China’s Overreach Is Putting Its Economic Rise At Risk

When Susan Shirk first visited China in 1971, GDP per person was $118 – roughly what my family spent on a takeout dinner last night.

China’s rise since then has been breathtaking. Its economy is now the world’s second largest and it has accumulated $3 trillion of foreign currency. Along the way hundreds of millions of people have been raised out of poverty.

For much of that time China’s rise was peaceful. But starting in 2006 Shirk began noticing a change. And when Shirk notices something about China it’s important – she now chairs UC San Diego’s 21st Century China center and is one of the most influential experts on US-China relations.

She recently published Overreach: How China Derailed Its Peaceful Rise and was recently my guest on the Top Traders Unplugged podcast. This is an insider’s story full of unintended consequences and irony, with much of the detail coming from her interviews with Chinese business leaders and government officials.

The Surprising Origins of Overreach

Ironically, the origins of “Overreach” began during a period of peak openness in Chinese society and the relatively weak rule of Hu Jintao. Under Hu, China was run as a “nine-man oligarchy” where each Standing Committee member was left to control his own portfolio. The power of each oligarch was tied to how much money he controlled, so each one began exaggerating the threats he faced – both domestically and internationally – in order to lobby for more funds.

Suddenly, foreign fishing boats and oil rigs were a threat and Chinese maritime agencies began harassing them. Europe’s color revolutions were said to endanger domestic stability leading to harsh crackdowns in both Tibet and Xinjiang. Private firms couldn’t be trusted to develop appropriate technologies, so resources were channeled instead to state-owned enterprises where oligarchs had massive influence.

A system emerged where each oligarch supported the others’ claims – and need for money – in return for being left alone to run their separate fiefdoms. Instead of checking aggressive actions and dispersion of patronage, this system reinforced it.

When Your Followers Praise You, You Know You Cannot Believe Them

When Xi Jinping assumed power in 2012 China was “deeply corrupt” and he made the case that centralization of power was needed to cleanse the system. His anti-corruption campaign was supported by Party leaders and deeply popular across the country. The next year he followed up by publishing a set of market-oriented reform proposals. It appeared China was moving back toward a more rules-oriented government and open economy.

That didn’t happen.

Instead, Xi’s focus shifted from eliminating corruption to eliminating rivals. This evolved into a “permanent purge” where the security officials who helped carry out the first round of purges were themselves jailed, many for life. In total over 5 million officials have been investigated and disciplined.

Xi now rules like a personalistic dictator, relying on a small circle of advisors that he’s known for years. Anyone outside this circle must demonstrate loyalty by “bandwagoning” – figuring out what Xi wants and then acting on it aggressively.

Zero-Covid is the most salient example. Xi made compliance with zero-Covid a test of personal loyalty. For local officials left to implement the policy, it created an incentive to enact extreme measures – like forced quarantining of people who were second-order contacts of anyone who tested positive, even if they had no symptoms.

These officials are now dangerously unpopular and, in some cases, the cost of their “over compliance” has bankrupted their local governments. The protests that erupted against zero-Covid were the first nationwide demonstrations against a central government policy since Tiananmen in 1989. The overreach of local officials, desperate to please an all-powerful leader, ended up badly damaging that leader’s credibility.

Could Overreach Kill The Economic Golden Goose?

Could the same unintended consequences play out economically? I think so.

China’s global power is founded on its extraordinary economic success. But the Party’s fear of losing control domestically is now undermining the very thing that elevated the country in the first place.

Using figures from Shirk’s book I estimate that China spends $200 billion each year on “social control”. That’s roughly half of its annual trade surplus with the US and an extraordinary sum of money to spend on anti-productive activities. Those doing the surveillance contribute nothing to productivity and those being surveilled presumably must spend some time in avoidance. An utter waste economically.

And what about the long-term impact on innovation and growth? Shirk interviewed one Chinese businessman who felt “traumatized” by Xi’s ability to destroy the precedent of regular leadership turnover. If no one could stop this move, he felt no one could stop Xi from expropriating private wealth. Not an ideal incentive structure if your goal is to generate innovation.

And China needs innovation to end its reliance on western technology. I wrote about this in my review of Chris Miller’s Chip War. Yes, the state plays an important role in the tech industry, but free competition, private markets and disruption are needed to drive innovation. State-owned enterprises, as the Soviet Union demonstrated, won’t get the job done.

Will China Resurrect Its Peaceful Rise?

Shirk hopes so and her book ends with recommendations that would demonstrate its peaceful intentions to the world – most importantly closing the camps in Xinjiang and reengaging with Taiwan’s leadership. She points out that Xi holds an immense amount of power, which includes the power to change.

She also has a message for the US – welcome Chinese students, tourists and businesses and acknowledge the remarkable accomplishments of the Chinese people. The best response to overreach is be the best version of our open-market democracy.