The Existing Clichés
From time to time, commentaries on the Chinese economy from economists have become more BORING than ever. Critics of China routinely cite its weak protection of private property and arbitrary state intervention in the market—but rarely explain why these problems have worsened in recent years, beyond vague or “personal” explanations.
Those who take a more neutral stance often focus on the property sector and local government debt crises, recommending central government bailouts while offering little on how to address the deeper structural issues that led to these crises in the first place. They also (rightly) call for a shift toward a consumption-driven economy, yet tend to gloss over the trade-offs and institutional obstacles involved, repeating the vague mantra that “the day will come.”
Perhaps most uninspiring—if not outright amusing—are those who continue to cheerlead for the Chinese economy at this stage. Chief among them is Justin Yifu Lin, who has consistently overestimated China’s growth prospects in recent years and continues to advocate for investment-led rather than consumption-driven expansion, as though it were still the 2010s. These economists continue to place false hope in ‘industrial upgrading’ as a panacea for all existing problems, without considering who will actually consume the resulting flood of products.
The Political Roots
While the third group of economists are simply wrong, what the other two groups lack—or perhaps choose not to acknowledge—is a deeper understanding of the political roots underlying China’s economic problems. By “political,” I don’t mean the simplistic dichotomy between “authoritarianism” and “democracy” often drawn by thinkers like Acemoglu—that would be far too dull an argument to make. I’m not the kind of writer who hides behind unnecessarily long paragraphs and jargon without getting to the point. My response is clear and concise, as outlined below.
Immediate Short Term: Ideational Obstacles
Simply put, ideas matter. This is something I hate to admit—as a political economy student trained in formal theory and quantitative empirics, I’ve never been a fan of constructivism (in International Relations). I’ve always found it difficult to assess the impact of people’s thoughts. It’s prone to reverse causality and often devolves into circular reasoning.
But I would argue that China is different—something else I hate to admit. This is because Chinese politics have reached a point where structural factors (interest groups, institutions, conventions) can be overridden by the beliefs or even whims of the leader in decision-making. This is bad news for formal modellers, who rely on stable institutions and rationality, and for empiricists, who base predictions on past data. Ideational factors become especially crucial in the short term, when structural forces have yet to fully unfold and compel the leader to adjust their policies.
This distortion is caused by the flawed information flow between the leader and their subordinates/advisors. The subordinates and advisors often speculate about the leader’s policy preferences and present “evidence” and “rationale” to support these assumptions. Conversely, policy advice that contradicts the leader’s preferences is either censored before reaching the leader or, more tragically, self-censored by the advisors themselves. Behind this distorted information flow lies the logic of loyalty: any opposition to the leader’s views is seen as a threat to their authority, or even a sign of a political coup—something that has historically occurred in China. On the other hand, supporting the leader’s (often flawed) policy preference signals loyalty, and those who do so tend to be protected, even when things go wrong.
Therefore, the message is clear: he dislikes “feeding the lazy” (养懒汉) and sees no issue with deflation. Until he changes his mind, no real progress toward a consumer economy will be made. The solution, ironically, is also quite simple: wait until things deteriorate so badly that the leader is forced to make a U-turn—much like what happened with the COVID-19 lockdown reversal in 2022.
This also helps to explain Paul Krugman’s puzzle over why China is “bizarrely unwilling” to boost consumption. Krugman’s assumption—that a left-wing government should be naturally inclined to expand the welfare state and stimulate consumption—runs up against a premodern mindset, arguably rooted in China’s agricultural and early industrial traditions, where production and thrift are valued, while hedonism is morally condemned. However, Krugman’s intuition is not wrong: expanding social welfare and promoting consumption are not inherently at odds with Communist ideology. In fact, such policies could not only revive the economic momentum but also enhance the ruling party’s legitimacy as a “party for the people.”
While simple cash handouts (AND DEFINITELY NOT MORE INVESTMENT) may offer a short-term solution, their sustainability is questionable without further structural changes, and the costs are likely to emerge in the short to medium term.
Short-Medium Term: Becoming Like America
The key to sustained consumption growth is inflation-more specifically, a healthy wage–price spiral. One can better understand this argument by returning to a question President Xi once asked: “what’s so bad about deflation?” The answer is simple: when prices are falling, people tend to delay consumption, waiting for even lower prices. In this sense, inflation is not just a consequence of consumption—it can also be a cause of it. Deferred consumption, in turn, often leads to layoffs, wage cuts, and rising real debt burdens, all of which further weaken consumer demand. This self-reinforcing cycle is known as the deflationary spiral.
Furthermore, China’s current deflation poses a problem that Beijing may not have fully realized—it is worsening the country’s international relations. China’s unmatched industrial competitiveness has expanded into high value-added sectors, sparking concern among developed economies. Crucially, this industrial upgrading has not been accompanied by a retreat from low-end manufacturing, which concerns the developing economies. In fact, efforts to shift supply chains away from China have been only partially successful.
What’s more, China is unable to offer its own domestic market to trading partners in a reciprocal way. Due to weak domestic demand, Chinese imports from other countries are declining in both RMB and USD terms. As a result, China is not only exporting goods—but also exporting the pain of deflation to its trade partners. These partners are facing growing pressure to protect their own industries and jobs from Chinese competition—creating a structural tension that diplomacy alone cannot resolve.
The benefits of inflation are essentially the reverse: people spend more in anticipation of rising prices. Firms hire more and raise wages—making people more able to consume. As a byproduct, China would also import more goods and services from abroad, improving its image on the international stage and strengthening its diplomatic leverage. Once China achieves a trade deficit, there will even be a foundation for China to truly internationalise its currency and even replace the status of the US dollar (see Germain & Schwartz (2017) for a great discussion on this).
Moreover, inflation could help alleviate three of the current administration’s major headaches: the property sector crisis, local government debt, and wealth inequality. The core dilemma in the property sector is that high housing prices stimulate property-linked industries but at the expense of other sectors—and, crucially, undermine young people’s willingness to have children. In contrast, low housing prices create a negative wealth effect and trigger a credit crunch, further fuelling the deflationary spiral. In this sense, the sector behaves like a cancer: too aggressive to contain, yet too dangerous to remove entirely.
Inflation offers a viable way out of this problem. Property prices may rise, but as long as they grow at a slower pace than the overall inflation rate, the bubble can be effectively inflated away. Similarly, the accumulated debts of local governments—as well as the central government’s stimulus-related borrowing—can also be inflated away if nominal growth (roughly real GDP growth plus inflation) outpaces the rate of debt accumulation. In essence, this is a more subtle and intelligent form of deleveraging.
More interestingly, inflation also serves as a tool for implicit redistribution. In a country where good investment options are scarce—capital controls remain in place, the housing market is struggling, the stock market is a joke, and government bond yields are, remarkably, lower than Japan’s—the wealthy have few reliable channels to preserve their wealth. Gold and cryptocurrencies may seem like alternatives, but I would argue that their supply is far too limited to absorb the scale of China’s capital stock.
However, sustaining inflation is not without cost—it requires a shift in income distribution away from capital (in the form of profits) and toward labour (in the form of wages). The reason is simple: capital does not consume—it invests. A pro-capital distribution model encourages the expansion of productive capacity, which in turn adds to deflationary pressure and forces the government to run ever-larger deficits to plug the demand-side gap—an approach that is ultimately unsustainable.
Alright, enough economics. Let’s turn to the real challenge: politics. Here’s the political cost—making this kind of distributional shift would require empowering independent trade unions (not the current state-sanctioned mascots). That means enabling collective bargaining, tolerating strikes, and genuinely enforcing labour laws. These are all perfectly sensible policies for a left-wing government—but the CCP remains deeply reluctant to embrace them.
Moreover, inflation inevitably comes at the cost of export competitiveness. This means Beijing will need to find ways to take care of its export sectors. I hope it will achieve this by building a social safety net that enables both labour and capital in these industries to transition toward the service sector.
These are significant commitments—and not easily reversed. If inflation overshoots or the economy overheats, dialing it back can be painful. Tightening monetary policy in such a context is financially costly, especially for a highly indebted government following rounds of quantitative easing (QE)—a topic I explored in my Master’s dissertation, if you’re interested.
Trying to reverse the inflationary path by rolling back supportive policies would be politically costly, and would require a level of democratic legitimacy that the current system may not be willing—or able—to provide.
Medium-Long Term：A Need to Reform the Central–Local Government Relationship
Lan (2022) tells a compelling story of how the newly commercialised property sector became a major driver of the economy as well as a major source of fiscal revenue for local governments following the Tax-Sharing Reform of China in 1994: Local governments charge property developers a “fee” for the right to use land—an essential component of local government revenue. This burden is then passed on to homebuyers, who are often more than willing to pay this indirect tax during the most productive decades of their lives in exchange for access to public services, social benefits, social prestige, and, perhaps most importantly, a seemingly reliable investment.
During the golden age of China’s property market, it was common for households to view their home as the family’s most dependable breadwinner. Rising property prices were, in turn, underpinned by a booming economy—and, crucially, by infrastructure projects financed by local governments through loans from commercial banks, secured against the steadily growing income from land transfer fees.
It almost created the illusion of “common prosperity.” Local officials overshot their GDP targets and were rewarded with promotions, all while dipping their snouts into the trough of rent-seeking through land auctions and infrastructure projects. Banks, too, were happy—earning profits from loans to homebuyers, developers, and local governments. Rural migrants could easily find work on construction sites, making far more than they would from growing crops. Urban residents enjoyed the “Chinese Miracle” of world-class infrastructure and rapid wealth accumulation from soaring property prices.
People’s only regret? That they were too late to the party.
Although Lan (2022) assembled the puzzle and helped popularize the concept, both the Chinese public and the government have long recognizsed the dangers of this economic opium. In fact, the Chinese administration’s efforts to cool the spiral predate even the 2008 financial crisis. Nevertheless, awareness alone is not enough to resolve a problem of this scale—especially when the shared interests involved are deeply embedded across multiple layers of society. Even a regime as ostensibly “centralized” as China faces immense challenges in unwinding such entrenched dynamics.
The good news—perhaps also the bad—is that the spiral has ended, and it won’t restart even if the government wishes it would. Now that the party is over, the mess must be cleaned up: unsold houses are being bought back by state-owned enterprises (SOEs) using loans from the central bank, and local government financing vehicle (LGFV) debts are being replaced with local government bonds.
But history reminds us that heroin is not a good treatment for opium addiction—it may be a Pandora’s box in its own right. The housing buybacks add financial pressure to SOEs and local governments without generating new revenue, while the local government debt restructuring exacerbates problems of moral hazard and soft budget constraints.
The observations and rhetoric above are neither new nor original to me—they have largely been acknowledged by Beijing as part of an emerging consensus (even if not articulated in such a provocative or explicit manner).
That said, I would like to contribute two additional points to this discussion, which I have not seen widely addressed elsewhere:
Ban on Sub-Provincial Government Bond Issuance
It’s easy to fall into the false dichotomy of “central vs. local” when analyzing China, while overlooking the multilevel nature of governance in such a vast country. In 2014, China amended its Budget Law to allow provincial-level administrative regions to issue debt independently. Nevertheless, sub-provincial governments are still not permitted to issue government bonds directly at the time of writing—despite being at the center of the local government financing vehicle (LGFV) debt crisis. This means that, even after recent rounds of debt restructuring, lower-level governments still lack legal channels for raising funds, which remains a major structural issue. Worse still, the restructuring process shifts repayment responsibility from lower-level to higher-level governments, further exacerbating the problem of moral hazard.
Moreover, relying on financing vehicles as the main source of fundraising further reinforces local governments’ preference for investment-led growth over consumption-driven growth. This is because LGFV debt is essentially commercial debt, which requires corresponding assets to be added to the balance sheet when new debt is issued. As a result, governments are compelled to invest the proceeds—regardless of the investment’s quality—rather than spend them on social benefits, cash handouts, or subsidies that would promote consumption.
Therefore, relaxing restrictions on sub-provincial government bond issuance—and allowing the proceeds to be used for consumption-promoting policies—are necessary steps to unlock the full potential of local governments in China’s transition toward a consumption-driven economy.
Public Services Should be Centralised
Further relaxing restrictions on local government bond issuance will, of course, risk exacerbating the moral hazard and soft budget constraint problems. The key is to enable the central government to make a creadible threat not to bail out the local government if it fails to pay its obligations, which is currently not the case. In fact, the recent central government-backed debt restructuring broke this exact promise.
A crucial aspect of China’s soft budget constraint is that local governments are primarily responsible for financing and providing basic public services—such as education, transportation, and healthcare. They are also responsible for paying the wages of local civil servants. This means that if the central government were to refuse a bailout for a bankrupt local government, it would risk major social unrest and political instability—outcomes the central government is unwilling to tolerate.
Aware that the central government cannot credibly commit to letting them fail, local officials may borrow aggressively to fund infrastructure projects in pursuit of GDP growth and personal promotion, leaving their successors—and ultimately the central government—to deal with the resulting debt. Paradoxically, the central government is more likely to provide fiscal support to those who have over-invested, further reinforcing the incentive to over-invest.
One way to overcome this credibility problem is to centralise the responsibility for public service provision. These services should be funded through the central government budget and, ideally, managed vertically by their respective higher-level departments, rather than by local governments. In such a system, basic public services would remain uninterrupted even if a local government defaults—an outcome that would be acceptable to the central government.
With this arrangement in place, the central government could more credibly commit not to bail out fiscally irresponsible local governments.
One might argue that this solution does not address the incentive for local officials to over-invest at the expense of their successors and local citizens. This is a valid concern—but addressing it would require something even more politically costly for Beijing: more powerful and independent local people’s congresses, rather than the current rubber-stamp institutions.
Local citizens are more likely to prioritize long-term fiscal sustainability over short-term growth. If granted real authority, they would be more inclined to hold officials accountable for over-investment and excessive borrowing.
Institutional Roots of Profit-Driven Law Enforcement
One consequence of the property market downturn and the fiscal crisis facing local governments is the rise of profit-driven law enforcement. Not only are local governments more frequently imposing fines on residents to fill the fiscal black hole, but it has also become increasingly common for local authorities to arrest entrepreneurs outside their jurisdiction in order to collect fines—practices that often resemble outright extortion. This phenomenon has even earned a nickname: “long-distance fishing” (远洋捕捞).
While the CCP has acknowledged this issue and instructed relevant institutions to halt such practices, I remain skeptical about the effectiveness of this response. The reason is twofold: it addresses neither the direct cause of profit-driven law enforcement—namely, the shortfall in local government revenue—nor the institutional root of the problem: the dual accountability of local law enforcement entities. These agencies answer both to local governments and to corresponding institutions at higher levels of government. In practice, they are largely funded by local governments, and their appointments are often determined by local party committees—giving them a vested interest in serving local bureaucracies, even at the cost of broader negative externalities and long-term governance sustainability.
If we consider law enforcement a form of “public service,” then centralising and vertically managing these powers could also reduce the incentive for profit-driven law enforcement. Local governments would have less leverage over law enforcement agencies and therefore fewer opportunities to induce them to engage in illegal or coercive activities for local gain.
Of course, this is a top-down solution that still depends on the central government’s political will to implement it—a will that may be weak if the proposed solution introduces bureaucratic inefficiencies. A more fundamental remedy would require making governments and law enforcement agencies more accountable to the people. This would involve stronger protections for free speech and independent media, the lifting of internet controls, more active judicial review, and a more independent judiciary—steps that would be far more difficult for the CCP to undertake.
Long Term: Incompatibility between Marx-Leninism, Private Property and Political Inclusion
To use a deliberately uncomfortable simile, the relationship between the Communist Party and Chinese private entrepreneurs (or capitalists, if you prefer) resembles that of an abusive husband and his victimized wife: after each incident, the husband apologizes sincerely and behaves with exaggerated kindness—but one should never expect him to change his nature.
Many observers—from the West, across Asia (especially Singapore), and even within China itself—seem to have forgotten that China is governed by a Communist Party, one that remains committed to abolishing private property at some stage. Although the CCP frequently emphasizes that China is still in the “primary stage of socialism,” which incorporates many capitalist elements, this framing often obscures the party’s long-term ideological goals.
People continue to fool themselves into thinking that the vanguard party of the working class has been thoroughly assimilated by capitalism—transformed into a bureaucratic bourgeoisie during the course of the Reform and Opening period—with a vested interest in preserving the capitalist system, regardless of the “socialist” label attached to it.
To these surface-level observers, China appears to be just another case of authoritarian-led economic development—no different from Singapore, South Korea, or Taiwan (which, of course, is part of China—to be a good boy 🙂).
A preliminary alarm was sounded in 2018, when opportunistic financial commentator Wu Xiaoping published an article claiming that the private economy had fulfilled its historical mission and that it was time for it to exit the stage. Although this rhetoric was publicly rejected by state media, the rejection was largely framed around the idea that “current policy has not changed,” rather than grounded in a reinterpretation of Marxist principles—such as dialectical or historical materialism.
In other words, the current policy may change when “the time is ripe”: the real danger for private capital in China arises only when it becomes too successful—when its scale grows so large that its independent decision-making risks conflicting with the Party’s objectives, or even poses a perceived threat to its authority. A particularly relevant example is the downfall of Jack Ma, whose public speech angered Beijing, after which he effectively disappeared from public view.
This is further compounded by the influence of left-wing rhetoric from the public. Unlike other political ideologies, such as liberalism, Marxism remains enshrined as China’s official state ideology—even though the CCP has de facto deviated from many of its core principles. It is difficult to suppress such voices when they invoke the speeches and writings of past leaders—which remain publicly accessible—to legitimise their calls for restraining the profit-seeking motives of capital and advancing a more egalitarian society.
As a result of these factors, the CCP may feel compelled to restrain private capital when it becomes too successful. This does not necessarily take the form of outright nationalization—which can be costly (especially if shareholders must be compensated) or simply unnecessary. A more convenient approach is to summon major entrepreneurs to meetings where Party officials “communicate” the latest policies, and the entrepreneurs are expected to “express their support.” Alternatively, Party commissions may be embedded in companies to “advise” them.
Entrepreneurs understand the consequences of noncompliance: failure to cooperate can lead to charges of tax evasion, bribery, or other criminal offenses. As a result, private capital almost always aligns itself with the Party’s objectives—even at the expense of its own profits—regardless of what those objectives may be. These goals might include internet censorship, sharing sensitive data, making “donations” for specific causes, paying overdue social insurance contributions for employees (as is currently happening), or expanding employment (which, I suspect, will be the next directive).
The problem lies less in the policy objectives themselves—many of which are arguably justifiable (such as requiring the payment of social insurance contributions)—than in the process of policymaking. Policies are typically formulated behind closed doors and only revealed when they appear as “recommendations” from the Party’s Central Committee and/or the General Office of the State Council, rather than being developed through a transparent legislative process with proper representation, consultation, and public debate.
As a result, such policy uncertainty can discourage investment and lead to capital flight in the long run. The need for capital controls, in turn, undermines both the transition to a consumption-driven economy and the internationalization of the RMB, as we previously discussed. At the end of the day, China remains caught in a cycle of private sector growth, regulatory pushback, economic slowdown, and expedient policy shifts aimed at reviving the private sector.
This problem cannot be resolved by incorporating private entrepreneurs into the People’s Congress or the Chinese People’s Political Consultative Conference—these are not genuine decision-making bodies, as I’ve mentioned. Including them in the Party itself does little to help either: Party discipline rules out the possibility of simultaneously holding substantial political power and serving in private enterprises.
The option of shifting decision-making power from the Party to the legislature (the People’s Congress), while opening the latter to capitalists, is not compatible with Marxist-Leninist principles. Under this framework, the vanguard Party—purporting to represent the interests of the proletariat—must remain dominant over all other social classes. This is a fundamental characteristic of “socialism” as defined by the ideology.
This has a philosophical root: Marxism-Leninism asserts that the historical trajectory predicted by Marxism represents truth—a truth that must be believed in, and one that is accessible from within the Party. Ideally, this truth emerges through internal debate; in practice, however, it is often shaped through power struggles and political purges.
In essence, the Party may be “wrong” at times, but it is presumed to ultimately return to the “correct path.” A key implication of this worldview is that there is no theoretical basis for unconditional power-sharing, as found in multiparty electoral systems. Other social forces may be permitted to participate in politics, but only insofar as they only advise the Communist Party—when the Party is willing to listen.
A more scientific version of “scientific” socialism (i.e., Marxism) would require at least an agnostic view of the future—if not a complete abandonment of historical determinism. Moreover, it would need to distinguish its positive claims (which are testable and therefore scientific) from its normative judgments (to which others are not obliged to subscribe). Such a shift would be sufficient to eliminate the theory’s totalitarian roots and make possible a credible normalisation of political discourse—rather than merely a temporary ceasefire with competing ideological perspectives.
As such, the long-term prosperity of the Chinese economy hinges on both the recognition of private property and the autonomy of private enterprises from the state. The former requires reforming the economic components of the Marxist-Leninist framework; the latter demands political reform—which, in turn, necessitates a deeper philosophical overhaul.
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Citation
@online{yang2025,
author = {Yang, Dianyi},
title = {Chinese {Economy?} {It’s} the {Politics,} {Stupid}},
date = {2025-03-24},
url = {https://rubuky.com/blog/2025-03-24-PoliticsStupid/},
langid = {en}
}