An Uncommon Theory for Common Prosperity

The lyrics to the Chinese national anthem contains the line “The Chinese nation faces a most dangerous time.” If the word “dangerous” is swapped out for “crucial”, then that is the essential message Xi Jinping has been sending to the country since the 19th Chinese Communist Party (CCP) Congress in 2017.

Lately, that message has been rendered as “once-in-a-century strategic transformation” to lend more urgency to the task at hand. That task is, and has always been, to make China great again.

What that boils down to is a rather concrete goal: turn China into the world’s largest economy by 2035, with roughly a $30 trillion economy and a per capita GDP of ~$25,000. That puts the country solidly in the high-income club.

But the nature of that task has changed considerably, captured in the crucial decision at the 19th Party Congress: defining the “new principal contradiction.” Cutting through the Marxist jargon, the “contradiction” is a full acknowledgment that making China great again now requires a reset of the Chinese growth model.

In short, China will no longer be defined by growth, but by how it tackles long neglected scarcities across the economic, social, and political realms—in order to meet “people’s ever-growing needs for a better life.”

That is the new principal contradiction in a nutshell, which also happens to be the central argument that Bill Adams and I put forth in our book nearly a decade ago. Scarcity, in fact, is still the relevant prism through which to view the litany of neologisms—from “dual circulation” and “supply-side structural reforms” to the latest “common prosperity”—that the Xi administration has test-driven over his two terms.

Common prosperity, then, is simply a means to an end and serves a political purpose. Along with the other neologisms, what they share is that each illustrates a type of scarcity that needs to be overcome to refashion the current growth model.

Now that Xi has apparently resolved history, he is now asking the political class and middle class to give him time to resolve the principal contradiction. Only by doing so, according to the CCP, will the Chinese Dream be realized and Xi’s legacy cemented.

Dual Circulation and Economic Scarcity

One of the most consequential economic scarcities highlighted in our book was that of China’s labor force. By now, there’s broad consensus within China that the country has reached its “Lewis turning point,” whereby the rural-to-urban labor force transition has peaked. Huang Qifan, former mayor of Chongqing and well-known technocrat, admitted recently that urbanization will only contribute marginally to China’s future growth.

What’s more, an aging population and an anachronistic fertility policy simply mean more workers are aging out of the labor force than being replaced. Or to the extent that they’re being replaced, it’s from the excess of college graduates over the last decade, many of whom are barely making more than migrant workers. China’s college bubble left graduates without prospects but at least without debt.

Although China’s total labor force is still some 900-million strong, the structure of the labor force no longer supports an export- and investment-intensive growth model, not least because there is significant upward pressure on labor costs.

Dual circulation, then, is the strategy put forth to initiate the necessary pivot to developing the domestic market now that exports and urbanization are no longer the main engines of growth. In other words, the Xi administration is hoping to actualize what has been previously referred to as “rebalancing,” which is ultimately about building a more robust consumption economy.

Although “self reliance” is an aspect of the dual circulation strategy, it is mainly about expanding the middle class, the only tried and true way to create sustainable domestic consumption. To do so requires a host of consumption-oriented policies, including a more market-based currency, financial sector liberalization, and pro-income measures—all of which have been put into motion.

Foreign investment and foreign goods, so the logic goes, will naturally flow into the China market on the back of the world’s largest middle class with rising purchasing power—just as they flow into the United States. This is why the messaging behind the strategy insists that it isn’t about walling off the domestic market at the expense of foreign investors but to ensure that the latter also serves the China market to ride the consumption wave.

Supply-side Reforms and Social Scarcity

From higher education to welfare and affordable housing, social scarcity mainly manifests itself as prolonged underinvestment in these sectors. Supply-side structural reform is many things wrapped in often unintelligible CCP lingo, but at the core it is the recognition that China has over-invested in areas such as steel and infrastructure and under-invested in everything from the high-tech supply chain and clean energy to pensions and healthcare.

One does not need to look far to see how that scarcity has played out. Beyond the demand and supply mismatch of college graduates, the recent blossoming of “edtech” can be viewed as an indictment on the public education system. The very existence of a popular and profitable alternative education sector reflects on both the hyper competitive nature and ailments of an education system that needs remedies.

When it comes to healthcare and pensions, local governments have systematically underfunded these mandates, leading to empty pension accounts and a crisis in China’s hospital system that has led to bouts of violence. More than once, corruption cases have involved local officials using pension funds to invest in the next bridge or housing project.

All these issues directly impinge on the ability to bolster domestic consumption because this type of social scarcity affects households’ precautionary savings and constrains increased spending today. If Millennial Chinese believe they must save 15 years to have any hope of purchasing a home, it will be difficult to unleash consumption quickly.

As such, supply-side reforms are actually fairly simple to understand. It is basically about investing less into “GDP-maximizing” efforts and investing more into “quality of life” areas—in other words, a reallocation of capital from supplying the “wrong things” to supplying the “right things” that are aligned with the current stage of development.

Of paramount importance in supply-side reforms is investing in human capital, which of course is at the heart of how innovative China can become. This focus will lead to reforms in the education system that appears quite proficient at turning out Steve Wozniaks but perhaps fewer Steve Jobs.

Common Prosperity and Political Scarcity

While the principal contradiction paves the way for resetting the current growth model, it is a proposition that’s as profound as it is risky. At the macro level, it will necessitate a broad tolerance for slower growth, which will be politically difficult and a recipe for fomenting opposition.

Although Xi’s administration has so far shown fortitude in embracing austerity, including throwing out the GDP target in the 14th FYP, such a transition is certain to undermine beneficiaries of the current growth model.

For one, local governments and property developers are constituencies that could well end up in the “loser” column. Their centrality in sustaining the status quo, from land and housing to infrastructure investments, will likely wane as existing pistons of growth are dialed back.

A China that’s no longer viewed as a “growth engine” is akin to a loss of identity and is a difficult pill to swallow for local governments accustomed to a single, clear metric. Throughout all levels of the Chinese polity, if GDP is no longer worth striving for, then what is?

These powerful constituencies can contest Xi’s agenda and create vulnerabilities, and any change of this magnitude requires political buy-in. Xi has relied on two tools to create political space for this risky gambit: dialing up propaganda and providing sustenance to fill the ideological scarcity.

This is where “common prosperity” enters the picture. Xi has wrapped up a challenging agenda into a palatable political message: this economic transition isn’t exclusively about taking away your bread and butter, but about achieving prosperity for all.

Indicative of how politically fraught this transition could become, the CCP has already backpedaled a bit. It has taken pains to explain that when it comes to common prosperity, it is prosperity first, common second. In the debate between redistribution and growing the cake, it would appear that growing the cake is still the precondition for redistribution.

That’s because Xi is on the hook to deliver on the “Chinese Dream” that he first articulated in 2012, which has since been concretized as the 2035 long-range plan. That goal, as noted above, hinges on doubling the Chinese economy in 15 years—in a word, prosperity.

Yet that goal will be accompanied by a socioeconomic shift that will likely be painful, particularly for those in the political class that have also profited from the prevailing model. When the going gets tough, then, Xi can turn to common prosperity as a salve. In other words, the pain is worth it because it is ultimately about turning China into a respected superpower.

Indeed, the instrumental role that such an aspirational vision has played during Xi’s tenure is key to his credibility. One may interpret it as good old nationalistic propaganda, but its effect is tantamount to creating a “national myth” around which the country can rally.

Xi articulated the myth’s plotline in his CCP centenary celebration speech earlier this year. The cliff notes version goes thusly: China was born 5,000 years ago ➜ fast forward several millennia ➜ China was down and out in 1840 ➜ experimented with many things in the intervening 80 years but couldn’t overcome weakness ➜ until the CCP came to the rescue in 1921 to restore China to greatness.

Like all national myths, it deliberately omits uncomfortable chapters and skirts over inconvenient truths. But its simplicity is what makes it compelling as both a political platform and in filling the ideological void that was becoming an endemic problem for the CCP.

When he entered office, Xi inherited a fractious Party. He had immediately identified ideological scarcity as one of the most pressing threats to the Party that he leads. Over the course of his two terms, he has aggressively supplied a concoction of ideas, vision, and aspirations to articulate a “Chinese way” and the “Chinese idea.”

That idea of the great restoration, or national rejuvenation, has never been more prominent than on the eve of the sixth plenum of the 19th Party Congress.

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Skepticism is certainly warranted on whether the path China has embarked on will be realized. In retrospect, one can trace an arc of disappointments since those 60-points of reform were offered at the third plenum in 2013. The deleveraging campaign has also had its fits and starts, bringing with it market uncertainty. Even the latest effort to reverse one of the growth engines, namely property, has led to more volatility than expected.

For the top leadership, the key lesson of the past nine years may be that the inertia against change is so strong that the center has to apply even more force. In a system where internal checks and balances remain weak, course corrections that require turning the entire ship of state may simply require force.

And that force’s name is the CCP, a formidable behavior modification machine. It is no coincidence that much of the language around reform and the principal contradiction often traffics in militaristic metaphors. That mobilization mentality may be the only method the CCP knows how to make fundamental change.

But that forceful method will invariably be accompanied by more unpredictability and trigger occasional volatility, which may have to be increasingly priced in as this process unfolds after 2022.

In the introduction to our book, we concluded that the “…dramatic transformations that have sprouted every ten years or so since the founding of the modern Chinese republic are reasons to believe that changes will come, if not willfully, then by the indomitable force of necessity.”

That force of necessity appears to be the CCP’s assessment as well.