 Hello and welcome to a World Economic Forum discussion with Li Daokui, the Director of the Center for China and the World Economy at Tsinghua University. My name is Jillian Tett and I'm with the Financial Times. And thank you for joining me in this conversation. My pleasure. Now, at this year's Davos, there is a lot of discussion about the outlook for the Chinese economy and about whether or not the Chinese economy is slowing down, speeding up, whether a growth rate of 8% or so can be sustained. How optimistic are you about the trajectory of the Chinese economy right now? One of the last things I worry about about the Chinese economy is the GDP growth rate. Indeed, last year, the GDP growth rate came down to 7.8% down from over 10% of the average of the past five or seven years. However, I don't worry at all. For the coming decade, at least for the rest of the decade, most likely the GDP growth rate will be still reasonably fast, by reasonably fast, I mean 7% to 8%. That implies that by the end of this decade, most likely the economy will be the largest in the world. And I'll come back to that in a minute, but do you believe the official GDP data suggesting 8% growth or so? Do you think it's accurate? Yes, it is accurate as an aggregate number because there are many aspects of the economic activities which are under-reported and other aspects are over-reported, and history tells us that overall the balance out, especially in the service sector, the under-reporting has been so severe that overall, every time the government tries to do a complete counting of GDP, the number goes up. So what about people who say that so much of China's growth in the last decade has been driven by exports and essentially dependent on a buoyant external demand in places like America, that as we see the West slow down, China will inevitably slow down too? Are you concerned about that hit-to-export growth? Yes, this is a great question. The reason I do not worry about GDP growth per se is that the country, if you look at the country today, is still a very poor country. Per capita GDP is still less than 1.5% of the US per capita GDP, that is 18% of the US per capita GDP. And also if you look at the whole country as consisting of multiple regions, there are still lots of regions in the central and the western part which are still juiced up for further economic growth. So that's the reason I do not worry. Now coming to the issue of foreign constraints from foreign markets, we have to understand there is, I call, a quiet revolution going on in the Chinese economy, a quiet revolution which is not recognized by most Chinese economists and let alone external observers. That is, in the Chinese economy since financial crisis, rich rates, rich rates among the blue-collar workers have been increasing much faster than normal GDP which is driven by relative labor shortage because in the countryside, China no longer has surplus labor in the countryside. Not enough people willing to move from the countryside to cities. So that implies that labor shortage implies the fast growth of rich rates implies that domestic demand in the form of consumption is coming up. By the way, I've done a very careful recalculation of private households consumption in China different from the official statistics. My calculation tells me that ever since 2007, the ratio of private consumption to GDP has been increasing by roughly 1% a year. The official statistics is grossly underestimating consumption because they rely upon household service and in Chinese household service, high-income people do not cooperate for reasons that are easy to understand. So they only get low-income households and the way they did it is very strange. They gave people something like 50 US dollars a month asking them to write down every penny of consumption who among the rich high-income people would be willing to spend that time to do that anyway. So as a result of high-rich rates, as a result of income increase, trade surplus has been coming down as an overall trend. Although last year was an exception, this year it was further coming down. So essentially you would argue there is a rebalancing of the Chinese economy going on of the thought that many external economists and some internal economists have been calling for namely less reliance on export growth, more reliance on domestic consumption. Correct. Correct. And I'm least worried about this continued structural change. I think the momentum is there. Nobody can stop that. So on GDP growth, on structural change, I am very easy. I feel very comfortable. I worry about the other things. Well, I'll come on to what you do worry about in a minute, but what about investment? I mean, because many people have pointed out that China has an extraordinarily high investment to GDP ratio. There could be excess capacity being created. You do have a financial sector which essentially may or may not be having a lot of bad loans. The government has been trying to rein in credit and yet the question is whether it can actually do that given the scale of shadow finance is now developed. How do you see the economy in terms of its internal structures on the investment issue and the credit issue? Yes, another wonderful question. First on the issue of investment. Since the past five years, the structure of investment has changed. Before financial crisis, most of the what we call fixed asset investments were in the production sector. For example, beefing up aluminum smelter machines, equipment, steel plants. However, since 2007, most of the investments have been in the areas of infrastructure. And infrastructure is still in huge demand in China. For example, let me give you an example. City of Beijing, one of the most relatively sophisticated cities in China. The host of Olympics. And July 21st of last year, a big rainfall caused death of 70 people. Why? Because the drainage system is not modernized. So even for city of Beijing, tremendous amount of fundamental work, infrastructure work has to be done. Then the issue is who will pay, right? I would predict and also argue that the government's local central should be the main money payers, main cost barriers of the upcoming infrastructure investments. Why? Because they do have assets in the form of state-owned enterprises. And state-owned enterprises should be divested by the government. So therefore, I've been proposing that raise more public debt today. The opposite of what has been going on in other countries, right? Raise the debt, right? And then incur some deficit today. And tomorrow, divest away from state-owned enterprises, use the money to balance the budget. So in many ways, they're polar opposites of what countries in the West are now having to do. Exactly, yeah. On paper, on surface, the Chinese economy and the Western economies are on two extremes. However, I think fundamentally, we have the same problem. Fundamentally problem. Why? Two problems. We can expand a little bit into Western economies, right? Two problems. The number one problem is welfare. In the West, maybe the welfare system is too generous in many areas. In China, we are too stingy in our welfare system. We need a basic social welfare to enable people to be courageous to participate in market economy. Today, many of them are left behind by fierce market competition. The other one, the other thing China and the rest of the world are also facing the same challenge is regulation, right? In China, we do not have effective regulation, for example, on financial markets. Our stock market is lousy, is, you know, a failure, ashamed, you know, 1.3% per average annual increase of market price in the past 22 years, despite that the economy has been growing almost 9% a year. I'm not even counting about inflation. 1.3% nominal price increase. That's crazy. But that is partly a function, I mean, the problems in the stock market or the capital markets, with the fact that the capital markets as a whole is very underdeveloped compared to the banking system. And essentially, you've had a banking dominated financial sector that in many ways mirrors the situation in Japan, say, in the years after the Second World War. Now, the story of Japan shows us how hard it is to move smoothly from a banking-centered financial system to a more capital markets focus system. Do you think China can start to enable its financial system to grow up and to mirror the development of the economy by moving away from bank-centered finance smoothly or not? That's very difficult. That's also a very, very challenging task. However, right now, there are enough discussions and enough political will and political capital in this area in the financial sector so that I predict in the coming few years, there will be a lot of action in this regard, specifically two things. Two things will be done in the coming years. Number one, securitize some of the assets of the commercial banks so that the commercial banks will be smaller in terms of capitalization. Today, Chinese commercial banks' capital or assets is about 250% of the GDP. Crazy, too high, too much risk is concentrated in the banking sector. Second thing, also very simple and has to be done. That is, to go after those illegal and inappropriate dealings among the listed corporations in the stock market. Because otherwise, the Chinese stock market will, again, disappoint us. And what's your estimate for bad loans in the banking system? Do you have a? Banned loans, well, that is a complicated issue. I would say, to simplify, I would say most of the bad loan issue is issue of public finance. It's the issue of local governments borrowing from commercial banks at the command of central government in order to do the stimulus package, which we saw four or five years ago. So fundamentally, I think I predict the so-called bad loan problem will be resolved by the central government issuing more debt, transfer the money, proceeds of the debt issuance to local governments, local governments pay the commercial banks. So that, to me, is the fundamental solution. And I strongly believe that will be the case. Because most Chinese commercial banks are now multinational banks. You know that? They're listed in Hong Kong, they're listed in other countries, and they have strategic investors from foreign countries. So I don't think commercial banks will suffer in the end. Local governments will pay. But the scale of changes you're calling for in terms of reform with the financial system and the potential implications of the kind of rebalancing you're talking about could essentially lead to a much bigger change in the Chinese economy. Do you think the current political leadership has the willingness or capability to embrace these kind of radical reforms? Again, a very good and a fundamental question, right? Everybody's concerned. Everybody's asking that question. Judging from the performance of the past two months, two and a half months, I would say that the new leadership has the best hope for us to push meaningful changes and to make tough decisions. In terms of background, these people went through the hardship of the Cultural Revolution. They were farmers in the countryside. And these people also came to college, came to colleges for their education during the I call the honeymoon years of reform and opening up. So they have, to me, they have religious beliefs in reform and opening up. And most important for me as an economist, they are better educated as economists than any previous generations of leaders in China. The two top guys have graduate degrees in economics. Of course, we can debate what kind of economics courses they took. I still argue that having economics degree is much better than not having economics degree. So I strongly believe they will have to make tough decisions down the road. Right. And what do you think is the kind of model that they should be looking to? What are the key priorities for the new leadership in terms of trying to reform the economy? I mean, is China heading towards a path of becoming like the US or becoming like modern day Russia or something else altogether? Again, a big, big question. You're asking a very good question, right? In today's China, lots of debates, lots of discussions on this issue, that is, what kind of market economy or society China should go, should shape up, should shape up, right? Of course, you can imagine economists and scholars have very different views. Many of them argue that China should go to the US, go after the US model, right? Free market, minimum regulation, relatively low, in low tax rates, right? However, the governments of many of the government officials tend to move, tend to lean towards the Singaporean or the German model. Now, my view on this one is that fundamentally, this is a question which will be answered by millions and billions of Chinese people, right? Their public preference will eventually shape the future landscape of the Chinese economy. And let's look at the Chinese people's preference. Their preference, I think, is quite different from the Americans. In China, because of the tradition of Confucianism, people put more emphasis upon social order, public goods, then, relative speaking, to the US than on individual liberty. I try to make this as an objective statement without my personal view, right? So if you agree with my analysis, I would say eventually, the Chinese market economy will be more like the Singaporean or German model with relatively effective regulation, good public goods, social order, and relative speaking, to the US, less individual, economic, perhaps personal, liberty or freedom. But it raises the question of how does anyone know what the Chinese people want, because there are no elections, and certainly to the outside world, it does look as if there aren't these channels for popular expression. Again, very good question. No election, how do the leaders hear the opinions or the preference of the grassroots people? Answer is very simple. Twitter. Twitter. Twitter, right? Who needs election? Well, you were telling me earlier that you have five, six million Twitter followers, and I was talking to Rui Qing Zhang from China Biz, who's a key Chinese television anchor, who's telling me he has 10 million Twitter followers, which makes both of you a bit like the Beyonce of the Chinese economic world. I mean, that's extraordinary numbers, isn't it? Exactly. Nowadays, with the modern technology, the smartphones, the internet, so on and so forth, really, there's a tremendous, tremendous amount of channels through which grassroots people voice their concerns, voice their, transmit their preference to policymaking and eventually political changes. And leaders do listen. They do listen. I think they are much more sophisticated than I am. I'm the laziest tweeting person. I claim I have the highest follower divided by Twitter message ratio. I tweet only once or twice a week. When coming to doubles, I tweet three, four times. But at home, I don't tweet that much. I mean, it's quite amazing to think that there is that much interest in economics amongst ordinary Chinese Twitter followers or Twitter readers. I mean, I couldn't imagine Ben Bernanke having 10 million Twitter followers or Alan Blinder or one of the big economists in the US there. That's right. Actually, if you go outside the US, if you go outside Europe, economists, economists have more command of respects or attention from the general public. I don't know why. In Hong Kong, it's the same. In, I believe in Korea, in Japan. Japan, I don't know. I'm not sure. In Korea, in Taiwan, in the region of Taiwan, in mainland China, that's the case. That's why I have been very careful because so much attention is on economists, on me. I have to be super careful when I say things because I can be easily misunderstood and attacked very badly, personally attacked by the followers. Well, particularly given that you've formally had a role at the Chinese central bank for a number of years. Looking on the world stage though, I mean, if you believe that China is indeed rebalancing, if you believe that growth will be propelled by catch-up and if you believe that the leadership is going to try and follow a path which is more akin perhaps to Singapore or Germany, those are all quite optimistic pictures for China. The big question though is how is China going to interact with the rest of the world? Because of course, we are already seeing a lot of tensions developing, say, in relation to Japan right now. Are you concerned about that? Yes, I'm very concerned. Now, first of all, I do not mean to paint a rosy picture for the social changes we just discussed. I am concerned actually. I'm saying I do see some early hopes, rays of hope, of good lights coming in in the past few months. Overall, I'm still quite concerned. Now, yes, you asked about the China and the world relationship. Indeed, it's heightened and I believe I would call upon leaders in China and the leaders outside China to really work together to control the emotions of the young people in China, to convey the right messages to the Chinese young people who are looking at the internet every day, to make sure their emotions are not scaled up out of proportion. That's the biggest concern. And also to the Western world, I also would call them to recognize the following fact. That is, whatever China is claiming nowadays, whether it's Diaoyu Island, whether it's the South China Sea islands, these claims have been there for the past 50, 60 years, ever since the founding of this country. China is not claiming the land from Russia. But Russian friends should be very easy. Don't worry. In the past 150 years, Russia took a lot of land from China, much bigger than the islands. But issues is already settled. The border is already settled between China and Russia. There's no case, no chance for us, for China, to go back to claim. However, the current claims are small, relatively small if you compare with the Russian border issue. Small claims and old claims, and we should cool down and find ways to resolve it. In fact, if I want to go deeper, in fact, the Chinese government has been calling for collaboration called co-development, putting aside the sovereign issue, co-development region. Let's come together, drill the drill, the will, and we share the equity. We share the flow of the natural gas, whatever. That was the model proposed by Chinese governments. It is our neighbors who are so concerned that China is emerging. China is powerful. China is more assertive. Then we better get these islands. That is what's going on. So I believe lots of work has to be done to enhance the mutual understanding between China and the neighbors and also the Western countries. But, I mean, leaving inside the territorial issues, which are, of course, very deeply felt on both sides, what about the more immediate question of, say, a currency war? I mean, the arrival of the new government of Abe has essentially put on the table the prospect of Japan trying to weaken the end significantly. And that's part of a lot of concern, not just from the neighbors, but Europe as well. I am not too concerned about so-called currency war. Why? Because, as I mentioned earlier, some things are already going on, which I call a quiet revolution. That is, the Chinese economy is now increasingly less dependent upon exports. Trade surplus declined from what it was like 8.8% as of 2007 to just over 2% in 2011. And last year it rebounded a little bit to 2.5%. This year it will continue. So trade surplus is coming down. Trade is no longer a big issue as it was. So I take the easy. I don't think this will cause major problems down the road. I'm still more concerned about the popular emotions, the border issue, the island issue. These issues can be much more explosive. What about America, though, living aside the issue of Japan? What about America? I mean, you commented, you probably tweeted to your five million followers after the re-election of President Obama that that could be very bad news because it could reawaken the prospect of China-Japan tensions over the currency. Do you see that being a problem going forward? Yes, I worry. I worry about the US. In fact, if you, I can expand it a little bit. In today's world, I am not so worried about Europe. I think Europe, fundamentally, Europe, if you look at the big picture, Europe is fine. Europe has been working hard in doing is whatever reforms, right? Physical reforms, cutting expenditures, so on and so forth. It is the US which has not been doing major homework, right? People know that no major homework is done except for delaying the problem. So I do worry that a second term, President Obama, may not be able to solve the economic and the physical issue effectively. And when these issues drag on, right? Chances are the president of the US will channel the attention of the general public towards foreign countries. China is a target. So I do worry about the US-China relationship in this regard. And I do hope, I do hope the Americans and American government do understand one thing, that there is tremendous room to work with China on many, many issues, including economic issues, right? And provoking disputes, provoking fights would make both parties both sides lose. But I mean, one issue that's obviously very much on the radar screen is this whole debate about the fiscal cliff, about whether there's going to be any deal on the debt ceiling, et cetera. Do you think there's any prospect of Chinese investors, Chinese sovereign world funds selling treasuries out of concern about what's happening in the US or even in retaliation for any kind of language that comes out of America in relation to trade issues or currency issues? Not at all, not at all. The Chinese side, okay, let me tell you the perception of, my reading of the perception of Chinese leaders of the American situation. The perception is that America is a big boss. It's a grumpy big boss. Grumpy big boss. Grumpy, grumpy, complaining a lot, right? Right. Try to stay away from the grumpy boss, right? Please them as much as possible, right? We don't want to provoke problems. It's a grumpy boss who is complaining, who is raising issues with the little brother at China, right? Why do provoke? We don't want to provoke problems. We want to avoid problems. Now, that being said, I do see a possibility for the two leaders on both sides to really sit together to find ways to make better use of the Chinese 3.2 trillion US dollar currency reserve investments in the US. Channeling that investments partly towards some of the badly needed infrastructure investment projects, that is possible. But again, that I think is mainly depending on the domestic politics in the US. But you don't think there's any chance that the Chinese would stop buying US treasuries in the short to medium term? Minor, minor changes, technical changes, possible. I do not see at all any strategic and big changes in this regard. Again, the Chinese side do not want to provoke problems with the US. So essentially your message is all of the investors who are running around Davos debating endlessly is Chinese growth going to be 8%, 7%, 9% next year are kind of getting it wrong. They should just relax. It's probably going to be fine in the medium term growth outlook. Is that correct? Correct, I've been saying this for past two years. But the big questions really are is where is China going in the long term and what kind of relationship is it going to have with the rest of the world? Very good summary. Right, well that is in some ways reassuring in the medium term, short to medium term but also pretty challenging in the longer term. But it just remains for me to say a very big thank you for your very thoughtful, very provocative and very open answers. I can certainly imagine they will translate very well to Twitter for your six million followers. And I just think that if only we could have Chinese economists and American economists and perhaps some European economists sit down and solve the world's problems we'd probably get a lot further than we are today. So thank you very much indeed for your time. My pleasure, thank you. Thank you.