• A decade ago, there were signs that economic policy under Xi Jinping would remain focused on reform.
• However, a series of economic and financial crises, coupled with an increasingly hostile international environment, derailed the reform agenda of the Xi administration.
• China’s new approach now prioritizes political and security concerns over rapid economic growth.

Prevailing Winds is a China-focused blog written by Nicholas Borst, Director of China Research at Seafarer. The blog tracks the economic and financial developments shaping the world’s largest emerging market.

It has been almost 10 years since Xi Jinping became General Secretary of the Communist Party. In that time, he has significantly reoriented economic policy in China toward new ends. Political and security concerns are shaping economic policy much more prominently than in the recent past.

Before Xi, China’s economy had been guided, with fits and starts, by the policies championed by Deng Xiaoping. These policies – commonly referred to as Reform and Opening – transformed China from an impoverished nation to the world’s second-largest economy.

The Reform and Opening policies focused primarily on achieving rapid growth, raising living standards, and promoting China’s integration into the global economy. In contrast, China’s focus under Xi has been on defusing domestic economic and social risks and making China more self-sufficient in the face of a hostile international environment.

Understanding the reasons behind this dramatic shift is critical for understanding the future direction of China’s economy.

High Hopes

When Xi assumed power in 2012, many analysts predicted that he would become a bold economic reformer.¹ Before rising to the upper echelons of power in Beijing, Xi served as administrator of many of China’s wealthiest and most globally integrated regions, including Fujian, Zhejiang, and Shanghai. In each of these areas, he oversaw an economy that was driven by a large and influential private sector.

Xi inherited a family legacy of economic reform. His father, Xi Zhongxun, was one of China’s leading economic reformers during the late 1970s and 1980s. Deng Xiaoping chose the elder Xi as the head of Guangdong province. In that role, Xi Zhongxun was responsible for establishing Shenzhen as China’s first special economic zone (an area open to foreign trade and investment) at a time when the rest of the economy was closed.² After taking power, Xi Jinping chose Guangdong for his first official visit, where he paid tribute to a statue of Deng Xiaoping.³

Xi assumed control of the economy at a time when the hangover effects of China’s massive stimulus in 2008 were being felt acutely. Between 2009 and 2011, rapid credit growth buoyed the Chinese economy to the point where many economists were worried about overheating. This growth lay in stark contrast to the situation in much of the rest of the world, which was mired in a deep recession.

By 2012, Chinese growth began to slow, and there were growing concerns about financial risks and the housing market. To offset falling external demand, China stoked investment in infrastructure, real estate, and business. The economy was severely unbalanced, with the investment share of gross domestic product (GDP) at extremely high levels and household consumption subdued.

These policies bolstered the economy somewhat, but GDP growth has slowed throughout Xi’s tenure, as shown in Figure 1. As a result, slowing growth and economic distortions were key concerns as Xi began to formulate his initial economic policies.

Source: International Monetary Fund.⁴

In the early years of Xi’s administration, there was good reason to be cautiously optimistic that he would be an economic reformer. The Third Plenum of the 18th Party Congress, held in November 2013, proclaimed the “decisive role of the market in allocating resources.”⁵ This new language was viewed as potentially heralding a shift toward a more market-based economy.⁶ Expectations were further bolstered by a major policy document released after the congress – the Decision of the Central Committee of the Communist Party of China on Some Major Issues Concerning Comprehensively Deepening the Reform – which described a wide range of new market-based policies that seemed to suggest a resurgence in economic reforms.⁷ A lengthy explanatory note, under Xi’s personal authorship, released alongside the document further supports the notion that the Third Plenum reforms were a major priority for Xi.⁸ Although there was no chance that China would abandon socialism or fully privatize state-owned enterprises (SOEs), it did appear that market reforms would continue, or perhaps even accelerate, under Xi.

Black Swans and Grey Rhinos

A series of financial and economic crises derailed the economic reform agenda of the early Xi administration, shaking the confidence of China’s leaders about the stability of the economy and financial system. Xi now frequently references “grey rhinos” (known threats that China is unprepared for) and “black swans” (unpredictable crises for which no preparation is possible).⁹

During the past decade, China experienced a series of both types of events. In 2013, the Chinese interbank bond market seized up, threatening a liquidity crisis for the financial system. The problem was precipitated by an effort by the People’s Bank of China to clamp down on excessive credit growth. The interbank market turmoil exposed that many Chinese banks were vulnerable to a funding crisis.

In 2014 and 2015, China’s housing market experienced a severe downturn. After many years of rapid growth, China was faced with a major housing glut and concerns about the health of property developers and other industries linked to the real estate market.

In 2015, China suffered a major stock market meltdown, shown in Figure 2, which threw the capital markets into disorder and created huge losses for shareholders. Concurrent with the stock market meltdown, the Renminbi came under significant stress as China experienced large capital outflows. They were staunched only after China spent nearly 1 trillion USD of its foreign exchange reserves to support its currency and implemented new capital controls.¹⁰

Source: CEIC.

Past performance does not guarantee future results.

In 2017, China sounded the alarm on growing financial risks in the banking, insurance, and fintech sectors. With Xi’s approval, Chinese regulators launched what they called a regulatory storm – a major crackdown on the financial sector designed to defuse risks. As part of this effort, regulators seized and shut down several large private conglomerates.

In 2018, the long-running effects of China’s financial crackdown culminated in a broad-based financing crisis for the private sector.¹¹ The stock market once again fell precipitously, and China’s leaders were forced to roll out a series of new policies to bolster the beleaguered private sector.

As a backdrop to these specific economic crises, China experienced growing tensions over inequality, uneven regional developments, and environmental damage during this period. The Party worried that these social pressures would reduce economic stability and lead to social unrest.

This period also saw many positive developments. Although China’s GDP growth rate slowed, the economy still doubled in size over the course of a single decade. During this time, the Chinese private sector came into its own, despite many challenges. The Chinese government now admits that the private sector is the primary driver of economic growth, innovation, and employment.¹² Nevertheless, private firms fell out of favor because Xi viewed state-owned enterprises as more reliable implementers of the Party’s strategic objectives and contributors to social stability.¹³

Changes Unseen in a Hundred Years

In his speeches, Xi frequently invokes the phrase “changes unseen in a hundred years.” It is shorthand for a significant shift in the international system driven by China’s rise, America’s relative decline, and the stresses both phenomena have put on relations between the United States and China.¹⁴

From Xi’s perspective, these trends accelerated in the second half of the 2010s. China’s growing strength was fomenting an international environment that was increasingly hostile. A dynamic emerged in which Chinese actions created a backlash in the West, which then reinforced the sense in China that there was a concerted effort to derail its rise.

This dynamic was very apparent in the economic sphere. In 2015, China unveiled Made in China 2025, a wide-ranging industrial plan with the goal of accelerating China’s move up the value chain in global manufacturing. The plan evoked a hostile response from the U.S. and European countries, which were concerned that it would displace their own firms.¹⁵ Two of Xi’s showpiece economic projects – the Belt and Road Initiative and the Asian Infrastructure Investment Bank – met with almost immediate resistance from the United States, and U.S. policymakers launched a pressure campaign to dissuade allies from participating in either.¹⁶

In 2018, U.S.-China economic tensions exploded into a full-scale trade war. Early in the Trump administration, there was an effort to resolve trade imbalances through the “100-Day Action Plan.” After this effort failed, the U.S. Trade Representative began its Section 301 investigation of Chinese trade practices. The findings of the investigation were used as the primary justification for imposing tariffs on nearly all Chinese goods.¹⁷ Figure 3 shows the share of Chinese exports to the U.S. subject to tariffs over the course of the trade war.

Source: Peterson Institute for International Economics.¹⁸

Concurrent with the trade war, the technology conflict between the U.S. and China intensified. In 2018, U.S. sanctions almost forced Chinese technology firm ZTE out of business; only a last-minute deal between Xi Jinping and Donald Trump provide it with a lifeline.¹⁹ Relations between China and the U.S. deteriorated even farther in 2018, when the chief financial officer of one of China’s leading tech companies, Huawei, was arrested in Canada for violating U.S. sanctions.

The U.S. government took action to dramatically restrict China’s access to key U.S. technologies. Foreign investment reviews began to target Chinese firms much more frequently, and rules were put in place to limit even minority stakes in U.S. companies with strategic technology.²⁰

Growing U.S. restrictions threatened China’s access to global capital markets. In 2020, a presidential executive order banned U.S. investors from investing in nearly 60 Chinese military companies. The U.S. Congress passed a law that could result in nearly 250 Chinese companies being delisted from U.S. exchanges. The role of the U.S. dollar as the dominant global currency means that Chinese companies subject to U.S. sanctions could find their ability to conduct business internationally severely curtailed. The recent example of Russia being cut off from the global economy by U.S. and European sanctions was a stark reminder of this threat.

The Covid-19 outbreak exposed yet another international vulnerability, as countries’ efforts to control the pandemic with lockdowns severely disrupted global supply chains. The effect on China – which imports many goods for domestic consumption and critical inputs for its manufacturers – was severe. Many countries, including the U.S., began to call for moving supply chains for critical goods outside of China.

The New Development Philosophy

The economic goals and priorities of the Xi administration shifted significantly in the second half of the 2010s. A growing sense of both internal and external vulnerabilities helped shape Xi’s decision to change the fundamental orientation of China’s economic policy. It is impossible to say whether another Chinese leader would have responded to events differently. The move toward greater state involvement in the economy certainly mirrored Xi’s other efforts to assert greater control over civil society, the military, and the bureaucracy. However, the gap between Xi’s initial proposals and rhetoric and the policies of today is most egregious when it comes to the economy. The bold vision of economic reform Xi offered at the start of his tenure is now nowhere to be seen.

The evolution of Xi’s thinking on the economy over the past several years has been synthesized in a series of proclamations on the New Development Philosophy (NDP).²¹ At its core, the NDP is about giving more weight to security and political concerns within economic decision making.²² China’s previous framework, Reform and Opening, prioritized spurring rapid economic growth, raising living standards, and integrating into the global economy. After nearly 45 years of rapid growth, China’s economy is massive, but it is riven with distortions, inequality, and environmental degradation. These issues have created a mix of domestic economic risks and social divisions that threaten China’s social stability – and by extension the Party’s unchallenged grip on power. The NDP claims that it will deprioritize rapid growth in favor of more balanced economic development – “common prosperity” to reduce inequality and help create a greener economy.

In practice, the change means that domestic economic policymaking will be more focused on reducing what the Party views as the negative impacts of unbridled capitalism. Chinese policymakers now frequently comment on the “barbaric expansion” of private capital and the need for companies, both state-owned and private, to follow the Party’s guidance.²³ Xi believes that it is the responsibility of the Party to guide the market in a direction that furthers national goals and priorities. Private companies and entrepreneurs that hinder these objectives or create new risks face severe regulatory crackdowns.

The NDP has also altered China’s long-standing goal of integrating more deeply into the global economy. Previously, China’s leaders believed that the country faced a relatively benign international environment. China, therefore, could focus on developing its economy and selling to global markets. While this strategy transformed China into an industrial powerhouse and the world’s largest exporter, it has also left the country deeply vulnerable to sanctions and other restrictions from the U.S. and its allies. In Xi’s view, China cannot achieve its goal of becoming a major global power as long as its economy is hostage to countries that increasingly view China as a threat.²⁴

This new framework does not call for closing the Chinese economy or increasing trade and investment restrictions. Instead, it focuses on removing China’s technological dependency on Western countries. China has invested billions of dollars to develop domestic sources of key “chokepoint” technologies that it currently imports. It is, for example, developing its own semiconductor industry, by providing billions of dollars in government financing and other subsidies to domestic firms.

The NDP seeks to leverage China’s large domestic market as a buttress against foreign economic pressure. As China’s economy has grown, its domestic market has developed its own gravitational force for foreign companies and investors. China can use access to its domestic market to force concessions from trading partners and derail U.S. attempts to build economic coalitions against China.

Chinese Economic Policy in a New Era

China has not officially turned its back on the Deng-era policies that drove rapid economic growth. In fact, Xi and other Chinese leaders frequently pay lip service to the need for continued reform and further opening up of the economy.

The shift in both policy priorities and tone in the Xi era is palpable, however. Going forward, Chinese economic policy will focus on balancing security concerns against economic imperatives. The more vulnerable Chinese leaders feel at home and abroad, the more security considerations will trump economic ones.

The check against economic priorities being completely subsumed by security concerns is that the legitimacy of the Chinese Communist Party and China’s goal of being a global power require a strong and vibrant economy. This means that there is still a floor on how low the Party will allow the economic growth rate to fall. During periods of economic and financial volatility – such as March 2022, when Chinese equity markets were in freefall – China’s leaders have felt compelled to step forward to reassure foreign investors and the private sector that China is still committed to economic growth.²⁵

For the foreseeable future, the balance between security and economics will be tilted toward the former, however. Xi believes that China is beset by threats, both domestic and international, that threaten to derail China’s goal of becoming a global power. China’s leadership will use the levers of state power to mitigate those risks to the extent possible. To do so, they will use both carrots (subsidies and preferences for strategic industries) and sticks (draconian regulatory action against problematic companies and industries).

These actions, particularly regulatory actions, may become more predictable and transparent in the future, but they are not likely to cease. Chinese economic policy has been reorientated under Xi. Our understanding of how the Chinese economy works must be updated accordingly.

As of June 30, 2022, the Seafarer Funds did not own shares in the securities referenced in this commentary.

The views and information discussed in this commentary are as of the date of publication, are subject to change, and may not reflect Seafarer’s current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. It should not be assumed that any investment will be profitable or will equal the performance of the portfolios or any securities or any sectors mentioned herein. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Seafarer does not accept any liability for losses either direct or consequential caused by the use of this information.

1. See Zhuang Chen, “The Symbolism of Xi Jinping's Trip South,” BBC, 10 December 2012; and Nicholas Kristof, “Looking for a Jump-Start in China,” The New York Times, 5 January 2013.
2. Susan Lawrence, “China’s Vice President Xi Jinping Visits the United States: What Is at Stake?,” Congressional Research Service, 6 February 2012.
3. Willy Lam, “Xi Jinping’s ‘Southern Tour’ Reignites Promises of Reform,” The Jamestown Foundation, 14 December 2012.
4. “World Economic Outlook, July 2022 Update,” International Monetary Fund, July 2022.
5. “Communiqué of the Third Plenary Session of the 18th Central Committee of the Communist Party of China,” China.org.cn, 15 January 2014.
6. “Every Move You Make,” The Economist, 16 November 2013.
7. “Decision of the Central Committee of the Communist Party of China on Some Major Issues Concerning Comprehensively Deepening the Reform,” China.org.cn, 16 January 2014.
8. Daniel Rosen, “Avoiding the Blind Alley,” Asia Society Policy Institute, October 2014.
9. “Xi Says China Should Make Contingency Plans for "Black Swan" and "Grey Rhino" Events,” Reuters, 29 January 2021.
10. Calixte Ahokpossi, “People’s Republic of China – Selected Issues: China: Capital Account Liberalization,”, International Monetary Fund, 14 July 2017.
11. Nicholas Borst, “China’s Private Sector is Feeling the Pinch,” Seafarer Capital Partners, 16 November 2018.
12. Xi Jinping, “Speech at the Symposium on Private Enterprises (在民营企业座谈会上的讲话),” Xinhua, 1 November 2018.
13. Nicholas Lardy, The State Strikes Back: The End of Economic Reform in China? (Peterson Institute for International Economics, 2019).
14. Zhang Yunling, “Analysis and Reflection on the ‘Hundred Years of Great Changes’ (对“百年之大变局”的分析与思考), Qiushi, 8 October 2019.
15. David Dollar, “Xi Jinping’s Mixed Economic Record,” China Leadership Monitor, 1 September 2022.
16. Michael Schuman, “The U.S. Can’t Make Allies Take Sides Over China,” The Atlantic, 24 April 2019.
17. Wayne Morrison, “Enforcing U.S. Trade Laws: Section 301 and China” Congressional Research Service, 26 June 2019.
18. Chad Brown, “U.S.-China Trade War Tariffs: An Up-to-Date Chart,” Peterson Institute for International Economics, June 2022.
19. Ana Swanson, “Trump Strikes Deal to Save China’s ZTE as North Korea Meeting Looms,” The New York Times, 7 June 2018.
20. Martin Chorzempa, “U.S. Security Scrutiny of Foreign Investment Rises, but so Does Foreign Investment,” Peterson Institute for International Economics, 1 September 2022.
21. See Xi Jinping, “Understanding the New Development Stage, Applying the New Development Philosophy, and Creating a New Development Dynamic,” Qiushi, 8 July 2021; and Xi Jinping, “The Whole Party Must Completely, Accurately, and Comprehensively Implement the New Development Philosophy (全党必须完整、准确、全面贯彻新发展理念),” Qiushi, 15 August 2022.
22. Kevin Rudd, The Avoidable War: The Dangers of a Catastrophic Conflict between the U.S. and Xi Jinping's China, (PublicAffairs, 2022).
23. “Uphold Regulatory Standards and Promote Development with Both Hands, Both Hands Should be Hard (坚持监管规范和促进发展两手并重, 两手都要硬),” People’s Daily, 8 September 2021.
24. Tai Ming Cheung, Innovate to Dominate: The Rise of the Chinese Techno-Security State, (Cornell University Press, 2022).
25. “China Stocks Leap after State Council Pledges Support for Economy, Capital Markets,” Reuters, 16 March 2022.