The Chinese government has announced several major initiatives to cool off growth, deflate the country’s housing bubble, and stabilize China’s surging economy. Unsurprisingly the scope and nature of these reforms caused market jitters and sent the Chinese Shanghai Composite down 3.7 percent on Monday, capping off a three day slide before markets rebounded by 2.3% on Tuesday. So far, property developers have taken the biggest hit as the government moves to cool off China’s surging housing market.

Chinese Stock Market

The Chinese government has set a growth target of 7.5% and perhaps most importantly is aiming to shift emphasis away from exports, even as they have been surging in recent months, in favor of increasing domestic demand. While 7.5% may sound astounding to U.S. and European ears, for a country that has regularly enjoyed double digit growth over the last decade, this would represent quite a cool down.

Many analysts have been openly wondering if China has become a sort of run away train, moving too fast for its own good and unable to apply the brakes. Doomsayers have been saying that it’s only a matter of time before China derails and various bubbles pop. With housing costs surging, numerous troubling issues in its domestic credit market, increasing labor strikes, and numerous other issues these critics have plenty of reasons to worry. And should China’s economy suffer a major collapse it would likely plunge the world economy back into recession.

The Chinese government is more than aware of these criticisms and now appears to be trying to reposition its economy and deflate the various growing financial bubbles. China is now aiming to increase the scope and impact of its diminutive social welfare system. The government aims to increase health care spending by 27% to $41.8  billion dollars and is ramping up its spending on other welfare and social spending programs. In theory this should free up discretionary income as people will be increasingly willing to spend their money rather then save for a “rainy day.”

China is also moving to aggressively bring down soaring housing costs, which is putting a squeeze on consumer spending and causing discontent over high living costs. The government has announced plans enforce a 20% tax on profits from home sales, this has long been on the books but rarely been enforced. Now many buyers are rushing to sell their homes before the tax comes into effect. This increased supply should hopefully cool of the housing market, which has surged across urban China through the first 2 months of 2013.

Importantly, the 20% tax will also provide local governments with more income. This should effectively ween local governments off of the need for Central government loans and land sales, which often result in the unscrupulous practice of sizing land from poor farmers at pennies on the dollar of their value. Hopefully, this income can also start to deflate the government loan bubble that emerged during the 2009 Financial Crisis as easy loans were doled out to local governments, much of which was then wasted on questionable infrastructure projects. With more income, local governments should be able to make good on their loans.

Xi Jinping’s new government, which has held the reigns for only 4 months, has shown that it is more willing than its predecessors to get actively involved in the market through macro-economic policies. While President Xi seems unwilling to step in as a sort of micro-manager, his public policies clearly have aims to transform the Chinese economy and so far he has shown a willingness to develop the mechanisms to drive this change.

The shift towards domestic demand isn’t just about diversifying the economy, but also about providing the Chinese citizenry with a greater level of well-being. While wages in China have generally increased, many people working in the low end manufacturing sector still struggle with low wages and high living costs. With hundreds of millions of Chinese still wallowing in poverty in the rural hinterland, China has ample supply of low cost labor, but now Chinese citizens are beginning to demand a greater portion of the “good life.”

If China is able to succeed in building a domestic consumption engine, it could not only deflate many of the growing bubbles that are emerging in China, but also greatly increase its power on the world stage as countries and companies clamoring for new markets come knocking at the Chinese borders. Whether or not Xi Jinping has the clout and skill to pull off these reforms remains unknown,  in-spite of the recent stock drop, his actions could turn out to be of great benefit for China.