Xi’s ‘common prosperity’ mantra carries risks
Alicia Garcia Herrero, Natixis Asia Pacific Chief Economist, Bruegel Senior Fellow
Chinese leaders have been obsessed with economic growth since Deng Xiaoping launched his “reform and opening-up” strategy more than 40 years ago. To encourage growth and repair an economy devastated by the Cultural Revolution, he was willing to cast aside some of the features of a communist regime in favor of private ownership and individual wealth. This model, although extremely successful for overall economic growth, had the unintended consequence of worsening income distribution despite a dramatic reduction in poverty.
This model seems to have taken a sudden turn as President Xi Jinping pushes income distribution higher up in the country’s objectives by calling for China to achieve something called “common prosperity.” Alongside this change in official rhetoric, the Chinese government has embarked on a regulatory crackdown in a large number of sectors.
The first is in the tech sector, which has been interpreted as only to do with data-handling and not “common prosperity.” However, prosperity does have bearing: China’s billionaires have mostly made their fortunes through private companies in the tech space. Reining in private companies and their rich owners fulfills dual objectives for the Chinese leadership, that is, control over both citizens and a very important source of income, which can be redistributed in the pursuit of “common prosperity.”
In the crackdown on the education sector, the link with “common prosperity” is even more obvious. In fact, access to private education is one of the main reasons for worsening income inequality, especially among young people.
The third crackdown is in the real-estate sector, which is possibly the most important contributor to worsening income inequality because of the rapid growth in house prices sustained over many years. Housing affordability has continued to worsen and access to housing, or the lack thereof, has long been a key factor in income disparity.
The unrelenting increase in housing prices stems from the lack of investment opportunities for Chinese households in a financial system with little choice and no access to foreign assets. To cater to this demand, and faced with increasingly expensive land, which has long been the main tax base of local governments, real-estate developers leveraged themselves in order to afford land. Limiting and bringing this leverage under control was another key reason for the government crackdown, which also wants to moderate house prices so as increase housing affordability.
In August 2020, Chinese regulators introduced “three red lines” to limit the expansion of the most leveraged developers. Among them, Evergrande, with a worth of US$300 billion, stood out as the most leveraged and as owning the most assets.
For many, it is hard to understand how a construction company could become so large and complex. Leverage did not seem to worry anybody until mid-2017, when President Xi created a high-level commission to deleverage Chinese corporates. The reality is that corporate leverage continued unabated until the Covid-19 pandemic hit the economy, the real-estate sector and, by extension, Evergrande.
The Chinese real-estate sector has long been too big and too risky, and this is no coincidence. Part of the solution to reflating the Chinese economy after the global financial crisis of 2008 is now part of the problem. Increasing the supply of housing, as well as commercial real estate, were easy ways to earn money, as local governments were keen to see employment creation and growth. Investment in housing has been the “El Dorado” of Chinese households as prices have been on the rise nearly continuously until recently.
The sudden deceleration of house prices in 2021 is for several reasons: First and foremost is the sudden regulatory push to control the overstretched balance sheets of real-estate developers. The second is the effect of tighter controls on the buyers of real estate who need to deal with huge down payments as well as the fear of a nationwide property tax, which has been rumored for quite some time. This, again, can be read as a necessary measure to push common prosperity.
Finally, Chinese households are feeling the brunt of an economy that has been decelerating rapidly for the last few years, pushed by its own overcapacity, the US-led trade and tech war, and the pandemic.
“Common prosperity” is Xi Jinping’s new economic mantra, highlighting the importance of better income distribution and more equal opportunities. Excessively high, and growing, housing prices are likely the largest drivers of income inequality in China. Taming billionaires, both in tech and real estate, is also a welcome signal of the changing times.
There is, however, an important risk with China’s new development objective: Growth could simply become too low to be able to redistribute it. Plummeting housing prices as households decide to stop purchasing new houses for fear of a similar event as that of Evergrande could be a warning sign.
On the other hand, they could reduce household consumption as they will feel less wealthy (at least for those who already own property). Furthermore, investment in real estate is one-third of total fixed-asset investment, which is bound to collapse if housing prices plummet. China runs the risk of having more “common” but less “prosperity” to go around.
All in all, the Chinese leadership probably has good reasons to push for common prosperity instead of growth. Actions taken so far indicate that this is an important imperative, but worsening related incentives for the private sector should not be underestimated. The current crackdown on the private sector, which is far more productive than state-owned enterprises, could result in the stagnation of the economy, with much less to share.
*This article was originally published on Asia Times at
https://asiatimes.com/2021/10/xis-common-prosperity-mantra-carries-risks/
