China’s Covid Policy Will “Exact A Very High Cost On The Economy”

China’s “zero-Covid” policy response to the spread of the Omicron variant in the country this year will “exact a very high cost on the economy,” a former long-time American diplomat in Greater China said in an interview today.

“Sentiment about China is definitely more negative, just because of how long this situation is lasting,” said Kenneth Jarrett, a senior advisor to the Albright Stonebridge Group whose earlier posts also include president of the U.S. Chamber of Commerce in Shanghai and Greater China Chairman APCO Worldwide. “If ‘zero Covid’ remains the policy, lockdowns can happen all over China for the rest of the year. Given the complexity and size of supply chains in China, this could mean additional disruptions in the months ahead, which would ripple through and disrupt global supply chains.”

U.S. companies cutting forecasts in connection with slower-than-expected business in China this year include Apple and Starbucks. Disney’s resort in Shanghai has been closed since March 21.

Jarrett has a solid on-the-ground view: He has been locked down in hard-hit Shanghai for the past 39 days. “Internationally, people are scratching their heads trying to understand how a city with a strong reputation for competent management could be in such a state of crisis, including having people short of food,” he said.

“The Chinese government throughout the Covid period has pointed to its success compared to almost every country in the world. Most of the time that was true, but we have the irony now that China is suddenly the odd man out,” Jarrett said. “Their role is now reversed, in part because they haven’t been able to make the transition to dealing with the more contagious Omicron variant,” he said via Zoom and in a follow-on email exchange. Jarrett also commented briefly on China’s recent calls for U.S. cuts in tariffs imposed during the Trump administration and on the country’s compliance with U.S. sanctions imposed on Russia follow its invasion of the Ukraine. Excerpts follow.

Flannery: What’s behind the extreme measures China is taking to control the pandemic?

Jarrett: There’s a political dimension and a public health dimension. Right now, politics is in command and trumping public health, though it’s not that the Chinese government is oblivious to public health considerations. For example, the government recognizes that the vaccination level among the elderly is not high. And public fear of the disease is runs deep. The government realizes this. In the (Communist Party’s) standing committee meeting last week, they highlighted the need to accelerate vaccination efforts. In the compound where I live, there was a notice over the weekend asking anyone who’s over 60 and hasn’t been vaccinated to submit information so that shots could be arranged. In Shanghai, all of the deaths that occurred have basically been elderly with underlying conditions. There’s also a general concern in China about the state of the healthcare system, particularly in rural regions, and the government is also aware that the Chinese vaccination efficacy level is lower (than foreign vaccines). For political reasons, however, they still refuse to allow foreign imports. In that sense, they’re painted themselves into a corner in terms of public health policy options.

The Chinese government throughout the Covid period has pointed to its success compared to almost every country in the world. Most of the time that was true, but we have the irony now that China is suddenly the odd man out. Their role is now reversed,

in part because they haven’t been able to make the transition to dealing with the more contagious Omicron variant. Even if they recognize at the intellectual level that Omicron is different from Delta and the other variants, the politics makes it difficult to behave differently. For Xi Jinping, part of his justification for a third term is that he’s done a very good job of managing China in many dimensions, including Covid.

China isn’t a government that makes dramatic policy shifts overnight. And if they’re considering a shift in a sensitive area, they’re not going to talk about it a lot in a public manner. So “dynamic zero Covid” will be the official policy until it’s not. And as it moves to not being the official policy, this will happen quietly. The fact that the government is now becoming more serious about getting the elderly vaccinated is a sign that they know they have to transition, but they’re not going to offer a public mea culpa and say, “Oh, we made a mistake. Now we’re really going to turn dramatically in a different way.” That’s just not how it works.

Flannery: How much inconsistency is there in the implementation of the Covid policies at the local level?

Jarrett: There’s very strong consistency in that everyone is over-interpreting guidance from their superiors and being stricter than they need to be. In that sense, it’s very consistent.

People make comparisons between Shenzhen’s swift success at managing its outbreak and Shanghai’s protracted difficulties. The lesson taken by most political figures is that Shenzhen succeeded because it moved very quickly and dramatically; Shanghai took its time and tried an approach that gave consideration to economic concerns, but this unfortunately allowed the situation to get out of hand. If you’re in the standing committee in Beijing or a senior official in the capital, your conclusion is the Shenzhen model is better. As a result, that’s the approach we’re seeing used in Beijing at this time.

Flannery: Does any of this pose a threat to Xi Jinping’s grip on the leadership?

Jarrett: Will he have a third term? I don’t think this is going to upset that plan. However, if you’re Xi Jinping, any development that makes you look as though you’re not managing the country well is particularly unwelcome with the Party Congress

around the corner. Many people in Shanghai are unhappy and they’re sounding off. Internationally, people are scratching their heads trying to understand how a city with a strong reputation for competent management could be in such a state of crisis, including having people short of food. Many of the (video) clips of Shanghai in lockdown that made their way around the world don’t reflect well on China. Some of this does rub off on Xi Jinping. I’m sure he’s not happy with the situation. However, he’s been quite clear about what he wants Shanghai to do. Shanghai has received the message, and local officials are busy fighting the battle.

Flannery: What’s been the fallout for foreign companies?

Jarrett: The impact has been quite serious. The biggest short-term impact is on sentiment. Sentiment about China is definitely more negative, just because of how long this health crisis is lasting.

There is an industry dimension and a time dimension. On the former, you have to differentiate between manufacturing and services. For some in the services sector, this is a disaster. The hospitality industry is a good example. Keep in mind that consumption is a big driver of the Chinese economy. Even now, here in Shanghai people might be eager to consume, but the logistics network is in disarray. It’s hard to get things to people, even if they want to spend money. As for the time dimension, if you had asked me in mid-April, I would have said foreign companies were relatively optimistic that by the end of the year, they could recover (business lost in the first half). Now, even if companies do expect a recovery in the second half of the year, we see more large corporates issuing profit warnings. At this point, the expectation that companies can fully recoup in the second half has been lost.

Flannery: There was also a forecast in the past week by the Biden administration of a spike in U.S. cases between now and the end of the year.

Jarrett: That’s a reason why there is an overhang of pessimism about the general situation. If “zero Covid” remains the policy, lockdowns can happen all over China for the rest of the year. Given the complexity and size of supply chains in China, this could mean additional disruptions in the months ahead, which would ripple through and disrupt global supply chains.

The political narrative for this year emphasizes the “zero Covid” policy. Unfortunately, that is going to result in actions that will exact a very high cost on the economy. Even if, in the meantime, China tries to address its public health shortcomings, that will take time. For example, it could take six months to complete the process of two vaccines and a booster for those elderly who are currently unprotected.

Flannery: Will there be a diversification of some manufacturing out of China, or will companies continue to try to wait it out?

Jarrett: In thinking about this question, you need to differentiate between types of companies. For the bigger multinationals, the importance of China or their commitment to China is quite deep and strong. I don’t sense any change of heart from that crowd. But for expats who came here as entrepreneurs because they saw a potential business opportunity, conditions have been difficult. They have taken a big hit. It has also been challenging for SMEs, who lack the deep pockets of larger corporates.

Flannery: China’s U.S. Ambassador Qin Gang in an interview recently criticized Trump-era tariffs on China. It is possible that the Biden administration is going to reduce some of those tariffs as a kind of anti-inflation action?

Jarrett: (U.S. Treasury Secretary) Yellin and a couple of other senior officials have talked about this publicly. Perhaps those comments were to test the political waters. Overall, my sense is the administration doesn’t have much appetite to make a change right now. The problem with tariffs is once they’re put in place, it’s hard to remove them. And even if the administration understands the economic rationale for doing so, the politics are difficult. The administration would need to get something from China in return for removing tariffs, to help with the politics of explaining tariff removal to the American public, but I doubt that China is in a bargaining mood. In addition, you have the midterm elections coming up. In short, I don’t expect movement on tariffs.

Flannery: Is there any sign that China is taking advantage of sanctions that were imposed by the U.S. on Russia after the Ukraine invasion?

Jarrett: Energy would be the area to look at to answer that question. Since the natural gas or oil generally flows through pipelines from Russia to Europe, it’s not so easy to redirect to China. In general, Chinese companies have been quite careful to avoid triggering secondary sanctions. There have even been a number of reports of Chinese companies that are essentially withdrawing from Russia, as the safest way to steer clear of trouble. The Chinese government is quiet on this point. They oppose the sanctions against Russia as a point of principle but seem to understand what’s at risk for China’s economic relationship with the West.

See related posts:

China’s Ambassador To The U.S. Talks Pew Poll, Trade, Air Travel In Exclusive Interview

China Covid Policies Causing “Massive Uncertainty For Businesses,” European Chamber Says

China Messaging On Ukraine Shows Support For Russia’s Invasion: U.S. State Department

Tips at [email protected]

@rflannerychina