Newsletter 138 - October 30, 2022
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Welcome to the 138th edition of Trade War.
Private business is running scared post 20th Party Congress. Entrepreneurs fear ‘extremist policies’ and capped corporate profits. Chinese stocks on Nasdaq experience their worst day in history (and the Hong Kong market was bad too.)
Why Xi needs China in an existential struggle with the world. Political goals placed above economics equals slower growth and could spur a military move on Taiwan. And Xi team unprepared for economic challenges ahead.
Covid Zero controls make Beijing feel ‘Pyongyang-like.’ SME job creation ‘dead in the water.’ And unskilled workforce a huge challenge to China’s economic future.
Hostage standoff over Huawei executive Meng Wanzhou and Canada’s ‘two Michaels’ reveals the ugliness — and arbitrariness — of geopolitics. U.S.-China conflict moved past the “point of no return,” says Taiwan academic. And migrant workers suffer in massive Foxconn iPhone factory Covid lockdown.
Private business is running scared
“How did business respond to Xi Jinping gaining an unprecedented third term as party general secretary and the unveiling of the rest of the Politburo Standing Committee, six elderly men, largely distinguished by their loyalty to China’s strongman chief?” I write in a commentary for The China Project.
Very, very badly.
A day after the new leadership team marched into an ornate room in the Great Hall of the People in Beijing before the world’s cameras on October 23, the markets swooned. Stocks in Hong Kong fell their most since the 2008 financial crisis. Chinese equities listed in the U.S. saw their biggest drop ever. And the yuan careened to a 14-year low.
“The market is concerned that with so many Xi supporters elected, Xi’s unfettered ability to enact policies that are not market friendly is now cemented,” Justin Tang, head of Asian research at United First Partners, told Bloomberg.
China’s richest tycoons, including bottled water company Nongfu’s Zhong Shanshan, Tencent’s Pony Ma, Pinduoduo’s Colin Huang, and Alibaba’s Jack Ma saw their combined wealth fall by $35 billion. And Chinese billionaires were the biggest losers among the world’s 500 richest people, according to the Bloomberg Billionaires Index.
Now there are reports that more of China’s wealthy are moving assets abroad and preparing to emigrate.
While some believed Xi might reverse some of his most market-damaging policies, including COVID Zero and the rolling crackdowns on big private companies of the last couple of years, that hope has been dashed. That was already clear when he gave his much-parsed opening address on October 16, with the pointed message that from now on security would trump the economy.
What appears to have really spooked the business community are signs China may finally set up a comprehensive tax system, as part of Xi’s Common Prosperity goal of making a more equitable economy. An inheritance tax, a strong capital gains tax, and the much discussed and delayed property tax, all of which China lacks and arguably needs — in part to help boost the revenues of struggling local governments — would hit the pocketbooks of China’s wealthier class.
China aims to “improve the personal income tax system” and better regulate “wealth accumulation,” Xi said in his speech.
Regardless of whether China finally gets serious about instituting new taxes (their track record hasn’t been good so far), it’s already been a bad year for private business, buffeted by COVID lockdowns and the property sector slowdown, not to mention under pressure from Beijing to invest in Party-sanctioned programs like poverty alleviation.
After growing for almost a decade, the proportion of China’s largest companies that are privately-owned has been falling since last year, research by the Peterson Institute for International Economics shows. And even though private firms’ production today still accounts for some two-thirds of GDP, and they employ about 80% of urban workers, their profit growth has stalled, falling 7% in the first seven months of this year. By contrast, state-owned firms saw their profits go up by 8%. “China’s private firms have been underperforming relative to the state-run sector,” write Peterson research fellows Tianlei Huang and Nicholas R. Lardy.
Concerns run deeper than new taxes and pandemic policies. Existential angst about what role the private sector will be allowed to play in China has returned to haunt its entrepreneurs. While the Party has long viewed private business with deep suspicion, and during the Mao Zedong years outright persecuted capitalists, that shifted dramatically towards a more positive perspective with Deng Xiaoping’s Reform and Opening in 1978 and later when former top leader Jiang Zemin welcomed entrepreneurs into the party in 2002.
As I wrote more than two decades ago, “President Jiang Zemin, Premier Zhu Rongji, and others recognize that the private sector offers the best hope as an engine of growth. As state firms shed workers and shut plants, new businesses are urgently needed to generate millions of new jobs.”
But under Xi things have taken a marked step backwards, with a much more suspicious eye cast on the private sector as China’s economy has grown far stronger, becoming the world’s second-largest. Even before he had finished his first five years as China’s top leader, Xi told entrepreneurs in 2016 they must “Love the Communist Party,” warning that some people had “unwittingly become trumpeters of Western capitalistic ideology,” which could lead to “disastrous consequences.”
Where did Xi decide to make his first visit after the 20th Party Congress? With the entire Politburo Standing Committee in tow, Xi traveled to the revolutionary cradle of Yan’an, visiting the former residence of Mao and the site of an earlier historic party congress. (Ten years ago he went to Shenzhen, China’s first special economic zone and a symbol of market opening.)
In a speech, Xi called on all party members to “strengthen the fighting capacity … and harness the indomitable fighting spirit to open up new horizons for the cause of the Party and the country.” Doesn’t sound much like a pragmatic leader ready to set aside politics and give entrepreneurs space to make money and grow, does it?
No wonder business is running scared.
‘They fear extremist policies’
“Another problem with autocratic regimes when they become less predictable and more centralized is their inability to make credible commitments on the tax rate. Tax increases in China are absolutely necessary given aging and inequality. Plenty of rich people in China can pay higher taxes,” writes University of Michigan political scientist Mary Gallagher.
“Why all the fear [amongst wealthy Chinese]? 1) they have limited input in policymaking, even less now 2) they fear extremist policies beyond tax collection. [It] drives a vicious circle of capital outflows/crackdowns on outflows.”
Capping corporate profits?
“Beijing says ‘Chinese path towards modernization’ will focus on ‘people,’ unlike the Western model focused on the ‘capital.’ In plain English, Beijing wants to raise the labor's share in the economy by capping corporate profits, a clear structural headwind for its capital market,” tweets Shanghai Macro Strategist.
Worst day in history for Chinese stocks on Nasdaq
“Nasdaq Golden Dragon China index had its worst day in history. Amazingly, it is now no higher than it was in December 2006,” writes Bloomberg News’ John Authers.
Why Xi needs China to ‘struggle’
Xi Jinping has broken with the central mandate of the Deng Xiaoping era and will no longer put economic growth as top priority, writes Guoguang Wu, a senior research scholar at Stanford University’s Center on China’s Economy and Institutions, in The Journal of Democracy.
“Just once did he state that the country would ‘adhere to economic construction as the center’—ten words (in Chinese) in a thirty-thousand-word report [to the 20th Party Congress], indicating its insignificance,” writes Wu, who once was an advisor to purged and now deceased reformer Zhao Ziyang.
“Xi did not mention it at all in his other speeches during the Congress. Rather, the themes and policies that Xi emphasized all herald a significant, if implicit, change: The economy-centered era is over.”
And what is Xi’s new priority? That can be seen in the two words most repeated in the speech: “security” and “struggle.”
“What he means by these words can be teased out from his political statements and the way he has governed over the past decade: domestically, to maintain regime security by struggling against any possible threats to the CCP’s monopoly on state power; in foreign relations, to enhance China’s national security by struggling to gain dominance on the international stage,” writes Wu.
“Many, including a huge number of CCP cadres, may find this fundamental shift in priorities—in CCP jargon, the ‘central task’—premature. Xi sees things differently; put frankly, the shift is in his interest. In the view of pragmatic CCP elites and party-state strategists, China should wait until its economy surpasses that of the United States to unveil its true intention not only to dominate the world but also to transform it according to the CCP’s rules of the game.”
“Xi could not wait, however. Had he chosen to continue the economy-centered program rather than introduce the “struggle for security,” he would have had no excuse to stay in power, and the Twentieth Party Congress would have witnessed his handover of power to someone else. That someone — and not Xi — could then have become the leader to oversee China’s world domination.”
*This powerful essay makes me consider a scary possibility: Xi must present China as facing an existential crisis and in conflict with the world or has no excuse to remain in charge — does that gives him then an incentive to exaggerate (and even inflame?) the real tensions between the CCP and the West?
Just how south things could go
“He has a lot of political goals, [and] he’s willing to accept probably slightly slower economic growth” to push his ideology and maintain control, says Dexter Roberts—a senior fellow at the Atlantic Council and author of The Myth of Chinese Capitalism, to The Dispatch’s Esther Eaton. “But I don’t think he necessarily realizes just how south things could go.”
“The markets seem to agree with Roberts. The benchmark Shanghai Composite Index slid 2 percent Monday, despite measuring a tightly controlled domestic market. The Hang Seng Tech Index—which tracks major firms listed in Hong Kong—dropped about 6 percent, its biggest one-day fall since the global financial crisis. Chinese tech giants including Alibaba and Tencent plummeted more than 10 percent. The onshore Chinese yuan also fell, hitting its weakest level since January 2008,” writes Eaton.
“Underlying problems keep growing—namely, debt in the economy, falling productivity—and at some point, they’ve got to deal with it,” Roberts said.
Economic woes could spur military move on Taiwan
Xi Jinping’s politicized approach to the economy will hurt growth and could lead China to take military action against Taiwan sooner, reports Politico’s Phelim Kine.
China’s economy is already facing a host of challenges, including from the tight pandemic restrictions, the effects of the property market crackdown, and soaring youth unemployment. Now after the 20th Party Congress a newly-emboldened Xi may make things worse.
“[Xi’s] ideologically driven economic policy prescriptions — which lean toward a strong-armed interventionist approach rather than support for the country’s burgeoning private sector — could stunt growth further,” writes Kine.
China is struggling under “Xi Jinping’s disastrous economic policies and a series of dangerous structural imbalances, including a declining birth rate, an inadequate social safety net, and the CCP’s long ago decision to correlate its political legitimacy with China’s economic growth rate,” says Alex Gray, former chief of staff at the National Security Council.
The severity of the economic challenges make it “highly probable” that Xi will take military action in the Indo-Pacific “faster than anticipated and from a position of domestic weakness,” says Gray.
The Biden administration too is warning against the heightened danger. Beijing seems “determined to pursue reunification on a much faster timeline,” Secretary of State Antony Blinken said last week. An invasion could happen in “a 2022 window or potentially a 2023 window,” said Chief of Naval Operations Adm. Mike Gilday two days later.
“Xi is a known risk-taker and seems highly confident — if misguided — in both his judgment and the weakness of his opponents,” said Robert Haddick, a visiting senior fellow at the Mitchell Institute for Aerospace Studies, Air & Space Forces Association. “Few expected Vladimir Putin to be so irrational as to actually invade Ukraine, but he obviously did. Why not Xi too?”
Others are pushing back. “Any conflict over Taiwan would represent an existential threat to the CCP regime, so it’s the last thing a beleaguered Xi would look to as a distraction from domestic troubles ... so no, I don’t buy the ‘wag the dog’ theory,” said Lonnie Henley, a former U.S. intelligence officer who focuses on China’s military.
Beijing becomes ‘Pyongyang-Like’
With China’s stringent Covid curbs and the tightening of social controls under Xi Jinping, Beijing feels ‘Pyongyang-Like,” according to one China economy expert, reports Bloomberg News.
Visiting China’s capital “felt more like Pyongyang” than an international city, says Scott Kennedy, a senior adviser for Chinese business and economics at the Center for Strategic and International Studies, after making his first visit to China in three years. Kennedy referred to his comment as “half” in jest.
“The level of social control is far higher. You can’t be invisible and anonymous in China anymore, because you simply cannot physically move anywhere without being tested to get a green code on your phone, and then scanning your phone everywhere. That is a dominant part of people’s lives,” Kennedy told Bloomberg.
“The economy is in pretty bad shape and my expectations are relatively grim for the remainder of this year and next. Diplomatic tensions are leading governments starting with the U.S. to encourage their companies to diversify, to restrict sharing of technologies and to reduce China’s participation in global innovation. That’s going to constrain China’s growth and opportunities,” points out Kennedy.
“On top of that, you’ve got the self-imposed problem of the Covid Zero policy. This is signaling to consumers that there’s an immense amount of risk. Consumers are not spending and companies are not investing.”
Face masks and Xi’s divine vibes
“What is the message with everyone in the new politburo having a face mask apart from Xi Jinping, divine vibes?” tweets journalist Jojje Olsson.
SME job creation ‘dead in the water’
China’s small firms, typically a major employer, are struggling to get by and hiring fewer workers, reports Bloomberg News.
“The ‘Blue Collar’ Job Index for small and medium-sized businesses, which are mostly in manufacturing and services, showed little improvement in the third quarter after hitting an all-time low of 0.3 in June, according to the Beijing-based China Institute for Employment Research,” reports Bloomberg.
“The recent plunge is a sharp reversal from the situation in late 2020 and early 2021, when the index climbed as factories struggled to hire enough workers to meet surging overseas orders for Chinese goods during the pandemic.”
The index “reflects declining hiring demand in manufacturing and services due to the economic downturn” says labor expert Zeng Xiangquan, head of the institute which is housed at Renmin University of China.
Along with weak factory demand and pandemic restrictions slamming the tourism, catering and hospitality businesses, the property downturn has hit construction jobs particularly hard, notes Zeng.
Job postings for construction supervisors fell 94 percent in the third quarter, as compared to a year earlier, while construction workers, forklift operators, and heating and air-conditioning mechanics, all saw drops of over 80 percent.
“Job creation in China among SMEs — normally a growth engine — is pretty much dead in the water. 3 x as many applicants as jobs,” tweets author George Magnus who formerly served as chief economist at UBS.
‘Almost a disregard for a healthy economy’
“I call Xi’s approach to the economy, ‘Xi Jinping's politics in command economy,’ and what we've seen over the last couple of years is almost a disregard for a healthy economy. Instead, Xi Jinping very much puts his ideology above that,” I say in an interview with Radio Free Asia’s Paul Eckert.
“For example, he cracked down on private education and basically wiped out this flourishing industry that was providing tens of thousands of jobs for smart, young Chinese people to teach English or teach math or teach Chinese or whatever. And he basically wiped it out with a little concern for the economic consequences.”
“One of the primary challenges is soaring youth unemployment -- around 20 percent, something which China hasn't seen in a very, very long time. Well, wiping out that sort of private tutoring and education sector was a direct blow to youth employment. Cracking down in a very heavy-handed fashion on the larger tech sector and some of China's wealthiest tech entrepreneurs-- people like Jack Ma and others also--without question contributed to growing youth unemployment.”
Low-skilled workers unemployable?
“A large population of uneducated workers was not a problem when China moved from low to middle income. Unskilled wages were low and there was growth in low-cost manufacturing and construction,” says a report from the Stanford Center on China's Economy and Institutions based on research by co-director Scott Rozelle and researcher Natalie Hell.
“But China’s growth model is changing as it gets wealthier. Unskilled wages are much higher, but the lure of cheaper labor elsewhere and China’s massive push to automate is rendering low-skilled workers redundant.”
“Construction jobs have tapered off as investment in infrastructure cools. These factors suggest China’s unskilled workers may be increasingly unemployable as the economy upgrades.”
*Short version: China will face a huge challenge in maintaining adequate employment as it tries to move to a more value-added growth model, because of the relatively low level of education amongst its workforce.
This is an argument made persuasively in Rozelle and Hell’s Invisible China: How the Urban-Rural Divide Threatens China’s Rise; it also is a central point in my 2020 book The Myth of Chinese Capitalism: the Worker, The Factory, and the Future of the World.
Xi team unprepared for challenges ahead
“As China faces the daunting challenges of moving from its old and outgrown model of debt- and investment-driven growth, and trying to become a much more innovative and domestic consumption-reliant economy, all the while trying to avoid outright hostilities with the United States and other countries, the ideologically minded and power- and stability-obsessed Xi seems singularly unsuited to be the leader in charge,” I write for the Atlantic Council.
“The rest of the Politburo Standing Committee, promoted for their loyalty to Xi rather than any technocratic ability, also seem very unprepared to push through the tough reforms needed. Where the new leadership, now even more under the thumb of Xi, takes China and its people next is deeply uncertain.”
“Chinese Foreign Ministry officials briefed [Xi Jinping] on the arrest [of Huawei’s Meng Wanzhou] when he returned to Beijing on Dec. 6. Ms. Meng, ranked China’s eighth most powerful businesswoman by Forbes magazine, was in custody and under severe distress,” reports the Wall Street Journal in this impressive deep dive into the hostage crisis that arose after Canada, on the U.S.’s bidding, detained the Huawei senior executive who also is the daughter of company founder Ren Zhengfei.
“China’s Ministry of Public Security, which had a list of Canadian names, proposed two for him to select. Canada’s ambassador was summoned to a Foreign Ministry office in Beijing and warned China would retaliate.”
*Biggest takeaway for me: The arbitrariness of who got punished in China following the arrest of Meng — and the fact that Xi Jinping himself made the final decision that wreaked havoc in the lives of two apparently innocent people, for a period of several years.
Check out this tweet thread based on a sobering interview with Taiwan scholar Wu Jieh-min, in which he discusses different scenarios for China's future and what they mean for the U.S. and Taiwan, and concludes the U.S.-China confrontation has gone past the “point of no return.”
“Wu Jieh-min of Academia Sinica analyzed 3 possibilities for China's future following the 20th party congress, which are 1) involution and long-term stagnation; 2) implosion like coup/revolution; 3) foreign aggression,” tweets the New York Times’ John Liu.
*Here is the full interview (in Chinese) in Taiwan’s The Reporter.
“Foxconn Technology Group is scrambling to contain a weekslong Covid-19 outbreak at an iPhone factory in central China, trying to appease frightened and frustrated workers during a crucial period for smartphone orders,” report the Wall Street Journal’s Wenxin Fan and Selina Cheng.
“In Foxconn’s main Zhengzhou facility, the world’s biggest assembly site for Apple Inc.’s iPhones, hundreds of thousands of workers have been placed under a closed-loop system for almost two weeks. They are largely shut off from the outside world, allowed only to move between their dorms or homes and the production lines.”
“Many said they have been confined to their quarters for days and that distribution of food and other essentials has been chaotic. Many others say they are too scared to carry on working because of the risk of getting infected.”
*Sounds like yet another case of China’s migrant workers getting mistreated, this time updated for the Covid age.
*I wonder what this Foxconn mess — and possible other factory lockdowns — will do to the availability of electronics good and global inflation?
The English version of the Constitution of the Chinese Communist Party — after the 20th Party Congress revisions — for those who may be interested.
Blast from the past
Here is our Trade War author saying goodbye to Han Zheng as he departs the top ranks of leadership following the 20th Party Congress.
*Kidding, of course. A picture taken long, long ago in Shanghai!
Snow comes early to Western Montana.