The politicized quest to stamp out the coronavirus is damaging the Chinese economy and forcing foreign businesses to rethink their dependency on China

China’s ruling Communist Party has developed a reputation for technocratic competence since the dawn of the “reform and opening up” era in the late 1970s. Though the party has squelched political reform, it has been an able economic steward, facilitating China’s transformation from an impoverished backwater to the world’s factory and one of its paramount consumer markets.

Key to China’s economic success has been a leashing of the party’s political excesses, which plunged the country into repeated turmoil under Mao Zedong’s ideologically driven leadership. Unfortunately, the CCP elevated another ideologue into power in 2012. Though he is more pragmatic than Mao, Chinese leader Xi Jinping shares the erstwhile chairman’s zeal for political struggle.

Xi’s bid to eradicate the coronavirus, dubbed “zero Covid,” is his riskiest political warfare campaign to date. Xi has doubled down on the policy as he tries to secure an unprecedented third term at the 20^th Party Congress this fall. He exalts zero Covid as superior to measures taken in the West (especially the United States), which has suffered many more Covid deaths than China. If zero Covid began partially grounded in science – it did seem to work when SARS-CoV-2 was less transmissible – with the arrival of the hyper-infectious omicron variant it has devolved into a mostly political gambit. If it fails, Xi’s leadership will be compromised regardless if he wins a third term as expected.

No wonder that at a May 5 Politburo Standing Committee meeting Xi expressed confidence that Shanghai’s lockdown would stamp out the coronavirus. “We won the battle to defend Wuhan. We will certainly be able to win the battle to defend Shanghai,” he said, adding, “We will resolutely struggle against all words and deeds that distort, doubt and deny our epidemic prevention policies.”

Yet zero Covid cannot succeed without inflicting serious damage on the Chinese economy. Shanghai, which endured about 60 days of a hard lockdown, saw gross industrial production fall 60% year-on-year in April and retail sales drop almost 50%. China’s exports in dollar terms grew just 3.9% in April from a year earlier, down sharply from 14.7% in March and the slowest rate of growth since June 2020. Urban unemployment reached 6.1% in April, the highest rate since February 2020.

Xu Jianguo, associate professor of economics at the National School of Development in Peking University, said during a May webinar that China’s Covid-related disruptions this year have affected 160 million people in cities with a combined economic output of RMB 18 trillion yuan (US$2.68 trillion), including Shanghai, Suzhou, Shenzhen, Dongguan and Beijing. By comparison, the regional outbreak in Hubei Province two years affected 13 million people in an RMB 1.7 trillion economy.

Given the damage inflicted by zero Covid, most economists doubt China can reach its GDP target of approximately 5.5% this year. Morgan Stanley expects the Chinese economy to grow 4.2%, “predicated on no further extended lockdowns of major cities,” chief Asia economist Chetan Ahya said in a May research note. Also in May, JPMorgan Chase revised its forecast down to 3.7% from 4.3%, while UBS slashed its forecast to 3% from 4.2%. Peking University’s Xu is even less sanguine: He was quoted by The South China Morning Post as saying that China’s economy may not even grow 2.3% in 2022, which was the annual GDP figure in 2020.

Economists are also concerned about how the massive cost of regular Covid testing will weigh on China’s growth. JPMorgan Chase estimates that the cost will be at least RMB 40 billion to 50 billion (US$5.97 billion to US$7.46 billion), or 0.4% to 0.5% of annual GDP. Testing 70% of the population every two days would amount to 8.4% of China’s fiscal expenditure and could crowd out government expenditure in other areas like infrastructure, Nomura economists said in a May research note.

Twilight of an era

China’s response to the zero Covid-induced chaos in its economy is revealing. Firstly, it did not take quick action to ease restrictions. Shanghai’s lockdown lasted roughly two months, though the economic damage was clear much sooner. China not only remains mostly shut to non-residents, but is also curbing the issuance of passports and telling its citizens not to travel abroad. The National Immigration Authority said in May it would “strictly limit” unnecessary overseas travel as part of its pandemic response.

Premier Li Keqiang, long sidelined by the imperious Xi Jinping, has emerged from obscurity to steady the shaky economy, but it is unclear if his efforts will bear fruit. In late May, Li convened an emergency meeting with thousands of representatives from local governments, state-owned companies and financial firms during which he told them to make sure unemployment falls and the economy “operates in a reasonable range” in the second quarter.

In a recent State Council meeting, Li announced 33 support measures to help businesses, including more than RMB 140 billion (US$21 billion) of additional tax reductions, including one for vehicle purchases. Local governments were told to spend most of the proceeds from RMB 3.65 trillion of bonds used mainly for infrastructure by the end of August.

Financial regulators also met with major financial institutions in late May to urge them to boost loans. State media reported following the meeting that some banks had been given specific quotas requiring them to increase loan disbursement.

Though the stimulus measures may help China’s economy recover later in the year, the endurance of zero Covid augurs ill for the country’s economic future. Indeed, Beijing is more eager to implement testing, tracing and quarantine infrastructure than to inoculate the Chinese population with the most protective vaccines. Beijing has ordered officials to be capable of testing whole city populations within 24 hours. Large metropolitan areas are required to have testing sites within 15 minutes’ walking distance of people’s homes. Permanent testing booths developed by private medical firms are replacing makeshift facilities.

Domestic mRNA vaccines are under development, but it is unclear when they will be ready and how effective they will be compared to international brands. Under Xi Jinping’s push for self-sufficiency, China is refusing foreign vaccines.

Given that SARS-CoV-2 is a capricious pathogen that has become ever more contagious, an elimination strategy like China’s will inevitably lead to the country being estranged from the rest of the world in the long run. Most other countries have long since adjusted to coexistence with the virus.

Exasperated by China’s dogmatism about the virus, foreign businesses are rethinking their dependency on the world’s second-largest economy in a way they did not during the U.S.-China trade war. Compared to that tiff, zero Covid is far more disruptive for business. It is not just a matter of navigating tariffs and Donald Trump’s tweets. Rather, the policy makes China’s business environment both mercurial and inefficient. It makes little sense for a business to rely on China as a manufacturing base if severe supply chain disruptions are the norm.

In May, The Wall Street Journal reported that Apple has told some of its contract manufacturers that it wants to increase production outside of China, likely in Vietnam and India. More than 90% of Apple’s products are currently made in China. While Apple will want to maintain a large China production base to serve the domestic market, making products in China for customers elsewhere no longer appears to be a foolproof strategy. The bromides about China offering advantages that no other country can must be measured against the risks of reliance on a country ruled by a pugnacious and increasingly unpredictable authoritarian regime.

European firms are also souring on China. An April survey by the European Chamber of Commerce in China found that 23% of 372 respondents are considering a move out of China, the highest level since 2012. About 78% said that China is less attractive as a business destination due to its Covid-19 policies.

Joerg Wuttke, president of the EUCCC and one of the foreign business community’s most vocal critics of zero Covid, told the Swiss magazine The Market in an April interview that foreign firms are considering moving parts of their investments to other countries. “China has lost its nimbus as a base for sourcing and manufacturing, at least for the moment,” he said.

Commenting on the politicized nature of China’s Covid response, he said, “For now, China is not getting out of the corner the president has maneuvered the country into. They are prisoners of their own narrative. It’s rather tragic: China was the first to get into the pandemic, and it’s the last to get out.”