Nicholas R. Lardy is the Anthony M. Solomon Senior Fellow at the Peterson Institute for International Economics. He joined the institute in March 2003 from the Brookings Institution, where he was a senior fellow from 1995 until 2003. Before Brookings, he was the director of the Henry M. Jackson School of International Studies at the University of Washington from 1991 to 1995. From 1997 through the spring of 2000, he was also the Frederick Frank Adjunct Professor of International Trade and Finance at the Yale University School of Management. He is an expert on the Chinese economy. He was interviewed by Shivani Pandya '18 and Anna Balderston '18 on Nov. 24, 2015.
The prevailing wisdom about in the market these days is the Chinese economy is headed for sustained growth deceleration. Is such pessimism justified? In what ways do you think the conventional wisdom may be wrong?
The Chinese economy has been slowing continuously since the last peak. Since 2010, year after year it’s been slowing, and 2015 will be no exception. So this will be the fifth year of deceleration. Historically, the statement about growth deceleration is accurate. I think the question is what happens next? My view is that China is not likely to sink two or three or four percent in growth because the service sector is playing a stronger role in sustaining economic growth.
What do you think will be the biggest short-term stumbling blocks for China in reviving its growth?
One of them is certainly the property sector. Property investment has been decelerating since 2010; investment in property is going to be roughly zero this year. And if it goes to minus 10 or minus 15 or minus 20 percent per year over the next couple of years, the economy will slow down and the service sector will not be able to completely offset the further weakening in property investments. So that’s one of the biggest stumbling blocks. The second one is reforming state-owned enterprises, which are much smaller than they used to be. They still control a significant amount of assets that are generating very low returns.
In your last book, Market over Mao, you offered empirical evidence that Chinese economic growth has been primarily due to market forces rather than state intervention. Nevertheless, do you think the government influence had any sort of positive impact on Chinese economic growth?
I think the answer is yes on two levels. Number one, they made it possible for the private sector to do very well by reducing the number of constraints on the private sector. I think I outlined that very clearly in the book. The second thing is they have done very well at building infrastructure, which has been very positive for economic growth. I wrote a lot about that in my previous book, which was called China’s Economic Growth After the Global Financial Crisis. Obviously for most economies, the state has a very large role in building up infrastructure, and China is no exception.
What are some examples of infrastructure projects that you find particularly influential in strengthening Chinese economic growth?
Transportation is the most obvious example. They have reduced transportation costs substantially and created a more efficient and integrated domestic economy.”
Chinese investment seems to be delivering less bang for the buck. Do you see consumption pick up the slack?
2015 is going to be the fifth consecutive growth in which consumption growth has outpaced GDP growth. The increase of the consumption share of GDP is still fairly modest. If investment were to fall dramatically, consumption would not be able to offset the decline in investment. So consumption can pick up and offset gradually over time, but if there is a sharp decline in investment, the economy will slow down.
How resilient is China’s financial system? The debt level is apparently very high, but only a very small number of defaults have been reported. What is going on? Will the debt overhang increase the possibility of a Chinese hard landing in the near future?
I don’t think the financial system is quite as fragile as many people are writing or saying. Remember that the increase in lending, the increase in debt is funded entirely by deposits in the banking system. It’s all domestic currency. All the significant Chinese financial institutions are all funded by deposits or are funding themselves in the inter-bank market. There’s very little foreign currency mismatch, and there isn’t going to a liquidity problem. The central government has massive capability to increase the liquidity in the system should it become necessary. So I don't think China will have a domestic banking crisis.
You have noted that China’s service sector has been doing very well and now contributes more than half of the GDP. How do you counter those who argue that because productivity growth in the service sector is traditionally lower than in the manufacturing sector, growth in the service sector may not have the same positive impact on income growth, which is the key to China’s economic future?
I think this is a worry. But when you start looking at the service sector, you can still find that there are plenty of areas in which there are huge improvements in productivity. I think online retail is probably a good example and so is financial services provided via the internet. I think the old view that there is little productivity potential in services is not so true in the Chinese case. The share of the population that is using smartphones in China is higher than the U.S. … and in that kind of environment you see a lot of areas where there’s substantial improvement in productivity in services.
Would you go so far as to say growth in the service sector would have the same positive impact on income growth as an alternative to that thought (i.e. manufacturing)?
It has a positive impact on income because services are still more labor-intensive. So that’s part of the reason why the consumption demand is going up.
How much of an impact do you predict the increasing competitiveness of other East Asian countries to have on China's export performance?
If I won a dime for every time I read that China is losing competitiveness, I’d have been very rich. Frankly, I don’t buy into that. If you take the period since the global financial crisis, China’s exports, maybe not this year, but for this period as a whole, China’s exports are still growing more rapidly than global exports. They’re gaining market share. Now, in some products they’re losing competitiveness, but in other products they’re gaining competitiveness, but the gains are more than offsetting the losses so that their share of global exports is still going up. So, yes, wage increases have been very high in China, but productivity gains in the export sector seem to be very strong, so even labor costs are still relatively low. Remember, if wages were the determinant of exports, India should be the export powerhouse. I can’t remember exactly, but India’s wages are something like of 50-60% of the Chinese level, and they are not a significant exporter, so rising wages doesn’t automatically translate into declining competitiveness.
What keeps you up at night about the Chinese economy?
I think I already mentioned this that housing investment could decline, so that’s one risk. And the second risk is: What if the government decides they need to have a highly expansionary credit policy like they did at the time of the global financial crisis? We’ve already talked about how the debt-to-GDP is going way up, but they have moderated the growth of credit in the past two years; so one thing that would make me much more apprehensive is if they went back to the old expansionary, hyper-expansionary credit policy.