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University of California Institute on Global Conflict and Cooperation

China’s Great Gamble: A Conversation with Barry Naughton

July 05, 2022
Barry Naughton and Lindsay Morgan

Podcast

China is the world’s second largest economy and has become a technological powerhouse. But this year, the economy of China’s main rival, the U.S., is forecast to grow at a faster rate than China’s for the first time since 1976. Is China’s economy at a crossroad? In this interview, Talking Policy host Lindsay Morgan talks with Barry Naughton, one of the world’s most highly respected economists working on China, who says that increased government intervention is bad for China’s long-term interests and for the world. Naughton also answers questions about what role the private sector will play in China’s economy going forward, whether China is looking for a new economic model (and if so, what is it?), and whether talk of decoupling from the United States a real possibility or just bluster.

Barry Naughton co-leads IGCC research on China’s science, technology, innovation, and industrial policy and is an economist at UC San Diego’s School of Global Policy and Strategy.

A headshot of Barry Naughton.

In your book, The Rise of China’s Industrial Policy, you write that there’s a huge disconnect between the success that we attribute to the Chinese economy today, and the orientation of Chinese policy today. What is the story of the Chinese economy since 1978? And what is this disconnect you’re talking about?

The development of China since 1978 is a huge topic because the changes have been so vast. The simple story at the heart of it is that, as China drew back from its bureaucratically controlled planned economy and opened up, allowed market forces, allowed more personal freedoms, allowed more personal mobility, Chinese people responded with a tremendous surge of hard work and entrepreneurialism that [transformed] China from [being an] underperforming Maoist economy into the world’s second biggest economy. It’s the world’s biggest manufacturing sector and the world’s biggest trading economy. It’s a simple story of extraordinary growth unleashed by a process of marketization, liberalization, and internationalization.

The disconnect in Chinese policy today is that over the last 10 years, Chinese policy has gradually shifted to stress governmental stewardship of this vibrant economy. That shift was initially gradual. At first, you could look at it and say: this is a market economy, so maybe a little government intervention might be a good thing that would improve things like healthcare delivery to poor people or technology development and diffusion. But what we’ve seen over the last decade is that these policies of government intervention have gotten stronger and stronger. We’ve reached a point today where it really is a very open question: do these policies make sense for China’s economic, social, and political interests?

Beginning in 2021, China instituted a major crackdown on its domestic technology sector which has wiped billions of dollars of value from some of its most prominent companies. In an op-ed in the Wall Street Journal, you wrote that these abrupt regulatory and policy changes are likely to do long-term damage to the performance of the Chinese economy and pose risks to investors and business operators. This regulatory blitz has extended beyond the tech sector to areas like private tutoring, entertainment, and real estate. China has also imposed severe lockdowns to try to stamp out COVID—shutting down Shanghai, the financial hub, for months.

We’re seeing what feels like a real acceleration of the expansion of the state and a clash between public and private power in China. Can you walk us through these recent clashes? And are there signs that Beijing sees these moves as mistakes?

There are definitely signs that very important leaders in Beijing possibly see these [moves] as mistakes. As your question implies, it’s hard to disentangle some of these things. For instance, should we consider the extreme COVID lockdowns to be part of the phenomenon we’re talking about? Clearly, they have a very immediate negative impact on the economy, [but] they are arguably separate. [But] we still see very substantial evidence that the most recent set of crackdowns have hurt the economy. We see it in the flight of capital out of China, which is exacerbated by interest rate changes.

We also see a very clear crisis of confidence among Chinese businesses. Until very recently, the assumption was that, even if the Chinese Communist Party and the national government sometimes are at odds with us [i.e., Chinese businesses], the government wants us to thrive, especially if we’re a high-tech business, if for no other reason than to build China’s relative wealth, strength, and power. All of the sudden, that assumption has been shattered. There is no confidence among the Chinese business class that the government actually wants them to succeed. Of course, it would rather they succeed than not, but if there’s a tradeoff between other government objectives, then the government is very willing to simply say, well, too bad. A half a trillion dollars of stock market equity is wiped out: tough luck. We don’t care about that because we have a set of national goals which are going to override that.

How do we make sense of that willingness to sacrifice economic wellbeing, at least for some, to achieve these other goals? What are the other goals? And is this likely to continue?

We don’t know, but it will probably continue if we assume that Xi Jinping continues to be the paramount leader and is reappointed for a third term this fall, which is what most people expect. Xi laid out a whole spectrum of goals last year that he suddenly said were extremely important. One of those is technological competition with the United States. That was already there, but it got ratcheted up a level. Other things include greater financial control to ensure financial stability. It includes so-called “common prosperity,” which sounds like a return to socialist principles, but hasn’t been backed up by any kind of coherent policymaking. And it includes much tighter ideological controls.

So, it’s not just one thing that he’s doing. He’s laying out many, many things, any of which have the potential to interfere with economic growth and development, which makes it harder for [ordinary] people. If you’re trying to do business in China, it makes it harder to try and figure out what you’re supposed to do—what hoops you have to jump through in order to stay on the good side of the company.

Do you have a sense of how people in China are experiencing these changes?

Because of the severe COVID lockdowns, people like myself have not been able to go to China for two and a half years. So we don’t really know how people are taking it and people have to be careful what they say. But we know that there’s, at the very minimum, a large minority of people who are very troubled by this turn. We can see this because, for about three or four months now, the government has been trying to walk back some of these policies. Premier Li Keqiang and Xi Jinping’s key economic advisor and Vice Premier Liu He have both been out in public saying things like “we want the stock market to flourish.” That’s an amazing statement. The fact that they need to say it speaks volumes. Liu said: “we want a transparent and fair regulatory regime that has green lights as well as red lights,” implicitly acknowledging that, “what we did last year was all about red lights.”

Clearly, they see the damage that it’s done. But we don’t see Xi Jinping coming out and saying, I’m going to walk this back. We see him displacing the responsibility onto people with much less power, so it has much less credibility.

What role will the private sector play in China’s future economy? Do you think it will ever be brought under total party control?

If China’s economy is going to continue to be successful, then I think the private sector will play an enormous role. There’s no question that the Chinese private sector is capable. It’s creative. It can do anything. The question is whether the government is going create conditions where that can happen, or whether it’s going to continue to exert more and more control, which by the way, will occur in a context of increasing tension, not just with the United States, but with the entire capitalist world. Even before the Russian invasion of Ukraine, before Donald Trump became president, China was already carrying out what we sometimes call a “securitization,” where more and more things were declared to be covered by national security, therefore legitimizing government intervention. And so, China has made a big contribution to the tense condition that the world is in today.

Which is not to say that the United States has not on occasion also contributed to tensions. But if you have to think about drivers, in my view, the Chinese shift towards greater government intervention and more security orientation is one of the big drivers that predates behavior on the other side.

One of your colleagues at the 21st Century China Center, Lei Guang, said that China is in search of a new political and economic model that will allow the Chinese Communist Party to remain in control and the economy to grow and flourish. Do you think China is searching for a model? If it is, what are the key ingredients?

China’s rule has become so personalized that I don’t think we can talk about China searching for a model. I think we have to talk about Xi Jinping. I don’t think he’s searching for a model. I think he thinks he knows what’s best. And his vision of what is best is one of very thorough party control over everything. You’d almost say that it is more extreme than the typical Soviet or Maoist version because it has tools of surveillance and propaganda that can be exercised with a subtlety that was never available in the past. So in some ways it’s stronger, but of course it’s also smarter because it recognizes that people are consumers and want to be happy and well off and that you should treat them in a certain way. I can’t see into Xi Jinping’s brain, but my guess is he thinks he can be an authoritarian leader who can steer his people and make China the most powerful and greatest country in the world.

Some Chinese officials, academics, and media outlets have been using the rhetoric of self-reliance and even talking about a “forced decoupling” from the United States. You already mentioned the immense geo-economic and geo-strategic shifts that are happening, spiraling out from Russia’s war in Ukraine and the great power competition between China and the United States. Is talk about decoupling bluster or an actual possibility?

That’s a great question. It’s hard to answer in the sense that two apparently contradictory answers are in fact both correct. That is yes, decoupling is real, and no, the two countries are so deeply entangled economically that the process of decoupling will take decades. Unless there’s a war or something, it will take decades and go through many different layers because billions of dollars are at stake. China makes hundreds of billions of dollars from exports to the United States every year. The United States makes hundreds of billions of dollars in profits from subsidiaries of American corporations in China and from contracting import to the United States, which are very profitable for American companies, which often controls those import networks. Given all that, it’s tempting to say decoupling is ridiculous, it can’t happen. But the truth is, it can happen and both sides are taking steps on the margin to reduce economic interdependence.

And if the war in Ukraine has taught us anything, it’s that things we don’t think are going to happen sometimes happen.

Yeah. That’s exactly right.

Is China’s industrial policy a threat or an opportunity?

Well, it’s not an opportunity. We don’t really know. It’s a great gamble—for China to turn away from something that has worked and try something that hasn’t. But, you know, gambles don’t always fail. I certainly would never advise doing this, but they’ve done it. And there are a lot of intelligent people in China. There are a lot of good engineers. There are a lot of entrepreneurial businesspeople. China’s industrial policy will certainly succeed in some areas.

It’s a threat because China is going to nurture some competitors [to the U.S.] and probably waste more money than it successfully invests. I’m not sure it’s good for China, but it’s certainly not fair for [the United States] to have to compete with a deeply subsidized strong company. And so we have to take defensive measures. We already see it in semiconductors. Although the U.S. Congress still hasn’t passed the semiconductor bill, we see companies that install solar panels promise to buy a certain amount of domestically produced solar panels. If we could do it, we’re going to bind to this. We’re responding because we feel that we have to, and personally, I think we do have to. But this means that the efficiency of the whole global system will decline because different regions will adopt their own self-sufficiency policies. I think that’s inevitable. And I think it’s mainly a response to Chinese policy.

What are the most important things to watch over the next year in terms of China’s economy?

There’s always the big wild card: will there be another big COVID outbreak this year? If that doesn’t happen, then I think their economy will probably return to growth pretty quickly and grow as fast as the U.S. or maybe a little faster. The whole Chinese economy right now is on artificial life support. They’re starting to pump stimulus money into the economy. Every other economy is doing the reverse as we worry about inflation. At the same time, they’re suppressing inflation by keeping caps on energy prices. I guess the main question is going to be: will consumption recover fast enough to pull other parts of the economy up? Right now, they’re relying way too much on government investment and way too much on controls of the whole thing. What I’m really watching are Chinese consumers.

The Chinese Communist Party will hold its 20th Party Congress in the fall. Xi Jinping is expected to take on his third term, potentially a life term, as the leader of China. Is that going to be a particularly important moment, do you think?

It’s a very, very important moment. Like any important event that’s talked about a lot and thought about a lot in advance, at this point Xi Jinping’s assuming a third term is what most people expect. When it happens, in some sense, not that much will change except we will then know for sure that everything has changed. If Xi Jinping is ruler for a third term then, as you said, he’s ruler for life. And that means it’s not a system, it’s a dictatorship. And it seems that’s where we’re heading.

You have done research on China and in China for many, many years. What in recent years has surprised you? What were you not expecting at this stage in your career?

Like many people, I’m surprised—indeed amazed—at how far Xi Jinping has been willing to take his authoritarian rule and how little he seems to understand [about how] China benefited from openness and a more liberal social policy. Chinese people have a complicated relationship with Mao Zedong, the founder of new China. People have a lot of historical esteem for Mao, but they also realize that Mao did some terrible things. The idea that a Chinese leader would take the whole society back to a kind of glorification of Mao, even though he’s not repeating specific things from the cultural revolution period—but that kind of blindness to historical experience… I never thought I’d see that again.

The music featured in the IGCC podcast is courtesy of Gato Loco de Bajo.

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