(Bloomberg) -- On the first day of China’s biggest political event of the year, Xi Jinping sent a clear message to Donald Trump: We’re going to do what we want in Hong Kong, and we’re not scared of the consequences.
China confirmed on Friday that it would effectively bypass the city’s legislature to implement national security laws, which have long been resisted by residents who fear they will erode freedoms of speech, assembly and the press. The announcement, which came on the same day China refrained from setting an economic growth target for the first time in decades, triggered immediate calls for fresh protests and sent the MSCI (NYSE:MSCI) Hong Kong index to its worst loss since 2008.
For Xi, the move allows Beijing to reassert dominance over a piece of Chinese territory where his government was rendered impotent during sometimes-violent protests last year. Facing rising unemployment in the mainland due to the Covid-19 outbreak and the potential for a big loss in Hong Kong legislative elections set for September, the Communist Party decided it had more to gain by acting decisively to stem any potential threats.
“Xi feels threatened, the leadership feels threatened -- this is a crisis,” said David Zweig, an emeritus professor at the Hong Kong University of Science and Technology and director of Transnational China Consulting Ltd. “This is, ‘We’re not going to give an inch, we’re going to tighten up, and Hong Kong’s national security as a potential subversive center is greater than its economic value.’”
The move risks triggering yet another round of tit-for-tat escalation between the U.S. and China, which have seen ties spiral to their worst in decades since Covid-19 began spreading around the world. From supply chains and visas to cyberspace and Taiwan, the world’s two largest economies are poised for confrontation on a number of fronts as both Xi and Trump seek to win over domestic constituencies looking for someone to blame for a deterioration in living standards.
The unease within the party leadership was on display at the opening of the National People’s Congress in Beijing, where Premier Li Keqiang announced China would abandon its decades-long practice of setting an annual target for economic growth due to “great uncertainty” in the world economy. While rolling out only moderate stimulus, the government nevertheless made clear that stabilizing employment had become the top priority. Defense spending this year was set to grow at the slowest pace since 1991.
“We will strive to keep existing jobs secure, work actively to create new ones, and help unemployed people find work,” Li said.
The shifting away from a hard target for output growth breaks with decades of Communist Party planning habits and is an admission of the deep rupture that the disease has caused. Economists surveyed by Bloomberg see an expansion of just 1.8% this year, the worst performance since the 1970s.
China sought to avoid reviving trade tensions with Trump, who has escalated his rhetoric against Beijing as his poll numbers have fallen in the wake of the pandemic. Li noted that China will work with the U.S. to implement the “phase one” agreement they reached in January, just before the virus sent the economy -- and potentially Trump’s re-election prospects -- into a tailspin.
“The Chinese leadership does not want to be accused of walking away or reneging on the U.S.-China trade agreement,” said James Green, a former State Department official who is now a senior adviser for geopolitical consulting firm McLarty Associates. “If it fails, in their view, the U.S. will have to be the one to pull the trigger and walk away.”
The big question now is how Trump will respond. He has threatened for weeks to abandon from the trade deal, and on Thursday said the U.S. would react “very strongly” if China pushed ahead with the national security legislation in Hong Kong.
Economic Sanctions
Any concrete U.S. action will likely be announced in an assessment of Hong Kong’s autonomy: Secretary of State Michael Pompeo delayed a report earlier this month, seemingly in anticipation of China’s latest move. Under the terms of the United States-Hong Kong Policy Act of 1992, the U.S. agreed to treat the former British colony as fully autonomous for trade and economic matters even after China took control in 1997.
A law passed last year allows the U.S. to either put sanctions on any Chinese officials deemed responsible for undermining the city’s autonomy, or to do something more sweeping like revoke its special trade status. Congress could also do something in between, such as prohibit Hong Kong from importing sensitive U.S. technology with consumer and military applications -- like carbon fiber used to make both golf clubs and missile components.
No matter what, U.S. actions won’t have much impact on how China governs Hong Kong given the recent decisions in Beijing, according to Antony Dapiran, a lawyer based in the city and author of “City on Fire: The Fight for Hong Kong.”
“If Hong Kong is not able to serve effectively as a safe haven insulated from the political risks of doing business in the rest of China, there is no rationale for international businesses to be here,” he said. “They can either go direct to China, or base themselves elsewhere in Asia.”
Trump’s other options for hitting China aren’t great: The economic downturn has made it less likely that Trump will pressure Xi through tariffs, which can increase costs for American businesses and consumers. Instead the U.S. has focused on reducing financial ties with China, taking action that could lead to delisting some Chinese companies from American stock exchanges and moving to restructure supply chains for essential goods.
China is also feeling heat from other countries: Disputes over its handling of the virus has strained ties with Australia and the European Union, while poorer countries who borrowed large sums for infrastructure under Xi’s Belt and Road Initiative are struggling to pay back the cash.
But the biggest risk for Xi is still unemployment at home. With lots of young people out of work on the mainland, the last thing the Communist Party wants is a revival of violent Hong Kong protests, Zweig said.
“They feel at threat, at risk, and therefore they’re doing it,” he said. “Maybe five or six months ago, they were feeling okay. But I think a lot of stuff’s come crashing down.”