Externally, US policy towards China has shifted from strategic engagement to salient trade and technological competition. And internally, economic return on China’s existing low value-added export-led paradigm is declining. Many highly speculated sectors — like real estate — are also posing systemic financial risks as evidenced by the recent Evergrande debt crisis. China is responding to these challenges by prioritising state-led domestic economic reforms to sustain growth and deploying economic diplomacy to secure a less hostile political environment to preserve global cooperation.

China’s economic diplomacy is defensive in nature, aiming to prevent it from being ostracised from the extant international economic system that it relies on for further development. So far, this is proving considerably effective, and China has deterred US efforts to boycott the upcoming Beijing Olympics as US business attempt not to use cotton from Xinjiang. In other words, China continues to counter US value diplomacy

For Western European countries, the economic gains from trading with China — as well as China’s commitments to further liberalisation that will grant foreign companies more access — provide China leverage to balance against US efforts to form a cold-war style anti-China alliance. Despite the European Union’s current suspension of the EU–China Comprehensive Agreement on Investment over China’s human rights conditions, the agreement is likely to move forward considering the political influence of large European corporations. The deal will grant these corporations first-mover advantages in the Chinese domestic market over their American competitors.

For US allies in Asia, the Regional Comprehensive Economic Partnership successfully created a de facto FTA between China, Japan and South Korea. Without an alternative US-led trade pact, the potential opportunity costs of participating in an anti-China alliance deterred key US allies like Germany and Japan from following its China policy.

In addition to fending off a larger US-led alliance, China is also reinforcing its leadership in the Global South through foreign aid and development financing. Compared to private capital, China’s state-led overseas development assistance is more ‘patient’, allowing focus on long-term investments — for example, creating political influence and new markets for Chinese firms. It also has fewer conditions of political transparency and market liberalisation than development financing from the World Bank, which strictly abides by the Washington Consensus.

In contrast to its ‘streamlining’ economic diplomacy, China’s domestic economic reforms face significant hurdles. On the surface, the central dilemma seems to be the sharp contradiction between the political centralisation under President Xi Jinping’s power consolidation and the economic liberalisation advocated by many private companies, academics and public intellectuals.

But it is neither helpful nor accurate to depict domestic reform in a simple state vs market manner. For one, political centralisation gives the state more control to implement its macroeconomic policies — from antitrust policies in tech to deleveraging China’s heavily speculated sectors. On the other hand, Xi’s preference for political centralisation also impedes China’s much-needed economic transition from an investment-driven, export-led model to a domestic consumption-driven growth paradigm. Such a transition would inevitably give more political bargaining power to society.

Another concern brought about by China’s current political centralisation is the entrenchment of the less efficient and market-sensitive public sector, which will cause it to absorb more scarce resources. Without a clear signal of preference from Xi, and effective political institution reform, this internal contradiction in China’s economic reform is likely to intensify in the coming year as external and internal pressure increases.

In 2022, China is likely to see dramatic declines in export demand as well as rapidly increasing energy and raw material prices due to multiple factors — from post-COVID inflation to China’s commitment on lower carbon emissions. China’s recent crackdown on many service sectors, like private tutoring businesses, will further increase short-term pressure on employment, social stability and economic growth. The above developments inevitably reduce available resources for grandiose infrastructure investments and foreign aid in the Global South.

More importantly, the aggregated domestic pressure derived from these short-term shocks, combined with Xi’s priority to demonstrate his accomplishments to ensure a third term in 2022, will likely intensify multiple stress points in China’s domestic political economy. In other words, Xi can behave like a ‘Tiger Dad’ to implement rapid economic reform, but whether Chinese society and its political economy can tolerate such stress while still delivering the expected reform dividends is entirely another matter.

For sure, Xi intends to continue strengthening ties with developing countries across the globe, retaining them within China’s political orbit and supporting China’s own economic growth. Yet the fate of China’s economic diplomacy will depend heavily — if not fully — on China’s domestic political economy. Xi’s political decisions and China’s economic performance will undoubtedly play a crucial role in shaping the strategy and effectiveness of China’s economic diplomacy. It would not be surprising to see China’s economic diplomacy experience a bumpier road ahead.

Chen Wang is an independent researcher based in the United States and managing partner of Roger&Rebecca LLC, a business services company. He is an alumnus from UC Berkeley.