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On China: A Conversation With Larry Summers

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On China: A Conversation With Larry Summers

Larry Summers, former U.S. treasury secretary, discusses China’s domestic challenges and the lessons of China’s economic success.

On China: A Conversation With Larry Summers

The world looks at China as it faces one of the toughest economic restructurings in world history: changing the growth model of a colossal economy against the backdrop of ebbing domestic growth, environmental degradation, human rights violations, and pockets of financial disequilibrium. But in the global political economy, the world watches China gaining weight in the existing economic order and pushing for greater influence.

Lawrence H. Summers, now President Emeritus and Professor at Harvard University, has advised the United States on economic affairs for many decades in various roles, meeting numerous times with Chinese leadership to help deepen Sino-U.S relations. Summers has been a key economic decision maker and adviser under the aegis of Presidents Bill Clinton and Barack Obama. The former treasury secretary recently sat down with The Diplomat’s Maurits Elen in Beijing to discuss various Chinese domestic challenges, as well as China’s place in the world, concluding that the nation must “have more to say in a range of international fora.”

The Diplomat: In the last decades, millions of people have been pulled out of poverty in China. Still, China faces, along with the United States, one of the highest levels of income inequality in the world. How do you think China can make growth more inclusive? 

Larry Summers: In driving prosperity, markets work much better than planned-economies. After all, letting market forces operate so individual initiative can flourish and so individuals are rewarded for taking initiative can produce staggering opportunities and returns.

The other side of markets, however, is that rewards can be very unequally distributed. It is the role of policy to try and make sure that everybody has an opportunity to share in economic growth. There are many dimensions of that, there is giving everybody a chance to compete in the marketplace, that’s why education is so central and it must be made sure everybody can get as good an education as possible, regardless of family background. Taxes must be collected in a fair manner and in which those who are positioned to pay more are expected to pay more. It is important that prosperity be based on giving people what they want, producing new products, and producing old products in more efficient and effective ways, rather than working the system to consolidate monopoly power.

China needs to work on all of these elements. Making sure that opportunities for children are the same, regardless of where in China and to whom in China they are born. Making sure that success of enterprises depends on the quality of what they sell, not on the depth of their relation with officials in government. Making sure that taxes are collected in a fair way, and making sure that those who lead enterprises and communities do so for the benefit of their stakeholders, rather their own. I think these are all core elements of inclusive prosperity that China should take into account as it moves forward.

Due to the economic slowdown, the convergence between poor and rich provinces in China is stalling. A government official said in the People’s Daily that divergence between provinces is a necessity of economic development. What are your views on convergent and divergent approaches to economic development?

Usually progress starts somewhere, not everywhere. It starts in some places, it starts in some sectors, and it starts with some individuals. As such, there is some divergence that is inherent in the idea of progress, and it is inherent in the idea that there is leadership before progress. One would certainly not want to insist on convergence. At the same time, one would very much want to see upwards convergence, that is to say, convergence achieved by those who are behind catching up, rather than those who are ahead being pulled down. I would not subscribe to the idea that divergence is per se good, or that divergence is to be encouraged for its own sake. The right strategies recognize the desirability of divergence, which is after all inherent in the idea of innovation. But they should work to create as much convergence following divergence as possible.

China has large amounts of savings, but allocating them efficiently is problematic. How can the Chinese financial system be reformed to make capital allocation more efficient and what lessons of the U.S. financial crisis are applicable?

China’s problem is not the quantity of savings, but the efficiency with which they are allocated. More efficiently allocated savings need to get more return for each yuan of saving. And that is the equivalent of having more savings and investment. I think it is crucial for China to get a market-oriented and well-functioning financial system, that when credit is allocated to those seeking to maximize returns, capital is more likely to flow to the highest return place than when capital is allocated on the basis of tradition, necessity, or administered to diktat.

So in general, a move toward a more market-oriented financial system is appropriate. I think that the lesson of the American experience in 2008 is that in market-oriented financial systems, and certainly not in an entirely deregulated one, that financial institutions need to be regulated with respect to capital, with respect to liquidity, and with respect to business practices.

But there is a difference between a system in which financial institutions are regulated for stability and consumer protection and a system in which financial institutions are regulated, so as to channel capital to particular uses. That is the evolution from regulation for capital allocation to regulation for stability that I think is important for China as it moves toward a more market-oriented system.

China needs to urgently attract private investment. After all, the scope for fiscal policy is closing in, with public debt surging and the fiscal deficit being the largest since 1979. What can the government do to stimulate private investment in an environment with low returns on assets?

For enterprises to be able to succeed it is key to have a relatively predictable business environment. In a situation where the rules for private enterprises are very unclear, it is going to be seen as very risky to make investments in private enterprises and that is likely to discourage the level of investment. So it comes back to a predictable path for policy and certainly for a non-punitive approach to businesses that are succeeding. It also goes to creating a freer environment in areas relating to in particular the provision of consumer services in China.

In the West, monetary policy has been used excessively. In the United States and Europe, there have been zero to low interest rates, and in Japan even negative interest rates. Large-scale quantitative easing programs have been used to stimulate economies. One of the things economists worry about is how far asset prices have been decoupled from underlying fundamentals. What do you think the implications would be for the Chinese economy if an interest rate cut would take place now?

I don’t agree that monetary policy has been used excessively in the West. I would argue that economic circumstances have changed in the West, that for a variety of reasons saving has increased and investment has decreased, and that has led to a lower neutral equilibrium rate of interest. With lower interest rates, central banks have not found ways of generating the necessary level of demand, except by low interest rates, and that has led perhaps to assets prices inflation in some cases. But I am not sure I would accept the view that those examples represent excessive monetary policy, rather than necessary monetary policy.

In other words, monetary policy has been excessively relied upon.

The right strategy involves more than just central banking, it involves for instance measures to promote private consumption and private investment. I would say in China, the challenge is the famous trilemma of international macro-economics. This famous trilemma is the desire to simultaneously have more capital mobility to and from the country, more set monetary policies, and achieve certain exchange rate objectives. China’s challenge is that if it were to try and have easier capital, easier monetary policy, and lower interest rates, while simultaneously to have higher levels of capital mobility, there would be very substantial capital outflow pressure, as well as substantial pressure on the exchange rate. This would be consequential for China’s external position, China’s relations with the rest of the world, and perhaps confidence in China.

So an interest rate cut would put downward pressure on the exchange rate, which could further drive capital outflows. China has been facing historically large capital outflows, but it seems GDP growth has remained largely unaffected by this. How do you look at this?

It is very difficult to know what China is doing in terms of capital outflows issues. Clearly, there are very substantial informal administrative controls and pressures placed on people with respect to investment and I think that is an important aspect of the current situation.

This past year, one of the drivers of growth has been the Chinese real estate market. It has helped ameliorate some of the effects of slowing growth in China, but in particular the residential property sector looks bubbly. Asset prices in some cities have risen more than 30 percent this year alone. What are your views on how Chinese policymakers deal with this situation?

I think they are pursuing the right kinds of approaches. They are looking hard at various kinds of controls on down-payments and the like. Moreover, they are implementing restrictions on leverage, both for purchasers of homes and for developers. International experience suggests that when you have residential real estate bubbles it is hard to know, because sometimes real estate bubbles can rise very substantially and keep rising. This makes it very hard to gauge the timing. I think it is a somewhat problematic type of question. But surely the inflated asset prices are a sign of distress and a sign of potential problems to come, and so it is appropriate for the Chinese authorities to respond to that.

China is the second largest economy and is gradually opening its capital account. While there are many case studies of capital account liberalization, never have we seen it with such a massive economy as China. Should we be worried about increased volatility as a result of this process?

Surely there will be more flows in and out of China, and those are likely to lead to higher volatility, but I do not believe that is necessarily a bad thing, as that is part of the process of capital being allocated in a world where opportunities change.

How does the future of China and the world looks like in terms of growth?

I would be surprised if either China or the world economy grew as rapidly in the coming 15 years as they have grown in the last 15 years. Some of that is demographic, some of that is technological, and some of that is political. I think that it is reasonable to aspire to continue significant progress, although I doubt it will be as rapid as it has been historically in the non-crisis years.

Given the slowing growth and constellation of economic challenges facing China today, Chinese officials are often worried about the economy falling into the middle-income trap. What is your view on this matter?

I never been really a huge believer in the middle-income trap as a concept. I am not sure that it is really true that there a certain levels of development at which growth slows. What is true is that as you get richer, the easiest opportunities for convergence have already been captured. This makes things harder, especially now China has both challenges in maintaining stability in the near term and challenges with respect to the achievement of longer-term growth at rapid rates. Nonetheless, I do not see any reason why China should not aspire to be a significantly larger fraction of the global economy in 2030 than it is today. Certainly China cannot assume rapid growth in the future because it has achieved so in the past. Still, I do think this is a reasonable aspiration for China.

In what ways do you think that international economic arrangements need to be adjusted to reflect the reality of a more economically powerful China?

China needs to be given more of a voice and have more to say in a range of international fora, in particular the international financial institutions. There needs to be more willingness to learn the lessons of China’s tremendous economic success, but also the canon of traditional Western economics, as Western institutions provide technical assistance to developing countries. I think there needs to be more serious conversations with China about what the nature of the global system ought to be looking like in a go-forward basis, rather than simply conversing in ways that are focused on Western visions and trying to have China to become involved in those Western visions. In general, it needs to be a process of mutual respect in the formulation of international economic policies.

Could you expand on what those positive lessons are?

It is more for China to draw the lessons from its experience than it is for me. China has certainly demonstrated the power of a gradual liberalization strategy, they have demonstrated the power of an urbanization strategy, and they have demonstrated that a basic governmental responsibility for education and healthcare can have very substantial benefits. They have also operated in a model that has had more reliance on administrative controls and direction, and less pure reliance on prices, especially in earlier stages of economic development, than would be the traditional advice of the international institutions. In just what ways those lessons do or do not carry over is subject to ripe debate, but in light of the fact that China has for several decades achieved more rapid growth than anyone else has, over a very long period of time, one has to regard that as an impressive achievement, from which the world should be prepared to learn.