How Xi Jinping Led China’s Economy Astray

From reining in the property market to a big tech crackdown, Chinese President Xi Jinping has left his mark on the economy. While some may call him an anti-capitalist ideologue, he’s got his own rationale: Unless he shakes things up, China’s economy will probably fall off a cliff. As he tries to right the ship, though, he has also brought risks onto himself, destabilizing a sprawling bureaucracy and sowing popular discontent.

Among Xi’s signature policies, the most significant has been his crackdown on the housing sector, which kick-started in late 2020 with tighter scrutiny over the debt of developers. In the last two years, existing home prices in more than half of tier-2 and tier-3 cities have fallen by at least 15% from their peak.

The property sector was taking up too much capital. As of 2018, real estate investments accounted for almost 20% of China’s gross domestic product, but only employed 2% of the workforce, according to Bloomberg Economics estimates. Most of the 16 million working in the industry were poorly paid migrants, laboring long hours on construction sites, while top management morphed into billionaires. In 2017, China Evergrande Group’s founder Hui Ka Yan, now under criminal investigation after his company’s spectacular defaults on its dollar bonds in 2021, became the country’s richest man. At the 2019 peak, of the 500 billionaires tracked by Bloomberg, close to 20% were real estate tycoons.

It was the golden era for property magnates. Home ownership had already hit 70% a decade earlier, but the Chinese were still buying flats. They saw real estate as a financial asset.

The property boom became a palpable threat to social stability. Seeking a fast churn, developers relied on the so-called pre-sales model, where apartments are often bought 18 months to two years before completion to pull in operating cash early. With pre-sales, a homebuyer’s down payment and bank mortgage proceeds are wired into an escrow account, which a developer can access once construction starts.

That means developers have an incentive to break ground as fast as they can. In 2020, when the government’s regulatory crackdown began, residential projects under construction already hit 10 times the floor space completed.

By the end of 2022, distressed developers had run out of money to build and deliver pre-sold homes.

At Country Garden Holdings Co., once China’s biggest builder by sales, among its roughly $200 billion of debt, close to half was contract liabilities, or pre-sale deposits from homebuyers.

The real estate boom also ushered in rising wealth inequality. Housing was no longer affordable: The average sales prices to median household disposable incomes in the smallest cities were nearly double those of the largest OECD cities, according to the International Monetary Fund.

Meanwhile, the world’s biggest factory was losing its edge. In 2020, value added from manufacturing accounted for only 26% of GDP, a 5 percentage point drop from a decade earlier. The growth engine that pulled modern China out of poverty was leaving for Vietnam and Mexico.

Seen in this light, Xi’s signature policies start to make more sense. His mantra that “housing is to be lived in, not speculated on” sought to eradicate consumers’ blind faith in real estate as an asset class. His “common prosperity” drive was aimed at broadening the middle class, while painstakingly stressing that he was not advocating for a welfare state or egalitarianism. “Made in China 2025” was an effort to revive manufacturing.

But Xi’s policy fixes also turned out to be problematic. He has ruffled too many feathers not only in the private sector but among local officials.

In 1994, China implemented a tax-sharing reform that diverted more revenue sources to the central government. Since then, to make ends meet, municipalities have had to rely on land sales and borrowings from local government financing vehicles, or LGFVs, to pay expenses.

Before Covid, regional authorities got roughly one-third of their total income from land sales. In 2022, this crucial revenue stream tumbled 23% as developers ran out of cash and halted bidding on new plots.

Last year, local governments’ share of general expenditure reached a record 86%, widening their fiscal deficits — or the difference between their share of spending versus revenue. There is now a saying that Beijing holds the purse strings, while local cadres hold dirty shovels.

Cash-strapped local officials once again resorted to LGFVs to fix their fiscal problems. The liabilities of these financing vehicles rose to 57 trillion yuan in 2022, or 48% of China’s GDP and almost as big as official government borrowings, according to the IMF. Debt-to-GDP ratio hit a record 360%, from just over 200% a decade ago, when Xi took over.

Worsening local fiscal financing must be a matter of great frustration for Xi. During his first term as president, he proactively cleaned up LGFV debt, swapping more than 12 trillion yuan into official municipal bonds.

He is now back to ground zero, except saddled with more borrowings and chaos in the ranks. Provinces have cut civil servant pay, including for school teachers, thereby denting morale. The poorest regions are lobbying for a central government bailout, with veiled threats of bond defaults.

When the property roulette stopped, symptoms from the sector’s worst ailment — the unchecked pre-sales model — started to appear. As indebted developers could no longer deliver homes, angry buyers staged protests and threatened mortgage boycotts.

Even the common prosperity drive has missed its goal. A slowing economy hurts the masses the most.

To some extent, Xi’s gambit to move China away from a property-driven growth model is starting to work. People have become more cautious, steadily paring back their risk appetite.

That’s cheap money that state-owned commercial lenders can use to give out to industrial high-end manufacturing companies, which Xi favors.

Nonetheless, it will be years before high-end manufacturing can replace property investments as the new growth engine. For instance, while Huawei Technologies Co.’s new smartphone Mate 60 Pro was a major breakthrough despite US sanctions and export controls, its Kirin chip is still not as advanced as the ones that power Apple Inc.’s most advanced new iPhones. Mass production also remains a question mark.

China has no approval ratings polls and social media is heavily censored, so we don’t have an accurate measure of Xi’s popularity. But we have a sense. Given the high homeownership and that more than one in five young people are jobless, many can’t be too happy right now.