Podcast music: Blindhead and Mick Lexington.
DEVIN STEWART: Hi. I'm Devin Stewart here at Carnegie Council in New York City, and today I'm speaking with Scott Kennedy. He is deputy director of the Freeman Chair in China Studies and director of the Project on Chinese Business and Political Economy at the Center for Strategic and International Studies (CSIS) in Washington, DC.
Scott, great to have you on the line today. Thanks for speaking with us.
SCOTT KENNEDY: Sure. Happy to talk with you, Devin.
DEVIN STEWART: Scott, give us a sense of what the China program at CSIS is working on these days.
SCOTT KENNEDY: Of course. We have officially three senior scholars who work on China—myself, and I focus on the economy; Chris Johnson, who focuses on Chinese politics and foreign policy; and Bonnie Glaser, who works on security issues. But actually, everyone at CSIS is a China specialist these days because for every problem in the world, whether you're talking about cyber, maritime security, or public health, China is important. So everyone is looking at China with at least one of their eyes.
Amongst the China team, we're looking today at a whole variety of issues, including Chinese technology innovation and whether their economy can become more productive so that it can emerge out of this middle-income trap, or we're looking at China's relationships with the United States and its neighbors, what's going on on the Korean Peninsula and China's role, as well as their cross-strait relations in Taiwan. So plenty of topics to keep us busy.
DEVIN STEWART: Great. Your specialty is the Chinese economy. Can you give us a sense of where the Chinese economy is today, and where do you see it headed?
SCOTT KENNEDY: Sure. I think everybody is impressed by China's performance over the last 40 years, and if you're not, you're crazy. The economy has grown faster, longer than any other country in history, so it's worthy of that praise and recognition. But in the last few years not only has the economy slowed down, but the government's commitment to economic liberalization has waned.
Growth right now is still pretty high at almost 7 percent, and it could stay that way for a while, but China is having to throw more at the economy in the form of stimulus to continue to get growth. Productivity is declining, and this is a product of the government not being committed to economic liberalization, which had brought a lot of benefits over the previous decades. So I see an economy that is facing more troubles, not because there is so much debt, which some people worry about, but because of the policy mistakes centered around continuing government intervention in the economy. To me that's the biggest concern when I look at where China is economically.
DEVIN STEWART: When you say "government intervention," do you mean state-owned enterprises, like entities owned by the government, or are there other things that worry you?
SCOTT KENNEDY: That is certainly a big problem. China's state-owned sector is still a big part of the economy, a significant part of employment. It is also very inefficient, so the debt that it holds is outsized relative to its contribution to growth.
But I'm thinking even more importantly of the government's role in regulation, its daily micromanagement of every sector of the economy, of the difficulties that are growing for foreign companies that want to sell to China or that invest and operate on the ground in China. I'm thinking about Chinese government coordination and China's outward investment to acquire advanced technologies, of Chinese state-based funds that are pouring money into every high-tech sector imaginable, that are challenging companies and countries that have tighter budget constraints. So across the board there is government intervention, whether it's about actors in the economy or the government's regulatory role.
DEVIN STEWART: What do you worry would happen from the government's intervention with the economy? Are you worried about just a gradual slowdown, a lack of efficiency, or is it something more dramatic, like a financial crisis?
SCOTT KENNEDY: I think there are potentially several negative repercussions from China continuing headlong on the path which involves extensive government intervention and stimulus to keep the economy growing, as opposed to a more liberal direction.
One is, as you just said, it's going to require more and more money to get the same output of growth. Secondly, it means that not only is China's economy going to grow more slowly, and as a result not consume as much either domestically or through imports, but it also is going to create greater volatility in China as stimulus works and backs off. So you're going to see ups and downs in China's economy more often.
But I'm also worried about the effect on the global economy, including not just individual companies that compete against the Chinese where, because the Chinese have a bottomless well of funding to support them, it's making it difficult for companies to compete, but I'm also worried about the business models of those industries, where innovation has led to generating excess profits which then go back into research and development. Now, if you think about the way the Chinese spend, China can do to semiconductors what it has done to the steel industry or the aluminum industry, and the aluminum and steel industries are not very innovative right now—they are facing big problems. So if high-tech sectors end up facing the same consequences, that is going to have effects on productivity growth elsewhere. So I think there are lots of potential negative effects.
This is because of China's size. If China were a much smaller economy, say, the size of Thailand, it wouldn't have those types of global implications. But because China is the world's largest trading country and because it's the second-largest economy—and in some measures the largest economy—in the world, everything China does matters for everybody else.
DEVIN STEWART: Part of our current podcast series is looking at what is the possible worst-case scenario. If you imagine that the government does not address these problems in the economy, what would you say is the worst case, and what's the likelihood of that happening?
SCOTT KENNEDY: I think there are two worst cases. One is if this results in a crisis. This could come about through a collapse of housing prices or a bunch of defaults on bonds or a bank collapse. That, obviously, would then lead China into a recession. It would probably have a big effect on everyone that trades with China, on global commodity prices. It would then cost us all a lot of money to get China up and running again.
On the other hand, at the other end of the spectrum, if China doesn't have a crisis, if it continues to have a turbo-stimulus approach to investment in different industries, then China might do really well, but it might have a really negative effect on other economies beyond China that are competing in those same spaces. For me, that would have just as negative a consequence for the global economy, maybe in different sectors, but nevertheless it would still be difficult for us to swallow and adapt to it. It would take quite a bit of time for the world economy to adapt to a China that essentially was trying to dominate every high-tech sector they could.
DEVIN STEWART: Now, looking at the crisis scenario, do you think that the Chinese Communist Party is resilient enough to weather such a crisis?
SCOTT KENNEDY: You never know. A lot of other countries have had financial crises. They've changed political leadership, for example, in the case of South Korea and Thailand as well, but Thailand just rotates through political leadership all the time because of coups.
But I think China looks less like the South Korea of 1997-1998 and more like the Malaysia of the late 1990s and Mahathir, and I could see the Communist Party weathering this. Xi Jinping has an immense amount of power himself, and the Party has lots of coercive power. They have no good plan B; there is no real good alternative. So I'd be quite surprised if a financial crisis in China, if it were to break out—and I think the likelihood is pretty low—but if it did, I don't think it would affect the Party's leadership.
DEVIN STEWART: Thanks so much, Scott.
Just to sort of wrap up here, do you get a sense of the Trump administration's approach to China? Do you get a sense of where it's heading? If they could do a better job, what would you have them do?
SCOTT KENNEDY: I don't have a clear sense of where the Trump administration is going overall with China. I get a sense of where they're going day to day.
When the campaign ended, my expectation was that the United States was going to get much tougher on China, and quite quickly, across a range of areas. I think a lot of people would have welcomed that because there was a general feeling that the Obama administration had focused so much on dialogue and integrating China into the global system, whether it's economics or security, that China had basically decided that it could get away with a lot, with paying few costs, by not living up to its agreement for policies, whether it was in the South China Sea or on economic issues.
The Trump administration came in with a lot of leverage because there was a sense that he was going to really put it to the Chinese, and I think he frittered away most of that leverage beginning with the phone call with President Tsai in early December, and then moving toward whatever was necessary to have the Mar-a-Lago summit. Then there is a desire amongst many in the Trump administration to have momentum in the relationship, a win-win outcome. I think that is what we see in the 100-day negotiation process, which generated an initial series of outcomes in May, which really didn't add up to much. I think when we get to July we'll see another small basket, and the president is planning a summit later this year.
It's quite possible, and there are already signs that the Trump administration has tired of some of this effort to collaborate with the Chinese, for example, on North Korea. Just today the State Department identified China as a major violator in human trafficking, and there could be other things related to Taiwan that come out this week.
But I don't think that kind of approach toward suddenly shifting from a cooperative approach toward high pressure and dissatisfaction would be very effective with the Chinese because I think the Chinese will feel that the Trump administration is just switching from one strategy to another and eventually will switch back in another direction, and they just need to wait them out.
There is no broader foreign policy or Asia policy into which our engagement with China currently is attached. That makes me worry that the increase in tensions aren't going to be very productive. I'd like to see a clearer, broader strategy into which our relationship with China is placed. Then I think we'd be able to decide whether pressure, engagement, or some other approach would make more sense.
Last is that it is very unclear how the U.S. relationship with its allies in Europe and Asia, with others, relates to what we want to achieve with China. Certainly, bilateral pressure with China is not going to be very effective, and so you have to bring in others to work together. That is why the Trans-Pacific Partnership (TPP) had so much promise. But whether it's going to be on trade, whether it's going to be on Korea or the South China Sea or other issues, we'd like to figure out not just what the U.S. policy is on its own, but how it's going to work with others. Right now I don't see that coming together. Perhaps it's just part of the natural learning curve that every administration faces, but sitting in Washington now, it feels like the learning curve for this administration is steeper than for most.
DEVIN STEWART: Scott Kennedy is deputy director of China studies at CSIS in Washington, DC. Scott, thank you so much for speaking with us today about China.
SCOTT KENNEDY: Happy to talk with you.