Episode 2: Should You Be Freaking Out Over China?

Hey guys, what's the weather like in San Francisco. It's like boiling here, foggy and cold, the way a good San Francisco summer should be like. In case you missed us last week, Benchmark is a podcast about the global economy. It's twists, it's turns, it's upstance, downs, and how it affects you. We break down the most interesting numbers and ideas from around the world, share them with you in a way that hopefully will be understandable and lo and

behold fun. So last week we talked about productivity and we were talking about, um, what we could potentially talk about this week. A lot has happened over the past week, but nothing has kept us up at night the way China has um. So this week we're going to be talking about China. Some quick context here. The Shanghai Main Stock Index is down thirty nine percent since it hit

its peak in June. And when China sneezes, everyone captured a cold, so um emerging market stock markets have lost two trillion dollars collectively just over the course of August, So you know, this is a pretty big meltdown. Today we're going to be talking about this and what it means for the rest of us, and we're also going to talk a little bit about China's economy. You know, how, how would you guys describe what China's economy is like?

Socialism with Chinese characteristics was the way down described it. But I gotta tell you I was there in May and the Starbucks in the basement of our office in Aging Wall was holping, absolutely hoping. And you know what else, Grande plant cost about the same as it cost me across the street this morning. So it seems like there's a decent amount of private enterprise going on there now. But also the government still has a ton of control.

To shed some more light on all these things, we've got Kenneth Lieberthal from the Brookings Institution here to help us. Ken thank you so much for joining us. A pleasure to be here. Aki. Those numbers were crazy, and clearly investors are semi panicking. So it's kind of weird because we always think of China, or we've historically thought of China as this place where you know, growth is nuts, it's off the charts, they're stealing us jobs, are doing

all this stuff. What's changed and what's happening now? Well, first of all, i'd encourage you not to attach too much important to the fall off in china stock market. That stock market went up by a hundred and fifty percent over the last eighteen months, so the fall off of thirty so it still has most investors way ahead of the game. Number one, but number two, it clearly

was a bubble. It had to burst, and it burst, and it still has a ways to go, probably before you hit a real market determined uh, you know, equilibrium rate there. The good news is that the stock market is very little to do with the real economy in China. While the stock market was going up, the real economy was slowing dramatically. You know, the China stock market is not like the US market or the markets in Japan or Europe. The thing to focus on really is what

is going on in the management of China's economy. How accurate are the numbers? So what do we know about it and what are the implications of that for US

and UH. I think there are now a lot of worries about the quality of management of the economy about UH, the accuracy of the numbers coming out of China, and since as the second largest economy in the world and the largest trading partner of more than half the countries in the world, if not mistaken, what happens in its real economy is a great significance and we be happy to explore that as you know, as you want to get into it. Many people probably aren't used to seeing

the words Slowdown and China next to each other. Yet if you look under the hood, it's been a couple of years since they clocked ten, but even so seven that's the official target. So many countries would kill for that. You bet they would. I think we would kill for that. China for years grew at ten percent on average real growth of GDP per year, absolutely astonishing, especially when you

consider they're almost one point four billion people there. But a lot of that growth was a combination of smart economic management but also the having rapid growth by bringing people in from the countryside to the cities, getting inserted into the global supply chains so that you take high value added products from Japan, from South Korea, from the US and elsewhere and assemble them in China and then sell them, then export them out of China, and you

build infrastructure to make all that quite efficient. So that's not technologically innovative. Growth is not very high quality growth. Catching up story, it's really catching up, and it's following a model that a number of East Asian countries have followed before, and they ran with that model. They ran very effectively with us. They deserve a lot of credit for it, but they've exhausted that model. That model assumed that trying to keep pumping out exports, increasing the exports

at a substantial rate every year. But then the global economy has slowed. Uh. Protection is sentiment on a lot of places has increased, and there's no way that trying to can grow by simply pumping out exports in larger and larder large your volumes Secondly, it counted on a

huge labor surplus. You look at the age distribution of the Chinese population, and from the time they started this grossburg until two thousand and thirteen, they had more people of working age than they had people either too young or too old to work, than is typical of countries at that stage and development. So they had a lot of cheap labor coming in and they could afford to pay them little, give them very few benefits, work them very hard, and make a lot of money off of it.

And that is more or less the model they had since done. Began the opening in seven so it's been going for three decades. Yet I have the impression that's certainly in the minds of most Americans and most Western is that's all they still think China is. Yeah, and it isn't. That's the point. It takes a while for a changing reality to kind of catch up and how people think about things. China actually is now entering a period is working age population is shrinking in absolute terms

of shrinking. Does that have anything to do with their one child pause? It's it's a kind of result of their one child policy, which began back in the early nineties. When this big growth spurt began, and they still don't have a lot of kids too young to work. What they're going to get a huge increase of is people too old to work, and those are very expensive people. And they went on a huge infrastructure binge, which made a lot of sense. But they've now basically build out

the infrastructure that has high payoff. And so if you want to keep investing in infrastructure, you're going to be investing in things. You know, see proverbial bridge to nowhere, and the bridge is still as expensive as a bridge in the middle of New York, but you aren't making money from it. And so this combination of things has forced them to look at how to transition to a

to an innovative economy. During economy that's creating new technology that's competing at the high end of the international economic profiles you see, and have the low end assembly operations and that kind of thing moved to places like Vietnam and Bangladesh and India, Pakistan. It's it's interesting you should say that. I mean, last weekend I did back to school shopping for my son, and I bought him some clothes.

I probably shouldn't name the outlets I went to. But it's the sort of thing you can imagine, and just out of curiosity, when I got home, I looked at the tags to see where all these things were made. Not a one of them. And I went to three name brand outlets, not a one of them was made in China. It's Vietnam, Pakistan and Indonesia. Yet I'm sure if I was doing that ten years ago, they all would have been made in China. And how did this happen?

Yet somehow not permanent to popular consciousness here. Many of the producers in these other countries now are actually Chinese businesses that had moved their business out of China to lower cost places to produce. So they're doing a shen z and elsewhere exactly everyone not on the scale of Shenjum, but that kind of thing. You know, there's a lot of capital coming out of China, especially initially things like textiles, because you know there's such a small margin in that

you and it's so labor intensive. You go where the inexpensive labor and basic infrastructure is and that's for example of Vietnam Um. So China is trying to shift the problem is it's a very hard shift to do without

some significant disruptions. So, you know, we have this great team here at Bloomberg and they regularly survey economists around the world, announced them, you know, health asces each country you're going to grow over the next year, over the next two years, three years, And right now the expectation is for China to grow six point nine percent this year. Um So, like we said, this is way slower than a ten percent average over over the past few decades.

Is six point nine percent really that bad? And earlier you mentioned that, you know, some people don't really trust the numbers that are coming from the Chinese government anymore. You know, I've read some reports that maybe growth is closer to six percent, Like, what does that really? What does that look like? If you're you know, a normal person in China talking to normal people in China, It is a mixed back. People are worried about the economy.

Their unemployment figures are very low quality for a variety of technical reasons, they're not very accurate. I think a key thing here is that the statistical system in China that we all rely on is really quite good at measuring capital investment, at measuring output of industrial firms UH, those kinds of things. The old economy, if you will, UH is quite poor and measuring things like service sector businesses UH and consumption. Those figures are collected less frequently

and they're usually subject to large adjustments. The system just was geared to what the Chinese were most concerned about over the last three decades. They're now trying to shrink the relative portions of investment of exports and manufacturing in their economy, and they're trying to grow the service sector and especially household consumption as a demand driver since exports can go longer do The trick part of the problem

with that is their own numbers are not high quality. Yeah, I know, I know if people don't really trust the numbers out of China depending on who you talk to. So I'm just kind of curious to why that is. We have always theories about numbers here as well. Of course, it sounds like you're saying it is a little more too of them. I think there is a little more to her. I don't think the government is lying. I

think the government's reporting the best it's got. The problem is the growth sectors of the economy are the ones where their numbers aren't as good, and the sectors that are ratcheting down are the ones that their numbers are come out every month and they're actually pretty good, and we know how to do adjustments and that kind of thing. So it's a problem in figuring out what's really going on.

It appears that while manufacturing is clearly in the dumps, the reality is it seems that wages actually are continuing to go up. Well, the housing market is way off from where it was. Real estate development, especially of residential real estate, is way off, and that was a huge driver in the Chinese economy. Uh So there's just a lot that is shifting around in China. It's very hard to get your arms around it. So I can I are primarily US focused reporters, you know, I'm curious on

your thoughts. We can't really just tune out China, even though we mostly focus on what's going on here in America. Um, it's not only we can just block out China, especially not with markets doing what they're doing. So for someone who doesn't cover economics, why should the average American care about what's going on in China beyond what it's doing

to their stock portfolios? We do roughly six billion dollars of trade a year, and with China, so relative prices of goods, relative competitiveness, and that kind of thing matter a lot. Secondly, the Chinese are now very rapidly increasing their direct investment in the United States. They're building factories, they're investing in the energy sector, They're doing a lot

of things. Uh. If you live in San Francisco, pay attention, or in New York, the Chinese are driving up your real estate values by a lot, especially at the if you're, for example, in the American automotive sector and you look at let me take GM as an example. GM early on got into China. For I think the better part of a decade, maybe even a little longer than that, China has been the bigest private center in the world for GM. Well, North America has lost money every year.

China has been a huge profit center. Now, vehicle sales in China are slowing and in some cases actually the market is actually going down. If you're paying GM retired workers pensions, it's money from China in a real sentence that is making that more affordable. So given all of that, let me just ask you to step back in time and we should mention to our listeners that you were the China guy at the National Security Council during the

Clinton administration. China's economy is so much bigger now than it was then. What would happen now? I mean, you're a sleep in bed, you get a call from one of your aids. They've just reset the reference rate for the yuan, or they're doing this with the stock market, and there's been a shift in this and the Premier has just said X. What happens? Do you get the call say, come in brief the president at seven o'clock and he or in the future, maybe she's is ken

what the heck is going on? I thought we had this figured out. I thought it was the second biggest economy in the world on the way to be the biggest. I thought they had it all figured out. What goes through the minds of policymakers during a period like this way? The US does have so much at stake. It's a

very good question. It's very important when you get that kind of calm, that you have very clearly in your mind what really matters short term and long term to the US and what is just one of these things that's a blip. The stock market in China in terms of its economic impact on the US is frankly a blip. And you want to say that, You want to say, you know, the stock market doesn't tell you much about

what's going on in China. And as you all know better than I do, markets act on sentiment very often as much as they act on hard numbers and deep analysis, you know. And what we've seen is a classic example of that. Where people were worried about China. They're worried about emergant markets are over are all don't quite know what's going on, and suddenly it looks like a bubble has burst in China, and Chinese are losing their shirts

in the market, and so markets everywhere react dramatically. You won't be able to say to the President and to the National Security Advisor and the National Economic Advisor and so forth, that's not what's going on. You see this sentiment, but the real economic significance of it is small. What what I would be more concerned about is not, for example, the stock market went down, but what the Chinese leadership did when they saw it going down, because they then

intervened in almost startling fashion. I would say that the really big problem is here. A lot of people are going to feel that the reforms that Chi ching Ping, the Chinese leaders, has put right up on the wall and said this is where we're headed. It didn't take much to knock them back a good peg and resort to very non market approaches and do it, frankly, at the wrong time, so they were bound to fail. He didn't wait till the market was near as natter and

then try to provide confidence and move it up. It was still in the middle of a fall, so they expended something like two hundred billion dollars in addition to all kinds of other interventions. They put out roughly two billion dollars to stabilize that market, and then the market fell, so a key. You know, when Ken was talking earlier about demographics and a shrinking labor market, did that make you wonder about your own homeland? Yeah, I was about to say this sounds a lot like Japan. Well, in

a sense resonates with Japan. China's age distribution by I believe two thousand and thirty will be roughly what Japan's

is now. And as you know, Japan, it's a very old society, uh, in terms of age distribution, the big differences China doesn't have nearly now or perspectively even by two thousand and thirty, the per capita wealth that Japan has what it has had, and we don't know the future on this, what it has had is very dynamic economic decision making, you know, I used to say, and it was true experience supported this that one of the things you could admire about the Chinese leadership, regardless of

what you think about the nature of their system, is they did not duck problems coming up when you talk to them. They talked about the future. And let me tell you, if you pointed out problems that you don't understand how big those problems are. And here are some other things, and let me tell you what we're gonna do about them, you know, and we'll experiment. But fundamentally we've got to move in this direction, and they would do it. You look over the ensume a few years

and they do it even more than you thought. Big question and for Japan that has not been the case, you know, sincerely and uh. And the question is whether China is going to get tripped up as it goes forward, And frankly, no one knows the future. It would be nice if we did, but no one does. But these last few weeks have I think raised more doubts and more concerns abroad, and I suspect in China too than we are accustomed to With China. That's not a good thing.

So we used to worry about Japan and then Aki when Japan's big growths but finished and we thought it was just a temper everything in the country would get back on its fate and go back to what it was doing in the late nighties and the early nineties. That didn't happen, but that was a cave of the world economy because China came online and its economy began growing and growing and growing. Do we need a new China? Well, what is it? Frankly, is too soon to tell what's

going to happen to China. They may pick up where they are going to get to tempercent again, but they can sustain five to seven percent for the that's fifteen years on average, and transition to higher quality growth, less environmental impact and all that. Uh, that will be a be a huge contribution to global economic growth. The next big comer possibly will be India. They're already. No, their per capita GDP is miniscule compared to China's. Their infrastructure

is almost non existent compared to China's. So you know, India is not there by a very long shot, and therefore you have this huge growth potential in India. It's really great you could be with us today and we loved your insights. It's great to hear from someone who has studied China both academically and has been involved at the nexus of US policy banking on it. Well, all right, that's it for us today. Thanks again for listening to

Bloomberg Benchmark. We will be back next week and until then you can find us on the Bloomberg terminal as well as Bloomberg dot com. We are also on iTunes, where if you visit, please give us a rating so more listeners can find us and let us know what you thought of the show. We love feedback here um. You can talk to us and follow us on Twitter at at the Eto seven, at Tori Stowell with one L in the middle, and at Dan Moss d C. Thanks again, and toward the goodness I can exploring is