The China cushion has deflated — Q&A with Stephen Roach

Politics & Current Affairs

I spoke to the renowned economist and former Morgan Stanley executive and found him gloomier on China than he’s ever been, and that his upcoming book will cost him access in Beijing. He also told me to get new friends.

Composite image by Nadya Yeh

Stephen Roach is a senior fellow at Yale University’s Jackson Institute for Global Affairs and a senior lecturer at the Yale School of Management. He was formerly the chairman of Morgan Stanley Asia and the firm’s chief economist, positions of immense influence on Wall Street.

He is the author of several books, including the upcoming Accidental Conflict: America, China, and the Clash of False Narratives, which diagnoses the current trans-Pacific malaise, and offers some prescriptions to cure it.

I spoke to him by video call on April 28. This is an abridged, edited transcript of our conversation, part of my Invited to Tea interview series.

—Jeremy Goldkorn

This week, you published a piece on Project Syndicate, The downside risks to global growth, in which you look at the World Economic Outlook just released by the International Monetary Fund. It forecast a sharp reduction in world economic growth for 2022, down to 3.6%. But you think it may still be too optimistic, and you give three reasons:

  • It is extrapolating from “the sugar high of 2021” into the future.
  • The downshift in the global growth cycle is being accompanied by a major upswing in the global inflation and interest-rate cycles.
  • The “China cushion” has been deflated.

Can you talk about the deflation of the China cushion?

Well, I wrote about that a lot in the period after the global financial crisis (GFC) from 2009 to [around] 2014, where there was a growing criticism of China by the U.S. administration, especially during the Trump era, and the U.S. was like, “We don’t need China. We’re going to put a lot of pressure on China and we’re going to be fine without China.” So I wrote a piece saying “Be careful what you wish for, because you have no idea how precarious the world would’ve been without China in the immediate aftermath of the GFC.”

I did some simple global arithmetic, Jeremy, where I started with the Chinese growth trajectory, which was very impressive in that post-GFC period, cruising along steadily at close to 8%. But then I performed the following thought experiment by removing that rapid GDP growth from the world economy to see what the world would have looked like without China. Specifically, over the five-year, 2012–2016 period, actual global GDP growth averaged 3.5%.

Without China, the growth trend would’ve been reduced to just 2.3%, which is fractionally below the 2.5% threshold that we normally associate with outright recession in the world economy.

So I argued that the world without China, in the post-GFC period, would’ve been a world that was flirting with a possibility of lapsing back into global recession. The resilience of China, or the China cushion, as I called it in my latest Project Syndicate piece, the China cushion was the only thing that stood between a weak post-GFC recovery and a relapse back into global recession during that earlier period.

Fast-forward to today: The cushion has no air in it. I mean, China’s growing at well below the post-GFC pace, if it’s growing at all, and you show me another source of resilience.

In your piece in Project Syndicate, you talk about three aspects of the China cushion being deflated: The new wave of COVID-19 lockdowns, the deleveraging, especially in the property sector, and the collateral damage from the invasion of Ukraine.

You didn’t mention the common prosperity agenda of Xí Jìnpíng 习近平 and the crackdowns on the technology sector. How significant are these?

Look, I think they are a big deal. I really do and I had written about it earlier and my new book, which is coming out in October, goes into that in a lot of detail. I think these twin actions of cracking down on internet platform companies and income and wealth redistribution under the guise of common prosperity are big risk factors for potential Chinese economic growth over the next several years. They go right to the heart of the productivity leverage that China really needs right now to offset the demographic headwinds of a rapidly aging and potentially shrinking population.

I’ve written about them so much that I didn’t include them in my three factors for the deflated cushion, because, I don’t know, this just goes back to my old Wall Street days, when you make a point. This is just a dumb marketing point, you like to have three reasons to support your point, not four.

So I eliminated that because I had written so much about it before, but in all honesty, I should have put it in. I should have said, “There are four reasons.”


Because it’s just as damn important. It’s not quite as immediate, because the lack of the cushion is here and now, and these actions, the regulatory actions and the redistribution under common prosperity, are likely to be more of a medium-term headwind. But yeah, there’s nothing uplifting about what those actions portend for Chinese economic growth.

You’ve met and you know many of the important people behind decision making in China. You’ve had quite unique access to some of the people whose thinking has gone into Chinese economic policy over the past decades. What’s your sense of the decision-making process in China right now?

Obviously we have the great leader, Xi Jinping, the chairman of everything, but in recent months there does seem to have been some pushback from, I don’t know if economic realists is the right word, but people like Liú Hè 刘鹤, who seem to be pushing back a little bit against some of the tech crackdowns and some of the government actions that seem to be harming the economy.

Well, you mentioned that I have enjoyed good access over a long time, which is true, and I still do today and continue to have great dialogue, now through platforms like [Zoom] because no one travels to China anymore. But yeah, I’m worried that my legacy of great access is about to be constricted when this new book gets published because it does say some rather tough things about China that I haven’t ever really said in a book or an article before. And your connections are as good as your point of view, and this book is likely to be unsettling in some respects.

The strong grip that Xi Jinping now has on all aspects of the Chinese discourse, both internal and external, has closed down a lot of the internal debate over the wisdom of policy. This is really unfortunate. I think even a one-party, authoritarian state needs to have debate and needs to be able to look in the mirror and challenge itself at critical junctures.

One of the singular events that I’ve featured in a previous book and in my work for now 15 years was the commentary that former premier Wēn Jiābǎo 温家宝 made in March 2007, at a press conference after the National People’s Congress, where he said, “The Chinese economy is strong on the surface, but beneath the surface, it’s unstable, unbalanced, uncoordinated, and ultimately unsustainable.”

That was a really important criticism of the strategy of hypergrowth that had been emphasized since the days of Dèng Xiǎopíng 邓小平 and it forced China to really engage in a frank and open debate about changing the growth model and moving away from resource energy, pollution-intensive manufacturing to drive exports and investment, to have more of a balanced, greener, services-led, consumer model that provided opportunity for Chinese consumers.

That structural rebalancing was an outgrowth of a very intense period of internal debate and there is no debate in China right now.

I mean, the closest thing we came to debate recently under Xi Jinping, I think, was in May 2016. There was a famous interview published anonymously on the front page of People’s Daily. The so-called authoritative person who raised in a Q&A interview with the editors of People’s Daily, a person who has, to this day, never been identified, raised questions about debt-intensive China going down the road of Japan and that led to the rolling out of a number of new policies, immediately after that, such as supply-side structural reform and the deleveraging campaign.

That came out of a critical view, albeit one that was expressed anonymously and the highest-profile state-sponsored media platform that the government allows, and there’s really been nothing since then.

We hear that there’s some concerns about zero COVID. They’re calling it a new name — now the Chinese do not call it zero COVID, they call it zero tolerance, a dynamic COVID containment policy, whatever that means. But they’re digging in their heels. You see from the clips you get from Shanghai, the long testing lines now in Beijing, and the earlier incidents in Shenzhen.

What this all speaks to is the lack of flexibility in Chinese policy and unwillingness to rethink strategy.

Whoops, did I lose you? Jeremy? I have lost you. Or you’ve lost me. Jeremy?

[The conversation was cut off and resumed several hours later.]

When we were interrupted, you were in the middle of talking to me about the frozen decision-making process in China. Since then, I read this piece in the FT that quoted the investor Weijian Shan (单伟建 Shàn Wěijiàn), which was very gloomy. Usually he’s very bullish about China, but he was quoted as saying, “We think the Chinese economy at this moment is in the worst shape in the past 30 years.”

It reminded me, a little bit, of talking to you earlier in that I hadn’t heard him ever say such negative things.

But the reason I was cut off was I was in Virginia about an hour away from Washington, D.C., where I am right now, and there’s no mobile phone signal at my friend’s place, and the satellite internet cut out.

How can you have a friend without a mobile phone signal? Are you sure about this friendship?

Well, we’re in America, and only an hour’s drive away from the nation’s capital. They actually live in quite a nice part of Virginia. It’s wine farms and horse people. It’s not meth heads and trailer parks.

So I know there’s a lot of gloom about China and the decision-making seems really messed up right now, but I don’t think I’ve been anywhere in China in the last few years without a booming mobile connection, and I used to visit some very remote areas. China can be so surprisingly, so extremely organized.

So are we maybe reacting a little bit too much to the current crisis in Shanghai? These are the people who built all this infrastructure.

Look, there’s always a risk that any brilliant analyst will get conditioned by the latest shock and then draw a line between one point. So you’ve got to be careful that you don’t overblow it, but when we were talking earlier, I made the point that it’s not just rolling COVID waves that are leading to these draconian “dynamic” lockdowns from city to city. And even though none of us are expert epidemiologists, we know enough about the news flow to understand that Omicron is highly transmissible and likely to keep moving. And the latest reports show it’s creeping into Beijing, so who knows if that will happen.

But it’s COVID, it’s the supply chain ripple effects of that. It’s the headwinds of deleveraging. And I think the biggest wild card now is the Russian unlimited partnership. And so what I take away from this, and I’m a longtime optimist with respect to China, like my good friend, Shan, whom you just mentioned, he and I go way back. And we’ve written things together, and I’m usually in very tight agreement with him on most things. And I am in agreement on what appears to be this meeting held that was reported in the FT.

It speaks, to me, of a shockingly rigid decision-making process that is number one, incapable of admitting a mistake, and number two, not being nimble enough to come up with a different strategy.

And I think that’s worrisome.

I won’t pin this just on Xi Jinping or China. Lord knows, policymakers around the world suffer from an unwillingness to admit mistakes. Look at the Federal Reserve in the United States. We held interest rates too low for too long. Inflation popped up, and the Fed just stayed stuck and converted this into a transitory inflation scare that, count on it, will pass immediately.

And it took them a long time, belatedly too long, to reverse course. And they’re talking now that they’re tough and everything, but so far they’ve only boosted short-term interest rates by a lousy quarter of a point. So we’ll see if they deliver.

The point is, Jeremy, that China’s got a lot of issues to address, and it needs to have an active debate over those issues. That’s the point we were talking about when we were cut off. What worries me is that because of the consolidation of power under Xi Jinping, that active and productive debate is being stifled.

And so he is digging in his heels with zero COVID, whatever you want to call it, digging in his heels on deleveraging, digging in his heels and even more so on the Russian partnership, on common prosperity, on regulatory crackdowns, not giving in at a time when there are lots of challenges that I think require a more nimble approach to policy making. And so that is, I think, the broad constellation of forces that has me worried.

I’ll just complete this one thought, and then I’ll shut up.

I teach a class at Yale on China, and I had the final class on Tuesday night. And the students, there’s always a portion of the class where I throw it up for the students to ask critical questions about what they’ve read or what we’re covering in the lecture. And one of the questions that really struck me was along the same lines because we study a lot, and I think I mentioned this before we were cut off, one of the big milestones of the internal debate came in 2007 with Wen Jiabao raising questions about the strategy.

And the student asked the class, they said, “With this consolidation of power, are we ever going to see another Wen Jiabao who will speak up publicly and challenge the strategy and the context of the problems that China is facing?” And it’s a really good question. The absence of a vigorous policy debate in any country is always a huge risk, and that’s the case in China.

Do you have any reaction to the last couple of days? There have been a few announcements and speeches from Xi Jinping and then today from the State Council. Yesterday, Xi Jinping promised he’s going to spend on infrastructure to stimulate the economy. And then today, the State Council came out with announcements about support for the unemployed, even stimulus payments, essentially. They said they’re going to give living allowances to unemployed migrant workers.

Where does this come from? Are they just falling back on the old playbook, and it’s primarily there’s going to be an investment in stimulus? Or do you have a sense of what the thinking behind this is this week?

I think it just shows that there is a clear sense that the growth shortfall is significant and likely to last. You’re entirely right. The infrastructure approach is right out of the classic proactive Chinese stimulus playbook. We’ve seen it before. We saw it in the depths of the financial crisis of ’08. It was very powerful, and it allowed China to probably say it was the first economy to recover from the recession during that period.

Unlike the case back then, this current stimulus appears to be just bringing forward a lot of projects that were already on the books, so it’s more of a timing adjustment to an existing backlog of infrastructure rather than a brand-new set of initiatives. I saw the unemployment insurance. That’s a slightly different twist.

I may be wrong in this, but the last time I recall seeing that was during, actually right before the global financial crisis, when there were significant layoffs of migrant workers as well. And I think that’s worrisome because this is an unusual development and speaks to labor market distress that is rarely captured by the official unemployment data in China. And so the fact that the government’s moving may be an indication that the supply chain and repercussions of rolling COVID shocks is more serious than we’ve been led to believe.

Is there any meaningful communication, do you think, between the Fed here in the U.S. and the Chinese Central Bank, or are we just heading into really uncertain global storms and the U.S. and China, the two most significant economic actors, are not talking to each other?

I don’t know for sure about day-to-day communications between the Fed and the PBoC, but I suspect that they’re ongoing, maybe not at the policy-level basis between governors and vice-governors and at that level, but plenty of discussion on the operating side. And look, the Fed is reasonably transparent right now in indicating what it intends to do. And so there’s no big surprise from the standpoint of what China is expecting, to see the Fed raising expectations on rate hikes over the balance of this year.

I think the more interesting aspect of that is what this means for the renminbi, which is under a lot of downward pressure because of a deviation in the expected interest rate paths between the Fed and the PBoC. So China’s central bank, I think, is mindful of the currency risk and certainly does not want to see instability in the renminbi have further repercussions in its financial markets.

Tell me about your book, when it comes out, and what should people know as they prepare to buy it.

Well, first of all, they should prepare to buy it.

You’ll note how I asked the question.

The book will not be available until late October, unfortunately. It’s done, but believe it or not, I have been told that they would like to shorten the lag between the final edits, which have taken place this week, and production, but they’re having supply chain issues due to rolling COVID waves in China. So I said, “You’ve got to be kidding me.” But anyway, that’s what they’re telling me.

So the book is called Accidental Conflict: America, China, and the Clash of False Narratives. So my main thesis is that this conflict is very worrisome. It’s gone from bad to worse. It’s been building for a number of years, but beginning with the Trump administration, a full-blown trade war quickly morphed into a tech war, and now we’re in the early stages of a cold war, in my view. It’s a conflict that didn’t have to happen were it not for a confluence of false narratives that each nation has with respect to the other.

And the bulk of the book goes through an equal number, because I want to be fair, of false narratives that the U.S. has with respect to China and that China has with respect to the U.S. And the thesis is that these false narratives come together in a clash and lead to conflict escalation that has put us on a really dangerous trajectory. And the approach that we’re using to manage this conflict clearly hasn’t worked. It needs to be abandoned, and we need to come up with a new framework.

If I told you the framework — I lay this out in the book — you won’t buy the book. But I can assure you that I have three chapters at the end of the book that lay out a very, I hope, new, different, and innovative approach to resolving what could be the greatest conflict of the 21st century.

All right. Well, thank you very much, Stephen. That’s great. Thanks so much for being willing to do this again after my internet cut out this morning.

You’ve got to get new friends.

Invited to Tea with Jeremy Goldkorn is a weekly interview series. Previously: 

‘The mandate of heaven, ain’t falling yet, but there’s a lot of shit on people’s shoes’ — Q&A with Howard Snyder