Xi Prepares to Eat Economic Bitterness

Chinese President Xi Jinping always knew it was a matter of when, not if, China’s economic miracle would reach its zenith. Anticipating today’s economic storm, Xi spent many years battening down the hatches and laying the ideological groundwork for his boldest gambit yet: transforming China from an export-dependent, debt-saddled behemoth into a resilient, self-reliant powerhouse. Now, Xi’s moment to implement his vision has arrived—albeit more quickly than he likely expected.

In the West, where democracies demand leaders prioritize near-term economic results, Xi’s restrained response to China’s current crisis might seem perplexing. Yet Xi’s focus on what he has called “comprehensive national security” prioritizes the strategic autonomy of the Chinese state over economic growth, with the former increasingly viewed in Beijing as a precondition for the latter.

Xi’s strategy, rooted in the notion that a stringent focus on security can fend off any threats to his power stemming from economic troubles, may well navigate China through today’s headwinds. But the journey promises to be anything but smooth, even under the improbable assumption that everything goes Xi’s way.

Xi’s pursuit of comprehensive national security has redefined Chinese society, transforming security from a mere policy goal to a mode of governance. Beyond underpinning Beijing’s assertive foreign policy, Xi’s bid for all-encompassing national and regime security aims to reduce, if not eliminate, China’s economic and technological dependence on the West. Relatedly, his corporate crackdowns, as well as the party-state’s ever-deeper push into China’s private sector, seek to curb capitalism’s excesses and return China to its socialist roots. In attributing China’s current challenges to Western “encirclement” and “containment,” Xi also sees his sweeping security framework as a hedge against any risks to the legitimacy of the Chinese Communist Party (CCP) among the population as the country enters a period of significantly slower growth.

With this in mind, Chinese leaders likely view China’s current slowdown not solely as a near-term challenge but, more importantly, as an opportunity to correct economic imbalances in ways favorable to the party’s longer-term interests.

Thus far, Xi’s response has been limited to meager supply-side stimulus served with a heaping portion of “I told you so.”

Indeed, from his earliest days in power, Xi has philosophized about the “eventual demise of capitalism” and socialism’s “ultimate victory,” albeit one preceded by “hardship.” Xi has rarely held back in highlighting China’s myriad economic ills, attributing them to structural factors, not merely cyclical ones. Today’s spiraling debt, high youth unemployment, and real estate insolvencies are, in Xi’s mind, a symptom, rather than the cause, of China’s economic slowdown, which he views as an outgrowth of corrosive capitalist forces that have undermined China’s ideological cohesion. Xi’s diagnosis is debatable, but his concerns about China’s unbalanced economy are not. China’s inflated growth has been overly reliant on increasingly nonproductive investments in infrastructure, as well as its hyper-leveraged real estate sector, which accounts for one-third of China’s GDP. It now takes China an estimated $9 of investment to produce $1 of GDP growth, up from $3 of investment per dollar of growth in the 1990s. Beijing’s economic model is the very definition of unsustainable.

Tantalizing headlines about China’s rapid slowdown aside, the Chinese economy has actually been trending toward lower growth since 2011, the year the country’s population peaked. Now, China’s crisis of confidence has entered a new, self-reinforcing phase, in which Chinese consumers and businesses refuse to either spend or borrow because of uncertainty over the country’s trajectory. Meanwhile, direct investment by foreign companies has cratered, largely because of growing concerns about Xi’s maximalist national security orientation. That includes a sweeping recent revision to China’s counterespionage law that categorizes routine commercial engagements, such as performing basic due diligence, as acts of espionage punishable by imprisonment. Further compounding China’s crisis is weak global demand for Chinese goods, which has undercut any hopes Beijing may have harbored about manufacturing its way out of today’s problems.

Thus far, Xi’s response has been limited to meager supply-side stimulus served with a heaping portion of “I told you so.” Apart from marginal interest rate cuts and a few minor consumer subsidies, which have failed to spur growth, Chinese policymakers have signaled to businesses, consumers, and free-spending local governments that they should not expect any more help. Speaking to college graduates worried about landing jobs, let alone high-paying ones, Xi advised they instead “eat bitterness” and consider relocating to the countryside to perform menial labor. Meanwhile, Chinese regulators essentially shrugged this year when a major Chinese investment firm, Zhongrong Trust, missed several multimillion-dollar payments to corporate investors. That news sparked fears of a Lehman moment in China’s so-called shadow banking industry, which manages financing activities outside the formal banking system controlled by China’s party-state.

Xi has shown even less sympathy for Chinese households that plowed their life savings into China’s housing market, which is beset by dangerous price bubbles and inflated debt levels. Having railed for years that “houses are for living in, not for speculation,” Xi barely batted an eye when Chinese construction behemoth Evergrande declared bankruptcy and another housing conglomerate, Country Garden, announced that it was on the brink of default. Combined, both companies account for about 40 percent of China’s home sales. Now, Chinese investors may be left without their new property even after plunking down pre-sale deposits. Xi has pleaded for patience with housing investors concerned about real estate values—but not without expounding that the West’s pursuit of similar material wealth led to “spiritual poverty.”

But Xi’s frosty calculus is also predicated on simple economic truths encountered by nearly every country that has followed a high savings, high investment growth model, as China has. Chief among them is that decades of growth built on the back of misallocated, nonproductive, debt-financed investment are, in the long run, unsustainable. For context, the International Monetary Fund estimates that debt held by China’s local governments alone has nearly doubled over the last five years to about $9.3 trillion, roughly equivalent to half of China’s annual economic output. China’s commercial banks hold trillions more in debt, with many borrowers now struggling to repay their loans. If China maintains its current policies, the country’s debt burden will surge to ever-higher levels in ways that Xi realizes, as most economists do, could lead to financial collapse.

Xi’s non-response response suggests he understands China must change course by taming its balance sheet and adjusting its economic model away from unsustainable investment—two objectives easier said than done. Previous efforts to shift China’s investments from unproductive to productive sectors, such as high tech, have struggled due to the limited size of these industries and their inability to absorb significant investments. Pursuing this type of radical restructuring also poses social and political risks with distinct winners and losers, potentially pitting powerful, entrenched bureaucracies against the country’s upstarts as power and wealth are redistributed from the former to the latter.

Besides stimulus spending and redirecting investments, Xi’s other option to stabilize the economy is boosting consumption, essentially encouraging Chinese consumers to spend more. But this strategy faces hurdles. Consumers, tackling wage cuts, rampant job insecurity, and falling home values, remain wary of spending, choosing instead to save for what they fear will be many more rainy days ahead. No doubt, Xi exerts tremendous influence over the lives of China’s citizens, but even he can scarcely compel consumers to part with their cash. Moreover, the structural shifts required to boost the role of consumers in driving growth—for example, by strong-arming local governments and businesses to allow workers to retain more of their earnings—would similarly disrupt Chinese society by shifting power from the state and state-controlled enterprises to the people.

Which is why Xi has chosen to do next to nothing or, at a minimum, to not repeat his predecessors’ mistakes of resorting to massive stimulus to nonproductive investment to temporarily juice the economy. Nor, for ideological reasons, will Xi pull back from his anti-capitalist purge, even as China faces business failures, banking sector stress, and capital flight. Instead, Xi will likely adopt piecemeal or sector-specific measures to alleviate some of today’s pressures, with the goal of orchestrating a controlled economic contraction. Still unclear is whether China’s slowdown will be a short, sharp affair or a long, drawn-out period of stagnation like Japan’s. Regardless, Xi’s desired end state remains the same: a reformed, more balanced, party-first economy free from what he perceives as today’s capitalist burdens.

All told, Xi’s evolving response will likely be a blend of risk aversion when confronting challenges to party authority, social stability, and security and risk acceptance in the economic and ideological realms if he believes his actions align with the CCP’s long-term vision for China. For Xi, managing an economic contraction requires increasing censorship and surveillance to tighten control over information and quell any unrest or criticism. Already, China has ceased publishing youth unemployment data. On the foreign front, Xi will likely adopt a more conciliatory posture with alternative trading partners, especially among developing nations or those less aligned with Western interests. At the same time, he may double down on more assertive messaging against the United States to divert attention from China’s woes and rally nationalist sentiment.

The problem, of course, is that Xi’s emphasis on security over the economy may serve as a buffer in the short run. Sustained economic malaise, however, could have widespread consequences that security measures alone might not be able to contain.

As much as China remains a tightly controlled society, there are indicators—many of them nuanced or easily suppressed—that could signal Xi’s hold is starting to weaken. One such signal could be elite public dissent in the shape of criticism from high-ranking officials, retired party officials, or influential business figures. Shifting or intensifying propaganda could also provide clues. An increase in nationalist messaging, for instance, could represent an attempt to rally the public around a common cause to distract from domestic issues. Similarly, a surge in internet censorship might indicate growing concerns about public sentiment or the spread of information deemed threatening to the regime.

While large-scale protests in major cities could be significant, even small, localized protests or strikes could be telling. A heavy-handed approach to these incidents might suggest heightened regime anxiety. Other potential indicators could include significant boosts in internal security spending, signaling concerns about maintaining stability, as well as abrupt policy changes, leadership reshuffles, and unexpected delays in policy implementation, any of which could hint at dissent within the CCP’s ranks about China’s economic direction. Finally, domestic displays of military might could reflect underlying authoritarian insecurities and fears of threats to the regime.

From today’s vantage point, the notion that China will economically eclipse the United States seems implausible, even far-fetched. Yet Western policymakers would be wise to remember that Xi is charting a course for the long term and continues to believe that a China returning to its “socialist roots” can replace the United States as the world’s dominant power. Given the stakes, it’s not in Washington’s interests to make Xi’s journey any easier by suddenly easing up on the pressure.