Foreign Affairs November/December Issue Launch: Who Killed the Chinese Economy?

Tuesday, November 14, 2023

Maurice R. Greenberg Fellow for China Studies, Council on Foreign Relations; @ZongyuanZoeLiu

Senior Fellow, Carnegie Endowment for International Peace; Professor of Finance, Peking University; Author, Trade Wars Are Class Wars

President, Peterson Institute for International Economics; CFR Member


Executive Editor, Foreign Affairs; @justin_vogt

Foreign Affairs Executive Editor Justin Vogt and authors Zongyuan Zoe Liu, Michael Pettis, and Adam S. Posen launch the November/December 2023 issue of Foreign Affairs and discuss the Chinese economy and what is causing its stagnation, along with China’s ability to recover and how U.S. policy is affected.

VOGT: And good morning to everybody. Thanks for joining us.  

This is a dual event. It’s a Foreign Affairs event launched for our November/December issue. But we’re doing this in partnership with our friends at the Peterson Institute for International Economics as well.  

I like to think about what we’re going to do this morning as sort of like a game of Clue—a Foreign Affairs edition of Clue—the board game Clue with the mystery that we’re trying to solve being who killed the Chinese economy, and we’re going to get a couple of different, you know, guesses at that.  

You know, was it zero COVID in the 2020s with the excessive state interventions? Maybe it was Chinese leader Xi Jinping in the 2010s with the civil-military fusion strategy or maybe it was the CCP in the aughts with an outmoded growth model. 

We’re going to get variations on those guesses today from our terrific panel of guests, Adam Posen and Zoe Liu and Michael Pettis. You have their bios. I’m not going to bore you with those. But take my word for it when I tell you that these are three of the very best experts on China and on the Chinese economy.  

They’re going to share our—their perspectives with us on this question. We’re also going to talk a little bit about the current situation in China, U.S.-Chinese relations, and what we can expect to come. So we’re not just going to focus on the past but also the present and the future as well.  

I’m going to start with Adam because actually this entire sort of question was brought to the fore by this tremendous piece that Adam wrote for the magazine a couple of months ago called “The End of the China’s Economic Miracle.”  

That’s what sort of started this debate and the piece that is in this issue of the magazine is what’s called a response package where we asked some people to respond to Adam’s argument and to critique it and then for Adam to respond to them. So in some ways this is like a live action version of that response package. 

And so what I’m going to do is I’m going to start with Adam. We’re going to hear from Zoe. We’re going to hear from Michael. I’m going to ask them some questions. About half an hour in I’m going to turn it over to our audience. We have a lot of people on the call today and I’m sure a lot of you will have questions for our guests. It should be a really good conversation. 

What I’m hoping we get out of this today is not just a sense of the history here—the economic and the political history that’s relevant to the current moment—but a real understanding of how—the way in which you interpret that history can shape the way you understand policy today and policy going forward. That’s really what matters and where the rubber hits the road.  

So Adam and Zoe and Michael, thank you. Welcome, and let’s try this out. Let’s see if we can solve this mystery.  

Adam, let me start with you. Can you explain for me and for all of us what—the idea that you put forward in your original article, which was that what China is struggling with is something that you refer to as economic long COVID. Can you explain what that is and the sources of it and the ramifications for the Chinese economy?  

POSEN: Thank you, Justin. I’ll try, and thanks to you for your editing and for Foreign Affairs for giving us the forum and bringing us all together.  

So, in my view, the stunning fact about China’s economic slowdown is how little bounce China got after reopening in zero COVID, and most economies, including Japan, including other neighbors in Asia, but all high income economies saw some degree of big consumer rebound right after they reopened. In China that rebound barely existed and then fizzled out. 

And so when I look at that what I find more deeply is that you see a huge shift in Chinese household behavior. They stopped buying durable goods, autos, expensive things. Small businesses, which are essentially owned by households, do the same thing. They start putting more and more money into bank accounts and to cash like liquid substances or forms of assets, and in general savings go up. 

But, importantly, they’re moving towards liquidity and I interpret this as a reaction to the zero-COVID policy which made China’s Communist Party and Xi’s more aggressive interventions in the face of the average Chinese person.  

For decades there was what I call the no politics, no problem compact in China. This, to me, was a big part of the actual Chinese miracle, that from Deng until Xi takes power in 2013 if you weren’t a democracy protester, if you weren’t an oppressed Muslim minority or some other ethnic minority, basically you could go about your commercial life. You might have to pay a bribe. You might not always get the contract you wanted. But basically you were left alone as long as you did no politics. 

Starting with Xi’s consolidating power in 2015 but especially with their zero-COVID crackdown average Chinese suddenly were subjected to your company is closed, you can’t go to your job, you’ve lost your business, and it’s arbitrary by a given party member in a given city making up their mind. And this resonates in a way with the people that putting an Alibaba executive in jail or putting on an anti-corruption campaign does not, because that’s just abstract leaders.  

And so when we have this this breaks the compact and it’s very hard for an autocrat, which is what Xi and the Communist Party are, to reestablish credibility. They can say, oh, gee, we did it just because of COVID and look at all the millions of lives we saved. 

It’s still not credible that they’re going to go back especially since there’s a laundry list of ways in which Xi and the party have been more and more intrusive in recent years, and the two key points that go with that, this behavior—this long COVID—economic long COVID, meaning the nonresponse of consumers to incentives because they’re hoarding liquidity. They’re trying not to get expropriated. They’re basically scared. 

This occurred well before the breakdown of the real estate market. The real estate market is on top of that. Doesn’t help, but it occurred and is independent of that. And, in fact, the behavior of moving into savings and out of durable goods is not necessarily what the real estate market crash would do.  

And the other point is this goes with a turn against the private sector, not just the big fancy, you know, platform companies but against the private sector more generally in China, which is marked and is different than the previous thirty years in China.  

So, to me, we have economic long COVID in China. The ability to stimulate the economy is very limited even though they keep trying, and therefore there’s pressure for capital, people, talent, and money to exit and that’s the direction I think policy needs to think about.  

Thank you.  

VOGT: And so the sort of metaphor here that you’re making with economic long COVID is that it’s not the virus itself that sort of has caused these lingering symptoms but the kind of overactive immune response on the part of the state that has stuck with us, right? That’s sort of—that’s sort of the— 

POSEN: Thank you for bringing it out. Yes, that is what I wanted to convey. 

VOGT: Sure. Good. Good. 

Zoe, you wrote about this. Obviously, you took up Adam’s article and you wrote a really interesting critique of it. I wanted to ask you, some of—I think some of—if I understand your critique correctly some of what Adam has written you sort of agree with but the emphasis is slightly different.  

Can you explain—I’d love to hear your kind of basic take on his—the story that Adam tells about this and where your view of it differs.  

LIU: Yeah. Thank you very much, Justin, for the opportunity to write this response. 

And, you know, I do think Dr. Posen’s metaphor of long economic COVID is very creative and I do share with him in the sense that in terms of the—how COVID has shifted or put in front of the Chinese—normal Chinese people’s face in terms of the intrusiveness of the party as well as President Xi Jinping.  

However, you know, I would like to consider myself as the student of a lot of these great economists including Adam Posen, including Professor Michael Pettis, as well as Nicholas Lardy and all that. 

Therefore, you know, where I come from, really, I understand this situation as, you know, President Xi Jinping, he did not assemble China’s economic time bomb but I do think he should be blamed for having shortened the fuse, and if I can explain this a little bit more, you know, this is how I view the Chinese economic problems.  

I view it as having the problem of four Ds including debt, demographics, demand, and decoupling. I think Professor Pettis can explain this—interpret the structural problems way much better than I do especially in terms of the debt and demand and demographics and all that. 

What I think President Xi Jinping’s—you know, his share of the responsibility here is that it is really with regard to how his policies accelerated the trajectory of decoupling and, you know, a lot of these—the four Ds that I talk about—you know, debt, demand, demographics, and decoupling—a lot of these problems have long been evident, as Professor Pettis noticed, and he’s written widely about this, and President Xi Jinping and his predecessor they were aware of these problems but they really didn’t do enough to mitigate these long-standing issues.  

So, therefore, I think it’s unfair to blame Xi Jinping entirely for creating all these problems or for the lack of economic recovery post COVID and that’s why I think he didn’t assemble the time bomb. However, really his responsibility is in terms of the last D, the decoupling. 

So this is where I think I agree with Dr. Posen in terms of, you know, the policy missteps that he did have been highly consequential. But I would differ with Dr. Posen in terms of, you know, the role of the decoupling or, for that matter, identifying COVID-19 as a critical juncture. 

I would argue that actually, you know, the critical juncture happened several years before zero COVID—COVID-19 as well as zero COVID because if you remember back in 2013 President Xi Jinping already put out his own personal explanation—his own explanation to what does he mean by—what he thinks reform and deepening reform and opening up means. And in writing and in his speech, he’s specifically talking about, you know, for him reform and open up really is about the emphasis of the state sector, the role—the leadership of the party in, you know, economics and in finance. And, you know, in a way, he has been quite honest.  

And then if we—why this matters for decoupling and why this relates to COVID I would say that, you know, the net effect of zero COVID was actually to make President Xi Jinping overconfident that his assertive foreign policy could be persuasive and, you know, many of us probably still remember the initial shock of COVID the Chinese government response has been—was relatively successful in terms of control of the virus, the spread of the virus compared with the rest of the world and in a way the Chinese government response actually is very much reflective of their—you know, the governance philosophy.  

In Chinese, you know, crisis is the same term. Like—it’s, like, crisis and opportunity is wēi and jī, and you know, wēi is very much like Sun Tzu kind of thinking—in chaos, there is great opportunity. And this is also where I think President Xi Jinping’s draconian zero-COVID policies actually created the debt not just for himself but exacerbated—exacerbated, not created, the previous, you know, demographic, debt, and demand problem. 

Therefore, you know, in our term member meeting earlier this year I described this whole situation as, you know, before COVID or before 2019 when we think about the Chinese economy it looks like a Monet. It’s like an impressionist painting. It looks beautiful from afar but it looks like a jumbled mess up close.  

But after COVID the problems still exist but it’s now like a Jackson Pollock in a sense that it looks like a jumbled mess from afar and a jumbled mess up close. So from that perspective I really don’t think President Xi Jinping should be blamed for the lack of recovery or for assemble the time bomb but he actually did to shorten the fuse.  

VOGT: I like this. We’ve moved from a sort of medical metaphor to an artistic one. Just in defense of Jackson Pollock, you know, tastes may differ. You know, some people like those jumbled messes.  

That’s interesting, though, because I also—I’m thinking about what you said about the overconfidence, that it’s good to remind ourselves that in the early phases of the pandemic, you know, there was reason for the Chinese government and for the CCP to believe that what they had done was sort of correct and they were doing so much better.  

That’s an interesting thing that I think we tend to forget in our—you know, in our presentism. Speaking of presentism I think, you know, Michael, your contribution here and your critique, if I understand it, again, correctly and you can explain this more thoroughly, is that you see the roots of some of the problems that China is now facing far earlier than both Adam and Zoe and sort of not only see them there but believe that they were sort of foreseeable and even foreseen.  

Can you explain exactly what you mean by that? And whereas Adam has talked about the turning point being, or maybe not the turning point but the point of no return being 2020, Zoe has talked a little bit about 2015 and 2013 with Xi’s arrival on the scene. 

You put—I think you seem to put this turning point closer to around 2006 and I’m curious about what are the factors—what was happening then that sort of cast the die, in your point of view?  

PETTIS: Sure. Well, thanks very much, Justin, and thanks, Adam and Zoe.  

The other famous Adam, Adam Tooze, refers to me as the structuralist, and I think that’s accurate. I think it’s a much more structural argument as to what happened with China.  

Basically, the Chinese growth model, this sort of a high savings high investment model, is not particularly Chinese. Many countries have followed it, and it always seems to follow a pretty similar path. You have a period of very rapid healthy growth followed by a period of very rapid unhealthy growth driven by a surge in debt and then a difficult adjustment, and one of my favorite economists, Albert Hirschman, talked about this way, way back in the 1970s and what he argued is that this is what happens to a successful development model. 

A successful development model by definition makes itself obsolete because it resolves the problems it was designed to address, and then you need to shift the model and if you don’t shift the model you end up developing a different set of imbalances.  

And he also noted that almost no one shifts the model and the reason, he argued, is because a successful development model creates a series of institutions that disproportionately benefit certain constituencies that become very powerful and it’s very hard to shift the model because of the blocking efforts by those constituencies.  

Well, you know, he died before the whole China story but he could have been talking about China. And so what I would argue is that this high investment model made a lot of sense in the 1980s and 1990s when China was possibly the most underinvested economy in the world. But with the fastest growth rate of investment they closed the gap pretty quickly between what they had and what they could productively absorb.  

Now, at that point you’re supposed to shift to a different model but no one ever does. Not Brazil in the 1970s, not Japan in the 1980s, not the Soviet Union in the 1960s, and that’s when you end up with very high investment rates that are no longer productive.  

So when that happens you start to see debt grow faster than GDP. So this is a pretty old story. I would argue that most people would say the problem began in 2009-2010. I think it started earlier than that but it doesn’t matter.  

At some point we started to see this unsustainable acceleration of debt in order to maintain high growth rates and here’s where another economist that I cite a lot, János Kornai, is very important. Kornai argued that in these types of economies you have a shift from the hard budget constrained part of the economy to the soft budget as long as you want high growth rates because a hard budget constrained part of the economy, for example, the private sector, won’t systematically engage in nonproductive behavior. If they do they go bankrupt.  

So if you want to maintain higher growth rates than the real economy can deliver then you have to increasingly shift activity to the soft budget constrained, which in China was, largely, local governments and the property sector. And so as a result the problems in China predate Xi Jinping. In fact, back in 2012, remember when Xi Jinping became party—a party secretary we all agreed this was a good thing because he was a pragmatist and a market guy, and back then I argued that if you looked at the historical precedents what was very likely to happen was a recentralization of economic decision making because the conflict over adjustment would be so difficult that without a recentralization of power they would probably fail to do it.  

So I would argue that all of this was already baked into the pie before COVID. Now, I agree with Adam and Zoe that COVID mattered and I think it mattered because it accelerated what was already a pretty bad process, not just in China but in the U.S., Europe, and the rest of the world.  

So we saw debt pick up even more rapidly and, more importantly, during that period we saw the household share of GDP drop, and what was particularly bad we saw income inequality increase, which put even more downward pressure on consumption.  

So I would argue that that’s the basic problem and, you know, if I could summarize it in a snappy phrase I would say it’s not that the recentralization of the economy caused the slowdown. I would say it was the slowdown that caused the recentralization of the economy. 

VOGT: That’s interesting. You have the causal arrows reversed, in a sense, from where Adam does, that you—the two of you sort of see this as—you see the same factors but you see them affecting each other in a different sequence almost.  

POSEN: Can I add?  

VOGT: Yeah. Please jump in, yeah.  

POSEN: Yeah. And I just want to affirm Dr. Liu and Professor Pettis’ characterizations. These are very different points of view. As you just said, Justin, causality runs the other way.  

I would make two points. I think, first, the structural—the heavy duty structuralist version which Michael argues for is too dismissive of the agency of both the party and the average Chinese household.  

If you look at the period even including the period Michael talks about there’s an enormous growth in private sector employment, in returns on private sector assets, in private sector investment, as my colleague Nick Lardy documented in Markets Over Mao, and then starting in 2015 and accelerating the—Xi turns it around. But then again, the households don’t react until we have the zero COVID in the way that I identified.  

And so, to me, while the structuralist problems are there it both exaggerates the determinism coming out of the structural problems and also, frankly, their magnitude. All economies slow down. All economies accumulate over time. There was nothing inevitable that you couldn’t have put more money in the private sector and gotten higher returns than you did the last several years. 

 Anyway, just to say I think Michael and Zoe are being perfectly fair. Contrasting views, but just that would be my point of difference. I don’t think their model fits the developments that I saw.  

VOGT: Right. Let me ask you to clarify one thing, though, and then—and I’ll ask and that will probably generate a response either from Zoe or Michael. 

You say this wasn’t inevitable, and I guess what I’m curious then is that it’s really sort of a political question and I’m wondering why—if it wasn’t inevitable why were the choices made that you see, you know, as having led to this point that—where there was agency.  

You talked about the household spending patterns. What about on the policy question? What was the particular policy choice and why do you think that was the choice that the CCP opted for instead of the other choices that presumably you think might have if not averted the current situation at least pushed it further off into the future?  

POSEN: I’m not a good enough Chinese expert—I’m a macro economist—to do that. But I would have—I think there are two clear contributing factors.  

One is that—not to over personalize this but in an autocratic system the views of the leader do matter and Xi’s views clearly, from the time he took office but particularly from 2015 forward, were that the market had gone too far, the party had gotten soft, the people had gotten soft, and you had to deal with it.  

A second factor is you can argue how much instead of—what something none of the three of us have mentioned yet, the external environment. How much—although Zoe makes reference to the remilitarization needs, to be fair.  

So how much this is a reaction to perceived threats or external ambitions and that pushes you in this direction. But I think it’s ultimately mostly about control and that’s why, again, I tried to speak of the long COVID. It’s the immune-system response, as you kindly invoked. 

It’s not because the Communist Party ever was not in control; it was that the Communist Party’s self-control broke down—that, unlike Deng and his successors, Xi broke this no politics, no problem compact. And I don’t know if it’s inevitable but it’s very hard for an autocratic system, a party, to resist that temptation for decades. It’s amazing to me how long China did. 

VOGT: Right. Yeah, that’s one of the things that comes through in your piece originally is that it’s sort of like they were—the image that I had in my mind and I almost put this in in the edit and I decided it was not—it wasn’t OK for Foreign Affairs but I’ll do it now, though, is it was that image of, you know, the old Road Runner cartoons, right, you know, where Wile E. Coyote kind of goes out over the edge of the road and is sort of running on air until suddenly he realizes and drops. That’s kind of the image that I got from your analysis of Chinese—you know, recent Chinese economic history.  

Zoe—actually, I want to go back to Michael in a second but, Zoe, Adam mentioned something that I did want to bring in because one thing that your essay talks about is this question of Xi’s kind of broader foreign policy and its effect on some of this, the sort of the reembrace of nationalism, what you describe as this civil-military fusion and its effect on the Chinese economy. 

Can you pick up where Adam left off there and kind of talk a little bit about that context in which this happened? Because that’s also on our minds now, I think, with the APEC summit happening this week and with a meeting between Biden and Xi, and I’m sure that some of our attendees are going to want to hear a little bit about that.  

So it’d be interesting to hear your take on that.  

LIU: Sure, Justin. 

I do think President Xi Jinping’s elevation of the civil-military fusion strategy to the level of national strategy— 

VOGT: Can you just explain what that is, quickly? What you mean by that? 

LIU: So this—it did not—this so-called strategy did not start from Xi Jinping. The whole civil-military fusion started during Hu Jintao’s era. The idea is to empower or basically mobilize a whole of a society, whole of a nation element blurring the nature of military as well as—and the private sector and the civilian sector in terms of technological advancement and technological self-sufficiency.  

So President Xi Jinping really elevated that into—to the level of national strategy and combining that with, you know, the Made in China 2050. So a lot of these really triggered—alerted Western politicians and in particular here U.S. policymakers in Washington, D.C. And in response, the United—U.S. policymakers accelerated a lot of the preexisting mechanisms such as export controls, such as investment screening, and now we are in an era of outbound investment screening.  

So, you know, if Xi Jinping weren’t—if President Xi Jinping been not, would this have accelerated a lot of these policies to such a higher level? I do not think it would have triggered such a response from the United States. And as a consequence, what used to benefit China’s economic rise, on the one hand, international confidence in the Chinese economy as well as policy predictability, and then on the other hand China’s easy access and cheaper—at a lower cost to advanced technologies in that market, those things are no longer there. 

And I would agree with Dr. Posen in that, you know, President Xi Jinping—a lot of his policy missteps did matter. But I would say that it matters before COVID and more specifically he removed the predictability and the lack of political drama that used to benefit the Chinese economy.  

VOGT: Right. Thank you.  

Mike, I’m going to turn to you and I have a sort of clarification question for you that I hope will be fruitful. In the meantime, folks who are joining us if you want to start thinking about the questions you want to ask I’m going to—I’m going to go to that next.  

But, Michael, when you—both you and Adam sort of tell this story that to my kind of layperson’s mind it brings to mind this expression that at least when I was, you know, a college student I learned which was the middle income trap, right—that there was this kind of problem where, as you put it, you know, a system was developed to solve a certain set of problems and then once it solved those problems it became obsolete and you had to switch. 

Is that essentially what you’re describing? Is that another name for what you’re describing or is that different from what you’re talking about? And regardless of whether—what the answer is there I guess my question for you is if China missed its opportunity or the opportunity it had some time in the aughts to shift growth models do you only get one chance as a regime type or do you—is this the kind of thing that you can kind of—you can try again, you can keep adapting? What’s your view of that? 

PETTIS: Well, to address the middle income trap it’s not a phrase that I really like because it seems to me that we often trot it out to mean we don’t know so it must be the middle income trap.  

But in terms of—in terms of the—you know, I would call it an investment trap because it affected all countries that had very, very high investment growth models.  

Japan, which is certainly not a middle income country—it’s quite a rich country—also went through this trap. Poorer countries like Brazil in the 1960s and ’70s and so on—there was about a dozen, two dozen countries that went through this growth model and what’s really striking is how they all followed the same pattern. You have very rapid healthy growth followed by very rapid unhealthy growth followed by a very difficult adjustment.  

And the adjustment can range. You know, I talk about the American style adjustment, which Brazil followed too, which is a rebalancing in the form of a crisis. So the United States in the 1930s you’ll remember GDP contracted by 35 percent. Household income contracted by half of that. Brutally painful but it rebalanced and it was quite quick.  

In Japan what we saw is that GDP growth went from, roughly, 4 (percent) or 5 percent to around .5 percent. Consumption growth dropped by a lot less. I don’t have the per capita numbers but the per capita numbers look like they dropped from around 3 percent to 2 percent. So it wasn’t as brutal an adjustment but it took a very long period of time.  

And what’s really striking about this—and Daron Acemoglu and James Robinson do a series of very interesting papers on this—what’s really striking is how politically disruptive it’s always been except for two types of political systems. They argue highly competitive political systems, which seems to mean robust democracies, and then highly noncompetitive, which basically seems to mean a highly centralized autocracy.  

By the way, the example of the latter was China in the 1980s—a series of reforms ferociously opposed by the party but with a highly centralized leadership that were able to implement the reforms anyway.  

So I think that’s a really important part of it. We always see that and that’s why I argued that if you were going to advise Xi back in 2012 you would have said, you know, either become a democracy or recentralize power. That’s part of the process.  

Now, I realize my answer is getting a getting a little bit long but I wanted to talk a little bit about the rise and fall of the private sector.  

What really seems to drive the private sector in China has been a combination of domestic consumption and exports, and so from—domestic consumption bottomed out around 2010-2011 with household consumption at a truly surreal 34 percent of GDP, and after that we started to see a partial recovery of consumption and the private sector benefited from that.  

But that more or less stopped a couple of years before COVID and during COVID we saw, again, the consumption share of GDP go down and that’s much more important than exports. And so I would argue that what’s really driving the expansion and contraction of the private sector has really been the distribution of income to the household sector. I think that’s what’s really been key. I’m aware that this is already a long answer so let me stop there.  

VOGT: OK. I’m going to open it up now, and I’m hoping that some of our questions might get at the point I was making earlier about what this—how our interpretation of this matters, going forward. If not, I’ll jump in and kind of ask you all to weigh in on that.  

But I’d like to give our many guests a shot here. So, Sam, I’m going to turn it over to you for our questions.  

OPERATOR: (Gives queuing instructions.) 

Our first question is a written submission from Bert Ely, who asks: To what extent are China’s economic issues an inevitable consequence of its authoritarian governance? Viewed more broadly, is authoritarianism over the long term an economically unsustainable form of government? 

VOGT: OK. I think Michael was sort of gesturing at some of that in his last answer.  

Maybe, Adam, do you have a kind of very, very short answer to that one? Yeah.  

POSEN: So as I tried to say a minute ago I think that there is an autocratic temptation by the individual or by the party—look at Orbán, look at Putin, look at Duterte, look at Chavez and Maduro in Venezuela, look at Erdoğan—that after—at a certain point you want control, and so it’s very hard to resist the urge to exert that control.  

And so it’s not inevitable but I would say it’s very unlikely that you can sustain having authoritarianism and not having excessive intrusions and, importantly, arbitrary intrusions. I mean, that’s the key thing that I would emphasize about the household sector reaction, the zero—long zero—long COVID in China is that it’s about the arbitrary nature, the capriciousness of authoritarian policies, and that’s what causes the immune reaction of people trying to self-insure. 

So authoritarianism can work for long periods. There was the old Sam Huntington argument about political order and changing societies with the example of Korea in the ’50s and ’60s. But Korea has done even better as a democracy.  

VOGT: It’s hard to be a despot and it’s hard to—it’s even harder to be an enlightened despot is what you’re sort of saying is that you can’t keep it up for that long.  

Let’s go to the next question, Sam.  

OPERATOR: Thank you so much. Our next question is a live question from Tara Hariharan.  

Q: Thank you so much. My name is Tara Hariharan. I work at NWI, a hedge fund in New York.  

We’ve heard some very incisive diagnoses of the problems with the Chinese economy. I now invite the panelists to talk a little bit about viable policy prescriptions. We’ve already seen some easing in monetary policy but it hasn’t really resulted in a pickup in consumer demand or in housing demand.  

Similarly, on the fiscal side fiscal easing has not yet shown growth multipliers and separately, again, based on the structure of the economy and the government it seems like for moral hazard reasons China will not be ready to bail out the developers or the local governments or, for that matter, even do some kind of consumer handouts.  

So what do the panelists see in terms of actual, you know, viable policies that China can take at this point? Thank you so much.  

VOGT: That’s a great question. Thank you, Tara. 

I’d love, actually, all three of you to take a crack at that because that—and if you can, if you can connect it to your—you know, as Tara put it, your—if you can connect your prescription to your diagnosis to the extent that you’re willing to I’d love to hear what you think is the answer to that question.  

Why don’t we start with Zoe and then we’ll go to Michael and then Adam? 

LIU: Yeah. Sure. Tara, thank you very much for your question.  

I think there are two pieces. One is domestic, one is international because I do think—you know, I do think the Chinese economy right now is at a stage where reform and open up—deepening reform domestically is not necessarily going to be about the pure distribution of benefit, but it also involves the allocation of—(inaudible)—because the systematic financial repression already viewed around (it itself ?) institutions as well as the incentives that people are—people just resist additional reform. And I think Professor Pettis also made a similar argument as well.  

So in terms of domestic I think, perhaps, immediate—in the immediate term the government really need to figure out how to distribute—to stimulate household consumption. I’m not exactly sure whether this is going to be in the format of direct, you know, stimulus check or, you know, household debt eased, things like that.  

But direct household support is necessary both to solve—to on the one hand address the lack of household confidence issue, then on the other hand at least to give people some sense of short-term relief, right.  

And internationally I do think this—it’s tremendously important for President Xi Jinping to show that he cares about stabilizing U.S.-China relations and because this is the moment I always remember what Deng Xiaoping said when after he visited the United States and on his plane back to China he told everybody on the plane saying that, you know what, you know, if you look at—if you look around the world for those who became—who are friends of the United States they all become rich. 

And I think—I’m not exactly sure to what extent this kind of political willingness is still there but at least I think APEC is an opportunity for President Xi Jinping to restore the relationship and in particular to try to stabilize the relationship.  

VOGT: That’s interesting. I wonder whether that perception holds about the value of a friendship with the United States these days. 

Michael, what’s your basic sort of prescription or policy advice for how to deal with this slowdown?  

PETTIS: You know, I think it’s not very surprising—in fact, there is a consensus. It’s not universal but there is a consensus among economic policy advisors and economic policymakers about what China needs to do and very specifically they need to boost domestic demand, domestic consumption, because if you bring investment down—and everyone agrees that China has an over investment problem—but if you bring it down the economy slows, workers lose their jobs, consumption drops, and you get all these terrible things.  

So what you really need to do is as you bring investment down you’ve got to bring consumption up. So everyone agrees on that. So how do you bring consumption up?  

Well, there’s basically two ways. One way is you encourage somehow households to save less. Quite hard to do because the weak economy is probably what’s encouraging them to save more. Or you encourage household debt and, in fact, banks have been told to expand their consumer loans.  

Of course, banks only want to lend to professionals who own their own homes and it’s become sort of a joke here. If you’re part of that favored group banks are desperately trying to get you to borrow at incredibly low rates.  

But that’s not sustainable. China already has the highest household debt as a share of GDP, among the highest in the world, higher than in the U.S. So monetary—the problem with monetary stimulus in China doesn’t work like in the U.S.  

Monetary stimulus tends to stimulate the supply side of the economy. So every time we’ve seen fiscal expansion or monetary expansion in China, rather than rebalance the imbalances have gotten worse.  

So what do we do? Well, again, everyone agrees we have to increase the household share of GDP. We have to increase their wages, transfers, the social safety net, et cetera, et cetera. What hasn’t really been discussed yet is the hard part—if I increase my share then by definition I have to reduce your share—and we haven’t really discussed who you are in this case.  

That’s not totally true. There is a growing recognition that it’s going to be the government, not the business sector. But which government, Beijing or the local governments? 

And what we’re seeing in China—it’s been developing over the past year and I suspect it’s going to be the big story of the next year or two—an increasingly contentious dispute between Beijing and the local governments as to who’s going to pay for the adjustment costs, who is going to liquidate assets in order to increase the household share of GDP. 

I could go on on that for an hour. It’s a very complicated issue. But, ultimately, I think Beijing knows what they have to do. They just don’t know how to do it.  

VOGT: That’s fascinating. There’s a bit of a zero-sum quality to what you’re describing and the question is who’s going to wind up with the short end of the stick. 

Adam, is that—Michael said that basically everybody agrees about what has to happen, that the disagreements are about how to get there. Do you share that view and do you have thoughts about—I know you do from your piece but can you tell us what your sort of prescription is in terms of how to get there?  

POSEN: I think there’s disagreements on how much those solutions would help, I think, so let me go directly to Tara’s question, which was excellent.  

So, first off, on stimulus one of the key differences between the structuralist view and my view is that in the stimulus the issue is for structuralists you restructure the debt and stimulus will work and that fiscal stimulus is just as—it should be effective even if monetary stimulus is not, whereas in my point of view because the households are beaten down it’s not going to work that way.  

And so the Chinese officials, despite the moral hazard, have been doing stimulus and in fact they’ve just announced a 1 trillion yuan bond issue which is going to be directed to plugging the holes in local and state. Not state, but anyway local and regional government balance sheets. 

And I’m expecting that to not have very much effect, whereas in the structural model that should have a decent effect. And that’s the opposite of Japan, by the way, which my work and others absolutely confirmed, that in Japan they didn’t do any of that public investment. This is one of the big differences that gets elided over in the structuralist field is that in Japan the debt was in the corporate sector, not the household sector, and in Japan the public investment was not there whereas the private investment was and what’s what went bust.  

So anyway the upshot of all this is that it’s not enough whereas in Japan it was enough to take on a combination of monetary stimulus and debt cleanup.  

In China, because the effect is through the fear of a household sector—this autocratic immune response—that the stimulus policies will not do enough and they will not be very effective. What you need is a credible commitment from the authorities that they are not going to interfere with life and that’s very hard to get.  

VOGT: This is why I think it’s fair to say, Michael, you feel that in the short term actually Adam’s view and those of others may be a little bit too pessimistic. You think it actually—this may—some of the things they’re doing now may work all right in the short term, although in the medium and the long term are a little more pessimistic. Is that fair to say?  

PETTIS: Yeah. I’m not sure that I would say the structuralist view is that fiscal stimulus works and monetary stimulus doesn’t, at least my view. I don’t know if there are other people who claim that title. 

What I would argue is that supply side policies are not sustainable. It’s demand side policies that China really needs because China doesn’t have a supply side constraint— 

POSEN: But, Michael, that’s the whole point because that is stimulus policy. If we follow the logic of your argument putting more money in the hands of households should raise consumption. 

If you follow the logic of my argument putting money in the hands of households should raise savings. So it is a very distinct— 

PETTIS: Should what? 

POSEN: Should raise savings because people don’t want to spend, whereas you’re saying they’re spending constrained. So there is a very clear difference in our predictions on what would be the result of fiscal stimulus. 

PETTIS: OK. Yeah, definitely a very clear difference in our views.  

VOGT: It’s good. Let’s—that’s good. That’s very well distilled. Let’s take another question. 

OPERATOR: Our next question is a written submission from George Arritas (ph), who asks: To what extent does the demographics, particularly aging population, impact the ability to stimulate domestic demand and provide the safety net within the confines of the growing debt crisis?  

VOGT: Zoe, I’m going to throw that one to you because you actually—you talked about this in your piece. You talked about the one-child policy and some of its lingering effects. Can you elaborate on that?  

LIU: Sure. I think the one-child—the demographic is that both a positive effect and a negative effect because it’s not that the demographic trend or the aging population is going to doom the Chinese economy because as the population becomes—an aging population also creating new demand and such as, you know, elder health care or, you know, like, adult diapers, and it drives a new industry, right.  

But then the downside of that is what worried me more. If you just look at the trajectory, by 2040 China is going to have about 402 million people who are above the age of sixty, which is the current legal retirement age, and at that time, you know, the United States population is going to be around—the entirety of the U.S. population is going to be around 390 million. 

In other word, within the next—within the next twenty years China is going—the older—like, retired Chinese people is going to—the population is going to be higher than that of the United States. And that is not—that is not going—not only removing China’s demographic premium but also going to raise the health care cost tremendously and the social safety—the social welfare system already has been a burden a lot during COVID.  

And then the final part in terms of why demographic trend(s) in the long run is both not good for the Chinese economy is really about the real estate sector. Real estate sector is about 30 percent of the economy. And as family formation rate decline as Chinese women not necessarily willing to get married, to bear children, you know, basically, that is going to permanently drag down demand in the housing sector.  

So demographics, I don’t think, in the long run is going to bode well for the Chinese economy. 

VOGT: Let’s take another question.  

OPERATOR: Our next question is a live question from James Galbraith.  

Q: Yes. Thanks very much. It’s a pleasure to listen to you.  

I wrote a paper on China for the Council on Foreign Relations around 2001 and some of these issues were already being raised. In fact, I experienced there in the 1990s people were saying—economists were saying they should raise consumption and lower investment. 

There’s nothing more dangerous than when economists reach a consensus. You can be sure that something’s about to go wrong. In this case it seems to me that the incomes that the Chinese households have in excess of what they consume are because of the high investment share.  

That’s what gives them the incomes over and above what they’re spending. So you can’t really ask them to raise their consumption share out of their savings. The savings is what they’re not consuming right now because they don’t want to and they don’t need to and they have incomes above and beyond their needs.  

Back in the 1990s when I was advising the government of China this question was already being raised and I asked them what are you talking about here materially? Are we going to build roads and not—sell cars and not have roads to drive them on or gas stations to fill them up in?  

Are you going to ask people to buy televisions and not have apartments for them to live in? What is this distinction in material terms and why are Western economists fixated on it when the Chinese have been doing quite well for the last forty years by essentially not following this advice?  

Thank you very much.  

VOGT: OK. I’m going to try to draw a question out of that. That’s an interesting comment.  

I think what Mr. Galbraith is getting at is what’s the—what is the real capacity that the state has to alter this decision making whether it’s in the—amongst companies or households, right. What can they—how much ability do they really have to change decision making at all?  

I don’t know whether, Adam or Michael, one of you want to—wants to respond to that or whether you heard another question in there that you wanted to address. 

POSEN: No. No. So thanks to Professor Galbraith for listening and contributing.  

I would take the question you put forward, Justin, and I would say two things. First is, again, Michael Pettis and I are on opposite tracks but have some parallels. So I also read a lot of Albert Hirschman, and I invoke in my response Exit, Voice, and Loyalty. And so when we ask what’s the response I think a lot of it is going to be Chinese households, Chinese businesses, exercising more exit, meaning instead of showing loyalty or just complaining domestically, which is not an option, really, they are going to be trying to move their people, their plants, their money, out, not in a huge number but in a markedly larger number and all the data over the last several months—the movements from the yuan, the stories about China cracking down on outflows of capital—fit that. 

And then that has the policy question which you may want to get to, Justin, of my arguing that the U.S. should instead of doing sanctions to constrain China should be doing suction to get stuff out of China and put pressure that way.  

VOGT: Let’s go right to that, Adam, actually, because I do want to ask that question. I want to hear what Michael and Zoe have to say about that as well.  

We’ve talked about what you would sort of advise President Xi or the CCP. One of the real questions, and I would recommend to everyone on the call to look at a piece we ran this week by Dan Rosen and Logan Wright on this question of what should American policymakers do in reaction to this slowdown.  

How should they treat it? You know, should they try to exploit it? Should they lean into it? What’s the proper response from the U.S. point of view to what’s happening in China regardless of what the sources of the problem are?  

So why don’t you take a stab at that and then we’ll hear from Zoe and Michael and that will probably bring us to time.  

POSEN: Yeah. So I’ll try to be quick.  

As I argued in the original article, which you guys posted on in early August, you want to think in terms of suctions, not sanction—that the way to put pressure on the regime is to make it so that it’s attractive for people to leave and then that creates a dynamic we’ve seen with other autocrats in the economic sphere that they try to put up more controls against capital flight, against outward migration, against outward investment, and those controls induce more desire to leave.  

And so you’re not going to collapse the Chinese Communist Party regime but this is a much more constructive, positive way of putting pressure on the Chinese Communist Party regime than being confrontational and trying to bottle them up. 

The key—and I’ve made this case to various senior U.S. economic officials with who knows how much influence at this point. It also depends, obviously, on domestic politics in the U.S. to take advantage of this.  

But it’s a much more attractive position and, frankly, a much more sustainable position with allies and with the world and in U.S.’s own economic interests to be pursuing pressure through this means than pursuing pressure through trying to push China down.  

The second point to go with that—and this will be my last point—is that we have a world in which for a while the Biden administration and the Trump administration were saying China’s a huge threat because they’re so economically powerful. Then shortly after my article came out—no causality, of course—President Biden suddenly says China’s in deep economic trouble so they’re a big threat because they might lash out.  

Now, these are not necessarily contradictory, but there is a tension there. One’s about capacity and one’s about intentions. And I think the Biden administration, since the president’s statements in August, has wisely moved into this APEC summit more about we’re not trying to beat China down. 

As Secretary Yellen said a couple days ago, we want to construct an economic relationship with China. Let them fail on their own terms. Don’t be us saying we’re against the Chinese people, we’re against the Chinese people making a living, we’re threatened by Chinese students or Chinese business.  

Let us be focused on the Chinese Communist Party and their external intentions but don’t beat them while they’re down, and I’m hopeful that there has been that change in the Biden administration approach. 

VOGT: Michael, is that your view as well? Is that—would that be your advice or would you differ on anything there? 

PETTIS: Well, you know, first of all, I don’t think China is the economic threat that we make it out to be. I think Americans have a history of paranoia. And maybe it’s a strength of the U.S. but, you know, we were terrified of Japan, terrified of the Soviet Union. It’s a—economically. I’m not talking about geopolitically. It’s a common trend, and we tend to get it wrong for the same reasons.  

I would say what really matters to the U.S. is not whether China slows down but the way in which it slows down. You know, one of the big problems is that if you look at China within the global context—I had an article that came out in the FT last week—China represents, roughly, 18 percent of global GDP, which is probably overstated. It accounts for 13 percent of global consumption, which is incredibly low. It accounts for 31 percent of global investment and 30 percent of global manufacturing.  

So what really matters to the U.S. and to Europe and the rest of the world is how those things shift as China adjusts. Now, if China has a Japanese style adjustment where you see consumption growth sort of stable, maybe down a bit, and much of the adjustment incurring with a reduction in investment, what you’re likely to see is the savings rate in China go down faster than the investment rate so that the current account deficit as a share of global GDP will contract, which is exactly what happened with Japan in the 1990s, in which case China’s adjustment adds a bit of global demand to the world.  

It’s unevenly distributed. If you’re a Brazil, an exporter of iron ore, you’re going to get badly hurt. If you export agricultural commodities or consumer goods or import industrial commodities you’ll benefit more from China’s adjustment. But that’s the key.  

Now, if China adjusts or as it attempts to adjust tries to shift the lending away from the property sector and into the manufacturing sector, which we’re already seeing, right—the decline in property investment has been more than matched by an increase in industrial investment—that creates a real problem for the world because if you assume that China continues to grow maybe at 4 percent in about a decade China’s share of global manufacturing will rise from 30 percent to 37 percent while its share of GDP rises from 18 (percent) to, say, 21 percent. 

That means the rest of the world in order to accommodate China has got to reduce its own manufacturing share, and you’ll have a better sense of this than I do but I don’t get the feeling that that’s what the U.S. wants to do or Europe or India or any of the large economies. They want to increase their manufacturing share.  

VOGT: Yeah. 

PETTIS: So that creates a real problem. But from our point of view what matters is how China adjusts, not whether it adjusts.  

VOGT: That’s interesting. It’s an interesting challenge.  

I’m going to give Zoe the last word here before we close.  

Zoe, your—what’s your basic baseline advice to the Biden administration, to American policymakers, in terms of how to react to the Chinese slowdown?  

LIU: I would say that we would reevaluate the premise for America’s China policy because our—the premise of our China strategy has been that China will surpass the United States economically, challenge the United States ideologically, and confront the United States militarily. 

However, you know, our China strategy it just seems that that we have been—we haven’t paid enough attention to the Chinese people until during COVID and we started to say, oh, actually, there are—when we think about China there is also the anger of Chinese people, and as Dr. Posen’s article showed actually, you know, the Chinese people not only have agency but also perhaps there is a growing incentive mismatch between the party and the Chinese people.  

And I think U.S. government should be aware that this is not necessarily the moment that we want to push China or President Xi Jinping or the party to look inward because a country as big as China, the second largest world economy with 1.4 billion people, if an isolated China with that big of economy and that large number of population who become angry and in particular angry at the United States that is going to be very dangerous. 

VOGT: Well, I would—I don’t envy any policymakers or officials in the administration right now trying to puzzle through exactly how to do this and what to what to do over the next couple of days, and I certainly don’t envy whoever is putting together President Biden’s briefing book.  

I do hope that they have read all three of you in Foreign Affairs. I think if they do they’ll be a little bit better prepared for that very difficult job.  

I want to thank all three of you, I want to thank our friends at the Peterson Institute, and I want to thank everybody who attended this morning. Best of luck to you and thanks again. Bye. 

POSEN: Thank you. 

PETTIS: Thank you very much. 

LIU: Thank you. 


Top Stories on CFR

South Africa

The provincial and national elections on May 29 come amid waning support for the ruling African National Congress thirty years after South Africa transitioned to democracy.


In his inaugural address, Taiwan’s new president Lai Ching-te signaled broad continuity on cross-strait issues. China, however, is likely to respond with increased pressure. 

Election 2024

The European Union (EU) began implementing the Digital Services Act (DSA) this year, just in time to combat online disinformation and other electoral interference in the dozens of elections taking pl…