Did Authoritarianism Cause China’s Economic Crisis?

China’s economy, the world’s second largest, is facing its most serious setback in a generation. During the past two years, economic growth appears to have been cut nearly in half. After emerging from the “zero COVID” policies that Xi Jinping, China’s leader, ordered early in the pandemic, the country now faces a real-estate crisis and faltering confidence from both its own citizens and overseas businesses. The problems have sparked debate among economists about whether Xi’s increasingly autocratic regime is to blame, and what a major slowdown could mean for the rest of the world.

To talk about China’s economy and the possible causes of its malaise, I recently spoke by phone with the economist Eswar Prasad: a professor at Cornell University and a senior fellow at the Brookings Institution, an expert on the Chinese economy, and the author of “The Future of Money.” During our conversation, which has been edited for length and clarity, we discussed why Xi may be hesitant to implement significant economic reforms, how serious a threat a crashing Chinese economy is to the rest of the world, and the lasting impact of China’s pandemic policies.

What do you think has gone wrong with China’s economy, and why has it manifested itself so clearly now?

The Chinese economy has been beset by a combination of short-term problems as well as longer-term structural challenges, all of which seem to be coming to a head at the same time. It has long been powered by investment, and investment certainly sounds like a good thing, because if you invest more, the economy can grow faster. But China has had relatively inefficient investment. A lot of it has been undertaken by state-owned enterprises that are not necessarily investing in the most productive way. China has in particular relied a great deal on investment in the real-estate sector, so the property market is now beginning to unravel a little bit because there was a lot of speculative activity in that market.

Then there is the problem that some parts of the economy, including local governments, have a lot of debt, a lot of fiscal pressures. There is also a longer-term challenge: China has an aging population and a labor force that is already beginning to shrink. If there isn’t a path to higher growth via investment, and if the labor force is shrinking, the only way you can generate growth is through more productivity, and they’re not able to do that.

On top of that, global demand for China is weak, so it’s not able to export as much to support its economy. China took away its “zero COVID” policy, but consumers and businesses seem quite nervous about the country’s economic prospects. Businesses—private businesses in particular—aren’t investing and consumers are not spending that much. All of this is now leading to another problem, which is deflation, or falling prices.

In an economy with these types of problems, what are the solutions that a government would normally try to implement?

It can use fiscal policy. In other words, the government can go out and spend more. It can give people money, it can spend more on investment and on buying things, and that can stimulate economic activity. It could also do things like cut taxes, which leaves more money in the pockets of people, in the hope that they will go out and spend. Then, the central bank can make money cheaper, essentially—by cutting interest rates and flooding the economy with money, they can make money cheaper for both businesses and consumers and also reduce the cost of that money.

The difficulty that China faces right now is somewhat larger in scope, because even if you give people money to spend, if you make it cheaper to borrow, if you give them government handouts, people need to be confident about their future economic prospects so that they go out and spend rather than save. Right now, China could use its traditional policy tools, but I think the fundamental problem that the Chinese economy is beset by is really a lack of confidence, and we’ve seen this in a variety of measures. Private investment has essentially collapsed during the last year, although a lot of that is attributable to the real-estate sector. Retail sales, especially of big-ticket items, such as cars, have gone down a bit. The real problem seems to be that businesses and consumers don’t quite have confidence in the government’s ability to turn things around.

There’s been a big debate going on with a number of very prominent economists about the degree to which China’s current problems and difficulty finding solutions really stem from its authoritarianism. China’s obviously been an authoritarian country for a long time, but it’s got significantly more authoritarian in the last decade under Xi Jinping. How do you think about the contours of this debate, and why is this debate important?

It is certainly the case that the command-and-control mentality of the Chinese government has made it somewhat harder for them to recognize problems as they arise and to tackle them in a frontal way. Additionally, state-owned enterprises, which still comprise a significant share of economic activity, are under the direct control of the government, as is much of the financial system, especially the state-owned banks. The government seems to believe that it can manage its way out of any problem.

What I think is the real problem for China is that they’re stuck halfway. I’m not saying that a fully command-and-control model would be ideal, but what China wants to do is let the markets work to some extent, and that is a bit of a problem. It’s very challenging to have markets work when you don’t have the necessary institutional reforms. What that means in plain language is that you need the rule of law. You need good corporate and government transparency. You need good auditing and accounting procedures. Without those attributes, which China doesn’t have, the market cannot really function well, so we’ve seen a lot of volatility in stock markets, in land prices, and so on.

The other problem is that when things are not going well in the part of the economy led by the private sector, the government steps in and tries to set things right directly. Now we have a situation where people think the government will step in, but they’re not quite sure, so this creates even more volatility and uncertainty.

The case that Chinese authoritarianism is causing problems goes beyond just the factors you have cited. There have been reports in the Wall Street Journal and elsewhere that Xi is for ideological reasons unwilling to orient the economy toward more consumer spending. There’s been concern that Xi’s crackdowns on foreign business have sorely hurt international confidence in China.

There is certainly a sense that Xi tolerates private enterprise but sees state-owned enterprises as the bulwark of the economy. During the last year and a half, especially, that tightening has been very apparent. We have seen high-flying tech companies get cut down to size. We have also seen crackdowns on private funds in the medical and educational sectors. There is a very clear sense that, while the government is willing to tolerate private enterprise, it doesn’t want private entrepreneurs to become so successful or have their firms become so big that it makes it difficult for the government to control them.