 My name's Chris Johnson. I'm the Freeman Chair in China Studies here at CSIS. I want to thank everybody for coming out on a glorious day, right before a holiday weekend. We're very honored to have speaking today Barry Norton. And Barry is, of course, a professor at the University of California, San Diego, been studying and analyzing the Chinese economy since the early 1980s. He published his comprehensive study The Chinese Economy, Transitions and Growth, in 2007, and has been translated into Chinese and Korean. His first book, Growing Out of the Plan, Chinese Economic Reform, 1978 to 1993, won the Masayoshi Ohira Memorial Prize. More recently, Norton has published and edited volumes of essays by Wu Jinglian, China's foremost reform economist, called Wu Jinglian, Voice of Reform in China. In 2015, Cambridge University Press is publishing his co-edited volume, State Capitalism, Institutional Adaptation, and the Chinese Miracle. Norton publishes extensively in Top Economic and Social Science journals, and he also publishes regular quarterly analysis of Chinese economic policymaking online at the China Leadership Monitor. And of course, Barry's also professor at University of California, San Diego, my own alma mater, and very close personal friends. So I'm really pleased to have you here, Barry. We're also joined by Tom Orlich. He is Bloomberg's chief Asia economist based in Beijing. He leads a team providing in-depth analysis of Asia macroeconomic data and policies and how they will impact financial markets globally. So how we're going to do this is Barry's going to come up and give us a formal presentation. And then Tom will comment on that presentation, and then we'll open it up to the floor for questions and answers. Thanks very much. Barry, please. I guess I'm mic'd, right? Can everybody hear me OK? OK, great. So it's an enormous pleasure to be here. It's actually my first visit to CSIS, so it means a lot to me personally. They've also, I have to put in a very, thank you, very brief advertisement. CSIS has given us the first opportunity to showcase the new name we have for what used to be the Graduate School of International Relations and Pacific Studies. It is now the School of Global Policy and Strategy. We just want you to know that we are still Pacific focused, and we have a great China group, and I invite everybody to come out and visit us. This guy is, in fact, just as blue as it looks in that picture, and I'm happy to join with us. I just want to say a couple of things about a giant topic today, which is, of course, China's economic reforms under Xi Jinping. And I want to start out. The first thing to say here is, I think, something blindingly obvious that still needs to be said. And that is that the economic reform program that Xi Jinping is carrying out is real. There's actually something here, something big, something important for us to talk about. I sometimes feel a little frustration because I feel that our view of China, China's so big and so complex. Of course, we naturally want handles, simplifying handles, to understand things. But at the same time, our conception often lags behind a little. In my personal view, under the Hu Jintao Wencha of our administration, economic reforms really ground to a halt, kind of stagnated. And it took us years to incorporate that recognition into our understanding of China. Today, we see dramatic, multifaceted economic reform initiatives underway. And again, there's a little bit of a lag, I think, as it takes us time to grasp how wide-ranging and how important some of these changes have the potential to be. But at the same time, I don't want to come across as somebody who's just thoroughly optimistic about China's economic reforms as if this somehow, once the decision had been made, to adopt some kind of economic reform program, that that inevitably meant China would move in a direction that we can foresee, and even necessarily a direction that we would consider positive and desirable. On the contrary, I think it's a much more complex situation. And to me, I try to encapsulate some of the complexity by, again, stressing something that, on the one hand, is, again, blindingly obvious. And that is, this is an authoritarian top-down reform program. Everybody sees the authoritarian nature of Xi Jinping's rule in many, many different dimensions. I don't have to talk about it here. But in terms of economic reform, that means that some of the aspects of economic reform are different. The way it unfolds is different from some of the reform programs that we've seen in China in the past. And just to emphasize one point right at the outset, that means that the role of grassroots incentives in carrying out the reform program is very different today than it was in the 1980s or 1990s. That is to say, in previous waves of reform in China, a great deal of the action has come through decentralization, opening up initiative on the bottom, letting policies percolate up from the bottom. And that aspect of policy making and policy implementation is much less prominent under Xi Jinping than it was under some of the earlier leaders. And that means the dynamics are different, the problems are different, the sequence of events is different. It also means that the natural objective we have Xi Jinping and Li Keqiang said before they came to power, they called for a top level design of reform. But in fact, what we see is a situation where the leader retains this discretionary power to the very last minute. And that's inconsistent with a blueprint that really lays out exactly what's going to be done and what's going to happen. Instead, we see a mechanism for implementing reform and then a very complex process by which implementation percolates through the system depending upon what the issue is, depending upon who has ownership of that issue, depending upon what kind of resources they have to enforce compliance. One of the most obvious examples of the way this type of dynamic is playing out in a clear issue area is coming with state enterprise reform right now. Because one of the remarkable things that's happening is on the one hand, the Xi leadership team is talking about a very complex, potentially meaningful restructuring of the state sector hasn't progressed very far. At the same time, they've also passed a rule that says managers of state-owned firms, including state-owned banks, including even the state-owned sovereign wealth fund, should be paid as bureaucrats. Meaning that managers of these large state-owned firms are taking huge pay cuts, even as they're suffering from the impact of an anti-corruption campaign and all kinds of other forms of surveillance and politicization of the economy. Is that consistent with economic reform? It's hard to know. Is it consistent with this stage of state-owned enterprise reform? That's hard to know as well. So when we look at how reforms are taking place, I think it's very important for us to avoid the mistake that says, oh, once you have an authoritative boss who's committed to this, then it becomes easy. That's not true. Authoritarian systems don't work that smoothly. If they did, we'd live in a very different world. But the simple fact that you have an authoritative boss with a commitment to reform doesn't necessarily mean that reforms will succeed or that they'll go smoothly. So instead of a top-level design for reform, what we have is a mechanism. I think most of you are familiar with this. This is the leadership small group for deepening comprehensive economic reform. But in a way, on this graph, so this shows sort of the structure of it. Of course, you know who the chair of it is. Obviously, it is Xi Jinping himself as the chair. But I really want to direct your attention to two numbers here. The first is 336. That's the to-do list that came out of the third plenum in 2013. That big, comprehensive, bold statement of reforms at some point was boiled down into a to-do list. It had 336 different initiatives on it. And those initiatives are disaggregated to subgroups, of which the most important is this economic system and ecological civilization. What a term. Wow. Subgroup that has 118 initiatives to take care of. And when we say initiatives, this doesn't mean pick up your dry cleaning today on your way to work. This means restructure the fiscal system. That's one initiative. And create a new international payment system is another initiative. So this is incredibly dispersed and wide-ranging set of objectives. And we can see the, you know, those were drawn up at the end of 2013. Last week, the old planning commission, the National Development Reform Commission, published their key points of work for this year. And it's got just as many things in it. It's got hundreds of items in it, including at least 50, by my count, major new documents that NDRC is supposed to preside over to be produced during this year of implementation. So in other words, we've got a pipeline that's full of half-done, and in some cases, half-baked items that are working their way through the system. And you know, some items, we see a strong push, giving the support of the top leaders to an individual reform measure. But there are also scores of measures out there that's sort of languishing with partial support or with the leadership more naturally kind of holding back and waiting to see if they can assemble some kind of consensus. If it comes together and there's enough buy-in, then boom, they'll push it forward. That makes it very difficult for us to track the different cases and understand what's happening overall with the reform process. So I want to take an example or two. And the examples I'm taking, obviously I'm choosing them because I think they're important. But as you'll see, they retain the same complex mixture of ambition, achievement, and failure that I think we see in the reform program overall. So let me start with my first example, which is the restructuring of local government debt. Now, first of all, notice something right away that's kind of peculiar. I just laid out this story about this big institutional mechanism to carry out reform, the leadership small group. And then I go to this important reform example. And does this important reform example actually come out of the leadership small group system? Yes, in a way. But really, when you dig into it, it's more of a case of a single dedicated civil servant, the minister of finance, Lojiwe. Somebody who's been committed to reform for decades and is now finally in a position of power. So essentially, he's got this program. And Xi Jinping and Li Keqiang nod their heads and say, yeah, do it. So that's what drives this forward. So Lojiwe advances this extremely ambitious program during 2014. He says we're going to audit all of the local government debt. We're going to cap it so that local government financing vehicles will no longer have the ability to take out additional debt, except through a clear set of procedures. And then perhaps most critically, a certain portion of the existing debt will be swapped for bonds. That is, new bonds will be sold. New, essentially, the equivalent of municipal debt in our system will be sold onto the marketplace. And this will be the beginning of the whole conversion of the program. Now, let me stress how ambitious this is because it does at least three big and really important things, right? It addresses this potential financial crisis. The real, the very real danger that China's excess lending over the past five years will result in some kind of serious financial disorder, maybe even a panic, capital flight, et cetera. That's a real threat. Everybody knows it's a possibility. This is the first time that the system has really grappled head on with the bad debt problem and started to take measures to tackle it. So it's absolutely fundamental in that sense. Second, of course, it's also part of a program to improve the finances of local government by reducing their interest payments. Some estimates are that local governments today pay maybe as much as 8% on their very large debt because they have to, in a situation where they're forced to roll over bank loans, they sometimes have to recourse to these off-the-book shadow banking facilities to get access to credit. So we don't know for sure, but certainly it's above 6%. It might be as high as 8%, whereas these new bonds would be substantially less, perhaps, 3.5% to 4%. And also in terms of its reform content, a very, very important objective of this is that these new bonds, these new local government bonds, would then become a part of a rapidly growing diversified bond market that is an absolutely crucial part of creating a new modern financial system. The bond market's grown dramatically over the last few years. There's already 3.4 trillion rem in B worth of so-called chungto or urban construction bonds. So it's a very significant, it's just 5% of GDP. It's nothing compared to bond market in our economy. But from nothing, it's growing significantly. We've got the beginnings of a diversified bond market in China of government bonds, bank bonds, and enterprise bonds. So that's a very, very important part of the overall transition to a more marketized economy. And again, part of this program is that the people who are buying bonds would be not only banks, who are the main actors today, but would also include pension funds, insurance companies, et cetera, et cetera. So when you look at this program, you've got to say this is really serious, both in terms of the willingness to tackle the core problems, the core things that threaten the Chinese economy today, and in terms of the direction it's going, in terms of a much more sophisticated and market-based financial system. I can skip that slide, because it's too abstract. But here's the catch, it failed. And I mean, it really failed. I don't mean just implementation has been difficult. In some sense, every strand of this proposal fell short. So in the first place, Lo Ji Wei said, all right, we need the local governments to report their debt, and they did. They essentially said, ah, this is the last chance for somebody else to take over responsibility for my debt. So they reported one point, sorry, 16 trillion, which was much more than people expected and much more than the system was willing to handle. So Lo Ji Wei said, go back, look again, figure out how much debt actually should belong to different kind of commercialized entities that can take over responsibility to themselves so it doesn't have to be government debt. And they had to set up a whole new program where the Bank Regulatory Commission and the banks and the NDRC and the Ministry of Finance all together were going to do a much more detailed audit in order to try and control the scale of the, in order to control the auditing process of the debt, in other words, the local governments perceived a potential bailout in this and so they wanted to overstate or at least report as much debt as possible. And then when time came to sell the first batch of these bonds, province of Jiangsu, obviously a relatively rich and sophisticated province, marketed the first batch of bonds in April or late March and they failed. Nobody bought them. Nobody wanted to buy them basically because there's already, as I said, there's three trillion in these urban construction bonds that have an average interest rate of 6% and have a kind of implicit local government guarantee. So if you can get a, if you can invest your money at 6% with an implicit guarantee, why would you buy these local government bonds at 3.5% with even though the guarantee might be somewhat more formal? So they failed. And then at the end of April, the Politburo met and the Politburo essentially said the economy's doing worse than we think. One of the problems with the economy doing poorly is that local governments are somewhat paralyzed. They're not spending money fast enough. Infrastructure projects are not building out fast enough and one of the problems is the high level of uncertainty about financial resources for local governments. So this program, really failed. It failed perhaps because the design was too sophisticated perhaps because the implementation mechanism wasn't properly thought out but also because the macroeconomic conditions meant that a debt restructuring that had a contractionary impact just wasn't gonna fly. With the economy slowing down the way it is, the political leaders backed off their support for it and said, let's do something different. So instead we got debt restructuring 2.0 which still will convert a trillion ren and b worth of debt into bonds but the nature of the restructuring is something really completely different. They took this trillion and they said, well where did the original debt come from? If it came from this bank, then this bank is responsible for buying the bonds that the debt is gonna be converted into. So that's a very different proposition, right? Especially because the interest rate on the bonds was sort of equally low with the interest rate on the bonds in Jiangsu that nobody wanted to buy but now the banks don't really have any choice but to carry it out. Supposedly it's a negotiation, supposedly it's a market-based transaction but of course what it really is is a one-on-one transaction where everybody knows that transaction has to be carried out and where there are guidelines that drive it towards a relatively low interest rate. And then to sweeten it, the central bank agreed that these bonds would serve as collateral for any central bank lending to the commercial banks. So in other words it's sort of similar to the European system where the European central bank guaranteed to the European commercial banks that they would be able to use Greek debt and Spanish debt as collateral for central, for European bank lending. But that was a better deal for the European commercial banks because that allowed them to buy debt that was high-yielding at the time and then use it for collateral and also profit when the interest rate came down. It's a very different deal for the Chinese commercial banks who don't really need collateral right now and who would be forced to buy bonds with a lower interest rate to begin with. In other words, this is a bailout. It's a bailout of the local government by the banks who don't have any choice but to take the new debt. So this is a very, very substantial change. It's a big deal. And it also displays the kind of mix of success and failure that we should be looking for as we look at this whole big reform process as a whole. In a way, we can say that the key thing that doomed Logeeway's initial plan to failure was the downward pressure on the economy overall. The economy's weakening because of the secular trends towards slowing but the inflation rate's also dropping because energy prices have been low. So it's clear that optimal macroeconomic policy, this is controversial but I think it's true, optimal macroeconomic policy should become more expansionary. Logeeway's bond swap was moderately contractionary so that killed it. But in other areas, in other areas, the need to, the opportunity maybe we should say to move towards a more expansionary macro policy could also be harnessed in favor of reform. And so while we see this failure on the part of fiscal reforms, when we turn over to financial reforms, we find that this same need to adopt a slightly more, somewhat more expansionary policy creates some opportunities because as the central bank pushes to drive down funding costs, it gives them a new kind of leeway. So here's a graph, this is the justification for having a PowerPoint, really was to be able to show this graph. And what it shows on the top is the PVC set benchmark one year lending rate and at the bottom black line is the benchmark one year deposit rate. So if we look over at the left hand side, what we see is sort of the old system, right? A big gap, 300 basis points, that's three interest, 3% interest, three percentage points of interest, this sort of enforced gap that provides profit to the banks which can take deposits at the low rate and lend at the high rate. Over the years, the PVC has liberalized the lending rate so banks can lend at higher and different rates but the deposit rate has not been liberalized until very recently so look at what's happened in the last year as the benchmark rate has gone down. The ceiling of what commercial banks can give to depositors has barely changed because every time they lower the benchmark rate they've increased the band so that now commercial banks can give 150% of the benchmark rate to depositors. Why does that matter? It matters for two reasons. One, the spread with the benchmark lending rate has decreased very substantially from 300 to 170 basis points so there's less of an enforced profitability for banks which is an enforced kind of taking from depositors but even more important as interest rates have fallen the actual interest rates that the banks give to the depositors which is shown there way over on the right in that red circle and black diamond has now fallen below the ceiling for deposit interest rates. In other words, deposit interest rates are now deregulated in China. That's a big step forward. That's something that central bank has been trying to do for a decade and now we finally start to see it as the macro policy shifts towards something more liberal. I won't go through this slide either. You can look at it for your reference later. The point is just these measures of liberalization of financial markets are being accompanied by a broad span of different liberalization measures in financial markets just for one major for instance the linkages now being established between the Shanghai stock market, the Hong Kong stock market and now the Shenzhen stock market as well mean that equity markets and these growing bond markets are starting to be linked up in terms of the way demand for funds influences asset pricing in these different markets. They've still got a long way to go but these are major changes in the direction of creating a modern integrated financial system that is now significantly open to world financial markets as well. So where does that leave us? As you can see, I'm not saying, oh, everything's great reforms are perfect and underway but I think we do have to acknowledge there's such a dramatic spectrum of new reforms. I think it makes sense to think of them as already falling into sort of four categories, right? There are some things where reforms are just working, right? The deposit rate liberalization, true. It needs to be sustained when interest rate conditions change but essentially if the will is there, we're already there in terms of the deposit rate liberalization has been achieved. There are a lot of other ways where changes are underway. Momentum has been established. We just need to sort of expect these things to continue and then we should see changes. Reformulation is gonna be a huge part of it. Local debt restructuring, round one, failed but it's not going away. That's only one trillion out of 15, 16 trillion. You're gonna see the next tranche will be handled in a different way, the next tranche in a different way and I think my expectation would be that particular area. You'd see a process of reformulation that probably will ultimately succeed and other things certainly are gonna fail. For instance, I think urban, the transformation of rural to urban land is something that so far has failed. SOE reform so far has failed but it's gonna be a mixed and complex picture. So my last word then, these changes won't necessarily produce our dream system of a market economy in China especially maybe a fair market economy in terms of the way foreign businesses are treated but they're already important enough that they're dramatically changing the way this system works and they're making changes that will continue to be resonant over the next decade and decades as well. And I'll stop there and turn it over. Thanks very much. Thank you. Thank you. Thank you. Thank you. Up to you. I'm gonna stand up because it lends me an air of greater authority. So thanks very much to CSIS for the opportunity to speak here. It's a great honor for me to be on the same platform as Professor Norton. I moved to China in 2007 and the one book on the Chinese economy which came with me in my suitcase was Barry Norton's book on the Chinese economy. It still has a prominent position on my bookshelf. Unlike my book on Chinese economic indicators which I'm currently using to prop up a wobbly table. So I'm Chinese, I'm Bloomberg's chief Asia economist. I'm part of a global team of economists at Bloomberg that started to produce systematic and detailed coverage of major economies. So I cover China, my team cover Japan, India and other countries in Asia. And we have colleagues in Europe and the US doing a similar job. So as I said, I've got a huge amount of respect for Professor Norton. That said, you guys didn't take a morning out of this beautiful sunny day to hear us agree with each other. So I'm gonna do my absolute best to try and pick a few holes in his argument. First of all, I'm gonna try and sound a slightly more optimistic tone on the reform agenda. And then I'm gonna speak a little bit about why even though I think we can be optimistic about reform, that still doesn't make us optimistic about where China's growth is headed. So first of all, Professor Norton mentioned the absence of a blueprint for reform and the continued role of discretion at the top of China's decision-making system as a problem. And I share that view, I think that is an issue. But I think it's also important to remember where we came from. If you go back in time to the Hu Jintao Wenjiao Bao administration, the concern was really about leaders who were too consensus-oriented, leaders who didn't have the willpower to take on vested interests and push through tough reforms. Well, if that was the problem, then under the Xi Jinping, Li Keqiang administration, I think we can all agree that it's been resolved. Now we have leaders who are tough, who are muscular, who are willing, demonstrably willing to take on the vested interests and push through painful reforms. So yes, there isn't an overall blueprint, but relative to where we were with consensus-orientated leaders who couldn't take the difficult decisions, I think we're in a better position. Secondly, Professor Norton mentioned the absence of bottom-up initiative. I guess we're sort of thinking back to the 1980s where land reform didn't come from Deng Xiaoping. It came from the sort of autonomous innovation of China's farmers. So I have a slightly different view on this based on what I see in innovative companies in China using technology to respond to the demands of consumers in a way which has a reforming impact on China's overall economy. So let me give you a couple of examples of what I mean by that. It's very hard to get a cab in Beijing. There aren't enough taxis. And the reason there aren't enough taxis is because the government regulates the fare for taxi drivers at a level which is unattractive. So people don't wanna work in the industry. Now, that problem has started to get better. The problem has started to be solved. And it hasn't been solved by the government changing the regulation on taxi fares. It's been solved by companies like Didi Dacha, which is kind of like a Chinese Uber, which has created an app which lives on people's smartphones and which they can use to summon a taxi and to incentivize the taxi driver by offering them a tip. So the government hasn't changed the regulations, but an innovative private sector company has taken advantages of changes in technology to take the system a step forward. That's one example, but you can also see perhaps more significant examples in areas like telecoms where Tencent's Weixin application is changing the way people communicate, taking revenue away from the big Chinese state-owned telecom companies, making communication easier and cheaper for Chinese citizens, or in the banking sector where money market funds like Alibaba, Alibaba's money market fund, are taking funds away from the banks. And even before the significant moves on interest rate liberalization, which Professor Norton, I think, completely rightly identified as a major step forward, even before that happened, these innovative private sector players like Alibaba's money market fund were taking funds out of the banking system, allowing customers to manage those funds over the internet, which, as any of you who've been to a Chinese bank knows, is a huge improvement, and offering them a market-set interest rate. So on the question of whether reform is centralized or decentralized, yes, Beijing continues to call the shots on shifts in the regulation, but I think if you look at what's happening in the real economy, you do see these innovative private sector firms using technology to address consumer needs, and that having a significant impact on everything from taxis in Beijing to the way people communicate, to the way people manage their finances. So that said, I'm just gonna make a couple of remarks on, well, I guess we could say I'm a little bit optimistic on the reform agenda, but I'm also a little bit pessimistic on the outlook for growth for a couple of reasons. Firstly, I think people wonder whether China's economy is gonna continue growing at a reasonable pace or slow sharply. I think that's the wrong question. China's economy has already slowed sharply. If you look at the real growth rate, back in 2007, the economy was growing at 14% a year. Now it's growing at 7% a year. If you look at the nominal growth rate, which is more relevant for understanding corporate profits, in 2007, we were growing at 21%. Now we're growing at 5.8%. So there's just been an extremely pronounced slowdown in China's growth, and that's starting to show up in the places where you'd think it would show up. Iron ore prices, for example, are extremely low compared to where they were a year ago. Now, a lot of people doubt that the validity of China's official data, and so we also look at a range of alternative measures of China's growth. I just completed that exercise for the first quarter yesterday. So we look at things like electricity production, land sales, Macau gambling revenue, same-store sales for Yum, who have a lot of Kentucky Fried Chicken restaurants in China, volume at Shanghai's ports, and all of these measures, every single one of the measures I just mentioned is either contracting or growing in the very low single digits. So based on that, I think there's some cause for concern that not only has China's growth slowed extremely sharply over the last few years, but that it continues to slow at a reasonably rapid pace. So finally, just a couple of thoughts on what growth might look like if the reform agenda succeeds. So for me, I think even a successful reform agenda is not going to support growth if the fundamental drivers of demand are not there. By fundamental drivers of demand, I'm talking about exports, investment, and consumption. And across each of those areas, I think there's reason for pessimism. So China is already the world's number one exporter. They've also seen very strong appreciation of the yuan and strong increases in labor costs over the last few years. Now what that means is that China has limited room to grow its share of global trade and problems with competitiveness which impede its capacity to take market share. So even a successful reform agenda isn't going to do much to grow exports. How about investment? Well, investment has been the workhorse of China's growth for the last decade and that's been very successful as a way of keeping growth strong through the financial crisis but it's also brought problems. Industrial overcapacity, overstretched banks. So what we're seeing now in the last few months is that even as the PBOC has started reasonably aggressively cutting interest rates, we're not seeing bank lending accelerating and we're not seeing business investment accelerating. So I think the reform agenda and I think interest rate liberalization has really been one of the successes is going to be more efficient allocation of investment but against that we have to set the headwinds of industrial overcapacity and overstretched banks and I think that means that we can't be too optimistic about the capacity of investment to drive growth either. Finally, consumption. Consumption is where everyone wants to see the Chinese economy moving, rebalancing is the order of the day in Beijing and I think of the drivers of growth that the area where we can be most optimistic is the consumption story but I think it's also important to remember that households work in the industrial sector and they own real estate and so the slowdown in the industrial sector and the fall in house prices has a real impact on household welfare. Wage growth is slowing, households have the majority of their assets, the majority of household wealth is in real estate so as house prices start to come down we see a negative wealth effect on China's consumers and what that means is that the slowdown in investment, the slowdown in trade is not going to leave the household sector unaffected. It's not reasonable to expect extremely rapid growth in wages, extremely rapid growth in household wealth and so extremely rapid growth in consumption when the rest of the economy is not doing terribly well. So with that, I'll return to my seat and back to you. Great, thanks Tommy, appreciate it. Okay, we're gonna dive in with the audience here in a moment but I'm gonna kick off with a couple of questions that maybe try to bring that very focused discussion up a little bit and give you guys some things to chew on before we turn over to the audience. The first one is you see a lot now of discussion when we look at what's happening in the economy especially with the slowdown that Tom was highlighting, comparisons to Japan in the 1990s and even going forward. So how similar are the economic reform challenges, would you say, that the Chinese are facing now to those that Japan faced? And would you say is Xi Jinping's task easier, more difficult, something in between? And then the second one is we talked a little bit about this very in your presentation, the whole issue of the mechanism for how to implement these reforms. I wondered if maybe you could drill down a little bit on that and tell us a little bit about your view of the economic experts that are involved in analyzing and making these policies now. There's obviously a lot of discussion about how the mainline ministries don't seem to be playing the role they used to in the past and that there are these kitchen cabinet advisors, if you will, that are extraordinarily influential. I wonder if you might compare those with similar individuals, say, from 10 to 20 years ago or the Zhu Rongji period of reform, something along those lines. What's your impression of how they think and is there a relative consensus among them or are there really fierce debates on these policy issues? Thanks. I guess I'll stand up. I know I'm not qualified to know this glass of water, but let me take a quick sip on it. Just thought I'd put it at a safe distance. Thanks for those great comments. I think I pretty much agree with most of the things that Tom said. In particular, I mean the downward pressure on the economy is really serious. And I guess that's a good way to sort of bring in Japan too. I think that when we compare China and Japan, China is exiting its miracle growth period. I think there's no question about that. And so the similarities with Japan, actually not so much in the 1990s, but in 1973 and Korea in 1987 are quite substantial. I think there's sort of two reasons why China might be in a little better shape and two reasons why it might actually be in a worse shape. China might be in a little better shape paradoxically because its incomes are lower and economists believe in a tendency to convergence. And China's income is substantially lower than Japan's was even in 1973. And so there's still many sectors where Japanese companies and businesses have strong competitiveness based on lower costs and lower wages in particular. The second reason is just the investment in human capital has been so massive in China. The investment in university education, a number of people coming out with degrees, a number of people going back from after education in the United States, the investment in research and development that's over 2% of GDP. I mean these are real even though, I mean I have a lot of criticisms of the way these policies are carried out so that they might be less efficient in terms of the way some of these knowledge resources are used but still there's still a huge investment in these knowledge resources. On the other hand, China's labor force changes are even more rapid, more dramatic, more concentrated than the changes in Japan and Korea. In the sense that if we think of the high growth period as basically ending when surplus labor is mopped up, when the pool of underutilized labor in the economy and rural areas and other areas is finally drawn down, in Japan and Korea that took place at the time of the initial slowdown but it wasn't for another 20 years that the population started to age and the labor force started to shrink. Whereas in China these two things are happening together. The pool of labor's been absorbed and the labor force is already plateaued and is actually declining slightly and that exerts a kind of down draft on the economy as we saw in the 1990s. And then also just at the financial mess is really big and there's probably gonna be some growth costs involved in clearing it up. My take of Japan in the 1990s is the biggest problem that Japan had is that they tried to defer addressing those financial issues for so long and they just carried this bad debt load for almost a decade before they began to deal with it significantly. I think that China's gonna do a lot better than that. I think that they're gonna tackle the bad debt problem more aggressively and that they'll do so more thoroughly. So I'm not worried about a decade of stagnation in the Japanese sense of the 1990s but I am worried about short run disruptions to growth caused by the difficulty of regearing economic policy and regearing development strategy once that miracle growth phase ends. So I very much agree with Tom. I mean, I think our sort of short run of the warranted growth rate I think is below 7%. Quite, you know, and I'd love to, so I guess I would give Chinese policymakers credit for recognizing that there is a new normal, that we're not trying to sustain growth at the super high levels that it was at before. There is a new normal but I think we'd have to say the new normal isn't normal yet, right? We're not actually at the new normal yet and my guess is if they were listening to me, which they're not, I would say, a target four or 5% growth for this year in order to give the economy more space to make the kinds of reorientation that's necessary even if you're hoping to come back up to a 6% sustainable growth over the next few years. That would be what I'd like to see. I guess Chinese economists don't have consensus on that, right? I mean, quite a few Chinese economists, most famously Lin Yi-Fu, Justin Lin thinks that China's capable of 8% growth. I don't quite get it, I don't see how he gets there. And in any case, we've certainly seen in the most recent Politburo meeting this determination to try and keep growth higher. So I think that's very much, it's hard enough to know what the sustainable target growth rate should be. And if we think of macro policy as trying to adjust money supply and interest rates to come as close as possible to that sustainable warranted growth rate, we don't even know what that warranted growth rate is in China and there's not even agreement about it. So it's certainly a factor that makes setting economic policy properly much, much more difficult. In terms of the people who are advising Xi Jinping, I mean, it's funny, because of course, the probably the two most important operational hands-on policymakers are central bank head, Joe Xiaotuan, and Minister of Finance, Lo Jiwei. Well, if you say, how different are they from the advisors of the 90s and the 80s? And we say, they are the advisors of the 90s and the 80s. They're the same people. And they, I think it's fair to say that their advice was mostly neglected during the Wenjiabao era and now they are listened to and they're in positions of great power and responsibility. Of course, they don't always agree. And we know, just precisely in terms of this local debt restructuring, there were some real frictions between the two. And I think one hears, and you never know, there's such a gossip in Beijing, the one hears that Joe Xiaotuan was quite frustrated at the outcome that sort of forced the commercial banks, which are after all part of his portfolio to take on responsibility for the local debt, which is Lo Jiwei's portfolio. But I think those things are pretty natural part of the business. In terms of the advisors directly to Xi Jinping, of course, everybody I think is aware, especially in Washington where people are very attuned to advisors, people have paid a lot of attention to Liu He, who is, of course, in that picture that I showed of the leadership small group and the subsidiary group that is responsible for the most of those initiatives, the economist Liu He is the co-chairman of that specialized group. So he's in a very critical position in terms of managing the flow of decision-making and being the one who has to decide has our policy-making on this particular issue reached a mature enough level. They love that term, the policy has to mature and then be approved by the top leaders. So he's really sort of the person right there in the cat seat in terms of determining whether a policy has reached the point where the leadership can approve it and push it forward. And I can't really detect any major differences in the way he views the world and say, Zhou Xiaochuan and Luo Jiwei view the world. They have somewhat different institutional constituencies but I think they're people whose thinking is easy for other economists to understand. I mean, they're very influenced by economic reasoning. They see things as economic problems. So I guess the one question is Xi Jinping who is obviously a politician just down to his toes, somebody who has a strong populist sense, not a democratic bone in his body and not really an economist mindset but he has so far relied on these economic advisors very strongly. I hope he continues to, but we don't have any necessary reason to expect that he will, but so far he has. Did you want anything? So I think on the Japan question, I think if you look at the metrics which Professor Norton alluded to, GDP per capita, urbanization levels, China looks a lot more like Japan in the immediate post-World War II era than it does Japan in 1989 or even Japan in 1980. So I think based on the idea of convergence and catching up, I think there's a reason for optimism that China is not on the brink of a lost decade. The reason why, I think there's also a reason for a bit more pessimism though and that's for a couple of reasons. So I recently read the classic study of Japan's economic miracle, Mitty and the Japanese economic miracle by Chalmers Johnson and the thing which struck me about it was just that Mitty, which is kind of like that the Japanese NDRC was just a much more efficient development institution than anything which existed in China. So China's industrialization has come with rampant over capacity, with rampant over borrowing and that's because even though the NDRC looks pretty powerful relative to whatever we have in the United States or Europe, relative to Mitty's capacity to control industrial capacity expansion or industrial borrowing, NDRC is really very puny. So my concern is that China has achieved a moderate level of prosperity in a way which is so much less efficient than what Japan did that that space for growth, which it appears to have will actually turn out to be illusory. Great, thanks. Okay, we're gonna turn it over to the audience now for standard CSIS procedure if you could announce yourself and what your affiliation is and do please keep your question in the form of a question rather than soliloquy. We're gonna go right up here at the front and please wait for the microphone. Microsetting PBS online news hour. To what degree does the uncertainty of the purges and the anti-corruption campaign weigh here in the sense that in the best of times it wasn't that risk taking the society and now there's must be much more fear of taking risks. And that sort of then plays into your thoughts on Nicholas Lardy's point that a lot of decision-making and power has moved from the state to the private sector. How do you? Go for it. So unquestionably the anti-corruption campaign and the other thing we don't necessarily think of in the same basket with that though is the sudden disruption in terms of what success indicators are for people. So they face not only, it's not just more risky it's also a lot less fun and there's a lot more uncertainty about what they're supposed to be doing and you do see it's funny in some of the things including that NDRC plan for the year that I just mentioned, you see a certain amount of new emphasis on hey we really need to tie specific reform objectives to the success indicator of local officials, sort of more or less officially recognizing that what you're saying is a problem. Is a problem. People are dragging their feats because they're not sure what to do. You know I guess in terms of Lardi's book I think that you know it all depends on what time frame work you're looking at. I mean he's the title of the book says it all, right? Markets over Mao if you're making the comparison of 35 years ago, of course that's absolutely right. I mean my God the economy is predominantly private and that's a key driver of the success of the economy. I don't think there's any question about that. So you know in some ways I would focus on a slightly narrower time frame. I think there has been a, let's say a consolidation of the state sector over the last 10 years and maybe a, this is very subjective so it's really hard to measure but what you often heard say five years ago from people in China was that it was more difficult to do business as a private entity without having some kind of connection or some kind of patron in the government and so in that sense that private decision making had been eroded somewhat. That's something I would worry about but I couldn't prove it. There's no objective indicator that shows that that's true. I just build on what Barry said by noting that I think this is one of the, we talk about the new normal in the economy what I find striking is that there's a bunch of new normals across a variety of different things and one of those is as you just alluded to how being a local official has gone from one of the best jobs in China to one of the worst and how difficult that is for them and one of the issues you highlighted in your comments Barry about the pay for state owned enterprise managers and I think we see this also for local officials where the central message on anti-corruption and in the frugality campaign is effectively hey you know that social contract we've had for the last 30 years where you get paid a poor official salary but you get the home vow you get all these other, that's gone. You're on the emperors grain now and this is I think causing a real serious rethink among the smart people just at the time when the rub of these reforms where they really need that technical expertise and so on is coming into play and I think they face a real serious brain drain issue and problem. I have a slightly more optimistic take on the anti-corruption campaign so I would really cast it in terms of Xi Jinping's capacity to push aside the vested interests which everyone says are the main barrier to reform. So if you go back in time to the Hu Jintao Wenjao Bao era everyone said okay we'd love to do reform but the state owned enterprises, the local governments they're too powerful, we can't do anything about it. Well what of Xi Jinping and Wang Qishan done? They've come into power, they've grabbed the head of SASAC, they've grabbed the heads of the major state owned enterprises, they've grabbed heads of local government. It's part of the clean governance anti-corruption campaign but it also sends a very powerful signal if you mess with us, if you oppose our efforts on anything including economic reform then woe betide you. Now I think that there is a reasonable concern about what impact this has on China's government system. Does everybody say the corruption investigators are out there, the safest thing for me to do is to hide under my desk? I'm certainly not signing any bits of paper. And I'm definitely not gonna eat at a luxury restaurant. Now I think intellectually that makes a lot of sense to me but actually I think if you look at where that should be showing up in the numbers I don't see it showing up in the numbers. So if you look at the investment data the only bit of investment that's accelerating is infrastructure investment which requires a sign off from local governments. So I don't think they are sitting on their hands. If you look at luxury spending which is meant to be this index of whether the frugality campaign is taking hold or not you can certainly find evidence of areas where it's come down. Macau is doing really, really badly but it's not a universal picture. I was in Seoul recently. The duty-free store in Seoul is rammed with Chinese luxury shoppers. There was a queue at the Prada store and I was kicked out for taking a picture of it. So even though I was using a Samsung phone when I got on the out of the problem. So I think the corruption campaign is I think there's a positive read on it in terms of its relationship with the reform agenda and I get the point that it could be really confusing and freezing up the government machine but where I look for evidence of that happening, I didn't see it. I'm back there. Thank you. My name is Hong Zhang. I'm a PhD student from George Mason University. So for both of speakers, my question is to what extent do you think the whole set of financial reforms represent a breakaway from the Chinese model of political economy in the sense that in the traditional model the state-owned commercial banks have played crucial roles in providing funds for local governments and to state-owned enterprises for the investment-driven economic growth. So now the commercial banks are moving towards a more market-oriented direction and local governments are also pushed towards a more market-oriented fundraising model. So what's the implication for the whole political economy? And that would tie back to the question of Varadis which is to what extent the state economy still plays a central role in the Chinese economy and what's the implication for the whole political system? Thank you. In three minutes. Yeah, those are good questions. But let me specify that there are sort of two different questions, right? So let's look at the first one first. I mean, if we move away from a system of financial repression where quantitative controls are really used to steer predominantly bank credit to especially privileged beneficiaries, that results in some change in the allocation of resources. The state doesn't have the same kind of prior claim that it used to have. But it doesn't mean that local infrastructure investment has to disappear. I mean, the government has lots of money, it has lots of taxation authority, it has lots of clout in all kinds of different ways. So it's, I mean, personally I would hope that the investment rate would in fact come down gradually over time several percentage points. I think that would be consistent with a better functioning economy. But we know that the modern financial systems actually are more efficient in a way that kind of gives you a percent or two of a GDP kind of efficiency bonus. So I think that would be a very positive transformation that's still consistent with China still being a very high investment economy in any kind of comparative sense. What was the second part? I think that's the second question. Is it going to change the whole political economy of China? What? Is it going to, is a liberalized financial system going to change the whole political economy of China? Yeah, well, so I mean, there is an argument that a modern financial system plus an open capital account can have very fundamental effects not just on the efficiency of the economy, but also on sort of the distribution of power. People sometimes turn to say Indonesia as an example of this. It definitely provides a check on government decision making. I think can be quite positive. So apparently Lenin said all communist governments need one very large bank, which is a great quote. And I've always wanted to use it, but I've never been able to find the original attribution. So I'm not sure whether he actually said it or not. And I think that goes to the kind of the evident truth that if you control the flow of credit, that gives you massive influence over a whole range of different things. Now, by liberalizing the financial system, I think when we talk about the liberalization of the financial system, I think we have to recognize that we're talking about the liberalization of financial instruments. We're not talking about a shift in the ownership of China's big banks. So ICBC is now going to be operating in a market-based interest rate system. However, ICBC is still majority owned by the Chinese government. So I think it will continue, it will hopefully operate in a more efficient way, but the Communist Party will still have one very large bank, so. Although, I mean, I guess to me, the main differences in the first system, it's so easy to hide different kinds of costs so that nobody can really perceive them. ICBC, if their financial system reforms succeed, yes, ICBC starts out state-run, no question about it, but two things are different. One is it has to compete on more or less equal terms and some of the competitors will do better and some of them are private. But the other is that ICBC's bottom line is gonna be increasingly driven by things that ICBC can't control. And so when the government says, hey, by the way, we'd like you to fund this, then ICBC is gonna push back and say, well, we can't fund that because, you know, it's gonna hurt our bottom line, hurt our shareholder, including you. Right there on the edge. Good afternoon. Alomar Santos, Air Force Intelligence Analyst with DIA. My question is, with China's economy slowing down, how do you see it affecting their vision of global economic engagement, for example, and their one road initiative? I'm sorry, I'm sorry. It's with the economy slowing down, how do you see that impacting their global economic engagement, especially under like one-to-one road? Yeah, well, so far, no impact because as domestic demand is weak, it means that they have the credit available and the capacity available for dramatic externally oriented initiatives. So in a way, one road, one belt, one belt, one road can be thought of as a kind of a domestic stimulus program that provides new markets for Chinese companies. That's not the whole reality, but it's very consistent with the needs of the domestic economy. So I think one of the obvious things, so a couple of obvious points to make, firstly, it's slower growth from a significantly larger base. So 7% growth today from China is a bigger incremental contribution to global demand than 14% growth in 2007. Second point to make is that within that growth, there's clearly a progressive rebalancing taking place from investment and heavy industry towards consumption and services, and that affects the winners and losers in the rest of the world from China's growth. In the past, the winners were Chilean copper mines and Australian iron ore mines. In the future, it's far more likely to be US soybean farmers or manufacturers of luxury brands, and we're already seeing that transition taking place. The third thing to say on things like the one belt, one road initiative, I certainly agree with Professor Norton that this has a kind of stimulative effect. On China's domestic demand, I think the other question on a sort of slightly longer-term horizon is does this fundamentally change the competitiveness of China's economy relative to other, to trade rivals? Does, if you build significantly better infrastructure connecting China to neighboring countries, connecting maybe connecting China overland to Europe, then has that affected the competitiveness dynamic such that China can start outpricing its trade rivals again? If it does, then I think that would be a reason for a little bit of optimism about China's export prospects. I would just add on to that too. I think if you look at the strategy, say in particular with the Asian Infrastructure Investment Bank and their ability to draw in a great number of partners all at a fairly strong entry fee, if you will, they're getting funds coming in from others yet they're taking the credit for the initiative. So pretty smart diplomacy in that regard. Right here. Peishi from Voice of America. And talking about China's reform, the issue of China's SOE state-owned enterprises cannot be avoided. Talking about reform, people say that to expect China's SOE to reform is something like to expect dogs spitting out meat dumplings in their mouth Chinese, some Chinese would say. Yeah, I want to ask you, how do you look at the issue? And here we have examples such as Alibaba put forward a very good product of money market product and quickly, quickly was killed by state-owned banks. So how do you look at the issue? Thanks. Don't have a go, okay. So firstly, dogs spitting meat dumplings out of their mouth. Colorful analogy, I love it. I'm gonna be trying my best to work that into all future speaking engagements. So I think that the second thing to say is that I think that in some ways the full frontal attack on the privileges of state-owned enterprises has been slow to materialize. The overall plan for reform of the state sector is still, I think it's imminent, but it's still on the drawing board. So you could say that was a lagging part of the reform agenda. But I think there's a certain amount of credibility in the view that other aspects of the reform agenda are a kind of death by a thousand cuts of China's state-owned enterprises. So things like interest rate liberalization, the appearance of defaults in the financial sector, including the default on a bond from a state-owned firm, reform of energy prices. All of these things are removing the implicit subsidies which support China's state-owned enterprises. So even in the absence of a frontal attack on the state sector, these other reforms are starting to change the dynamic. On the money market funds question that you mentioned, I think there a remarkable thing there was really that the state banks did push back against the appearance of money market funds and they lost. And money market funds continue to grow and be dynamic and suck funds out of the banking sector. Yeah, no. Yeah, Hank. Thank you, Hank Levine with the Albright Stonebridge Group. First, a brief comment and footnote just thinking relative to the previous question and that is the U.S.-China bilateral investment treaty if ever completed, would it seems to me make a significant contribution to SOE reform or at least increased competition for SOEs because it would require opening up so many sectors that the SOEs are in, so just a random thought. But related to that, I think I saw in one of Barry's early slides a reference to nationalism as an input into reform and I think in the interest of time you really didn't discuss it and I wonder if you could expand on that a little bit and particularly as it relates to your later comment that the ultimate form of the Chinese economy may not be one that we particularly want to see and particularly the U.S. business community or the foreign business community may not be, you know, especially thrilled given that the U.S. business community is very focused on the opening side of reform and opening. So I'd be interested in the nationalism question and then how that relates to the progress of kind of the opening side of reform and opening. A great question. You know, I wish I had a sort of firmer prediction, a clear statement to make about that and I don't because I think what we're seeing is the interplay between two different instincts which are both contradictory and occasionally coinciding. So, you know, it's most obvious I think in the sense of this enormous sense that China needs to move into a more innovative economy. And so, you know, on one level that leads them to support small firms, startups, a much more lively milieu for, you know, private business and especially entrepreneurial business and I think there are many signs that that's happening but at the same time, there's this intense paranoia about information technology. This, you know, still in spite of all the things they've said, the reality of sort of industrial policy on the ground is still highly interventionist, highly distortionary and highly anti-foreign. And so, you know, how do these two things work out? I don't know. And then at the same time, you know, Xi Jinping's drive for China's greatness clearly leads him to support opening the capital account, having their M&D play a bigger role internationally, starting with being a member of the Special Drawing Rights Basket this fall. But that's leading to, you know, in that sense, it's very positive to economic reform because I think it gives them a willingness to take risks with financial opening that otherwise they might recoil from. So I just, I wish I had a, you know, sort of straightforward, simple takeaway and I don't but I do think that the interrelationship and interpenetration of nationalism and the need to have a strong modern economy which implies a degree of liberalization and openness, these two things are gonna be interacting for years. I think you can't, we can't expect to have a better answer than what you just laid out because it is messy, it is messy, right? I guess I would say, picking up on Hank's comment though, one thing that's interesting is that BIT may in fact be the best opportunity for the US side to affect the arc of the trajectory of the program they're on because I think we would all agree that there are certainly people in the system who see the endpoint being one that we would very much not like, right? And something like a BIT might be our best opportunity to, you know, without, while acknowledging that we can't, you know, get in their game, if you will, it does perhaps allow us to tilt where they're headed a little bit. Good. Any other questions? Someone's got an idea, Chris. Oh, I'm sorry. Sometimes it's hard to see the people in the front. Thank you, thank you for the great talk and I want to return to the question that Dr. Norton. Can you identify yourself, please, sorry. I'm sorry. I'm David Cowig, I'm serving, I'm a Foreign Service Officer at the US State Department. My question is thinking about the effectiveness of Chinese government because when I talk with Chinese officials over the years and ask them to explain the system to me, they would often talk about China having the dual leadership system, Shuanglingdao Zhedu, and which means, of course, that the different government departments working at their level, their subject to their local government and financing personnel, but they're also responsible in the dual leadership to the next functional level of government above. But then the officials would always caution me. We also have a saying in China, we have measures from above and countermeasures from below. Xiangyou zhengsi, xiaoyou duetzi. And I've also seen Chinese academics criticize this dual leadership system as being a critical weakness for China, meaning that while China is supposedly very centralized, actually, because, of course, the part of the leadership at the local level names the personnel and controls the budget, you're gonna pay an awful lot more attention to your local leader than to the departmental level above. So I always get the impression in my years in China that China is a much more decentralized place than we expect and that the government is actually much weaker. In fact, one of the big problems with China is the government is weak, not that even though the Chinese human rights people, of course, have a different perspective, the ability of the central government to impose its policy is actually quite difficult. When I looked at Dr. Norton's slide talking about the local government financial vehicles that was for help helping with finance for local governments, maybe, oh, this is another countermeasure from below, which local governments set up to try to raise some money for themselves. I worked in Chengdu for five years and Chengdu, like many of the big cities, they get about one third of their income from basically confiscating the value of real estate from people at the periphery as the city expands. And, of course, this is a way for them to capture funds for the development without getting permission from the center. Now, I hope for the good of China that things can do better, but the question, I'm sorry, it's almost thinking about the political side. Now, this sort of consideration, should I really be keeping this in mind that I think about economic reform or is economic reform a little bit of a different track? So that's what I'm like, question, okay? So it's a great question that is super hard to answer because it is so huge, right? I mean, and it is, but you're absolutely right. I mean, talking about local government debt in some level, trying to sweep under the carpet the fact that there are all these important issues about what are the funding sources that local governments have? Is it adequate? They, of course, have relied tremendously on land conversion from rural to urban and development as a key source of revenue. But I guess, so I agree with you that the interplay between center and local is subtle and complex and we need to think about it all the time. The other thing I'd add is local governments in China lack the accountability to an electorate that local governments here have. And so just allowing, I mean, there's a reason that the system has never allowed local governments to take on debt. And they did anyway and it caused a bunch of problems and now we're trying to allow them, we meaning they, trying to allow them to take on debt through a more transparent and easily monitored process of issuing bonds, but that's still without the accountability that comes from having a local electorate. So there's a whole additional level of risk in there because of that. And I wish we had another hour or we could talk about it. So I think absolutely it's a relevant consideration and it also helps explain why progress has been significantly faster in some elements of the reform agenda than in other elements of the reform agenda. So where have we seen very rapid progress? Well, interest rate liberalization and exchange rate liberalization. Two instruments that are controlled by the central bank in Beijing and where you don't really need to have any debate with anyone at a provincial or a local level or rely on them for any aspect of implementation. Just not to overstate the simplicity too much but you flip a switch in the PBOC headquarters and it's done. Where have we seen slow and painful progress on reform, land reform, hooker reform, dealing with over capacity, all areas where progress and implementation relies on painfully negotiated agreements with local governments? Great. Okay, well I think we're at time and I want to thank you. Been a very active audience, we appreciate that and please join me in thanking both Barry and Tom for their excellent speech. Thank you.