As U.S.-China relations continue to deteriorate, Beijing is making a major policy shift in regard to social and economic governance. According to analysts, this new prioritization is setting up a long-term decline in the nation’s corporate productivity and economic growth, while defusing and managing political discontent.

Richard Yetsenga, chief economist at ANZ Bank argues that a number of restrictive factors including demographic constraints on consumption, climate constraints on manufacturing, and macro constraints on monetary and fiscal policy indicate that China is inevitably facing a downshift to a slower growth path. And analysts agree that today’s sweeping regulatory clampdown on the nation’s education, tech and property sectors signals that Beijing has reset its priorities to tackle social inequality, data security risks and environmental sustainability, rather than focusing solely on bolstering economic growth.

Therefore, some economists now expect second-half year-over-year economic growth to drop to around 5-or-6 percent after China’s sharp economic recovery in the first half of 2021. Analysts also say that 5-or-6 percent could be the full-year growth rate for 2022, which is roughly the same growth path the country was on at the end of 2019, before the coronavirus hit.

The implications of China’s “policy U-turn” are tectonic. And if a shift to information technology is unable to restart China’s high rate of growth, the focus will have to shift back to manufacturing and consumption which are both facing structural challenges of their own.

To be sure, economic growth remains important, as top leaders still want to double China’s GDP by 2035. But after 40 years of rapid economic growth that has widened China’s wealth and income gaps, policymakers feel they need to address social issues to revive a public perception of “fairness and justice.”

This is reflected in the theme for China’s 14th five-year plan: “common prosperity.”

Publishing this mandate has triggered worries that the nation’s socio-economic model will return to that of a planned economy, where all sectors increasingly become nationalized.

Recent regulatory moves remind us that, by design, the Chinese economy is socialist. And following the road to “common prosperity” likely means that the Chinese economy will move from a stage of pursuing efficiency, to a stage of pursuing what the Chinese define as “fairness.”

President Xi Jinping seemed to reinforce that idea last October when he said: “Common prosperity is a basic goal of Marxism and has long been a basic ideal of the Chinese people. According to Marx and Engels’ vision, a communist society will completely eliminate the antagonisms and differences between classes, allocating resources according to one’s abilities and needs, so as to truly realize each individual’s freedom and complete development.

Recently the education sector became the latest target of regulatory action which has already wiped tens of billions of dollars off the market value of Chinese tech companies listed in the United States, Hong Kong and Shanghai. The decision to overhaul the private tutoring sector barred it from teaching core subjects such as math, science and history and eliminated teaching children younger than six years old on weekends and public holidays. The regulation change regarding education companies is rooted in an attempt to reduce the cost and burden of raising children, so as to increase fertility rates. Importantly, these actions caught the stock market off guard, spreading fears that the regulatory invasion would widen to other sectors.

Beijing has also set a goal of raising the nation’s average per capita income to $20,000 U.S. dollars a year by 2035. This would mean that the path laid out for economic development would require a growth rate of at least 4.5 percent a year for the next 20 years. To help it catch up to leading global economies, China has acknowledged that its economic model needs to transition from one based on high capital investment to one based on productivity growth.

However, deteriorating U.S.-China relations have forced regulators to take into account priorities other than economic and financial ones. For example, the decision to prevent private tutoring schools from raising funds or accepting investments from foreign companies was said to be a direct result of Beijing’s security concerns amid tense relations with Washington.

In fact, the Chinese government has become very sensitive about foreign participation in all its industries. Most importantly, they are afraid of importing Western ideologies that will influence the thinking of China’s youth.

As is the case with today’s high U.S. inflation rates, China’s 2021 full-year economic growth rate of 8 to 9 per cent is largely a product of so-called “base effects.” That is, this relative surge reflects last year’s low growth and is unlikely to be sustainable.

In fact, growth appears on track to slow to 5 to 5.5 percent over the second half of the year. And there are a number of uncertainties around this outlook. In particular, the year-to-date strength of export demand has been more robust than was expected this year, and there is fear that this may fade as stimulus measures in other countries ease back and as reopening efforts shift demand from imported goods to domestic services.

Moreover, efforts to control the real estate sector, in concert with China’s agenda of “deleveraging to curb the off-balance-sheet risks of local government borrowing,” remains a high priority for China’s policymakers. This suggests that there will be continued downward pressure on local government spending that could slow broader economic activity. In fact, international experience strongly suggests that even when carefully managed, deleveraging is likely to lead to lower growth rates.

But, given the Chinese Communist Party’s fear of losing control, it makes perfect sense that it would try to carefully manage China’s inevitable slowdown which is driven by structural factors beyond its control. As the Trends editors have repeatedly explained, it becomes harder for a modernizing economy to continue to generate high rates of return on investment as it catches up with the most developed nations. Coupled with demographic and natural resource constraints, maturing of the economy has put China in a precarious long-term situation. For the CCP, it’s a matter of making the most of the hand it’s been dealt.

Given this trend, we offer the following forecasts for your consideration.

First, China’s economic growth will slow to three percent a year by 2030 and remain near that level. That’s likely slower than U.S. growth at that time. This conclusion by the Trends Editors, is consistent with a growing consensus shared by leading experts on China’s economy. Nick Marro, lead analyst for global trade at the Economist Intelligence Unit expects China’s GDP growth to hover around 3 percent by the end of this decade, and he suggests this would be a respectable pace of expansion given the size of China’s economy; however, Marro does not conclude that growing issues related to economic stagnation and financial risks will have receded by then. In that same vein, Louis Kuijs, head of Asia economic analysis at Oxford Economics expects that China’s economic growth will continue to slow to around 4 percent by 2030, as the volatile resurgence of economic activity following the coronavirus crisis winds down. Similarly, the International Monetary Fund now forecasts China’s GDP growth will slow from 8.1 percent this year to 5.7 per cent in 2022, and continue easing to 5.1 percent as soon as 2025. Meanwhile, Mark Williams, chief economist at Capital Economics predicts 8 percent growth this year, followed by 5.7 percent in 2022, then a decline to around 2 percent by 2029.

Second, required reforms in the financial system will contribute to China’s reduced growth trajectory. Given macro constraints on monetary and fiscal policy, China will continue cutting banks’ reserve requirements to maintain ample liquidity. However, another round of large-scale stimulus like the one it enacted in the spring of 2020 to combat the effects of the pandemic is unlikely because that could lead to worsening corporate balance sheet strains in the coming quarters as the economy slows.

Third, as the threat of decoupling from the U.S. intensifies, China will push for greater supply-chain self-sufficiency. That means it will increasingly prioritize policies to enhance industrial and national security while reducing reliance on technological imports. For example, Reuters reported that Beijing quietly issued new procurement guidelines for state firms in May 2021, requiring that only domestically made materials be used in hundreds of items, including X-ray machines and magnetic resonance imaging equipment, erecting fresh barriers for foreign suppliers. As “national security” concerns increasingly overshadow much-needed economic-reform policies, structural issues in the economy (including excess debt, under-employment, and low productivity) will worsen. This focus on domestic localization risks forcing companies to switch away from foreign suppliers simply because they’re foreign, not because it makes commercial sense to do so. This policy carries inherent risks of dampening optimization and productivity. As a result, this push for self-sufficiency will inevitably exacerbate economic inefficiencies over time, making China less competitive in relative terms.

Fourth, by the early 2030s, China’s state-controlled self-sufficiency model will make it unable to compete against the United States as a peer. According to the latest five-year plan, the Chinese Communist Party’s vast state-planning agencies will promote domestic self-reliance to ensure that industrial supply chains are not disrupted. But unlike Trump’s “America First” policy which encouraged private market actors to simply favor domestic sourcing, Xi’s new self-sufficiency policy implies a shift back toward central planning and greater reliance on State-Owned-Enterprises. As part of this push, China has recently vowed to make state-owned companies “stronger and bigger,” pointing to a trend toward the state playing an outsize role in the economy at the expense of private enterprise; that’s particularly true in technological sectors that work with 5G, artificial intelligence and datacenters. Mark Williams at Capital Economics speculates that productivity growth may no longer be one of Beijing’s primary objectives. “Instead, the leadership is more concerned with maintaining control over key parts of the economy. To that end, the state sector will remain protected.”  - The good news for the rest of the world is that China’s state companies are not known for their effective operational management, prudent resource allocation or market-based decision-making, despite several rounds of rather tepid reforms aimed at addressing these deficiencies. And,

Fifth, China will become less interventionist and threatening to the rest of the world if it can successfully navigate the next few transitional years. Throughout its history China’s culture and geography have created incentives for it to turn inward. The past 40 years of globalization represents an extraordinary deviation from that norm. However, the managed slow-down that lies ahead implies a greater inward focus, consistent with China’s history and culture. Such an outcome would benefit the United States and China’s East Asian neighbors as well as the leadership of the Chinese Communist Party, which values stability above all. A self-sufficient and well-fed middle-class China could play a role in the world, totally different from that of the “hegemonic dragon” seemingly bent on displacing the “American eagle.” The next 12 to 18 months should make clear which way China is really headed.