Henry Paulson, U.S. treasury secretary from 2006 to 2009, is chairman of the Paulson Institute. His book “Dealing With China: An Insider Unmasks the New Economic Superpower” was published in April.
How serious are China’s economic problems, and how big an impact will they have on the United States and world economies? Beijing and Washington, separately and jointly, will determine the answers.
First, both countries are essential to global growth, and both must carry out structural reforms to move their economies onto a growth-conducive footing for the long term.
One byproduct of China’s recent stock market volatility has been the emergence of a veritable army of “perma-bears” who believe the Chinese economy is essentially falling off a cliff. Growth in China is slowing and will continue to do so in years to come. But the stock market drop in itself tells us little about China’s real economy.
All markets, of course, incubate asset bubbles. In that sense, the summer’s collapse, while a tragic and painful experience for many Chinese investors, has brought equity values back to earth in Shanghai and Shenzhen.
We need to focus squarely on Beijing’s underlying structural challenge: the need to transition to a new economic model while restructuring local debt resulting from its flawed current model. The biggest risks for China — and, by extension, for the world — can be avoided if China does the right things now to deal with its immediate challenges while accelerating President Xi Jinping’s economic reform agenda. It has the necessary tools and financial capacity to do so.
In recent years, China has made two principal contributions to global growth: It sustained its own growth in the wake of the 2008 financial crisis and served as a demand driver for the commodity and industrial exports of other countries — consuming about half the world’s copper, nickel, tin and iron.
Both of these contributions are now in jeopardy. China’s growth, which was premised on an unsustainable model, was bound to slow as its economy matured. But if there is a silver lining to the slowdown, it is that it reinforces the urgency of reforms that will establish the foundation for slower, but higher-quality, growth.
China’s leaders understand this. That is why, in November 2013, they committed to ambitious structural reforms. But implementation has stalled in some areas, including on the fiscal and state-owned enterprise reforms essential to the new model.
Frankly, Xi inherited a bad hand after a decade in which Beijing kicked the most difficult reforms down the road. And the sheer scope of his challenges is exacerbated by powerful vested interests resisting reforms.
This presents a staggering challenge of political will, sequencing and execution that will take years, not months. Reforms have consequences: Reforming state-owned enterprises, for example, will mean laying off millions. Such reforms will also require complex labor-market and competition reforms to bolster job creation.
There is no playbook for rebooting a slowing $10 trillion hybrid economy still in a tug of war between state control and markets. Mistakes will be made. Even under the best of circumstances, global markets will be shaken by periodic bouts of instability until the Chinese economy works its way toward a new normal of slower, more balanced, market-determined growth.
The United States, for all its differences with Beijing, should be rooting for China’s economic reformers to succeed. And as a large holder of Treasury securities and a major funder of U.S. structural deficits, China has a lot at stake in whether the United States undertakes urgent fiscal, tax and structural reforms that will allow our economy to grow faster.
Second, U.S. and Chinese companies need expanded opportunities in each other’s markets.
From agribusiness to medical devices, the U.S. and Chinese economies are increasingly complementary. What is missing are policies to better enable direct investment and to provide companies a level playing field.
This is a particular problem for China, which badly needs competition to remove economic inefficiencies and distortions. The private sector is China’s principal job creator, but Beijing has yet to open many high-growth sectors to it. And policies such as subsidized land and energy and regulatory protection shield state-owned firms from market discipline.
This handicaps Chinese private firms and impedes job creation. By failing to open to U.S. and other foreign competitors, China is also denying itself the benefits of best-in-class competitive practices.
Breaking state-led oligopolies and opening closed sectors would offer huge opportunities to private Chinese and American companies alike, including small and medium-size U.S. firms in sectors such as health care, clean energy and water treatment that offer services and technologies China badly needs.
The United States needs more investment, too. China is already the top market for U.S. agricultural goods, purchasing 20 percent — or nearly $30 billion worth — of all U.S. exports in the sector. In 2011, the value of farm exports to China supported more than 160,000 U.S. jobs. Direct investment from China can expand these opportunities. For example, a private Chinese firm has bought Smithfield Foods, and the company’s pork exports to China jumped 45 percent in the first half of 2015. Total direct Chinese investment now exceeds $54 billion, including green field investment.
One way to assure these gains would be through a high-standards bilateral investment treaty that supports reforms in China while giving China a fairer shot at the U.S. market. But negotiations have bogged down over the scope of market-opening on each side. Xi and Obama need to give their negotiators a lift.
Third, as treasury secretary I saw firsthand during the 2008 financial crisis that the world needs effective economic governance. Global economic institutions simply will not adapt to 21st-century realities and function effectively without U.S.-China coordination.
That is why the Group of 20 was put in place in the wake of the crisis. The advanced industrial democracies share interests, but they cannot monopolize global economic governance if it is to be effective in tackling current challenges and future crises.
The G-20 will never work without a smooth U.S.-China relationship. And on issues such as climate change, joint U.S.-China action can help to spur broader progress from other G-20 members. We also need an enforceable, rules-based cybereconomic regime to punish and curb cybertheft. This requires the cooperation of all the major economies, including China.
Likewise with international financial institutions. It is high time to implement reforms to the International Monetary Fund and World Bank to give China and India, among other large emerging economies, a role that reflects their weight. Unless we do, economic governance will further fragment. China and others will form new institutions.
Beijing’s creation of the Asian Infrastructure Investment Bank is a case in point, and it will test Washington in this regard. The United States mistakenly opposed it. Now, it should help to shape the bank — preferably by joining it, certainly by becoming an observer, and in any case by encouraging existing institutions to work with it to shape its rules and practices and jointly fill Asia’s multitrillion-dollar infrastructure needs.
More broadly, China’s foreign policy reach and ambitions are naturally expanding to match its growing network of trade and investment links. Having China as a key participant in an evolving rules-based global economic regime has the potential to mitigate foreign policy conflicts between the United States and China.
Xi will land in Washington this week at a time of increasing mistrust and growing tensions. The list of issues that divide the United States and China is long, including conflicts over cybersecurity, human rights and the South China Sea.
Yet we ignore at our peril the shared economic interests that benefit millions of Chinese and Americans and that have formed the core of the U.S.-China relationship since the end of the Cold War.