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This is a precarious time for China. The economy is slowing down, but the bigger concern is the loss of confidence among Chinese consumers and businesses in their government’s ability to address deep-seated economic problems. Without addressing this fundamental issue, any other measures taken will have limited impact on reversing the downward spiral.

The Chinese government has prioritized state enterprises, which align closely with the Chinese Communist Party and are directly controlled by the government, over the private sector. This crackdown has affected not only technology companies like Ant Group but also private companies in education and other sectors. The government’s apparent hostility towards foreign businesses amid rising tensions with the US and other Western countries is also contributing to the loss of confidence.

The government’s unwillingness to adjust its “zero Covid” policy and its abrupt reversal of that policy have further undermined confidence. As a result, private investment and household consumption have been tepid, with households saving more and spending less on big-ticket items like cars. The Chinese currency is depreciating as capital flows out of the country and foreign investors become less willing to invest in China.

During a recent trip to China, officials in Beijing seemed relatively optimistic about the economy, while entrepreneurs saw the government’s actions as indicative of its hostility towards private enterprise. The reality is that the private sector plays a crucial role in driving the economy, particularly in terms of innovation and productivity. Encouraging domestic innovation and transitioning towards higher-tech industries requires support for small and medium-sized companies in addition to large state enterprises.

The centralized and often unpredictable nature of policymaking under President Xi has also damaged confidence. The property sector, which has been a key source of growth, has seen policy changes introduced abruptly, leaving little time for adjustment. This has led to a sharp fall in housing prices and construction activity. The government’s response to rising youth unemployment has been to suppress the release of data, fueling concerns about transparency. The government’s recent interest rate cut may not be enough to boost spending if households and private businesses remain anxious about the future.

To reverse the deflationary spiral and achieve the vision for the Chinese economy, the government needs to recognize the importance of a strong relationship with the private sector. Concrete measures, such as financial-sector liberalization and transparency in policymaking, are necessary to support the private sector. President Xi must understand that private-sector confidence cannot be controlled easily and is essential for the success of his economic goals.

The government’s response to concerns about rising youth unemployment has been to suppress data releases. Similarly, the government has resisted acknowledging the deflationary pressures from falling prices and restricted access to certain financial data. The central bank’s interest rate cut may have unintended consequences such as currency depreciation and capital flight. Measures like income tax cuts and increased spending on health and education may provide some relief, but they may not be sufficient.

The real challenge lies in the government’s explicit recognition that without a strong private sector, its goals of transforming the economy into a high-tech and productive one are unrealistic. This recognition must be backed by concrete measures to support the private sector, including financial-sector liberalization. Transparency and clear communication will also go a long way in restoring confidence.

President Xi may prefer a command and control system, but he must learn that private-sector confidence cannot be easily controlled. It is crucial to the success of his economic vision for China.

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Eswar Prasad is a professor in the Dyson School at Cornell University, a senior fellow at the Brookings Institution and the author of “The Future of Money.”

Source photograph by Phill Magakoe/Agence France-Presse — Getty Images.

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