China must abandon successful but outdated policies to revive economy in 2023

China enters the new year facing more economic uncertainty than it has faced in decades, but there is a path that can steer it clear of pitfalls
It requires adapting old policies to new conditions to boost domestic consumption, navigate Covid challenges, and strengthen trade relationships

Yukon Huang

Published: 3:30am, 21 Dec 2022

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China enters the new year with greater downside economic uncertainties than it has encountered in decades. Recent projections showing growth rebounding from 3 per cent for 2022 to 4 to 5 per cent in 2023 seem far-fetched as Covid-19 cases soar and China’s exports fall precipitously.

Moreover, the October 7 restrictions by the US limiting China’s access to semiconductors mark an unprecedented move to impede Beijing’s efforts to become more technologically self-sufficient. All this is occurring during an administrative transition, making it difficult for officials to act decisively.

But there is a path in the coming year that could get China out of this morass. It requires discarding policies that have served China well previously but are no longer appropriate given altered global and domestic conditions.

This means moving away from the traditional stimulus measures being contemplated to revive the economy to actions that would improve the productivity of investment, adjust pandemic policies to reflect the nature of the new variants, and forge stronger foreign economic relations to preserve a rules-based multilateral system.

I have elaborated elsewhere on reforms to achieve more sustainable and rapid growth by increasing labour productivity and returns on investments. The report from the recent meeting of the Central Economic Work Conference is encouraging in signalling support for the digital economy and private sector.

But both the recent Communist Party congress and the work conference fail to recognise that the most significant adjustment would be a much bolder effort to liberalise hukou residency policies that restrict people from relocating to more productive jobs elsewhere. These restrictions served a useful purpose decades ago in managing the migration of millions of rural workers to major commercial cities.

Now that China is largely urbanised, future productivity gains will come from allowing workers to move to where higher-value jobs are being created. These are often in the largest cities, where hukou restrictions are the most stringent. More flexible residency policies could also generate a surge in consumption since established residents tend to spend more and save less than migrant households without hukou rights.

Learning how to live with Covid-19 is critical to resuming normal economic activities. China’s “zero-Covid” policy has drawn global criticism, but few countries can claim to have handled the pandemic well. China was the only major economy to achieve positive growth in 2020 as its draconian policies kept the virus in check.

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But Beijing’s policies did not evolve quickly enough when it became apparent the new Covid-19 variants are less lethal but more contagious, making it impractical to continue with its zero-Covid approach.

Beijing’s issuance of 20 mitigating measures in early November unexpectedly facilitated a spike in cases nationwide, leaving the leadership with no attractive immediate options. Given the protests against zero-Covid policies, Beijing unexpectedly allowed localities to abandon widespread lockdowns and mass testing programmes in favour of at-home quarantine and ambitious efforts to vaccinate the elderly.

Given the weaknesses in the Chinese healthcare system and need to change the mindset of the population, the sudden shift in approach means the transition will be messy. A sharp rise in new cases could overwhelm medical services, and the economy will take a hit. A phased regional reopening could be warranted to bring China in line with global practices.

Perhaps the most challenging issue is adjusting to a hostile international economic environment as the United States has shifted from being a major advocate for free trade to its most prominent sceptic.

Washington’s tariffs and technology restrictions have targeted China, but even the European Union has been critical of the protectionist elements in the US Inflation Reduction Act. Moreover, the administration of US President Joe Biden has indicated it will reject the recent World Trade Organization rulings that its tariffs violate global trading norms.

Beijing is prioritising engagement with the EU given the sharp deterioration in bilateral relations with the US. Europe has similarly negative feelings towards China as the US built on shared concerns about human rights, but individually European nations are less focused on great power rivalry and technological leadership.

Countering US pressures on Europe to contain China’s economic rise should begin by pointing out that China differs from Russia in its support for a rules-based trading system. Russia’s huge energy resources gave it leverage to intervene recklessly in Ukraine and elsewhere with a sense of impunity.

But China needs a properly functioning global economic system to prosper given that it is the major trading partner with more than 100 countries. Constructive engagement with China on economic issues offers a path to a less contentious dialogue on the more sensitive security issues for Western powers.

In the coming years, China might become more active in demonstrating its support for a rules-based global trading system that the US is abandoning. This could include unilaterally dropping any sanctions against the EU as a signal for resuming negotiations on the suspended bilateral investment treaty.

Beijing could also abolish its punitive tariffs on the US even if Washington has shown few signs of moderating its own punitive tariffs levied on China during the trade war. Beijing could begin addressing the EU’s security concerns by suggesting that Huawei partner with Europe’s Nokia or Ericsson to provide 5G services to build more trust.

China’s leaders have secured all the authority they need out of the recent party congress. The challenge in 2023 is to adjust policies to ensure sustainable growth at home and more constructive relations abroad.

Yukon Huang is a senior fellow at the Carnegie Endowment for International Peace