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From Beijing to Washington: China's Economy with Oliver Melton | China Considered | Hoover Institution · China Considered

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[MUSIC]
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>> Elizabeth Economy: Welcome to China Considered, a podcast that brings fresh
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insight and informed discussion to one of the most consequential issues of our time,
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how China's changing and changing the world.
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I'm Liz Economy Hargrove Senior Fellow and co-director of the program on the U.S.
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china and the World at the Hoover Institution at Stanford University.
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Today, we're going to return to one of those fascinating but
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often vexing issues that we all confront when we're thinking and
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working on China, namely, what's going on with the Chinese economy.
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The stock market is up, exports are up, but
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the property sector still seems to be a drag, and consumption is still low.
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Fortunately, we have with us today Oliver Melton.
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Oliver just returned from five years as the Treasury Department's financial
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attache in Beijing.
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He's now the director of Rhodium Group, an economics consulting and
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research organization.
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Welcome, Oliver.
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>> Oliver Melton: Hey, Liz.
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It's really great to be here.
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>> Elizabeth Economy: Really great to have you.
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All right, and I should say, I guess,
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welcome back to the United States after five years in Beijing.
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How does it feel to be back?
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>> Oliver Melton: It's really, really nice to be back.
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And coming back to D.C.
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is always really great because it's so green and small compared to Beijing.
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>> Elizabeth Economy: Anything you miss, anything you miss about.
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>> Oliver Melton: China right now,
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the food is going to be really hard to do without.
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We need to really improve that in the US, I think.
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>> Elizabeth Economy: Improve the Chinese food, or
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just in genera,l the Chinese food.
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>> Oliver Melton: The Chinese food we're really lacking here.
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>> Elizabeth Economy: Okay.
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All right, so let's get started.
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We're going to focus on the Chinese economy, but let's start with what
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it was like to be the Treasury's financial attache for five years in Beijing.
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What did, what does that even mean?
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What did you do on a daily basis?
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>> Oliver Melton: Yeah, so no day was really the same.
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I spent probably about half my time being Treasury's sort of chief analyst
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in the field.
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So my job was to go around and
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talk to really smart people about what was happening in the economy,
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what we thought the policy direction was, what the leadership was thinking.
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So that could involve talking to economists,
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that could involve traveling around, talking to real estate developers.
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Really, just about anything.
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That was a lot of fun.
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And you had to be resourceful and try to find people who'd have interesting
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insights into an absolutely massive, ever changing and complicated economy.
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And then the second half of my job was to be a diplomat, right?
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It was to facilitate communication between the Treasury Department, Secretary Yellen
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and her team, primarily, but then Secretary Bessen with Chinese leadership.
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And so that would involve Negotiations, it would involve a lot of planning for
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the contacts that we had, the engagements we had, and a degree of advice
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back to headquarters about what I thought the Chinese were thinking or
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how I thought that they would respond, or why they were acting in a certain way.
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>> Elizabeth Economy: Great. I want to
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come back to the negotiation side of it and, and, you know,
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hear something from you about what it was like to sit in those negotiations and
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your impressions of, of the US and the Chinese and how they negotiated.
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But let's just focus a little bit in on, you know, what you thought about
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the Chinese economy and whether what you were seeing, you know, being on the ground
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there, you know, did it differ a lot from what you might read in the Western press?
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Did you think this is so radically not how I understand the Chinese economy, or
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did what you were seeing, roughly speaking,
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dovetail with what we might be getting back here in the U.S. you.
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>> Oliver Melton: Know, both probably, is the answer.
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So, you know, living in Beijing,
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you're not really living in the Chinese economy, right?
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You're living in this very different, this very sort of isolated,
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niche component of the Chinese economy.
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It's a capital city, so
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it's a little bit more resistant to the fluctuations in the rest of the economy.
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It's much more service sector oriented than the vast majority of the economy.
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And so you really had to get out of Beijing to get any sort of sense of what
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the rest of the economy was like, what the majority of the economy was like.
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And even then, China is incredibly diversified, Right.
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It's as big and complex as Europe.
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And so talking about what the Chinese economy is like is as nonsensical as
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talking about, like, what Romania is like in, in the context of London.
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Right. And these are just two fun.
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It's just an enormous and varied economy,
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and parts of it can be doing really badly and parts of it can be doing pretty well.
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And that, that was certainly happening when I was there.
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So I would say that we always struggled getting a sense of what real growth was.
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Right now I'm at the Rhodium Group and my colleague down the hall,
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Logan Wright, has done a lot of forensic data analysis,
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the kind of stuff that we certainly did a lot of inside the Treasury Department
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to get a sense of what we really thought was happening.
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But the hardest part of the job, and maybe even arguably the most important,
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was to try to figure out what was coming next, what the policy direction was for
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the leadership.
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And that was very difficult, the Chinese have gotten stricter and
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stricter under the current leadership, but even in the last few years,
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they've gotten much more aggressive with information controls and
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censorship and sort of oversight, you could say nicely,
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of who says what to your friendly foreign diplomats.
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And so it's difficult to get an honest assessment of what the leadership
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recognizes to be weaknesses or shortcomings in the policy strategy.
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So we really all had to become experts in how the Communist Party
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communicates to itself, right?
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So I had a large stack of people's dailies on my.
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On my desk.
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We spent a lot of time reading Xi Jinping speeches and other leadership speeches to
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try to understand what the intellectual framework was for
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their policy strategy and then also the institution.
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So you can't skimp on understanding how China is structured.
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There's a very strong leader at the top, but
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the institutions really still matter quite a bit.
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And you have to understand what they control,
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what they're trying to achieve and how they're structured if you
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want to understand how policy evolves in that system.
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So there's a lot of kind of Kremlinology in my job and a lot of going around trying
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to, you know, talk to people about what they were seeing as well.
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>> Elizabeth Economy: So did you see a vast gap between, you know,
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what you were reading in the People's Daily or in Xi Jinping speeches and
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what you would see on the ground?
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Or was it really a function of.
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Here, Xi Jinping announces something like made in China 2025.
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And then you go out and, how much of the country did you actually see?
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How many provinces did you visit actually?
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But you go out and you look and you see, actually, I am seeing.
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These policies translate very directly into change on the ground.
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>> Oliver Melton: How many provinces do we go to?
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You know, we know we haven't counted, [LAUGH] l really.
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>> Elizabeth Economy: You do keep track of how many provinces you went to?
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>> Oliver Melton: [LAUGH] Okay, I think, to be honest, in one meeting, one very,
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very boring meeting, I think I listed all the places I'd been, but
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I don't have that in front of me.
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But we went to the majority of provinces and we made a real point as a family and
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also as a diplomat trying to go to a diverse set of regions in China to see
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places that were heavily industrial, hyper modern, like Shanghai or
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Shenzhen, and fairly rural and so forth.
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And yeah, you do see, you do see transmission quickly, but
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it doesn't work always.
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Right.
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It's a normal country where they try things and it doesn't always happen.
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It doesn't always work.
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And so real estate is probably the best example of that, where no issue could have
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been closer to the center or closer to the leadership's attention in the economy.
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And some of the things they did were incredibly effective, right?
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So when they decided to cut off real estate finance for highly speculative
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investments, they were hyper successful, arguably way too successful,
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and developers of all stripes hyper over leveraged.
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Pretty healthy developers.
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Nobody could get finance anymore.
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And the industry came to a grinding halt.
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And they basically engineered, on purpose or by accident,
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a total collapse in the sector.
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And then when they decided to kind of try to turn that back on several years later,
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not, not to reflate the property sector, but to restore finance to healthy
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developers, or at least healthy projects, they really struggled to do that.
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And so there was a lot of effort, there was a lot of motion in the system,
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but they didn't impose the right kinds of guarantees.
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They didn't line up the incentive structure with the economic institutions.
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And so nothing really happened at first.
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So you had a lot of action, a lot of activity, a lot of talking, and
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that worked, but you didn't have a lot of financing going out the door.
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>> Elizabeth Economy: So give us the time frame here.
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When are we talking about?
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>> Oliver Melton: I think 20.
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I think we're at this point, 2020, late 2023, early 2024.
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There were two rounds of trying to restore finance to the whitelisted projects.
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This is when the cities started to have whitelists for
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the projects that should receive financing for completions.
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And it didn't work because the banks are smart enough to know that if they lose all
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their money on a project, the government's going to come after them in the future, or
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they're going to.
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I mean, frankly, they're just going to lose the money and
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they're going to have to deal with that.
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And so, you know, the Communist Party has an enormous amount of authority over
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certain types of decisions,
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but they can't just will economic activity if it's against their interest.
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And so they really can be successful sometimes and
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they can fail in other times.
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>> Elizabeth Economy: So the banks were not confident
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that the Chinese Communist Party would recapitalize them, is what you're saying.
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Right, which they've done in the past.
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>> Oliver Melton: Yeah, they weren't confident that they would get
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recapitalized, and they initially weren't even confident, it seems they weren't
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even confident that they wouldn't be held responsible for loans that went bad.
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There's sort of two layers in the banking system.
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One is the, you know, your profits and losses, which can be managed rationally.
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You can take more risks and get more profits, and
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the banks can kind of handle that.
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But then there's also the.
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The corruption side of it.
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And bankers are often investigated for
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corruption if they lose money on an investment or on a loan.
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And so there's a huge amount of conservatism in the banking system and
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frankly, in the investment community.
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Because if you lose the state's money,
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it can suggest corruption even when it was actually a good business decision.
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And so when the, when the government came along and said, hey, we want you to
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lend to these loss making or near loss making property developments so that they
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can complete the houses, banks were correctly or rationally wary to do so.
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And then they came along and then the party had to promise a year later and
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said, okay, look,
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we won't investigate you for corruption if you lose money on these deals.
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And that was sort of a prerequisite for things to go forward.
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But it still hasn't turned back on.
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>> Elizabeth Economy: Right. I was just going to say
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that the property sector still hasn't really rebounded though.
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Right.
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Maybe less of a drag, but still a drag on economic growth.
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>> Oliver Melton: Yeah, and nor will it.
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And, and for their, you know, in their defense,
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they were not trying to reflate the property sector.
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They were trying to just get the half finished apartments,
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complete ones that had already been sold to folks.
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>> Elizabeth Economy: So take the property sector and fit it into sort of
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the overall, as you mentioned, very complex, complicated Chinese economy.
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So that's a little bit of a drag.
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But where, where else is the Chinese economy having trouble?
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Where is it, you know, doing well?
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And how do you see all these pieces fitting together?
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I guess what is your model in your own
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head of how the Chinese economy works?
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>> Oliver Melton: Maybe a simple version would be better that basically China,
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as everyone knows, has a, an economy that's,
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that has a really high savings rate.
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Right. So too much of national income is saved by
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your households or the government.
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And as a result that money needs to be invested or
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China needs to run a really large surplus for the rest of the world.
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In the early two, in the mid-2000s, they ran a huge surplus, you know, 10,
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10, 10% or greater current account surplus.
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And a lot of that savings was then absorbed in this massive
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investment boom in the 2010-2017, 2018 period.
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First with infrastructure and then with real estate.
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And so real estate,
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the way I think of this is that real estate was a non tradable,
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somewhat productive investment target that allowed China to get for about, you know,
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five or six or seven years to allowed them to extend this imbalanced model, right?
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So super high savings rate doesn't have a huge current account surplus because
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they're investing this money domestically.
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But you can only build so many houses and so many, so many new cities or so
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many railways before, before you run out of places to build.
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And so they, they definitely reached that point where they had more Stuff than they
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needed more, more apartments and than they need.
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And that came, that came crashing down really quickly partly because of policy
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decisions, but partly just because of the kind of the physics of it.
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They had enough houses at this point and so now we're kind of back where we
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started, which is you have an imbalanced economy and
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you either need to significantly increase consumption or
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you're going to return to really significant trade surpluses.
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And so right now, I think, you know, for the last few years you've seen
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the government kind of trying to feel its way through this problem,
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on the one hand, trying to find new destinations for investment.
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So if real estate wasn't going to absorb all this investment,
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maybe advanced manufacturing would maybe new, you know, maybe electric vehicles,
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maybe robotics, other sectors.
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And that's what the last administration was particularly nervous about,
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was that this kind of massive tidal wave of, of investment cash could be,
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could be channeled away from real estate into these sectors and
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create really significant disruptions for the rest of the world.
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And indeed we started to see that.
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And on the other hand, you see the government trying to boost consumption so
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saving less.
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But they're not really exploring the kinds of policies or
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they're not really pursuing the kind of policies you would need to have
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a fundamental shift in the overall level of savings in the economy.
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So I see real estate as a drag on the economy, but
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also sort of the elimination of sort of a temporary band aid or a temporary,
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sort of a transitional or a temporary fix to a structural problem that's
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been around for 20 years that now is really coming to a head.
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>> Elizabeth Economy: Right. So you mentioned that
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the Chinese government is not undertaking the types of policies that it needs to,
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to boost consumption.
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And certainly we've heard a lot about this and we know that they've done these
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trade in programs for, you know, goods and even for cars in some places.
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I guess they've, you know, increased salaries in some areas for
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civil servants or for teachers at some, in some places.
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So there have been some moves.
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But what, what would you be looking for
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when you say the policies that they need to undertake?
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What would be sort of your set of two or three things if they started to make moves
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in those areas, you'd be like, check, check, check.
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They're getting it right.
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>> Oliver Melton: Yeah, I mean.
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Well, Rhodium has a whole paper on this that,
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that was published recently that we can link to.
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But I would say probably the same thing that the World bank and
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the IMF have been saying.
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And honestly, frankly, a huge number of Chinese economists have said publicly or
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privately.
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The first is you need a much more comprehensive social safety net.
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You need government transfers basically to households in the form of pensions and
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social welfare or social insurance programs, healthcare in particular,
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healthcare spending, and
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the quality has improved significantly over the last 10 years and.
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People might not appreciate that.
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Liz, I'm sure you've been to a Chinese hospital or a doctor 20 years ago or
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five years ago and there's a massive difference.
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>> Elizabeth Economy: Yeah, no, I haven't been, but
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my daughter spent several days at a Chinese hospital with an ulcer.
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I don't think it was a great.
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Experience, but I'm sorry, sorry to hear that.
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>> Oliver Melton: But it would have been worse 20 years ago, I guess, but-
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>> Elizabeth Economy: No doubt.
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>> Oliver Melton: So there's, there has been progress, but
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there needs to be just massively more progress, right?
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Because Chinese families still social self insurers, they keep a pretty
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significant amount of their income and savings just in case something goes wrong.
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And the state has the power to reduce that precautionary savings through greater
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investment in social services.
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One of the biggest areas is definitely the share of the state in the economy.
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So a little bit of a complex argument, but basically the problem is,
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is that the state controls a pretty significant amount of corporate revenue or
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corporate profits in the economy and is prone to reinvest those profits,
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sometimes in the, in the same business, sometimes in other businesses or other
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government controlled ventures, including government vc, which is kind of new.
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But it doesn't ever get to a point where it says, you know what,
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my rate of return on this project is only 2%, I'm going to consume this, right?
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And if you're a household and you, your investments reach a level,
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a rate of return that's too low, you'll consume it, right?
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You'll make a rational decision about deferred consumption or consumption today.
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And so you stop investing when it's no longer profitable to invest and
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you can kind of enjoy the fruits of your labor today.
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And that doesn't happen in the Chinese system, right?
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The state profits are kind of insensitive to intertemporal substitution.
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So they just keep investing and keep investing and that needs to change.
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And that can happen either through transfers or
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through greater privatization or private ownership of state assets.
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So that's a big one and really, really hard to see.
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I think the number one thing though that we would like to see,
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that I would like to see is more ambition for household income as a share of GDP.
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I think 10 years ago this was in the five year plan and in some of the party
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documents and certainly in the, in the work reports that the,
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that the state was actively pursuing higher wage growth than GDP growth.
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And now, and for the last maybe five or six years at least, the,
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the target has been household income should grow in line with gdp,
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which means that the party is not trying to see its people get richer faster.
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And if people don't have a higher and higher share of national income,
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there's a ceiling on how fast consumption should grow.
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And as a corollary, Larry, to that, they used to promote the service sector.
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They used to think that the service sector white collar jobs, you know,
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the kind of jobs that dominate, I mean to completely dominate the US Economy,
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have a much higher wage share of output.
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You know, the, the amount of revenue that then goes into household
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bank accounts is much higher than for factories.
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And I would be encouraged to see the, the party kind of reduce its focus on
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manufacturing and the production of physical stuff and you know,
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the building of factories and more human centric jobs to, to raise wages as well.
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>> Elizabeth Economy: That's a really interesting point that I actually have not
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heard made before.
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You know, one of the things that, that I've been thinking about or
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I have thought about is just the really slow rate
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of growth in per capita GDP in rural sector over the past several years.
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I actually, you know, Common Prosperity, for whatever that was worth,
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I think was targeted at the, you know, absolute most impoverished in the country.
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But I mean, this is still a country with, you know,
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600 million people living on a couple of $100 a month.
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And I've really been surprised at how little attention seems to be being
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paid to this, you know, very significant part of the Chinese population and
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their sort of consumption ability and also just their ability to participate
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in the 21st century economy because I don't even see that the government is
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doing much to train them up for this, you know, incredible sort of technological,
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you know, revolution that's underway in much of the rest of the country.
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>> Oliver Melton: Yeah, and your, your colleague Scott Rosel has done some
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of the best work in the world on this to highlight not just the,
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the severity of the, the wealth gap between rural areas and urban areas,
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but also the fact that the HUCO system actively prevents workers
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from bringing their children into urban environments.
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And because of the, the gap in education quality is really leaving behind
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millions of children in ways that are a human tragedy, but
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also really counterproductive to China's long term growth.
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So it's a, it's a mystery to me as well.
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It's, it's, there's, there's really just no fundamental,
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there's no compelling reason to do this other than just sort of a failure to
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address basic fiscal transfer issues.
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And you're right that with Common Prosperity they talked it up.
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It was on the front page of the People's Daily.
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I very Very, very wrongly predicted to my headquarters that if you put something
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on the front page of the People's Daily,
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it means you're going to follow up with it, follow up with real dollars.
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And they, they just didn't do it.
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They just didn't follow up with actual fiscal transfers of the magnitude that
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would really make a huge difference.
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There was, there were some, usually city to county, but
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we just didn't see the scale needed to make a, a really fundamental difference.
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>> Elizabeth Economy: No. And
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there's a great book by Steve Tsung and Olivia Chung that looks at,
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you know, what Xi Jinping has said, you know, are the priorities.
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And then actually if you track how policy was implemented,
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what really is a priority and common prosperity, you know, didn't,
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didn't make it onto the list of, of actual priorities for Xi Jinping.
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So follow through was actually not terribly robust.
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So let's pivot a little bit.
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You know, one of the things about China is that they often, you know,
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Chinese leadership is prone to have massive campaigns of one sort or another.
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And I want to just get your take on where you think three of them sort of stand.
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How successful has, you know,
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the leadership been in pushing forward with them?
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What do you see as the sort of up and down sides of each?
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And they're the Belt and Road Initiative made in China 2025 and
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de dollarizing the global economy.
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So let's just start with the Belt and Road Initiative because this is one where
23:00
you may be aware, since you were just in the U.S.
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government, that there lot of chatter in Washington that the Belt and
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Road Initiative had kind of failed, that it was over.
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Beijing didn't have the resources to push forward with it.
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That wasn't a position that I subscribe to.
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But I'm curious, what's your take on where the Belt and Road stands today?
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>> Oliver Melton: Yeah, so I think it's, it's fair to say that
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the criticism is right and wrong at the same time.
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Right. So most definitely it had
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the characteristics of a campaign.
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Right. You know, they said go forth, you know,
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2013, 2014, everybody go out, everybody do this.
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All the banks are authorized to lend, take your forex and
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use it for something abroad.
23:54
And everybody did it.
23:55
It was kind of kids soccer with everybody chasing the ball and.
24:00
Then lo and behold, about three or four years later, right,
24:03
as the first repayments were scheduled from these projects, they started to
24:08
figure out pretty quickly that a lot of them weren't going to make money, right?
24:12
The political risks in Africa and Latin America and
24:16
Central Asia that had depressed in foreign investment before China showed
24:21
up were in fact applicable to Chinese firms as well.
24:25
And you had a whole lot of, you know, spectacular failures,
24:30
moderate failures, delays, etc.
24:33
You also had a huge amount of corruption, right?
24:36
There it is, there's still a massive trail of corruption investigations that
24:40
are chasing some of these deals.
24:43
Some of them are kind of lower, lower in the headlines.
24:45
But there's a long hangover from this period in, in China.
24:51
And they got burned, right?
24:53
And we saw pretty quickly that these firms and
24:56
financial institutions pulled back, got a whole lot more conservative.
25:02
The better firms were able to keep investing or keep lending, but
25:06
the sort of cowboy firms or the folks that weren't particularly good at learning
25:11
from mistakes pulled back and a lot.
25:13
So from that perspective, you could say, yeah,
25:16
it was probably overly ambitious, even you could say something worse than that.
25:22
And they got burned and it was predictable and look how funny that was.
25:28
On the other hand, they achieved a lot of their strategic objectives.
25:32
So buried within the sort of general rush of, you know, thousands and
25:36
thousands of companies going abroad were a number of very carefully orchestrated and
25:42
targeted investments and projects that fulfilled strategic objectives.
25:48
You know, ports that could be dual use, that are dual use,
25:52
vertical control over minerals and processing of,
25:56
of minerals that are really crucial for modern industry.
26:00
I mean, you know, at the time we were all reading the, you know,
26:03
we were reading the plants, these were public.
26:05
They, they were not concealing what they were doing,
26:08
going after minerals that I had to look up first,
26:10
you know, first in Chinese and then in English to see what they were doing.
26:14
And, and we knew they were going after this.
26:17
But the scale and the fact that these resources would be so
26:22
integral in things like batteries wasn't as apparent back then.
26:27
But even then, you know, they had foresight and they,
26:30
they may have lost some money on some of these deals and they may have overpaid,
26:33
they may have invested kind of too prematurely or
26:35
at the wrong point in the cycle, but they did pretty well.
26:39
And so I think the, the ultimate evaluation of the Belt and
26:42
Road initiative really depends on what your perspective is.
26:46
And my guess is that Beijing would say, okay, we made some mistakes,
26:49
we learned a lot of lessons, but we achieved a huge percentage of our goals.
26:52
And as we go for round two or round three we'll be smarter, we'll be more targeted.
26:59
We'll be a little bit more market disciplined in the sense that
27:02
we won't lose as much money, but
27:04
we're still going to be able to pursue our strategic objectives carefully.
27:09
>> Elizabeth Economy: Yeah, I mean, from my perspective, you know, I think looking
27:12
at the, you know, point at which Xi Jinping seemed to take a step back and
27:16
talk about small is beautiful and
27:17
there seemed to be a little bit of a retrenchment.
27:20
Actually what they did was they just got small, smarter and more efficient and, and
27:25
more targeted.
27:25
And so the real push now is, you know, in the clean tech space.
27:30
You know, it's in the digital space.
27:32
And it still, I think, is in minerals and mining and
27:35
then some infrastructure projects that are, you know, very carefully chosen.
27:39
So you know, I think, you know, Washington and
27:42
other places should be more concerned as opposed to less concerned because I
27:47
think the Chinese have learned that and they don't want to build palaces and
27:52
soccer stadiums anymore or big white elephant infrastructure projects.
27:56
They're really focused on what their strategic needs are and
28:00
I think in extending their sort of infrastructure globally in
28:05
these extremely core areas for example of Digital Stack, right?
28:09
The Digital Silk Road and Cleantech.
28:11
So I think the alarm bells should be going off more in Washington
28:16
if we're thinking about competition space as opposed to less.
28:22
And in that same vein, of course, made in China 2025 and there have been some good
28:28
studies that have come out by Merix, for example, maybe Rhodium has done some work
28:33
in this area as well of evaluating how well made in China 2025 has actually done.
28:38
And this of course was, you know, the big plan, you know,
28:42
around 10 critical cutting edge areas of technology where China, China wanted
28:46
Chinese companies to dominate in the manufacturer up to certain percentages,
28:51
70, 80, 90% would be controlled by Chinese companies.
28:55
And then of course, you know, China, these companies would become global champions.
28:58
So you know, new materials, semiconductors, AI.
29:02
How do you see it?
29:03
I see it as a success.
29:05
But what do you, what do you think?
29:07
>> Oliver Melton: Yeah, yeah, so Rhodium did do a study a little while ago and
29:11
Merrick did a really good study as well,
29:13
evaluating their success relative to different metrics.
29:16
And I think they key is to look at the different,
29:19
different competing goals that they had.
29:22
So on the one hand was the sort of loftier, more ambitious
29:25
goal of dominating certain sectors or being a world leader in certain sectors.
29:30
But the core goal was to eliminate dependence and vulnerability on foreigners
29:35
and particularly the United States in, in these technologies.
29:38
Right. So it's, you know,
29:40
offensive goal is to be dominant defensive goal is to just eliminate the U.S. u.S.
29:46
Ability to sort of choke China, which is a vocabulary they use quite often.
29:52
And in several sectors they did a really good job, right?
29:55
They, and, and you know, in a few sectors they achieved their maximum goal.
30:00
Right? EVs are just unambiguously world leading
30:03
and incredibly good.
30:04
And they've done really well with clean, clean energy as well.
30:09
I should also say that,
30:11
that Xi Jinping himself has also said that they wanted to choose a select number of,
30:15
of technologies where they would make the rest of the world dependent on China.
30:20
And they have absolutely done that for the purpose of deriving political leverage.
30:25
And they have succeeded in that as well.
30:27
So I'd say on their security goals they've done pretty well.
30:31
There's still obviously several choke points in,
30:34
in the economy where they remain dependent on foreign producers, but
30:38
in some of those sectors like aviation, they have secondary suppliers.
30:42
And so it's not a total concentration on the United States, but
30:45
as we've seen in recent months, they've, they have also developed countermeasures.
30:50
Right? So their dominance
30:51
of things like rare earths and, and even more than the rare earths,
30:54
the higher value added manufacturing of intermediate inputs like magnets and
30:58
motors have really given them leverage over the global economy.
31:02
That has been used fairly effectively to neutralize the US Dominance of
31:06
semiconductors in this case.
31:09
So I would say, I would say that they're, they're pretty confident.
31:13
The other thing that Made in China did was it wasn't just,
31:18
it wasn't just the ambition and the industries that Made in China pioneered.
31:23
It was also the way in which they were willing to work with commercial firms or,
31:29
or private or semi private firms to commercialize technologies.
31:34
Right. So they recognized that it wasn't
31:36
sufficient to have, you know, a state lab or
31:38
a state owned enterprise developed a technology.
31:41
You had to be able to make it at a competitive price and
31:44
it had to be designed for a consumer market.
31:47
And so they used made in China 25 in that period to experiment with
31:53
different approaches to industrial policy where they would help private firms.
32:00
Invest and develop capabilities.
32:03
But they would do it in a way that maximized competition within that
32:07
sector to improve the efficiency of resource allocation,
32:10
but also the quality of products.
32:13
And they would also basically draw out the input
32:15
output tables of an entire sector and make sure that there weren't any choke points.
32:20
Right. So they didn't just go after evs,
32:22
they went after batteries.
32:23
And they didn't just go after batteries, they went after the minerals.
32:26
And they literally had input output tables that could take up your whole wall.
32:30
And they made sure that in every single sector the banks and
32:33
the local governments were, were helping, helping companies along to ensure that
32:39
they could produce at scale and at quality the individual inputs that they needed.
32:44
And most importantly, again, that there were enough of those firms that they
32:49
could compete like crazy to ensure that they didn't just kind of sort of
32:53
extract rents from the sector or perform badly.
32:56
And they look back at this experience and they,
32:58
they recognize that they produced over capacity.
33:00
They over invested in a lot of sectors.
33:03
There's a lot of boom bust cycles where companies do really great work but
33:06
then they can't make any money because the state encouraged too many entrants and
33:11
frankly prevents bad firms from going out of business.
33:14
But by and large they, they think they did a hell of a job.
33:17
And so they know that they need to tweak their toolkit.
33:20
They need to, you know, they, Maybe they wanted 30 EV companies.
33:24
They didn't need 130.
33:26
>> Elizabeth Economy: I think they had over 200 at one point [CROSSTALK].
33:28
So no, it was, it was, yeah, right, but this idea of involution, right,
33:32
I think is a, a big issue now that you're talking about.
33:36
>> Oliver Melton: Yeah, but I think that they
33:37
think they've got the recipe for success.
33:39
They know that, you know, in round two, around three, they're gonna, I think they
33:43
think they're gonna be able to build off their successes and they're gonna be able
33:47
to, they're going to be able to do this more efficiently with less disruption and
33:51
they're going to be able to do it across a much broader range of industries.
33:55
And I'll just say, sorry to go on for so long, but tying into the belt and road,
33:59
you're seeing Chinese firms go global in a way that they hadn't before,
34:03
partly because of slowing domestic growth, partly because of trade frictions, but
34:08
also partly because Chinese firms have reached a level of sophistication and
34:12
product quality that there's real money to be made abroad now.
34:17
And so you're seeing some of the fruits of made in China.
34:19
25 and the, the development model and the success of the technology or
34:23
technology investment starting to spill out into the rest of the world.
34:27
And so I think that going forward for Mick 30 or made in China 35 or belt and
34:32
road 2.0 or whatever we want to call it, one of the things we are seeing already is
34:36
more greenfield investment, more globalization of the Chinese supply chain.
34:41
That will be complicated and can't be dealt with just through tariffs.
34:47
So it's going to be a new challenge.
34:50
>> Elizabeth Economy: There's always a,
34:50
there's always a new challenge when it comes to China.
34:52
Speaking of which, the last of the three China's efforts to,
34:57
let's call it de dollarize the global economy and
35:00
you know, I think most economists here say not going to happen.
35:05
Don't, don't get all worked up about it.
35:09
Nonetheless, you know, China is pretty consistently pushing forward not only
35:13
with, you know, renminbi internationalization, but
35:16
with this whole idea that all countries should be able to use, you know,
35:20
their own currencies, you know, for trade and investment settlements.
35:24
And certainly we've seen, you know, China, you know,
35:27
it's moved down the ladder in terms of, of its holdings of U.S. treasuries.
35:33
So what's your, your take for sort of China's effort in this regard?
35:37
And you know, what, what actually does it think it can accomplish?
35:44
>> Oliver Melton: So I think that it's.
35:46
So I think that actually their primary objective has been and
35:52
is, but especially now, is defensive.
35:56
They want to insulate themselves from sanctions risk.
35:59
And so this is less about, in my mind, this is less about the international
36:04
financial architecture or reserve currencies and things like that, and
36:09
much more about payment systems, right?
36:12
And so we saw them pivot in the last five years towards not just trying
36:17
to get more countries to use the renminbi in trade settlement,
36:22
but to establish the physical infrastructure, in some cases or
36:28
technical infrastructure to settle transactions bilaterally.
36:33
And the primary objective there is not to convince the Argentines or
36:37
the Pakistanis or somebody to hold renminbi.
36:40
It's to convince them.
36:41
It's to set up the architecture to be able to make payments that don't touch
36:45
the United States or even Hong Kong or London.
36:48
So to me, it's the biggest objective at this point is sanctions defense.
36:55
And I think that they've more or less downgraded the ambition
36:58
of trying to convince foreigners to really, to really hold their mmb,
37:02
recognizing that they're not going to, I mean, this is, this is my private view,
37:06
but recognizing that they're not going to open the capital account anytime soon.
37:11
Maybe there had been hope of that five, 10 years ago, but
37:14
absent the liberalization of the capital account, foreigners
37:18
are not going to hold large amounts of Chinese assets or renminbi assets.
37:22
And if you don't have that, you can't truly internationalize currency.
37:25
And so my, my sense is that they've recognized that and they're settling for
37:29
the sort of the core security objective of sanctions insulation,
37:32
and they're going to chip away at that.
37:35
You know, there's a settlement bank in, in the capitals of, of several countries
37:42
that would give them a degree of insulation from sanctions if needed.
37:48
But it's, it's not a perfect defense, obviously.
37:51
>> Elizabeth Economy: Right, I mean, they also have sips, right.
37:53
Their sort of own payment system that they're trying to take global.
37:57
And you know, when I last looked, I think there were about 1100 banks or
38:00
something that had signed up to, which wasn't many.
38:02
Now there are probably many more.
38:04
But what about that is, I mean, that's also, I think,
38:07
a clear sanction proofing measure.
38:10
>> Oliver Melton: Yeah, it's part of it.
38:11
Right. So CIPS is the,
38:12
the settlement information system.
38:15
And then you still need to find a way, you know, at some point you need
38:20
a sort of a hierarchy of correspondent accounts where your company in Moscow or
38:26
in, well, let's just say Moscow for now can, can settle its bills
38:31
with a Chinese bank or a Chinese company through its ICBC account or,
38:36
or through SIPs in ICBC to another, a third bank into, in China.
38:43
>> Elizabeth Economy: So I want to finish up by talking a little bit about
38:46
the US China negotiations that you've, you know, been part of, where you,
38:51
you know, been at the table or at least you've been backbenching them and, and
38:57
get your sense for, you know, what you think each side at this point, what you
39:02
think each side is trying to accomplish in negotiations with the other and then
39:07
a little bit about the negotiating styles that you see and, and how they differ.
39:13
>> Oliver Melton: So I think that the styles are very different.
39:17
Obviously there may have been a time before I was, you know,
39:22
20 years ago, 30 years ago, where, you know,
39:27
Brent Scowcroft would go for long hikes or, and, and
39:31
there was a lot of wine flowing and you might be able to.
39:36
>> Elizabeth Economy: Personal diplomacy.
39:37
>> Oliver Melton: Personal diplomacy.
39:38
Yeah, exactly.
39:39
Or you might, you know, you know, in the, I mean, even not that long ago,
39:41
where you would have the meetings at the table and then you would have the dinner
39:44
conversation and then you would have the conversation in the hallway and
39:47
you had a much better sense of what your interlocutors were thinking.
39:51
China has really clamped down.
39:53
There's much less of that, and so it's much more formal and
39:57
it's difficult for US Diplomats and.
40:00
Some of our folks in our, especially in our foreign policy, so foreign affairs
40:04
side found their conversations with the Chinese pretty frustrating because you
40:09
would get a lot of talking points and not a lot of introspection or
40:13
reflection that, that deviated from what they were supposed to tell you.
40:18
So it's difficult.
40:20
And, and even some of the track two conversations actually are, are.
40:24
I would say that the message discipline on the Chinese side is, is near infinite.
40:29
And so it makes it extremely difficult to have honest exchanges back and
40:35
forth to understand each other.
40:39
But that said, I think, you know, we, on certain issues were able to,
40:44
you know, certain issues, including some really thorny issues that
40:49
could have been fairly escalatory in our time, the last administration
40:54
were able to have pretty effective communication at a kind of a mid level,
40:58
I won't elaborate on that, but they're still very talented and
41:03
very thoughtful people on the Chinese side when they need to be.
41:07
But at the high level, as we sort of present our, our major concerns to
41:11
the Chinese, I think that basically their objective is to buy time.
41:16
You know, they understand that their trade surplus, especially their goods trade
41:19
surplus, is causing trade friction in the United States.
41:22
And frankly with all of their major trade partners, they understand that.
41:26
I don't think they're going to take major decisive action to address that.
41:29
And so their goal is to basically draw out, you know,
41:33
draw us out or to prolong the negotiations.
41:40
So that's, that's a little bit frustrating.
41:42
>> Elizabeth Economy: Yeah. Your boss, though,
41:44
I think your former boss, Janet Yellen, you know,
41:48
seemed to have a bit of respect, I think from the Chinese leadership.
41:54
At least that's the way that I read it.
41:57
A few moments there was a little bit of some rock star status almost.
42:01
What was, what was that like?
42:03
You know, do, am I, am I reading that right or, or.
42:06
>> Oliver Melton: I, I think so.
42:07
I mean, I think it's, you couldn't really invent someone who would be
42:12
more credible than Secretary Yellen.
42:15
She was, she answered almost all of their questions with an academic anecdote and
42:20
then an anecdote from her personal experience, either either as a Chair of
42:25
Council of Economic Advisors, Chair of the Fed, or the Secretary of Treasury.
42:31
Yeah, they, I think that they,
42:32
they genuinely did respect Secretary Yellen quite a bit.
42:35
And it's, it's easy to understand why.
42:37
I mean, you couldn't design somebody who has more credibility either from
42:40
an academic perspective or a policy perspective.
42:43
And they would ask hard questions, right?
42:45
They, they asked questions that were clearly relevant to their own thinking and
42:49
she would answer with an economic explanation and
42:52
Then she would answer with a story from when she confronted a similar problem in,
42:56
in her time in government, either as the Chair of Council of Economic Advisors,
43:00
the Fed Chair or Secretary of Treasury.
43:02
And, and they were all writing it down.
43:04
And I, and I don't think it was just perfunctory.
43:07
So I do think that, I think we made a small amount of headway in explaining
43:12
our understanding or our assessment of the structural tensions and
43:16
the bilateral relationship and the fact that we were on a collision course.
43:22
That wasn't good for us, but it wasn't good for China either.
43:25
And I think that she was credible in saying that she didn't want that, right?
43:29
We don't want China to over invest to the point where it's dependent on external
43:34
demand, causes deindustrialization in third countries, and then there's a trade
43:39
backlash that hurts China but also hurts the rest of the world.
43:43
And so China boosting consumption is in its own interest and
43:46
it's in the US Interest.
43:47
And Secretary Yellen I think was credible in explaining that although it didn't get.
43:52
>> Elizabeth Economy: Them to change their behavior, let's be, let's be honest.
43:55
Right. >> Oliver Melton: It has not yet
43:56
gotten them to change their behavior.
43:57
But I, yeah, yeah, I did think there was one area where some progress was made and
44:04
that was in terms of the debt sustainability and
44:08
working with some of the emerging economies.
44:11
>> Elizabeth Economy: Not, not like gigantic progress, but
44:14
that there were a few steps that the Chinese began to take with some countries.
44:19
Can you share a little bit about that?
44:22
>> Oliver Melton: We tried very hard to raise this issue to the highest levels,
44:26
but to do so in a quiet way that didn't look like the US was trying to
44:31
shame the Chinese and to encourage them to take it seriously and
44:36
to move as quickly as possible.
44:38
And I, I would like to think that our leadership kind of hit the sweet spot of
44:43
that, of putting public pressure on China when it was necessary and helpful, but
44:48
was also able to convey the urgency of this issue to really the top of
44:52
the Chinese government in a way that might not otherwise have happened and would not
44:57
have been as effective if we had just been screaming about it and criticize them.
45:02
So I think that we played a small role in that.
45:07
And, and yeah, so I think that that was effective and,
45:12
but, but, but not fast enough, frankly.
45:16
>> Elizabeth Economy: Right, right.
45:18
Okay.
45:19
So you're out of government now and able to speak freely and, and
45:23
recommend things to people.
45:26
You're watching the trade negotiations going on.
45:29
Right. With USTR Greer and Howard Lutnick,
45:33
Secretary of Commerce and Secretary of Treasury Scott Besant.
45:41
You know, clearly some, some hard fought negotiations underway right now.
45:47
If you had to offer a tip or two to them, what, what might you suggest?
45:58
It could be big recommendations like just pack your bags, go home, give it up.
46:03
Or it can be like,
46:04
here's some ways I think that you could speak more effectively to the Chinese,
46:09
or here's some leverage maybe you haven't thought of or whatever.
46:13
>> Oliver Melton: Yeah, so these are smart guys and they know this.
46:18
But what I would say is that there is no approach to China that can
46:22
convince them to change their development and manufacturing oriented
46:28
growth model that doesn't meet, that doesn't involve the US,
46:33
Japan, Korea and Europe operating in complete lockstep.
46:37
We have to move with our allies or we will fail.
46:41
And this isn't just sort of the knee jerk reaction of a globalist,
46:46
retired globalist, deep stater who believes in partners and allies.
46:51
This is a real, this is math, right?
46:54
We can defend ourselves, we can put up a wall, maybe we can get the Mexicans and
46:58
the Canadians to be inside this wall with us.
47:00
But if we want to incentivize or protect the investment in modern
47:04
infrastructure and modern technology and supply chains outside of China,
47:10
if we want that investment to happen, the combined market that that
47:14
investment feeds into has to be much larger than what we have alone.
47:19
And so if you, as the Chinese move into robotics and biotech and other sectors and
47:25
threaten to do what they did in solar or wind and totally dominate it,
47:30
we need to have German, Japanese and Korean and Indian and
47:34
Brazilian companies that can survive, that can survive that threat.
47:39
And if we don't find a way for those companies to feed into our market and
47:43
Europe's market and Japanese, the Japanese market in a way that accounts for
47:48
China's subsidies and industrial policies, we're going to end up with this small
47:54
little rump of the world that we protect and it just simply won't be effective.
47:59
And so Picking a trade fight with the entire world doesn't
48:03
really work unless you're advancing this goal.
48:06
And I don't,
48:07
I frankly just don't see us moving towards that global response quickly enough.
48:14
>> Elizabeth Economy: Yeah, I think wise, wise words.
48:17
Maybe somebody's listening.
48:19
So I always end with a couple of very quick questions just to get your
48:22
quick take.
48:24
What do you think that now that you're back in the US and you're hearing,
48:28
you know, all about China, you know, from the US Perspective,
48:32
what do you think Americans don't know enough about China that they need to know?
48:41
>> Oliver Melton: You know, I, I would say Americans are afraid of China,
48:46
feel afraid of China right now.
48:50
And I would say that people are, are, are right about the,
48:54
the censorship, the surveillance state, the kind of,
48:58
the state's reach into the economy and society.
49:01
And these things are all quite concerning and alarming,
49:04
including to people who live there.
49:06
But it's important to appreciate that China is also incredibly dynamic.
49:11
It's fun.
49:12
People are smart and clever and creative and subversive with a lowercase S.
49:19
You know, I mean, people have, you know,
49:23
there's a lot of clever sarcasm and, and rebelliousness within a boundary.
49:30
And so it's a really vibrant and exciting and
49:32
fun society to be in, even though all of the negative things or
49:36
many of the negative things that Americans see are also true.
49:40
And so that's that.
49:41
It's not easy to square those two things, but it's, it's true.
49:45
>> Elizabeth Economy: It's a really important point and I think,
49:47
unfortunately, it's one that fewer Americans probably than almost ever before
49:52
are going to experience because so few are actually traveling to China these days,
49:57
whether as students or, you know, as tourists or anything.
50:02
So I think it's a great, a great point is, you know, realize the diversity and
50:09
the sort of just the sheer vibrancy of the people and the culture.
50:16
What about a book or an article that you would recommend to people?
50:20
Any topic related to China?
50:23
>> Oliver Melton: You know, I'm cleaning out or I'm moving back into our house in
50:27
the US and so I've got old books packed up five years ago in my mind.
50:31
And so I wanted to recommend How Asia Works by Joe Stadwall, which is about,
50:37
it's about industrial policy and it's about the fact that know.
50:41
And now that we're all doing industrial policy,
50:44
I think we could use a refresher in what learned over the last 50 years.
50:48
And it's all about how the key to industrial policy is letting bad firms go
50:51
bankrupt, basically.
50:53
And so as we roll up our sleeves and start doing it ourselves.
50:57
We need to figure out how to.
50:59
How to deal with failure better.
51:01
>> Elizabeth Economy: That truly a great recommendation.
51:03
And what about a recommendation for President Trump?
51:05
He gave your recommendation to the negotiators, but what about for
51:09
our president as he tries to navigate, you know,
51:12
one of the most important relationships that the United States has in the world?
51:19
>> Oliver Melton: I would.
51:21
Well, I don't even know anymore.
51:22
But I would say that you have to have.
51:30
You have to have a realistic set of objectives, and
51:32
then you got to work back from there.
51:35
And, you know, whatever you think you want the world to look like in 2030 or 2035,
51:40
you need to figure out the things that you need to get there, and
51:43
then you got to deploy tools and policies that advance those causes, and
51:47
we don't do a lot of that.
51:48
And the other thing I would say, coming from the Treasury Department, is that and
51:53
background in macroeconomics, is that if you would like to have balanced trade,
51:57
you cannot have a massive fiscal deficit.
52:01
Your fiscal deficit is going to cause a trade deficit,
52:03
no matter how high your tariffs are.
52:05
And that fact, ironically,
52:07
was conveyed to us by the communist leadership of China many times.
52:13
>> Elizabeth Economy: Okay, good advice.
52:14
Have a China strategy and have a domestic economic strategy.
52:19
Okay, I'll take both of those points.
52:23
Okay, last question.
52:24
Scale of 1 to 10, how likely do you think it is that assuming
52:28
that President Trump meets with President Xi, you know, as they're kind of
52:33
talking about on the margins of apec, or President Trump actually goes to China,
52:37
how likely do you think it is that you get.
52:40
We get a big, you know, breakthrough, a big Nixon Mao moment,
52:45
scale of 1 to 10, 10 being the most likely.
52:49
>> Oliver Melton: I would put that very low.
52:53
I can imagine a lot of theatrics.
52:54
It's hard for me to imagine any sort
52:59
of strategic alignment that changes our.
53:07
Our policy approach to each other.
53:09
At best, I think you could find a sort of a tactical pause.
53:11
I mean, what we have now, basically, which is a tactical pause that.
53:16
That turns the volume down.
53:18
>> Elizabeth Economy: Yeah, okay, I think, yes,
53:20
most people who've appeared on this podcast are right with you on.
53:25
On that one.
53:26
I think we had one person who said that they.
53:29
They were optimistic that you could get a real breakthrough.
53:33
So, Oliver, let me just say thank you for taking the time to do this with us.
53:40
You've given us a masterclass on the Chinese economy, and I have to say that
53:45
it's a real loss, frankly, to the US Government that you are now back in
53:50
the private sector, or I guess maybe the first time in the private sector,
53:55
given your long sort of time also at State Department beforehand.
54:00
But, but my good friend Dan Rosen is very fortunate to have you, that's for sure.
54:06
He got a real gem.
54:07
So congratulations on the new job and hopefully you'll find your way back into
54:11
government work because you know, our country could use you.
54:16
>> Oliver Melton: Same for you, Liz.
54:16
We were all sad to lose you.
54:18
And maybe, maybe someday we'll serve together.
54:19
Who knows?
54:20
>> Elizabeth Economy: Okay, that.
54:21
That would be great.
54:22
So if you enjoyed this podcast and want to hear more recent discourse and
54:27
debate on China, please subscribe to China Considered on
54:31
the Hoover Institution YouTube channel or the podcast platform of your choice.
54:38
>> Oliver Melton: Thank you so much, Liz.
54:39
>> Elizabeth Economy: Thanks, Oliver.