China’s Economic Pain Is a Test of Xi’s Fixation With Control

In Xi Jinping’s strategy for securing China’s rise, the Communist Party keeps a firm grip on the economy, steering it out of an old era dependent on real estate and smokestack industries to a new one driven by innovation and consumer spending.

But he may have to relinquish some of that control, as that strategy comes under pressure.

Consumers are gloomy. Private investment is sluggish. A big property firm is near collapse. Local governments face crippling debt. Youth unemployment has continued to rise. The economic setbacks are eroding Mr. Xi’s image of imperious command, and emerging as perhaps the most sustained and thorny challenge to his agenda in over a decade in power.

“It’s a moment of great uncertainty, and arguably the moment of least confidence, surrounding the Xi administration,” Neil Thomas, a fellow at the Asia Society’s Center for China Analysis, said in an interview. “The worse things get for China’s economy, the more likely it is that Xi Jinping has to make some course correction.”

Earlier this year, Mr. Xi started his third term as China’s president, appearing indomitable. He had cast aside three years of bruising pandemic lockdowns and was confident that business would recover. He was committed to taming the debt-laden real estate sector even as home sales fell. And he had a new Communist Party leadership team of loyalists poised to push through his growth plans.

Mr. Xi’s government now confronts a tangle of difficult choices. On the one hand, he may have to give more freedom to private businesses and financial support to debt-saddled local governments. On the other hand, he may have to apply more of his power to push through painful steps that some experts say are needed to fix the economy and state finances, such as introducing new taxes.

Central to the country’s economic troubles is the slump in housing sales, which is at least partly the outcome of Mr. Xi’s choices. The real estate sector has been a main driver in China’s growth for more than two decades, but developers have built up daunting levels of debt, and Mr. Xi has cracked down on excessive borrowing by them. Now, as the real estate crisis ripples through the broader economy, officials have eased restrictions on home sales, and may take bigger steps.

In recent years, Mr. Xi sought to rein in private capital through regulatory crackdowns, drives against big tech firms accused of abusing consumers, and warning against “disorderly expansion of capital.” Now, to spur growth, the government may have to open up new sectors for private entrepreneurs and investors, who have often been wary of Beijing’s promises of more support.

The property sector downturn is also straining the balance sheets of local governments, which have long relied on revenues from land sales. Some experts say that the central government may be forced to either give local governments more revenue sources or relieve them of some spending burdens.

“Xi Jinping likes control, but a lot of those changes mean giving up some control,” said Dave Rank, a former deputy chief of mission at the American Embassy in Beijing who is now a senior adviser at the Cohen Group. And under Mr. Xi’s highly centralized leadership, he added, “the circle of people who’ll make the decisions about how to get out of this really, really challenging patch is very small.”

The party has been making the case that the country’s economic challenges are manageable, and that new drivers of growth, including electric vehicles and clean energy, are surging ahead. Indeed, not all observers believe that China’s economy is in a sharp downward spiral.

But the recent troubles have brought into focus long-term problems, and fed unusually candid domestic debate about the direction of economic policy under Mr. Xi, especially his expansion of the state’s control over the economy. Even as growth has slowed, Mr. Xi has been absorbed with beefing up national security against threats he sees from the West.

Proponents of the private sector have been making their case with fresh urgency, arguing that such statist policies are taking China down a dead end. Chinese internet users circulated an essay by a retired Hong Kong businessman, Lew Mon-hung, that implicitly laid the blame for China’s economic problems at Mr. Xi’s feet, declaring: “The problem is the economy, the root lies in politics.”

“The old ways for achieving stable growth aren’t working,” Liu Shijin, a retired senior Chinese government economist, said in a speech last month that was also shared by many users on social media. “The unstable expectations of entrepreneurs and their lack of confidence is constraining new activity and the growth of new cutting-edge industries.”

Hu Xingdou, an outspoken academic in Beijing, made a bolder call for change, urging Mr. Xi to end China’s “Wolf Warrior” brand of pugnacious diplomacy that has fueled tensions with many countries, and to reaffirm the importance of the free market.

For now at least, Mr. Xi seems disinclined to make any major changes to his broader strategy. And Beijing has also avoided issuing a big rescue plan for distressed developers and local governments.

China’s leadership does not want to encourage a perception that the central government will be the savior, said Alicia García Herrero, the chief economist for Asia-Pacific at Natixis.

“It’s like a pressure cooker — a way to show them that he wants them to take responsibility for their problems,” she said.

But a hands-off approach may not be sustainable. The central government controls most taxes in China, and then transfers most of those funds to local governments. But that falls far short of what many counties, towns and cities need to meet demands to generate growth and to implement Beijing’s policies, pushing local governments to take on debt.

Local governments, especially in many poorer areas, may need the central government to step in by absorbing some of their debt, by allowing them a bigger share of tax revenues, or by directly shouldering more of the costs of expanding social services.

“As the first priority, I would put revamping the fiscal system,” said Bert Hofman, director of the East Asian Institute at National University of Singapore, said of China’s economic policy priorities. “A lot of the dysfunctionality in the system results from a fiscal system that’s no longer fit for purpose.”

But restoring government finances while reassuring private investors is a daunting policy conundrum, even for Mr. Xi.

Cuts to taxes paid by businesses have already weakened government finances in recent years, especially in smaller cities and towns where small businesses make up a big part of the revenue base. China may need to restore such taxes to earlier levels, and ultimately even impose new ones, including a long debated and long delayed property tax, some experts say. Such changes could be deeply contentious, especially in tough economic times, and would test Mr. Xi’s claims that he dares to make changes that previous leaders flinched from.

“Fiscal reform in China will need him to be almost almighty to achieve what needs to be done,” said Ms. García Herrero, the economist. “It’s ironic that we criticize him for being too powerful, but in a way here he needs to be more powerful to get this done.”

Many are looking to Communist Party meetings in the coming months to see how Mr. Xi will seek to restore confidence in his economic agenda. In 2013, Mr. Xi used a meeting of the Central Committee — called a “Third Plenum” because of its position in the five-year cycle of committee meetings — to unveil an ambitious 60-point program that promised to give the market an expanded role in the economy. Many of the goals remain unattained.

Some Chinese economists and former officials have warned that time may be running out for the country to embrace difficult changes.

“Housing has also hit a ceiling, consumption has hit a ceiling,” Lou Jiwei, a former minister of finance said in a recent video interview with Caixin, a Chinese business magazine, in which he urged sweeping reductions to officials barriers to rural migrants settling permanently in cities. “You’re institutionally stuck and if you don’t solve this, you’ve hit a ceiling.”