Churchill famously said that democracy was the worst form of government apart from all the others that had been tried. The same can be said about free markets and their alternatives. If proof of such a statement was ever needed, recent political and economic developments in London and Beijing have provided it.
We would ignore these developments at our peril, especially given China’s outsized importance to the US and global economy.
In London, it was less than 40 days before the UK’s vibrant democracy and free financial markets forced Liz Truss, the new Prime Minister, to abandon her reckless budgetary stance of unfunded tax cuts and generous public spending. It was only a few days longer before she was forced out of office.
With the pound falling and interest rates skyrocketing in response to her unorthodox and irresponsible commitment to economic growth, Truss was forced to fire her Chancellor of the Exchequer. That opened the door for tax hikes and spending cuts to get the country’s public finances back on a sustainable path and spare the UK a full-blown currency crisis. It has also paved the way for a new prime minister to chart a course that could put the country back on a sensible path of economic growth.
A very different story unfolded in Beijing. At the 20th Congress of the Chinese Communist Party this week, President Xi Jinping will be anointed for a third five-year term – the first since Mao Zedong. He gets the honor despite the egregious economic policy mistakes he’s made over the past five years. These mistakes have already caused China’s economic growth to stall as the government targeted a growth rate of 5.5%.
This is extremely unfortunate as it will likely mean that China will be slow to correct its economic missteps. With the backing of the Communist Party, Xi will most likely stick to his economically damaging zero-tolerance COVID policy, which has led to the closure of major cities like Beijing and Shanghai.
It also likely means that Xi will continue to roll back Deng Xiaoping’s market-based economic reforms of the early 1990s that put the country on its path of rapid economic growth. He will do this by continuing to wage war against the big tech companies that pose a threat to his economic and political power.
Among Xi’s past policy blunders that have clouded the country’s long-term economic prospects is his creation of a housing and credit market bubble on a scale larger than what preceded the US housing market collapse in 2006. Given Xi’s interventionist tendencies, it is doubtful that he will be able to tackle the looming property debt crisis without clogging China’s banking system with bad loans and populating its economy with zombie companies. This will almost certainly herald a lost economic decade for China, similar to Japan’s in the 1990s.
Given China’s greater importance to the global economy, we have to regret that the economic stables clean-up took place in London and not in Beijing. China is now the second largest economy in the world, six times the size of the UK. Until recently, China was also the world’s most important economic engine and the world’s largest consumer of international commodities.
Napoleon famously said that the world will shudder when China wakes up. This line also has its financial applications. With Xi in full charge of China’s struggling economy, we will likely soon find that if China’s economy stumbles, the rest of the world will struggle to regain its former economic growth momentum.
Desmond Lachman is a Senior Fellow at the American Enterprise Institute. He was Associate Director in the Policy Development and Review Division of the International Monetary Fund and Chief Strategist for Emerging Markets at Salomon Smith Barney.