What to expect as China’s economy transitions towards common prosperity

Investors have two main questions regarding China. The first is, why has Beijing changed course and cracked down on certain sectors, particularly private education and tech? And, second, why does China’s economic policy remain restrained when growth faces increasingly strong headwinds? While the two may not look very related, both point to a single question: has China changed its development strategy of prioritising economic performance? A deeper question is perhaps: has the fundamental framework that favours “efficiency” over “equality” been abandoned? China observers should know that after Deng Xiaoping advocated the establishment of a market economy in his 1992 southern tour, a market-centric, efficiency first, equity second “neoliberalism” took hold in China’s political and economic ideology. However, it might be premature to make a bold call and say that the Chinese authorities will abandon this ideology, which has after all helped to boost the economy over the past decades. In fact, although the Chinese government is now pushing for “common prosperity”, officials have been quick to explain that seeking to tackle inequality does not mean “killing the rich to help the poor”. A more practical way to understand China’s policy dynamics is, I believe, to narrow down the question. That is, given that achieving common prosperity will be a relatively long-term goal, what will happen in the next couple of years? More specifically, what will the policy approach be during this period of transition? In fact, China has already figured out its new policy approach and refers to it as “cross-cyclical adjustment”. This terminology is not new – the Politburo first referred to cross-cyclical adjustment on July 30, 2020. At the time, however, the market interpreted it to mean that policy needed to be adjusted due to the dynamics of the Covid-19 pandemic. After the term began to crop up increasingly in important policy meetings, the market started to realise that “cross-cyclical” needed to be viewed in much broader terms. An intuitive interpretation is that since the authorities have turned to focus on the new economic cycle, this suggests that medium-term achievements have become more critical for China. Clearly, a few things need to be prioritised, including a stronger manufacturing base, a more balanced demographic dynamic, and consolidated political support, at least domestically. In the meantime, certain issues from the current and past cycles need addressing. These include debt, the housing market bubble and income polarisation, which are all widely seen as hurdles for China to overcome before it can move into the next phase. Unfortunately, given the complexities of the economy and society in general, it is not easy to remove these hurdles and execute policy smoothly. Ultimately, there is a trade off between the short-term economic costs and the long-term benefits. Despite the economic headwinds, the authorities are sticking firmly to the crackdown on financial excesses. Regulators are likely to continue to tighten their grip on the property sector, for instance, and policymakers are very unlikely to back down on property deleveraging. While this has dampened growth prospects, Beijing now has little incentive to provide stimulus measures, as it did in the past. How is China’s regulatory crackdown already hurting its economy? Stringent new regulations on the private education sector and tech giants have also triggered panic and attracted criticism from investors. But there is growing recognition that Beijing will continue its regulatory tightening and antitrust activities to combat social dissatisfaction and prevent divisions widening. In the meantime, Chinese officials have gradually changed their style of communication with the market. Notably, they now prefer a moving average approach when assessing economic performance. On one hand, this will help to filter out the short-term noise in the economic data; on the other hand, it indicates that Beijing has become more patient and tolerant of economic volatility, with more room for the authorities to focus on longer-term issues. In July, Sun Guofeng, the head of the monetary policy division at the People’s Bank of China, illustrated this new patient approach when he discussed the producer price index (PPI), a reflection of inflation in factory-gate prices. “Regarding the increase in the PPI during the year, we must look at it objectively,” he said. “It is due to last year’s low base. In this case, we should take into account PPI changes from last year, this year and next year to have an overall perspective from three consecutive years.” All told, China is engaging in change and giving more weight to tackling challenges in the medium to long term. While it is too early to say that Beijing has completely shifted its growth strategy, the cross-cyclical adjustment policy suggests that the market must prepare for more volatility in the near future. During this transition period, while the authorities could provide some policy support to prevent an economic slump, China is unlikely to conduct aggressive policy easing as that would only exacerbate the debt issue. Hao Zhou is senior emerging markets economist at Commerzbank