Decoding China’s Dilemma: The Difficulties Of Economic Reform

On November 27, the State Council of the People’s Republic of China (PRC) unveiled a new policy, titled “Notice on Strengthening Financial Support Measures for the Private Economy (关于强化金融支持举措 助力民营经济发展壮大的通知)” (People’s Bank of China, November 27). The notice introduces a set of 25 measures crafted to reinvigorate the private sector. These prioritize key areas such as technological innovation, green initiatives, and primary support for small to medium-sized enterprises. The package includes increasing financial assistance and gradually enhancing the proportion of loans to private businesses. It underscores the importance of facilitating credit, lowering interest rates, issuing bonds, and other kinds of financial instruments to meet the varied financing needs of private enterprises.

This policy measure echoes mandates put forth during the 20th Party Congress in October 2022 and Central Financial Work Conference held at the end of October 2023 in response to China’s deepening economic woes (Xinhua, November 1). This backdrop has prompted policies aimed at addressing the challenges facing the Chinese economy. In October, the PRC National Bureau of Statistics announced that the Consumer Price Index (CPI) fell by 0.2 percent year-on-year—worse than expected and marking a contraction since July (RTHK, November 9). This ominous data, which includes price deflation for both July and October this year, is indicative of significant weakness in domestic demand, particularly due to the underperforming real estate market, which affects citizens’ expectations for asset prices. The ongoing economic downturn in China also refutes the notion that economic chaos would clear up after the abandonment of the Zero-Covid policy. This situation is also similar to the Japan-style recession in the 90s in which consumption and investment are further repressed in favor of paying down debt. China’s recent response has been to implement a series of economic stimulus measures in an attempt to revive its weakening national economy.

These stimulus measures initially sparked surprise and optimism within among Chinese business people and enterprises, whose “eyes lit up (眼前一亮)” at the news, according to one online report (Baijiahao, November 11). For these people, it signals a strengthened commitment to empowering the private sector within China’s economic landscape through long-awaited support measures, and potentially indicates a departure from the controversial strategy of “the state advances, the private sector retreats (国进民退).” Historically, this strategy posed severe challenges for private enterprises, especially during the Wen Jiabao era (2008–2012). At that time, the government disproportionately supported state-owned enterprises (SOEs) to help the nation recover from the aftermath of the global financial crisis (China Brief, November 16, 2012). By comparison, small and medium-sized firms received very little state support and could not apply for loans at interest rates anywhere near as favorable as those offered to SOEs.

The question remains as to whether this seemingly relaxed policy of further stimulus can succeed in boosting domestic demand where previous policies have failed. And the PRC, especially under the leadership of Xi Jinping, has followed a pattern of advancing only to retreat, revealing an undercurrent of contradiction and indecision that often perplexes and exasperates both domestic and international observers. The economy has suffered from weak domestic demand for a while, with challenges in industrial and retail sales, and a housing market that continues to be beset by crisis. Investments into China’s real estate market declined for the 17 consecutive months up to August. (Reuters, August 15).

Xi Jinping is clearly aware of the structural imbalances within the Chinese economy. At the peak of pandemic in 2020, he underscored that in this era filled with uncertainty, weakened demand, and external hostility, China must adjust its economy and become more self-reliant to maintain growth even if an adversary tried to harm China’s economy (Yicai, May 15, 2020). Xi said that China needs its people to spend more money and its domestic manufacturers to innovate more. Xi called his new grand scheme the “Dual Circulation (双循环)” strategy. Under this policy scheme, China should regard internal demand and innovation as the primary drivers of economic development and establish a domestic economic ecosystem, while maintaining foreign markets and investors as a secondary engine for economic growth. In September 2020, Xi further issued “important instructions” on his new economic plan, stating that it is necessary to unite private economic individuals around the Party to promote the development of the private economy (Xinhua, September 16, 2020).

In February 2021, the State Council’s implementation of the “Anti-Monopoly Guidelines for the Platform Economy (关于平台经济领域的反垄断指南)” briefly rekindled optimism for a flourishing private sector (SAMR, February 7, 2021). However, this was quickly overshadowed by stringent crackdowns on numerous private sector tech giant, including Jack Ma’s Alibaba and Meituan (a platform akin to Uber-Eats), as well as ride-hailing service Didi Chuxing. A slew of new regulations accompanied the crackdowns. These moves by the regulatory authorities confounded market expectations and ironically signaled a strengthening of control over private businesses and a politicized commercial environment. No signs have shown that the private sector is strengthened significantly. To take one example, after Xi’s attempt to assist the private sector, between January 2022 and June 2023, growth in private investment, however, continued to decline. (World Bank, June 2023).

Economic struggles are also evident in the dramatic decline in Foreign Direct Investment (FDI) in recent months. This summer, the PRC State Administration of Foreign Exchange (SAFE)’s latest data showed that from April to June, China attracted only $4.9 billion in FDI. This is a decrease of 76 percent compared with the first quarter of 2023, and an 87 percent drop over the same period in 2022—the lowest level in the past 25 years (RFA, August 8). Despite this, China’s central bank has intensified oversight of large-scale dollar purchases. This adds too many uncertainties for international businesses, including growing concerns about the disturbing impacts brought by the latest counter-espionage law, data-transfer regulations, and unexpected raids on foreign firms (China Brief, October 20; China Brief, November 3). For instance, Craig Allen, President of the US-China Business Council, expressed reservations about the counter-espionage law, cautioning that “Confidence in China’s market will suffer further if the law is applied frequently and without a clear, narrow, and direct link to activities universally recognized as espionage” (USCBC, December 1). Such concerns are supported by data from American businesses, many of whom are pessimistic about their prospects in China (AmCham, April 28). For the first time in history, a majority of responding companies said China is no longer seen as a “top three investment priority.” A separate statistical dataset also noted a 61 percent plunge in private equity and venture capital investments in China’s telecommunications, media, and technology sectors in the second half of 2022 (Caixin, June 16).

The primary challenge facing China’s economy goes deeper even than longstanding structural issues like an aging population, a dwindling labor force, and a severe wealth gap. The more pressing and overriding concern lies in the Party’s extensive control over domestic industries. This also entails the problems caused by Xi Jinping’s conflicting actions and indecision, and the crucial question of whether the market and international business community perceive China as a reliable and trustworthy actor.

One new proposal by the State Council can hardly restore the confidence of both foreign and domestic investors, not to mention stimulating a new economic growth, without addressing its interventionist approach. It is, unfortunately, a common belief among autocratic leaders that a centralized approach is more efficient for directing a nation’s economy. However, as China stands at this pivotal juncture, the challenge of balancing conflicting policy objectives while still fostering a conducive business environment is increasingly daunting. It may be too soon to take argue that this latest policy notice can bring about the fundamental changes for the economy required to alter the landscape for the private sector and to stimulate domestic consumption.

The current situation thus presents a stark reality: The new policy by the State Council is likely to be another failure, as it seeks to perpetuate the status quo and avoid the reconciliation of Xi’s competing agendas and ideologies. At the end of the day, the true formula for China’s economic success might not be as miraculous as the CCP claims. A controlled economy will eventually struggle to reap the benefits of a free market, where creativity and opportunity are celebrated as successes rather than controlled as threats.

The prospect is not favorable for Xi Jinping, as the market and foreign investors increasingly responds by withdrawing from the Chinese market. Wealthy Chinese also are opting to relocate their assets overseas, with an estimated outflow of over $150 billion this year, instead of investing and spending domestically (Bloomberg, August 14). The need to balance security and foreign policy priorities against the imperative to create an attractive business environment presents a formidable challenge. However, if Xi Jinping sincerely hopes for this new policy to be effective, he must work harder and in the right direction. This pivotal moment for China is made even more complex by the interplay of political rhetoric and diplomatic posturing on the global stage. The future of China’s ongoing efforts at economic reform will continue to require careful observation and assessment, but it is evident that the success of this latest measure is unlikely unless there is a fundamental shift in Xi’s approach to governance.