David Dollar is a senior fellow at the Brookings Institution’s John L. Thornton China Center. He is a leading expert on China's economy and U.S.-China economic relations. From 2009 to 2013 he was the U.S. Treasury's economic and financial emissary to China. Before his time at Treasury, Dollar worked at the World Bank for 20 years, and from 2004 to 2009 was country director for China and Mongolia. His other World Bank assignments primarily focused on Asian economies, including South Korea, Vietnam, Cambodia, Thailand, Bangladesh and India. From 1995 to 2004, Dollar worked in the World Bank’s research department. Prior to his World Bank career, Dollar was an assistant professor of economics at UCLA, spending a semester in Beijing teaching at the Graduate School of the Chinese Academy of Social Sciences.
Hank Snowdon CMC '21 interviewed David Dollar on Nov. 15, 2018.
How has the U.S.-China trade war affected the overall economy in China so far?
The direct effect of the trade war on China has been pretty small so far. China's economy continues to grow well. It has been slowing down for a variety of reasons, even before this trade war started. Nonetheless, last quarter China was growing at 6.5 percent, which is quite good. If you look more specifically at Chinese exports, they've actually been growing quite rapidly. So, it's hard to see much direct effect. Having said that, the trade war is likely having some indirect effects. As I said, the economy was already slowing down, and the trade war is now creating uncertainty and nervousness in China. The most recent consumption data showed some slowing in the growth of consumption. So, the mood is changing, which is affecting consumption and even investments in some sectors. But overall, the effect so far is pretty small.
One of the policy responses by Beijing has been monetary easing. The People’s Bank of China has repeatedly cut reserve requirement ratios for banks this year. How would you assess this strategy?
China is trying to walk a careful line. Given that the economy was slowing, and that the trade war creates uncertainty, it makes sense for them to ease up a little bit on monetary policy. But, the Chinese are being careful not to really open up the spigots of credit. If you look at the most recent monthly data, credit was growing rather slowly, as was the money supply. So you can see monetary measures like cutting the reserve requirement ratio as an effort to counteract a natural credit slowdown. They do face a big issue, as they’ve allowed leverage to build up over time. They ultimately need to stabilize indebtedness levels, and ideally reduce it. Their monetary policy is a little bit accommodative, but not too loose at this point.
One potential course of action for China could be to devalue the Yuan in order to offset the impact of the tariffs. Do you believe this is the right move for China to make?
I would argue that the market has pushed down the Chinese currency. It has depreciated about 10 percent against the U.S. dollar since the spring. That is part of a worldwide trend; the dollar is up 8 percent against a basket of currencies. That is natural, given that the U.S. has launched the trade war, and that they have a large fiscal stimulus, which is increasing the U.S. fiscal and trade deficits. Those are reasons for currencies around the world to be depreciating against the dollar, and China is just part of that trend. Then, you can ask the separate question: Should China try to accelerate that trend by intervening, pushing down the value of the Yuan further? China has not been doing that. It would be a mistake to do so. If the Yuan depreciates much further, there will be more inflation. People will begin losing confidence in the market and take investments out of the country. The Chinese are smart to mostly follow what the market is pushing. There isn’t much reserve accumulation or decumulation going on. They're letting the market move the exchange rate without really intervening, and that's actually sensible strategy for them.
China has also increased short-term infrastructure spending in an effort to buoy GDP growth. For how much longer can China rely on short-term efforts like these to protect the economy?
China still has quite a bit of fiscal space, and if the local governments are borrowing for infrastructure projects, that’s a type of fiscal stimulus. However, that isn’t necessarily the smartest move at the moment. There are quite a few infrastructure areas where they have created excess capacity. If you look at the highway system, the rail system, and the airports, it's difficult to see demand for more facilities. If they try to stimulate the economy through these types of infrastructure, there's a risk at this point that they’re building “white elephants” — they’re going to create debt and not create value. Having said that, China is a big complicated country, so of course there are still some legitimate infrastructure needs. They could probably invest in wastewater treatment and in certain types environmental infrastructure. The key thing is to pick the right projects, ensure the projects are high-return, and stay away from areas where there seems to be excess capacity already.
How will China’s policy response to the trade war affect its goal of debt deleveraging?
The trade war creates a challenge for China with this goal. They've been trying to stabilize leverage and there has been some progress: there were several quarters at the end of 2017 and beginning of 2018 where leverage was not increasing, and if it was increasing, it was doing so very slowly. The trade war creates complications, because, to some extent, the economy is slowing down. If they cannot accept some slowdown in the economy, they’re likely to make the mistake of creating too much additional credit, which would work against that deleveraging campaign. We haven’t seen that happen yet, but if things get worse in terms of the trade war, they might be tempted to go back to some of the old ways. They might create extremely rapid credit growth. While that would help stimulate the economy in the short term, it would likely create serious problems in the long term.
There are reports of a tax cut. Will a fiscal stimulus be more effective than Beijing’s monetary stimulus?
Yes, fiscal stimulus is definitely the way to go. One of the key differences here is that they can use fiscal policy to encourage consumption. It’s possible that monetary stimulus can affect consumption, but the main thing China does with monetary stimulus is encourage investment. There is evidence that they have excess capacity around the economy, so that’s not a very smart strategy. But when you cut taxes it feeds into household consumption, and people can live better lives. Also, spending more money on health and education shows up in the national accounts as consumption, and that makes people’s lives better. So, there are definitely things they can do with fiscal stimulus that would be good for the macroeconomy, while also helping with other adjustments they're trying to bring about in their economy. For that reason, fiscal stimulus makes more sense than monetary stimulus at this point.
Overall, do you believe that China has a coherent and effective strategy to offset the adverse effects of the trade war? Are there policy measures you think China should have adopted but has not? For example, do you believe that Chinese leaders should announce a radical and credible plan to reform the state-owned enterprises that will both address the concerns of its trading partners and allocate resources more efficiently?
China is responding moderately well to the challenges of the trade war. Their macroeconomic policy is largely sensible, and that's one reason why their economy has not slowed dramatically yet. But they could do more in terms of structural reforms. In particular, they still have quite a few sectors of the economy that are relatively closed, either because of trade barriers, or more commonly, investment barriers. Many service sectors like financial services, telecom, and healthcare all have investment restrictions that hinder foreign firms from entering and competing in the Chinese market. China would have more efficiency in the economy if they opened it up more. This relates to the state enterprise issue; the best way they could discipline state enterprises is open up them up to competition. In these closed sectors you tend to get big inefficient state enterprises. Beyond that, I’d certainly be happy for them to create a comprehensive reform program for state enterprises. Ideally, that would include privatizing a lot of the locally-owned state enterprises, because it's hard to justify the local governments owning these enterprises. However, I don't have great hope that they're going to do anything dramatic in terms of state enterprise reform, which is why I put more emphasis on opening up the economy. This would certainly create a certain amount of discipline for these enterprises. The link to our discussion is that there are still things China can do with structural reform that would make the economy more efficient. If they take a certain macroeconomic stance, they can grow faster, people's lives will improve, and jobs will be created. If they don’t make those structural reforms and the growth continues to slow, there will always be the temptation to use fiscal and monetary stimulus. They have some room for fiscal stimulus, but too much monetary stimulus will lead to the problem we discussed, namely that they'll be backtracking on their deleveraging campaign. The Chinese have talked about opening up some of these sectors, but we really need to see more action.
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