Meet the New (Same as the Old) Boss

What to Watch for at the 20th Party Congress

In October, China’s Communist Party will unveil changes in its leadership—except at the very top.  Xi Jinping is expected to receive a third five-year term as General Secretary of the Party, state President, and Chair of the Central Military Commission. That development alone will dominate coverage of the event, and be the focus of international reaction. 

Other critical questions include:

  • Does the makeup of the new leadership below Xi point to greater pushback against his policies or a consolidation of his authority?
  • Will political priorities continue to dominate policymaking, or will newly appointed technocrats be able to shift the system to focus more on economic performance?
  • Will these technocrats be able to change China’s highly restrictive approach to COVID-19 containment?
  • Will changes in China’s foreign policy approach and relations with the West emerge once the Congress comes to an end?

For investors and corporates, the media narratives surrounding the 20th Party Congress will be just as important as the leadership changes themselves, as conservatism and continuity of leadership and policy under Xi will be seen as negative signals for markets and for China’s medium-term economic trajectory.

The Importance of the Public Narrative

The results of the 20th Party Congress of the Chinese Communist Party will be difficult for even informed observers to interpret. The Congress is not a policy event and new policies are unlikely to be announced, besides broad objectives for the Party detailed in an extensive five-year work report. Instead, the primary outcomes of the Congress will be the announcements of new members in the Communist Party’s Central Committee, Political Bureau, and Politburo Standing Committee. It is difficult to discern the individual policy preferences of individual Chinese leaders, if these can even be known. Factional alignments among these leaders are opaque and have not been as relevant in policy debates during the Xi Jinping era.

As a result of this ambiguity, the narratives that major media outlets develop around China’s leadership changes will be significant and are likely to influence both the reaction from foreign governments and financial markets. The most important decision coming out of the Congress will be the widely expected announcement of Xi Jinping’s third term as General Secretary of the Communist Party. Virtually every other appointment will be viewed through the lens of whether or not it points to a further consolidation of Xi’s authority within the Party, or pushback against Xi’s rule.

The fact that Xi was willing to travel abroad ahead of the Party Congress—he visited Kazakhstan and Uzbekistan in recent weeks—suggests that any challenge to his leadership at the top of the Party is not a serious threat. The formal announcement of Xi’s third term will cement the global narrative of a more authoritarian China that is distancing itself from the notion of collective leadership. The Chinese Communist Party may have been moving inexorably toward one-man rule over the past five years, but many analysts will conclude that Xi’s third term marks the arrival at that destination. This development will also mark a new era of uncertainty in Chinese politics, as the question of succession will emerge almost immediately after Xi’s reappointment, with questions about whether or not the 69-year-old leader’s third term will be followed by a fourth.

Financial markets are hoping for some evidence of internal resistance to Xi, given the arbitrary policymaking over the past three years that has created significant market volatility. But for market confidence to grow, there would need to be clear evidence that a new team of economic officials plans a different approach to shoring up a Chinese economy hit by strict COVID-19 containment measures, a property crisis, and in the longer term, formidable demographic challenges. A further consolidation of Xi’s authority, in contrast, would imply continuity in policy, and more importantly, continuity in the elevation of Party priorities above those of China’s economic technocrats. This could deepen investors’ concerns about regulatory overreach.

New Economic Leadership—What Changes?

While the Congress is not the place for major new economic policy announcements, it will have important implications for longer-term economic dynamics, as Politburo Standing Committee lineups tend to reveal preferences for China’s economic governance. The past ten years have seen increasing Party involvement in economic policymaking, less policy coordination and balancing of interests, and a marginalization of the State Council and economic technocrats. The Congress will offer key signals for whether these trends are likely to endure in the next five to ten years.

If they do, optimism will wane that Beijing can make the tough choices required to tackle structural headwinds to the economy—demographic changes, the property market contraction, financial sector instability, external pushback—and push the economy closer to potential growth. The drastic economic slowdown of 2022 was precipitated by COVID-19 lockdowns but driven by much deeper weaknesses in China’s economy, as well as a series of policy mistakes, including an attack on the private sector and an absence of meaningful consumer stimulus.

Some might argue that in cementing his authority over the Party, Xi will be in a better position to delegate power back to the technocrats. This could be true, but it is equally true that his empowerment of government agencies like the Cyberspace Administration of China (CAC) over the past two years (the agency which led the push to delist Didi Chuxing from overseas exchanges) will be hard to reverse. Decisions made over the past decade have created new interest groups that will be strong obstacles to reform. Their continued influence could produce more surprise regulatory actions, such as those taken again Internet platform companies, education and tutoring firms, and firms such as Didi.

Two nominations will be closely watched: Li Keqiang’s replacement as premier (and the possibility of Li taking up another high-level position, which would signal continued influence); and Liu He’s replacement as vice-premier in charge of finance and economics.

Realistic candidates to replace Li as premier include current Politburo Standing Committee member Wang Yang, Vice-Premier Hu Chunhua, and Executive Vice-Premier Han Zheng. The emergence of another surprise candidate is possible, though unlikely. Neither Wang nor Han would be viewed by markets as denoting a change in economic policy, given their identification with the current leadership—though Han’s inclination toward fiscal austerity, which may be negative for economic momentum in the short term, could be more favorable for the private sector in the long run. Because Hu Chunhua is seen as closer to former General Secretary Hu Jintao, his appointment as premier could be viewed as heralding a change in approach to economic policy. But for that to materialize, other officials that do not have close ties to Xi would need to be put in place.

The replacement for Liu He in the finance and economics post is arguably even more important for China’s medium-term economic trajectory, and current head of the banking regulator Guo Shuqing filling this spot would be the most positively received by Western observers and financial markets. The candidate generally seen as closest to Xi is He Lifeng, a former NDRC official and largely unknown to financial markets. If appointments like He’s produce a narrative that Xi is favoring loyalty over technocratic competence, this would be one of the strongest policy signals out of the Congress—and one that would be interpreted negatively for China’s economic outlook over the next five years.

Transitioning Away from Zero-COVID

The Party Congress itself is unlikely to be the venue for a shift away from China’s “zero-COVID” policy.  The more important period to watch will be the two to three weeks after the conclusion of the Congress, when easing political pressure on Beijing and local officials could produce a different approach. As the Congress ends, and as other countries in the region continue to relax controls and travel restrictions, China risks appearing more and more isolated from the rest of the world.

International travel restrictions are likely to be the first to be lifted, ahead of the early Chinese New Year holiday in late January. The fact that Xi Jinping is already traveling abroad makes it more difficult for Beijing to maintain travel restrictions for Chinese citizens. But how domestic pandemic controls are eventually eased will be significant for economic momentum. A formal  announcement for China’s exit from “zero COVID”, and a timeline for lifting restrictions, would be more beneficial for the economy than a slow and muddled easing—even if controls are not lifted right away. It would provide some sense of certainty for businesses and consumers, boosting investment and employment. However, it is more likely that the easing of controls will take place incrementally, led by local governments rolling back testing and other restrictions, without a “big bang” announcement from Beijing.

The wild card is the path of the virus itself.  Either the COVID-19 restrictions that China has imposed so far have been effective in controlling the disease, or the number of cases has been suppressed by local reporting. Either way, trouble looms. China will inevitably face a significant COVID-19 outbreak when restrictions are eased. The only question is how soon it comes. Such an outbreak, regardless of when it occurs, will disrupt the economy,  with many fewer people working and others

refraining from travel and spending given newfound caution about contracting the virus. Still, given the tendency of Chinese officials to favor the vague concept of “stability” ahead of major political events, the end of the Party Congress could bring something of a reprieve.

China’s Relations with the West

Another question surrounding the Party Congress is whether it will have a material impact on China’s souring relations with the US and Europe. The short answer is no. Xi’s trip to Central Asia and meeting with Vladimir Putin—despite an acknowledgement of concerns about Russia’s actions in Ukraine—showed that the anti-Western partnership between Beijing and Moscow, and its defense of the idea of regional spheres of influence, is here to stay. This has reinforced concerns that Beijing could use the same logic to assert its rights vis à vis Taiwan.

A third term for Xi would cement the idea in Washington and other Western capitals that China’s political and economic divergence from the West will continue—making deeper economic engagement increasingly difficult, including in green technology supply chains where China has an edge. Nominations of technocrats seen as somewhat distant from Xi’s personal networks could revive hopes for an embrace of limited reform, but promise fatigue is real. And any evidence of a hardening of Beijing’s policy toward Taiwan during the Congress would generate more discomfort in Washington and Brussels at a time when the US Congress is trying to advance the Taiwan Policy Act.

In short, continued multilateral cooperation to push back against China’s actions and policies in the economic, security, technology and human rights spheres should be expected in the highly likely event that Xi receives a third term. We expect the Biden administration to roll out new measures to control technology flows to China around the time of the Party Congress (see our latest note). In Europe, we can expect the development of further policy tools in the economic and human rights spheres aimed at China, a broader debate about dependencies, and steps toward closer engagement with Taiwan, particularly at the parliamentary level.

As China eases some of its pandemic restrictions, we will see more high-level visits to Beijing, including expected trips by Germany Chancellor Olaf Scholz and French President Emmanuel Macron in the coming months. But the political space for them to engage actively with Beijing will be limited by souring opinion at home, and increased concerns around China’s trajectory.

Running Target: Next-Level US Tech Controls on China

With the US midterm elections around the corner and the 2024 presidential race set to unfold after that, the White House is preparing the next phase of its China strategy, with a focus on preserving US technological leadership. The recently passed CHIPS and Science Act, which aims to revitalize US semiconductor manufacturing, forms the offensive prong of the Biden administration’s strategy. Now for the defensive components. From list-based export controls on specific technologies to the buildout of outbound investment screening, the White House is putting together a playbook with important implications for a range of actors—including US industry and America’s allies abroad. Among the key questions: Where should the US draw the line when defining technologies as “leading edge”? How far should it go in using “long arm” provisions that target certain Chinese entities? And what role should human rights, supply chain resilience, and data privacy concerns play in technology restrictions under a broader national security umbrella?

The signposts point to a concerted attempt by the White House to expand the technology control tent while applying more precision to how controls are applied. But in trying to minimize the chances of an electoral upset, the Biden administration is squeezing a lot of ambition into policies designed on a compressed timeline. This can have widespread ripple effects—on countries and companies that cooperate with the US in the technology sphere and on China’s self-sufficiency push. This note unpacks the most significant elements of the emerging US strategy on tech controls and associated risks for US policy and industry. 

Unpacking the White House Agenda on Tech Controls

The summer was full of clues about the White House’s fast-evolving agenda on tech controls:

  • August 9: Biden signed the CHIPS and Science Act into law, allocating $39 billion in subsidies for US semiconductor manufacturing (including $2 billion for legacy chips) and an additional $11 billion for boosting R&D.
  • August 12: The Commerce Department’s Bureau of Industry and Security (BIS) issued an interim final ruleon Wassenaar-level multilateral controls, including for Electronic Computer-Aided Design (ECAD) software designed to develop integrated circuits with Gate-All-Around Field-Effect Transistor (GAAFET) structures—innovative 3D transistors that support node sizes at or below five nanometers (nm).
  • August 31: US technology firm NVIDIAdisclosed in an SEC filing that, as of August 26th, it was being restricted from selling its most advanced AI-powered Graphics Processing Units (GPUs)—A100 and H100 chips—to China. US semiconductor company AMD confirmedthat it had alerted Chinese suppliers of the new licensing requirement. A Commerce Department spokesperson told Reuters that a “comprehensive approach” was being taken with regard to “technologies, end-uses, and end-users” in order to protect US national security and foreign policy interests.
  • September 1: NVIDIA disclosed in an SEC filing that as of August 31st, it had received licenses to export newly restricted A100 chips in support of US customers through March 1, 2023 and A100 and H100 chips through its Hong Kong facility through Sept. 1, 2023, giving the company time to adapt to the new restrictions.
  • September 2: Semafor reported that the White House was planning to move ahead with an executive order on outbound investment screening ahead of the midterm elections but was still debating whether to go beyond a notification requirement to include blocking authority.
  • September 11: Reuters reported, citing unnamed sources, that the Commerce Department intended to formalize new requirements to restrict a) AMD and NVIDIA from selling advanced AI-related GPUs and b) KLA, Lam Research, and Applied Materials from selling semiconductor manufacturing equipment for sub-14nm logic chip production. The restrictions would apply to China and Russia.
  • September 15: The White House issued an executive order providing presidential guidance on the risks CFIUS should consider when reviewing transactions, with a special focus on critical technologies, supply chain security, investment patterns, cybersecurity, and personal data protection.
  • September 16: US National Security Advisor Jake Sullivan delivered a speech at the Special Competitive Studies Project Global Emerging Technologies Summit, drawing attention to “force-multiplying” technologies and asserting that the US needs to go well beyond the objective of staying “a couple of generations ahead” in strategic technology development.

These developments show that a more coherent US strategy on technology controls is taking shape, but one which risks verging into more extreme regulatory territory. A White House shift toward more list-based technology controls—against the backdrop of rising US frustration over the readiness of key allies to restrict tech exports and domestic political incentives to out-maneuver the Republicans on China policy—is likely to give rise to more trade volatility, including in global semiconductor supply chains.

Narrowing tech priorities

An important policy debate in Washington in recent years has been over how best to design export controls, both in terms of technology subsets and thresholds for defining “leading edge” technologies. The BIS has fended off repeated demands by lawmakers to issue a master “emerging and foundational technology list”.  Meanwhile, the White House Critical and Emerging Technology List remains alarmingly broad. However, the executive order issued by the White House offering guidance to CFIUS, Sullivan’s recent remarks, and the leaks on the White House’s upcoming outbound investment screening order point to a narrowing priority list for critical technologies that includes: advanced semiconductors, artificial intelligence, and quantum computing (large-capacity batteries and biomanufacturing are also growing areas of focus.) These technologies will likely be the focus of new export controls and investment screening.

Broadening beyond entity-focused technology controls

The recently disclosed BIS restrictions on AMD and NVIDIA AI computing chips confirm a new focus on a smaller list of critical (or, to use Sullivan’s terminology, “force-multiplying” technologies.) Although NVIDIA was granted a license to fulfill pending orders for US customers, the intent was clear: Commerce is focusing on a number of cutting-edge technologies that it wants to keep out of China’s hands.

This could mean a shift in emphasis away from entity listings (an exasperating cat-and-mouse game of BIS chasing down spinoffs in labyrinthine party-state business ecosystems) to broader technology-based controls based on potential military end-use and applied against countries of concern, such as China and Russia. Ad hoc entity listings will remain a tempting shortcut for policymakers to ratchet up sanctions and score political points, but a deeper foray into list-based technology controls can have a much broader impact on transactions related to dual-use technologies.

As the White House sharpens its focus on “force-multiplying” technologies, the next logical step will be for Commerce to better define military end-use and end-users in justifying list-based technology controls. This could impose a much heavier regulatory burden on companies to make a determination on end-use if their products fall into a military-civil fusion tech ecosystem.

Defining “leading-edge” and “chokepoints” for advanced chips

The US administration is also creeping closer to defining thresholds for what constitutes the “leading edge” in “advanced” semiconductors:

  • Export controls that BIS is reportedly formalizing would target semiconductor manufacturing equipment (SME) “chokepoints” by restricting US suppliers (KLA Corp, Lam Research Corp, and Applied Materials) from exporting equipment capable of producing logic chips at or below 14 nanometers (nm).
  • The BIS interim final rule on Wassenaar controls restricts “Electronic Computer-Aided Design (ECAD)” software specifically designed for producing chips with Gate-All Around Field-Effect Transistor (GAAFET) structures. This is an advanced 3D transistor architecture that supports the production of cutting edge chips at or below 5nm.
  • The CHIPS and Science Act sets the bar for “legacy chips” at or above 28nm, for the purposes of restricting recipients of CHIPS funding from engaging in “significant transactions” that involve the “material expansion of semiconductor manufacturing capacity” in China.

The signs so far suggest the White House wants to freeze China’s capabilities in place at 14nm (chips that China’s SMIC is capable of producing) at a time when multilateral controls are geared toward more advanced technology thresholds (5nm and below). The White House is consciously taking a more rigid approach toward defining the leading edge. As US National Security Advisor Jake Sullivan stated in a September 16 speech:

“On export controls, we have to revisit the longstanding premise of maintaining ‘relative’ advantages over competitors in certain key technologies. We previously maintained a ‘sliding scale’ approach that said we need to stay only a couple of generations ahead. That is not the strategic environment we are in today. Given the foundational nature of certain technologies, such as advanced logic and memory chips, we must maintain as large of a lead as possible.”

It can be reasonably inferred from the Sullivan comments and recent reporting on emerging controls that the Biden administration intends to set a more stringent threshold at 14nm in order to prevent advances in China’s logic chip development instead of designing semiconductor export controls to keep pace with innovation. Such an approach is designed to give the United States “as large of a lead as possible,” but it comes with important side effects. For example, the US administration is also trying to target perceived chokepoints in the semiconductor supply chain to hamstring China’s indigenous chip development. Semiconductor manufacturing equipment (SME) is a growing area of focus for this chokepoint strategy. But many SME components are not specially designed for sub-14nm production, and are used for producing both leading edge and legacy node chips. Wider ripple effects in semiconductor supply chains can therefore be expected if a blunt 14-nm standard is applied across export controls.

Lithography—a complex patterning process in chip fabrication—attracts the most attention in the SME chokepoint debate. Dutch firm ASML’s current generation of extreme ultraviolet (EUV) lithography machines uses a wavelength of 13.5nm. These machines are already restricted from export to China. But SMIC is reportedly producing at sub-10nm, using less-advanced deep ultraviolet (DUV) machines. There is a big difference between developing prototypes and producing leading-edge chips at scale. However, SMIC’s recent progress has nonetheless reinvigorated the US policy debate on whether the SME threshold should be lowered to restrict DUV as well. Such a restriction would stray further from “leading edge” controls.

Long-arm provisions

The Biden administration has made a concerted effort to coordinate technology controls with its partners to avoid alienating allies and ceding market share to foreign competitors. To this end, it has created arrangements like the US-EU Trade and Technology Council, Indo-Pacific Economic Forum working groups, and the emerging CHIP4 alliance (including the United States, Japan, Taiwan, and South Korea) to try to harmonize technology development and controls.

Progress has been predictably slow, however. US tech partners are ready and willing to join the strategic conversation (partly out of fear of missing out) but would rather focus these forums on constructive themes (coordinating development) than on restrictions that risk provoking a backlash from Beijing or raising costs for businesses.

Slow progress on the multilateral front risks feeding US anxiety over technology competition with China, driving it toward broader controls, with an extraterritorial flavor. The areas we are watching as we assess the potential for US long-arm provisions include:

  • Outbound investment screening provisions: A June congressional proposal for outbound investment screening led by Senators John Cornyn and Bob Casey contained broad language on covered activities carried out by any US person, foreign person, or their affiliates, including any entity “influenced” by a country of concern. The White House has instead been focused on plugging holes in existing export controls to prevent US private equity and venture capital from reaching entities of concern.
  • The White House is likely to take a step-by-step approach to outbound investment screening, starting with a Treasury-run mandatory notification requirement, linked to the White House priority list of technologies (advanced semiconductors, AI, quantum computing, and possibly biomanufacturing and subsets of clean energy technologies like high-capacity batteries.) The White House may be tempted to broadly define the covered activities as it tries to prevent US companies from evading controls through foreign subsidiaries.
  • BIS controls on “activities of US persons”: In addition to the Entity List Foreign Direct Product Rule, which was applied first to Huawei and then more broadly to Russia in cutting off the supply of US-origin technology, the US government has another powerful weapon that could come into play as it narrows its technology priorities. Under Section 744.6 of the Export Administration Regulations (EAR), BIS could impose comprehensive controls on the “activities of US persons” that support the development for specific dual-use technologies, military-intelligence end-use, or end-user. Given the pervasiveness of “US persons” linked to technology supply chains, from design to financing, the extraterritorial reach of such a measure would be extensive and could damage relations with allies producing advanced technologies.The all-encompassing national security umbrellaBuilding resilience in critical supply chains, preventing human rights abuses, protecting US citizens’ sensitive data, and bolstering US cybersecurity are all big objectives that overlap with the national security goal of preserving US technology leadership. In trying to address these concerns (and score political points along the way), it may be tempting for US policymakers to package policy objectives together under the national security umbrella when developing new controls. The US government may also end up targeting Chinese technology conglomerates on multiple grounds, straying further from the technical approach that usually informs export controls.  The Biden administration has tried to differentiate itself from the haphazard approach of its predecessor in targeting Chinese entities. This approach was highly disruptive to businesses, prone to legal challenges, and polarizing to US partners. But the White House is still trying to link its broader objectives to its strategic tech agenda. For example, after launching an export controls and human rights agenda at the December 2021 Summit for Democracy, we expect the administration to roll out more on this theme ahead of the midterm elections. Going forward, this could mean a ratcheting up of long-arm sanctions on entities involved in surveillance and cyber intrusion technologies and focusing on Chinese tech conglomerates involved in developing “force-multiplying” technologies in the military-civil fusion ecosystem.

Loaded Assumptions

The White House is trying to balance its strategic goal of advancing US technology leadership with the political objective of getting out ahead of the Republican agenda on technology controls should Congress flip in November. As a result, we can expect a flurry of policy announcements this fall that underscore a “tough on China” approach.

The Biden administration would prefer to put the focus on export controls in its China strategy and avoid potentially provocative measures (such as the Taiwan Policy Act being developed in Congress) which could ratchet up tensions with Beijing. By quickening its pace on technology and related investment controls, the White House hopes to build an unassailable lead in the technology race with China and establish limits for US policymakers. This approach is based on several, still untested, assumptions:

  • That China, already falling short of its technology self-sufficiency goals (especially in semiconductors) and undergoing a deep economic slowdown, will mostly absorb hard punches while struggling to innovate around controls. Beijing has mostly held back on retaliatory moves over export controls given its overwhelming external dependency on external tech inputs. However, China has extraterritorial tools—including anti-monopoly veto power on foreign tech mergers and anti-suit injunctions for standard essential patents—that could be applied more forcibly as the US tightens controls.
  • That foreign partners will follow the US lead and align on controls rather than run afoul of US restrictions (or risk ceding the moral high ground on human rights). For more geopolitically exposed partners like Taiwan, the US may hold more sway. Japan will try its best to steer the US toward more pragmatic controls. But Europe may resist signing on to policies that are specifically aimed at Beijing on the grounds that space for engagement must be preserved. Plans by German Chancellor Olaf Scholz and French President Emmanuel Macron to travel to Beijing in the coming months to meet with Chinese President Xi Jinping attest to their desire to maintain dialogue.
  • That non-US technology firms from like-minded countries won’t feel compelled to whittle down US content and develop non-US alternatives in critical tech supply chains, especially in the medium- to long-term.
  • That new US regulatory tools, even if based on narrower technology priorities for now, will not end up enabling a more extreme approach to technology controls under a more hawkish US administration down the road.

The White House is moving beyond its mop-up of Trump-era policies to action on technology controls targeting China. In developing a more coherent framework for designing those controls, the Biden administration is taking a big step forward in defining the policy debate. But the pressure of election cycles can lead to policymaking that creates big spillover effects. As the US quickens its pace on tech controls, we are likely to see a ripple effect on US-China relations, existing US dialogues with like-minded technology partners, and on private industry in the months ahead.

The Chosen Few: A Fresh Look at European FDI in China

After decades in which China felt like a one way bet for European firms, market conditions have become far more challenging due to restrictive COVID-19 policies, slowing economic growth and rising geopolitical tensions. Against this increasingly uncertain backdrop, we have taken a close look at European (EU+UK) FDI in China to assess the current state of investment on the ground, and shed light on how it has evolved over the past decade. Our key finding is that European investment has grown much more concentrated, both in terms of the companies that are investing there, the countries they come from, and the sectors in which they operate. While a handful of large firms, many of them German, continue to pour money into their China operations, many other firms with a presence in China are withholding new investment. At the same time, virtually no new European firms have chosen to enter the Chinese market in recent years. And acquisitions of Chinese firms have stalled, with greenfield investments increasingly dominating the FDI landscape.

Our findings point to a widening gap in how European firms perceive the balance of risks and opportunities in the Chinese market. They also suggest that a more nuanced perspective on the issue of European corporate dependencies is needed. From a direct investment point of view, it is wrong to talk about a broad-based dependence of European, or even German, companies on the Chinese market. As policymakers in Berlin and other European capitals consider measures to reduce economic dependence on China, they would be wise to take the growing concentration of corporate risks into account.

The Chosen Few

Our review of core trends in European FDI to China over the past decade has yielded one especially striking finding: today, the overwhelming majority of European investment in the country comes from just a handful of companies. We find, for example, that the top 10 European investors in China in each of the past four years made up nearly 80%, on average, of total European direct investment in the country. In 2019, the trend toward greater concentration was especially marked, with the top 10 investors representing 88% of all European FDI (see Figure 1). In comparison, over the previous decade (2008-2017), the top 10 European investors in China made up just 49%, on average, of the total European investment value.


European investment has also become more concentrated in terms of sectors. Five sectors—autos, food processing, pharma/biotech, chemicals and consumer products manufacturing—now make up nearly 70% of all FDI, compared to 57% in 2008-2012 and 65% in 2013-2017 (see Table 1). Among them, the auto sector stands out. It now consistently represents about a third of all European direct investment in China. This proportion was even higher in H1 2022 as German carmaker BMW increased its stake in its China JV from 50% to 75% and other European automakers poured money into new facilities to build electric vehicles.


Finally, European FDI in China has become more concentrated in terms of countries of origin. Four countries—Germany, the Netherlands, the UK and France—made up 87% of the total investment value, on average, over the past four years, compared to 69% in the previous ten years (see Figure 2). Among them, Germany stands out as the top investor by far, making up 43% of the total, on average, over the past four years, compared to 34% in the previous 10 years. In 2018, German firms accounted for more than half of all European investment in China. This trend is driven by a number of factors: German companies were early entrants to the Chinese market and their presence there was actively encouraged and aided over decades by the country’s political establishment; they are typically in capital-intensive manufacturing and engineering industries, meaning large fixed investments; and they are present in sectors that have seen strong growth in China over the past decade.


Among German firms, the three big automakers (Volkswagen, BMW and Daimler[1]) and chemicals group BASF have led the way in China. These four firms alone contributed 34% of all European FDI into China by value from 2018 to 2021.

The biggest European investors in China have maintained steady investment flowing into large greenfield projects due to three main considerations: First, they have generated significant profits in China and believe the market will continue to be lucrative despite the economic and geopolitical headwinds. Second, these companies feel they must continue to invest and develop products in China in order to safeguard the value of past investments and remain competitive with increasingly innovative domestic rivals, for example in sectors like electric vehicles. Third, they are trying to insulate their China operations from rising global risks through greater localization—an approach that is also being actively encouraged by Chinese authorities. In this respect, recent FDI in China looks quite different than it did a decade ago. It has become more defensive, in a reflection of a more risky environment, in China and globally.


The Others

The concentration around a few major German players is notable, but it does not mean that companies from other European countries are showing no interest in the Chinese market. Firms from France, the UK and the Netherlands consistently rank among the top ten investors as well, with non-trivial FDI in the automotive, chemicals, pharmaceutical, insurance and consumer goods sectors. Among them, Ikea, Diageo or AXA stand out as companies that have continued to make new, sizeable investments in China.

A closer look at transaction count, rather than investment value, points to continued engagement from firms in other European countries as well—including Italy, Sweden, Finland, Belgium, Denmark, Spain, and Austria. Together, these countries’ firms made up a stable 20-30% of all FDI transactions in China over the past decade. Still, the profile of these companies is slightly different from that of the “chosen few”. Generally speaking, their investments are more sporadic, and although they are typically active in the same industries, they tend to specialize in more specific niches like automotive components or green energy supply chains. Smaller firms, particularly from Germany, Sweden, and Finland, are also prominent in lower capex industries like industrial machinery and equipment, which represented 11% of deals but just 3% of transaction value between 2018 and 2021.

Because our database of EU FDI in China only includes transactions over EUR 1 million, we may not be capturing some smaller scale investments in services, less capital-intensive industries, or R&D activities. Additionally, in focusing on FDI, we are not accounting for other forms of economic engagement with (and dependence on) China. French and Italian luxury brands, for example, rely heavily on trade with China but are not deploying the vast amounts of capital that we see in the above-mentioned industrial sectors.

The Missing

Finally, our analysis reveals another noteworthy category of European investors—those that are missing from the picture. Given the size and growth of the Chinese economy in recent decades, one would have expected the country to attract a much broader range of foreign firms. But three types of investors are conspicuously absent in our review of recent trends.

First among them are investors in the services sector. Our data shows that between 2018 and 2021, business services made up less than 2% of the value and just 7% of the total deal count, while software & IT services made up 0.5% of the value and 3% of the deal count. This is despite the fact that, as of 2020, services made up 53% of China’s GDP (compared to 65% in the EU and 72% in the UK)[2] and despite the strong competitive advantage that European firms enjoy in those industries. Explanations for this include continued market access problems and the belated opening of the Chinese market to European players.

Second, we are seeing far fewer European companies looking to acquire Chinese firms. Greenfield investment makes up the lion’s share of European investment in China, representing two-thirds of the total over the past five years. Its share of total investment has been steadily increasing since 2019. By contrast, the value of European acquisitions in China hit a four-year low in 2021. As an economy matures, one would expect acquisitions to become a more common investment channel.  That hasn’t happened in China, as European firms remain wary of buying Chinese companies given formal restrictions, high valuations and a lack of transparency around financial accounts and other liabilities. COVID-19 travel restrictions have amplified the M&A downtrend.

Third, China is seeing fewer and fewer new entrants on its market. Since the outbreak of the pandemic in early 2020, for example, stakeholders on the ground say that virtually no European investors that were not already present in the country have made direct investments. It’s true that many globally-minded European companies are already in China, and have been for some time. Still, one would expect new European players to be showing interest given the size and growth potential of China’s economy. This may be a temporary phenomenon, related to the pandemic and China’s zero-COVID response. However, conversations with stakeholders suggest that a longer-term dynamic may be at work, with smaller European companies reluctant to accept the growing risks of investing in China.

The absence of new players has contributed to the greater concentration of European FDI around a few big players. Incumbents have a distinct advantage in an increasingly politicized market where foreign firms face high barriers to access, an uneven competitive playing field vis à vis local players, and a less-than-transparent compliance landscape. This explains why fewer small and medium-sized enterprises (SMEs) are venturing into the country, and why in sectors like financial services, which have been opened to foreign investment in recent years, only a handful of big European players have made the leap, despite the growth opportunities.


We have established that European investment in China is now increasingly dominated by a small number of big players, predominantly German companies, and their top suppliers. What is less clear is how this dynamic will play out in the years to come. China’s highly-restrictive zero-COVID policies will presumably be phased out over the coming years. This could encourage new firms to enter the Chinese market, reversing the concentration trend we have seen in recent years. However it is also possible, perhaps even probable, that the concentration of European investment in China around a small number of well established European firms whose presence is welcomed by the Chinese authorities becomes more entrenched.

As China’s economic slowdown accelerates, amid a real estate crisis and crackdown on private enterprise, and as policymakers in Berlin and other capitals press ahead with a resilience and diversification agenda, the proportion of China skeptics in European corporate boardrooms may continue to grow. We believe it is likely that the gap between the “chosen few” and the broader swathe of European companies that are reducing their China exposure, either by paring back their footprint on the ground or putting future investments into other markets, could become more pronounced in the years to come. What does the future hold for those firms that remain fully committed? We are already seeing what might best be described as an “internal decoupling” dynamic taking hold within some of these companies—as staff, supply chains and data flows are increasingly localized and ringfenced. This “in China for China” push risks opening up a greater divide between the headquarters of European firms and their China operations, a dynamic that poses long-term challenges for the companies concerned—reputational, cultural and financial (due to smaller economies of scale). Corporate boardrooms and policymakers will have to consider these risks as they weigh up their future relationship with China.

[1] The transaction value attributed to Daimler includes FDI by both Mercedes-Benz and Daimler Truck, which was spun off in December 2021.

[2] World Bank and OECD.

Minimizing the Economic Pain of European Industrial Gas Rationing

With Russian gas supplies reaching record lows, and natural gas prices reaching record highs, Europe is bracing for a very hard winter. On August 5, the European Council approved a European Commission proposal for a EU-wide gas demand reduction plan to last until March of 2023. This plan instructs Member States to develop implementation plans that minimize economic, social, and national security costs. This includes identifying which industries have the greatest ability to reduce gas consumption, and which should be protected from both voluntary and mandatory cuts. In this note, we provide an overview of the role that industry plays in Europe’s natural gas landscape and the role that gas-intensive industry plays in the European economy, and we provide recommendations for Member States to consider as they develop gas reduction prioritization plans.

Industry’s role in Europe’s natural gas market

Before the current crisis, the European Union (EU) consumed about 400 billion cubic meters (BCM) of natural gas each year. Of this, more than 40% was supplied by Russia (Figure 1). European gas demand is split roughly evenly across power generation, building heating, and industry.


European efforts to reduce Russian gas dependence this year have focused largely on securing alternative sources of supply, and increasing non-gas forms of power generation (including accelerating renewable construction, ramping up coal generation and delaying or canceling nuclear power plant retirements). These measures are having a meaningful impact, but not enough to offset the decline in Russian gas supply. As of June, Russian exports to the EU were only 30% of 2016-2021 average levels, including a 75% reduction in flows through the Nord Stream 1 pipeline to Germany. In the months since, Nord Stream 1 supply has been completely halted. This has helped push natural gas prices in Europe to record levels (Figure 2) – surpassing 200 EUR per MWh ($60 per MMBTU) in August.


Rising natural gas prices have pushed up the cost of electricity as well. In Germany, for example, electricity prices have been trading above 400 EUR per MWh on the spot market in September, compared to a little over 100 EUR during the same period last year and less than 50 EUR during September 2020. In addition to raising costs for European households and businesses through higher-priced gas bills for heating and cooking and electric bills for cooling and lighting, the rapid growth in natural gas and electricity prices is threatening Europe’s manufacturing base. Price-driven factory closures threaten a regional economy already teetering on the edge of recession. At the same time, reductions in industrial gas demand may be less costly from a humanitarian standpoint this winter than balancing the market on the back of households, small businesses, schools and other public buildings that need gas for heating. As European policymakers prepare gas reduction plans, they are grappling with these trade-offs, and looking for where reductions in industrial gas demand would be least economically damaging.

While this note focuses on gas-intensive manufacturing, electricity-intensive manufacturing is also a significant indirect gas consumer, given the role of gas in Europe’s power system, and warrants additional analysis.

The role of gas-intensive manufacturing in the European economy

Industrial gas consumption in Europe is concentrated in a handful of industries which, by themselves, play a relatively modest role in overall economic activity and employment in the European Union. Just six sectors account for 87% of total industrial gas consumption: refining and coking, chemicals, basic metals (iron and steel), non-metallic mineral products (cement and glass), paper and printing, and food and beverage manufacturing. Yet only 4% of total EU employment is in these industries, half of which is in food and beverage manufacturing—the most labor-intensive of the six. If you exclude food and beverage manufacturing, the remaining five account for 81% of EU industrial gas demand but only 2% of total employment. One million cubic meters of gas demand supports 10-163 jobs directly in these energy-intensive sectors (Figure 3) compared to 1,398 jobs on average for the rest of European manufacturing. Refining and coking is the most gas-intensive relative to employment, followed by chemicals, then basic metals, then non-metallic mineral products, and paper and printing.


Gas-intensive manufacturing accounts for a slightly larger share of EU economic activity. The six gas-intensive industries account for 5% of total economic value-added, which drops to 3% if you exclude food and beverage manufacturing. The rank order among these for economic value-added per million cubic meters of gas consumption (Figure 4) is the same as for employment-intensity (Figure 3). Refining and coking adds the least economic value directly per million cubic meter of gas used, followed by chemicals, basic metals, non-metallic mineral products, and paper and printing.


While this paints the picture across the EU, there are important differences between EU Member States. In absolute terms, 81% of all industrial gas demand in Europe occurs in Belgium. France, Germany, Italy, the Netherlands, Poland, and Spain (Figure 5). Germany alone accounts for a quarter of all industrial gas demand in the EU.


In terms of the importance of gas-intensive manufacturing to individual member-state economies (Figure 6), Romania is the most exposed, with more than 7% of total economic value-added coming from gas-intensive manufacturing (though most is from food and beverage manufacturing), and Iceland is the least exposed. In terms of individual industries, refining and coking plays the largest role in Croatia, Hungary, and Poland. Chemicals play the largest role in Belgium, Germany, Finland and the Netherlands. Basic metals play the largest role in Austria, Slovenia, Slovakia, and Bulgaria. For non-metallic mineral products, it’s Czechia, Poland, Bulgaria, Latvia, Portugal, and Slovenia.

These data just cover the direct economic and employment contributions of gas-intensive manufacturing. Some of the output of these industries is used in downstream manufacturing that employs more people and contributes additional economic value added. Other output is used directly in non-manufacturing activity, like construction (in the case of basic metals and non-metalic mineral products), transportation (as in the case of refining and coking) or directly consumed by households (like food and beverage manufacturing). Thus, as EU policymakers develop industrial gas demand rationing plans, the downstream effects of gas-intensive manufacturing disruptions are some of the most important factors to consider.

Evaluating near-term industrial gas demand rationing options

Over the medium term, the most successful strategy for mitigating the impact of Russian gas supply disruptions on European industry and the European economy, while still meeting EU climate change targets, is to invest in technology that reduces the amount of gas required to produce these goods. These investments include efficiency improvements, as well as production processes that use other fuel sources. Electrification, renewable-powered hydrogen, and sustainable biomass are all potential options. For example, a recent report published by the European Climate Foundation found that by 2025,  industrial electrification and energy efficiency improvements can reduce European industrial gas demand by 10-13 billion cubic meters per year.

While it’s crucial that European policymakers and industry start making these investments as soon as possible, they will only have a modest impact in time for the coming winter. In directing Member States to develop near-term gas rationing strategies, the European Commission has suggested Member States consider the following (approved by the European Council):

(a) The impact of a disruption on supply chains that are critical for society;
(b) The possible negative impacts in other Member States, in particular on supply chains of downstream sectors that are critical for society;
(c) The potential long-lasting damage to industrial installations;
(d) The possibilities for reducing consumption and substituting products in the Union

While it’s difficult to make sweeping generalizations about the implications of supply disruptions in any individual gas-intensive manufacturing sector on these four criteria, we offer the following observations.

1. Avoiding damage to industrial facilities requires forward planning

The Commission was right to urge Member States to consider the potential impact of shutting down a manufacturing facility on the health and longevity of the equipment. This is not a generalized issue for gas-intensive manufacturing but limited to certain equipment times and production processes. Indeed, nearly all industrial facilities need to be taken offline for maintenance from time to time. The most important factor in mitigating potential damage is ensuring that facilities have as much lead time as possible to plan for potential outages.

2. Focus on areas with spare production capacity outside the EU

Mitigating the economic and employment costs of a disruption in gas-intensive manufacturing will depend heavily on the availability of downstream industries in Europe to source substitution inputs from outside the EU. This is particularly true for chemicals and metals (Figure 7) where the majority of EU production is consumed by downstream manufacturing in the EU (for example, steel used in automobile manufacturing). European policymakers should actively engage in conversations with chemicals and metals consuming industries (as well as the construction industry, which is a large consumer of steel, cement, and glass) about potential availability of supply outside the EU and the speed at which they could switch to other providers. EU officials should then coordinate outreach by Member States to government officials in allied countries with potentially available chemicals and metal manufacturing capacity to assess the potential for increased or redirected production, and to enlist their help in addressing any potential barriers to that increase/redirection. The high cost of gas in Europe is already driving some of this substitution on purely market grounds, but policy engagement is important both for emergency planning purposes and to maximize the availability of non-EU supply in the event of a severe crisis this winter.


3. Ensure that non-EU supply doesn’t also come from Russia

While Russia is a large producer of oil and natural gas, it’s also a large producer of many gas-intensive manufactured products. As European officials evaluate the availability of foreign gas-intensive products as inputs for downstream European industry or for direct consumption by households and businesses, it is important they don’t trade one Russia-driven supply crisis for another. Even if the non-EU supply of gas-intensive products doesn’t come from Russia directly, current or future disruptions of Russian production could limit market availability globally. For example, Russia accounts for 7% of refined petroleum products traded globally (Figure 8), and disruptions in Russian supply have contributed to the tight refined petroleum product market globally and the currently limited amount of spare capacity. As a result, any natural gas shortage-driven reductions in European refining capacity would have an even larger impact on gasoline, diesel, and jet fuel prices, both in Europe and around the world. Russia is also a reasonably large player in commodity chemicals, steel, and pulp production, less so in cement and paper.


4. Beware of areas where regulatory structures will limit the speed of supply diversification

The ability to sell certain products in the European market is subject to regulatory standards that foreign producers might not be able to meet immediately, even if they have spare production capacity. This is most pronounced for food manufacturing. Quickly shifting from domestic production to imported supply of major manufactured food products at scale would be challenging, while still ensuring food security for the continent throughout winter. Regulatory standards can also slow substitution in the construction and chemicals industries.

This nonpartisan, independent research was conducted with support from the William and Flora Hewlett Foundation. The results presented in this report reflect the views of the authors and not necessarily those of supporting organization.

China Pathfinder: Q2 2022 Update

China Pathfinder is a multi-year initiative from the Atlantic Council’s GeoEconomics Center and Rhodium Group to measure China’s system relative to advanced market economies in six areas: financial system development, market competition, modern innovation system, trade openness, direct investment openness, and portfolio investment openness. To explore our inaugural data visualization and read our annual report and updates, please visit the China Pathfinder site.

China’s economic growth slowed to 0.4 percent year-on-year in the second quarter of 2022, despite aggressive steps by authorities to support struggling companies, boost consumption, and address the spike in youth unemployment. These measures amounted to short-term firefighting. There were few signs of the fundamental structural reforms needed to put the Chinese economy on a sustainable long-term growth path. Beijing’s aversion to relinquishing economic control to market actors has laid the groundwork for more financial instability in the second half of 2022, including in the struggling property sector. With the 20th Party Congress looming, we see little chance of a change in approach, even if the Chinese economy veers toward a hard landing. Some analysts point to episodic Q2 endorsements of market reform and the end of “campaign style” regulation as evidence of correction. Until more definitive policy reversals are evident, however, the outlook for liberal policy reform in China to address deep-seated structural flaws in the economy remains dim.  

Quarterly Assessment and Outlook

The Bottom Line: In the second quarter of 2022, Chinese authorities were active in two of the six economic clusters that make up the China Pathfinder analytical framework: financial system development and competition policy. There were fewer developments in the innovation, trade, direct investment, and portfolio investment clusters. In assessing whether China’s economic system moved toward or away from market economy norms in this quarter, our analysis shows a mixed picture.


Figure 1 reflects the direction of China’s policy activity in the domestic financial system, market competition, and innovation system, as well as policies that impact trade, direct investment, and portfolio investment openness. This heatmap is derived from in-house policy tracking that weighs and evaluates the impact of Chinese policies in Q2. Actions are evaluated based on their systemic importance to China’s development path toward or away from market economy norms. The assessment of a policy’s importance incorporates top-level political signaling with regard to the government’s priorities, the authority of the issuing and implementing bodies in the Chinese government hierarchy, and the impact of the policy on China’s economy.

A Look at Q2 Trendlines

Policy activity in Q2 2022 was dominated by measures to offset economic slowing caused by COVID-19 lockdowns and an ailing property sector. The State Council rolled out “33 Measures” to stabilize the economy, most of them temporary steps to support businesses. This “all hands on deck” support showed that, despite bullish official messaging, the economy is not doing fine and is unlikely to come close to meeting the targets China’s leaders have set for it. While some of the measures introduced in Q2 could boost small- and medium-sized enterprises, most amounted to subsidies that undermine, rather than promote, reform. In June, the State Council announced an increased credit line of RMB 800 billion for policy banks to fund infrastructure projects. This was followed by the announcement of another RMB 300 billion in financial bonds for infrastructure projects, innovation, and local bond-funded projects. In addition, China is reportedly negotiating with auto manufacturers about extending electric vehicle (EV) subsidies that are due to expire this year. All of this underscores how shaky China’s commitment to market reform is, when confronted with risks to the economy.

Financial System

The Chinese government took small steps to liberalize the financial sector, while retaining its “common prosperity” drive. On the positive side of the ledger, the National People’s Congress passed the Futures and Derivatives Law (FDL), the first comprehensive attempt to bring a legal framework to this growing market. The law took effect on August 1. China’s derivatives market has suffered several high-profile setbacks in recent years. The first was the $10 billion short squeeze on nickel giant Tsingshan Holding Group in Q1 2022. The second was the crash of a Bank of China wealth management product linked to global crude oil futures contracts in 2020, which generated significant losses for over 60,000 individual investors. As a result, the Chinese government has pushed for further improvements in the oversight of derivatives markets. Besides protecting investors and preventing market manipulation, the FDL legally recognizes practices like close-out netting (whereby a company’s contractual obligations to a defaulting counterparty are terminated), bringing China more in line with international norms.

The People’s Bank of China (PBOC) upgraded its toolkit for guiding bank deposit rates, a change quietly introduced in early 2022. The idea is to price deposits in line with market interest rates, such as government bond yields and the loan prime rate, rather than setting them using PBOC benchmark rates. This can help lower lending rates for corporates and shore up credit demand within the flagging economy. The move is a meaningful step toward interest rate liberalization. In addition, the State Council and the China Securities Regulatory Commission (CSRC) introduced a private pension scheme that would allow individuals to invest their pensions in certain stable financial products. This scheme would diversify investment options for Chinese households and offer more medium-term opportunities for growth in household incomes and private consumption.

On the other side of the ledger, Chinese regulators sought to place limits on salaries in the financial sector, inserting themselves into internal business decision making. In May, the Securities Association of China issued guidance warning the industry to avoid handing out “excessive” short-term incentives to employees and said doing so would result in compliance risks. A month later, the Asset Management Association of China published a regulation on performance assessment and compensation in asset management companies, which stated that at least 40 percent of bonus payments to senior staff should be deferred for three or more years. Media outlets, including the Financial Times and Bloomberg, reported that in mid-June the CSRC officials held meetings in which they asked foreign investment banks to reveal the salary details of top executives and urged pay curbs, though the CSRC later denied the reports. This campaign should be seen in the context of the Party’s “common prosperity” drive, in which regulators have used vague guidance or targeted crackdowns to compel companies and banks to prioritize their “social responsibility.” For foreign companies in China, this is a new sign of government intrusion in business operations.

Market Competition

The Central Committee of the CCP and State Council released opinions on building a “unified national market,” part of a broad push to centralize the fragmented domestic market. The document targets local protectionism and market segmentation. While previous policies focused heavily on reducing entry and exit barriers, the latest top-level guidance expands the scope to factors of production and covers areas such as intellectual property rights and regulatory standards.

While combating protectionism may lead to more market-based outcomes, the push for a “unified national market” could also result in a centralization of authority, leading to market-distorting outcomes. Importantly, the centralization effort includes unifying the social credit system—which ranks citizens and companies based on their behavior and trustworthiness—and “integrating social and financial credit information” for commercial entities. It is unclear how far this push will go and the extent to which it will affect individuals as well as companies. It seems likely, however, to further consolidate the central government’s control over Chinese citizens’ data, giving local officials more latitude to target specific firms and punish entities that run afoul of the CCP’s ideological red lines. In sum, these developments could help or hinder marketization depending on how they are applied.

Continuing a years-long mission to improve standard-setting and centralization, the Standing Committee of the National People’s Congress (NPCSC) passed amendments to the foundational Anti-Monopoly Law (AML), which will increase oversight of mergers and acquisitions (M&A) and introduce prohibitions on the use of data, algorithms, technology, capital advantages or platform rules to engage in monopolistic behaviors.

The tech crackdown has shifted focus, but platforms are still in the crosshairs of China’s regulators. During a CCP meeting in April, President Xi reiterated the need to regulate the “disorderly expansion of capital,” on the grounds that capital has a profit-seeking nature and can harm economic and social development if not regulated and restrained. It appears that China’s digital platforms should be bracing for further government intervention. In Q2, regulators turned their attention to controls on apps, the use of data by citizens, and gaming (Figure 2).


The Cyberspace Administration of China (CAC) finalized rules on cross-border data transfers, which go into effect September 1. Companies that transfer personal, important, and other sensitive data overseas may be subject to security assessment. Many outstanding questions remain, including what constitutes a data export or “important data.” For foreign companies in China, compliance risks may rise as CAC kicks off enforcement.

CAC also announced a formal campaign to rein in internet giants’ algorithm abuses—an important indicator that the campaign against tech companies is entering a new phase rather than ending. The regulator said that this effort will include on-site inspections of firms and reviews of various services provided by platforms. While the campaign further develops standards for algorithm use, it also gives the government broad license to continue tightening its grip on information platforms. These latest regulatory measures reiterated the importance of upholding “socialist core values” in the online space, making it harder for platforms to balance market-based goals with adhering to regulators’ ideological guidance.

Special Topic: China’s Unemployment Problem

Ensuring stability in employment acquired a new urgency in 2022. Absorbing a record 10.7 million new university graduates into the labor market was always going to be challenging during the pandemic, but in Q2 the shrinking economy and zero-COVID lockdowns in major Chinese cities pushed unemployment to new highs. In April, the urban unemployment rate reached 6.1 percent, the highest since the early days of the pandemic in March 2020. The unemployment rate for those aged 16-24 grew even faster, from 15.4 percent a year ago to 19.3 percent in June. This was the highest rate recorded by the National Bureau of Statistics since it started publishing the data in 2018. Unemployment data are politically sensitive in China, so official reporting likely understates the severity of the problem.

Hiring shrinks, firing swells. The ongoing regulatory campaign that shut down China’s private education industry last summer has impacted hiring in many sectors. Employment data from Maimai, a job networking platform, showed the steep decline in new hiring in sectors (gaming, ride-hailing, social media, and e-commerce) targeted by the crackdown that began in July 2021 continued in Q2 2022 (Figure 3). In these sectors, Q2 hiring fell 65 -75 percent from one year ago. The slowdown was steepest in June, with new hiring down 82 percent at top ride-hailing platforms and 79 percent at top e-commerce and food delivery platforms.


The private sector is becoming less desirable for new graduates. With zero-COVID policies and regulatory crackdowns shaking public and investor confidence, private firms have become riskier places to seek employment. Large tech firms including Alibaba, Tencent, and have announced heavy layoffs, in some cases up to 15 percent of their workforces. Meanwhile interest in government jobs has soared: in 2022, over 2 million applicants took civil service exams, a new record and a 28 percent increase over 2018. Though the public sector generally offers lower pay than the private sector, it is seen to offer lifetime security (an “iron rice bowl” in old Chinese parlance). This perception endures even as civil servants in some provinces have seen their annual incomes cut 20-30 percent this year.

Falling salary expectations are reflected in the data. Zhaopin, a Chinese recruitment firm, reported that expected salaries have dropped 6.2 percent this year compared to 2021. In 2020 and 2021, university graduates saw only a 4 percent increase in starting salaries, as opposed to a 7 percent increase for 2018 and 2019 graduates. Concerns over employment prospects, economic stability, and income are weighing on consumer sentiment. A PBOC survey in Q2 found that more than 58 percent of respondents planned to prioritize saving over consuming, compared to 54.7 percent in the previous quarter. Computer science majors are having an especially difficult time finding employment due to the tech crackdown. Graduates with a degree in Marxism, on the other hand, have seen their fortunes lifted in the current political environment. Demand for graduates with Marxism degrees has risen 20 percent over the past year, with some places offering quadruple the average salary and a signing bonus to attract that talent. As President Xi prepares for a third term, he and CCP leadership are rewarding alignment with Party ideology in both the education system and the private sector.

The Party is concerned about youth unemployment, but there are no easy solutions. Millions of young Chinese talk of “lying flat,” a metaphor for doing nothing (or opting out of the rat race) at a time when the job market is highly competitive and pressures to succeed are on the rise. Premier Li Keqiang called the current employment situation “complex and grave” as his government struggles to stabilize job markets with tax and fee breaks designed to encourage companies to hire or defer layoffs. But unemployment insurance premium rebates or discounted utility prices cannot make up for the effect of shrinking profits on hiring. More job fairs and graduate recruitment platforms will not solve China’s employment problems.

Acknowledging that the private sector cannot create the millions of new jobs China needs on its own, the State-owned Assets Supervision and Administration Commission (SASAC) urged SOEs to expand recruitment efforts. Authorities are also assuming the role of career planners. In June, four ministries issued a document encouraging college graduates to work and start businesses in rural communities. In return, the government is offering tax breaks, special entrepreneurship subsidies and loans.

It is not the first time the government has directed its most educated citizens to work in undeveloped rural areas and poorer regions for the purpose of alleviating the urban labor surplus. As early as 2003 and 2005, the State Council piloted programs encouraging college graduates to become grassroots government officials or to support economic development in the western regions. Young Chinese have been reluctant to follow the government’s call due to a massive urban-rural income gap. Research from 2017 shows that 100,000 village officials in China hold an advanced degree (only about 17 percent of all village officials), and more than 80 percent of graduates who leave urban centers for the countryside are doing so because they were born there.

Looking Ahead

The outlook on China’s growth beyond the first half of 2022 depends on a careful reading of government intent and how it is likely to respond to realities on the ground. The feeble growth in gross domestic product (GDP) is emblematic of an economy weighed down by Beijing’s policy missteps. The unrelenting crisis in China’s property sector means it will remain a drag on the economy in the second half of the year, even if COVID restrictions ease and activity in other sectors improves. The banking protests that rocked Henan province and the rising incidence of people walking away from their mortgages—trends that have dominated the headlines in July—point to a deep structural malaise that will require decisive action to reverse.

Some analysts believe the severe economic headwinds China is encountering will force changes in policymaking. As Q3 2022 got underway, some leaders were talking more openly about the downturn and the challenges it will bring. Speaking to foreign business leaders at the World Economic Forum, Premier Li Keqiang said arduous efforts would be needed just to maintain stability in growth rates.  The GDP growth target of 5.5 percent for 2022 that Beijing stuck with through the first half of 2022 now seems likely to be shelved, with early reports that leadership has instructed government officials to view 5.5 percent growth as “guidance” instead of a firm target. Voices urging respect for entrepreneurs and an end to “campaign style” regulations are becoming more frequent. Think tank economists are being given more latitude to talk about policy adjustments with foreign counterparts.

These signs point to a revision of official priorities in favor of reform, but it is not clear yet whether a meaningful shift will materialize. Policy messaging remains muddled. There are signs that zero-COVID policies may be softening, though not enough to cheer markets. At its Q2 meeting, the Politburo, China’s top decision-making body, made clear that “political calculations” were paramount in tackling the pandemic and warned against relaxing efforts to stamp out the virus—despite the economic costs. The challenges of steering China back to a market course are gargantuan, but they may be less insurmountable than telling millions of Chinese citizens that low growth is the most they can hope for.

A Congressional Climate Breakthrough

It’s been more than eight months since the US House of Representatives passed a comprehensive package of climate change investments as part of its Build Back Better Act (BBBA), which then stalled in the Senate. Yesterday, Senate Majority Leader Chuck Schumer and Senate Energy and Natural Resources Chair Joe Manchin announced a compromise agreement and a path forward. The new Senate package includes a suite of clean energy tax credits for commercial and emerging clean technologies as well as other key emissions reduction investments.  

In this note, we provide a preliminary assessment of the Senate agreement, the Inflation Reduction Act (IRA) of 2022, and its implications for the US’s 2030 target of reducing emissions by 50-52% below 2005 levels. Last fall, Rhodium Group published Pathways to Paris, a comprehensive assessment of a portfolio of policy actions that can help the US achieve its 2030 target. In that report, we found that joint action consisting of the climate measures in the BBBA, plus additional federal regulations and other activities across all levels of government, can put the 2030 target within reach. In a recent progress update, we found that congressional measures along the lines of what was in the BBBA represent some of the highest potential emission reductions across all components of a joint action scenario.

Our preliminary assessment of the new Senate package in this note is based off of our newly updated emissions projections under current policy in Taking Stock 2022 and is informed by the broad components of congressional action that we considered in Pathways to Paris. Our preliminary estimate is that the IRA can cut US net greenhouse gas emissions down to 31% to 44% below 2005 levels in 2030—with a central estimate of 40% below 2005 levels—compared to 24% to 35% under current policy. The range reflects uncertainty around future fossil fuel prices, economic growth, and technology costs. It will also meaningfully reduce consumer energy costs and bolster US energy security over the medium-term, and it picks up where the Infrastructure Investment and Jobs Act (IIJA) left off in supporting the widespread commercial deployment of emerging clean technologies. While more action across other levels of government will be required to cut emissions by 50-52% below 2005 levels, the Senate package represents an important and historic step forward.

Note: On August 12th after Congress passed the Inflation Reduction Act, we published an updated, in-depth assessment of the final climate and clean energy provisions in the package, available here. 

A long-awaited Senate deal on climate and clean energy investments

Following the passage of the BBBA in the House last fall, all eyes shifted to the Senate, where talks fell apart. Yesterday, Senate Majority Leader Chuck Schumer (D-NY) and Senator Joe Manchin (D-WV) announced a deal that includes important climate and energy security provisions, plus it requires the offering of specific public lands tracts for fossil fuel development for lease, increases royalty rates, and ties future public land access for clean energy to additional fossil fuel lease sales. The array of clean energy tax credits has the greatest impact on emissions. Long-term, full value, flexible clean energy tax credits for new clean generation and retention of existing clean generators are roughly in line with the scenarios we examined in prior research. Long-term tax credits for carbon capture, direct air capture, clean hydrogen and clean fuels provide a launch pad for these key technologies to scale and build on the investments of the IIJA hub and demonstration programs. Federal investments have the potential to generate multi-megaton scale natural carbon removal in soils and forests. Long-term electric vehicle (EV) tax credits will accelerate the diversification of passenger vehicles away from their over-reliance on petroleum, though the EV credits included in this bill are scaled back from previous proposals. Manufacturing tax credits and investments will help diversify supply chains, expand domestic capacity to produce the clean technologies the world needs to achieve deep decarbonization, and can help enable the record levels of wind and solar deployment we project in our modeling.

There are a few notable departures from the House-passed bill, key among them changes to public lands fossil fuel policy. The IRA increases oil and gas royalty and rental rates and increases the minimum bid in onshore lease auctions. It also requires four lease sales by the end of 2022 that were previously included in the 2017-2022 Outer Continental Shelf Oil and Gas Leasing Program, and it implements timing and annual acreage minimums for onshore and offshore oil and gas lease sales as prerequisites for federal renewable leasing and right-of-way issuance. From an emissions perspective, increases in royalty rates put downward pressure on future emissions from oil and gas production. Meanwhile, expanded leasing may put upward pressure on emissions depending on how much private land production (where currently roughly 80% of US oil and gas production occurs) is displaced. At the same time, it’s worth keeping in mind that only a fraction of public land acreage put up for sale actually gets purchased, and only a fraction of sold leases actually get developed. In addition, the minimum acreage requirements—the lesser of 2 million acres or 50% of nominated acreage onshore, 60 million acres offshore—are within historical trends for onshore and offshore lease offerings. We incorporate these provisions into our preliminary estimates of US emission reductions from the package.

Another key change is that direct pay of most tax credits is now only available for government and nonprofit entities such as rural cooperatives, or for a limited time for all actors using select emerging technology and manufacturing tax credits such as the section 45Q tax credit. This is a departure from the BBBA where all market participants could elect for direct pay. However, the IRA also authorizes clean energy project developers to transfer the credits to an unrelated third party that has tax liability and the ability to monetize the credits. Our initial assessment is that transferability may be sufficient to avoid financing bottlenecks that we previously noted could constrain clean energy deployment, though it may have implications for the cost of capital these developers face.

Putting the 2030 climate target within reach

Our preliminary assessment of the IRA is that its policies, including the new leasing provisions, reduce net GHG emissions by 31% to 44% below 2005 levels in 2030 (Figure 1). We model the impacts of the IRA on three core emissions scenarios—high, central, and low—from our newly updated baselines for 2030 US emissions under current policy in Taking Stock 2022. The range in Taking Stock and in our IRA results reflects uncertainty around future fossil fuel prices, economic growth, and technology costs. In the high emissions case, which features cheap fossil fuels and more expensive clean technologies plus faster economic growth, we find that the IRA can accelerate emissions reductions to a 31% cut below 2005 levels in 2030, compared to 24% under current policy (Figure 2). On the flip side, in the low emissions case, with expensive fossil fuels and cheap clean technologies, the IRA can drive even larger reductions, from 35% below 2005 levels under current policy to 44% below 2005 levels with the bill. In the central emissions case, the bill accelerates emissions reductions to 40% below 2005 levels in 2030, compared to 30% under current policy. If Congress passes this package, additional action from executive agencies and subnational actors can put the US’s target of cutting emissions in half by 2030 within reach.

Along with the emissions reduction benefits, the measures in the package appear to have additional benefits. The clean energy investments in the package, combined with improving energy market conditions and technology deployment driven by current policy, can help to reduce household energy costs in the medium-term. These costs—residential electricity bills, bills for home heating fuels like natural gas or fuel oil, and expenditures on transportation fuels like motor gasoline and diesel—decline by $730 to $1,135 in 2030 relative to 2021, driven by a mix of lower fuel prices and electricity rates as well as more efficient energy consumption (Figure 3). The IRA’s contribution to these savings are $16 to $125 per household on average in 2030.

The aggregate impact of the package can also improve US energy security by reducing energy imports and exposure to volatile global fossil fuel prices as well as put the country in a position to better assist allies abroad in providing secure affordable energy. Many of the provisions in the package also help reduce conventional pollutant emissions, which complement programs in the bill explicitly targeted at reducing these pollutants and assisting communities facing unequal environmental effects.

We plan to take a deeper dive into these benefits in future work, as well as continue to refine our modeling of the emissions and energy system outcomes. In the meantime, put simply, the Inflation Reduction Act has the potential to be the biggest climate action ever taken by Congress. However, 2030 is not too far off on the horizon. Swift action in Congress to enact the package, along with additional accelerated action across all levels of government, can help put the US that much closer to its 2030 target of cutting emissions in half.

Note: On August 12th after Congress passed the Inflation Reduction Act, we published an updated, in-depth assessment of the final climate and clean energy provisions in the package, available here. 

For more information on our analytical approach, see the Technical Appendix of Taking Stock 2022, linked below. 

A Turning Point for US Climate Progress: In-Depth Assessment of the Inflation Reduction Act (August 12, 2022)A Turning Point for US Climate Progress: In-Depth Assessment of the Inflation Reduction Act (August 12, 2022) Related: Taking Stock 2022Related: Taking Stock 2022

Has the Supreme Court Blocked the Path to the 2030 Climate Target?

Yesterday, in a 6-to-3 decision in West Virginia v. Environmental Protection Agency (EPA), the Supreme Court ruled that EPA does not have the authority under the Clean Air Act to regulate carbon emissions from the power sector through a system-wide mandate to shift from coal-fired power generation toward cleaner sources. The ruling constrains one of the most powerful regulatory tools from the executive branch’s toolbox of regulations to help reduce US greenhouse gas (GHG) emissions. In light of the decision and amid stalled climate action in Congress, many are now questioning what climate policy options are still left on the table, and whether the US still has the ability to achieve its 2030 climate target of reducing emissions by 50-52% below 2005 levels.

We find that the Supreme Court’s ruling does not change the game by much. Last fall, Rhodium Group published Pathways to Paris, a comprehensive assessment of a portfolio of federal legislation, regulations, and other actions across all levels of government, which together could put the 2030 target within reach. In this note, we revisit that list of actions and assess the implications of the Supreme Court ruling for the pathway to the 2030 climate target. We find that while the ruling certainly makes the pathway rockier, it hasn’t necessarily put the target out of reach. The silver lining of the ruling is that it has cleared up ambiguities that have plagued power sector GHG emissions regulations for a decade. Going forward, EPA may have more legal certainty and can still leverage other regulatory tools that could drive significant emissions cuts in the power sector and other sectors. However, EPA needs to move fast in order to help achieve the target. Without swift progress on all fronts—including in Congress and across other levels of government—the 2030 target is in jeopardy.

What West Virginia v. EPA does and doesn’t do

The Supreme Court’s 6-3 decision in West Virginia v. EPA rules that EPA does not have the authority under section 111(d) of the Clean Air Act to regulate emissions from the power sector at a system-wide level. While the ruling certainly limits regulatory pathways to reducing emissions and removes one of the more efficient and low-cost regulatory options, the decision was also not the worst-case scenario for EPA’s ability to regulate emissions that many had feared. The ruling does not entirely revoke EPA’s authority to regulate greenhouse gas emissions, nor does it state that EPA can’t regulate GHG emissions from power plants. EPA still has the authority to regulate emissions at the point source or individual power plant level—what’s often referred to as “inside the fence line” of the facility, as opposed to “outside the fence line” or a systems-based approach, which is now off-limits under the ruling.

One consolation from the ruling is that it potentially clears up legal ambiguities that have plagued power sector emissions regulations for a decade. EPA may have more certainty about the rules of the regulatory road and how to regulate emissions from point sources. The Supreme Court made it clear that if EPA wants to regulate emissions from point sources, it can only consider emissions-control measures at the source. This is the same approach that EPA has used for an array of other pollutants over the 50+ year history of the Clean Air Act. Indeed, it’s the same approach EPA has used in setting GHG standards for new power plants as well as one of the three building blocks in the Obama EPA’s Clean Power Plan. While the ruling means that some regulatory options are now off-limits, it also means that EPA now knows that it can leverage existing emissions-control technologies to drive significant emissions cuts in the power sector, such as carbon capture and fuel blending. Some of these options may cost more than a system-wide approach and may result in fewer co-benefits like reduced local air pollution, but all of that will depend on how EPA ultimately chooses to exercise its clarified authority and what other conventional pollutant regulations it pursues.

What the ruling means for the 2030 climate target

In light of the ruling, and especially as federal climate legislation is currently stalled in Congress, many are now questioning what regulatory options and other climate policy options are still left on the table, and whether the US still has the ability to achieve its 2030 climate target of reducing emissions by 50-52% below 2005 levels.

In order to answer those questions, we revisit Pathways to Paris, a comprehensive assessment of a portfolio of policy actions that the US could take to put the 2030 climate target within reach, which we published last fall. We found that without any new climate action, the US is not on track to meet its 2030 target of reducing emissions 50-52% below 2005 levels (Figure 1). With no additional action, at best emissions get halfway to the target—25% below 2005 levels in 2030—but could be as high as 17% below 2005 levels (reflecting the uncertainty around energy prices, technology costs, and carbon removal from natural and working lands). This leaves an emissions gap of 1.7-2.3 billion metric tons between current policy and the 2030 target. To fill that gap, we developed a “joint action” scenario— congressional passage of the Infrastructure Investment and Jobs Act and the now-stalled Build Back Better Act, alongside regulations and other executive branch actions and supplemented with subnational action in climate-leader states. All together, this scenario would achieve an emissions reduction of 45-51% below 2005 levels—putting the 2030 target of a 50-52% reduction within reach.

Two weeks ago, we published a progress update on the measures we considered in the joint action scenario. We found that while some movement has occurred on some fronts, most big-ticket items, including major federal regulations like power plant carbon rules and legislation in Congress, have yet to get started or are still under deliberation (Table 1 below).

On the question of the implications of the Supreme Court ruling on that list of measures—when we constructed our joint action scenario, we modeled three actions by the executive branch that rely on section 111 of the Clean Air Act to cut emissions. These are (highlighted in red in Table 1):

  • New and existing source performance standards on CO2 for electric power plants (no current progress)
  • New and existing source performance standards on CO2 from select large and fast-growing industrial sources (no current progress)
  • New and existing source performance standards on methane from oil & gas wells (some progress)

While the West Virginia v. EPA ruling pertained to power plants, the decision applies to all three of the above components of our joint action scenario. However, when we constructed the joint action scenario, we only considered “inside the fence line” controls for methane from oil & gas wells and CO2 from the industrial sources—meaning that the actions we modeled fit within the new legal constraints under the ruling. The Supreme Court affirmed EPA’s authority to regulate these sources and clarified that the approaches already used in EPA’s proposed methane rules and the approach we contemplated for the industrial regulations are legal.

For power plants, we considered an “outside the fence line” standard, which the ruling clearly deems illegal. However, there is no reason why EPA can’t craft new regulations on existing fossil fuel fired power plants using an “inside the fence line” approach that attempts to reach a similar level of ambition as we contemplated in our joint action scenario. Even if they pursue less ambitious GHG standards, they can also pursue more stringent conventional pollutant standards, with a combined impact that is in line with what we modeled previously.

This is the silver lining in the West Virginia v. EPA cloud, because these three measures are some of the highest-impact actions that we assessed in Pathways to Paris. We found that the power plant regulations (combined with subnational actions) could achieve more than 250 million tons of reductions in 2030, while the industrial source and oil & gas well regulations could each achieve 100-250 million tons. It also means that the Supreme Court’s decision in and of itself is unlikely to limit the potential ambition of future EPA regulations, and that it won’t solely jeopardize the US’s ability to achieve the 2030 climate target.

That being said, any action that constrains the ability of the US to tackle climate change is not good. In this instance, EPA now has a narrower set of technologies and actions it can consider when regulating GHGs from existing power plants and other stationary sources. “Inside the fence line” control technologies on which EPA has previously relied in the power sector only go so far, so EPA must go beyond heat rate improvements and the like to truly move the needle on emissions. EPA has less experience with some new control technologies, such as carbon capture or hydrogen blending, and these technologies are more expensive than a more cost-effective “outside the fence line” approach. Some new control technologies may also require additional build-out of infrastructure that have their own costs and may take time to deploy. These factors may add up to bigger political challenges around the total cost of regulations and may face opposition from some stakeholders who have traditionally opposed certain control technologies like carbon capture.

Without swift action, the 2030 climate target is in jeopardy

The West Virginia v. EPA ruling by itself doesn’t put the US’s 2030 climate target in jeopardy, but the pathway to the target certainly isn’t guaranteed. As we wrote in our mid-June progress update, it’s clear that there needs to be swift progress on all fronts of government if the US is going to get on track to achieving the target. This means that Congress, the Biden administration, and states all need to accelerate progress this year towards closing the emissions gap. If any front fails to act, it will be increasingly difficult to see a reasonable path to the 2030 climate target.

While the ruling constrains a powerful regulatory tool, EPA and the executive branch still have other options in their toolbox, ones that now may have more legal certainty. But they need to get moving fast if they’re going to play their part in achieving the target. New regulations proposed this year have a good chance of being finalized outside the Congressional Review Act window, limiting the power of potential future anti-climate presidents and congresses. In addition, it takes time, often more than a year, for rules to be finalized, take effect, and be fully implemented. Given that 2030 is less than eight years away, the sooner that regulations are finalized, the sooner they can have an impact on reducing emissions.


Pathways to Paris: A Policy Assessment of the US 2030 Climate Target, published October 2021

Progress on the Pathway to Paris?, published June 2022

Progress on the Pathway to Paris?

It’s been nearly a year and a half since President Biden entered office and made addressing climate change one of his administration’s top priorities. Pledging to take a whole-of-government approach to the problem, Biden built out a climate team inside the White House and promptly set an ambitious target to reduce US greenhouse gas (GHG) emissions to 50-52% below 2005 levels by 2030. Congress also prioritized addressing climate change, first with key infrastructure investments and then with the House of Representatives passing over $500 billion in climate and clean energy spending through budget reconciliation. In addition, 24 states have adopted the same 2030 target or have comparable targets in place.

Last fall, Rhodium Group published Pathways to Paris, a comprehensive assessment of a portfolio of policy actions that the US can take to put the 2030 climate target within reach. In that report, we found that no single action taken by any single part of the US federal system is sufficient. Instead, joint action consisting of a steady stream of legislation, regulations, and other activities across all levels of government can put the 2030 target within reach. In this note, we revisit the list of actions we considered and assess progress on each. We find that while some movement has occurred on some fronts, most big-ticket items have yet to get started or are still under deliberation in Congress. Without ramped-up action across the board in the very near future, it will be increasingly difficult to envision a pathway to the 2030 target.

Nearly 18 months of a whole-of-government approach to climate change

When President Biden entered office, he made climate change a top priority, more so than any other president before him. Coming after the Trump administration’s systematic dismantling of climate and clean energy initiatives, the Biden administration has taken hundreds of actions to undo the damage and reverse regulatory rollbacks. The high-caliber appointments of Gina McCarthy and John Kerry as the first-ever National Climate Advisor and Special Presidential Envoy for Climate, respectively, sent a strong signal that the President was taking the climate challenge seriously. With unified government, there was hope of ambitious and swift congressional action on investments in decarbonization.

Now, nearly 18 months in, the administration has set ambitious goals on everything from offshore wind deployment to ramping up electric vehicle sales, cutting global methane emissions, and achieving a 100% clean electricity grid. Regulatory actions to rein in greenhouse gasses are moving forward in a few key sectors. Congress passed the Infrastructure Investment and Jobs Act (IIJA) which contained several multi-billion dollar investments in emerging clean technologies and clean infrastructure. The administration has also taken key steps to help achieve long-term decarbonization goals, including standing up a Buy Clean Task Force to use the federal government’s purchasing power to help clean up heavy industry, and committing the federal government to increased sustainability targets. Critically, the administration has emphasized environmental justice across agencies and started initiatives to address disproportionate climate and environmental impacts in disadvantaged communities.

Subnational actions also have the potential to accelerate and amplify emission reductions catalyzed by federal actions and, in some instances, deliver tons that the federal government can’t easily reach. States have kept a steady drumbeat setting ambitious climate targets to help do their part to achieve climate targets, especially during the federal inaction of the Trump administration. And we’ve seen several states step up climate action in key sectors in recent months as well.

However, at the same time, the $555 billion in climate spending in the Build Back Better Act (BBBA) that passed the House in November remains in Senate deliberation limbo. Congress, states and the White House aren’t tackling climate change in a vacuum but instead are dealing with a host of other challenges. The country is in the midst of the ongoing pandemic, once-in-a-generation inflation, sky-high energy prices, a war in Europe, and ongoing supply chain disruptions—all of which at best distract from additional climate action and at worst may lead to actions that could run counter to long-term climate goals.

In Pathways to Paris, we found that without any new climate action, the US is not on track to meet its 2030 target of reducing emissions 50-52% below 2005 levels. With no additional action, emissions stay roughly flat, getting to 17-25% below 2005 levels in 2030 (reflecting the uncertainty around energy prices, technology costs, and carbon removal from natural and working lands). This leaves an emissions gap of 1.7-2.3 billion metric tons between current policy and the 2030 target. To fill that gap, we developed a “joint action” scenario— congressional passage of the IIJA and BBBA, alongside regulations and other executive branch actions and supplemented with subnational action in climate-leader states. All together, this scenario would achieve an emission reduction of 45-51% below 2005 levels—putting the 2030 target of a 50-52% reduction within reach.

Following through on the joint action scenario does more than get the US in line with its 2030 climate commitment. It also can lead to dramatic cuts in conventional air pollutants from electric power plants and to improvements in public health. A cleaner US energy system can also save the average American household roughly $500/year in energy costs in 2030. Finally, the joint action scenario bolsters energy security for the US and its allies around the world, with oil and liquified natural gas exports increasing by up to 29% and 15%, respectively.

Taking stock of current policy progress

How does the current level of US policy action as of mid-June 2022 compare to what we contemplated in our joint action scenario? Table 1 below breaks down the key components of the joint action scenario. We’ve consolidated some actions for simplicity and in line with how they may work in tandem during implementation. Overlap is a natural consequence of our federal system. For example, ramped-up state clean energy standard targets and federal regulations on GHG emissions from new and existing power plants overlap in both targeting emission reductions from the power sector. But this overlap is a feature, not a bug, as a suite of policies targeting emissions from the same sector can provide important insurance against the sorts of policy risks we discussed in our Pathways to Paris report, including unfavorable judicial review and other implementation challenges. Overlapping policies are also sometimes greater than the sum of their parts, both in terms of overall effectiveness and consumer costs.

In Table 1, we’ve marked actions by estimates of the magnitude of emission reductions to help give a sense of which actions contribute more than others to meeting the 2030 climate target. Due to interactive effects between actions, the emissions estimates in Table 1 are not additive, but they give a sense of relative impact on closing the emissions gap. We’ve also marked them by their current status. Some policies are in the implementation phase, while others are in legislative limbo or have seen no action at all. In a third tranche of actions, we have seen some progress, ranging from modest preliminary steps to published regulatory proposals, but in all cases additional progress is required to achieve the reductions we included in our joint action scenario. For more details on components of the joint action scenario, please refer to the Pathways to Paris full report and the technical appendix.

In implementation:

A review of the status of all the building blocks of the joint action scenario reveals that there are several actions in the implementation phase, though nearly all of these have a small impact (less than 10 million metric tons of CO2-e each) on US emissions in 2030. These actions are all associated with the IIJA and focus on carbon capture demonstrations, orphan mine and well remediation, energy efficiency in buildings, supporting existing nuclear plants through 2026, and electric vehicle charging infrastructure. All of these investments are important for solving climate change, but they have a small impact on 2030 emissions for a variety of reasons. Some programs expire well before 2030, such as nuclear support. Some investments, such as those in building efficiency, aren’t large enough to substantively move the emissions needle—though they often provide other important co-benefits beyond near-term emissions reductions. Finally, investments in early-stage deployment of emerging clean technologies help reduce the cost of these critical technologies. It takes time for these technologies to get to commercial scale, so they don’t deliver a lot of tons by 2030. However, they do create more opportunities for deeper decarbonization in the long run.

In progress:

There are important actions that are in the proposal stage where the regulator, usually the Environmental Protection Agency (EPA) or Department of Energy (DOE) has proposed a regulation and is seeking comment before finalizing. Within the “in progress” category, one of the most important proposals from an emissions impact perspective is the regulations on methane emissions from the oil and gas sector. Some appliance standards and standards on medium-duty and heavy-duty vehicles (MDVs and HDVs) are also in the proposal stage but have a smaller impact.

Several other policies are earlier in the adoption process. EPA has published a white paper supporting regulations on CO2 from power plants but may be waiting on the pending Supreme Court decision in West Virginia vs. EPA, expected later this month, to provide some clarity on how EPA can use the Clean Air Act to regulate existing stationary sources of CO2. Likewise, small actions in a handful of states have occurred that can help the US make progress, but these actions are not widespread enough to reach parity with what we considered in our joint action scenario. Indeed, a few states have adopted ramped-up clean electric targets and clean vehicle standards, but not to the extent we modeled in Pathways to Paris.

Uncertain/no action:

Some of the actions with the largest potential impact on 2030 emissions either have an uncertain fate or there has been no action at all to date. For example, the climate investments contained in the BBBA have been in legislative limbo for months and, despite ongoing rumors that a deal may be possible, there is no clarity on the fate of the package or something like it at the time of publication. Meanwhile, EPA has taken no action on regulating CO2 from new and existing industrial sources. We also have seen no action from the Commodities Credit Corporation to procure multi-megaton-scale carbon removal from investments in natural and working lands. In addition, no states have acted on agricultural emissions, something that could add up to 50-100 million tons of reduced emissions if all leadership states were to take them on promptly.

The clock is ticking

It’s clear that a lot more needs to happen if the US is going to get on track to achieving the 2030 climate target. New regulations proposed this year have a good chance of being finalized outside the Congressional Review Act window, limiting the power of potential future anti-climate presidents and congresses. In addition, it takes time, often more than a year, for rules to be finalized, take effect, and be fully implemented. Given that 2030 is less than eight years away, the sooner policies are finalized, the sooner they can have an impact on reducing emissions.

Action this year on multiple fronts by Congress, the Biden administration, and states are needed to accelerate progress towards closing the emissions gap. Without action, it will be increasingly difficult to see a reasonable path to the 2030 climate target.


Pathways to Paris: A Policy Assessment of the 2030 US Climate Target, published October 2021

Has the Supreme Court Blocked the Path to the 2030 Climate Target?, published July 2022 after the West Virginia v. EPA ruling

Rethinking China’s Economic Future

China’s economy is clearly contracting sharply under the weight of “zero COVID” policies, even though Q1 GDP growth beat expectations and April data showed only a modest decline in industrial output. Consensus expectations have not fully factored in the degree to which China’s economy is weakening this year, or the probability that slower growth will extend into future years. As the gap between this economic reality and rosier expectations closes in the months ahead, we are likely to see significant downgrades to consensus views on global inflation, commodity demand, future carbon emissions, and both direct and portfolio investments in China.

The Direction of Travel is Clear

The events of the past few months in China’s economy have been difficult to comprehend, even for experienced analysts.  The years that are supposed to be politically “stable” in China—the Olympic year of 2008, the political transition of 2012, this year—always carry some turbulence, but 2022 represents a watershed in questioning long-held perceptions of China’s technocratic competence and capacity. We are seeing China’s leadership abandon long-term economic and political objectives for transitory, politically motivated gains against an indefatigable foe—the Omicron variant of COVID-19.  More than the futility of the exercise, it is the inflexible commitment to sustaining the attempt, despite its dramatic consequences, that is generating a new wave of concerns about China’s economic future, and its position within the global economy. Financial markets have reacted accordingly, selling Chinese assets in large volumes, while corporates reassess the importance of China within their global strategies.

Today, even Premier Li Keqiang was forced to observe that economic “difficulties in some aspects and to a certain extent are greater” than in the epidemic’s first phase in 2020, while urging cadres to keep economic growth in positive territory in Q2. The recent data releases—both official and unofficial—unequivocally point to a contracting economy, possibly by larger margins than in Q1 2020, when GDP contracted by 10.3% q/q within the official data. Goldman Sachs just revised their own expectations of Q2 q/q growth to -7.5% annualized; UBS and JP Morgan made similar adjustments on Tuesday. It goes without saying that China’s 5.5% real GDP growth target this year is impossible to meet—in fact, we doubt we will hear Chinese officials mention the target for the remainder of the year. Our views on China’s growth rate in 2022 are clear—we are headed for very low growth this year, at the most 2% if there is a dramatic rebound in the second half, and a recession or economic contraction for the full year is becoming increasingly probable.

Freight and passenger traffic volumes nationwide have fallen by around 39 percent y/y in China in May as a result of lockdowns and COVID restrictions, based on Gaode data. Official industrial value-added fell by 2.9% in April, and will likely decline by similar margins in May.  Property sales officially fell by 39% y/y in April, car sales declined by 47.6%, and excavator sales fell by 61%. Consumption is falling sharply as a result of COVID restrictions, with headline retail sales down 11.1% in April and even online sales from Alibaba’s Taobao and Tmall (undoubtedly hurt by delivery problems) are down 25.6% y/y. These are not small declines—they reflect a massive disruption to the regular operations of China’s economy, and they have continued in May from the declines in April.

Nor is there much evidence that policy support is starting to right the ship.  China’s policy support has emphasized infrastructure construction, but this activity is being limited by lockdowns and restrictions just like other sectors. The evidence can be seen in continued drops in production for raw inputs: asphalt output has declined 33.6% so far this year, cement production fell by 18.9% in April, and capacity utilization rates for unsaturated polyester resin (UPR), a key polymer in building materials, are down 42% in April and 65% so far in May.

Yet despite this economic carnage, forecasts of China’s growth in 2022, and beyond, have barely adjusted. After the release of Q1 GDP data, which put growth at 4.8% (well above the consensus view of 4.4%), analysts counterintuitively rushed to downgrade their full-year forecasts. The current Bloomberg consensus forecast (Figure 1), even after the release of the April data pointing to an economic contraction and some of the recent downgrades already discussed, is for a 0.2% q/q growth rate in Q2, still in positive territory, and for 4.7% GDP growth for the full year.  The forecast for y/y growth in Q2 is 3.3%, only a moderate slowdown from 4.8% growth in Q1.

There are some reasonable arguments why growth might only slow modestly, particularly if China abandons its COVID restrictions altogether and provides significant cuts in interest rates and stimulus to the property sector.  But this path seems highly unlikely. Restrictions are more likely to lift gradually and in response to local government subterfuge rather than central government diktat.  The property sector is going to remain a significant drag on investment growth this year, and recent zero COVID measures have added to the sector’s woes. It is difficult to understand what sector will actually grow at all this year, given the dramatic disruptions that zero COVID policies have created for the economy.

The direction of travel is clear, even if the magnitude of adjustment is not.  Companies, investors, and governments should be thinking about far slower Chinese economic growth, both in 2022 and in the future.  Consensus expectations have not yet adjusted meaningfully—in part because of China’s excessively rosy economic data—but they will.

Telling the Truth is Dangerous

We described all of the pressures created by Beijing’s political reliance upon high and stable GDP growth rates in our 2019 note, “China’s GDP: The Costs of Omerta”. The code of silence among most sell-side institutions and global policymakers regarding the quality of China’s GDP data has consistently created false assumptions about China’s growth and the potential for policy mistakes in response to mistaken economic signals. The costs of refusing to engage with economic reality are rising because even onshore market analysts are reluctant to publish any bad news or negative forecasts.  The key point is that consensus expectations as we are now seeing them—0.2% q/q growth in Q2, 4.7% full-year growth (according to Bloomberg’s survey)—are still wildly unrealistic, a fact that is acknowledged but unstated publicly by most forecasters.  And when those expectations adjust, the scale of the downgrades to China’s expected growth could be large.

The reality of China’s economic distress has been clearly revealed in onshore and offshore equity markets, which have fallen to the lowest levels since the start of the pandemic. Naturally, this has generated considerable risk aversion within China’s financial markets.  But actually talking about the woes of the equity market and the state of the economy has caused several mainland investors and commentators to seemingly have their social media access restricted in response, and some may have actually lost their jobs.  In this climate, we should not expect significant downgrades of growth expectations from any analyst servicing mainland clients.

Even sell-side firms have been cautious.  There is always pressure to remain within consensus, and an awareness that consensus on Chinese growth will remain heavily dependent upon Beijing’s official GDP growth target, unrealistic as it may be. Hence, even those that are downgrading Q2 GDP growth aggressively are seemingly cautious about how that will implicate full-year 2022 GDP growth rates, which may explain the more limited adjustments to full-year forecasts.  If one assumes Beijing will continue to publish stable growth rates regardless of how the real economy performs, it makes little sense to go out on a limb with a sharp downgrade of GDP growth forecasts.

The Long-Term Constraints on China’s Growth

More problematic for Beijing is the fact that even after lockdowns ease, the economy is unlikely to spring back to the rates of growth seen before the pandemic.  Lockdowns and restrictions on movement of citizens generate immediate economic costs—to production, consumption, services sector activity, employment, incomes, and in other areas as well.  But even before the wave of new lockdowns was imposed, China’s economy was suffering considerably from the weakening property industry, a sector that represents around 25% of GDP.

Every cyclical recovery in China’s recent history has been led by either the property sector or local government spending.  Beijing is trying to prop up infrastructure investment right now, but these efforts are useless as long as lockdowns and restrictions remain in place, preventing construction projects from launching.  Credit growth to drive new investment is slowing, rather than accelerating, driving the PBOC this week to issue yet another set of instructions for banks to boost lending.  And even if infrastructure investment picks up, this will only put a floor under activity, as it cannot compensate for the weakness in the property sector.

Over a longer horizon, China’s growth outlook is constrained by demographics, falling productivity, and more significantly, the failed structural reforms of the past decade.  Our China Practice head Dan Rosen highlighted these dynamics in much more detail in a recent piece in Foreign Affairs.  China’s potential growth rate at present is probably closer to 3% than 5%, and China is currently growing well below that potential rate. With the property market and the financial system in distress, it may take several years to close that output gap, even if policy is more supportive.  Yet the current consensus expectations for GDP growth are 5.2% in 2023 and 5.1% in 2024.

There is a reasonable argument that economic conditions will improve due to a boom in pent-up demand in the months ahead, with April and May representing the worst months of lockdown-induced stress. High-frequency indicators of passenger and freight traffic are showing some modest improvements in late May, and the mere fact of passing the worst moment may even be sufficient to drive a rally in China-linked risk assets.  But the uncertainty about the future, and the potential for additional lockdowns, are likely to keep a ceiling on any rebound in new investment by foreign firms or Chinese private sector firms.  These types of disruptions to supply chains will take months to resolve, and the longer-term impact of lockdowns on employment, incomes, and consumption is likely to persist as well.

The Stakes: Implications of Downgrading China’s Economic Future

Once consensus expectations for China’s medium-term growth adjust meaningfully, this will have significant implications for several important global economic trends.

Commodity demand. One of the obvious transmission channels from slower growth in China into the global economy will be weaker demand—and probably lower long-term prices—for imported commodities, particularly those associated with construction activity, including iron ore, copper, aluminum and other base metals, and some refined petroleum products.  The direct impact on China’s crude oil demand will probably only emerge over time, tied to overall trends in China’s energy consumption, since China also re-exports significant volumes of its refined product output. There can be some offsets to weaker demand and changes in development plans for individual commodities, and in some cases, lower commodity prices can actually incentivize lower-cost imports relative to higher-cost domestic production in China.  But the probable implication of much slower growth will be a downgrade of China’s commodity imports in the coming years.

Global inflationary pressures. In the short-term, disruptions to China’s supply chains and outbound shipments are inflationary, as scarcities of key components will dominate.  After that, in around six to nine months, rising corporate inventories of finished goods may create downward pressure on prices. As companies struggle to sell into flagging domestic markets, they may look to sell overseas, at lower prices (factoring in the recent weakness of China’s currency).

These lower Chinese import prices may not have much of a direct impact on global inflation in the short term, particularly given all of the other inflationary forces and geopolitical factors driving prices higher.  But the reassessment of China’s growth and downgrades from this year’s expectations of 4.7% have probably not yet been incorporated into global inflation and growth forecasts. If central banks underestimate the disinflationary pressures coming from a slower-growing China, expectations of the monetary tightening and interest rate hikes that are necessary should moderate.

Similar surprises have happened before. In 2014 and 2015, when China’s economy disappointed due to a flagging property sector while headline GDP growth remained stable at rates above 7%, emerging market central banks suddenly became far more dovish than expected. This was because the Chinese economy produced disinflationary surprises that spilled over into other markets even though headline growth in China was unchanged. The effect was pronounced in commodity prices (Bank Indonesia’s turnabout from hiking rates in November 2014 to cutting them in February 2015 is just one example).  As expectations of China’s growth adjust, the same effect is plausible on a global scale, and central banks may look toward less severe tightening paths relative to current expectations.

Carbon emissions. Hundreds of billions of dollars are being invested now for a future of low-carbon energy production, requiring planning for mining of critical metals and raw materials. But all of these investments are likely based on current expectations of China’s own growth in energy demand and carbon emissions, which may simply fail to materialize.  A change in the economic trajectory of the world’s largest emitter—at an estimated 14.1 billion tons CO2 equivalent in 2019—is bound to have an impact on global emissions projections. China’s industrial output has been heavily leveraged to property construction, and that sector alone is likely to see construction activity cut in half or more over the next decade.

But China’s own growth targets are set politically, and are likely to be disconnected from actual emissions levels on the ground. This can lead to significant policy mistakes around China’s energy mix as well, as the most important signals to China’s energy bureaucracy this year have been to avoid power disruptions such as those seen in September and October 2021. This has required China to double down on coal output, even though there are likely to be far smaller chances of a power shortage during a year in which China’s economy is slowing so significantly.  But overall, slower Chinese GDP growth in the years ahead is almost certain to alter the medium-term trajectory of global carbon emissions as well.

Portfolio investments. Global investment portfolios have been dramatically underweight Chinese equities and bonds for years—and for good reason, because China’s financial markets had not undertaken sufficient reforms to provide confidence that investors could generate returns and reallocate funds out of China when they chose to do so.  During the pandemic, portfolio investments into Chinese markets increased dramatically (Figure 3), as China appeared more stable than the rest of the world, investor-friendly reforms continued to advance incrementally, Chinese yields rose far higher than those in developed markets, and more global equity and bond indices started to include Chinese securities, providing investors more confidence in inbound portfolio investments.

The future of China’s position within the global financial system is now far less certain than at any point in the last two decades.  Capital outflows have been building throughout the past four months, not only because of weaker Chinese growth, but because of newfound political risks attached to investments in Chinese securities, including China’s political alignment with Russia and Beijing’s zero-COVID crusade.  Damage to China’s policy credibility is not easily repaired, and can severely weaken long-term portfolio inflows, along with the prospects of China playing a more important role within the global financial system.

Every time China has faced similar challenges maintaining investors’ attention, there have been concerted efforts from technocrats to reach out to the financial sector and signal some restart of reforms and opening—the 2020 liberalizations on foreign equity restrictions in key financial market segments are just one example.  A renewed emphasis on stability in market regulations and relaxations of capital controls may help to stabilize medium-term passive bond market inflows in the coming years, as Chinese yields are likely to decline in the medium-term if growth slows.

Foreign direct investment. US foreign investment in China has averaged about $13 billion over the past decade, while investment from the EU-27 and United Kingdom has averaged roughly $9 billion over the period. Much of this investment was predicated on expectations of long-term growth in Chinese domestic demand. This is now in question. An April survey by the European Chamber of Commerce in China found that 23% of surveyed European companies, the highest share in the past decade, are considering shifting current or planned investments in China to other markets. A significant downgrade of China’s growth expectations could accelerate the debate over diversifying supply chains, particularly as the risk premium in China grows.

There are other consequences to slower Chinese growth which merit discussion. What is clear, however, is that expectations for a 4.7% expansion of China’s economy this year are untenable, and will need to be adjusted soon given the disruptions to the economy caused by the property market downturn and zero COVID policies.  The direction of the adjustment is clear—the only questions are how much growth needs to be downgraded and how long the weakness will persist. If the credibility of Chinese data and policy responses suffers in this process, the rerating of growth prospects will become deeper. Beijing will struggle to maintain its narrative of economic stability as these unprecedented pressures grow.

China Pathfinder: Q1 2022 Update

China Pathfinder is a multi-year initiative from the Atlantic Council’s GeoEconomics Center and Rhodium Group to measure China’s system relative to advanced market economies in six areas: financial system development, market competition, modern innovation system, trade openness, direct investment openness, and portfolio investment openness. To explore our inaugural data visualization and read our annual report and updates, please visit the China Pathfinder site.

China’s leaders spent the first months of 2022 in damage-control mode, as a host of economic problems and new pandemic-related challenges piled up. With the entire city of Shanghai under a zero-COVID lockdown, the crackdown on technology firms ongoing,  and the property sector deteriorating, good economic news was scarce. The lockdowns alone—not considering the less dire zero-COVID measures—have affected more than 25 percent of China’s population, hitting consumption and manufacturing across the country and triggering a broad public outcry. On the geopolitical front, Beijing’s ambiguous positioning on Russia’s invasion of Ukraine raised the prospect of secondary sanctions, amplifying the risk calculations for foreign businesses in China. Foreign capital, meanwhile, has been flowing out of China amid a mounting debate about whether the country is becoming “uninvestable.” With the 20th Communist Party Congress scheduled for November, China’s leadership will be firmly focused on ensuring stability and growth this year, pushing reform down its list of priorities.

Quarterly Assessment and Outlook

The Bottom Line: In the first quarter of 2022, Chinese authorities were active in three of the six economic clusters that make up the China Pathfinder analytical framework: financial system development, competition policy, and portfolio investment openness. There were fewer developments in the innovation, trade, and direct investment clusters. In assessing whether China’s economic system moved toward or away from market economy norms in this quarter, our analysis shows a distinctly negative shift.

Figure 1 reflects the direction of China’s policy activity in the domestic financial system, market competition, and innovation system, as well as policies that impact trade, direct investment, and portfolio investment openness. This heatmap is derived from in-house policy tracking that weighs and evaluates the impact of Chinese policies in Q1. Actions are evaluated based on their systemic importance to China’s development path toward or away from market economy norms. The assessment of a policy’s importance incorporates top-level political signaling with regard to the government’s priorities, the authority of the issuing and implementing bodies in the Chinese government hierarchy, and the impact of the policy on China’s economy.

A Look at Q1 Trendlines

State intervention to shape market outcomes and boost growth defined policymaking in Q1 2022. In March, China’s leaders met for the so-called “Two Sessions”—important annual meetings where policy priorities are set for the coming year. The Government Work Report for 2022 sent conflicting signals: an aggressive target for gross domestic product (GDP) growth of “around 5.5 percent,” but only modest measures to support this target. The Chinese government insists that growth must be strong this year, but the prospect of delivering on this aim is fading with COVID lockdowns impacting the most important cities in the nation, and household demand and factory supplies curtailed.

Financial System

Beijing backpedals on holding real estate developers accountable but increases controls on how capital is allocated. Financial system policy centered on at-risk real estate firms this quarter. Overall, Beijing is not providing significant concrete support for property developers, but is using heavy-handed interventions to try to prevent a credit crunch in the sector. The People’s Bank of China (PBOC) and China Banking and Insurance Regulatory Commission (CBIRC) encouraged Chinese asset management companies (AMCs), such as China Huarong Asset Management Co., to support troubled real estate developers by absorbing bad loans and taking over suspended projects. The PBOC issued window guidance (an unofficial method to align banks with the government’s lending growth targets) to prevent banks from calling in their property developer loans.

The 2022 Government Work Report stated that the PBOC, CBIRC, and Ministry of Finance may take financial stability promotion to new heights by raising several hundred billion renminbi (RMB) for a fund to bail out financial institutions. These policies exacerbate the moral hazard in China’s real estate sector in numerous ways: they encourage AMCs to engage in transactions with risky developers that are unlikely to be profitable; incentivize large developers to add leverage; and ensure limited liability from high-risk lending practices. The property mess has been a long time coming, but this year, temporary fixes will take precedence over meaningful steps to tackle problems in the sector because political priorities come first.

Elsewhere in the financial system, CBIRC announced it would set up a “traffic light” system for investment. Though the announcement was light on details (beyond promising to strengthen oversight of high-leverage and monopolistic behavior), related government messaging provides additional context. This marks the latest step in the government’s campaign on capital expansion in select sectors or, as the People’s Daily described it, the “disorderly expansion and barbaric growth of capital.” In the same piece, the People’s Daily said the goal of managing capital was to “guide and urge companies to obey the party’s leadership.” Investors are unlikely to welcome another attempt by the government to tell them where they should put their money. Certainly, Beijing’s tolerance for over-investment in property does not inspire confidence.

Market Competition

The tech crackdown, which accelerated in the summer of 2021, continued in Q1 2022 with the state’s increased scrutiny on China’s innovative industries (Figure 2). The Cyberspace Administration of China (CAC), which has emerged as a super-regulator over the course of the crackdown, summoned various tech chief executive officers (CEOs) in January to lecture them on the importance of following state guidance. According to the CAC, CEOs raved about the session and agreed to be more cognizant of their social responsibility. An example of the growing influence of regulators in the business decisions of private companies was Tencent’s announcement in Q1 2022 that it would reorganize its film unit to produce more patriotic content instead of Hollywood blockbusters. Companies are increasingly unsure about how to follow Beijing’s ideological guidance while simultaneously achieving market-driven results.

The CAC also began implementing new regulations that steer enterprises toward using algorithms to “promote socialist core values,” increase the spread of “positive energy,” and effectively deal with “illegal and bad information.” How to deal with algorithms and their pervasive influence on social discourse is an ongoing conversation worldwide. In the Chinese context, however, this new wave of regulation coincides with the tech crackdown and tightening state control over how firms and individuals share information.

The only development in the tech regulatory space that can be seen as a bright spot was on the data front: the Ministry of Industry and Information Technology (MIIT) revised draft rules issued in Q4 2021 on corporate data security, removing an outright ban on exporting “core data.” While the regulations still leave the government in control of data rules, the revision points to a less restrictive approach. Even so, the real impact will depend on how the regulations are implemented.

China’s small and medium-sized enterprises (SMEs), chronically starved for capital, received another boost from the government, which may have a positive impact on market competition. SMEs have been hit particularly hard by disruptions to the economy resulting from structural problems and COVID outbreaks. Based on anecdotal reports of SME failures and data showing deeply negative new business registrations, the outlook for healthy market competition could be badly impaired by myriad business failures. To alleviate these risks and support SMEs through the current tempest, China—like countries throughout the world during COVID—has sweetened emergency measures to help enterprises. The 2022 Government Work Report included plans for a tax cut and tax rebate in 2022, amounting to 2.5 trillion RMB. The tax reduction supports manufacturing, small and low-profit enterprises, and self-employed businesses. The report includes a temporary provision for small-scale taxpayers to be exempted from value-added tax (VAT). These measures should promote cash flow to small businesses and encourage investment. This policy is both pro-growth and pro-market, as it reduces market distortions and enables small firms to compete on a more even playing field.

Openness to Investment

This quarter has seen major shifts in the portfolio investment space, with investor confidence in China declining. After net inflows totaled a record $138 billion in 2021, portfolio outflows surged in Q1 2022: Net holdings of onshore bonds and equities fell by $36 billion and $16 billion, respectively, in the quarter (Figure 3). Though narrowing US-China yield spreads were a big factor, other drivers of these outflows included concerns over the tech crackdown, falling GDP growth expectations, and growing political risks tied to China’s stance on Russia.

Long-term investors have based their bullish China bets on Beijing’s commitment to a gradual liberalization of finance. Recent signals have offered reasons to doubt that commitment, and these “passive” investors are now rethinking their assumptions. To be sure, there have also been some inflows recently, but these were mostly short-term in nature. With interest rate spreads between China and the United States closing quickly as Washington raises rates, we are seeing a reversal of flows for investments of less than one year in duration.


US-listed Chinese firms saw their shares decline steeply over the span of a few months (Figure 4) amid long-simmering questions about access to auditing information and indications that firms could be delisted as early as 2024 under the Holding Foreign Companies Accountable Act. At the time of publication, the SEC has provisionally identified 128 companies as at risk of being delisted, and the list is evolving. The China Securities Regulatory Commission (CSRC) went so far as to modify a decade-old rule restricting the sharing of financial data by offshore-listed firms. Throughout the quarter, Chinese regulators talked up the prospect of a breakthrough with US regulators, although there has not been a positive outcome yet. While the rule modification is a positive step, the core conflict has yet to be resolved, as the Public Company Accounting Oversight Board (PCAOB) has insisted on nothing less than full access to audit information for all listed firms.


Special Topic: The Improbable 5.5 Percent Growth Target

At 5.5 percent, the Chinese government’s GDP growth target for 2022 was seen as a stretch even before a new round of COVID-related lockdowns was imposed in the waning days of Q1. Beijing’s subsequent insistence on upholding the target suggests that political objectives will trump reform priorities in the run-up to the Communist Party Congress in late 2022. China’s ambiguous stance on the Russian invasion of Ukraine—voicing support for an end to the conflict, yet blaming NATO for it—has added to the geopolitical risks surrounding China’s growth outlook.

Real Estate: No Easy Reset

Property is by far the most important sector in China—representing up to a quarter of the country’s GDP. At the end of Q1 2022, all indicators pointed to a meaningful contraction in residential construction activity and sales (Figure 5), with numerous private developers in or at risk of default. In 2021, total property sales amounted to 18.2 trillion RMB, or 16 percent of GDP. With housing prices and sales volumes in decline, developers must prepare for a 2 trillion RMB reduction in annualized sales revenue. The sales decline is more than four times as large as China’s last market correction in 2014–2015. Even with the decision on April 27 to turbocharge infrastructure investment, it is unlikely that we will see growth in overall investment levels in 2022 given the ongoing weakness in the property sector.


Tech Crackdown: No End in Sight

The costs of Beijing’s tech crackdown go beyond reduced valuations: employment and new business formation have also taken a hit. Employment data scraped from Maimai, a job networking platform, shows steep declines in new hiring in the sectors targeted by the crackdown (gaming, ride-hailing, social media, and e-commerce) starting in July 2021 (Figure 6). Hiring in these sectors fell at a greater rate than the steep 8.2 percent year-on-year decline seen in the overall economy in the second half of 2021. In previous economic downturns, ride-hailing and other gig economy sectors absorbed displaced workers. This is no longer the case.


Despite efforts to support “hard-tech” industries, hiring, and business formation are showing mixed results in these sectors as well. One might hope that tightening measures in education and e-commerce would free up capital and labor for more strategic sectors like robotics or biotechnology. But, based on some business formation indicators, hard-tech sectors have not offset the lackluster growth in sectors directly affected by the crackdown. The continuing regulatory crackdown is dragging growth down further at a time when confidence is already strained. Regulatory goals are hindering the vitality of certain sectors and undermining China’s ability to meet its growth objectives.

Zero-COVID Lockdowns: Is There a Breaking Point?

In Q1 2022, 45 Chinese cities—including Xi’an, Tangshan, Dongguan and, critically, economic powerhouses Shenzhen and Shanghai—faced lockdowns due to COVID-19 outbreaks. In the major cities alone, around 97 million people had endured in-home lockdowns by the end of March. The response to the outbreak is now the most significant drag on the economy, with “dynamic clearing” hitting consumption. Official GDP statistics for Q1 suggest the economy performed well—an assessment that strains credulity.

Economists at the Chinese University of Hong Kong estimate that lockdowns will cost China at least $46 billion per month in lost output, the equivalent of 3.1 percent of GDP. While the Government Work Report pledged to promote a consumption recovery, the zero-COVID policy is making that impossible. The Baidu migration index (Figure 7) shows that restrictions are preventing the domestic movement of people for work and travel. This undermines services sector activity, household earnings, factory output, and consumption spending.


Looking Ahead

The government’s upbeat growth story is being sorely tested by economic realities on the ground. Despite significant headwinds, including the property sector contraction and lockdowns, China reported an improbable 4.8 percent growth rate for Q1 2022. This has raised questions about the credibility of China’s data among observers in the country and beyond. After the data release, the International Monetary Fund, banks, and private analysts cut their own China growth forecasts.

Lockdowns will raise economic costs in the months ahead. The Shanghai government’s inability to manage a citywide lockdown sent economic and political shockwaves across the country. Hoarding is taking place in preparation for future lockdowns, adding to food inflation and aggravating supply chain stress. Xi’an and Shanghai officials were put in a nearly impossible situation by the leadership in Beijing, and their struggles, in turn, will make it harder for authorities in other cities to maintain public confidence. As the broader Chinese public has witnessed the extremity of these lockdowns, fears of a repeat situation will send residents scrambling to escape in advance. Even if Shanghai’s outbreak comes under control, future outbreaks will be far more difficult to control.

With growth decelerating and fewer attractive policy options available to China’s authorities, might Beijing be tempted to reopen the reform debate? Our expectation is that policy flexibility will remain limited in the run-up to the Communist Party Congress in November. But, the worse the economy gets, the greater the need for China’s leaders to adjust their course.