Davos 2020: Phase 1 Of U.S.-China Trade Deal Won’t Solve Problems, China Reform Foundation’s Fan Gang Says
“An agreement is better than none, but I don’t think this will solve all the problems between the two countries,” Fan, director of National Economic Research Institute at China Reform Foundation, told BloombergQuint on the sidelines of the World Economic Forum 2020 in Davos, Switzerland. “You (the U.S.) aren’t selling us your advanced goods being a technologically advanced country.”
The U.S. and China last week signed the first phase of a broader trade pact, which commits China to do more to crack down on the theft of American technology and espionage while outlining a $200-billion spending spree to try to close its trade imbalance with the U.S.
But, according to Fan, trade war isn’t the biggest reason for the downturn in the Chinese economy. The tension with the U.S. led to a 14 percent drop in China’s exports to its largest trading partner but the nation’s overall outbound trade still grew in 2019, he said.
So while the trade war did play a part, it was the excess capacity created in the last upcycle that largely dragged down the nation’s economy, Fan said. And that was driven by an investment boom.
Fan expects that overcapacity to be cleared this year and China’s GDP growth to “moderate” to stabilise around the 6-percent range in 2020. The growth will rebound from there as the economy shifts from an investment-driven model to a consumption-oriented theme as incomes rise.
During the previous boom, China led the global growth and drove a commodity super-cycle that ended in a crash. Fan, however, doesn’t expect similar exuberance this time.
“All the bubbles were created by rapid growth last time. But this time, the growth would be moderate. So people will be rational,” he said. “The demand will have a positive impact on the commodity market but we won’t have a bubble impact.”
Watch | Fan Gang speaks about the phase 1 trade deal, resolving China’s overcapacity, China's new investment cycle and growth model.
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Here are the edited excerpts of interview...
Davos begins on the back of the announcement of Phase 1 of the trade deal between the U.S. and China. Do you believe that this is a sustainable move?
Having an agreement is better than none, right? I don’t believe this will solve the problems with other countries. The trade deficit of the U.S. is hard to be eliminated by selling primary goods to China—the beans, pork and the gas. As the most advanced country, you’re not selling us the most advanced goods but all those economic ones. I don’t think that will be sustainable. That is one thing.
Second, a lot of things are not in this agreement. I would say that this is a good thing, but it has not yet solved all the problems. So, we need to make more effort to improve the situation and the relationship between them.
Do you believe that an effort is possible in a year where we are going to see the presidential election in the U.S.?
This is the kind of uncertainty which this agreement did not really remove. Because, if things are determined by domestic politics, it could be very damaging for international relations. Somebody will oppose more sanctions or the tariff and when negotiations for Phase 2 will start— that is all uncertain. So, that’s not a good thing for both countries I would say.
The other point in news which we got a couple of weeks ago is that China’s GDP grew at 6.1 percent— the lowest since 1990, but it is not a bad number given that last year was difficult. What do you make of this kind of GDP growth?
Well, the Chinese economy is a large economy. That means, the outside factor may have an impact but it is mainly due to domestic reasons. So, the trade war has a negative impact but the main reason for this downturn is that the domestic over-capacity issue has not been totally removed and the market clearing is not yet finished.
But things are getting better. It is stabilising and the market clearing is going on and it is going to be finished in the last phase of the transition. So, we would expect that the economy in 2020 would be stabilised, that is one thing. If there is no higher growth, but at least it will stabilise around 6 percent and then, the next thing will determine is how much reform and how much of structural changes will really take place in the economy.
When you speak of reform and structural change, one of the big shifts that have been underway in China is the move of an investment-led economy to a consumption-led economy. How do you assess of that shift by the Chinese authorities?
The consumption now is really growing as a part of the GDP and as a contributor to the GDP growth. The reasons are really solid for this kind of a change. Number one, by the end of 2019, China’s per capita GDP reached $10,000. So, this is a milestone and that indicate that the people really have the money now for consumption.
Number two, social securities have been really reformed and started to function for Chinese consumers. Not only the urban people but the rural people have now got some basic securities. So, that will be making a big contribution for the lower saving but higher consumption. Also, these digital things really improve. Before, we didn’t have this—the so-called consumer credit. Now the internet is really growing very fast and the e-commerce is really fascinating.
Earlier, China’s saving rate was high and old people’s saving is so low. Earlier, they didn’t save much money but after retirement, they are not going to spend much money. But after 40 years, people who have retired have the savings. So, the structure of the economy and the population is now really changing but that will also make the consumption continue to grow in the next decade.
I believe that investment contributes about 31 percent to GDP, consumption is now at 51 percent. What do you believe would be the ideal balance of the Chinese authorities and they will be able to strike in the course of this decade?
Well, at this stage of development, as an economist, I do not want to see the investment going too low. This is because savings rate is around 42 percent. So, to utilise those savings, you need some investment. Also,China needs investment in the social capital in terms of the infrastructure and urbanisation. You still need those investments.
The investment in China now is going into the second phase of urbanisation. In the early phase, you had small cities grow up. But now, the government has finally adopted the policy encouraging the big metropolitan are adevelopment—you may have heard Hong Kong, the Schengen area, Shanghai. That’s a big area for urbanisation as it’s a group of cities. That also needed some investment. That will lay a better foundation for the future growth of consumption.
At the moment, the percentage of the ratio between this consumption and investment is okay. I would like to see that stays for a while—say three-five years, then go down further. We calculated it many years ago that if China has basic equity of the income, the better. The ratio is something like a 25 to 65.
So, you are not very far away from that at this moment?
No, not very far away.
You mentioned that the overcapacity issue in China has yet to fully play out. How much longer do you think that will take? I’m going to juxtapose that question with the second point, that whilst we did think that these trade tensions will hurt China in some way, from what I understand, exports have gone up only marginally. Do you see export playing a bigger role in the cleaning out or will it have to be any other resolution?
The overcapacity mainly is related to investments. If there is too much investment, it creates too much demand for those investment goods, not really exports. Exports continue to be at a high level, but in recent years because of trade friction with some countries they are now growing marginally. However, China’s export to other countries—emerging markets, including India, Russia, Asean, Africa and other markets, it is really growing.
I mean, our export to other countries is still growing. While I’m not saying that exports will play the role like it did 10 years ago or 20 years ago, I will not say it will decline or disappear. China’s export capacity will continue to be strong. If we can open up further to remove some restrictions for foreign capital, then growth of export, including export from the multinationals in China, will continue to be the part of the growth story.
Last year, our export to the U.S., was down by some 14 percent. But overall export continues to grow by two or three-point percentage.
You don’t believe that continuing strong growth of exports is what will help resolve the over-investment and overcapacity issue? Is there any other resolution that you expect will play out over the next few years?
It will play a part but definitely not the main part. Because this is mainly for the investment. Investment means infrastructure in domestic and those kinds of heavy industries. So that’s not really exports. Export mainly means the light industry—you know, the electronics and all those things. So, it plays some roles, but not the key for this.
So, this whole capacity issue, how long will it take to resolve?
Basically, our argument is in the last stage. Hopefully in 2020, we’ll see it to be over. From the beginning of the last century to the end of the last century. So, that’s a little bit too long. That means is it like a so-called ‘soft landing’. The good part is, we didn’t have negative growth. But soft-landing means, it took too long.
So, would you then say that if the overcapacity issues are dealt with this year or maybe next, there may be a scope for additional investment in the Chinese economy?
In the beginning of 2018, before the trade war started, China’s investment, including the private sector investment, really was growing. But then stopped due to this trade friction. So, I would expect that if the market clearing is finished and if we have the phase one agreement really playing its roles, in 2020 the investment will rebound a little bit.
In the future, we still need a lot of the investments. Particularly, this urbanisation process and the industries. So, the new industry, new technology, and that all the Chinese companies are really making investment plans for that. So, from that point of view, I would say investment growth is too important and that will create a big demand for the world market.
The last time we saw this kind of investment growth in China and maybe at higher levels, we saw commodity super cycle play out. What kind of impact will it have qualitatively on world growth this time?
Hopefully not. Hopefully not like last time and this time, the growth will be moderate. Last time, all the bubbles were created by fast growth. I mean, if growth is too fast, then you create the imagination that all the bubbles will take place.
But if it’s moderate, people will be rational to calculate, and the market will not have that kind of favour. From that point of view, the demand will continue. So, that will have a positive impact on the commodity market, but not really the bubble impact. So, hopefully this this time, it could be more stabilised.
You’ve been a strong advocate of reform in China. What is the unfinished agenda that you expect to play out over the next 10 years?
Well, the reason Chinese government adopt a lot of opening-up policies, that’s part of the reform. We need a market access for all people, not only the foreign companies but also the private sector, the domestic private sector. So that’s a very important reform. It is a set of institutions and the policies for the development, particularly for the development of the private sector and complied by the foreign companies. Now, China has more openings so that’s a very important part of market access—an open market.
Second, it is also the relationship between the government and the companies, including the issue of state-owned companies’ issue. So that has created quite a lot of distortion in the market, particularly in the domestic market. So that’s important for the future. Also, we need further reforms for the social security system—which we now call the stakeholder development—to avoid the income disparity and the social crisis. So that’s also a very important part of the reforms.
Do you see in this decade, 2020-2030, China’s private sector enterprises leading the way as opposed to the last two decades where it has been state-owned enterprises?
Yes and no. I believe now, most people, including the leadership, understand that we need a private sector. Particularly, we need the private sector to play the role of leading the technology revolution. The investment, the projects by the private sector is really fascinating. But for the whole economy, the state sector still plays the bigger role. They have so much money and capital, but of course they need some reforms. They need to give up some roles for the private sector, they need it and we need it.
We accumulated so much capital and invested a lot of them in the state companies. So, we need the state companies to play a role, including the resources, transportation and infrastructure. All these public goods, we still need. We’re in a stage of urbanisation. So, we need that kind of public goods to be provided. So, I would say both. Hopefully, more roles for the private sector, but still have the same sectors in the economy going very strong.
In the last few years, because of the dominance of state-owned enterprises and a state-led development model, there has been much concern around asset quality shadow-banking. Where does China stand in the cleaning-up process?
A lot of the things are not very clear for us as well. We do not know because it is hidden. But I will say when you add up all those stories, as a percentage of the economy, is still not big.
In some sense, the Chinese financial system plays safeguard too much. In effect, for example, banks have scarcely given any credit loans.Everything is a mortgage; everything has been securitised one way or another.So, they don’t take that much risk. You can say there are certain problems but overall, it’s not really a big deal as part of the economy and as part of the financial assets.
I will say with new things like P2P there is a new issue and new problems, but still, by the size of the total problem, overall assets are still handled. Handled in the sense, they are still not really going to create the crisis. So, now we’re in the transition to also clean up these kinds of things. That will take some time, but it’s not really putting too much pressure on the financial sector. Consumer credit is not growing very fast. So, I say the problem is there, but not the problem that can create a crisis like 2008.
There has also been in the last several months a shift in policy in China towards a more fiscal policy orientation. With several tax cuts that have taken place, I think over $200 billion of tax cuts that have been given away. Will that continue to be the main thrust versus monetary policy when it comes to fostering growth in China?
At the moment, the Chinese economy has a problem of liquidity. Meaning that the banking sector has the money, but they cannot find a better project. So, because there’s demand, the market is still low. That’s why we need to rely on the fiscal policy. You need the government to spend some money, create the demand and then, you make the whole economy start to roll up. I think this is a situation of the moment and I believe for this year or the next year policy will dominate.
Fiscal policy will continue to dominate over the next government?
The government has the limit for the fiscal policy. It also has the potential to play the better fiscal policy, particularly in a relationship between the local and the central government. China’s economy is complicated by that very much. So, if they can play that one, if they can really utilise those leverages for the local government, then I believe they can play out.
Will we continue to see more physical pushes in the frame of tax cuts or more spending towards local governments?
What kind of role in terms of economic leadership will China have with several countries, especially neighbours like India. Will Chinese demand fill up many of our industries in our economic growth? What kind of a leadership role do you expect China to play in this decade?
If China continues to grow, then it will make a contribution to lead the global growth. China right now contributes 30 percent of the total growth of the global economy. So that’s one thing we need to expect.
Second, I think that China really can play some role in keeping or pushing forward globalization—multilateralism. China needs it. That’s really in China’s own interest. So, that may not be a leading role but is an important role in that direction.