Donald Low
Hardly anyone in China wants to talk about COVID-19 or the zero-COVID policy that the authorities stubbornly pursued throughout most of the pandemic. Zero COVID was abruptly abandoned at the end of 2022, causing more than an estimated million deaths in the subsequent months. The authorities then brazenly declared in March 2023 that the country’s management of the pandemic was “completely correct,” even as they scrubbed references to the policy that had traumatized the economy – and people’s lives – for more than two years.
The initial success of zero COVID likely generated hubris and excessive confidence among Chinese leaders. It seemed to confirm that their approach to governance – an increasingly intrusive, ideologically-driven, and moralistic form of social engineering – was not only superior to Western ideas of governance, but that it could also solve some of China’s long-standing economic problems. Early success with zero COVID emboldened the authorities to intervene in the economy in extreme, heavy-handed ways that have now backfired.
More than a year after China scrapped its zero-COVID policy, it has become clear that most analysts underestimated the adverse impacts on business and consumer sentiment. The initial optimism that greeted China’s reopening in early 2023 has been replaced by deflation and a persistent gloom approaching a crisis of confidence over China’s economic prospects.
Zero COVID as Ideology and Virtue
Just as the Chinese authorities succeeded in suppressing the first outbreak of COVID-19 in Wuhan city and Hubei province in the second quarter of 2020, the pandemic was raging out of control in much of the world. As one government after another bungled their initial responses to the pandemic, government spokespersons and state media in China trumpeted the country’s ability to mobilize resources and public opinion in “the people’s war” against COVID-19. Later, as most countries switched to living with COVID, the Chinese propaganda machinery went into overdrive, denigrating this approach as “lying flat,” callous, reckless, and Darwinian.
Instead of framing zero COVID as a policy that was temporarily necessary to buy time to vaccinate the population (especially the elderly), the authorities ideologized and moralized it. Perseverance (with zero COVID), Chinese President Xi Jinping declared, was victory. Turning a public health issue into a moral contest, in which COVID-19 was portrayed as the enemy, was always myopic; it left China with less room to change course when it needed to.
As the virus evolved to become more transmissible and less deadly, and as almost every other government on the planet adapted to the reality of COVID-19 becoming endemic, China’s insistence on zero COVID in 2022 was archaic. More than that, it was also evidence of a government that no longer prioritized economic growth, that seemed to believe that its social controls could defy the laws of biology, and whose obsession with ideology and security now displaced pragmatic policymaking.
Targeting Internet Companies and Property Developers
The zero-COVID policy might not have had such devastating effects on the economy had it not been accompanied by regulatory crackdowns in almost every one of the high-growth industries that drove China’s economic expansion in the preceding decade. As the economy rebounded from the initial lockdowns in August 2020, the Chinese authorities unveiled the “three red lines,” marking the start of a large-scale crackdown on property developers aimed at reducing their leverage, lowering financial risks, and making homes more affordable. Soon afterwards, the authorities went after internet companies – including fintech, gaming, and ride-hailing – justifying the crackdowns in terms of preventing the “disorderly expansion of capital.”
Some of the problems the authorities sought to address – especially high levels of property debt – were long-standing ones that they had previously tried, and failed, to resolve. The Chinese state’s initial success with suppressing COVID-19 created an illusion of control and invulnerability that gave policymakers a misplaced confidence to solve these intractable problems in the middle of a pandemic.
Their interventions were also driven by a belief in the possibility and desirability of social engineering. If zero COVID reflected the Chinese state’s drive to control nature, the regulatory crackdowns reflected its desire to reshape the economy along utopian lines. As with zero COVID, policymakers also seemed to think that the harsher their policies were, the better they were.
Policies are, and ought to be, judged by their outcomes, not by their intents or goals. The proverbial road to hell often starts with good intentions. It is now clear that China’s economic malaise and the collapse of confidence in its financial markets are largely the result of the over-zealous regulatory crackdowns launched at the height of zero COVID hubris.
With the benefit of hindsight, one can also see that the zero-COVID policy that reached its inhumane, soul-crushing peak during the Shanghai lockdown in the second quarter 2022 did long-term damage to animal spirits in China. When zero COVID was finally lifted at the end of 2022, businesses and consumers were already scarred. A strong recovery in 2023 required not only fiscal and monetary stimuli, but also efforts to heal the trauma inflicted by zero COVID and the regulatory crackdowns.
Recovering From Trauma
The Chinese government responded to the slowdown last year in three main ways, none of which has been particularly effective. The first has been to lower borrowing costs. But the real problem in China today is not credit supply, it is the lack of credit demand.
The second has been for the central government to borrow and invest in infrastructure development. But a 1 trillion yuan ($141 billion) bond issue approved in October does not seem to have given a large boost.
The third has been to get banks to increase their sale of bonds backed by bad debts (which include mortgages, credit card debt, and business loans) as the property debt crisis spread. But fears that China’s property market has yet to bottom raise questions about the quality of these securities and reduce investors’ appetite for them.
These measures have had a limited impact partly because they were introduced in a piecemeal fashion. More importantly, these measures did not address the underlying sources of trauma facing the economy.
Dealing with trauma begins with leaders accepting responsibility for at least part (if not most) of the economy’s problems. Rather than blame others, recovering from trauma requires one to take ownership and to recognize that no one else can solve your problems. This first step is difficult for Chinese leaders to accept; they may not even acknowledge that the economy faces a crisis of confidence. To the extent that they acknowledge this, they prefer to blame the West for using “cognitive warfare” to undermine confidence in the Chinese economy.
While such a narrative may be useful in the short term – to direct public unhappiness at foreigners – it is likely to backfire in the same way that insulting other countries for living with COVID-19 made it more difficult for China to exit zero-COVID. Blaming Western governments for China’s problems also gives the former too much credit. Most problematically, it does not take much for citizens to reason that if “cognitive warfare” can do so much harm to China’s economy, then maybe it isn’t as strong or resilient as the authorities claim.
The second step involves concrete measures to help the parts of the economy that have been most traumatized in the last three years to recover. With real estate, lower interest rates are necessary but not sufficient. Recapitalizing troubled property developers may well be required. With internet companies, the authorities must send a clear signal that they understand the need for regulatory predictability. A moratorium on new regulations for the next three years might be sufficient to calm nerves and lift animal spirits among China’s internet companies.
Third, and in the longer-term, China’s economic structure needs to be “normalized.” While there is merit in investing in some new industries (e.g. green technologies, artificial intelligence), the economy overall suffers from excess capacity and insufficient demand. China also accounts for more than its fair share of exports globally, so net exports cannot be increased much further without provoking a protectionist backlash. That leaves consumption, which in China accounts for just 53 percent of its GDP, compared with 72 percent for the world.
Increasing consumption to a more “normal” proportion of GDP would require Chinese households to reduce precautionary savings. The only way to achieve this over the next decade or so is for the state to expand social security, especially in healthcare, pensions, and income support for the poor. This, in turn, requires the authorities to drop their aversion to welfare spending and build a social security system befitting a developed country.
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