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Looking ahead 2018

Could China spring a nice surprise in 2018?

Xi could prove pessimists wrong in economic and foreign policy

China's President Xi Jinping might delight some observers with three possible surprises in 2018.   © Reuters

After Chinese President Xi Jinping gained near-total political supremacy at the 19th Chinese Communist Party congress in late October, the most pressing question on the minds of China watchers was what he would do with his enormous power.

Conventional wisdom now appears to lean toward pessimism. Most analysts think that Beijing will most likely maintain its current course under a powerful leader who has centralized decision-making authority. On the domestic front, Xi is expected to continue to support investment-driven growth while delaying painful financial deleveraging and major structural reforms.

In terms of foreign policy, Beijing will not alter a strategy that appears to have delivered rich dividends in 2017. Specifically, China will leverage its economic strengths to expand its influence and take advantage of the U.S. retreat from global affairs. It will please U.S. President Donald Trump with flattery and minor concessions while doing just enough to keep the North Korean crisis from escalating into a nuclear Armageddon.

Could the conventional wisdom be wrong this time?

One can reasonably think of three pleasant surprises China has in store for the world in the new year. To be sure, they will be hard decisions for Xi to make. But if he is truly a bold leader with a long-term vision, there are realistic, although small, odds that he may expend his political capital and take these painful and risky steps. Not because he wants to be nice but because they would produce long-term benefits for him and the one-party regime he is determined to perpetuate.

Robust economic reforms

The first big surprise of 2018 would be the launch of radical liberalizing economic reforms. For the last five years, Xi's pledge of pursuing such reforms has remained largely rhetorical. His defenders have argued that Xi must consolidate his power first before implementing reforms that will hurt entrenched interests. As Xi has now become the most powerful leader in China since the Mao Zedong, it is hard to blame the lack of power as an excuse for not undertaking promised reforms.

The smartest thing for Xi to do in 2018 would be to prove his skeptics wrong. Few doubt that Xi intends to serve beyond 2022, when his second term ends, after successfully preventing the party from designating a successor at the 19th party congress. If Beijing continues its current economic course, debt accumulation and structural imbalances will almost certainly slow China's growth and raise the odds of stagnation in five years -- just when Xi needs the party's endorsement for a third term.

To build a stronger case for breaking the term limit, Xi would need to deliver a stellar report card. This can only be accomplished by embracing painful but necessary reforms in 2018. For example, he can exercise his unassailable authority to force through reforms that aggressively deleverage the Chinese economy.

Zombie firms, most of them state-owned, could be killed by cutting off credit. Hidden bad loans on the books of Chinese banks would be recognized and a program of recapitalization implemented. Profitable state-owned monopolies, such as China Mobile and China National Petroleum Corporation, would be privatized, with the proceeds used to recapitalize the financial sector.

While subsidized capital would end for state-owned entities, social spending to boost household consumption would rise significantly. In general, the state's role in the economy would shrink dramatically while economic growth would rely less on government-guided investment.

These bold measures would unavoidably trigger a short-term recession. But the long-term economic -- and political -- payoff for Xi would be great. Typically, such a recession lasts no more than three years and the recovery of a structurally rebalanced economy is often strong. If Xi gambles on this course and succeeds, the Chinese economy will likely resume healthy and sustainable growth in 2021-2022, just in time to burnish his report card.

Taming North Korea

Beyond economic reform, Xi could also surprise with a fundamental course shift on North Korea in 2018. As Trump is fast losing patience with Xi, he will likely escalate secondary sanctions against China and increase the deployment of more offensive military capabilities on the Korean Peninsula to deter Pyongyang. These two developments will almost certainly precipitate a serious deterioration in Sino-American relations.

Of course, Xi could stay the current course and gamble that Trump's bark is worse than his bite. But he may also finally realize that China would be much better off working with, not against, the U.S. in containing North Korea's dangerous nuclear program. Such an epiphany could result a dramatic change in China's North Korea policy.

Abandoning its long-standing reluctance to engage Washington in discussions about contingency planning in the event of a North Korean regime collapse and U.S. military deployment in East Asia following the reunification of the Korean Peninsula, Xi could strike a strategic bargain that dispels China's fears of a U.S. military presence on its northern borders.

This breakthrough would decisively alter Beijing's strategic calculus and lead Xi and his colleagues to conclude that a nuclear-armed North Korea is a far worse security threat to China than America's forward deployment in East Asia. As a result, Beijing would impose the tougher sanctions it so far has resisted, including the cutoff of oil exports and banking services and the repatriation of North Korean labor.

While it is unlikely that these sanctions would immediately trigger a regime collapse in Pyongyang, China's fundamental shift of policy would improve the odds for pressuring North Korea to reduce its provocations and even suspend its nuclear and missile tests.

Scaling back BRI

Another possible foreign policy surprise in 2018 would be a radical curtailment of Xi's ambitious Belt and Road Initiative. Launched as his pet project in 2013, the BRI has got off to a slow start -- for good reason. The economic risks are huge, while the returns are uncertain at best. It has also aroused suspicions about Chinese intentions around the world.

Although many countries have lined up to take Chinese money, many difficult issues remain unresolved. In particular, the financing model proposed by China -- preferential loans from China -- may saddle recipient countries with heavy debt burdens. If the promised returns from these infrastructural projects fail to materialize, the outcome will be a lose-lose situation for these countries and China.

According to conventional political wisdom, China will likely double down on the BRI in 2018 because the Chinese bureaucracy is eager to please Xi by plowing resources into his pet project. But things could change as Xi realizes that the BRI may be a costly distraction and he would be far better-off spending China's dwindling foreign reserves (which fell by more than a $1 trillion in the last two years) on recapitalizing China's banking system and rebalancing its economy.

As a result, the BRI would be drastically scaled back in 2018, while Beijing would target only a small number of projects that promise viable economic returns, instead of spreading its largesse indiscriminately.

These three China surprises in 2018 will undoubtedly delight those who have been insisting all along that Xi is a closet reformer and a leader with both common sense and a long-term strategic vision. Should Xi indeed make these three difficult decisions to produce long-term economic and foreign policy payoffs, he would vindicate himself by demonstrating that his concentration of power actually serves useful purposes.

However, if these sensible and much-needed policy changes do not occur in 2018, not only will China dig itself into a deeper economic and geopolitical hole, but also the task for Xi to showcase his leadership will become much harder.

Minxin Pei is a professor of government at Claremont McKenna College and a nonresident senior fellow of the German Marshall Fund of the United States.

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