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July 24, 2014

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Economic slowing in China not a problem, but less codependency with US is needed

EDITOR’S note:

Few people are in a better position to make observations about the Asian economy than Stephen Roach, former chairman of Morgan Stanley Asia and its chief economist. Roach now teaches at Yale University.

He has written extensively about the Chinese economy and Sino-US relationship, especially its element of codependency, which he considers unhealthy.

Roach spoke to Shanghai Daily reporter Ni Tao on Tuesday about how to rebalance both economies at CEIBS (China Europe International Business School).

Q: What is your view about China’s economic slowdown?

A: The slowdown that has been evident in China over the past year and a half seems to be stabilizing. There is always a risk that there could be somewhat weaker economic growth, but it is reasonable to expect growth to hold around 7.5 percent, maybe a little bit less, maybe a little bit stronger.

It is important to go back to why the slowdown occurred because it unfolded at a time when the global economy was slowly starting to heal from the crisis in 2008 and 2009.

And it’s unusual for an economy like China, which is so heavily dependent on the global environment, to slow in an improving global context.

The conclusion I draw is that the slowdown in China is a deliberate outgrowth of the reforms the new leadership is putting in place to deal with excessive imbalances that have arisen over the last 30 years, whether they come from too much debt, investment, local government spending, or production.

So as China moves toward a more balanced economy, as articulated in the Twelfth Five-Year Plan and further unveild in the reforms of the Third Plenum (of the Party’s 18th Congress), there has been some understandable and important shift in the structure of the economy.

What’s emerging now is a more balanced, services-led economy that requires slower growth. I think that’s fine and needs to be managed. Actually it’s quite good news for China on the road to rebalancing and ultimate reform.

Q: What do you think of the interest rate reform in China?

A: The People’s Bank of China has already indicated that within the next one to two years it would take the final step on the road to interest rate liberalization and free up deposit rates to be set by the market.

It is an important ingredient of China’s strategy to promote consumer demand. Consumer demand is weak for a lot of reasons in China. One of them is the lack of after-tax interest rate earnings on deposit accounts that households have.

Households in China have a very high savings rate and get returns from banks that are below the inflation rate, because of the regulation of lending rates. This could be holding back disposable income by as much as 5 percentage points of GDP in China.

The coming liberalization of interest rates will be very important for the rebalancing of China in the years ahead.

Q: China’s growth rate edged up one percentage point to 7.5 percent in the second quarter of this year. How will things pan out in the second half of this year?

A: It’s hard to know. There’s a lot of unexpected things that can come up inside any economy as large as China or in the outside world. But barring any unexpected disturbances, I think the growth rate will hold somewhere in the 7.25 to 7.75 percent range in the second half of this year, averaging about 7.5 percent.

And I just want to stress, with China now much more led by its services sector that generates about 30 percent more jobs per unit of GDP than does manufacturing and construction activity, which had been driving China in the past, China doesn’t need fast growth any more to absorb surplus labor.

In the old model driven by exports, investment and manufacturing, China needed 10 percent growth a year to absorb the surplus labor in the countryside.

But in the services-led model — and the services sector has become the largest sector in the Chinese economy starting last year — the 7 percent growth can now make the same achievement in terms of employment, poverty reduction or labor absorption.

So the fact that China is growing at 7.5 percent should not be viewed as a threat to jobs and social stability, but in fact a very visible symptom of an economy that can now grow more slowly but can still hit its poverty-reduction targets.

Q: If the Chinese economy contracts dramatically, should a massive stimulus package be in the cards?

A: No, I don’t think there is a massive stimulus package in the cards at all. The government clearly opted for a very aggressive stimulus package in late 2008 in response to the worst global crisis since the 1930s.

And when the government put in place that 4 trillion yuan (US$645 billion) stimulus package in late 2008, there was a huge risk to all major economies in the world, including China. And China was an unbalanced economy at the time before the crisis.

So the stimulus package actually had the unfortunate effect that while it put a floor under the economy, it created a great sense of imbalance, especially with respect to the excessive debt, investment and local government financing.

There’s no way the government wants to go down that road and enact another large stimulus when they’ve been trying now over the last couple of years to redress the imbalances that came about through that stimulus.

Sure, if there’s a huge crisis in the world again, they are going to react. But they are not, and no one is operating according to that assumption.

Q: In your book “Unbalanced,” you argue that the US and China may switch roles, with the US going from a consumption-based economy to one led by manufacturing and China the other way around. How will that transpire?

A: Both countries, as I argue in my book, are to some extent the mirror images of each other.

The US saves too little, consumes too much; China saves too much, consumes too little. And I argue that the only really sustainable way for both countries to address their mutual problems is through economic rebalancing.

And I do believe that the US needs to rebuild national savings and invest the savings in human capital, physical capital, manufacturing capacity, infrastructure and rebuild its competitiveness as a nation.

And the US has a lot of strength, but we’ve dropped the ball in focusing on competitiveness. In industries such as technology, software as well as hardware, biotech, new materials, new energy generation, the US has enormous capabilities. We are innovative and flexible. We are a dynamic economy, but if we don’t save, we will not be able to put those advantages into place and really rebuild our economy.

China, on the other hand, has to do more of what we’ve done over the last several years and begin to deploy surplus savings to boost the safety net of the Chinese families, rather than sending surplus savings to America, which ends up subsidizing American families.

That will force America to wake up to the fact that we cannot rely on China to fund our budget deficits and support our social problems. We have to do that ourselves.

Q: Tell us something more about your book “Unbalanced.”

A: The two countries now are at a point where there’s a growing trust deficit between them. And some of this arises in a political environment. With the US Congress being re-elected next November and one third of the members of the US Senate also facing re-election, the relationship will get contentious.

What’s happened is that the reliance on each other has gone too far. That’s what happens in the codependent relationship between two people. It becomes so dependent on one another that ultimately they lose sense of who they are.

And they start to blame each other for their problems. The US blames China for trade deficit, for pressures that come about on American workers through that trade deficit, for hacking and for causing tensions in the East China Sea and South China Sea.

China blames the US for the same things. It blames the US for not saving and running too big a deficit that creates political problems in the US. It blames US’ so-called pivot to Asia for heightening tensions in the South China Sea.

So we’ve gotten to the point in a codependent relationship called the blame game, where nations or individuals with problems take it out on others.

We’ve got to move from a codependency to a more constructive interdependency where individuals or nations are better able to stand on their own and are more self-reliant rather than overly reliant on each other.

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