodium Group and the Asia Society Policy Institute, has tracked economic policy in China closely for signs of progress. Despite repeated commitments from Chinese authorities to open up and address the country’s overreliance on debt, the China Dashboard has observed delayed attempts and even backtracking on reforms. The Covid-19 outbreak offered an opportunity for Beijing to shift course and deliver on market reforms. Signals from leaders this spring hinted at fixing defunct market mechanisms. But notably, the long list of reforms promised in May was almost the same as previous lists—such as separating capital management from business management at state firms and opening up to foreign investment while increasing the “quality” of outbound investment—which were adopted by the Third Plenum in 2013. In other words, promised recent reforms didn’t happen, and nothing in the new pronouncements explains why or how this time will be different.
An honest look at the forces behind China’s growth this year shows a doubling down on state-managed solutions, not real reform. State-owned entities, or SOEs, drove China’s investment-led recovery. In the first half of 2020, according to China’s National Bureau of Statistics, fixed-asset investment grew by 2.1% among SOEs and decreased by 7.3% in the private sector. Finished product inventory for domestic private firms rose sharply in the same period—a sign of sales difficulty—while SOE inventory decreased slightly, showing the uneven nature of China’s growth.
Perhaps the most significant demonstration of mistrust in markets is the “internal circulation” program first floated by President Xi Jinping in May. On the surface, this new initiative is supposed to expand domestic demand to complement, but not replace, external demand. But Beijing is trying to boost home consumption by making it a political priority. With household demand still shrinking, expect more subsidies to producers and other government interventions, rather than measures that empower buyers. Dictating to markets and decreeing that consumption will rise aren’t the hallmarks of an advanced economy.
The pandemic has forced every country to put short-term stability above future concerns, but no other country has looming burdens like China’s. In June the State Council ordered banks to “give up” 1.5 trillion yuan (around $220 billion) in profit, the only lever of control authorities have to reduce debt costs and support growth. In August China’s economic planning agency ordered six banks to set aside a quota to fund infrastructure construction with long-term loans at below-market rates. These temporary solutions threaten the financial stability of a system that is already overleveraged, pointing to more bank defaults and restructurings ahead.
China also faces mounting costs abroad. By pumping up production over the past six months, as domestic demand stagnated, Beijing has ballooned its trade surplus, fueling an international backlash against state-driven capitalism that goes far beyond Washington. The U.S. has pulled the plug on some channels for immigration, financial flows and technology engagement. Without naming China, a European Commission policy paper in June took aim at “subsidies granted by non-EU governments to companies in the EU.” Governments and industry groups in Germany, the Netherlands, France and Italy are also pushing China to change.
Misgivings about Beijing’s direction are evident even among foreign firms that have invested trillions of dollars in China in recent decades. A July 2020 UBS Evidence Lab survey of more than 1,000 chief financial officers across sectors in the U.S., China and North Asia found that 75% of respondents are considering moving some production out of China or have already done so. Nearly half the American executives with plans to leave said they would relocate more than 60% of their firms’ China-based production. Earlier this year Beijing floated economic reforms intended to forestall an exodus of foreign companies, but nothing has come of it.
For years, the world has watched and waited for China to become more like a free-market economy, thereby reducing American security concerns. At a time of profound stress world-wide, the multiple gauges of reform we have been monitoring through the China Dashboard point in the opposite direction. China’s economic norms are diverging from, rather than converging with, the West’s. Long-promised changes detailed at the beginning of the Xi era haven’t materialized.
Though Beijing talks about “market allocation” efficiency, it isn’t guided by what mainstream economists would call market principles. The Chinese economy is instead a system of state capitalism in which the arbiter is an uncontestable political authority. That may or may not work for China, but it isn’t what liberal democracies thought they would get when they invited China to take a leading role in the world economy.