Xi Jinping’s Moment of Economic Reckoning

During the 1980s, as China plotted its way toward national recovery and strength following years of political and economic chaos under former leader Mao Zedong, it benefitted from a historically rare and golden combination of smart reform moves and profoundly lucky timing.

Even before Deng Xiaoping’s anointment in 1980 and 1981, Mao’s hand-chosen (and now largely forgotten) immediate successor, Hua Guofeng, began experimenting with ways to loosen the state’s stranglehold on the economy, which had long banned private enterprise and markets and relied instead on central planning for virtually everything that China produced.

Deng subsequently received almost all the credit for China’s extraordinary takeoff in the second half of the decade, even though much younger officials—such as Hu Yaobang, who was chairman and later general secretary of the Communist Party, and especially Zhao Ziyang, the country’s premier in the pre-Tiananmen Square massacre years—oversaw the generation and implementation of this new economic thinking.

To a far greater extent than many experts recognize even today, the ideas that these men carried out came from abroad, as economist Julian Gewirtz documented in his recent account of the country’s reform era: Never Turn Back: China and the Forbidden History of the 1980s. Chinese officials consulted with Eastern European economists who were involved in plotting their own countries’ way out of state-dominated markets, and they scrupulously studied the successes of nearby Asian countries, such as Japan and Singapore.

To their credit, instead of trying to reinvent the wheel, they overcame a powerful bias that has long existed in Chinese society of insisting on putatively native solutions to China’s problems by drawing on foreign ideas. This allowed them to quickly throw open the doors of their recently autarkic country to the international economy and radically reorient its strategy to one based on manufacturing for export.

Here, the first in a long string of lucky strokes came with changing tides in international relations. Japan, eager to find ways of sustaining its own then-fast economic growth, provided substantial help to China by extending loans, investment, technology, and advice to its neighbor. And the United States, seeking an edge in its Cold War competition with the Soviet Union, helped usher in a period of warmer relations with China, allowing the World Bank to play a major role in the reforms and welcoming large numbers of Chinese students who were heavily concentrated in economically relevant areas like science and technology.

Another great source of good fortune for China at this very moment was its shifting demographics. The country was entering into what population experts call a “demographic dividend,” a situation when the number of working age people, and especially those skewed toward the younger end of this range, is high compared to the dependent population, meaning children and older adults.

These young workers eagerly poured into China’s factories, first in the so-called special economic zones, such as Shenzhen and Zhuhai, that were rolled out during the Deng-era reforms and then onto shop floors throughout China as the country rapidly industrialized and became known as the world’s factory.

As this happened, China began to reap bigger and bigger trade surpluses and invested enormously in infrastructure. This term is usually understood as physically tangible things, such as rail and road projects, subways, ports, and fancy air travel facilities—all of which the country began to roll out in astonishing quantities. Yet that provides a too narrow sense of what infrastructure meant to China’s rise in the reform era.

Infrastructure was also understood to include a human dimension, and China began investing in upgrading its population as much as it did in physical things. The numbers of university graduates began to soar, with a particular focus on engineering and science. Crucially, education for women opened dramatically too, and in time, the workplace and career worlds largely followed.

With this mixture of good moves and good fortune, many scholars around the world—and in China—gradually came to see the country as a virtually unstoppable force economically, rising decade after decade almost as if without resistance. Over a three-decade period starting in 1990, China’s real GDP per capita increased nearly tenfold while urban wages quadrupled.

In a remarkably short period of time, however, that widely held sentiment has dramatically shifted, just as the country’s growth rates have downshifted more sharply after several years of steady, more moderate decline. In fact, things have now reached the point where some observers, myself included, are predicting that the world’s most populous country will not manage to claim, or at least hold for long, the title of world’s largest economy.

As the Chinese Communist Party opens its high-level Party Congress this week to consecrate Chinese President Xi Jinping as leader for a precedent-breaking third term, beneath the carefully polished surface of ritualized praise and approval, many of the offstage conversations will be about how to restore the country’s economic momentum.

To understand this requires stripping away from the word “repression” its usual political connotations and reimagining the phrase in purely economic terms. Used here, what it means is that China made it difficult for its citizens to consume. This was accomplished by keeping the interest rates that banks pay depositors artificially low, limiting access to foreign exchanges or personal investments outside of the country and slow-walking reforms to the domestic stock market that could make it more transparent and globalized and less like a casino run by powerful insiders.

Even as they grew richer and richer, these limitations left most Chinese citizens with only two choices for what to do with their money. They could place it in bank accounts that paid little, allowing the state to use the capital cheaply for its own purposes. Or they could invest in the only vehicle that seemed to offer them a big upside: real estate. That they did both of these things in huge numbers explains a lot about the country’s present predicament.

The Chinese state used its access to enormous national savings to pursue an investment-driven approach to economic growth, with the state making strategic decisions about which companies and sectors to back in a process it hoped would produce so-called national champions—that is, domestically dominant companies. This was seen as a necessary first step toward creating world-beating corporations that could roll out globally powerful brands, of which China so far has surprisingly few.

Citizens, meanwhile, poured whatever funds they could into real estate, taking the rosy but unrealistic view that in a rapidly urbanizing country with so many people, property values could only go in one direction: up. Today, as a result, the property sector accounts for an astonishing 20 percent to 30 percent of all economic activity in the country.

As an economic model, this costly strategy has crowded out consumption and engendered tremendous waste. This is best seen in officials’ continued addiction to big-ticket infrastructure projects—new highways, new high-speed trains, new subways even in already well-served areas—to sustain high levels of economic activity. Considerations of the long-term costs and benefits of many investments of this kind have been tossed out to keep propping up sagging topline GDP numbers and bolster the legitimacy of the country’s leadership.

For all of its past successes, this approach, in other words, has reached the end of its useful life span. Making matters worse, the state’s record of picking would-be corporate winners to back in what it deems to be the most strategically important sectors of the future has been mixed at best. With little success, China has poured untold billions of dollars into the passenger aircraft and microchip industries, for example, determined that Beijing must become a leader in these (and other) fields.

In the meantime, Chinese real estate, long seen by citizens as the best alternative for personal investment in a casino-like stock market, has come to look more and more like a Ponzi scheme. For decades, local governments in China have funded their operations by selling access to land and issuing permits to builders. But this has led to a bubble, with enormous quantities of housing stock and other real estate going unoccupied, creating unsustainable debts and a reversal of personal fortunes for the tens of millions of people who invested their savings so heavily in the sector.

This points to an additional crisis. The fact that people in China save more than in almost any other nation was once widely regarded as something of a cultural quirk. In reality, it is the result of insecurity about their financial futures based on the existence of a still nearly embryonic welfare state.

Chinese are both saving and investing in real estate for the day when they will have to finance their retirements and pay for the care of costly and incurable chronic conditions, such as diabetes and dementia, that proliferate with aging. They do so because the state, so eager to produce world-beating growth in recent decades, has put off the kinds of giant safety net investments that can provide more security.

Finally, this is all happening at a time when the population dynamics only recently so favorable to the country have grown starkly adverse. China’s population has begun aging with a speed and scale unmatched in history. Between 2012 and 2021, the country’s birth rate declined by a head-spinning 45 percent, meaning far fewer workers in the future to help pay for the retired and ill older adults of tomorrow.

This dramatic shift is only partly due to the so-called one-child policy, introduced nationwide in 1980 and only relaxed in 2016. It also reflects an unintended and seemingly unanticipated consequence that flowed from one of the country’s signal successes. By providing women access to education, the workplace, and careers in ever larger numbers during the reform era, the country enabled women to pursue fulfillment in both work and leisure, freeing millions of people from the traditionally confining role of motherhood.

Women in China have seized these opportunities with gusto, just as they have in other highly developed societies—with one crucial distinction. Shifts like these occurred in the West and in Japan and South Korea only after these societies had begun to reach a level of high per capita income. China, by this measure, is still relatively poor—and as I have previously written, this also will make the funding of so-called entitlements, meaning elder care and social security systems, much more difficult.

This means loosening up and relinquishing some control over people’s savings by abandoning financial repression as well as scaling back investment-driven growth and the costly efforts of picking winners that accompany it. A growing, classic guns-versus-butter dilemma means it may also require taking the foot off the pedal some in terms of the build-out of an ever larger and more costly national security state, which not only includes the ongoing rapid modernization of the world’s largest military but also its biggest and almost certainly most costly domestic security apparatus.

This would be difficult enough to imagine under any circumstances, but it is especially hard to do in a situation of increasingly direct rivalry with the United States. Unfortunately for China, like it or not, a stark reckoning with difficult choices like these is coming. The choice before the new Xi leadership team is whether to try to kick the can down the road—when the pain from overdue choices will be ever greater thanks to the population’s rapid aging—or whether a leader who seems to brook no criticism bites the bullet now.