From Bloomberg, March 5:
As artificial intelligence threatens jobs and deflation strains growth, Xi Jinping may finally be forced to expand the nation’s social safety net.
Xi Jinping has long resisted putting cash directly into the hands of Chinese households. When world leaders raced to unleash stimulus to help citizens cope with the Covid-19 pandemic, Beijing recoiled.
It wasn’t just that China was still saddled with debt from the 2008 global financial crisis, when it poured money into infrastructure and upgrading factories. The Chinese leader feared that direct cash handouts would set a precedent that could ultimately backfire on the Communist Party — and himself.
Addressing China’s top economic policy makers in December 2021, Xi railed against countries that “embraced populism and pampered a large number of lazy people who were given something for nothing.” “Welfarism beyond the means of the state is unsustainable and will inevitably have severe economic and political consequences,” he said.
More than four years later, the world is again on edge — rattled by war in the Middle East and AI doomsday scenarios threatening further economic upheaval. Citrini Research spooked global investors with a speculative report last month that suggested advances in AI could trigger mass white-collar layoffs, a collapse in stock prices and unemployment above 10% in the US.
Even as economists and investors question such dire predictions, a consensus is emerging: AI will likely force governments worldwide to expand social safety nets, possibly with a universal basic income. Such a shift would pose a unique challenge to the Communist Party of China, which — somewhat ironically — now leads one of the most conservative governments in the world when it comes to direct handouts.
In the wake of the pandemic, China’s fiscal response amounted to 4.8% of gross domestic product, well below the 25.5% in the US and among the lower end of Group of 20 nations. More broadly, China’s spending on social services as a percentage of GDP is roughly half the average of OECD countries. While the sheer number of people supported is vast, rural pensions amount to a dollar or two per day. Healthcare only covers the basics, forcing families to stash away funds for medical emergencies. Direct cash assistance is typically reserved for the poorest of the poor: A research paper published last year showed that just 40 million people received such assistance in 2022, roughly 3% of China’s population.
The resistance to expanding welfare spending stems from the Communist Party’s obsession with control, exacerbated by an aging population and a distressed economic model. Although Xi runs the world’s second-biggest economy with an iron fist — swiftly neutralizing potential rivals — the need to keep 1.4 billion people happy also exposes the limits of his power. Xi is wary of any policy that might jeopardize social stability, such as raising taxes or making long-term welfare promises he can’t fulfill.
Over the past five years, as the property market has slumped and the economy has become more reliant on exports, Beijing has brushed off calls from the International Monetary Fund and private-sector economists for bold measures to stimulate consumer spending. Instead, Xi has kept the focus on export-led manufacturing and technological self-reliance, prioritizing the AI race with the US. That model has contributed to deflationary pressure just as a property collapse strains the nation’s finances, forcing Xi to look for new revenue streams.
He has no obvious place to turn without incurring some political cost. To date, Xi has preferred a slow and steady approach to economic policy to maintain stability, avoiding major fiscal stimulus and welfare pledges. Yet if the AI transition accelerates and triggers mass layoffs, he may be forced to act faster to stave off social unrest.
In many ways, China is well placed to benefit from AI, even though it still lags behind the US in making advanced chips. In his annual budget address on Thursday, Premier Li Qiang said the government would advance its “AI Plus Initiative” to “encourage large-scale commercial application of AI” including “faster application of new generation intelligent terminals and AI agents.”
The Asian country already generates nearly twice as much electricity as the US, helping power the data centers needed to train AI models. Its private-sector companies are among the best in the world at putting the technology to practical use. China’s manufacturers are well ahead in building AI-assisted autonomous vehicles, drones and humanoid robots, which can help ease China’s demographic crisis as the labor pool shrinks. In addition to churning out cheap goods in factories, humanoid robots could take care of the elderly, deliver food and pick up the trash.
But even if robot workers help sustain China’s productivity, they don’t pay taxes, buy property, go on holiday or eat at restaurants. As such, they can’t help China pivot to a consumption-led economy and ease the supply-demand imbalances that are causing angst around the globe.
China’s manufacturing sector is by far the biggest in the world, producing about a third of all global goods — more than the US, Germany, Japan and South Korea combined. Yet the sector’s profit margins hovered around 4.5% last year, less than half the levels seen in the US. The deluge of goods is pulling prices and wages downward, fueling a deflationary spiral that is starting to hit the nation’s finances. For the past three years, real GDP growth has outpaced the economy’s nominal expansion, which is crucial for tax revenues. Li kept China’s fiscal deficit at around 4% — the same as last year, when it hit a three-decade high.
To reverse course, the IMF and others have urged authorities to ramp up spending on healthcare and education, reduce industrial subsidies, expand benefits for migrant workers, allow more bankruptcies and implement broad-based stimulus, including direct cash transfers. China has started to do some of this, with social spending rising last year at the fastest rate in nearly a decade. Yet for the most part, measures have been piecemeal, doing little to alter the overall picture. One analyst called Li’s speech on Thursday a “non-event for investors.”
Officials in Beijing are aware of the need to shift to consumption, yet note the political and practical obstacles. Quickly easing restrictions on foreign companies and China’s formidable private firms in the healthcare sector, for instance, risks triggering discontent by allowing the wealthy to buy better treatment. Letting a bunch of businesses go bankrupt could trigger mass layoffs. And giving benefits to migrant workers in major cities would further strain the finances of local governments.
Authorities prefer subsidizing goods like televisions and washing machines over direct cash handouts. While they argue that older citizens would simply save the cash, a China-based economist tells me that the Communist Party simply doesn’t want to grant individuals the autonomy to choose how they spend the money. Both explanations likely hold weight.
This reluctance has historical roots. After establishing the People’s Republic of China in October 1949, Mao Zedong faced a challenge: quickly turning an agrarian society into an industrial powerhouse.
One of his early moves was to require companies to provide social insurance. Known as the “iron rice bowl,” employees received cradle-to-the-grave benefits, including housing, education, healthcare and a pension. It also made it nearly impossible to fire anyone, which over time gave legions of workers little incentive to perform.
There was one major catch, however. Mao’s new government couldn’t afford to provide such welfare to the entire population. So the benefits were largely reserved for urban workers, with some 80% of the population left to fend for themselves in rural communes. To prevent mass urban migration, he also tightened the hukou system, which ties welfare benefits to location — allowing authorities to control the movement of most people in the country.
The policy contributed to the world’s deadliest famine in the early 1960s, as rural residents were blocked from traveling to areas where food was more readily available. By Mao’s death in 1976, the “iron rice bowl” was also weighing down China’s economy. Any cash companies did earn mostly went to pay pensions and other benefits.
When Deng Xiaoping emerged as leader, he signaled his intent to start dismantling the system and initiated pro-market reforms that unleashed China’s economic miracle. But after decades of stagnation, the revival of market forces got off to a rough start. Prices surged nearly 20% in 1988 and 1989, and many urban workers on fixed wages suddenly found key staples unaffordable. Afraid of losing their cushy benefits and their jobs, civil servants and employees of state-owned enterprises joined students in the Tiananmen Square protests in 1989, which ended with hundreds or even thousands dead after Deng ordered soldiers to disperse them.
In the late 1990s China dismissed tens of millions of workers from state-owned enterprises, dealing a psychological blow that has never truly healed: China’s urban population realized they could no longer rely on the state for benefits. The savings rate surged along with a sense of betrayal as people were suddenly forced to spend more of their own money on things like health and education....
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