1 Xi seeks ‘new development pattern’ to circumvent Western containment
On Jan. 31, the CCP Politburo held its second group study session on “accelerating the establishment of a new pattern of development.”
Xi Jinping presided over the session and delivered a speech with the following technology-related points:
- Only by “accelerating the establishment of a new development pattern” can the PRC “better survive, compete, develop and sustain its progress amid all sorts of predictable and unpredictable storms and high winds, so as to ensure that the process of the great rejuvenation of the Chinese nation will not be delayed or interrupted, and the goal of building China into a great modern socialist country in all respects will be realized.”
- The PRC must “deepen supply-side structural reform, promote scientific and technological innovation and institutional innovation, break through blockages, stuck points and vulnerabilities in supply-side constraints, and promote the competitiveness and security of the industrial chain and supply chain, meet existing demand with independent, controllable and high-quality supply, and create and guide new demand.”
- It is “imperative” that the CCP “move faster toward self-reliance in science and technology so as to relieve the stranglehold some countries have tightened on China’s development of core technologies.”
- The PRC must “improve our new system for mobilizing resources nationwide.”
The backdrop
The United States and its allies have been ramping up pressure against the PRC since late January, including tightening tech restrictions, signaling new sanctions on Huawei, and cutting U.S. investment in high-tech areas of China’s economy.
Our take
1. The CCP authorities have been talking about establishing a “new development pattern” since at least the third quarter of 2020. At the time, the “new development pattern” referred chiefly to “dual circulation” (“a new development pattern where domestic and foreign markets can boost each other”), but has in recent years included initiatives like the “unified national market,” expanding domestic demand, deepening supply-side structural reform, and boosting the PRC’s scientific and technological development to overcome sanctions from abroad.
The PRC has barely made progress in advancing the various agenda items in the “new development pattern” over the past three years, partly due to the “zero-COVID” policy. Xi Jinping’s latest push to “accelerate the establishment of a new development pattern” will likely remain a pipe dream even with the ending of “zero-COVID” if he cannot overcome the systemic deficiencies of the CCP authoritarian dictatorship, including endemic corruption and pernicious Party culture.
An example of the CCP’s failure to push scientific and technological development is the so-called semiconductor “great leap forward” (芯片大躍進) that was launched in 2014. The authorities invested hundreds of billions of yuan in the project but had little to show for it by the end of Xi’s second term due to corruption. To address the mess, the Xi leadership purged some officials responsible for overseeing the chip “great leap” before the 20th Party Congress (see here and here).
The CCP also cannot “accelerate” its “establishment of a new development pattern” if it cannot retain talent. Shi Yigong, the former dean of Tsinghua University’s School of Life Sciences, told state broadcaster CCTV in a 2017 interview that while the college had 2,251 undergraduates that year, 1,670 of them had decided to leave for America. The PRC’s brain drain problem will likely worsen with the scrapping of “zero-COVID.”
2. The PRC’s tech industry and the regime at large will be dealt a disastrous blow should the U.S. totally ban all American suppliers from selling to Huawei and enact tougher tech sanctions. Already, the PRC’s artificial intelligence and advanced semiconductors sectors are being choked to death by the “stranglehold” of export controls imposed by the U.S. and its allies.
The PRC could find itself using legacy semiconductor designs and producing equipment that do not require the latest technologies (like washing machines) for a very long time if it cannot overcome “stuck points and vulnerabilities in supply-side constraints.” The People’s Liberation Army will also increasingly lag behind the U.S. military and the militaries of other developed countries as the technological gap between Communist China and the world widens.
The CCP will undoubtedly still find ways to obtain advanced chips and other critical technologies by sourcing them through overseas shell companies, embarking on industrial espionage, and finding “creative” ways to evade U.S. sanctions. However, there is a limit to how many semiconductors and critical technologies that the CCP can acquire through side door means. Any chips or equipment gathered this way will likely fall short of enabling the PRC to “accelerate the establishment of a new development pattern.” The CCP regime could also face even stricter sanctions when the U.S. and its allies find out that China had circumvented export controls.
3. Xi has no good options for “breaking the blockade” of the U.S. “tech war.”
On the one hand, Xi could show a willingness to walk in lockstep with the rules-based international order, abandon the PRC’s “revisionism” with regard to Taiwan and the Russia-Ukraine conflict, and offer up other major concessions to win a reprieve from U.S. sanctions. However, this course of action essentially annuls Xi’s “great power diplomacy” political legacy and would chip away at his personal “quan wei” (authority and prestige), leaving Xi very vulnerable to intra-Party pushback unless he takes additional drastic measures to ensure that he is not sidelined or ousted outright.
The other option for the Xi leadership is to continue to sit on the fence on key issues of concern of the U.S. and its allies, if not double down on the PRC’s “revisionist” behavior. Either course of action will give the U.S. and its allies excuses to ratchet up pressure against Xi and the CCP to intolerable levels. Overwhelming pressure would in turn create favorable conditions for political Black Swans to emerge in China.
2 Sino-US tensions heighten over suspected spy balloon
On Feb. 2, the Pentagon announced that it was tracking a high-altitude surveillance balloon belonging to the PRC that was over the continental United States. According to an official statement, the PRC balloon was traveling at an altitude “well above commercial air traffic” and did not “present a military or physical threat to people on the ground.” The statement added that “instances of this kind of balloon activity have been observed previously over the past several years.”
Per news reports, two F-22 fighters were scrambled from Nellis Air Force Base in Nevada to Montana where the balloon, which is about the size of three buses, was spotted. The Biden administration, however, ultimately decided not to shoot it down. The U.S. has 150 nuclear-armed Minuteman III intercontinental ballistic missiles at Malmstrom Air Force Base in Montana.
A senior defense official told reporters that “clearly the intent of this balloon is for surveillance,” and that its flight path at the time “does carry it over a number of sensitive sites.” The official added that the balloon’s surveillance payload, from what could be assessed, “does not create significant value added over and above what the PRC is likely able to collect through things like satellites in Low Earth Orbit.”
Canada also said that it was tracking a “potential second incident.” On Feb. 3, the Pentagon said that it had observed another PRC balloon in Latin America.
On Feb. 4, U.S. fighter aircraft shot down the original balloon off the coast of South Carolina in U.S. airspace. U.S. Navy and Coast Guard ships were dispatched to recover the surveillance equipment that the balloon was believed to be carrying. In a statement, Secretary of Defense Lloyd Austin said that the balloon was used by the PRC in an “attempt to surveil strategic sites in the continental United States.” He added President Joe Biden had authorized the takedown of the balloon on Feb. 1 if it could be accomplished “without undue risk to American lives under the balloon’s path,” but U.S. military commanders determined that downing it while over land “posed an undue risk to people across a wide area due to the size and altitude of the balloon and its surveillance payload.”
U.S. reaction
Several Republican lawmakers and former President Donald Trump called for the PRC surveillance balloon to be shot down. They also suggested that the Biden administration’s response to the situation was inadequate. Sen. Tom Cotton (R-Ark) urged Secretary of State Antony Blinken to cancel his China visit. Meanwhile, House Speaker Kevin McCarthy said that he would request a “Gang of Eight” briefing about the balloon, or a classified national security briefing for Congressional leaders and both the Republican and Democratic leaders of the intelligence committees.
On Feb. 3, Secretary Blinken announced that his trip to China would be postponed. Blinken had originally been scheduled to visit Beijing from Feb. 5 to Feb. 6. In a phone call with CCP Central Foreign Affairs Office director Wang Yi, Blinken said that the PRC surveillance balloon’s floating over U.S. airspace was “an irresponsible act and a clear violation of U.S. sovereignty and international law that undermined the purpose” of his planned trip to China.
PRC response
In a statement on Feb. 3, a PRC foreign ministry spokesperson claimed that the balloon was a “civilian airship” used mainly for “meteorological” purposes. “Affected by the Westerlies and with limited self-steering capability, the airship deviated far from its planned course. The Chinese side regrets the unintended entry of the airship into the U.S. airspace due to force majeure,” the spokesperson said.
In a readout of his telephone call with Secretary Blinken published in state mouthpiece Xinhua, Wang Yi said, “China is a responsible country and has always strictly abided by international law. We do not accept any groundless speculation and hype.” He added, “In the face of unexpected situations, what both parties need to do is to maintain concentration, communicate in a timely manner, avoid misjudgments, and manage and control differences.”
After the balloon was downed, the foreign ministry issued a statement saying that the PRC “strongly disapproves of and protests against the U.S. attack on a civilian unmanned airship by force.” The statement further described the U.S. action as a “clear overreaction and a serious violation of international practice,” and added that the PRC “reserves the right to make further responses if necessary.”
Media framing and theories
The Wall Street Journal described the PRC balloon incident as “one of the most aggressive Chinese intelligence gathering maneuvers in recent years.” Axios also noted that the incident was one of “Beijing’s most aggressive intelligence-gathering attempts in recent years.”
In reporting Secretary Blinken’s canceled trip to China, The New York Times observed that “both the Trump and Biden administrations have adopted a combative stance toward China, saying that the Chinese Communist Party is intent on undermining the U.S.-led world order.”
Experts interviewed by the Times about the PRC’s reason for the balloon’s presence over the continental U.S. said that it was plausible given current weather patterns, but the PRC would have known where the balloon would end up.
The Times and other publications also ran short histories of the use of balloons in spying and military operations, including during the U.S. Civil War, World War I, World War II, and the Cold War (see here and here).
Media outlets published several theories as to why the PRC might be resorting to surveillance by balloon when satellites and other more high-tech means were available. Experts told CNN that balloons are smaller, cheaper, less easy to spot, and can loiter to a degree.
As for what the balloon might be doing, the experts interviewed by CNN suspected that it could be gathering information on U.S. communication systems and radar, signals intelligence, and U.S. military bases in the area. Meanwhile, an expert told the Washington Examiner that such balloons can carry electromagnetic pulse weapons capable of “nuclear EMP attacks,” and that the PRC balloon in question could be performing a “dry run meant to send a strategic message to the USA.”
Our take
1. The PRC’s claim that the surveillance balloon is merely a “civilian airship” used for “meteorological” purposes is barely believable given the public information currently available. The CCP has a long history of engaging in intelligence gathering operations in the U.S. using a variety of means, and is known to have carried out similar acts using balloons in the recent past. The odds that this was entirely an “accident” on the CCP’s part are vanishingly low.
Observers should not be shocked that the PRC would be carrying out such a controversial activity. CCP subversion of the U.S.—whom the CCP has long perceived as its chief rival and greatest obstacle in the regime’s quest to be the global hegemon—is always being carried out regardless of the state of Sino-U.S. relations. The CCP would also unlikely suspend routine intelligence gathering operations—especially the seemingly innocuous flight of a balloon over U.S. airspace that regular Americans would not immediately suspect of conducting surveillance work on behalf of the PRC until informed by the Pentagon—simply because bilateral tensions with the U.S. are strained.
2. It seems somewhat unusual for the Biden administration to be making a big fuss about the PRC balloon and turning it into a diplomatic crisis at this time. As the Pentagon indicated, such activity had previously been observed over the past several years. The Biden administration had also reportedly been tracking the balloon for months since it left China according to Fox News’s Tucker Carlson, citing Pentagon sources.
The administration’s attention to the balloon is also odd in considering that the surveillance, sovereignty, and legal issues it raises pale in comparison to those caused by TikTok. That being said, the idea of a Chinese spy balloon in American airspace, along with the notions of war and invasion that it conjures up, certainly does capture the public attention much more than the CCP having access to reams of data on U.S. citizens via a popular social media app.
We noted previously that the U.S. and its allies have been increasing pressure on the PRC in recent weeks (see here, here, and here). One of the possible reasons why the Biden administration would prefer to escalate tensions with the PRC instead of dialing them down is to compel the Xi leadership to reduce or cut off support for Russia ahead of an expected escalation in the Russia-Ukraine war in the coming months. The U.S. and its allies would also prefer that the PRC renounce its “revisionist” ambitions, change its stance towards Taiwan and the Russia-Ukraine conflict, and get in line with the agenda of the rules-based international order.
Another reason for greater U.S. pressure on the PRC now is worsening crises in China. Xi Jinping is struggling to rescue a rapidly deteriorating economy, reverse a demographic crisis, manage the post-“zero-COVID” health and death crisis, as well as deal with growing social tensions and anti-regime sentiment. The Biden administration could be sensing an opportunity to extract important concessions from Beijing by tightening the screws.
The Biden administration’s escalation of tensions with the PRC over the balloon incident could also be partly the result of domestic pressure. By getting tougher on China—a rare topic of popular, bipartisan consensus—the administration would be able to answer its critics, as well as divert public and political attention away from various troubling issues and scandals.
3. As with the intensifying U.S. “tech war” (see item 1 in this newsletter), Xi Jinping has no good way to simply paper over the PRC balloon incident.
Xi cannot offer up important concessions on Russia and other issues critical to the CCP without badly undermining his own “quan wei” and severely destabilizing his political position. Yet Xi cannot just pay lip service to Washington to “delay and wait for change,” which would give the U.S. and its allies an ironclad reason to take stronger actions against the PRC to safeguard their respective national interests from the CCP threat.
What’s next
The U.S. and its allies appear determined to sustain and step up pressure on the PRC until it abandons its “revisionist” agendas, particularly with regard to Taiwan and the Russia-Ukraine conflict. If so, Beijing will struggle to improve Sino-U.S. relations and relations with other U.S.-friendly countries even after adjusting its diplomatic approach.
As the international community becomes more “anti-Xi” and “anti-CCP,” Xi Jinping will increasingly be forced into deciding between preserving the Party versus securing his own position. Xi’s choice in this regard could lead to political Black Swans in China as soon as this year.
3 CSRC expands registration-based IPO system to all mainland stock exchanges
On Feb. 1, the China Securities Regulatory Commission published and sought public comment on draft regulations (首次公開發行股票註冊管理辦法) that expand the registration-based IPO system to the main boards of the Shanghai and Shenzhen stock exchanges. Under the registration-based mechanism, companies seeking a listing on mainland exchanges would be subject to a streamlined and expedited review process as compared with the previous approval-based IPO system.
The CSRC also published a Q&A between reporters and a “head of a relevant department” at the CSRC regarding the IPO system reform on its website. The “head of a relevant department” said that the reform is in line with “China’s national conditions.” They added that Shanghai’s Nasdaq-like STAR Market and Shenzhen’s ChiNext have set up “diversified and inclusive conditions” for companies to issue shares or get listed on the respective boards, especially for companies involved with “hard technologies” that are being subjected to a “stranglehold.”
The “head of a relevant department” further said that a “normalized” delisting mechanism will be established and delisting procedures will be simplified as part of the IPO system overhaul. Exchanges will be responsible for “comprehensively examining” whether a company is eligible for listing, and the CSRC will approve the IPO registration based on the exchanges’ review opinion.
The “head of a relevant department” said that the CSRC maintains a “zero tolerance” approach to regulating the registration-based IPO system, and will strongly crack down on fraudulent issuance, financial fraud, and other serious violations.
Background
The PRC’s previous approval-based IPO system was prone to serious corruption and left room for all sorts of fraudulent activities to flourish. The old IPO system was partly a reason why mainland exchanges were viewed as being no better than casinos and many investors entered the market with a speculative mindset.
Our take
1. Beijing’s reform of the IPO system is likely part of its broader effort to guard against financial risks, attract much-needed investments to the regime’s science and technology industries and manufacturing, and ultimately reverse economic deterioration and rescue the regime from crisis.
The Xi leadership also likely intends to use the IPO reform to hit the pocketbooks of the remnant Jiang Zemin faction and other “anti-Xi” forces, and in doing so, weaken the ability of the “anti-Xi coalition” to undermine Xi Jinping’s rule.
2. Xi has long sought to overhaul the PRC’s IPO system as part of his effort to reform and rescue the regime from the massive corruption and other problems that were prevalent during the Jiang-Hu era. For instance, a document issued on Nov. 15, 2013 on “several major issues concerning comprehensively deepening reform” (中共中央關於全面深化改革若干重大問題的決定) called for “improving the multi-layered capital market system, promoting the reform of the registration system for stock issuance, promoting financing through multiple channels, developing and standardizing the bond market, and increasing the proportion of direct financing.”
Xi, however, did not make much headway in reforming the IPO registration system for the bulk of his first two terms because he had to first consolidate enough power to safely move against the Party elite and other powerful interests in the financial sector. For instance, the Shanghai STAR board was only established through a twisting, start-stop process about five years (in 2019) after the Xi leadership stated its intention to reform the exchanges. Meanwhile, the expansion of the registration-based IPO system to all mainland exchanges was only done in Xi’s third term, or after he had finally established a leadership team that was mainly stacked with his allies and loyalists at the 20th Party Congress.
Xi’s ability to push through IPO reform now is also almost certainly linked to his anti-corruption efforts during his second term. The campaign to “rectify” the financial sector was launched shortly after the 19th Party Congress, and gained steam about a year before the 20th Party Congress as the Xi leadership moved to curb the “disorderly expansion of capital.” Notably, the Xi leadership would intervene to stop Ant Group from launching what would have been a world-record IPO, got Didi Chuxing to delist from the New York Stock Exchange, and sentenced Tomorrow Group founder and Jiang faction “white glove” Xiao Jianhua to 13 years in prison.
According to mainland media reports, Xi’s financial sector “rectification” also led to the arrest, detention, and sentencing of 18 actual controllers, chairmen, and general managers of 15 listed companies in 2022. These executives were charged with a host of financial crimes, including misappropriating funds, manipulating the securities and futures markets, illegally transferring and selling land use rights, collusive bidding, contract fraud, and bribing non-state employees. Incomplete statistics compiled by mainland media also found that the CSRC had investigated the related parties of more than 80 listed companies in 2022, of which 23 companies were probed in November 2022 alone.
3. We noted in our 2023 China Outlook, “To save the manufacturing sector, the CCP authorities could make it easier for companies to access financing from the markets (including adopting a comprehensive registration-based IPO system) to boost the confidence of private entrepreneurs and foreign investors. However, pessimism will continue to hover above China’s stock markets.” The first part of our prediction has already been verified.
We believe that the deficiencies of the CCP system will see Xi Jinping’s efforts to fix the markets bear little, if any, fruit. Officials will attempt to accommodate Xi’s “strongman dictatorship” model by either doing too much (“prefer left rather than right”) or not enough (“lie flat”) in encouraging businesses to get listed. Either extreme course of action will not restore investor confidence. Moreover, the IPO reform will unlikely resolve the problems of regulatory corruption and listed companies partaking in fraud. Interest groups will also inevitably find illegal or “gray” ways to abuse the registration-based IPO system for profit, undercutting the intended outcome of the reform.
