AS CHAIRMAN OF MORGAN STANLEY ASIA, Stephen Roach, 65 years old, spent three years based in Hong Kong and logged 1.2 million miles flying around Asia and the globe. That has afforded him an expansive world view, and a close-up look at China's teeming, and rapidly changing, society.
This fall semester, he's sharing both with students of Yale University's Jackson Institute of Global Affairs and the School of Management, while also holding down the job of non-executive chairman of Morgan Stanley Asia. Barron's met with the firm's former chief economist, and author of the book The Next Asia, in New Haven, Conn., after one of his lectures last week. Roach discussed his strong opposition to the recent Congressional bill to impose trade sanctions on China, the risks of protectionism and the challenges facing the U.S. and global economies.
Barron's : For the benefit of those who can't come to Yale, tell us what you're teaching.
Roach: The course is called "The Next China." It develops a case that the Chinese model of the last 30 years, as successful as it has been, isn't enough to take China to the next level, largely because it's critically dependent on external demand. And post-credit crisis, the vigor of external demand is a real question mark.
What's your outlook for the global economy, and for China?
The global recovery is going to be very anemic over three to five years, in large part because the world's biggest consumer, the American consumer, is dealing with post-crisis aftershocks caused by record debt, inadequate saving and persistently high unemployment. It'll be hard to find new sources of growth that will compensate for that shortfall. Other consumers―the Europeans and Japanese―can't make up the difference; they're facing post-crisis aftershocks of their own. I'm very optimistic on Asian consumers, but they're too small [a part of the global economy], so global consumption is a big issue. It's unbalanced, U.S.-centric, and will be weak. Global growth will be about 3.5% to 3.75% over the next three-to-five years, compared to a pre-crisis average nearer 5%.
Growth will continue to shift to Asia, but it remains heavily dependent on external demand in the West, and that's a powerful headwind for China. The trend over the next three to five years will be about 8%, versus a 30-year trend of 10%. Eight percent is spectacular, but that's a modest slowing in the Chinese growth miracle.
Asia emerged stronger from the crisis, having insulated itself and swelled foreign-exchange reserves from $1 trillion to $5 trillion. Is it enough?
The big challenge for developing Asia is how it has to develop much greater support from internal private consumption. Exports' share of the region's gross domestic product had risen from about 35% to 45% in the decade before the crisis, while internal private consumption fell to a record low around 45%. This structure now begs for a major re-balancing, and that has got to be consumer-led, as opposed to export-led, and that's the missing link in the Asian miracle.
You met with Chinese Premier Wen Jiabao when he was in New York in late September to attend the U.N. How's he tackling the challenge?
The Chinese premier has said before that the old structure is 'unstable, unbalanced, uncoordinated and unsustainable.' I think the Chinese recognize that they need to do three things to provide broad-based support for internal private consumption. They have to build a social safety net that will allow the Chinese to reduce the excesses of fear-driven―or what economists call precautionary―savings. And the safety net has to include far more aggressive funding and social security, private pensions, unemployment and medical insurance. They've taken very small steps, but they need to take big steps.
The second thing is to provide much more effective and aggressive support for lagging rural incomes. Some 750 million Chinese still live at impoverished levels in the countryside, and the income disparities have widened dramatically in the last dozen years between urban and rural China. They need to be more aggressive with tax policy, and in providing rebates to rural families. They need to re-think property-ownership rights of rural inhabitants and invest in information technology to boost agricultural activity.
The third thing is jobs. Ironically, while China leads Asia in GDP growth, it lags Asia in job growth. From 2000 to 2008, China's GDP grew 10% a year, but its net employment growth was just 0.5% a year. That reflected a disproportionate emphasis on manufacturing as the growth engine. When you boost manufacturing productivity, you substitute machines for people―it's a capital-intensive, labor-saving growth model. So what they need as an antidote is to broaden to labor-intensive services. The services' share of the Chinese economy is minuscule at 42%, versus 58% for India and 75% in the U.S.
If China succeeds, the consumption share of GDP could go from the current rock-bottom 35% to between 42% and 45% over the next five years. That's still low by global standards, but a huge improvement and a big shift in the momentum of China's structural re-balancing.
Are these initiatives in China's five-year plan for 2011 to 2016?
The plan will be enacted in February. I think the Chinese leadership understands that the current model relies heavily on exports, and they're very concerned about the state of the world post-crisis, and they know they can't count on the U.S. consumer, the European consumer or the Japanese consumer to provide vigorous support to their export business. They know they've got to come up with something new and different, and that something is the Chinese consumer. The time to change is now―not five years from now.
China is passing Japan as the world's second-largest economy, and its trade with the U.S. is one of the world's biggest. What are the threats to this relationship?
The main issue is jobs―in the U.S. and in China. We have an unacceptably high unemployment rate that doesn't look like it's going any lower. Wages aren't going up. At the same time, we have a very large trade deficit here, and the biggest piece of that is with China. So American politicians―and this has resonated with American workers―want to hold China accountable for the plight of the American worker, and this has come to a head. The House Ways and Means Committee has approved an anti-China bill that will allow U.S. companies to seek remedies in trade sanctions for an undervalued yuan. And that bill will most likely pass soon.President Obama was very tough, according to press reports, with Chinese Premier Wen Jiabao when they met in New York.
Unfortunately, I think this is dead wrong. We've completely missed the role that China plays in the U.S. economy. Last year the U.S. ran trade deficits with 90 countries. China was the largest, but there were 89 others that account collectively for a lot more than our trade deficit with China. We have a multilateral trade imbalance―not a bilateral problem with China. And the reason is we don't save. Our overall savings rate as a nation last year was negative, at minus 2.3% of national income. That's the lowest for a leading country in the modern history of the world.
Closing down trade with China is like rearranging the deck chairs on the Titanic. The Chinese piece just goes somewhere else, most likely to a higher-cost producer, which ends up taxing the American public. What is being suggested by Washington―and a lot of economists who should know better―is a bilateral fix for a multilateral problem. This is bad economics, and it's driving bad politics, and it's extremely dangerous. It will backfire on America and, by the way, the Chinese can retaliate and put trade sanctions on American products made in China. China is America's third-largest―and fastest-growing―export market. And if it really gets ugly, then the Chinese just stop buying U.S. Treasuries. Our interest rates soar, the dollar collapses and we're back in recession.
Is protectionism currently a threat to the markets?
The markets don't seem too worried about it. They've got other issues on their mind. The drumbeat of U.S.-China trade tensions has been getting louder over the last five years. I was concerned in 2005-2007 when some politicians kept pushing a bill similar to the one just proposed, but U.S. unemployment averaged 4.7% then. Today, the stakes are higher.
Turning to the U.S., there's a lot of debate about what additional fiscal stimulus we need. But you maintain that policy traction is very elusive in a post-bubble economy. Should fiscal stimulus only be used to contain crises―not to revive a deleveraging economy?
The $787 billion stimulus package worked in stopping the crisis, but it hasn't jump-started the recovery because of our deleveraging and the rebuilding of savings. If there's another stimulus, it must target the victims of long-term unemployment. We need a massive expansion of unemployment-insurance benefits, and massive retraining. I worry so much about workers who have lost jobs that won't come back, and how our public education system prepares workers for this new economy. That's the program I want to see. I don't want to see old-fashioned pump-priming tax cuts for middle-class Americans who are still working or for rich Americans who don't need tax cuts. That's divisive, polarizing politics that will do absolutely nothing to jump-start our economy.
Also, the idea that we can come up with a quick fix is ludicrous. Politicians aren't being honest. They're saying, 'Well, if you just listen to what my party says, we can turn America around tomorrow.' That's a crock. And the American public has lost respect for what politicians are saying on both sides of the aisle because they know in their hearts these are deep-seated problems that have been building over time and there's no quick fix. Yes, it's a hard sell, which is why I'm not announcing my candidacy for any political office at this time.
Back to China, what are the implications of its recent wage inflation?
It's an important part of the pro-consumption policies in China, and I think it'll get a lot of emphasis in the new five-year plan. Personal income is only 42% of Chinese GDP, roughly half that of the U.S. Wages are too low. Does this mean that the days of low-cost Chinese labor are over? Not in any way whatsoever! Even with rising wages, Chinese compensation per hour in manufacturing today is only about 4% of the levels prevailing in America.
Is the yuan undervalued?
The Chinese abandoned the peg in 2005 and allowed the yuan to move up 21% relative to the dollar over the next three years. During the crisis, they froze that because they were fearful of exacerbating the external demand shock, and then they relaxed that policy last July. The Chinese view their currency differently than we do; they see it as an anchor for financial stability in a very unstable world. I believe strongly that the Chinese will continue to allow the yuan to appreciate gradually over the next several years, but they aren't going to buy into a politically inspired vendetta urging a massive, one-off revaluation.
I wouldn't rule out another 20% appreciation over time. I think the model from '05 to '08 indicates what the Chinese are comfortable with. China has a massive imbalance, with a domestic savings rate in excess of 50%, a large current-account surplus, a massive build-up of foreign-exchange reserves. They, as responsible global citizens, need to deal with that imbalance in a way that makes the world a more stable place. Washington says the way to fix that is through the currency. What China says, and what I say, is fix it by stimulating internal private consumption. You will reduce surplus savings, your current account and your foreign-exchange reserve accumulation. China can fall for the Western prescription of using its currency as the instrument of rebalancing, or it can do it its own way.
Is the Chinese property market a bubble? Is Macau a bubble?
There certainly have been some excesses in Chinese equities, Chinese property markets and the quality of Chinese bank lending. But China handles these sources of financial instability by moving quickly, preemptively, aggressively to build firewalls between their asset markets and their real economy. We have this ridiculous sort of free-market ideology in America that bubbles come and go, as Alan Greenspan or Ben Bernanke would say, and we can't stop them. That view is wrong. The Chinese know that there are always going to be bubbles they have to deal with, but they want to deal with them early.
India emerged relatively unscathed from the crisis. Industrial production troughed in positive territory, roughly 0.3%, and yet they joined the rest of the world in monetary easing. What are the risks now as they tighten?
I'm very optimistic about India, because the Indian economy has improved a lot in the last five years. Their domestic savings rate has moved from just over 20% to 36%. Their foreign direct investment has accelerated dramatically and the infrastructure, while still woefully inadequate, has been moving up steadily as a share of GDP. I think India is moving into a sweet spot driven not just by the improved macro picture, but by long-standing solid micro fundamentals with its large population of world-class companies; well-educated, young, English-speaking workforce; its rule of law, democracy, relatively stable market structures and relatively sound financial institutions. Up until about a year and a half ago, the government was very constrained in implementing reforms because it had to share a coalition with the Communists, who have since been defeated. It now has a cleaner shot at reform, so let's wait and see.
What surprised you during your years in Asia?
The thing that surprised me the most was the breadth of the progress. It's not just a story of Beijing, Shanghai or Shenzhen, but increasingly also inland cities like Chong-qing and Xian. In the three years I lived in Asia, I lectured not just in leading universities in Beijing and Shanghai, but in some of the regional, provincial universities. The quality of education and instruction programs has really improved a lot. The students are bright. They're inquisitive. They're well informed and they're highly motivated. The aspiration of Chinese citizens was an astonishing thing to see first-hand.
