China's Politburo Standing Committee, the country's nexus of power, with Xi Jinping at its center.
China faces a long list of challenges over the coming year. Private investment has slowed significantly. Overcapacity plagues old economy sectors and threatens to swell the ranks of the unemployed by millions. Weak global growth has sapped export demand. And now you can add a US pivot to protectionism and nativism to China's list of challenges. But one factor looms over all others in 2017: The Communist Party leadership shuffle.
In the fall of 2017, China's Communist Party (CCP) will meet for its National Party Congress, as it does every five years, to select the Party leadership. Due to retirement age limitations, five of the seven members of the Politburo Standing Committee - the nexus of all power in China - will be replaced. Only President Xi and Premier Li will likely remain on the Committee. Eleven of the twenty-five members of the Party's Politburo are slated to be replaced as well. To put it simply, 2017 is a huge year for Chinese politics. Powerful officials and political factions looking to consolidate control will have a much lower tolerance for turmoil, economic or other, than any time in the past decade. Historically, the CCP strives for economic and social stability during leadership shuffle years.
The Party and the Politburo Standing Committee
For those who are unfamiliar with China's political system, here is a very quick primer. China's paramount leadership body is the CCP. The CCP runs China by sitting atop the military and the government. Within the CCP, authority over the government and military lies in the Politburo, a twenty-five member decision-making body.
The primary power within the Politburo resides in its seven member Politburo Standing Committee. The Standing Committee is the principal core power within Chinese politics, exercising control over the Politburo. Its members include the President and Premier, and like the Politburo, its membership is selected every five years. Membership in the Standing Committee is conferred through a system of patronage. Powerful men, like former president Jiang Zemin, attempt to put proteges and allies into key spots on the committee in order to extend their own power and influence. Ascendancy to the pinnacle of China's political power, the Standing Committee, remains an opaque process, prone to factionalism and surprises.
The Party's Politburo exercises its control over the military and government through appointments to key positions. Xi Jinping, for example, oversees the CCP as General Secretary and lead member of the Politburo Standing Committee. He directs the government as President, a role handed to him by the CCP. He also oversees the military as chairman of the Central Military Commission, an appointment given to him by the CCP.
So, in a year where nearly all Standing Committee members will be replaced, and nearly half of all politburo members will be reshuffled, there is much at stake for those looking improve their standing in the political hierarchy.
Xi will look to consolidate power
Since his ascendancy to Party leader in 2012, President Xi Jinping has maneuvered to consolidate his control and influence over China's political system. He has used anti-corruption fighting to purge political opponents. Last year, he took the unprecedented step of jailing a very powerful former Standing Committee member, Zhou Yongkang. He has squashed civil rights, jailed lawyers, clamped down on internet freedoms, and recently appointed himself effectively commander-in-chief of the armed forces for a more direct role in military leadership. It is highly likely that he is looking to 2017's leadership shuffle in order to amass greater control and extend his leadership mandate.
A widely spreading theory among China watchers highlights the extent of Xi's potential power consolidation. The next Standing Committee will include Xi's successor, who would possibly take control of the CCP chairmanship, the government, and the military in 2022. But, because no clear successor has been signaled, many analysts are reading this as a sign that Xi is not planning on relinquishing control when his term is up in just over five years. The role of president carries a constitutional ten year term limit. Xi's leadership of the CCP via his role of General Secretary of the Communist Party has no term limits. Maintaining control over China's political system beyond his ten year term would require stacking the ranks of the Party leadership with his own people. Xi may be looking to become the new Deng Xiaoping, the paramount leader for life, but so far the likelihood of that is not certain.
Xi's ambitions for consolidating power will require him to place as many allies and proteges in positions of power as possible, a feat made extremely difficult without insuring the CPP's mandate of maintaining stability.
What does this all mean for the economy?
There are two main forces at play in 2017. First, economic momentum is on a downward trend. Overcapacity in heavy industries will continue to drag down growth. Global growth is weak, and China's export manufacturers will continue to suffer. Private investment has slowed, and private firms have been the biggest driver of China's productivity over the last few decades. The massive corporate debt overhang limits monetary easing policies, and has created zombie firms that drain valuable economic resources just to stay open. Stimulus reflation has become less effective over the last few years. Spending and easing have been slow to spread to growth.
“Xi and his allies will do everything possible to postpone any signs of economic disruption until 2018, after they have locked in power consolidation for the next five years.”
But, efforts to maintain economic stability during the leadership reshuffle will trump all other economic factors. Recently in the developed West, accumulating political power can be achieved by exacerbating fear and highlighting turmoil. In China, the Party's leadership mandate comes with the expectation that stability - economic and social - will be provided. Government's key role is to deliver at least the appearance of harmony. Nothing threatens the Party's leadership mandate more than turmoil. A meaningful breakdown in economic or social stability over the next year would compel rival factions and party elders to disrupt carefully laid leadership transition plans already in the works. To that end, Xi and his allies will do everything possible to postpone any signs of economic disruption until 2018, after they have locked in power consolidation for the next five years, or longer. Worries of creating long-term structural problems at the risk of short-term economic gain will be shelved for most of 2017.
“The use of all of Beijing’s reflation tools are a potential detriment to long-term economic health, but can certainly be applied to keep the wheels on the rail in 2017.”
So, what should we expect? Due to the diminished effectiveness of broad fiscal and monetary policy, and because of the importance of patronage, we may see attempts to boost growth directed towards specific industries and provinces. Given the recent difficulty in pushing growth forward with fiscal spending, we may see more supply-side policies, like targeted tax cuts. But, if worse comes to worst, every possible reflation measure will probably be on the table.
One of China's largest economic stimulus packages came during the last political reshuffle. During the last leadership changeover in 2012, $157 billion was allocated to 60 specific infrastructure projects. Many of those projects were slated to take place in 2013, but presumably moved up to counter the economic slowdown in a Party Congress leadership reshuffle year. Large sums of capital was borrowed and spent by local leaders at the time as well.
While government intervention efforts have dinimished in effectiveness in recent years, those efforts are not ineffective. In 2016, stable growth was a result of state-firm investment and a government supported property market boom. Beijing has useful tools to stabilize growth, including a low sovereign debt load, the potential to easily drive down the currency, and complete control of the PBOC with its new monetary policy toolkit. The use of all of Beijing's reflation tools pose a potential detriment to long-term economic health, but can certainly be put to use to keep the wheels on the rails for 2017's power reshuffle.
So, while most economic factors seem to be applying downward pressure on growth prospects, the leadership reshuffle means that tolerance for economic turmoil and disruption is extremely low. The potential for reflation interventions is high. Expect all possible efforts to maintain economic stability in 2017. Those forecasting turmoil, a hard-landing, or financial sector problems next year will need to postpone dire predictions until at least 2018.