Xi Struggles to Reform China's Politics—and Its Economy, Too

Has the era of reform ended?

“His authoritarian style of leadership at home and belligerent posture abroad are ominous because they make China’s chances of being successful in reforming its own economy—on which the entire world now depends—increasingly unlikely,” writes Orville Schell of the Asia Society in New York.

Part of the difficulty for Xi in managing China’s economy is that the level of corruption among CCP cadres is extreme, thus consolidation of political power truly is a necessary condition for economic change. A key element of the structural reforms promised by Xi is to inject a degree of risk into China’s economy, notes Leland Miller, president of China Beige Book.

“Foreigners need to understand that China is in a constant state of stimulus,” notes Miller, who believes that Xi will eventually use his increase political control to start allowing state owned enterprises to fail and thereby force restructuring that will reduce excess capacity in many industries.

“Everyone thought that the anticorruption campaign would last for six months and then things would return to the status quo,” notes Miller. “Xi has shown that he will go after anybody outside of his inner circle, including former high CCP officials, which has given him the power to make difficult changes. But his attacks on high-level cadres has also injected a level of fear into society that has a negative impact on the economy.”

Miller expects Xi to continue to consolidate his political power and then turn to making significant structural changes to China’s state-dominated economy, but not necessarily changes that will magically produce a Western-style consumer economy. Western observers have for years expected a “rebalancing” of the Chinese economy away from investment led growth to a more Western-style, consumption-based model, but as we’ve noted previously in the National Interest, this may not really be possible.

Moving from a top-down command economy dominated by the CCP to a more decentralized model that allows for independent private business activity directly conflicts with Xi’s need for political control. Indeed, as the level of fear in China has grown in the two-plus years of Xi’s rule, the flow of capital flight to the West has accelerated. An estimated $700 billion flowed out of China last year, much of it flowing into the United States and other nations in the form of direct private investment.

Author and China observer James Rickards believes that the promise of structural reform touted by many Western observers is illusory. “He’s working around the edges, not really accomplishing much of substance,” Rickards tells the National Interest. “Just track monthly capital outflows, including the ‘trade deficit’ with Hong Kong, which is really just capital flight disguised as transfer pricing. That’s a good measure of confidence in the leadership. The outflows have fluctuated recently, but the major trend is those who can are getting their money out as fast as they can. The cronyism is too entrenched and the debt levels are too high. They waited too long to reform.”

Ultimately there is a conflict between the vision of China’s future held by most Western observers and the first priority of Xi—namely, maintaining the political dominance of the CCP with himself at the helm. Prior to Xi’s ascension to power, China’s leaders were reluctant to dismantle state-controlled industries for fear of a political reaction. Now several years into a political consolidation, Xi has established “rule by fear” such that he can make economic changes, but it remains to be seen whether change will actually occur. Meanwhile, China’s economy is increasingly moribund and the currency continues to weaken against the dollar, suggesting that the CCP may eventually return to the tried and true model of an export-led economy. Such a strategy may increase economic and political tensions between China and other industrial nations led by the United States, but it would ensure the political survival of the CCP.

Christopher Whalen is senior managing director and head of research at Kroll Bond Rating Agency. He is the author of Inflated: How Money and Debt Built the American Dream (Wiley, 2010) and the coauthor, with Frederick Feldkamp, of Financial Stability: Fraud, Confidence, and the Wealth of Nations (Wiley, 2014). His website is www.rcwhalen.com.

Image: Pixabay/Public domain.