With the incidence of the omicron variant now rising sharply in Hong Kong, China’s government has sent epidemiologists and other public health experts to help contain it and the risk of another key source of spread to the mainland. More draconian measures, including lockdowns, are possible if Beijing resolves to extend its zero-Covid policy to Hong Kong. This current news serves to remind us of the risks China faces from omicron, on top of other systemic risks that both preceded the pandemic and have developed since it started. With this year’s important 20th Congress of the Chinese Communist Party (CCP) taking place in 8-9 months, the government’s priority for the year – stability – can be well understood.

This is all a big change from the position China was in as its sharp recovery from the Covid-19 crisis began in the spring of 2020. In that year and subsequently, China’s confidence allowed it to feel a sort of victory, which spawned criticism and mocking of other countries, especially the United States, the pursuit of so-called wolf warrior diplomacy, and a campaign to supply public goods to the world and showcase what it believes to be its superior development and governance model. Last year, it was one of the first members to ratify the Regional Comprehensive Economic Partnership trade deal, and put in a formal application to join the more ambitious Comprehensive and Progressive Agreement for Trans-Pacific Partnership just after the announcement under which the US and UK agreed to supply nuclear-powered submarine capability to Australia, and just before Taiwan applied. 

We will see what transpires regarding this application, whether China is serious or not, and whether other members would sooner kick it in to the long grass or veto it. The decision to proceed has to be unanimous. Yet in other matters, some of China’s best laid plans have tended to go awry. 

China’s zero-tolerance approach to Covid-19 means that it persists with an infrastructure of containment, spanning travel restrictions, quarantines, mass testing, surveillance, and lockdowns. Because of zero-COVID, the resulting limitations on immunity, and the questionable efficacy of China’s vaccines, China’s population may be now among the most vulnerable. That’s why Beijing is probably anxious about what is going on in Hong Kong, and keeping details from mainland citizens. 

Covid-19 has caused problems for China’s economy, though the success of zero-COVID against previous variants has meant that the damage has been light and fleeting. It has caused additional downside pressure for the consumer side of the economy through its effects on transportation, hospitality and leisure, but until now, the direct effects of Covid-19 have not been serious. Omicron could change this. 

If it spread widely in China, it could torpedo zero-COVID, causing significant economic disruption, and political embarrassment. If the government doubles down on containment, the economic costs could escalate as there might then be multiple and lengthy lockdowns. We can assume this dilemma won’t continue forever, and that after the Congress, the government will have to take measures to try and accommodate an endemic disease, but for now, the status quo will prevail. 

Covid aside, though, China’s property market finally tipped over in the second half of 2021 in what was hardly optimum political timing. The catalyst was the regulatory requirement imposed in August 2020 for property developers to observe so-called ‘three read lines’ or balance sheet restrictions on their borrowing. By the autumn of 2021, few could boast they had met 2, let alone 3 of the red lines, and Evergrande, the second biggest developer and the world’s biggest real estate debtor, was running out of cash, and became, in effect insolvent. It wasn’t the only developer to get into trouble and many analysts had expected for a while that eventually something like this would happen. 

The financial crisis in real estate is probably not big or wild enough to spill over into a more general economic crisis but it is a good metaphor for the debt burden limits now being reached in the wider economy. There is little question that the real estate funk in the next few years will have deleterious effects on the economy, or indeed that the more generic debt constraints in China will circumscribe growth for a considerable time. 

The Chinese housing market is estimated at somewhere between 20-30 per cent of GDP, valued at over $55 trillion or nearly four times GDP, and provides the basis for about two-fifths of loan collateral in the economy as a whole. Given the dampened prospects now hanging over the market, the government can certainly and is trying to stabilise it this year but in the medium term, it will surely hold the economy back.

This certainly wasn’t in anyone’s plan or script, but it’s a new problem to manage. New borrowing will be subdued as developers deleverage. Demand outside Tier 1 cities is weak. Vacancy rates are high. Household formation rates are falling along with the age group of first time buyers – the tip of another of the demographics iceberg, coping with which will preoccupy China’s leaders for years to come. Prices are falling albeit modestly so far. And local governments that have previously propped up the market are out of money, in debt, and are in any case the first in line to shoulder the cost of China’s newest campaign – Common Prosperity. 

Common Prosperity has been revived as a slogan  to get people behind a campaign that promises to deliver material and spiritual prosperity for all. It is not about egalitarianism or welfare, as such, though benefits, as yet undefined, are part of the campaign. Rather it aims address inequalities and imbalances that have accumulated and become worse following the single-minded emphasis on economic growth over the last 40 years. It is no accident that in the political rhetoric the excesses of private firms and entrepreneurs have been prominent, as well as the collusive and corrupt relations between government entities and companies, especially technology, finance and data companies which have been in the forefront of a veritable blizzard of regulation that was implemented in 2021 and which will doubtless continue, if less frenetically. 

Other hallmarks of the common prosperity campaign include a significant recalibration of industrial policy in which the primacy of state enterprises is being strengthened further, regulations and pressures on private capital to align its interests with those of the Party, and measures to trim the sails of firms offering goods and services in the education, housing and healthcare sectors –  with the goal of relieving the cost pressures in these key areas for middle class households.

The regulatory clampdown arrived in the wake of a host of other initiatives designed to bring important parts of the private sector to heel, and set examples to others about how to behave and pursue both commercial and social responsibilities, aligned to the Party’s goals. Private firms, including foreign multinationals, face a much more politicised business environment in which new antitrust, cybersecurity, and data laws define more national security oriented behaviour, and in which coercive giving, or ‘donations’ is as part of the responsibility of private firms.

Conclusion

Omicron is an immediate threat to Beijing, but sooner or later, we should assume that China will learn to live with it as others now are. Yet, growing pushback in the global system, the tipping over of the property market, the deleveraging that will have to happen one way or another more widely, the sapping of dynamism and rising costs from rapid ageing, and perhaps the longer term productivity growth hiatus are more enduring constraints on the economy and on China’s ambitions. 

Some of these problems are self-inflicted, and common prosperity fits this description. It might work but it reflects strongly the turn in China’s direction of travel on governance, which appears as the fault line in the contradiction between the political control the Party craves, and the incentives for innovation and productivity it needs. It is a contradiction that may not be resolvable as things stand.