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China’s Economic Autocracy

China’s economic “miracle” wasn’t that miraculous. The country’s high-octane ascent over the past 40 years is, in reality, a triumph of basic economic principles: As the state gave way to the market, private enterprise and trade flourished, growth quickened, and incomes soared.

This simple lesson appears, however, to be lost on Xi Jinping. China’s leader is rejecting decades of tried and true policy by reasserting the power of the Communist Party within the economy and redirecting Chinese business inward. Indeed, faced with escalating hostility in Washington, Xi’s pivot seems, if anything, to be accelerating—with potentially serious consequences for China’s economic progress, and its relations with the world.

True, Xi isn’t completely drop-kicking free enterprise and free trade. In November, he told the G20 summit that China’s new economic agenda “is by no means a closed-door policy” and “will create more opportunities for the world to benefit from China’s high-quality development.” Beijing also recently joined the Regional Comprehensive Economic Partnership, a 15-nation pact that created a trading bloc with about a third of the world’s population. Hua Chunying, the spokesperson for China’s foreign ministry, hailed it as “a reflection of the commitment to free trade & multilateral trading system.”

But the picture looks much murkier if you’re Jack Ma, China’s tech-entrepreneur grand master. Regulators squelched what would have been a record-breaking initial public offering of Ma’s fintech giant, Ant Group, a mere two days before its November debut on the Shanghai and Hong Kong Stock Exchanges. The official reason they offered was an altered regulatory environment, but there is widespread concern that Chinese authorities were punishing Ma for criticizing their oversight of the finance industry. Xi reportedly made the call himself. (Beijing subsequently launched an antitrust investigation into Ma’s other creation, the e-commerce company Alibaba Group.) Days later, another prominent entrepreneur, Sun Dawu, was detained for “provoking quarrels and disrupting production,” and the government seized his agriculture company. Sun, who has sometimes been critical of the government, may have been targeted over a land dispute with a state-owned farm.

Jerome Cohen, a longtime expert in Chinese law, has worried on his blog that these actions could signal “a new central campaign to curb the political and economic power of major private entrepreneurs who refuse to follow the central Party line in every respect.” That rings true based on Xi’s efforts to tighten his grip on private enterprise. In a document issued in September, the Communist Party said it aimed to “guide” private companies to “explore the establishment of a modern enterprise system with Chinese characteristics.” The “opinion” of the party is that its cadres ought to have more influence over the management decisions of private firms, to ensure that they adhere firmly to the correct, state-determined line.

[Read: What happens when China leads the world]

Things weren’t supposed to happen this way. Deng Xiaoping, one of Xi’s predecessors, who launched China’s now-famous pro-market reforms in the late 1970s, understood that the country was destitute because it was strangled by the Communist state and cut off from the world. Deng and his successors steadily lifted controls on private investment, trade, and foreign business. Unfettered by overbearing state planners, China’s entrepreneurial energies, mixed with imported capital and technology, unleashed an explosion of growth and wealth.

When Xi took power in 2012, he initially appeared to be following the by then well-trod road of reform. In late 2013, a Communist Party plenum issued an economic blueprint that had many economists and businesspeople convinced that big change was afoot. And change did come, just not the kind they expected.

Though Xi has occasionally implemented market reforms—the financial sector has been opened more widely to foreign investors and firms, for instance—overall, he has shown a preference for the very visible hand of the state. His administration has gushed financial aid to a wide range of high-tech industries, including microchips and electric cars. Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics, notes that state-owned enterprises are gobbling up a larger proportion of vital resources, such as bank loans, while the share of national output generated by private companies is no longer expanding as it once had. “The surge of the private sector has come to end,” he told me.

Perhaps Xi believes that the industries targeted for state support are too important to be left to the unpredictable free market. Perhaps he thinks that a heftier role for the state could help firm his hold over party and government. “He wanted more control, and he thought having a big state sector was an element of achieving that,” Lardy explained.

Xi could also be motivated by fear and distrust. Since the days of Deng, the mantra of Beijing’s top policy makers had been “reform and opening up,” which stressed integration with the global economy. Xi, however, wants to limit that integration, or at least engage with the wider world on different terms. China, of course, will still sell you all kinds of stuff and happily take your money. But Xi wishes to reduce China’s reliance on other countries, especially potential adversaries such as the United States. From Beijing’s perspective, the Trump administration’s restrictions on technology sales to the telecom giant Huawei Technologies and other Chinese outfits exposed the dangers of counting on untrustworthy foreigners, and Xi intends to ensure that China’s advance can’t be upset by politicians in Washington or elsewhere.

Thus Xi’s priorities have turned inward. “He is feeling under siege,” James McGregor, the chairman of the China arm of the consulting firm APCO Worldwide, told me. Chinese officials “are eliminating all vulnerabilities to the outside world, or reducing them as much as they can.”

[Read: How Xi Jinping blew it]

Xi’s new strategy, something he calls “dual circulation,” splits Beijing’s economic worldview in two—a domestic focus on companies in China making stuff for Chinese consumers, and an international one on the country’s exchange with the outside. How this concept will work in reality is not entirely clear, but it signals a shift in China’s economic relations with the rest of the world. Beijing previously fused domestic reform and globalization into a powerful engine of development. Now it is hinting at intensified stress on strengthening the domestic economy to bolster China against an uncertain and potentially more hostile global environment.

In certain respects, this may not be a bad thing: For years, economists have been barking at Beijing that its economy’s growth would be healthier if it relied more on Chinese consumption than investment or exports. But this change may also mean China will engage in foreign trade and investment in ways that support this agenda. In other words, China will stay open for business—if that business helps protect its own interests.

This dovetails nicely with another of Xi’s goals, self-sufficiency. China, he believes, should produce homemade substitutes to key products now bought from overseas—especially microchips and other critical technologies. To protect national security, China needs “independent, controllable, safe, and reliable” supply chains, Xi said in an April speech, with “at least one alternative source for key products and supply channels, to create a necessary industrial backup system.” Localizing technology has been a long-standing Chinese ambition, but China watchers think Xi has thrown that plan into hyperdrive.

Xi’s refashioning of the economy has room to run. His government is preparing a “corporate social credit” system, paralleling one designed for Chinese citizens. In theory, it’s supposed to rein in polluters, tax cheats, and other corporate scoundrels. In practice, it’s seen as yet another state tool to intrude on private managers. Government bosses “have a strong sense that they are not controlling these guys enough,” Joerg Wuttke, the president of the European Union Chamber of Commerce in China, told me. All of this adds up to a grand experiment in the kind of state-directed development unseen since the days of Mao Zedong.

Classically trained economists frown upon Xi’s program. He’s ticking just about every box of what not to do to propel incomes and innovation. Yet we shouldn’t immediately dismiss his plans as doomed to fail. As a gargantuan market of 1.4 billion people, China can develop local companies of size and scope without bothering much with the outside world. (Ma’s Ant is a prime example.) If the program works, economists may have to rewrite their textbooks.

[H. R. McMaster: How China Sees the World]

Yet the undertaking is fraught with risks. By favoring the state sector, Xi is funneling valuable money and talent to notoriously bloated and inefficient government enterprises instead of far more nimble and creative private firms. The negative effect shows up in miserably poor productivity—a disaster for an aging society still catching up with the richest nations—and mounting debt, now nearly three times the size of national output.

In an October report, Julian Evans-Pritchard, an economist at the research firm Capital Economics, dubbed the self-sufficiency drive a “lose-lose” for China’s economy, because it diverts resources from more productive purposes and forces firms to choose suppliers for political, not economic, reasons. “Pursuing self-sufficiency may still be rational as a form of insurance against aggressive decoupling by the U.S. and its allies,” he wrote. “But China’s economy would be better off if such insurance weren’t needed in the first place.”

Xi appears to be betting on the insurance, and that has huge implications for the incoming Biden administration. Clearly, Xi is preparing for protracted conflict between the world’s two largest economies by attempting to fireproof China from measures President-elect Joe Biden might use against him. Yet in doing so, he is also repositioning the Chinese economy in the world.

The U.S. supported Beijing’s economic reforms based on the hope that as China grew richer, everyone would benefit from its greater prosperity and security. But if Xi succeeds in replacing more of what China purchases from the world, he will also undermine the economic rationale for continued engagement with a brutal authoritarian regime. Xi thinks he is shielding China against isolation. He could instead be causing it.

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