A Conversation on China's Economy
Video Transcript:
Matt Gertken: Hi, I'm Matt Gertken and I'm a senior East Asia analyst here at Stratfor, and I'm with Rodger Baker, vice president of East Asia analysis. We've been discussing, Rodger, the situation in China with the economy, and in particular June, with the jitters over the financial system, which really began when the Central Bank refrained from taking action to prevents the Interbank rates from spiking. Ever since that time we've seen the rates kind of calm down a little bit because of Central Bank intervention. But at the same time it really points to the broader issue of the rising cost of capital in China -- the fact that they're not going to be able to continue the economic system they've had for so long of keeping capital down, keeping interest rates down, and letting companies just kind of gorge on credit and expand to their to their heart's content.
So now we're looking at a situation where the new Communist Party leadership is trying to restructure and reform the economy. And it seems to me there's a big vagueness in all discussions about what the Chinese mean when they talk about reform.
Rodger Baker: Yeah, I think as we look at reform, there are different definitions floating around. So in some sense there's this concept, particularly I think from the way in which the U.S. looks at Chinese reform, that China will become a total free market liberal economy, it will follow western patterns of economic activity, they'll reduce maybe state involvement, you'll have a lot more competition and weed out a lot of the inefficiencies. I think the Chinese would like an element of weeding out inefficiencies, but I think that their definition of reform is very different. It involves a very strong state hand. And we have these parallel processes of reform and restructure. In which case, what the Chinese are talking about in the broader sense is a shift in the entire structure their economy from an export-based, export-oriented economy to one that's domestically oriented, and I think they have a very difficult time in making that transition. And right now, with the global economy the way it is -- with the Chinese economy in the way that it's down a little bit -- they have both the increased need to make the transition and the decreased ability to make the transition, because they don't have the freed up resources.
Matt: Yeah, one of the things that's been pointed out many times is that when Deng Xiaoping basically launched reform, you know with a capital R, the reform that everyone associates with China, the opening up -- that's where we get that kind of definition of Chinese-style reform. When Deng Xiaoping said that the economy would shift from a command-style to more of a market-based economy and going forward over the past three decades, we've seen that play out in a number of ways, basically a large growth story. But that's really come kind of to a halt over the process, especially since the crisis in 2008, of the Chinese realizing that consumption has not been there as a bulwark, as kind of a self-sustaining form of growth. So there's been an enormous amount of talk about, how can the Chinese rebalance so that they're not leaning entirely on that export sector for growth, they're not leaning entirely on state-owned banks for the investment, and instead they're starting to see households preserve more of their wealth and start spending it on appliances, maybe gradually buying more cars and basically becoming more Westernized in that sense.
But of course, as they attempt this, the first thing you have to do with your financial system is raise the -- increase the ability of banks to scrutinize who they lend to, maybe tell some of the state-owned enterprises that they don't like that business plan, they're not going to you know just give them free money for that. And meanwhile raising the deposit rates, so that consumers get to save more of their money and actually get to benefit from their savings, which hasn't been the case previously. Anyway, it's been interesting to see -- because of the slow process of reforming that financial sector, it's delayed reforms and other areas, and we end up with a situation like we have where a high degree of the lending that's going on is kind of in the gray area.
Rodger: Well I think the big problem that the Chinese government has, is that when they look at reform, they're not looking at it from the sense of necessarily true changes in the economic structure, the economic style, nearly as much as they're looking at it as a way to sustain China and in particular to sustain the ruling power of the Communist Party. And that means that, although efficiency in business is important, consolidation of some of these industries -- we see it in the need to consolidate steel, in particular -- that these are important factors. There is a question of things like employment. There's a question of the way in which society perceives the government. And so when you look at Chinese reform there's two elements of it: there's a practical element and then there's a perceptual element. And the perceptual has two audiences. It has the domestic audience, which is the way in which the Communist Party justifies its continued right to be the only legitimate power in China. And they have to convince the population that they still provide something valuable to the population, that they still have the mandate to rule and that they can continue in that position. But they also have to adjust to perceptions externally. And externally, the perception for the longest time was of course China was going to grow indefinitely. China was always going to be big, it's the place you could always put your money into. That perception has started to shift. People are seeing some of the realities of the Chinese economic model. There's the comparisons now coming up, even in the regular press, on comparisons to what happened to Japan, what happened to other East Asian economies and things of that sort. And the Chinese have a very careful walk in that balance, in that they have to demonstrate to the world that they recognize the inefficiencies, the problems in their economy, and that they're taking steps to address them.
And therefore they have to allow a certain amount of failure. They have to allow a certain amount of decrease in the numbers, as well as to verify that they recognize that people assume that the numbers are fudged, or highly irregular. But they have to do in a way that doesn't go so far as to completely lose the confidence of the international markets in their concept of reform. So they have to say, we recognize we need to reform, we're a little bit weak right now, but we are taking those steps and if you keep giving us the money we're going to be able to actually make this transition, and then everybody's going to be happy, the world economy will be saved, China will be good, there won't be a hard landing.
And one of those things that's interesting to me right now is looking at this kind of dichotomy of how the Chinese government tries to deal with this, because on the one hand they need to be able to make changes, on the other hand, they really need the funds to come in. And I think looking at these new special economic zones on the coast, you know, is just a small example of the Chinese saying, well on the one hand we're going to change, on the other we're just going to do the same thing we did in '79.
Matt: Yeah, that's interesting, I mean, reform typically, in the old way it meant that they would be opening up and liberalizing. And that's where you see this kind of coastal thing coming in. But then when they're talking rebalancing or restructuring, it can often mean something very different. Especially when rebalancing involves taking state-owned companies and giving, especially central state-owned companies, giving them more sway and trying to vertically integrate. And then you have a situation where you're actually recentralizing to an extent, even as you're pursuing more efficiency and economies of scale.
I wanted to ask, one thing about the leadership and the decision-making -- there's been a lot of talk about Premier Li Keqiang and what his style of economic planning and economic leadership is going to be. And in particular, there's been a lot of talk about whether he's going to be able or willing to bail out major companies that as a result of this transition start to flounder. And, you know, when we look back at Deng, and even at Mao in some ways, for better and for worse, these are strongmen decision makers. And one of the trends we've seen over the years has been that the Politburo Standing Committee is made up more of a collective of people who kind of carefully balance each other out. I mean, how do you think decision-making is going to play out for the Communist Party?
Rodger: I think the collective leadership was put in on purpose. It was put in coming out of Deng. He put it in place because looking at the vagaries and the wild swings between Mao, between Deng, that you didn't have a way to balance some of the things out, it became very individualistic. I think that there have been some hints that Xi Jinping is going to be trying to change that over, and I think that in the end is going to be the big question. I'm not sure that a collective leadership in China can make the bold decisions necessary and accept some of the risks necessary to bring about fundamental change in the structure of the Chinese economy, because in many ways that's going to require an alteration of the social contract and the relationship between society and the government, and I'm not sure that the CPC is ready to make that decision.
Matt: Excellent. Well, thank you for joining us. What we'll be watching as we go forward is to see how the reform process will continue, how kind of tough of an attitude the government's going to have in executing it and also how willing they're going to be to adopt palliatives to make sure that stability remains. Feel free to check us out anytime -- stratfor.com.
