WEBVTT - Michael Pettis on What Evergrande Means for China’s Macro Economy 0:00:10.760 --> 0:00:14.680 Hello, and welcome to another episode of the Odd Lots podcast. 0:00:14.760 --> 0:00:19.599 I'm Joe Wasn't Thal and I'm Tracy halliway, so, Tracy. 0:00:19.880 --> 0:00:24.599 We've been talking about China a fair amount, obviously on 0:00:24.640 --> 0:00:29.120 the podcast. We did that great episode on Evergrand with 0:00:29.200 --> 0:00:32.040 Travis LUNDI. We've been talking about how some of the 0:00:32.280 --> 0:00:36.360 reforms UM fit in with the broader vision with Isabella Vaber, 0:00:37.400 --> 0:00:41.320 some of the uh tech and other industrial policy changes 0:00:42.320 --> 0:00:44.280 with Dan Long. But it still feels like we haven't 0:00:44.360 --> 0:00:46.839 quite like I guess I would say, put all of 0:00:46.840 --> 0:00:50.880 the macro pieces together. No, I don't think we've connected 0:00:51.080 --> 0:00:55.480 the dots between all of those different developments and UM 0:00:55.480 --> 0:00:59.440 and talked about their actual impact on the economy. And 0:00:59.600 --> 0:01:02.400 I mean, I don't know. To me, the big question 0:01:02.440 --> 0:01:04.959 around all of this UM, you know, what's happening in 0:01:05.000 --> 0:01:07.720 the property market right now with Evergrand, and what's been 0:01:07.760 --> 0:01:11.920 happening with the tech crackdowns and various other crackdowns. To me, 0:01:12.120 --> 0:01:15.560 it's just the timing. You know, why decide to do 0:01:15.640 --> 0:01:19.720 all of this right after a global pandemic when you 0:01:19.760 --> 0:01:25.200 could argue that economic recovery might be relatively fragile. And again, 0:01:25.200 --> 0:01:27.200 like we're sort of seeing the impact in the property 0:01:27.240 --> 0:01:31.280 sector now, right, So China introduce this three red lines 0:01:31.400 --> 0:01:35.840 policy last year in order presumably to strengthen its real 0:01:35.959 --> 0:01:39.320 estate market. Um, and fast forward, you know a year later, 0:01:39.440 --> 0:01:43.720 it seems like that's actually caused quite a lot of tensions. Um. 0:01:43.760 --> 0:01:46.440 So yeah, I don't know. To me, it's it's still 0:01:46.520 --> 0:01:50.680 sort of a mystery. Yeah, And there's some interesting things 0:01:50.680 --> 0:01:54.880 so like even take ever Grand for example, And obviously 0:01:55.000 --> 0:01:58.280 there are the sort of like initial effects like okay, 0:01:58.280 --> 0:01:59.920 who is going to be left holding the bag for 0:02:00.040 --> 0:02:03.160 the losses? And I think that's still TVD right, Like 0:02:03.200 --> 0:02:06.320 we don't really know how these sort of like economic 0:02:06.400 --> 0:02:12.840 losses will be distributed among creditors, among regional finance chiefs, 0:02:12.880 --> 0:02:15.000 among people who may have put down a down payment 0:02:15.040 --> 0:02:17.560 for a home and so forth. And then there's sort 0:02:17.560 --> 0:02:20.040 of like limits of like macro impact. And you read 0:02:20.080 --> 0:02:25.240 these stories about commodities piling up in places where the 0:02:25.639 --> 0:02:30.920 home real estate development is slowing and rebar and other 0:02:31.080 --> 0:02:35.000 assets piling up, and so okay, then there's a commodity spillover, etcetera. 0:02:35.480 --> 0:02:38.160 And you know it's interesting you mentioned like why now 0:02:38.360 --> 0:02:40.200 and of course, coming out of the two thousand and 0:02:40.200 --> 0:02:43.840 eight two thousand nine Great Financial Crisis, China was seen 0:02:43.880 --> 0:02:47.040 as like one of the demand engines of the world 0:02:47.120 --> 0:02:50.600 like these, so much of the demand was coming from China. 0:02:51.560 --> 0:02:54.920 Very different dynamic right now from a sort of global 0:02:55.000 --> 0:02:58.640 spillover standpoint where there is a lot of global demand 0:02:58.880 --> 0:03:03.359 for Chinese goods, but not a huge demand impulse it 0:03:03.400 --> 0:03:07.160 would seem coming from China itself. Yeah, so we kind 0:03:07.160 --> 0:03:09.320 of need to have two conversations. So we need to 0:03:09.400 --> 0:03:12.840 talk about what all these recent developments actually mean for 0:03:13.040 --> 0:03:16.120 China's economy domestically, and then of course we have to 0:03:16.120 --> 0:03:21.680 have even bigger conversation about what those changes actually mean 0:03:21.800 --> 0:03:25.959 for China's role in the global economy. Absolutely, and there's 0:03:26.000 --> 0:03:28.200 one of their twists and all this, which is it's 0:03:28.240 --> 0:03:31.000 there's this global energy crisis right now and natural gas 0:03:31.080 --> 0:03:35.120 prices are surging and China is not escaping that. In 0:03:35.200 --> 0:03:38.040 fact that China energy prices are surging in China and 0:03:38.080 --> 0:03:41.120 the sort of curbs and energy consumption, and that don't 0:03:41.160 --> 0:03:43.400 fully understand how that what's going on, or how that 0:03:43.440 --> 0:03:47.200 plays into it. Anyway, we have the perfect guest, I believe, 0:03:48.080 --> 0:03:51.760 to talk about the domestic impacts than the global ramifications. 0:03:52.000 --> 0:03:54.200 He's been on Odd Lots several times. We had to 0:03:54.240 --> 0:03:56.640 get him back. At this moment, we're going to be speaking, 0:03:56.720 --> 0:04:00.920 of course, to Michael Pettis, finance professor Taking University and 0:04:00.960 --> 0:04:03.280 the scholar at the Carnegie Endowment, and of course the 0:04:03.320 --> 0:04:07.040 co author of the book last year, Trade Wars Are 0:04:07.160 --> 0:04:10.000 Class Wars. Professor Pettis, thank you so much for coming 0:04:10.000 --> 0:04:14.320 back on Odd Lots. My pleasure is old. Well, let's 0:04:14.360 --> 0:04:17.520 just start with I guess this sort of like I guess, 0:04:17.520 --> 0:04:20.679 I would say, the first order effects, and we'll probably 0:04:20.680 --> 0:04:23.719 get into second and third and fourth order effects. But 0:04:23.880 --> 0:04:27.120 you know, the big news obviously, Ever, grand we don't 0:04:27.160 --> 0:04:29.719 really know how that story is going to play out, 0:04:30.040 --> 0:04:32.640 kind of like I said at the beginning, they're going 0:04:32.640 --> 0:04:35.159 to you know, we don't know how the economic losses 0:04:36.040 --> 0:04:40.599 from that implosion will be distributed. But what is your 0:04:40.720 --> 0:04:45.640 view sort of a big picture of what that means 0:04:46.200 --> 0:04:49.480 for the Chinese economy, sort of the most straightforward take 0:04:49.560 --> 0:04:53.640 you have, Well, I'd say two things. The first thing 0:04:53.760 --> 0:04:56.359 is that I think the macro view is the is 0:04:56.440 --> 0:04:59.479 the right way to look at it. Ever, Grand d Ever, 0:04:59.560 --> 0:05:03.080 Grand Da in and of itself is uh, you know, 0:05:03.160 --> 0:05:08.599 pretty important, pretty painful, but it's much more important as 0:05:08.640 --> 0:05:11.599 a as a symptom of what we've been seeing. The 0:05:11.720 --> 0:05:15.960 latest round of defaults in China didn't start with ever Grande. 0:05:16.440 --> 0:05:19.320 You could argue that they started in May two thousand 0:05:19.480 --> 0:05:22.880 nineteen with bao Chang Bank, and since then we've had 0:05:22.920 --> 0:05:26.960 a series of very important defaults that have all been 0:05:27.040 --> 0:05:30.680 resolved by the regulators. Um I wouldn't even say ever 0:05:30.760 --> 0:05:33.800 Grande is the most important. I think Hurong is probably 0:05:33.839 --> 0:05:36.880 the most important, and you could also argue that h 0:05:37.000 --> 0:05:40.280 n A and and perhaps uh ping On in the 0:05:40.360 --> 0:05:44.919 future are also more important in terms of size. But 0:05:45.279 --> 0:05:48.640 what really matters about ever grand is not so much 0:05:48.680 --> 0:05:52.200 ever grand but what the property sector represents for China. 0:05:52.680 --> 0:05:55.159 I'm sure you know all the figures they've been they've 0:05:55.200 --> 0:05:59.880 been much repeated recently, but to go through them, the 0:06:00.040 --> 0:06:06.680 property sector, including upstream, upstream and downstream businesses, comprises between 0:06:06.760 --> 0:06:12.240 twenty five and thirty percent of China's GDP, probably closer 0:06:12.320 --> 0:06:15.919 to thirty than to five, and that's roughly twice what 0:06:16.080 --> 0:06:21.479 you would expect in other countries. Real estate investment is 0:06:21.520 --> 0:06:26.880 about thirteen percent of China's GDP. So that's about one 0:06:27.000 --> 0:06:30.760 third of total investment in China, and as you know, 0:06:30.880 --> 0:06:35.520 investment in China is extraordinarily high. It's roughly of g 0:06:35.640 --> 0:06:39.960 d P. In other countries, real estate investment is a 0:06:40.080 --> 0:06:43.000 much lower share. I think in the US it's roughly 0:06:43.120 --> 0:06:46.400 five So when you look at the direct impact of 0:06:46.400 --> 0:06:50.640 a slowdown in the property sector, the numbers are pretty scary. 0:06:50.680 --> 0:06:54.880 They're they're quite large. They represent a very significant part 0:06:54.880 --> 0:06:58.320 of the Chinese economy, and they represent perhaps thirty to 0:06:58.400 --> 0:07:02.680 forty pcent of growth and years. But there's another thing 0:07:02.760 --> 0:07:05.520 that matters a great deal, which may even matter more 0:07:06.000 --> 0:07:10.640 will see, and that is when you look at household wealth. 0:07:11.480 --> 0:07:17.760 Holmes homeownership represents roughly eighty percent of household wealth in China, 0:07:18.640 --> 0:07:20.960 and I've been trying to look at other numbers. This 0:07:21.080 --> 0:07:24.400 is more than twice what it represents in most other countries. 0:07:25.000 --> 0:07:28.520 But I was looking at Japan during the during the 0:07:28.560 --> 0:07:32.480 bubble of the of the late nineties, and there it 0:07:32.600 --> 0:07:37.960 represented I believe roughly sixty of household wealth, which at 0:07:37.960 --> 0:07:41.240 the time was considered a really high number. In China, 0:07:41.320 --> 0:07:44.200 of course, it's much higher than that. And the reason 0:07:44.240 --> 0:07:46.720 that matters, of course, is that if you start to 0:07:46.760 --> 0:07:52.160 see a decline in the price of homes um that 0:07:52.240 --> 0:07:56.960 will very significantly impact household wealth, which in turn should 0:07:57.080 --> 0:08:03.320 significantly impact household consumption. Is things. Yeah, I remember one 0:08:03.360 --> 0:08:07.200 of our previous guests, Travis Lundie, also mentioned that Japan 0:08:07.360 --> 0:08:11.600 bubble comparison. But okay, so here's my one big question 0:08:12.120 --> 0:08:16.520 about what's going on with China property and with ever grants. 0:08:16.560 --> 0:08:19.400 So a lot of people are talking about some of 0:08:19.400 --> 0:08:22.800 the current stresses being caused by the three Red Lines 0:08:22.880 --> 0:08:26.920 program that China introduced last year, where it was trying 0:08:26.920 --> 0:08:30.160 to encourage a lot of real estate developers to delever 0:08:30.280 --> 0:08:34.559 their balance sheets and not to cross um certain thresholds 0:08:34.600 --> 0:08:37.720 for borrowing. I guess, on the one hand, it makes 0:08:37.760 --> 0:08:40.800 some sense for China to try to shore up and 0:08:40.920 --> 0:08:44.800 de leverage its real estate sector because, as everyone knows, 0:08:44.880 --> 0:08:48.400 it is quite heavily indebted. It is very very financialized. 0:08:48.720 --> 0:08:52.520 But on the other hand, given real estates importance in 0:08:52.600 --> 0:08:56.480 the economy, which you, of course just described, it seems 0:08:56.559 --> 0:09:00.960 like a risky proposition to start ring fencing it at 0:09:01.000 --> 0:09:05.040 an economically sensitive time. So I guess my question is 0:09:05.400 --> 0:09:10.200 why did the authorities decide to do it. And then secondly, 0:09:10.960 --> 0:09:14.080 what impact do you think that program has had on 0:09:14.160 --> 0:09:19.400 the property sector overall. It's difficult to figure out why 0:09:19.480 --> 0:09:23.679 the timing, but but I'm not even sure that that matters. 0:09:23.720 --> 0:09:27.720 What I would argue is that the three red lines 0:09:28.240 --> 0:09:33.200 which were announced last year are sort of the trigger 0:09:33.480 --> 0:09:36.680 for ever Grands problems, but they're not really the cause 0:09:36.720 --> 0:09:40.120 of the problems. You know, We've discussed this many times 0:09:40.200 --> 0:09:43.679 before over the past several years, and and the problem 0:09:43.679 --> 0:09:48.439 in China was that you have two types of growth 0:09:48.440 --> 0:09:51.640 in China. You have what Beijing has been calling high 0:09:51.720 --> 0:09:56.920 quality growth, which is really consumption exports and business investment 0:09:57.400 --> 0:10:01.199 oriented towards consumption and exports. That's what I would call 0:10:01.320 --> 0:10:05.640 the sustainable growth, the real underlying growth in the economy. 0:10:05.720 --> 0:10:08.920 And then you have what I would call residual growth, 0:10:08.960 --> 0:10:13.440 which is really investment in the property sector and local 0:10:13.480 --> 0:10:17.920 government spending on infrastructure. And the purpose of that residual 0:10:18.760 --> 0:10:23.520 is to bridge the gap between the real underlying growth 0:10:23.559 --> 0:10:27.160 in China and whatever the GDP growth target is, which 0:10:27.160 --> 0:10:30.200 has always been much higher, in my opinion, at least 0:10:30.280 --> 0:10:33.920 twice the real underlying growth. And I would say that 0:10:34.000 --> 0:10:37.520 at this point, even Shi Jin Ping, the President is 0:10:37.559 --> 0:10:41.200 starting to think this way. In a very important essay 0:10:41.760 --> 0:10:46.040 that he published in July on the New Development Model, 0:10:46.520 --> 0:10:51.960 he talked about the difference between genuine growth and fictional growth, 0:10:52.000 --> 0:10:55.880 and he said, not surprisingly, we need more genuine growth 0:10:55.920 --> 0:10:59.280 and less fictional growth. So what's the problem with the 0:10:59.320 --> 0:11:03.080 fictional grow? Well, when you're when you're borrowing money to 0:11:03.280 --> 0:11:08.679 invest in nonproductive investment than by definition, your debt servicing 0:11:08.880 --> 0:11:12.400 needs your debt, your debt is going to rise faster 0:11:12.520 --> 0:11:15.720 than your debt servicing capacity. And this has been the 0:11:15.760 --> 0:11:18.920 problem in China for well over a decade. And so 0:11:19.040 --> 0:11:22.479 as debt rose, in fact, the growth in debt accelerated 0:11:22.480 --> 0:11:26.600 in the growth and GDP decelerated, That created more and 0:11:26.679 --> 0:11:28.840 more of a debt problem for China, and it was 0:11:28.880 --> 0:11:33.080 just a question of time before Beijing decided to step in. 0:11:33.679 --> 0:11:37.480 They postponed it for a very, very long time, because 0:11:37.559 --> 0:11:40.559 the costs of not stepping in are in the future, 0:11:41.160 --> 0:11:43.600 and the costs of stepping in are in the presence. 0:11:43.640 --> 0:11:46.760 So it's always been easy to postpone the problem and 0:11:46.840 --> 0:11:50.120 hope that something develops. But of course the longer you 0:11:50.240 --> 0:11:53.520 postpone it, you know the costs of both rise, but 0:11:53.679 --> 0:11:56.920 the costs of not intervening rise faster than the costs 0:11:56.960 --> 0:12:01.000 of intervening, and at some point um they were going 0:12:01.040 --> 0:12:03.920 to step in and try to constrain the growth in UM, 0:12:03.960 --> 0:12:07.600 in in in local government debt, and in the property sector. 0:12:08.000 --> 0:12:11.920 And they focus mostly on the property sector. UM So 0:12:11.960 --> 0:12:14.200 if this didn't happen this year, it would have happened 0:12:14.320 --> 0:12:17.240 next year, or could have happened last year. I think 0:12:17.280 --> 0:12:22.240 the timing is less important then the mechanics that that 0:12:22.240 --> 0:12:27.120 that required that eventually that would happen. It definitely sounds 0:12:27.200 --> 0:12:29.520 like she J and Pag has been reading the Michael 0:12:29.520 --> 0:12:33.599 Petter's blog, because of course you've been talking for years 0:12:33.720 --> 0:12:37.440 about this idea of g d P in China, I guess, 0:12:37.800 --> 0:12:41.320 meaning something different than GDP elsewhere. And so where is 0:12:41.559 --> 0:12:45.400 in say the US or elsewhere GDP is like you 0:12:45.440 --> 0:12:49.120 add up everyone's income. In China, they start with the 0:12:49.200 --> 0:12:52.880 GDP target, it would seem, and then they work towards 0:12:52.960 --> 0:12:55.640 them and they figure out how either through high quality 0:12:55.679 --> 0:12:59.520 growth or sort of like manufactured credit driven growth. There's 0:12:59.559 --> 0:13:01.959 a lot of things to unpeel there, and I want 0:13:01.960 --> 0:13:04.240 to get into the sort of life the prospects for 0:13:04.280 --> 0:13:07.400 the high quality growth. But one thing that came up 0:13:07.440 --> 0:13:11.440 in our episode with Travis Lundy and you mentioned it 0:13:11.480 --> 0:13:13.560 just now, I want to hit on it. Um. You know, 0:13:13.679 --> 0:13:19.120 the importance of real estate sales or the selling of 0:13:19.320 --> 0:13:24.840 land specifically for regional government revenue. And you mentioned regional 0:13:24.920 --> 0:13:27.760 government debt. And so if the property developers have to 0:13:27.800 --> 0:13:30.840 pull back and they start buying less land from the 0:13:30.880 --> 0:13:34.240 regional government, can you talk to us about the knock 0:13:34.280 --> 0:13:38.000 on effects and the structure of regional government finance in 0:13:38.120 --> 0:13:41.360 China and what that means if we do get for them, 0:13:41.720 --> 0:13:44.120 for those regional governments, if we do get this pull back, 0:13:44.160 --> 0:13:47.480 and is there some other structure of regional finance that 0:13:47.559 --> 0:13:51.199 may emerge in its wake. That's a very important and 0:13:51.320 --> 0:13:55.960 very interesting and also very complicated U point. What I 0:13:56.000 --> 0:13:59.679 would argue is that in a way, it was the 0:13:59.800 --> 0:14:03.240 way this thing had to develop. Let me let me 0:14:03.320 --> 0:14:05.640 digress a bit and talk a little bit about common 0:14:05.679 --> 0:14:09.160 prosperity is you know, that's the new buzz phrase, um 0:14:09.280 --> 0:14:13.440 that everybody uses, everybody invokes to explain everything. The way 0:14:13.559 --> 0:14:19.400 common prosperity works is that Beijing has decided that in 0:14:19.520 --> 0:14:25.359 order to resolve the over the over dependence on nonproductive investment. 0:14:25.800 --> 0:14:29.200 They have to increase the consumption share of GDP, and 0:14:29.240 --> 0:14:31.600 we've known this for many years. The first time they 0:14:31.640 --> 0:14:34.920 said this formally in public was way back in two 0:14:34.960 --> 0:14:38.200 thousand seven, but they've never been able to do it 0:14:38.720 --> 0:14:42.480 the way Common Prosperity seems to be working. As they're saying, 0:14:43.080 --> 0:14:46.720 the problem is that there is a very uneven distribution 0:14:46.800 --> 0:14:51.280 of income among Chinese households. The rich have too large 0:14:51.320 --> 0:14:55.120 a share, and the ordinary and poor have too low 0:14:55.160 --> 0:14:59.240 a share, and that's why consumption in China is so weak. 0:14:59.720 --> 0:15:02.320 So here is what we're going to do. We're going 0:15:02.360 --> 0:15:08.000 to implement policies that transfer income or transfer wealth from 0:15:08.120 --> 0:15:12.160 the rich and perhaps from businesses to the extent that 0:15:12.240 --> 0:15:17.640 businesses have quote unquote excess profits back to ordinary Chinese 0:15:18.080 --> 0:15:23.120 and that will boost consumption in China. Now that's technically true, 0:15:23.160 --> 0:15:27.200 but there's two big problems with it. The first problem 0:15:27.440 --> 0:15:31.200 is their concept of this gets a bit technical, but 0:15:31.400 --> 0:15:37.280 tertiary distribution in Chinese jargon, there are three forms of distribution. 0:15:37.800 --> 0:15:42.280 There is primary distribution, which is wages, salaries, income on 0:15:42.360 --> 0:15:47.040 your on your savings, et cetera. Distribution of income to households. 0:15:47.080 --> 0:15:53.120 So primary is wages and salaries. Secondary or redistribution are 0:15:53.560 --> 0:15:57.400 is fiscal transfers. And then they have this third thing 0:15:57.480 --> 0:16:00.840 which most of us would have never considered, which they 0:16:00.880 --> 0:16:05.360 call tertiary distribution, which consists of donations from the rich 0:16:05.480 --> 0:16:09.920 to the poor. So common prosperity relies a little bit 0:16:10.000 --> 0:16:14.800 on secondary distribution on fiscal transfers, but it relies primarily 0:16:14.840 --> 0:16:20.280 on tertiary distribution donations. So why is that well, I 0:16:20.320 --> 0:16:23.240 would argue that this was in a in a sense, 0:16:23.320 --> 0:16:28.200 the problem with the dual Circulation program. The dual Circulation program, 0:16:28.280 --> 0:16:32.720 which was introduced last year, argued that that China would 0:16:32.760 --> 0:16:36.160 use its strength in exports and its strength and consumption 0:16:36.840 --> 0:16:40.880 and growing consumption to reinforce each other and to drive 0:16:41.000 --> 0:16:45.320 manufacturing in China into the future. The problem with dual 0:16:45.400 --> 0:16:50.680 circulation is that China's exports strength and its large current 0:16:50.680 --> 0:16:55.480 account surplus. Large trade surplus is caused mainly, as it 0:16:55.520 --> 0:16:59.560 is in every country with large surpluses Japan, Germany, South Korea, etcetera. 0:17:00.080 --> 0:17:05.040 It's caused mainly by the relatively low wage share UH 0:17:06.200 --> 0:17:11.080 relative to productivity. So you're good in exports because your 0:17:11.160 --> 0:17:14.760 wages are low relative to productivity. But of course, as 0:17:14.800 --> 0:17:18.760 you know, that's exactly why consumption is so low. So 0:17:18.880 --> 0:17:22.040 the idea that you could solve both problems was always 0:17:22.080 --> 0:17:25.360 pretty complicated. If you want to solve if you want 0:17:25.359 --> 0:17:28.680 to increase exports, you have to keep wages low relative 0:17:28.720 --> 0:17:32.359 to productivity. If you want to boost domestic consumption, you 0:17:32.400 --> 0:17:36.000 have to raise wages relative to productivity. So how do 0:17:36.080 --> 0:17:39.760 you do that? Well, in a sense, Common Prosperity is 0:17:39.800 --> 0:17:44.359 an attempt to address that, because rather than way raise wages, 0:17:44.560 --> 0:17:49.480 which would undermine export competitiveness, you do so by forcing 0:17:49.520 --> 0:17:52.480 the rich to redistribute income to the poor in the 0:17:52.560 --> 0:17:57.640 form of donations. Now will that work there? There, As 0:17:57.680 --> 0:18:00.600 I said, two problems with it. The first problem is 0:18:00.640 --> 0:18:04.320 that donations are a tiny part of the economy. My 0:18:04.480 --> 0:18:10.719 calculation was that donations represented about three tenths I'm sorry, 0:18:10.760 --> 0:18:14.800 three hundreds of one percent of GDP. So let's say 0:18:14.840 --> 0:18:18.520 that China is able to multiply donations by ten, which 0:18:18.560 --> 0:18:21.680 I think is going to be quite difficult. That's less 0:18:21.720 --> 0:18:24.200 than one third of one percent of g d P. 0:18:24.960 --> 0:18:28.639 And while that helps at the margin, they need to 0:18:28.800 --> 0:18:32.159 redistribute two to three percentage points of of of g 0:18:32.320 --> 0:18:36.600 d P every year to really resolve that problem. So 0:18:36.640 --> 0:18:40.680 that's the first problem with Common Prosperity. The second problem 0:18:40.760 --> 0:18:45.160 with Common Prosperity is that they're trying to solve the 0:18:45.240 --> 0:18:50.360 American problem in China or the European problem in China. 0:18:50.480 --> 0:18:53.240 And by that I mean, if you think that there 0:18:53.359 --> 0:18:57.520 is a bad distortion in the way income is distributed 0:18:57.560 --> 0:19:00.160 in the US, and I think there is an I'm 0:19:00.200 --> 0:19:03.879 sure you agree, then the place you resolve that is 0:19:03.960 --> 0:19:08.840 within the household income share of GDP, which comprises roughly 0:19:09.760 --> 0:19:12.320 of the U S g d P. So if you 0:19:12.359 --> 0:19:16.160 can redistribute income from rich to poor, then you are 0:19:16.440 --> 0:19:20.800 significantly resolving the income distribution problem in the United States. 0:19:21.400 --> 0:19:25.159 But in China, household income is only fifty of g 0:19:25.280 --> 0:19:29.760 d P. The real distortion is the very high government 0:19:29.880 --> 0:19:34.119 share of g d P, which is perhaps twenty percentage 0:19:34.119 --> 0:19:36.959 points in the US and in Europe as much closer 0:19:37.000 --> 0:19:40.560 to zero, could even be negative. So what I would 0:19:40.640 --> 0:19:44.920 argue is that Common Prosperity solves the wrong problem. There 0:19:45.040 --> 0:19:50.040 is certainly huge income inequality within China, but the real 0:19:50.200 --> 0:19:54.439 distortion and distribution is the very high share government retains 0:19:54.960 --> 0:19:57.600 of g d P. So if you want to solve 0:19:57.640 --> 0:20:01.000 that problem, what you really have to do is transfer 0:20:01.160 --> 0:20:06.359 income from local governments to the household sector. Now, you 0:20:06.480 --> 0:20:09.960 asked about the impact of property on local government revenues, 0:20:09.960 --> 0:20:12.879 and as you know, it's a really important part of 0:20:12.920 --> 0:20:17.359 local government revenues between forty and six for you know, 0:20:17.440 --> 0:20:23.560 depending on which local government. So perhaps by by undermining 0:20:23.600 --> 0:20:28.320 the property sector, this is also part of this process 0:20:28.359 --> 0:20:33.800 of reducing the the income share local governments retain of 0:20:33.880 --> 0:20:37.399 g d P and and presumably passing it onto the 0:20:37.440 --> 0:20:41.600 household sector. So theoretically it makes sense, but you know, 0:20:42.119 --> 0:20:46.719 the obvious the obvious concern is that that's a really 0:20:46.760 --> 0:20:50.840 difficult process to manage and that has huge political implications. 0:20:51.240 --> 0:21:12.239 So we'll see how those political implications evolved. You know. 0:21:12.560 --> 0:21:16.159 The one theme that emerges from this discussion is the 0:21:16.200 --> 0:21:18.880 idea of adjustment or trade off. You know, you try 0:21:18.920 --> 0:21:21.840 to resolve or adjust the economy now in order to 0:21:22.200 --> 0:21:26.240 avoid bigger problems later on. But of course that kind 0:21:26.280 --> 0:21:30.400 of change ends up being um probably painful and at 0:21:30.400 --> 0:21:35.600 the very least uncomfortable. So what can China actually do? 0:21:35.880 --> 0:21:39.520 What can the authorities do to try to ease the 0:21:39.600 --> 0:21:44.920 adjustment process and avoid stirring up you know, a lot 0:21:44.920 --> 0:21:48.960 of public anger. You mentioned how much household wealth is 0:21:48.960 --> 0:21:51.240 actually tied to property, and of course we have seen 0:21:51.440 --> 0:21:56.520 some protests over losses tied to China ever grand from individuals. 0:21:56.960 --> 0:22:00.760 So what can China do to sort of manage process? 0:22:02.160 --> 0:22:07.080 You know, Tracy the Unfortunately, I think there is there 0:22:07.160 --> 0:22:10.639 is no way to manage it. Well. The options are 0:22:10.880 --> 0:22:14.480 between bad and and and worse. You know, this is 0:22:14.480 --> 0:22:16.679 what I've been arguing for many years. The longer you 0:22:16.760 --> 0:22:19.679 postpone it, the more difficulty adjustment is going to be. 0:22:20.600 --> 0:22:23.080 And the way I think about it sort of helps 0:22:23.119 --> 0:22:25.640 me think about it is, you know, you look at 0:22:25.640 --> 0:22:29.240 the existing growth model, and you look at the various 0:22:29.280 --> 0:22:32.960 alternatives you have to resolving this growth model. So right now, 0:22:33.000 --> 0:22:35.920 as you know, China has a growth model in which 0:22:35.960 --> 0:22:40.040 you're able to maintain high GDP growth rates only because 0:22:40.080 --> 0:22:43.919 of this explosive growth in debt. So what can China do? 0:22:44.400 --> 0:22:48.680 There are literally five paths it can take. One path 0:22:48.840 --> 0:22:52.040 is to do nothing and continue with this growth model. 0:22:52.520 --> 0:22:56.199 If you have infinite debt capacity, then that works. But 0:22:56.280 --> 0:22:58.639 I think most of us agree that you don't, and 0:22:58.680 --> 0:23:02.720 in fact, Beijing, uh seems to believe very strongly that 0:23:02.800 --> 0:23:05.840 you don't. So what else can you do? Well, you 0:23:05.880 --> 0:23:09.560 can bring down all of this nonproductive investment. You have 0:23:09.720 --> 0:23:13.320 to if you want to stop the growth in debt. 0:23:14.359 --> 0:23:18.960 So what happens if you bring down nonproductive investment, Well, 0:23:19.280 --> 0:23:22.280 perhaps you can replace it with another source of demands. 0:23:22.359 --> 0:23:26.600 So one source of demand could be productive investment. So 0:23:26.760 --> 0:23:29.560 switch out of you know, don't build bridges to nowhere 0:23:29.600 --> 0:23:33.160 and don't build empty apartment buildings and use that money 0:23:33.200 --> 0:23:37.480 to develop the high tech sector and productive sectors in 0:23:37.520 --> 0:23:41.439 the economy. That's much easier said than then. They've been 0:23:41.440 --> 0:23:44.399 talking about this for years and years, and later on, 0:23:44.440 --> 0:23:46.680 if you like, we can go into why. It's going 0:23:46.720 --> 0:23:50.680 to be very difficult, but at least that's one possible path. 0:23:51.200 --> 0:23:55.119 Another possible path as you bring a nonproductive investment down 0:23:55.680 --> 0:24:00.080 is to increase the trade surplus. But of course, you know, 0:24:00.119 --> 0:24:02.720 if we were talking about Singapore, that would be viable, 0:24:03.119 --> 0:24:06.640 but for a big economy like China, that's not viable. 0:24:06.960 --> 0:24:09.199 The trade surplus would have to grow by two to 0:24:09.359 --> 0:24:14.479 three percentage points of China's GDP every year for that 0:24:14.560 --> 0:24:17.000 to be the way out, and clearly the world can't 0:24:17.000 --> 0:24:21.439 absorb that. A third way is to bring down nonproductive 0:24:21.440 --> 0:24:27.320 investment and to increase consumption, and that requires really significant 0:24:27.400 --> 0:24:33.320 income transfers, primarily from the local government sector. And then finally, 0:24:33.720 --> 0:24:37.240 the only other path China can take is to bring 0:24:37.280 --> 0:24:41.120 down nonproductive investment and not replace it with other sources 0:24:41.160 --> 0:24:45.399 of growth, in which case GDP growth drops substantially. I 0:24:45.440 --> 0:24:50.080 would argue probably to below two to three. But that's 0:24:50.280 --> 0:24:53.840 literally it. There are no other options. And when you 0:24:53.880 --> 0:24:56.520 think about it that way, it's very hard to figure 0:24:56.560 --> 0:24:59.840 out what is a good way, what is a good 0:25:00.080 --> 0:25:04.080 ustment process. They're all going to be quite difficult. That 0:25:04.080 --> 0:25:07.359 that's very well laid out and striking of what you 0:25:07.680 --> 0:25:10.679 characterize the sort of I guess the true rate of 0:25:10.720 --> 0:25:14.480 growth when you stirp about the non nonproductive investment spending. 0:25:15.119 --> 0:25:17.920 You know, obviously, and we've talked about this with Dan 0:25:18.040 --> 0:25:22.760 Wong and some of China's industrial or tech ambitions, and 0:25:22.800 --> 0:25:25.000 we used to talk about it with the brad sets 0:25:25.000 --> 0:25:27.560 Are a lot before he joined the administration, and so 0:25:27.640 --> 0:25:31.840 now we can't talk to him anymore. But obviously, like one, 0:25:32.280 --> 0:25:35.720 you know, one path is just the economy becomes much 0:25:35.720 --> 0:25:38.479 more productive and you get much more high quality growth 0:25:38.480 --> 0:25:43.000 than China becomes a bigger leader in you know, wide 0:25:43.000 --> 0:25:47.359 body airplanes and micro chips and pharmaceuticals and all kinds 0:25:47.359 --> 0:25:50.040 of things like that, and theoretically that helps balance the 0:25:50.080 --> 0:25:55.680 economy towards something more productive. That's a long term project, though, 0:25:55.720 --> 0:25:58.560 So even if that's the type of thing that it's like, Okay, 0:25:58.600 --> 0:26:01.919 that's the path, and obviously that can't happen overnight or 0:26:01.920 --> 0:26:04.440 even next year or maybe even over the next uh 0:26:04.480 --> 0:26:08.399 ten years. How much, though, do you sense or do 0:26:08.400 --> 0:26:12.080 you believe that Beijing is sort of like betting on 0:26:12.160 --> 0:26:15.119 that path that ultimately that it can sort of do 0:26:15.240 --> 0:26:18.520 some sort of substitution from the more speculative growth to 0:26:18.600 --> 0:26:22.119 the more high quality growth in some reasonable time framet. 0:26:22.800 --> 0:26:25.520 It depends on you know, which part of Beijing you're 0:26:25.560 --> 0:26:29.879 talking about. I think the local government politico's, the foreign 0:26:29.880 --> 0:26:33.800 affairs people, the military people, the non the non economists 0:26:34.320 --> 0:26:37.840