Politics Will Determine China’s Economic Future During Xi’s Third Term

During the twentieth congress of the Chinese Communist Party, Chinese President Xi Jinping secured a third five-year term as the party’s general secretary and stacked its seven-man Politburo Standing Committee with his loyalists. These leadership appointments, as well as Xi’s speech to the congress, indicate that major decisions in China will now place more emphasis on politics—particularly loyalty to Xi—rather than on economic outcomes.

What do the announcements made during the twentieth party congress signal about China’s economic future?

Li Qiang, the party secretary of Shanghai, was promoted to the number-two position in China’s 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 to matter more than competence in economic governance. Party cadres and officials at all levels of government will likely prioritize loyalty to Xi rather than the commitment to reform and opening up initiated by China’s last transformational leader, Deng Xiaoping, in 1978.

The content of Xi’s speech to the party congress suggests that he is determined to lessen China’s economic vulnerability to global disruptions. Xi emphasized strengthening the development of basic research and indigenous innovation to drive the Chinese economy and protect national security. He referenced China’s “self-reliance in technology” five times, the need for “strengthening supply-chain reliability, resilience, and security” three times, and China’s “national security” twenty-six times. None of these narratives appeared as strongly in his report to the nineteenth party congress in 2017. In addition, this year, Xi called for a “diversified and stable international economic system” and reiterated his ambition for China to exert more influence in setting international rules and standards.

Taken together, Xi’s words and his choice of appointees indicate that China’s economic prospects increasingly depend more on politics than 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 relations with the West and ultimately lower China’s long-term growth potential.

A hit to the Chinese economy would have widespread and deep repercussions for the global economy; China is the world’s second-largest economy and the largest trading partner of more than 120 countries. Additionally, the wide-spanning pandemic stimulus policies China has pursued since May could complicate or even undermine the inflation-taming measures taken by major central banks in the West.  

What are Xi’s signature economic policies?

Xi’s signature project during his first two terms was the Belt and Road Initiative (BRI), a globe-spanning infrastructure project. The rollout of BRI has generated concerns among Western policymakers about China’s growing control over global strategic infrastructure and its expansive naval capacity, contributing to the West’s resistance of China’s influence. In his speech at the party congress, Xi did discuss continued efforts to promote BRI, but he focused more on boosting China’s self-sufficiency in technology and supply chains through the “dual circulation” strategy.

Xi and his comrades launched the dual circulation strategy in 2020, as China’s relations with the West deteriorated. 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 grow the Chinese economy, whereas “dual circulation” de-emphasizes the role of global markets, or “external circulation,” and instead prioritizes “domestic circulation” by developing China’s domestic market and consumption power. Xi has increasingly emphasized self-sufficiency for economic growth and technological innovation.

To promote domestic circulation, in December 2021, Xi proposed building a “unified national market” and leveraging the unified market to “agglomerate resources, promote growth, encourage innovation, optimize labor division, and enhance competition.” Furthermore, Xi has repeatedly emphasized the necessity of establishing and improving a new whole-of-nation system to achieve breakthroughs in core technologies in the face of with increasingly stringent U.S. export controls. The goal is to fully use the state’s power in concentrating resources to strengthen China’s indigenous technology development and innovation capacity.

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

There are two urgent internal challenges to the Chinese economy: weak domestic demand and swelling debt, both of which are tied to the troubled property market. A slowdown in the property market and construction is depressing demand in major industrial sectors, such as steel, concrete, and chemicals, and suppressing demand for consumer goods, such as home appliances and interior decorations. Furthermore, the slowdown in property development is reducing local governments’ revenues from land-use right sales, further straining their fiscal capacity and exacerbating their indebtedness. In addition, a colossal mortgage burden is further constraining households’ consumption. All these factors indicate that there will be no easy way to promote domestic circulation during Xi’s third term.

China also risks getting old before getting rich over the next few decades. It is struggling with low birth rates, an aging population, and growing pension costs and social security expenditures. However, demographic change is not a crisis on its own; a lack of proper policy response is. The Chinese government has responded to the demographic change with the launch of a three-child policy and vowed to strengthen its childcare and social health-care systems. These responses will add fiscal pressure going forward.

The most significant external challenge to the Chinese economy is heightened geopolitical tensions between China and the West, especially between China and the United States. China is likely to be slapped with broader and more stringent U.S. export controls, which will severely restrict its access to cutting-edge technologies and high-tech manufacturing equipment in strategic industries such as those for semiconductors, artificial intelligence, and quantum computing. The deteriorating relationship between China and the European Union could also prevent China from obtaining restricted technologies from European markets.

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

The lack of pro-reform minds on the new Politburo Standing Committee suggests that China’s trade policy and diplomacy are likely to be more assertive and less conciliatory, increasing the risk of escalating U.S.-China trade tensions. A less reform-oriented Chinese core leadership that prioritizes domestic circulation will likely draw increased criticism from U.S. lawmakers and prompt some U.S. businesses to reevaluate their positions in China.

The Joe Biden administration is expected to expand stringent 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 could be more inclined to press Beijing on unfair trade practices and resort to tariffs and non-tariff barriers, especially in areas where China enjoys a comparative advantage, such as solar panel and wind turbine production. Xi and his loyalists are unlikely to make easy compromises. A quick reconciliation in times of trade tension will be less likely.

To be sure, trade with China is still crucial for the U.S. economy and the American people. U.S. exports of goods and services to China supported an estimated 758,000 U.S. jobs in 2019, the latest year for which such data is available. China was the third-largest trade partner of the United States in 2021. Only 1 percent [PDF] of the $151.1 billion of U.S. exports to China in 2021 was subject to a license requirement by the U.S. Commerce Department’s Bureau of Industry and Security.

Tensions in U.S.-China trade relations will likely continue concentrating on the small but highly sensitive areas. Media focus on these high-tension areas gives the impression that the United States and China are heading towards a 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 of playing the blame game and escalating tensions.