Is Xi Holding China Back From Its Potential Greatness?

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Starting around 2023, in a seeming attempt to right the ship, Xi made a major policy pivot. Chinese banks (which are all effectively state-controlled if not state-owned) were instructed to stop lending to property developers and real estate-related companies, and instead to lend huge amounts of money to manufacturers . Along with the flood of bank loans, Xi dished out a truly massive amount of subsidies for manufacturing industries - the most expensive industrial policy that any country has ever undertaken.

The idea was to make China the world's supreme manufacturing power - an idea that Xi Jinping has long cherished as a route to Chinese national strength and security. Naughton, Xiao, and Xu (2023) write about how the imperative toward national power and national security lies at the center of Xi's policy program.

This new industrial policy has had some spectacular successes. Chinese EVs increasingly dominate the global auto industry , and it's achieving similar successes in industries like robots and drones that use a similar suite of technologies . China is also continuing to free itself of dependence on foreign-made components , which would help it to fight a hypothetical war, and which has led to large trade surpluses.

However, Xi's big success here may prove short-lived. The industrial lending boom is already slowing:

Source: Bloomberg

The reason is falling profitability. Contrary to popular belief, China isn't a very export-intensive economy - it consumes most of what it makes. And that means that when China's government pays its companies to produce more and more and more, it ends up competing their profits to zero, or even forcing many producers to take a loss. I wrote about this in a recent post .

The problem is only getting worse :

In principle, this isn't too hard of a problem to solve. Just cut off subsidies, restrict bank loans, and encourage the successful companies to buy the unsuccessful ones. Industries will consolidate, profitability will be restored, and China will have a set of healthy national champions. That's how industrial policy is supposed to work .

But there are two problems with this. First, there's the political problem - if you spend several years telling everyone they're going to get a job in a car factory, and then you start closing down all the car factories, people get mad.

Companies in China tend to be highly localized, with strong support from one regional government or another. A lot of them are basically regional champions. So if China's central government starts killing a lot of regional champions, it could lead to anger in the provinces.

A bigger problem, though, might simply be Xi's personal idea of what makes a good and powerful economy. He's less focused on GDP growth numbers than raw output, because his main focus is national security; even if companies are so unprofitable that they're destroying economic value rather than creating it, Xi might think it's worth it, in order to make more cars, more chips, more drones, more batteries, and so on. Whoever makes the most stuff, after all, can make the most military stuff, especially in the case of a war.

If China does start a big war, that'll be bad. But if it doesn't start a war, then all this preparation, in the form of structuring the whole economy around industrial overproduction, will also be bad, because it'll make Chinese people poorer than they ought to be. Naughton, Xiao and Xu write:

Put in plain terms, Xi Jinping is reorienting China's economy around producing a bunch of stuff that Chinese people don't want or need, because this fits with his idea of what makes a country strong.

Eventually, if the economic effects get bad enough, Xi will probably temper those policies, just as he canceled Zero Covid and tried to reverse his crackdown on the Chinese software industry . He is stubborn, but not infinitely stubborn.

But by then, the damage may be done. China's banking system may be saddled with a huge pile of nonperforming loans to manufacturing companies, on top of the pile of nonperforming loans to real estate companies that already sit on their books. China's total debt-to-GDP ratio - including both public and private - is now well ahead of Western countries .

A wave of industrial bad debt would add to the general financial and economic malaise in China. It would basically be like Korea's 1997 industrial debt bust, added on top of Japan's 1991 real estate bubble, but scaled up to China's size.

And if banks responded by keeping failing manufacturers afloat through infinite cheap loans, China really could start to look like 1990s Japan - but worse, since China's subsidies were more lavish and inefficient to begin with.

In other words, Xi's big idea for China's economy may end up being just as bad as his big ideas for Covid, the tech industry, real estate, diplomacy, and international development. Just as China's economy reaches the zenith of its potential, it might be brought back to Earth by one man's unorthodox ideas.

The lion in winter

Xi's ability to deal with external challenges may be wobbly, but up until now at least, he has always been able to deal swiftly and effectively with internal challenges to his own rule. But that could change over time, as Xi ages into the winter of his political career.

Xi is 72 years old. That's not exactly superannuated - Donald Trump is seven years older, and Deng Xiaoping ruled effectively throughout his 80s. But 72 is old enough where everyone starts thinking about who the successor is going to be.

In a liberal democratic regime, this is less of a high-stakes question because the parties are going to alternate in power anyway. But in a brutal, winner-take-all autocracy like China has once again become under Xi, the succession could literally be the difference between life and death - and certainly between riches and poverty - for a vast number of Chinese elites. Remember that many of Xi's enemies ended up in prison.

Xi hasn't yet chosen a successor . He has recently delegated some of his policy authority to a trio of loyalists - Cai Qi, Li Qiang and Ding Xuexiang, all of whom are in their 60s - but none of them has emerged as a clear successor, and none seems to have their own independent power base. They seem like the kind of people a leader appoints when he's getting old but doesn't want to elevate a potential challenger.

Xi changed China's rules to remove term limits, so as long as his health holds up, he could rule for another two decades; perhaps he doesn't think he needs to start thinking about a successor yet.

But other people in China will definitely be thinking about this all-important question; they'd have to be fools not to be plotting and planning and sharpening their knives right now. Xi, being a consummate master of backroom politicking, undoubtedly knows this. And he also certainly knows that whoever wants to rule China after his passing has an incentive to undermine his power before he's dead or out of office.

Like other aging dictators, Xi will have to spend an increasing amount of time fending off such challenges to his power. If leaders become more physically infirm or mentally slow, this only heightens their vulnerability and requires them to be even more ruthlessly paranoid in order to stay on top. Writing in“The Wire China”, Victor Shih explains how this typically goes :

It's notoriously hard to read the tea leaves of Chinese politics, since almost everything happens in secret. But there are some signs that Xi might be starting to enter his“lion in winter” phase. Shih notes that Xi recently skipped the BRICS summit, which he always used to attend. And the Economist reports that Xi has become more reclusive in recent months:

Meanwhile, Xi has stepped up his purges, especially of the military . Some of the generals he has purged were his own appointees. The Asia Society Policy Institute reports :

And The Economist has data showing that investigations of senior officials have tripled since the pandemic .

This will also probably have ramifications for the relationship between the state and the private sector in China. Even at the start of his rule, Xi instinctually tried to increase state control over the economy.

The 2021 tech crackdown was partly motivated by Xi's disdain for the consumer internet industry, but the desire to crush alternative centers of ideas and popularity probably figured into the decision as well.

Now, as Xi advances into his later years and his hold on power becomes more tenuous, he will be even less tolerant of private companies or entrepreneurs who could challenge him or fund his rivals. The natural response will be to double down on his traditional approach, and exert even more heavy-handed control over the private sector. That's unlikely to be good for the Chinese economy.

In other words, even though Xi is only 72, we may already be seeing him go into the“lion in winter” phase that other aging dictators tend to go through. And that may paralyze, distract, and unsettle China for years to come.

Will the world get a reprieve?

For people in China, one or two more decades of increasingly reclusive, paranoid Xi Jinping rule sounds like an unappetizing prospect. Chinese society - its corporations, its cities, its talent - is now robust enough that Xi is unlikely to be a calamity like Mao was.

But one or two decades of a slower-growing economy, less individual opportunity, and a more repressive society won't be the optimal way for China to enjoy the zenith of its power. China's people are incredibly talented, hard-working, and creative, and they deserve better than an aging Xi Jinping.

But for the rest of the world, Xi's blunders and his increasingly inward focus might provide a temporary reprieve. China's economic and technological power at this moment in history is truly spectacular; if its leaders wanted to turn that power toward conquest and domination, they could. In fact, every other great power did try to use their power to dominate weaker nations to some extent.

But if Xi spends the next one or two decades suppressing internal challengers and committing economic blunders, it could save the rest of the world from the threat of Chinese hegemony.

An inward-looking, mildly sclerotic China would be a bit of a tragedy, but it would also allow countries like Japan, India, Vietnam, and Korea - and of course the United States - to breathe a sigh of relief.

Right now, with Donald Trump busy smashing everything that made the free world such an effective bloc in the first Cold War, Xi and his personal shortcomings might be our best hope to avoid domination by the most powerful autocracy the modern world has ever seen.

NOTES

1 Note: I often post the UN's forecast that China will account for 45% of all global manufacturing value added by 2030. But Jonathon P Sine points out that 36% would be a more realistic projection:

Source: Jonathon P. Sine

36% is still a hell of a lot, though - it's about where America was in the early 60s.

2 Some measures put China still slightly behind the US, but closing the gap fast.

3 Obviously, Xi's rivals were corrupt, but so was every Chinese leader, including Xi himself . When everyone is corrupt, it's easy to crush your rivals while also actually reducing corruption somewhat.