Assessing Global Economic and Political Risks in 2016

Monday, January 25, 2016
China Daily/Reuters
Lawrence H. Summers

Charles W. Eliot University Professor and President Emeritus, Harvard University; Former Secretary, U.S. Treasury (1999-2001); Former Director, National Economic Council (2009-2010)

President, Council on Foreign Relations

CFR President Richard N. Haass and Harvard University's Lawrence H. Summers discuss the global political and economic outlook for 2016. Their conversation begins with a consideration of recent economic volatility in global equity markets, stemming primarily from financial instability in China and plunging oil prices. Haass and Summers go on to assess the position of the United States, the possible outcomes of the U.S. presidential elections, and the prospects of unexpected political instability across the globe.

HAASS: Well, good afternoon, and thank you for being so intrepid as to brave what’s now the slush. We should probably create a piece of, like, Council party favor, which is a shovel with our logo on it. (Laughter.) So we can work on that for next year.

Here with Larry Summers. Larry doesn’t need much, if any, introduction. As you know, he’s former secretary of the Treasury, former president of Harvard University, where he is now active as a professor. But he’s also active beyond the confine of the Yard in that he really is a public intellectual in this country and around the world, adding to the debate about things economic and more than economic.

So what we are going to do is have a conversation about 2016, the Outlook as we call it, and then we’ll open it up to you for questions. As you might expect, there will be a slight division of labor up here, where I will ask Larry more things about economics and he’ll probably ask me a few things about geopolitics. And then, again, we will open it up to you all.

So, Larry, let me start with you. And imagine this were actually a year from now, the end of 2016 or the beginning of 2017. What is your sense of what are likely be the dominant bold strokes of the year, the dominant themes of 2016?

SUMMERS: Whatever happens in the U.S. presidential election, which I don’t presume to be able to forecast, will surely be in anybody’s sense of what defined America and what defined where the world is going in 2016. And I’d have to say that the risks that that will be an extraordinarily frightening outcome, as judged by most people in this room, are substantially higher than they are in January of most election years.

Second, there is at least a reasonable prospect—I would say it’s probably one in—probably one in three, maybe slightly more than that—that a substantial downturn in the world economy, with the U.S. playing a prominent role, will be a defining—will be a defining story. It’s true that markets have predicted—Paul Samuelson said 50 years ago that markets have predicted nine of the last five recessions. It’s also true that professional economists have predicted zero of the last five recessions. (Laughter.)

The Economist had a remarkable statistic. The IMF makes forecasts for every country every April. There have been 220 instances across several decades and some number of countries where growth was positive in year T and negative in year T+1. Of those 220 instances, the IMF predicted it in April in precisely zero of those 220 instances. So the fact that there’s a sense of complacency and relative comfort should give very little comfort.

Industrial production down from a year ago. A number of recent indicators weak. GDP slow in the fourth quarter. Markets highly uneasy. Credit spreads widened out. Global economy in substantial trouble. Inflation expectations well below 2 percent. I mean, think about this: If you look at the industrialized world as a whole—the United States, Europe, Japan—markets are now predicting inflation over the next 10 years to be about 1 percent, and they’re predicting real interest rates to be zero. Well, they may not be exactly right, but that is a long-run pessimistic judgment. When you’re growing close to stall speed—you’re growing close to stall speed, the risks of a crash are that much greater. And, of course, with interest rates already in the zero range, the capacity of monetary policy everywhere to respond if trouble comes is much attenuated. That’s the second story.

The third—I’m going to have two more—the third story that could be there is what happens in China. The experience in East Asia is that driven growth based on investment and exports produces very good results until it doesn’t. And that when it doesn’t, there is substantial discontinuity and a substantial slowdown in the growth rate. That’s the way it was in Japan in the early ’70s. That’s the way it was in Japan after the bubble burst. That’s the way it was in Indonesia, Korea, Thailand, and so forth in 2007. And there have got to be very substantial grounds for concern, both structural and financial and conjunctural, with respect to China going forward.

And the fourth thing I’d say—and this starts to touch on your area, so I’ll ask you to elaborate on it more, Richard—is Europe. Right now, from an economic point of view, things are feeling marginally better in Europe, with some acceleration in growth. The politics around refugees are singularly surly. Mrs. Merkel is under more pressure than at any time in a decade and is unlikely to have capital to spare to deal with issues other than refugees over the next decade. Mario Draghi has been a remarkable figure in keeping the euro together, but his—he has less in reserve than he once did and probably less political support than he once had. Greece is somewhat out of mind, but not out of the woods. Brexit is close to 50 percent on most—on most judgments. Finland has not been profligate on any construction of any kind that one can conceive of, but is having profound economic difficulty and very substantial surliness towards the European Union. So I’d say the fourth thing that could be a real issue is a kind of breakdown and loss of a sense of such forward momentum as there has been in the European Union project.

How do you see that from a political point of view? (Laughter.) And how would—and also, how would you judge—leave aside the question of the probabilities of a more negative economic scenario in China, where you were asking me for possibilities, not confident forecasts. How would you expect disappointing economic performance in China to influence their behavior in the geopolitical realm?

HAASS: Let’s start, then, with China. There’s actually a big debate going on, or two big debates.

One is the economics debate, which is, are the pessimists overdoing it? And so that’s one debate. And you know, I lean towards the more pessimistic side myself. I don’t have a lot of confidence in the numbers and the like.

But I would say two things that are—to look for. One is—and we’re seeing signs of it—which is greater political lockdown at home. I would just think that, without the lubricant of fairly robust levels of economic growth, one expects Chinese politics to get more top-heavy. The anti-corruption drive has already put some of that into effect, and I don’t think there’s any chance that that fades as the year goes on.

There’s a bigger debate going on, is to what extent does China use foreign policy and geopolitical adventurism as something of a venting mechanism—that, if you can’t satisfy the folks at home with 8 percent economic growth, you satisfy them with nationalism, and you assuage that? There are those who think we’re seeing elements of that already in the South and East China Sea. On the other hand—and there I end up being slightly less alarmist, I guess is the word, because I think that China, as it slows down economically, is going to need a stable external environment. The last thing it could handle is a turbulent external environment. So I lean on the side that you won’t see a tremendous geopolitical push by China to offset or compensate from lost political standing. But I simply say that that is a robust debate, including people here at the Council as well as beyond.

Elsewhere geopolitically and the things I feel fairly confident about, Larry said quite a few things about Europe. I don’t disagree with essentially any of that. And what I think it means is that Europe not only grows at a fairly modest level, but its role in the world is fairly modest. Fringe political parties do rather well. The EU, I think, faces probably its greatest crisis since it—in some ways going back to the momentum of the European Community, and before that the Coal and Steel Community, because you have not just the British vote—which could be this spring or summer, what have you—but also the whole reversal of Schengen and the whole openness, which is really one of the fundamental features of Europe. We’re seeing the divisions.

Don Rumsfeld got ridiculed for talking about old and new Europe. We’re actually seeing elements of old and new Europe. And I just think that we’re seeing, in some ways, within Europe the renationalization, and the balance between Brussels and nations is moving in the direction more of national governments. And I think that trend—that trend continues.

The part of the world that’s given us the most heartburn over the last few years I see—which is the Middle East—I see zero reason to be more optimistic. Sorry, just zero reason to be more optimistic. And in particular there might be elements where you see a little bit of progress possibly, conceivably. In Iraq there are some positive signs. We’ve got a long ways to go in Syria at both levels of Syria—both at the diplomatic level, where we can’t quite agree on who should be there, much less on what the outcome should be, hence the postponing of what was to be today’s meeting; but even if you could get a little bit of progress at the diplomatic level, to translate that into progress on the ground is an enormous leap. So I would guess that Syria a year from now doesn’t look materially different or better than it looks today. You’ve got real questions, also, about what’s likely to happen on the north, where you have a looming clash between the Syrian Kurds, the YPG, and Turkey over what kind of territory the Syrian Kurds will be permitted to control.

Libya, I don’t see many signs of progress.

Yemen is in full force, and again I don’t see signs of progress. I don’t hold out much hope for the diplomacy there. And I think for the Saudis, who have made a major investment there, it’s one of those classic situations where it seemed like a good idea at the time, but it doesn’t seem like such a good idea now about what to do about Yemen.

Iran will have access to far more resources than it’s had, so presumably its regional behavior will, if anything, be, shall we say, more robust, and—getting slightly ahead of ourselves.

And I think one of the real question marks for the year in the—in the Middle East is what happens in Saudi Arabia. And I would simply say that if I had my list of big things that I’m not quite sure what percentage of possibility, but I would simply say more than negligible, would be uncertainty about the political orientation of Saudi Arabia, in part because of their heavy investment in Yemen, in part because of the infighting in the royal family, in part because of low energy prices and what it means for their ability to essentially spread money around to placate their society, and in part because of ISIS. If ISIS is essentially stymied in Iraq—and that seems to be, for now, the situation, where they’re getting slightly, gradually rolled back, and they’re also—they’re not going to unseat the Assad government in Damascus; the Russians have made a real difference there. And if you’re ISIS—you’re a momentum play—then it seems to me a question of when and not if they look at Saudi Arabia as a place to demonstrate that they still have the capacity for momentum. And I would just think that that is quite possibly going to be one of the features of 2016, is a greater challenge to Saudi.

I’ve left out other parts of the world. I’ll only mention Latin America for one reason, and that’s something I want to talk to Larry about, which is that there’s some examples of good news also. And I look at Latin America and, yes, there is, you know, lots of questions, but Mexico’s economy looks pretty good. The reform process unevenly, but all in all continues.

Argentina, some interesting signs for the—for the better.

Venezuela, now you have an opposition in parliament. And again, we’ll see how that plays out, but at least there’s reasons to believe that something more positive could ultimately come there.

You’ve got the normalization, or elements of it, between the United States and Cuba.

I’m aware of the overhang that is Brazil. But with Latin America you do at least have some positive signs economically and in some ways, Venezuela excepting, no sign of conflict on the horizon. It’s almost—Latin America is, to me, noticeable in some ways by a lack of geopolitics, and that’s not a—not a bad thing.

So let me push it back to you, Larry, and ask you, when you look around the world, what is it—I’ll actually ask you two questions, unrelated, but maybe. One is good news that you think, the things that you see out there that actually, rather than give you pause, give you some reason, some positive. And second of all, I guess to be the equivalent of black swans, what you think are the big things that are low probability, high consequence that you think are sitting out there that aren’t getting the attention they maybe deserve?

SUMMERS: Look, the big things are—that are positive are not the individual policy accomplishments that are going to happen in 2016. They are the continuation of profoundly important trends that historians will look back on as being more important than a lot of the stuff you and I talked about. It’s the fact that, over my professional lifetime, child mortality in the developing world will go from 100 out of 1,000 to a little above 20 over 1,000. It’s the fact that the presumptive location of an 11-year-old in the developing world in the 1980s was out of school and the presumptive location of an 11-year-old today is in school. It’s the fact that, for all of what’s happening in Syria, in Africa, in a variety of places that we’re worried about, the number of people who will be killed in a war in 2016, assuming it’s like 2015, as a share of the world’s population will be one-fifth of what it was in the 1970s, let alone what it was in the first half of the 20th century. It’s the fact that, if you define—and who knows what exactly the number means—poverty as having to live on a dollar a day, over the next generation poverty on planet Earth will be eradicated. It’s the fact that Bill Gates is saying that within a couple of years there won’t be any more polio, and that’s related to the fact that by 2020 there will be more smartphones on planet Earth than there are adults on planet Earth. And some of that’s due to the people in Hong Kong who have four of them. (Laughter.) But—

HAASS: Some of that’s due to the children of people in this room also. (Laughter.)

SUMMERS: But it’s still true that that is an extraordinary—that is an extraordinary thing. So while we worry about the various decisions governments will make and the ways in which they will interact, there is a huge tidal wave of progress. You know, you and I are old enough to remember hiding under our desks in elementary school for a nuclear weapons civil defense drill. You and I are older to—are old enough to remember much more acutely being worried about being drafted to serve in a war where tens of thousands of American soldiers were going to die. So I think that it’s right to focus on the various things we worry about, but it’s mostly right because it’s part of their becoming self-denying prophesies, and that generate resilient responses that in one way or another muddle through for a while and then ultimately solve problems.

I think I already hinted at, you know, the downsides are serious economic downturn, real breakdown of the euro area, China—

HAASS: When you say serious economic downturn, what is it—what would that look like?

SUMMERS: So I’m going to answer the question, but I don’t want anybody to confuse my answering the question what would serious economic downturn look like with my predicting that there will be such a serious economic downturn. I said one in three of a recession. By the way, if the Fed actually carries through with four increases this year, then I think it’s probably closer to one in two of a recession. But I don’t think they—but I don’t think they will, which is why I’m predicting one in three.

But what does it—what does it look like? The confidence in China starts to deteriorate. As in some—as in February, they have to spend $250 billion holding the currency, and people calculate that at that rate the reserves will all be gone in a year, so they can’t do it. And then they have to spend $350 billion in March or they can’t do it, so at some point they give—at some point they give up. The currency falls 15 percent, 20 percent, exporting huge pressure—deflationary pressure to the rest of the world and leading to a major switch in demand towards China. In that process, the price of oil falls to a point where the world is glutted with it and it has to be stored on tankers, which is enormously expensive, and so the price falls below $20. There’s a revision in sentiment about the global economy in the United States, and so stock market investors decide that the price-earnings ratio on the U.S. market, instead of being at the 85th percentile of history, should be at the 25th percentile of history, and at the same time corporate profits fall by 20 percent. And those two things are sufficient to take the Dow to 8,500. The—

HAASS: Can I withdraw the question now? (Laughter.)

SUMMERS: But I’m saying, I don’t expect any—I don’t expect any of that. But just think about the last—think about the last thing I said. Is it—it’s not—it’s not at all what I would predict, but it is not beyond the realm of possibility that multiples in U.S. markets would start to look like a significantly below-average level rather than a significantly above-average level. And it’s not beyond the realm of possibility that, in a troubled global economy, profits would fall 15 or 20 percent. And then the rest of it is arithmetic. And, you know, by the way, I think we’ve done a great deal to make financial institutions more robust, but if you take a scenario of the kind that I just described, there would at least be some questions about some major global financial institutions.

Again, that’s not my prediction, but it is why I think those who are worried about overheating the economy and generating inflation, rather than being worried about slowdown, low-flation, and difficulty of response, are sort of entirely missing the central issue of our time, from an economic point of view.

HAASS: Let me just throw out a few things on the political side, just to lighten things up. (Laughter.) It’s great, yeah. I’m so used to being the bad news bear in the room, so this is—this is actually a delight. (Laughter.)

One I’ve already talked about, which is Saudi Arabia.

Another Middle Eastern thing that worries me is an incident in the Temple Mount that one can imagine coming from either direction, but that would then be an explosive event throughout the world.

And then there’s two countries who I find—probably the two most—or two of the more difficult intelligence targets. One is North Korea. We’ve just a had a demonstration there, so the question is, what might they be up to at some point?

And the other is Pakistan, where you’ve got what I would call kind of a congenitally weak government. And the issue is whether at some point there’s another, for example, terrorist attack that emanates from Pakistan, strikes India, and I don’t think this Indian government, like the previous Indian government, is big on turning the other cheek. So I can imagine some sort of a confrontation of sorts in South Asia, and there have been things like that before. And then it’s a challenge to the locals, and to the United States in particular, about whether something like that can be—can be managed before it—before it escalates.

One thing we didn’t mention, and I want to—I’ll talk about and then I’ll turn to Larry for the other and then we’ll open up, which is—which is, in Europe, I don’t necessarily see the Ukraine situation in any way as escalating. As I look at what’s happening there, the tea leaves, it seems to have slightly quieted. I wouldn’t want to exaggerate it, but I don’t get the sense that Mr. Putin is getting up every day looking how he can stir that pot any more than it’s already stirred.

Larry, if the scenario you just talked about were to happen, I think it would crater TPP. But let’s assume your more likely scenario happens, where the worst doesn’t ensue. What is your sense for the prospects for TPP this calendar year? Some people are saying possibly the lame-duck Congress. What is your sense about the likelihood of that?

SUMMERS: None of—wouldn’t I be right in saying that, whoever you think the four most likely Americans to be the next president of the United States—who are probably Ted Cruz, Donald Trump, Bernie Sanders, and Hillary Clinton—none of them are in favor of TPP. That has to say something about the political—the political environment. I would like nothing better than to be wrong, but I’m finding it difficult to envision the scenario in which a new president signals the Congress that they want to see TPP passed during the lame duck, or the scenario in which a—or which the Congress, when everybody in the presidential campaign has been against TPP, decides to make this a—to make this a priority in the lame duck. I think the most likely scenario for TPP is that—most likely positive scenario for TPP is that a new president, in a—what is certainly a strong tradition, particularly among Democratic presidents, moves to a different place on trade issues than they did—than they occupied during their campaign, and gets—has some element of renegotiation or re-discussion that provides a basis for moving forward. But that’s not a process that can take place between Election Day and a congressional lame-duck session. So I would defer to you and I would defer to others in this room on the question of political prognostication, but I’m finding it a little hard to see how it happens in a lame duck. The Republican majority says one final bit of legacy gift for the outgoing President Obama? It could happen, but it doesn’t—(laughter)—it doesn’t overwhelm with likelihood. So I’m sorry to—I’m sorry to say it, but I think that—I think I probably would think the odds are reasonably good that at the end of the day TPP will happen, but I’d be surprised if the timing was during the lame duck.

HAASS: OK. Let’s see what—let’s open it up for questions from our members. Just the standard drill: just let us know who you are, keep it short. And we’ve got—we’ll bring the microphone around to you.

Q: Hamid Biglari.

Larry, my question is about the deterioration of liquidity in markets. So there are three structural changes that have happened in markets that make this far more dangerous today than in the past. The first is that the number of heterogeneous market participants has decreased, and the ones that are playing now are much bigger than they were before. Second is that there is a lot more algorithmic trading happening in the market, which—many of which are similar to each other, which means that herding behavior is more prevalent. And the third is that the market intermediaries are playing with far less inventory than they did because of capital rules and just the lower economics. So this—it feels like there’s a supply-demand imbalance. And if there’s a sudden rush to the exit, we may find ourselves with the next major financial crisis. I wonder what your view of that is.

SUMMERS: Never say never. I think that is—I think the scenario you describe is a risk, and a real risk. I think the experience has been—and the experience is short, and I’m with you on there needs to be a lot of thought and then a fair amount of action to correct the set of issues that you described. On the other hand, if you take—1987 is, in a sense, the classic example of what you just described. Markets were stretched, they were overvalued. Fundamentals and everything were kind of OK—yeah, there were problems, but were kind of OK. But there was a massive market breakdown which produced a massive event.

If you looked back, if I showed you a set of data on all the economic statistics and I didn’t label the dates, and I said, find 1987 and its aftermath, you couldn’t do it. You know, things slowed down for a little bit in the fourth quarter. So I don’t know that we have examples of market structure crises breaking down that have turned out to be fundamentally important economic events. If you look at the 2008 crisis, if you look at the depression, if you look at the Asian financial crisis, if you look at most of the crises we remember, it was about something more than there being a moment when markets couldn’t handle all of the pressure.

So if you said, what are the odds that there’ll be another moment when the 30-year treasury moves 50 basis points in 11 minutes, or the DOW makes a 1,700 point round-trip in 13 minutes—if you said, what are the odds that something like that’ll happen, I’d say abnormally high and certainly higher than they’ve been in the average year in the past. But if you said: What are the odds that that will happen in a way that will lead to an extra million people being unemployed? If we have a downturn of that kind, I think it’s more likely to have to do with the somewhat larger and more fundamental forces that I talked about when I sketched an adverse scenario, which is no reason not to be very worried about the question you raised, just I don’t think it’s the primary financial risk.

Q: Thanks. Yves Istel of Rothschild.

In the past when there have been major increases in the price of oil, they were considered as bad things, equivalent to tax increases. Could you expand on why the reverse seems so different this time around?

SUMMERS: Why the price of oil—

Q: Why with the decline in the price of oil it’s not viewed as a tax cut and a very strong pro-consumer event.

SUMMERS: So I think it’s a very good—so I think that’s a very good question, and if you had told me what was going to happen to the price of oil and you had asked me to predict what the reverberations would be, I would have gotten it wrong. But in the spirit of the person who said that econometrics is the study of forecasting the past with ever greater precision—(laughter)—I can attempt some elements of explanation. And I think three stand out.

One, some of it that you never—when the price of oil was going up, you never knew whether it was the fact that the price of oil was going up, or the fact that there was a big change that was causing it. You know, whenever there’s a big change, the losers are more unhappy than the winners are happy, and so on net it has a negative aspect. And I think there’s some of the dynamic going on.

Second, I think there may be—it is the feature of fracking that it is fast-on, fast-off. And so at other moments, when the price of oil went down, people were embarked on $2 billion exploration programs, of which they’d already spent the first $1.2 billion, and it was kind of hard to turn off because, you know, you had to do the program to get it, you had to do the program to get anything, so you kept going. In contrast, fracking, it’s more like a vending machine. You put your money in and wait three months and you get your oil out. So when the price goes to where it is now, you get a sudden collapsing of the investment spending.

And I think the third thing is that I’m not sure we know quite what liquidations are being generated as a consequence of this. And I think there’s at least a possibility that some of the producing countries that are now under very severe financial pressure have to liquidate something. And the thing that’s easiest to liquidate is their public equities. And that that’s a source of substantial pressure on equity markets.

The big puzzle—the big puzzle that I don’t—that is explained by my last remark, but I’m not sure how convincing the explanation is, but I don’t have another good explanation, is it’s easy to understand why oil should go down and the market should go down as well. If demand’s collapsing—suppose you just get really pessimistic news about the world economy and what would you expect to see? You’d expect to see the price of oil fall because there isn’t going to be any demand. And you’d expect to see markets fall. And you’d expect to see forecasts decline.

So in a sense, if the oil decline is caused by demand rather than caused by supply—the oil increases that you described were caused by supply interruptions. If this oil increase is caused by a demand decline, then you’d sort of expect it to go with bad economic news. So I think that’s probably core to understanding it. The puzzle is, you have a variety of days in the last month, like happened overnight, where there’s a pretty clear headline: Oil prices rise on—or, oil prices fall on new production from somewhere.

So it’s pretty clear that the oil price was falling because of a supply bit of news. And even on those days, the stock prices fall, and they fall even in countries like Japan where there aren’t any oil exporters and where it’s all oil imports. So I think there’s a puzzle. And the liquidations that I described may be an element of the explanation. And the other part of it that’s crucial is you’d expect something very different from a demand shock, which is probably the dominant part of what we have now, than from a supply shock.

HAASS: I’d just add one or two things. I mean, the one country that seems to be benefitting as much or more than anyone else is probably India, which is one of the few really also good news stories in the world also economically, but it’s obviously dramatically decreased its oil import bill. I think it’s—there’s a difference between the producers and others. I mean, the producers are—obviously Mexico will be hurt, even though they’ve reduced the percentage of the federal budget that relies on oil revenues by half.

Obviously the Russians—you saw the story, perhaps, in The New York Times over the weekend. And I think there’s interesting questions about, you know, if the Russian economy is shrinking at 3, 4 percent, the potential for some protest or instability there. And the question Larry asked me about China could also be asked about Russia, whether that would push Russia to be geopolitically more—sort of conceivably more with Russia than with China, given the degree—Russia’s less economically interdependent, in some ways, than China is. In the world, obviously, Saudi Arabia, we talked about that before.

I would just sort of agree with Larry that I think so much of this—the reason it’s not much more good news is that it’s really a combination of American and other supply, Iranian supply will add to it, be a further factor weighing down against prices and then lower demand. And so it’s—that’s what’s out there. And my guess is at the end of the year it’s easy to see oil where it is, plus or minus, rather than in a fundamentally different place, which still quite a stunning departure from where it was until recently.

Yes, sir.

Q: I’m Matthew Sippel from Indus Capital.

Larry, what prescription would you give to China to help heal some of its ills? And, Richard, what—do you think the dynamics of the leadership structure in China now is open to hearing those suggestions?

SUMMERS: I think we have probably made a mistake over the last couple of years in—we, the United States, and I think we, the international community—have made a mistake in part of logic and frankly in part of following financial interests, in putting substantial emphasis in our dialogue with China on financial liberalization and encouraging financial liberalization. And I think that the position that we have tended to take—we, the United States and the international community—which is we want financial liberalization and a more flexible remedy that floats upwards has been a sort of intellectually incoherent position because the reality has been that the market forces—that would have been a good position to have taken four years ago. But the reality has been that on net the desire of China is for capital to leave rather than for capital to enter.

And so it seems to me that we have sacrificed quite profound near-term values around growth and health of the world economy for the rather abstract long-run values associated with China’s membership in the SDR and the like, and that we have done it in conjunction with a substantial number of Chinese financial authorities, who have welcomed the international pressure to pursue what was their agenda of financial liberalization. So I think that probably some going slow on that agenda is one aspect of what I would recommend. I think the other parts of it are not that complicated to describe. They’re extremely complicated to execute. They go to the importance of state enterprise reform, in particular. They go to empowering the Chinese consumer.

Fundamentally, a choice has to be made about the substantial positive cash flows that are generated by a significant number of Chinese state enterprises. Are those cash flows going to go to support the new Chinese economy by going to households to spend on what they wish? Or are they going to go to a kind of convoy system model of keeping solvent and keeping going, existing but not market-viable state enterprises. And I think a change in that direction, which is complex politically, is probably indicated by the economic logic of the situation.

And I’ll just say one thing about the political part of it, and then Richard will give a much more informed answer. It seems to me that there is a profound tension—and this is one of China’s great challenges—between what is the central imperative for the Communist Party, which is maintaining control, which is done in part through force and strength, but is done much more through the selective dispensation of favors. On the one hand, being committed to the selective dispensation of favors to maintain social control, and on the other hand being deeply committed to anti-corruption as the route to legitimacy, those two objectives are in very substantial tension with each other. And that creates a very difficult balance that Chinese policymakers have to maintain.

HAASS: The world dilemma is overused a lot, but I actually think the Chinese leaders face a real dilemma. And Larry, I thought, got at it exactly right. There are things they know they need to do for long-term economic robustness and health and success. But in order to get to the long term you got to survive the near term and the medium term. And I just think it creates many competing pressures on them. So there’s been a lot of talk in recent years about moving more to markets, about shifting demand away from export to domestic consumption and so forth, that just pull—and among other things, also phasing back or out even state-owned enterprises.

And in principle, all that is good stuff. But in practice, all that is extraordinarily difficult stuff. So my guess is, since the principal concern of Chinese leadership is the physical integrity of the country and the position of the party above all, that it won’t do most of those things. And I think China will have something of a batten down the hatches approach. And we’re already seeing it with the trajectory, if you will, of phasing down support—dialing down support for state-owned enterprises. We’re beginning to see reversals there. We’ve seen the uneasiness with high market fluctuations.

So my own prediction is that the Chinese will find it very hard to stay the course of significant economic reform. Again, even though that might have real long-term consequences, you got to get to the long term. And my hunch is they will opt for a bit of stability and what they see is sort of the security of the familiar in the near and the—and the medium term.

Joan Spero, the former undersecretary for economic affairs.

Q: How does the new Asian development bank, I forget the name of it, fit into all of this, both economically and politically?

HAASS: You mean the infrastructure bank?

Q: The infrastructure bank.

HAASS: Well, I’ll let Larry speak about the economics. I would simply say that in terms of foreign policy malpractice, it figures high on my list. And no one has actually written a definitive public account—

Q: Ours?

HAASS: Yeah, ours. But this was something that it wasn’t clear to me why exactly we opposed it. I thought the idea was to get China to become a greater participant in various types of regional and global machinery. And even if we had some questions about this, for good reason we still could have said, well, then we would support it, if you were to do certain things. Instead, we did not suggest what those things were, we tried to get everybody not to participate, and we failed. So it seemed to be we got it wrong coming and going. Belatedly now we seem to be coming around the idea that maybe, just maybe, under certain circumstances we would look at it somewhat differently. But this was—this was botched.

And I simply think that this was an unfortunate—it’s not a major story, but it’s a minor story. And in some ways, one of the worst pieces of it, is it persuaded a lot of Chinese that the principal purpose of American foreign policy is to deny China its proper place in the sun. And I don’t think that’s true. And I think our policy needs to be one of integrating China on rules that are mutually acceptable in the region and the world. And this, to me, was an opportunity to reinforce that. And again, I would have argued not for unconditional American endorsement of the Asia—of the infrastructure investment bank, but conditional support, which is essentially where I think we’re coming around to now. It’s just was a bit of an awkward, circuitous path to getting there.

SUMMERS: I’ll speak slightly more gently than Richard did. With hindsight, it surely could have been managed better. Here was the—here, I think, was the problem: The probability that the U.S. Congress in any political environment like the current one would fund a Chinese development bank—a Chinese-led development bank that did not have the various congressional mandates that had been applied to the World Bank and other banks was roughly zero. And so having that bank go forward with the United States declining to fund it was obviously going to be a very unattractive strategy for the United States. And so the choice was made that maybe we could cause it not to go forward and avoid that embarrassment.

It’s not unlike a decision that was made, regrettable on similar grounds, during the Clinton administration not to provide first line—not to support first line of support money for Thailand at the very beginning of the Asian financial crisis, not because one didn’t want to be part of solidarity with Asia, but because that would not get through the Congress. It would create a larger problem. So I think that was the dynamic that caused it. And I think ex post getting positioned in a way where Great Britain led the charge of repudiation of the United States was hardly a successful bit of policy management. But I think you do have to understand what the dilemma was.

I think that this is worth—I think the bank is a symbol of a larger thing. Look, here’s another part of the problem or the challenge as the world looks from China. China laid more cement in China between 2011 and 2014 than the United States of America did during the entirety of the 20th century. So they have a vast capacity for laying cement and building infrastructure—immense. (Laughter.)

HAASS: Clearly.

SUMMERS: And they kind of—they kind of put airports in all the places where there were people, and a lot of places where there weren’t yet people. And so there is both an economic imperative to continue to employ those resources, and a geo-imperative to build close connections, and ultimately, you know, to run a kind of reverse Marco Polo from China back to Europe.

And that’s what this one belt one road initiative is all about. It’s about both the maintenance of full employment and sufficient demand, and the geopolitics of providing the—you tend to get along better with people for whom you provide connective tissue than people to whom you don’t provide connective tissue. And that’s what one belt one road is all about from the Chinese point of view. And the AIIB is an important aspect, but only one of quite a few aspects, of what is a much broader geoeconomic strategy around expansion towards ultimately a land connection with Europe.

HAASS: A lot of people have their hands up. We’ve got time for one more. There’s been a gentleman in the back who I’ve ignored for about 45 minutes. So we’ll get him. And I apologize to the others. It’s the gentleman with the red tie, sitting there, if someone would hand him a microphone. And if you keep the question short and we keep the answer short this will work.

Q: Thank you. Charles Seville, Fitch Ratings.

I just wanted to take us back to the U.S. Larry, you alluded at the beginning to slightly sub-optimal, sub-par growth and economic outcomes, and that’s partly why people are supporting the presidential candidates they are. I wondered, do you see any good ideas out there for solving some of those problems, and the chances that they will be adopted?

SUMMERS: Look, there are hard questions and there are relatively easy questions. If you have a country that can borrow money for 30 years at below 3 percent in a currency it prints itself, with epically construction unemployment and record low materials costs, it is an astonishingly bad idea to have the lowest level of net infrastructure investment in 60 years relative to income.

Look at the cost of borrowing, and look at LaGuardia Airport. (Laughter.) Look at the cost of borrowing, and look at an air traffic control system where oak tag bulletin boards and yellow stickies play a crucial role in guiding your flight to landing. So the first and most obvious thing to say is that there has been no better time to stimulate demand in the short run, supply in the long run, and to remove burdens from our children in the form of deferred maintenance through a major program of renewing the country’s infrastructure.

That’s not just a public sector concern. That’s a private sector concern as well, which goes to—you know, I make fun of the airports and all of that, but the truth is that a phone call is more likely to be dropped driving from LaGuardia into New York City than it is driving from the Alma-Ata Airport into downtown Kazakhstan. (Laughter.) And that’s about private structure—private sector infrastructure investment, which goes to a whole set of things in the regulatory environment, in the incentives that are provided to corporations.

Another example in the private sector is, has there ever been a moment to put coal in our past—a better moment to do that than now? That creates demand in the short run, environmental improvement in the medium run, and capital costs will never be lower. So that’s one crucial part of, it seems to me, getting things going.

I think a recognition by the financial authorities that if—that the problems used to be over-lending and over-heating, but today’s problems are low-flation and lack of availability of credit for many in small- and medium-sized business. And an orientation of financial policy to that would move things—would surely move things forward. There were lots of people who got loans to buy houses in 2005 who should not have gotten loans to buy houses in 2005. There are plenty of people today who should be enabled to purchase a home, who have good but not great credit, and who are not able to get access to that capital. So I think the priorities have to attach to stimulating public investment, stimulating private investment.

And I would say on final—one final thing, and I think this can be overdone, but I’ve come to think there’s substantial truth in it. When I was a student, we—an economics graduate student, 40 years ago—we were taught about a fundamental tradeoff between equity and efficiency, that you could make the economy more equitable but in order to do that you’d have to have more redistribution of various kinds and that would mean higher taxes, it would mean that as people got benefits you took more away when they got richer, and all that created disincentives, and so you had to choose a good place in the tradeoff between equity and efficiency. And there’s still substantial truth in that idea with respect to some policies.

But at a time when the economy is short on demand, the consistent trend towards income moving away from the middle class is leading to more of it going to people who don’t spend it, don’t inject it back into the economy, don’t create demand, and that is contributing to the sluggishness that is part of our problem. And so appropriately progressive taxation, a minimum wage that was higher than the minimum wage when Ronald Reagan was president—because we have made some economic progress since then—and such measures would, I think, also contribute to accelerating the growth rate of the economy over the next decade.

HAASS: I would concur with what Larry said on infrastructure. (Laughter.)

With that, let me thank Larry for giving us his time, and thank you all for coming out here today. (Applause.)


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