Why China should allow diverse viewpoints of its economy to avoid risks of 3 biases
After the US Federal Reserve chair Jay Powell gave the clearest signal yet that the United States central bank would begin to cut rates next year, investors responded by sending the benchmark S&P index to its highest level since January 2022.
Even if the market rally is short-lived, this does not detract from the fact that the Fed and the US economy have surprised on the upside this year. In much of 2022, the Fed was criticised for having underestimated the risk of inflation during a pandemic in which the US monetary and fiscal policies were unusually loose. Some questioned whether the Fed can be trusted to bring inflation down this year having misjudged it so badly before. At the start of this year, many analysts also thought that it would take a sharp recession in the US to bring inflation down.
Faced with widespread pessimism and scepticism, the Fed needed to show credibility and commitment in tightening monetary policy while doing so in a gradual, measured way that avoided crashing the US economy. The Fed has probably succeeded in achieving this delicate balance: not only will the US escape a recession this year, but growth and the jobs market have been resilient.
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By contrast, China's economy this year has surprised on the downside. The post-Covid rebound - widely expected after zero-Covid restrictions were suddenly lifted at the end of 2022 - failed to materialise in 2023. The property debt crisis remains unresolved and continues to be a significant drag on investor and consumer confidence. Interest rate cuts have been too modest to give meaningful support to the beleaguered property sector, much less spur a wider economic recovery. Consequently, the job market remains weak, wage growth is flat, and deflation remains China's key macroeconomic risk.
Fiscal support has also been tepid; the Chinese state remains as adamant as ever against using cash transfers or enhancements to social safety nets to boost consumption. It is rather surreal to hear Chinese leaders sound more like right-wing politicians in the US when they pontificate on the evils of welfarism.
It was also recently reported that China's state health insurance system lost 19 million subscribers in 2022 as rising premiums and co-payments put the scheme out of reach for many people. Premiums and co-payments have risen because local governments have become more stretched fiscally. When people have to save more for future needs - whether health or retirement - it also means that they have less disposable income with which to consume. Not only does this hold back the economy from recovering in the short term, but it also hinders China's shift to a consumption-driven growth model.
The steps that the Chinese government did take to boost the domestic economy - for instance, the 31-point guidelines announced in July to support the private sector and the 1 trillion-yuan sovereign bond issue announced last month to finance infrastructure and disaster relief efforts by local governments - have so far had limited impact on investor sentiment and consumer confidence.
Even as the Chinese economy floundered, the space for robust debate about it narrowed considerably this past year. Private sector analysts have been told to avoid giving critical assessments or pessimistic prognostications of the Chinese economy. Since July, the authorities have stopped releasing some key economic data such as the youth unemployment rate. More recently, the Ministry of State Security warned ominously that "talk concerning China's decline is in essence an intention to create a 'narrative trap' or a 'cognitive distortion'."
Just as the pessimism surrounding prospects for the US economy at the start of this year served a useful function in forcing the Fed to come up with robust, credible policy responses, so too can a case be made for the Chinese authorities to allow diverse viewpoints - including pessimistic and sceptical ones - on the country's economy. Markets work best when there is diversity rather than mimicry; this applies to the marketplace of ideas as it does to markets for ordinary goods and services.
The case for cognitive diversity rests on the argument that without such diversity, policymakers are likely to be blindsided by certain biases and so fail to spot emerging risks and dangers. Three such biases are worth highlighting.
The first is the optimism bias which causes us to pay more attention to good news and disregard or discount bad news. For example, in the years before the global financial crisis, not only did policymakers and mainstream economists in the US fail to identify the risks that were brewing in the financial industry, but some even fuelled the asset bubble by optimistically proclaiming that house prices would never fall, that rising property prices are proof of sound economic fundamentals, and that financial innovations such as securitisation have made the financial system safer.
The global financial crisis proved that the unquestioned, unchallenged faith in the merits of financial liberalisation was misplaced; it also showed that intellectual capture by the prevailing ideology of the day can reduce cognitive diversity in policymaking. This makes it even more critical for policymakers to allow informed outsiders to scrutinise policies, warn about hidden risks, and generate alternative scenarios and policy options.
The second bias, closely related to optimism, is the natural tendency to be overconfident in ourselves and our abilities. This has become more salient in recent years as officials have been instructed to project confidence in China's culture and governance. Overconfidence was probably a contributing factor in the regulatory crackdowns on multiple industries - many consumer-facing internet companies, the property sector, and the private education industry to name a few - during the pandemic. Not only were these crackdowns unexpected and heavy-handed, but officials may also have overestimated their ability to manage the fallout of their overreach.
The authorities finally seem to have recognised that their crackdowns were excessive. The recently concluded economic work conference issued a statement that included the following acknowledgement: "Next year we must persist in seeking progress while maintaining stability, promoting stability through advancement, and establishing the new before abolishing the old." This represents the closest thing to an admission from Chinese officials that their interventions in recent years had roiled markets and undermined confidence.
Finally, the omission or status quo bias explains why officials often prefer to err on the side of inaction (error of omission) rather than on the side of action (errors of commission). This, in turn, explains inertia, in which suboptimal policies are maintained for far too long simply because the risks of changing the status quo are perceived to be greater than sticking with it.
Nowhere was this bias more apparent than in the zero-Covid policy that was elevated to the level of ideology. This made it impossible for officials to even contemplate the alternative strategy of living with Covid, much less prepare the healthcare system and the country for the inevitable change in policy.
In an environment where expressing a contrarian viewpoint may be punished, policymakers have a much more difficult job figuring out the true state of the economy and generating a sufficient variety of policy options. Independent analysts and even critics are useful precisely because they help policymakers counter the "natural" biases of optimism, overconfidence, and omission. When alternative viewpoints are suppressed, it is unlikely that policymakers have the will, or even the ability, to question themselves.
Donald Low is senior lecturer and professor of practice in public policy, and the director of the Institute for Emerging Market Studies, at the Hong Kong University of Science and Technology.
This article originally appeared on the South China Morning Post (SCMP).
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