China's pivot is a bit of a mess

Plus: M&A among the chaos agents, and the end of the Cool Japan program

Over the last year and a half, China has stumbled quite a lot, with a pointless crackdown on IT companies, a haphazard and ham-fisted attempt to downsize the real estate sector, and a Zero Covid policy that seemed to have no exit. Some observers were optimistic, though, predicting that once Xi secured another term in office, he would no longer need to save face by doubling down on bad decisions, and would ease up on those policies. That optimism seemed to be confirmed when just a few weeks after the CCP’s party congress ended, Xi released measures to relax Zero Covid and support the real estate market. Bloomberg’s Shuli Ren reports:

President Xi Jinping has made a remarkable pivot, recalibrating the two policies that have suppressed China’s economic growth to the slowest pace since the Cultural Revolution…The notoriously stringent Covid controls and the harsh crackdown on real estate developers will be relaxed…The National Health Commission is now emphasizing a “scientific” approach to Covid control…The pivot on property financing is equally jaw-dropping. The new  16-point plan that financial regulators and state-owned banks must heed reverses most of Beijing’s tightening measures that have been in place for over two years.

Chinese stocks rebounded very modestly on the news.

If this is really what happened, it would seem to be a victory for the idea that dictatorships have the advantage of nimbleness and flexibility — give the top guy absolute power, and he can pivot policy on a dime. There seem to be a number of people in the U.S. business world who want to breathe a sigh of relief, assume that the Chinese leadership has set everything right, and invest as if China’s role in the global economic system is just going to continue the way it was before. That would certainly be easier than a rapid, risky, difficult reevaluation.

But when we take a closer look at this pivot, we see that not all is going according to plan. First of all, the reports of strange and violent incidents related to the Zero Covid policy are proliferating. There was a big riot in the “iPhone City” factory complex in Zhengzhou, partly over Zero Covid measures and partly over bad working conditions. Here’s a video from that riot:

黒色中国 @bci_

鄭州市フォックスコン工場。 本来、工場全体で20万人以上の従業員がいるそうだが、現在どれだけ残っているのかは不明。当局側も「万」単位で鎮圧部隊を派遣するわけにもいかず、ご覧の通りの結果。

And here are some more videos. The situation is creating quite a bit of trouble for Apple and its contractor, Foxconn. Then there was a big fire in Urumqi in Xinjiang that killed 10 people, where fire trucks weren’t able to get to the fire due to Zero Covid. (Update: See my China News list on Twitter for many more local outbreaks of unrest.)

Incidents like these create bad press for China, and discourage investment, but ultimately the government shouldn’t have too much trouble containing them. The real problem is that China is finding out that as soon as it lets up on its incredibly draconian containment measures, a bunch of people start getting Covid.

This happened in a bunch of other countries that abandoned their previously successful Zero Covid policies in the face of new hyper-contagious variants and widespread vaccination. It’s pretty clear at this point that you can’t actually suppress Covid completely while also preserving your economy.

In the first year or two of Covid, this wasn’t true. Countries like Australia and Taiwan and South Korea (and China) successfully suppressed the virus, closed off international travel, and then were able to ease off on social distancing measures. These countries did better economically than most of the countries with much weaker restrictions — in those countries, fear of the virus kept people hiding in their houses anyway, hurting the economy while also failing to slow transmission as much as a coordinated government effort. So there was no tradeoff between public health and the economy. And even for countries where lockdowns were too patchy to stamp out the virus, they could at least slow it until effective vaccines were developed — which was about one year.

So why did countries other than China abandon Zero Covid in 2022? Two reasons. First, the virus got much more contagious with the Omicron mutation, so that suppressing it with lockdowns and other restrictions became much, much harder. Second, effective vaccines became widely available, so that the human cost of opening up was much much less. These two factors mean that there really is a tradeoff between suppressing Covid completely and maintaining production and employment.

China alone stuck to Zero Covid, partly because of low vaccination rates among the vulnerable elderly, but partly because of pure posturing. There was a widespread triumphalist narrative in 2020 and 2021 that the Chinese government had proven itself superior to foreign governments by its successful suppression of Covid. Naturally, the Chinese leadership encouraged this narrative, and it seems to have also believed it — so much so, perhaps, that it felt confident in moving forward with plans to supplant U.S. hegemony on the international stage.

To exit Zero Covid now would be to admit that China was a merely mortal country after all. Even if China could successfully mandate universal mRNA vaccination to dramatically reduce the death toll (which it has not done so far), soaring case counts would have China’s enemies jeering. It could derail the entire narrative of Chinese ascendance.

So the government is stuck between a rock and a hard place. Right now, in the face of rising cases, it appears to have pivoted back to lockdowns, and people in Beijing are panic-buying goods off of store shelves. This all suggests that the government will keep flipping back and forth between tentative moves toward opening up (to please businesses and investors) and hasty draconian lockdowns. The only way out of this eternal twilight struggle is to abandon the 2020-21 narrative that China alone of all countries was mighty enough to defeat a highly contagious respiratory virus through state capacity and strength of will alone.

Meanwhile, the real estate pivot is also looking shaky, but for different reasons. Xi Jinping is probably not particularly sad to see real estate shrink as a percent of the economy, since he wants to shift resources toward manufacturing. The disordered and haphazard way that the shift is being managed is far from optimal — especially since the timing coincides with Zero Covid — but it’s unlikely to cause a full-blown financial crisis, since the Chinese central government either controls or will bail out the banks. The real problem is local government financing.

China doesn’t have property taxes, so local governments finance themselves with land sales. The country is quite fiscally decentralized, so these local government have to raise a lot of money, which means that they have to sell a lot of land, for as high a price as possible. And in fact it’s even worse, since these governments have borrowed a lot of money and the interest is coming due, just as both land sales and prices have collapsed. So there was really no way for Xi to continue merrily smashing the real estate sector without causing a gigantic fiscal crisis and making a lot of lower-level CCP members very very mad. This is why the Chinese government has rolled out a big rescue package of measures designed to pump real estate back up.

But the thing is, there’s no guarantee that these measures will have the intended effect. As Nomura economist Lu Ting has noted, most of the measures are aimed at supporting developers rather than homebuyers themselves. Chinese homebuyers are likely to still be cautious. China has reached developed-country levels of residential floor space per person; people don’t really need more houses. They could buy giant American-style single-family homes, but the infrastructure isn’t built for that. They could buy second homes purely as investment properties, but the recent crash has vividly demonstrated the Ponzi-like nature of that game. Homebuyers have been burned pretty badly by the grim spectacle of protests over uncompleted houses, and that memory will linger. And of course, Zero Covid will weigh on consumer demand.

Without fundamental demand from homebuyers, developers will simply be building ghost cities. This is why Lu doesn’t see a quick recovery for China’s housing sector. There’s also the fact that developers, even though they’re getting support right now, know that their industry is on Xi’s list of sectors to downsize in the long run. That’s likely to dampen their entrepreneurial spirit.

The same principle holds for the IT industry crackdown. China’s government softened its tone on IT companies months ago, but the optimism that existed earlier hasn’t returned. This is from Bloomberg in June:

[I]nsiders describe an ongoing sense of paranoia and paralysis, along with an unsettling realization that the sky-high growth rates of the past two decades are likely never coming back…One prominent startup founder said he’d pass on money from those companies because of the attention it would attract. Another said his company is proceeding on the assumption that it’s only a matter of time before officials double down again.

This is unsurprising. IT, like real estate, is on the list of industries that Xi fundamentally doesn’t like very much, because he thinks they drain resources from the activities he believes will make China more powerful. This will chill investment, entrepreneurship, and growth in those sectors.

So while China’s pivot is the smart thing to do, I don’t expect it to immediately restore the equilibrium that prevailed before the country started making big policy mistakes a year and a half ago. Xi’s attachment to particular public-facing narratives, as well as his disdain for economic sectors he doesn’t consider crucial, seem likely to outweigh the effects of the short-term, halting policy reversals.

Now of course, none of this means that “China is done”, or that the country’s manufacturing prowess will evaporate, or that it will become a weak actor on the international stage, or any of the other melodramatic things that people say on social media when they see news like this. These problems are stumbling blocks, and China will almost certainly recover after a while. But they illustrate the downsides of dictatorial decision-making in a way that should prompt observers to recalibrate their own narratives about the ascendance of autocratic systems.

Mergers and acquisitions in the chaos industry

Anyway, on to a couple of other topics. A lot of people are alarmed at a recent dinner that Donald Trump hosted with Kanye West and Nick Fuentes. Kanye, of course, famously went on some antisemitic tirades recently, and is trying to be Trump’s running mate in 2024. Fuentes is a far-right extremist who has praised Hitler, denied the Holocaust, endorsed violence against Jews, and defended segregation. Many liberals were alarmed that the forces of fascism seem to be uniting for another big push for power.

And it’s reasonable to be alarmed. But I think what we’re seeing here is not a fascist resurgence, but a sign of decreasing interest in the brands of right-wing chaos that people like Trump and Fuentes are peddling. Trump is coming under fire from many in the GOP after his chosen candidates, and people who denied the 2020 election, fared far worse than other Republicans in the recent midterms. That suggests a loss of interest in Trump’s brand of chaos among both Republican-leaning swing voters and GOP elites. Meanwhile, Fuentes tried to storm CPAC and got kicked out in 2021; no one likes this guy. And Kanye’s star has clearly fallen.

Every business prof knows that when demand for a product falls, an industry tends to consolidate; strong companies acquire weak ones, and many players are competed out. I think this is what’s basically happening with the “chaos agent” industry in American politics. If I’m right, and popular unrest is beginning to ebb, it makes perfect sense for the people who rode the chaos to power and/or fame in earlier years to want to band together and support each other, to preserve what chaos energy they have left.

And that’s scary, because uniting their efforts might make these guys more effective at disrupting the U.S. But along with the midterm results, it also suggests that the fundamental danger — the wild, angry, chaotic energy that allowed Trump and other disruptors to have their moment in the sun — is starting to fade.

Japan is still cool, but Cool Japan is no more

One topic I’ve tried to follow over the years is the notion of “cultural superpowers”. Some countries are very good at exporting their pop culture across the world, gaining both market share and mindshare in the process. Japan is one of these cultural superpowers, but it seems to have happened very much by accident. Big Japanese entertainment companies have mostly focused on the Japanese home market; in fact, for many years, the studios that made anime and manga had no idea how popular their products were overseas. Only the Japanese video game industry really made a concerted and successful effort to export.

In 2013, some folks in the Japanese government realized — decades too late — that people overseas liked Japanese cultural products. They decided to try to capitalize on this by creating a giant public-private fund called the Cool Japan Fund, to promote Japanese cultural products overseas. This fund proceeded to throw huge amounts of money at big hidebound old advertising agencies like Dentsu, who had no idea how to sell Japanese cool to anyone. Now, to absolutely no one’s surprise, the Cool Japan Fund is on the verge of bankruptcy.

But that doesn’t mean Japan is no longer cool! Anime sales in the U.S. (and thus, probably, in the world as a whole) are forecast to continue growing robustly through the rest of this decade. Manga sales in the U.S. dipped in the early 2010s but have recovered strongly. The country remains the second-largest video game exporter (after China, which is mostly just making hardware for the companies that own the IP). Japanese restaurants continue to command a price premium and line people up around the block. Even live-action Japanese TV shows like Terrace House and Midnight Diner are becoming more popular overseas; in fact, I know a bunch of Americans who are obsessed with watching old reruns of the 1991 reality show My First Errand (U.S. title “Old Enough!”), in which little kids were sent out to buy groceries, showcasing how safe and friendly Japan is. And now that Japan has reopened for tourism, people are clamoring to visit.

Which leaves the question: Is there something the Japanese government could be doing to accelerate this trend, that would be more effective than the hapless Cool Japan Fund? My suspicion is that the best strategy is just to give incentives for exports in general — something Japan needs to do anyway — and let companies’ greed prompt them to discover just how much foreigners love what they have to sell.

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