The economic dilemma facing China under Xi Jinping

IN BRIEF

China faces an economic challenge rooted in a struggling real estate sector and a strategic shift towards high-end industries, exacerbated by President Xi Jinping’s emphasis on national security and distrust of market forces. Despite some arguing that China’s economic predicament is not as dire as it seems, concerns persist about its ability to rebound from significant economic downturn if it continues its current economic policies, indicating a possible struggle to regain momentum.

China’s economic predicament is rooted in a struggling real estate sector and a strategy predicated on a shift towards high-tech industries. President Xi Jinping’s prioritisation of national security and scepticism of market forces is exacerbating the problem and leading to tensions between political will and economic imperatives.

China’s troubled real estate sector once accounted for an impressive 30 per cent of national GDP. Its peak in 2018 gave way to a sharp downturn — which, further aggravated by the COVID-19 pandemic, today functions at approximately half of its former capacity. This decline has left a big mark on China’s economic fabric, with property sales plummeting by 20.5 per cent in the first two months of 2024.

Historically, real estate was not just a financial powerhouse but also a catalyst for ancillary sectors, driving employment in construction, stimulating retail development and boosting banking through loans. This relationship fostered a dynamic cycle of economic expansion.

But as China transitions towards a middle class society, Xi’s administration is steering away from this growth model. The government’s ‘Three Red Lines’ policy — designed to mitigate substantial risks among the many property developers with mounting debt — was a lukewarm response that led to reduced residential investment. The policy indicates Xi’s pivot towards more technologically advanced industries, such as AI, big data, bioengineering, semiconductors and quantum computing.

This shift fits into a broader agenda to reposition the Chinese economy towards high-tech industries, mirroring global economic trends that favour scientific innovation and smart technology. Most importantly, it aims to secure a win in the US–China rivalry.

Xi’s prioritisation of national security over economic flexibility complicates this transition. His deep-seated scepticism of market forces, shaped by the experience of corruption and ideological deviations during former president Hu Jintao’s administration, continues to influence economic policy. His cautious approach has placed increased scrutiny and limitations on major tech firms, reflecting a strategy of economic statecraft that favours firm state control over market-driven growth.

The government’s preference for bolstering state-owned enterprises at the expense of the private sector — which has been a cradle of innovation and economic vitality — is a decisive political stance. But bureaucratic state-owned enterprises cannot yield the same successes as a thriving entrepreneurial sector when it comes to innovating in cutting-edge technology. Xi’s approach dampens entrepreneurial spirit and curbs the private sector’s capacity to innovate and compete globally. Already there has been a noticeable shift in career aspirations among the young, who now gravitate towards government jobs in search of stability rather than pursuing entrepreneurship.

Despite 5.3 per cent GDP growth in the first quarter of 2024, the International Monetary Fund suggests that China’s economic rebound could take several years and become a medium-term slowdown. The once robust manufacturing sector — though showing signs of revival — cannot fully offset the substantial downturn in real estate. While China excels in producing solar panels, wind energy and electric vehicles, its success is drawing unwanted attention from Western competition policy analysts and attracting import restrictions. Consequently, China risks developing manufacturing bottlenecks.

Meanwhile, consumer confidence remains subdued. Retail sales growth slowed to 2.3 per cent year-on-year in April 2024, a drop from 3.1 per cent in March. This deceleration in consumer spending underscores the economic uncertainties and the persistent negative wealth effects stemming from the real estate market downturn.

The government faces a dilemma. It must reignite growth without reverting to outdated methods that won’t solve the nation’s problems today. Yet Xi is so determined to keep political control that he is stifling entrepreneurship. Hence, the challenge lies not only in supporting Xi’s new economic prescription — ‘new productive forces’ — which is independent of the real estate sector but also in implementing it swiftly enough to yield results. This is crucial to ensure a V-shaped recovery and prevent a recession.

This scenario is a significant test for Xi’s ideological framework, which champions a Marxist-socialist model over Western capitalist paradigms. Xi’s push for ‘common prosperity’ seeks to alleviate income inequalities aggravated by decades of disparate economic growth. Former Chinese leader Deng Xiaoping permitted this disparity to optimise economic reform and opening-up. Xi’s focus on income equality and regional equity marks a pivotal shift back to state-led initiatives.

Some analysts in both China and the United States argue that China’s economic situation is not as dire as is sometimes suggested. But while the Chinese government announced several measures to stabilise the property sector in May 2024, the lack of precedents for China’s stance raises doubts about its feasibility under current policy strategies. For Xi, implementing these policies will require a balance of political fortitude and economic acumen that is historically rare.

The intertwining of governance, ideology and market dynamics under Xi presents a landscape where political decisions profoundly influence economic outcomes. The challenge lies in executing a balanced strategy that fosters economic vitality while adhering to ideological commitments.

China, renowned for its economic resilience, faces a narrowing window of opportunity to recover from its significant economic setbacks. China must regain momentum before it misses its opportunity for economic rejuvenation.

Dr Seong-Hyon Lee is Visiting Scholar at the Harvard University Asia Center and Senior Fellow at the George H. W. Bush Foundation for U.S.–China Relations.