China's Economic Forecast: The View from Congress

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This transcript is from a CSIS event hosted on November 28, 2023. Watch the full video here.

John J. Hamre: Good afternoon, everybody. My name is John Hamre. I’m the president here at CSIS and I want to say a hearty welcome to all of you who are in the room. We have – I always say every meeting now we have physicals and virtuals. We’ve got physicals in the room, and that’s a very important audience to give our speakers the kind of feedback that they need. But we’ve got this huge virtual audience that’s also going to be watching, and they need to have your enlivenment here to make these speakers really come to life. So thank you all for being here today, and this is a real privilege.

I was very surprised to learn about this initiative that Chairman Turner has created. He calls it Beyond the SCIF. And I think it’s an absolutely fabulous thing because, you know, every other committee in the Congress establishes its legitimacy and its credibility with the American public because they do things in open. They do open hearings. Their markups frequently are open. They go to the floor and it’s open. It’s been very hard for the Intelligence Committees because, you know, their work naturally has to be done in confidence. But it’s hard for them to establish – they are our representatives, acting on our behalf on some of the most important matters of state, and yet they can’t talk about it as much.

And so this initiative that you’ve begun, Chairman, is really astoundingly important. And it’s – I know that it’s a matter of getting some exposure to new ideas. But it’s really building the legitimacy of the committees. And I really commend you for it, Chairman. It’s really been astounding.

You know, the chairman has been active – of course, he’s been – I think six years you’ve been chairman. Well, you were on the committee for that, but he’s recently become the chairman. And it’s been a strong leadership. He’s dedicated his entire time in the Congress to national security. And it has been that leadership that we’ve seen in many different ways, many different times. And I’m very grateful for that.

I should just say a word, that we also have French Hill. Congressman French Hill is with us. He’s vice chairman of the House Financial Services Committee, but he’s on the Permanent Subcommittee for Intelligence. And so it’s his role here today – he’s bringing these two things together to explore a very important question. Where is China’s economy really heading? What does it mean? How do we understand it? How credible is it?

And this is going to be a very important conversation for the American public. And again, it’s emblematic of the leadership that Chairman Turner has given to the Congress and to the country by creating this series, and, of course, his stewardship of the committee. He comes from – he represents the 10th district of Ohio, in the Dayton area. He was mayor of Dayton for eight years. And as I said, he’s been in national security his entire time that he’s been in the Congress.

So would you please, with your very warm applause, welcome to the stage the honorable Mike Turner. (Applause.)

Representative Mike Turner (R-OH): Well, thank you, Dr. Hamre. I appreciate you hosting us today, and I appreciate CSIS and what they do and what a great resource they are for decision-makers in national security and in policy.

This Beyond the SCIF, as you were just saying, Dr. Hamre, is very important to our committee. When I was chosen to be chair, we were given three tasks. One was to return the Intelligence Committee to national security. Now, you’d think that that wouldn’t be an assignment that you’d have to get. But unfortunately, as you all know from the history of what occurred in the committee, we needed to reenergize our focus and to get the committee working together on the issue of national security. Even though our members had never lost their focus on national security as a committee, we had lost our focus.

Secondly was to get the committee working together on a bipartisan basis. And I want to thank my ranking member, Jim Himes. I think we’ve been able to accomplish that. On all levels our members are working together on a bipartisan basis. And, of course, that’s important to do because our adversaries have no partisan issues before us. So being able to work together helps us to contribute overall to our nation’s security.

And the third thing was to open up the committee, open it up to Congress, make certain it’s a resource that members, that chairmen and ranking members who have portfolios can come to the Intelligence Committee and receive intelligence as necessary for their policymaking decisions, and also then to open it up more to the think-tank community, the academic community, to make certain that we’re reaching out so that we have actionable information to be able to formulate our strategic plan, to be able to work together, and then also to inform of the work that we’re doing.

You know, as Dr. Hamre was saying, so many times we work in a classified session so that – down in our SCIF, our classified components, and no one gets to hear or see the work that we’re doing. But here we get to engage directly with policymakers and those that contribute to the academic world so that we can take that information with us back into the work that we’re doing.

This is the first Beyond the SCIF for this season. And we try to do them at the end of the year, where we’re formulating our strategic plan for the next year, but also we’re looking retrospectively at the work that we’ve done.

French Hill is graciously hosting this first one. And I appreciate, French, that you are doing that. He has studied economics in Vanderbilt. He served on the Economic Policy Council with George H.W. Bush. He was the deputy assistant secretary of treasury under George Herbert Walker Bush. And, of course, as Dr. Hamre said, he’s vice chair of the Financial Services Committee.

What’s exciting about our committee is that each member that comes with a different perspective contributes to our ability to take intelligence and focus on the national security area. French Hill’s financial services, or his economics background, really allows us to dig deep on some of the issues that we might not otherwise be able to. And I know that’s part of his effort today, and I greatly appreciate it. And I want to introduce and turn it over to French Hill. French, thank you. (Applause.)

Representative French Hill (R-AR): Well, Mike, thanks so much for commencing this series. I think it’s a very important role of the House Intelligence Committee to open it up. And thank you for your leadership of the committee. And I’m proud to be introducing this first panel of the Beyond the SCIF series for this Congress. I want to thank CSIS for being our host and grateful for their generosity.

We gather in the immediate aftermath of the Biden-Xi bilateral, where the economic outlook for both nations were top of mind. I look forward to an informed conversation today with the panelists on the important discussion about the Chinese economic outlook and forecasting. Since the CCP leader Xi’s last decade of asserting his goal of Chinese communist dominance, economically, militarily, diplomatically, conversations like this are crucial as we assess their aspirational and realized influence and work with like-minded partners and allies on a right-sized response.

Today, we’re joined by experts Jude Blanchette and Logan Wright, to dive into this critical topic. Jude is the CSIS Freeman chair in China studies. He previously served in Beijing, on the Center for Economics and Business board, and as assistant director of the 21st Century China Center at the University of California, San Diego. His expertise on the Chinese Communist Party and its engagements with foreign companies and investors will provide valuable insight.

Logan Wright is a partner at the Rhodium Group and is their lead China markets research analyst. He’s also senior associate of the Trustee Chair in Chinese Business and Economics here at CSIS. Prior to his current position, Logan was head of China research for the Medley Global Advisors and a China analysts with Stone & McCarthy research in Beijing. I look forward to hearing more about this work on the important credit expansion on the Chinese financial system and how that influences China’s position in the global currency and capital markets.

During our discussion today, we will debate tough questions about Chinese economic forecasting. Our panelists will attempt to pull back the bamboo curtain and address projections of Chinese economic growth, factors that affect it, and events that could alter or change those current projections. Over the past few months, sentiment in China’s economy has grown increasingly negative. Notably regarding the level of debt, the lack of a social safety net, over-investment in real estate and housing, growing unemployment, increasing signs of de-risking of supply chains, and let’s not leave out disappearing entrepreneurs and the crushing death of one country, two systems, China and Hong Kong.

At the same time, we see projections from the International Monetary Fund that have an increasingly positive outlook for Chinese economic growth. I look forward to hearing our panelists’ opinions on these two divergent positions on China’s outlook. I’d like to open our conversation today and ask both of them to talk about the Xi-Biden visit last week. And let me phrase it this way. President Xi was quick to say that the American export controls, and investment screening, and sanctions that that America has imposed, he says, quote, “Severely harm China’s legitimate interests.” But many, I think, here in the United States would argue that 30 years of intellectual property theft and a whole varied of China’s own export controls and economic intelligence gathering and infiltration in technology probably have hurt our legitimate economic thoughts.

So what were your takeaways? Let’s start with you. What were your takeaways from the Xi-Biden meeting last week?

Logan Wright: Sure. Thanks, Congressman. And thanks to everyone for attending, both in person and online. Appreciate the opportunity.

You know, what I was struck by in all of the media coverage was just how much China’s structural slowdown was a key part of the narrative going into the meeting itself; that, you know, virtually every single story that was discussing the summit was talking about how Xi was entering from a position in which he had to defend China’s economic record. And we haven’t seen that before. And it’s, ironically, belied by China’s own growth statistics, which still say that China was going to be on track for achieving their targeted growth rates. I don’t think that’s the case that’s happened over the course of this year, but it just shows how much the actual conversation, I think, has changed around China’s economy in general.

Speaking to the investment restrictions that are in place, I mean, I think it’s an important precedent that the administration has set with the outbound investment restrictions to say that foreign direct investment and controls on foreign direct investment imply a certain degree of technical knowhow and involvement that – in advanced technologies that are going to define sort of the force-multiplying technologies of the future, that there are good reasons to be cautious about that. But there’s a broader story that sort of underlies that that I think is – and is also present at the meeting – which is that we all assumed over the last decade and a half that China would gradually converge toward global norms of behavior in, you know, economic and to a certain extent in political realms. Not that anyone thought that the CCP was going to democratize, but that the system would become a little more open, a little more pluralistic over time, a little more liberal in terms of the media environment domestically even when it comes to, you know, economic – you know, and when it comes to economic news in particular. That hasn’t happened. And that reversal has required everyone to start to reappraise what the appropriate safeguards are to insulate Western economies from, you know, absolutely, you know, unregulated flows in trade and investment between China and the rest of the world.

Rep. Hill: Well, Jude, what was your takeaway?

Jude Blanchette: Unfortunately, going after Logan I find I agree with almost everything.

I’d say, to echo some of what Logan said, it is striking that if we were to go back just to 2019, just before COVID, the assessment here in Washington was really about China on this trajectory of galactic domination. You know, this was an economy that was a juggernaut, centralized political leadership under Xi Jinping. And now we’re – as Logan indicated, we’re having a much different conversation here – one that is looking at, I think, enduring structural limits on what China’s going to be able to accomplish; also seeing the weight of Xi Jinping’s techno-nationalist view of economic management now really start to sit heavily on China’s shoulders. And I think the other important point is it’s not as if it’s a mystery what are – what the reforms China would need to make to at least address some of the more pronounced productivity challenges, but the leadership in Beijing is singularly unwilling to expend political capital to go after some of these deep structural reforms, either unwilling or unable to.

The second point, again agreeing with Logan, is I think in Xi Jinping’s direct articulation of concern over U.S. technology and investment controls you hear an honest assessment that belies China’s own rhetoric on the self-sufficiency it can produce in its own economy. For all that chest-thumping about the superiority of the Chinese model and the mobilizational capabilities of China’s techno-state apparatus, they’re still deeply, deeply dependent on external markets for key inputs. And so you see in that, you know, dressed up in language of confidence, I think a clear articulation from Xi Jinping on what some of their most pressing vulnerabilities are.

Rep. Hill: Well, would you – Logan, would you put a number on a percentage of slowdown in GDP growth? We’re going to both assume they continue to have positive GDP growth, but would you attach a number over the next five years to the de-risking aspect? I think China saw for the first time a falloff in foreign direct investment, for example, despite announcing last week at the famous $40,000-a-plate dinner that both MasterCard would be granted a license to do credit card inside the country and Broadcom’s acquisition was going to move forward. Those were two positive things that came out of the – out of the meeting. But integration – if the EU and the United States and Japan were to, over a five- or 10-year period, truly de-risk and diversify supply chains, what kind of impact on GDP do you think that would represent?

Dr. Wright: I mean, I think that –

Rep. Hill: GDP growth.

Dr. Wright: Yeah. I mean, I think it would have a greater than, you know, 1 percent of GDP over time kind of impact over a five- to 10-year period.

It’s an interesting question, though, because it’s not – it’s not so straightforward exactly how that’s going to play out in the data itself. I mean, China’s going to – even if de-risking takes place – and de-risking is taking place. Decisions are being made. If you look at sort of inbound investment into China’s semiconductor sector, for example, substantially lower than what it was before. If you look at how companies are reallocating their own investment decisions into third countries. If you look at how Chinese companies are actually – and private Chinese companies are trying to de-risk and remove their own risk from the Chinese market, that’s also a critical trend that’s occurring.

But what’s interesting is, as investments go into some of these third countries that are then going to export to the United States and Europe in the short of friendshoring dynamics that we’re seeing, they’re still – those supply chains are not as developed. So they’re still going to be dependent upon imports from China of intermediate goods.

And so this is an interesting challenge, I think, for business and government. Business and government need to sort of have a conversation that’s very open about what really is the goal that we’re trying to accomplish here and what kind of supply chain insulation do – does government want in terms of the reductions of risk involved? Because in headline terms, China’s trade might not suffer that much even if de-risking goes on because they might still be exporting intermediate goods to third countries, but undoubtedly it will have an impact. And undoubtedly, the decline in foreign direct investment and the decline in inbound investment into China has been a major part of the change in business sentiment so far.

The structural slowdown that we’re seeing in China right now is, in my view, a byproduct of the end of an unprecedented credit and investment bubble. That’s really the vector that’s driven it down, through the property sector and through local government investment. The foreign investment component is important, but it is not really the key driver.

Rep. Hill: Let’s hold on that. But, Jude, pull the string a little bit on this – if you’re going to have slightly lower areas of foreign direct investment in China, and even if their exports are maintained by critical, you know, third-country components but they’re not addressing the misallocation of resources domestically, which he touches on, how does that work out? I mean, how can you deny that you don’t have to make those changes? So what’s your view on that aspect of it? So overinvestment in real estate Logan just noted. I would suggest that the trillion dollars or so allocated in Belt and Road around the – mostly the Global South is – would not be a(n) A-rated set of credits. I think they’re going to have some repayment risk there, although they were done strategically. There’s no social safety net, high youth unemployment. So what about that domestic side? Address that for a minute.

Mr. Blanchette: I mean, one point to make is it’s not as if 15 years ago the Chinese systems was humming along at peak efficiency and something has suddenly broken. You know, both companies operating in China as well as, you know, analysts and observers have always noticed the amount of duct tape holding this system together. It’s just that if we think about – again, a drastic simplification here – you know, over arcs of decades China has been able to extract productivity gains through some simple mechanistic reforms: simple allocation – better allocations of capital and labor and talent by dismantling a previous, you know, state-dominated, centrally-planned system; entrance into the WTO and its opening up of external export markets; building up a pretty sizeable manufacturing ecosystem. But even amidst all that, I mean, this was a very, very dysfunctional system when you got up close to it. Companies have just become very good about navigating that.

I think what’s happening here, though, is the slow – the rapid economic growth paved over a lot of these challenges, and now there’s a lot of external scrutiny of this. I think investors and companies – 10 years ago when you were operating in China, you essentially could – you know, you’re out in a boat. You could pick any direction and you had wind in your sail. Now I think companies/investors are sort of 10 feet off the shore and they’ve got a pole that they’re sticking into the ground to see if there’s any coral reefs around. So that, I think, is the – is the major challenge here. Issues around social safety net, regulatory dysfunctionality, a patchwork legal system, those have always been the case. I think we’re now just bringing the appropriate attention to bear on this.

And the other thing is, you know, China’s economy 20 years ago was much, much smaller and much less globally integrated, and the impact of domestic dysfunction was less widely felt. I think now the significant concern is understanding how an increasingly dysfunctional Chinese economic model is going to reverberate throughout the globe. I think that’s the big concern now.

Rep. Hill: Well, when you think about those things, either looking at the domestic economy trying to measure it or trying to look at it from an export power and the employment tied to those exports in that manufacturing hub, how do we measure that? I mean, in August, Beijing said that they would no longer release youth unemployment data. And if you’re a really nerdy economist, and you’ve dug into the current account balance and the reserves in their 1998 series, you see that it’s no longer comparable. So is China hiding the data that people need to assess their economy?

Dr. Wright: I think it’s – data availability is an increasing problem across virtually the entire Chinese economic space. Everyone kind of has to make their bets about what is the most important thing to follow. For us at Rhodium, what we follow is the money. We follow the credit system. We follow basically how much banks are allocating to different industries. And therefore, you can figure out in an investment-led economy what’s actually happening on the ground. And that has long led to very divergent views from the official statistics.

And if you look even bottom up from China’s industrial output statistics, if you look at a simple weighted average of the 103 products that they provide in industrial output, they show a more regular business cycle. Unlike GDP growth, which has been extraordinarily stable, far too stable to be credible, for far too long a period of time. If you look at China’s, you know, GDP growth from 2014 to 2019, I’m going to forget this off the top of my head, but I think the range of variance in every quarterly GDP growth rate was about 2.2 percentage points over that timeframe. We could not find another country that had similarly low rates of variance and GDP growth. And you should be able to see that in emerging markets in particular. It should be more cyclical growth outlook rather than – rather than less.

So we’re very skeptical of the higher up you go in terms of the headline use of data, especially GDP, we’re very skeptical that that’s useful. China still produces a lot of data that is useful. And we spend a lot of our time figuring out exactly can you extrapolate from the bottom up where money is flowing? Can you extrapolate what’s happening with individual industries? Corporate data is still available. There’s quite a lot of resources you can bring to bear. And that’s what we try to do.

Rep. Hill: And triangulate it with people from outside China who are using or selling into those markets.

Dr. Wright: Exactly.

Mr. Blanchette: Can I just add to that? There is an epistemological closing happening in China that I think is – it’s not just – the quality of data, especially top-line data, like GDP has always been problematic. So you would often look at directionality rather than, you know, the specific number. But this is – you know, there’s datasets that are becoming harder to find, if not disappearing. You’re also seeing, you know, databases like Wind, which provides, you know, financial data about China, is now being – you know, external users are being blocked from setting up new accounts. Other databases – you know, China’s version of our JSTOR, which is sort of all academic articles, it’s called CNKI, subscriptions are being cut off.

And, again, a lot of these challenges were always present, but you could compensate to them by traveling in the country, talking to people. But a lot of the vectors we had to try to understand China are just becoming murkier. They’re closing off. Or politics is acting as an increasing constraint on them. That’s affecting our ability as outsiders to understand the system. But the challenge in authoritarian systems is also for insiders. People in these systems often find that they’re unable to have an accurate sense of direction of travel, speed of travel. So this is –this is a problem I think we’re all dealing with.

Rep. Hill: I certainly learned that firsthand back in when I worked for President Bush 41. One of my assignments was – when the Berlin Wall fell – was coordinating U.S. economic policy assistance to the central banks and the finance ministries from Poland down to Bulgaria. And as a capitalist and as a banker in America, it was so disconcerting to recognize that the banking system is essentially part of the budget. Meaning central planning produces goals and that money flows through those state-owned banks out to the state-owned enterprises, and the non-state-owned enterprise sector, as an allocation mechanism.

And therefore, there was no transparency to it. And it was also very hard to convert people to a market economy. But you mentioned authoritarian impact on that. And I was looking at, a few days ago, a University of Chicago in 2021 study by Professor Martinez there, who wrote that authoritarian economies overstate GDP in his modeling by some 35 percent. And that’s sort of the impression I had from my own personal experience in Central Europe. We have that risk in China as well, I take it, from this discussion on statistics?

Dr. Wright: I think it’s – especially in the last two years, it’s quite notable. China’s having a structural slowdown. As I said, I think this is the byproduct of the end of an unprecedented credit and investment expansion. But we’re all just debating about how severe that structural slowdown is. And if you believe the official data from Beijing or, you know, from some of the IMF forecasts, as you’ve cited, you’re talking about a slowdown from around 6 to 7 percent growth to around 4 to 5 percent growth – 4 to 5½ percent growth in the future. That’s not that severe at all.

We would argue it is a far greater discontinuity, because the property sector was responsible for 20 to 25 percent of China’s economy. It has been cut more than in half in terms of its overall size. New starts are down over 60 percent from their peak. Sales are down 60 to 65 percent, properly measured. It will probably equilibrate somewhere at around 35 to 45 percent of its previous size. Nothing has replaced that, you know, full 20 to 25 percent of GDP. Local-government investment is similarly large, about 14 to 15 percent of GDP right now. It’s not going to be a reliable source of growth in the future.

So if you look at 2022, for example, when China was subject to extensive lockdowns, widespread, you know, controls on movement and activity, I mean, at one point we were tracking freight volumes and we were finding that nationwide freight had collapsed by more than half in the worst of some of these restrictions around the Shanghai lockdown in April and May. And these are enormous discontinuities in economic activity.

You can’t plausibly – there’s no plausible argument, in my view, that China’s economy really grew in 2022, despite the fact that they posted 3 percent growth. We think growth was negative. We know investment growth was negative from the property sector, from construction activity. Consumption growth, they even stated, was negative.

And so the question – yes, there’s a marginal source of growth from net exports, but that’s a huge difference. And this year, similarly, there has not been a recovery to anywhere close to pre-pandemic growth rates. The stated growth rates are, you know, 5.2 percent. We think it’s far lower than that.

Rep. Hill: Well, using the Eastern European comment and the mirror image of the overinvestment in property in China, you look at banking assets as a percentage of GDP and they’d be three to four times America’s banking assets as a percentage of America’s GDP, something in that range, maybe more.

Dr. Wright: And higher in absolute terms.

Rep. Hill: Yeah.

Dr. Wright: I mean, I think they’d be far larger, because U.S. bank assets would be probably close to about 100 percent of GDP, if I recall. But China’s banking assets – China has the largest single-country banking system in the world. It’s $57 trillion plus in bank assets. And it’s quadrupled in size in just eight years, between 2008 and 2016. This has been –

Rep. Hill: Is that a bubble?

Dr. Wright: That’s the largest – that’s the largest single-country credit expansion in relative to global GDP that we can find in over a hundred years, and probably well beyond that.

Mr. Blanchette: Let me just say, speaking of the mirroring comment, you know, what I was just going to say, that one of the challenges of making comparisons is just that China’s banking system is a fundamentally different animal than Bank of America, right. So these are political actors, as you mentioned in the Eastern European context. This is exactly what – Chinese state banks are designed, in part, to extract resources and channel them and ensure they’re being channeled toward state priorities.

The second comment I was going to make on GDP is I also think comparing Chinese GDP to U.S. GDP also just qualitatively doesn’t make sense, because these are measuring – we care about U.S. GDP growth and Chinese GDP growth for different reasons. And I think increasingly looking at Chinese GDP to tell us something meaningful is – that space is diminishing.

You know, we look to U.S. GDP growth as a proxy for health of the consumer, health of the private sector. That’s not what we see when we look at the Chinese GDP. So if Chinese GDP, at an official level – let’s say it drops down to 4 percent. What is that telling us, besides that there is a slowdown?

I think that’s where looking at more microdata is important. Looking at – Logan has done a lot of work at looking at local-government finances, you know, looking at income growth. These are far more meaningful than I think nowadays looking and saying that Chinese growth is going to be about 5.5 percent. I don’t know what that’s telling us.

Rep. Hill: So how do you assess this IMF forecast, which is 5.4 percent for next year? Their written justification is the revision is the implementation of new economic policies and stronger than expected growth in the third quarter of this year we’re in, 2023. It just doesn’t sit with – that doesn’t sit with where – you may not dispute the actual topline GDP number, which you’ve just said isn’t particularly valuable anyway. But how do you think the IMF turns and has that kind of optimistic view?

Dr. Wright: I think, first, I mean, just caveating – we’d have to ask the IMF exactly what they’re thinking here – but I think what they’re trying to do, if they press them, would be they’re trying to predict what Beijing is going to publish, not what the actual growth rate is. I’m not exaggerating. I mean, I think there was a revision. They’ve undergone four revisions so far this year of the 2023 growth rate. But I’m not sure what a revision now of what the 2023 growth rate is really serving.

There are – their medium-term growth forecast is closer to 3.5 percent for China. And that reflects the lack of reform. And, you know, I think that’s a far more defensible position from where we are. But in general, it is not a – you know, especially over the last two years, with the kind of dislocations in China’s economy that we’ve seen, it’s not a realistic story, I think, to argue that it’s been closer to continuity over time, nor I’m not sure that anyone’s really well served by forecasts that are just trying to prevent how Beijing is going – trying to message this externally, because, I mean, this is the great irony of 2023 in Chinese economics.

Ostensibly China is on targeted growth pace. Yet they have reacted as if, you know, it’s a pretty much full-on panic about how to stimulate the economy, how to open up to foreign investors, revise the budget for the first time to expand fiscal resource – to expand, you know, fiscal support for the economy for the first time since the Asian financial crisis, cutting interest rates.

None of this suggests that the economy is well on track for exactly the targeted growth rate that they were expecting. And it’s – you know, it just doesn’t make sense that we had, you know, this very significant adjustment from COVID restrictions in 2022 where growth was 3 percent to lifting all of those restrictions and growth is 5 percent.

Mr. Blanchette: You know, the IMF just started the or is in the middle of the Article 4 process. And I bet when we see their report come out next spring, we’re going to see a different analysis than that.

I agree with Logan. I think all that this is telling us is, you know, we’re going to see assessments coming out from banks as well on the Chinese economy for next year. It’s just telling us – it’s just throwing to the receiver. But, you know, so I think look at the Article 4 –

Rep. Hill: And Arkansas football. We couldn’t even do that this year.

Mr. Blanchette: (Laughs.) I think the other thing is, you know, 10, 15 years ago, if you were talking to corporate boards, slide number one would be a projection of Chinese growth. And this is the reason – this is the story about why we need to be in the market. I don’t see that slide anymore.

Rep. Hill: Yeah, and that slide would have included that it was going to overtake American GDP by 2030. So we’re not anywhere on track for that.

Mr. Blanchette: And companies just don’t – no one uses that as a selling point for why you need to double down on China, right.

Rep. Hill: Right.

Mr. Blanchette: Some companies are thinking about increasing investment in China, but it’s no longer this untapped potential. Growth is going to be, you know, 8 percent over the next few years. I just think, in a fundamental sense, looking at Chinese GDP is not remotely as meaningful to investors and companies as it was 10 or 15 years ago, for the right reasons.

Rep. Hill: Plus I’ve always been concerned, as an investment person, investment-banking background, you have a bad legal system. Every investment in China is now a national-security investment, by their own dictate of their own law. But they have the right to treat every investment in every company as important to their national security. I’m not sure I want to own their currency; not convertible. So legal system, threats to your own ability to operate in the country, with no – you know, knowing what the rulebook is, and currency problems.

So do you see that being addressed by any of these economic policy changes that they’ve asserted, really the meaningful addressing of those?

Mr. Blanchette: Yeah. Again, you know, in some sense, the exact institutional makeup of China is not the story, because the exact institutional makeup has always been bad. It was signals you were getting from the leadership, and also play space for local-level Chinese officials who were incentivized to basically be bringing in investment.

I think what has happened is the incentives for local-level officials to be focused on growth is fundamentally changing because the administration under Xi Jinping has a much greater clear security focus. So now, again, you know, the tide is receding and we’re left to see this thing in all its glory, and we’re seeing just how dysfunctional this is.

And I agree with you. I think arguably one of the most important changes that has occurred at a policy level in Beijing over the last decade is the institutionalization of the build out of an administrative state that is focused on national security, which has no fixed definition. And so it’s just now become, I think, this amorphous, very subjective conception that, you know, cultural issues are national security issues, ideological issues are. And in the business world, we’ve seen this over the last year or so with investigations of, you know, U.S. due diligence firms, exit bans of entrepreneurs and, you know, business executives.

That, to me, is one of the more fundamental changes, is companies always used to say, look, bad institutional system, but we have some sort of mental map of where the play space is. And I think now it’s upsetting investment is – marginal investment is companies no longer feeling certain that they know exactly where are the green zones, where are the yellow zones, and where are the red zones. Everything is starting to look like either a red zone or a yellow zone. And hence, the drawdown in FDI.

Almost every, you know, company or investor you talk to, even the ones who are in China, are saying, if 10 years ago we were going put, you know, a full dollar in, now it’s 30 cents on the dollar, right? We’re certainly not thinking about long-term heavy capital investments because the political outlook for China is just so uncertain. Why would you put a billion dollars into a massive – you know, build out a factory in China, expecting to get returns 10 or 15 years down the line, given all the volatility right now?

Dr. Wright: And even though there are economic officials in China who understand this reality, who wants to actually push back, who wants to actually reform the system, under this new scrutiny of a security-oriented administrative state, just as you said, they can’t necessarily win those battles. So you have these consultations and say that, look, all of these raids, these investigations, these are complicating the investment environment. They could acknowledge it, but they can’t really do anything about it because they’re not actually in the room where those sorts of decisions are happening in the same way. And I think this is kind of the environment that we’re seeing develop over the course of this year, and why it’s responsible for some of this slowdown.

Rep. Hill: How do you think this slowdown, economic slowdown, in China impacts the CCP’s thinking in Beijing about Taiwan?

Mr. Blanchette: It’s a hard question. Partly because –

Rep. Hill: Yeah, that’s why you get it. (Laughter.)

Mr. Blanchette: (Laughs.) I mean, the honest answer is, I don’t know. But I work at a think tank. That’s not going to stop me. (Laughter.) You know, I think, first of all, I would say China’s calculations on Taiwan are much more attuned to what conversations they hear here in the United States. Also, political dynamics in Taiwan. So if we’re really worried about what moves China on Taiwan, the two dynamics would be the electoral outcome on January 13th in Taiwan. I think there’s an expectation here that William Lai and the DPP are going to win, but I would just say in the polls the KMT and its candidate, Hou Yu-ih, is only a point or two behind. The second is how we talk about Taiwan here. And I think where there’s prevarication in our support for Taiwan, where they see changes in foreign policy, changes towards isolationism, that, I think, gives China opportunities.

The bigger question, though, is, what does an economic slowdown mean for China’s foreign policy writ large? I think this is where there’s a big debate going on right now. And you have two sort of mental models here. One is the classic wag the dog, you know, as you see a slowdown and these economic problems really start to sit on the system, and you see growing instability, you see local governments struggling to pay cadres, that there is an incentive for Xi Jinping to try to find some external vent for this. We’ve seen China do this before in territorial disputes with the Japanese, you know, around the Senkaku Islands, for example. So I see that as certainly plausible.

The other alternative, which is the one I think we should all hope for, is that as the weight of these economic challenges starts to settle it opens up space for new debates to occur in Beijing that were impossible. And I think, you know, you can run an economy into the ground longer than we would – we would want. But at some point, and I think we’re entering into that phase, functional constraints and scarcity is really going to start to impact.

And, again, I don’t want to speak for Logan, but I think if you look at local governments, you know, this is one where you’re now starting to see, Xi Jinping can dream big but what really matters for a functioning economy and political system is what happens at the local level. And Xi Jinping runs a Leninist system that gives him power. But in the end, he is absolutely dependent on tens of millions of cadres who are not in Beijing, at the local level. and you got to pay their salary. And you got to pay them on time. You have to have money to fund police and social stability.

And I think the question is, you know, as we look out the next one, two, three, five years, do those problems at the local level start to change some of the conversations in Beijing? It doesn’t mean liberal reform. It doesn’t mean the Third Plenum of 2013 is going to come back. But it might mean some new thinking about, how does China boost fiscal capacity?

Dr. Wright. Yeah, it means you can’t be closed off to the rest of the world. It means you have to continue to welcome in foreign investment, despite all of those concerns. And it means you have to make – the security people need to potentially make concessions in order to facilitate that. So, I mean, I think those are some of the hard constraints China faces. The problem they have is that they have the largest single country dollar money supply in the world and a historically closed capital account.

So there’s this huge pressure for capital outflows. Story in The New York Times today just, you know, citing some of the mechanisms that are facilitating that. If there’s no counterbalancing capital inflows, the exchange rate weakens. And they’re trying to basically continue – they face protectionist pressures everywhere as, you know, their economic global throw-weight continues to decline. And that’s the problem, you know, I think they’re going to face.

Just to Jude’s point of the local level, I think it’s completely underappreciated, especially here in Washington, but, you know, in the economics field as well in China, just how constrained their fiscal system is right now. China’s fiscal resources, total fiscal revenue as a proportion of GDP, has declined by about eight percentage points over the last 10 years. And it’s extraordinarily dependent upon an investment-led growth model. China doesn’t charge individual income tax, doesn’t charge domestic consumption tax in very large proportions. They charge VAT and they charge corporate enterprise income taxes.

Those are diminishing if there’s no investment-led growth. And the average pace of, you know, tax revenue growth over the last eight years in China, nominal, has been about 4 percent. It’s shocking how, you know, China’s now collecting roughly a low end of the OECD kind of estimate of tax revenue to GDP. Those constraints are going to bite. It means that tradeoffs are inevitable. They’re inevitable domestically, but they’re also going to impact, I think, Chinese foreign policy, as well as you just don’t have the same wherewithal to, you know, be as profligate as what China has done in the past.

Rep. Hill: Well, they’ve been profligate. And they’re not taking care of the home front, is what I’m hearing from you. So do you see a shift away from the tremendous resources that are being spent to project power around the world, through bad loans to poor countries? Or all the, you know, hundreds of billions of dollars going into defense expenses, obviously?

Dr. Wright: I think those tradeoffs are going to bite. The debt renegotiations that are going on right now, the fact that so many of China’s external loans – we could count $78 billion just since 2020 in Chinese external lending that is being renegotiated or has been – has been renegotiated or is in renegotiation processes. This is a huge opportunity for the United States. It is a huge exposure for China, precisely because they’ve historically been a source of capital to the developing world. That capital is no longer being extended. Those loans are being called in.

There’s an arguably – you know, China is now, you know, basically accepting more repayments than they’re making in disbursements. And these countries, in a rising dollar world and rising interest rates, need debt relief. And there need to be – this is at the center of a lot of this diplomacy. There needs to be – you know, something that I think Congress can do proactively as offering solutions for private sector, you know, for these countries to have access to private sector lending in ways that do not depend upon Beijing finally coming to the table with substantive concessions.

Rep. Hill: Well, I think it’s both. I mean, I think we have to press China to be a full and open partner in the Paris Club in debt restructuring, which they really haven’t. They’ve done some baby steps. Zambia is an example in the news this week. But grudging is the word. But I think the principal issue is there. They’ve made a bunch of bad, bad decisions, bad loans. And I think those countries are rejecting it. What America and our allies have to do is go in, step back. And you look at a map of influence in Africa, for example, of China and Russia today versus 20 years ago, and it’s dominant. And yet – and the countries that previously had a good relationship, they haven’t. So I think the door is back open for a European, or a democratic East Asian country, or America to step back in and help.

Mr. Blanchette: And just add to that, if you look at Chinese investment in Africa, it has built up goodwill with African state leaders. But if you look at polling data done by organizations like Afrobarometer, you see that younger Africans are incredibly frustrated with China because they essentially see Chinese investment as going in and propping up oftentimes autocratic leaders. So, again, if we’re looking at the short term, it looks like China’s doing well in Africa. But I think if we’re playing the longer game, we’re seeing that, A, you know, China has made a lot of bad bets. It has entangled itself with some complicated regimes and it is – it is investing in the alienation of a very young, vibrant population in Africa which will be of voting age in five, 10, 15 years.

The other thing I was going to say just quickly is, just to your point about making bad bets, again, that’s – one of the puzzling things here is Xi Jinping has an extraordinary amount of power. He’s clearly showed that. His ability to restructure a military is not easy, purge officials. It’s confusing to me why his policy agenda is what it is rather than really focused on rejuvenating China, because you can imagine cheap reforms he could make that are about confidence in the business community, and that’s just the absence of punitive, you know, unpredictable regulatory behavior. You then think about if he is going to spend political capital, it should be on tax and fiscal reform, right, rebuilding the fiscal capacity of the Chinese state. And then it should be long-term investments in China’s human capital via education and also boosting innovation.

Almost none of that is on the table for Xi Jinping, and it’s bewildering. And I think part of it is he is trapped in sort of a great-power nihilism where he’s trying to build up the country for conflict with the United States and making dollar investments in all the wrong things. He’s trying to expand China’s influence abroad, but that’s how it got them into a Belt and Road debt trap where – you know, I think China’s the one trapped in Belt and Road oftentimes rather than the other way around. But they – you know, they went and splurged in 2015-2016, you know, where you had massive Chinese conglomerates buying bowling alleys in Poughkeepsie, New York, with, you know, scarce, you know, U.S. dollars, scarce FX. And then I think China woke up in about 2016 and realized all the bad bets that Chinese corporates and SOEs had made, and is trying to reel it back ever since then.

But this is – this is not – you know, a lot of these structural headwinds we’re talking about are not insoluble. It’s just that the policy apparatus under Xi Jinping is looking in entirely different directions.

Rep. Hill: Well, it’s opaque to me what their economic strategy is. I think you’ve outlined that very well. And I cite this Taiwan saber-rattling. You’ve got 80 percent of a lot of global goods pass through the Taiwan Strait. You have Taiwan, South Korea, Japan, the United States as the largest investors in China, plus the EU all collectively. And all that stops if there’s any military action across the strait, which produces an immediate global depression – not a recession – with the epicenter of it in China. So do you – I mean, this is just your assessment – do you assess from your work in Beijing all these years and studying it that the CCP says, yeah, well, that’s worth it to do that? Because, obviously, it’s nonsensical for any rational thinker or any Western-thinking businessperson. So how do you – and do they view – part two of that is, do they view the breaking of their treaty with the United Kingdom and asserting control of Hong Kong as a big, big success story for them?

Mr. Blanchette: Answers on Taiwan are hours in themselves, but I would guess – you know, my theory of the case on this is I think China recognizes that the use of military force to take Taiwan would be existentially costly.

One of the reasons China is saber-rattling is to try to establish its deterrence. I think China understands that the credible threat of a military invasion is the very foundation of its deterrence to try to both shape events on Taiwan and to try to keep us in the wings. I think China feels like its gray-zone strangulation strategy is – A, it’s the only one it’s creative enough to think of; but, two, I don’t think it think it’s broken.

And again, keep returning to, you know, ultimately, the goal for China is to compel Taipei to enter into political negotiations over reunification. So Beijing is thinking: How do I create the conditions for that? I need to convince Taipei that it is alone, isolated, and nobody is coming to help. And that’s where events around Taiwan are important. That’s where political discussions in Tokyo, the United States, Canberra, Seoul are important. That’s where finding ways to deal with gray zone is important, because we need to show China – it’s hard to convince the Chinese that we’re going to be there if they invade if we’re not willing to expend resources to deal with them at the lower lend of the escalatory ladder, which is exactly where we are now.

So I think they know that an invasion would be costly. I think it’s their last option. I think they feel like they’ve got a toolkit right now that they can continue to use. And I think their view is, you know, support in the United States is not enduring and permanent. And in fact, you know, you’re seeing a potential United States that’s going to be distracted by multiple theaters, and that will open up some options for us.

Rep. Hill: Logan?

Dr. Wright: And just speaking about the Hong Kong question that you asked, I mean, I think – I was in Hong Kong and lived there until, you know, the middle of last year, actually, so watched the entirety of the aftermath of the 2019 protests and the National Security Law in 2020 and the impact that’s had on the business environment. The more alarming thing, I think, is that that’s – those developments reflect this change in the balance of economic technocrats versus security forces in Beijing.

We have these debates on whether we think that there’s a balancing of those two objectives. In the Hong Kong case, I’m not even sur that the economic technocrats were ever even in the room to make those decisions. I think that this was a reaction, essentially, to the 2019 protests and the political challenge they represented. The security forces essentially dictated the response, and if there were economic costs to be borne from that to China’s medium- and long-term future clean them up later was kind of the attitude. And so I’m not even sure that there has been the kind of retrospective was this worth it or was this a good balance. To the security forces, yes; there’s no longer protests. So, therefore, you know, they have demonstrated – they demonstrated their success to the overall balance of, you know, the quality of life in Hong Kong. And the impact on China’s diplomatic relationship and the longer-term impact on opening to China’s capital markets and the impact that had on inflows into China I don’t think anyone’s – you know, I’m sure that there are those in Beijing that are making those assessments, but I don’t think they’re very public at this point.

Rep. Hill: Let me ask the staff for guidance. Are we going to take questions from –

Mr. Blanchette: Out and about.

Rep. Hill: Good. Thank you. And also, help me on the time.

So let me turn to some online question and some in-person questions. First one, online: How easy or hard is it for Western countries to extricate themselves from China? What does reshoring/nearshoring look like for the U.S. and European allies?

Mr. Blanchette: I don’t think there’s a single answer to the first question, and I think this is where the conversation on decoupling/de-risking is fraught and challenging.

De-risking is a verb, not a noun. It’s a process rather than a destination. De-risking is everything from companies, again, having marginal drawdowns in ordinarily planned investment into China. This is thinking about moving money that was dedicated for China to destination A, B, C.

For some companies, de-risking, though, is being all-in on China and essentially creating firewalls. So you’re in China for China and you’re creating distinct, separate data ecosystems. That way, you don’t have to deal with any of the nonsense China’s put in place on, you know, cross-border data movement.

I think the kind of – I think what we’re realizing is companies and investors are becoming more cautious about China, but many are still addicted to China. And the reality is if the three of us decided right now we wanted to start a business manufacturing widgets, we could have them being – coming off assembly lines tomorrow in China. There’s – and at scale. There’s not many other countries that can do that. This is the promise of – you know, or the hope for something like an India, but you know, people who focus on India know that we’re a ways away from that. So – and even – you know, even in this declining, you know, China, you still have lots of headroom growth for companies in very specific sectors.

You mentioned, you know, license liberalizations in financial services and payments. You know, one of the reason(s) you got a lot of CEOs to pay $40,000 to be in the room, especially the financial services CEOs, is if you’re thinking about dealing with the real estate challenge, that’s really an asset-management challenge. That’s finding other places that Chinese consumers can put wealth where they can get asset appreciation. And it’s one of the reasons that sort of financial services is probably a bright-ish area in China, one of the few areas where China’s thinking about liberalization.

So de-risking is real. It’s happening. China’s paying a price. But I often think – I at times think we can overstate the price and underestimate just how reliant many companies are on China.

Rep. Hill: Logan, anything you want to add?

Dr. Wright: I would – if we’re going to more questions, I don’t have a lot to disagree with there.

Rep. Hill: Yeah. All right.

Dr. Wright: So please go ahead, yeah.

Rep. Hill: This is a very good question, online: Do you think the United States can still view China as a reliable partner, for example on North Korea issues?

Mr. Blanchette: No, would be my short answer. I’m not sure – I’m not sure – I mean, you could have asked that question 15 years ago on North Korea, and we would have said no. We obviously don’t find China a reliable partner in its relationship with Russia, vis-à-vis its ongoing support for Russia in the war in Ukraine. You’re starting to see China edge into the Middle East. But as we’ve seen in in the wake of Hamas’ attack on Israel on October 7th, China is trying to stir the pot there, I think to gain some marginal advantages over the United States.

It doesn’t mean – that’s not a blanket statement. I think if we do find areas of overlap, it will be because it’s in China’s naked self-interest. You could see it in issues like food security. You could see in an issues on AI, where China, I think, is worried about where AI goes. And you can imagine a conversation on governance on AI. But I think the big course correction that the United States has made – and I think we – this is not recent. I think we made this a decade ago. Was realizing that China is a big country with its own interests that don’t always overlap with ours. And Beijing is going to press its advantage where it can. And the rhetoric that comes out of Beijing on win-win cooperation, shared responsibilities, is precisely that – its rhetoric.

Rep. Hill: Speaking of AI, this is a question from one of our audience members: Alibaba this week announced they’re getting out of the quantum computing business. Can you speak to why you think this happened? And more broadly, about the public-private investment in the PRC and critical science and technology priorities? What are your – what are your thoughts there?

Dr. Wright: Can’t really speak to exactly an individual corporate decision like that. I mean, I think that there probably is some concern if you’re a, you know, venture capital investor in China and private equity investor in China about getting involved in sectors that – you know, that have been identified as potentially areas of strategic competition with the United States. And therefore, you know, you’re restricting your available market. So it wouldn’t surprise me if those are relevant considerations. But, yeah, can’t really speculate about an individual corporate decision in that respect.

China’s science and technology, you know, funding landscape is pretty varied. A lot of it is private in terms of actual private investment. A lot of it goes through the state labs. And then there’s, you know, different sort of, you know, applied innovation trials that happen, you know, well outside of state control and are kind of experimental. So it’s certainly not a – you know, there’s certainly not a single center at which, you know, you can say that this is really where China’s innovation – technology innovation research is taking place.

Rep. Hill: Just there was a follow up question, and which I think you’ve touched on. But online it was asked, and it’s a place where you could both reiterate this: Do you think these China economic problems that we’ve talked about played a role in Xi’s agreeing to meet with President Biden in San Francisco?

Dr. Wright: Personally, I don’t think that the meeting was ever really in question. I’m sure there’s always going to be diplomatic back and forth, but the truth is that Xi not showing up at an APEC meeting, even if it was in the United States, would have been a statement in and of itself. And so backing away from that meeting is probably – would be an abandonment of, you know, a potential channel for Chinese influence. Doesn’t necessarily mean that you have to do the extensive bilateral with the president. So that could be, you know, viewed in that respect.

I do think that one of the things that Xi was trying to do at the meeting was to say that we’re still open for business, the economy’s still performing, trying to reiterate China’s narrative therein. And so that was part of the incentive there. And so, therefore, you know, the economic slowdown and the change in narrative really does matter. I mean, this is a broader point, but the narrative about why China’s economy is slowing, in my view, is vitally important for the United States.

We should not be saying that, you know, the Chinese economy is slowing because we’re imposing these investment restrictions on China, and therefore, we’re succeeding in constraining their growth. We should be saying openly that this has been an enormous structural slowdown resulting from a massive political overallocation of credit and investment to unproductive resources. This is not a model that that other countries should emulate, and this will not make China a reliable economic partner to the rest of the world.

And that’s really the narrative that we ought to be – we ought to be pushing. And that narrative has the possibility of changing minds in Beijing, because there are many people in Beijing that actually do agree with that, and potentially gives them the opportunity to sort of change China’s economic direction to something that’s slightly more amenable to more sustainable global growth.

Rep. Hill: I think that’s a great place, Logan, to ask you what are your concluding thoughts? Because that is – that’s a conclusion, I think, that has important U.S. and European and Japan, South Korea, Philippines, you know, diplomatic positioning; which is you made 10 years, a decade, of mistakes, and you’re paying the cost for those now. We want a healthy – we want a China focused on an internal – something that’s important to both the CCP and U.S. would be harmony inside China, from that point of view, I think, vis-à-vis them exporting bad credit or exporting a militaristic point of view in the region.

So how do you – how do you want to sum up, Jude?

Mr. Blanchette: I guess, you know, realism dictates that we understand that Xi Jinping is not going to change his overall view of political economy and the geostrategic environment. And I think what that means, therefore, is the trajectory we’re on now is likely to be the trajectory we’re on in the future.

And I think we’ve been talking a lot about China’s economic weaknesses. I don’t think the Xi Jinping leadership assesses this the same way Logan Wright does. And I think the world would be a lot better if they were reading Rhodium notes.

I think Xi Jinping’s view – and this is where the growth rate does come in – I think Xi Jinping’s view is we’re not doing too bad. Yeah, we’ve got some – we definitely have volatility on the real-estate sector. But I’ve got a big fire hose back there that I think I can use if I need to, or I’m told I can use. We’re trying to break the back of moral hazard in the system. So frankly, we want a bit of pain at the local level. Yeah, we might be having some troubles with the G-7. But frankly, the Global South, I think we’re doing quite well. We still have CEOs lining up to come shake hands with me, and I’m going to make about 5.5 percent growth this year.

So, I think there’s oftentimes a distinction between how we external observers assess China and how the Chinese leadership does. And I think that is a real fundamental disconnect. I think we’re assuming that somehow the Chinese leadership is getting desperate and maybe wants to go take action against Taiwan.

I just don’t think that’s the case. My view is Xi Jinping sees China as not a patient with a terminal disease but as a bodybuilder with a cold, right? It is a fundamentally strong political system with lots of tools, that has overcome COVID, that is 100 years old. The Communist Party was founded in 1921. And you could argue that today the Communist Party is richer, you know, more resourced, has more external, you know, levels of external control, has a bigger military, and Xi Jinping has more control than any leader in Chinese history.

So I think part of this is where we’re going to start the clock and how far we’re going to zoom out. I think they are confident. And that’s probably one of the dangers that we’ll have to deal with.

Rep. Hill: I think the audience online and here at CSIS has seen why these two were ideal to talk about this challenging topic about the outlook for China and the outlook of those resources that China has and how they’re going to utilize them as a force for good or a force for ill, a force for domestic harmony and growth or a force for exporting a diplomatic and material surveillance state around the world.

And it’s fundamental, I think, to our national security in this country and in our allied nations, in Europe and in Asia, that we understand this and that we have as much a transparent outlook on what that economic future looks like and how those resource-allocation decisions are made inside a very opaque country behind that bamboo curtain.

But thanks for pulling it back a bit and letting us have a peak. And thanks, CSIS, for hosting us today.

Join me in a round of applause for our – (applause).