China – The year ahead

We speak with Andrew Cainey, Senior Associate Fellow at Royal United Services Institute (RUSI), about the future of China’s zero-COVID policy, recent Chinese political developments, China’s engagement abroad and the outlook for the Chinese economy in 2023.

Unravel: With the surge in COVID-19 cases in large Chinese cities, do you foresee a reversal into lockdown mode in 2023? What factors could determine whether or not China will continue opening up?

Andrew Cainey: Zero-COVID is over as a substantive policy. It lingers only as a surreal narrative where cases and deaths are barely reported, in stark contrast to the reality that people are experiencing and see on WeChat. 

In a short few weeks, government policy pivoted from unquestioning excess control to a disorderly exit from any controls. There is no path back. Reimposing restrictions now will do little to control infections. It will risk yet larger popular resistance and street protests.  Local officials are already dismantling the infrastructure for COVID controls and testing, and are out of budget to spend. It will take a new variant that both spreads yet more rapidly and has a much higher infection fatality rate to even start to shift the calculus back to lockdown.

China’s policy was at a dead-end. Lockdowns were economically, socially and psychologically unsustainable. Yet ending lockdowns promised mass infection and many deaths in a population with limited healthcare and low effective vaccination rates. These hard facts did not change when zero-COVID ended. While the final death toll is likely to remain below that in the US, when adjusted for differences in population, we will never know the true number. The data is not being collected.

Both Xi and the Party have taken a hit to their credibility. They had previously benefited from keeping COVID at bay while the epidemic raged overseas. Many now wonder why it took so long to change policy when almost all recovered from the omicron variant so quickly. Others question why preparations for opening-up were so poor. The focus now needs to be on the economy and making day-to-day life better – to restore credibility as well as living standards.

Unravel: Given domestic developments in 2022—such as the Party Congress and the protests that erupted across China—do you expect President Xi to tighten control, or have we been served a reminder that he’s not as powerful as he’s made out to be?

Mr Cainey: We have limited insight into the dynamics of Chinese politics. We know little about what is happening between the key personalities, their relationships, rivalries and agendas. So, assessments can be simplistic, and change easily based on limited new information. See, for example, the frame-by-frame analysis of TV broadcasts when Hu Jintao was escorted out of the Party Congress and then the appearance of Xi, Hu and Jiang Zemin together in a photo as a backdrop to Xi’s televised New Year message.

So, yes, Xi emerged from the October meeting as an even stronger ‘strongman’, having filled the Politburo Standing Committee with his loyalists. Yet six weeks later, street protests call on him to step down and he reverses his signature zero-COVID policy almost overnight. Does this show the limits on even Xi’s power and that he was forced into a policy retreat?  Or does it mean that Xi now has the strength to reverse direction without personal risk?

It may be either, but we risk focusing too much on the individual and not enough on the context. Trade-offs, pressures and priorities are always changing, even for a dominant leader.  Zero-COVID started as a means to protect people and maintain Party legitimacy and control. By the end, the policy was creating more security risks than it solved, undermining credibility and causing social unrest. Ending zero-COVID suddenly became the least-bad option for Xi. 

Faced with the dire economic impact, the policy had to end sometime – the question was when. The surprise was that it came so quickly and suddenly. Maybe Xi listened to ever-louder voices about the increasing harm to the economy. Maybe the protests tipped the balance. Maybe Xi felt more able to change course once he had secured his political objectives at the Party Congress – or simply had more time. We do not really know. Likely all factors were at play – but the economic imperative would be especially pressing.

Xi is now talking about the economy. He is communicating economic pragmatism, rather than imposing ever-greater controls. In 2023, both security and personal power may come above all from a focus on the economy.

Unravel: Do you expect China to deepen its overseas engagement in the coming year?

Mr Cainey: Throughout the pandemic, China has remained deeply engaged overseas. What is now again possible is active face-to-face diplomacy and that makes a difference. Before COVID-19, President Xi often travelled abroad or welcomed leaders to Beijing – much more so than Western leaders. With Western countries, a resurgence of in-person discussions at all levels will likely take the heat out of the more emotional rhetoric – and Xi seems especially keen to engage with Europe. But it will not change fundamental tensions and disagreements on Taiwan, technology, trade and other matters. China is though unlikely to initiate action on Taiwan given other challenges and priorities. 

China will also use face-to-face meetings to deepen relations with other parts of the world. Xi’s December visit to Saudi Arabia for the first China-GCC summit saw announcements on cooperation in economic development, renewable energy and the use of the renminbi in the oil market. This year will likely see a third Belt and Road Forum in Beijing that puts new impetus behind the Belt and Road Initiative. More countries are applying to join both the BRICS grouping and the Shanghai Cooperation Organization. Relations with Russia will remain a tricky balancing act depending on how the war in Ukraine develops.

For the US, President Biden has institutionalised and formalised much of the US approach to China that started under Trump. What has emerged are new and stronger structures (such as the Quad and AUKUS) and tightly-drafted legislation with China in its sights (such as semiconductor export bans).  These will grow only stronger. And 2023 will see China’s own response take shape more clearly as it too strikes agreements with interested countries.

Unravel: What is your outlook for the Chinese economy in 2023?

Mr Cainey: In 2023, China’s economy will fare better than in 2022. But that is a low bar indeed.  The first quarter will be difficult as COVID infections surge. Fundamentally, however, the end of lockdowns removes a major drag on economic activity and reduces uncertainty once infections have peaked however messy the exit from zero-COVID.  

But since 2020, COVID has not been the only drag. Both policy measures and rhetoric have chilled the business environment, especially in technology and real estate. 

In part, policy sought to address deep-seated problems in China’s economy, even if that meant short-term economic pain. But repeated talk of ‘common prosperity’ and the ‘disorderly expansion of capital’—without specific policy details—has led many in business to fear the worst about making money in the future. Regulatory interventions were often heavy-handed and poorly communicated. The state-owned sector seemed again to have the upper hand over private companies.

Throughout 2022, the Chinese leadership became increasingly worried about the economy.  China’s strong export growth is now at risk as the global economy enters recession, so the focus is back on the domestic economy. While commentators focus on what the GDP growth number will be, what really matters is what happens to jobs (with youth unemployment reportedly at 20%) and household incomes. 

In an attempt to bring back business confidence, both rhetoric and policy have turned supportive. Real estate restrictions are being relaxed. Financing is set to flow more strongly into infrastructure spending to help headline growth numbers. Chinese state media have quoted Xi as saying “I am a consistent supporter of private companies and have worked in places with relatively developed private economies”. But speeches alone will not restore business confidence overnight. And China’s underlying economic challenges remain. Indeed, they may become worse if higher growth in 2023 rests too much on debt-financed real estate and government-directed infrastructure spending.

Getting higher growth numbers in the short-term is relatively straightforward. For example, increased R&D spending, funded in part by government subsidies, means higher GDP immediately. What is much more difficult is funding R&D spend that generates innovation and spurs productivity growth and higher incomes in the mid-term. Without such innovation, R&D spending is no better than Keynes’s policy advice to dig holes in the ground and fill them in again. Moreover, in areas such as semiconductors, China needs to innovate to replace lost access to overseas technology. It is in effect running to stand still in productivity terms. 

And sustainable domestic growth will only happen if household incomes take a greater share of GDP – away from the corporate sector and government. What really matters in 2023 for the economy is not the precise GDP number achieved. It is whether or not there are sustained policy changes that both bring back private sector confidence and hold out the prospects of higher wage growth for workers. For this, the wait continues.