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Morgan Stanley Asia chairman Stephen Roach
Morgan Stanley Asia chairman Stephen Roach

The Outlook

Stephen Roach: Still a bull on China, despite bumps ahead Add to ...

Remember that television commercial about a stockbroker lunching with a client in a noisy restaurant? As he begins to talk about stocks, the room goes silent. All the other diners are leaning forward, straining to hear what he is going to say. "When we talk, people listen," the commercial ends.

That's almost the kind of reaction Morgan Stanley Asia chairman Stephen Roach elicits. He "has been proven consistently right, especially about Asia and, in a more focused way, China," noted The Australian recently. His "opinions on the global economy have been known to shape policy from Beijing to Washington," Newsweek said.

During the boom years of this decade, Mr. Roach warned of the growing imbalances in the global economy that eventually led to the financial crisis of 2008. Now he has a new book on Asia, warning of growing imbalances in their economies, particularly China. He is still a long-term bull on the region but sees potential for some rough weather in the short and medium terms.

His book The Next Asia: Opportunities and Challenges for a New Globalization (published by John Wiley & Sons), is a journal-like collection of his op-ed articles and essays published in the print media since 2006. It also includes transcripts of speeches.

In the introduction, Mr. Roach's book begins provocatively with the statement: "Many believe the Asian century is at hand. Such celebration may be premature."

The basic problem is that China needs to find a new growth recipe. The past focus on promoting exports has resulted in the country becoming heavily dependent on U.S. consumers who are now in a retrenchment phase that will go on for years, Mr. Roach believes.

China and the U.S. have stabilized their economies for the time being with massive monetary and fiscal stimulus. But once the infusions wear off, both countries will likely be faced with a rather subdued recovery compared to past norms. Policy stimulus will be like "pushing on a string," leaving in its wake an era of anemic, stop-and-go growth - similar to the one Japan has experienced.

Furthermore, if another financial crisis and economic downturn is to be avoided, China needs to move to a model of more consumption and less saving, he suggests. The U.S. has to do the opposite, moving toward less consumption and more saving. The old policies of stimulating U.S. consumers and ramping up Chinese exports will just exacerbate global imbalances, he says.

The resolution of the imbalances will likely follow a bumpy road. One of the bumps could be a trade war between the U.S. and China, says Mr. Roach. Already we have seen U.S. President Barack Obama levy tariffs on Chinese tires in response to complaints from labour unions in the U.S. tire industry.

So far, China has shown little interest in relenting on the suppression of the value of its currency against the U.S. dollar, a key prop in its export-led growth. What might effect a change in that stance is a move toward protectionism in the U.S., as spurred on by the growing voice of labour in U.S. politics, he says.

Investors who take the "big picture" into account will find Mr. Roach's book a treat to read; the writing is clear and the viewpoints are cogent.

The book is chock-full of arresting statistics. Here is a sample:

"The export share of [Asian economies']gross domestic product hit a record 47 per cent in 2007, fully 10 percentage points higher that the portion in the late 1990s."

"With nearly 80 per cent of its GDP going to exports and fixed investment, China has become overly reliant on cross-border exports and on the investments required to support the logistics and capacity of its increasingly powerful export machine."

"Although America accounts for only about 4.5 per cent of the world's population, its consumers spent about $10-trillion in 2008. By contrast, although China and India collectively account for 40 per cent of the world's population, their combined consumption was only about $2.5-trillion in 2008."

"In the second half of 2008 … the American consumer pulled back more severely than at any point in the post-Second World War era. Yet that correction left the consumption share of GDP at a still elevated 71 per cent in late 2008 - down only 1 percentage point from its record 72-per-cent high in early 2007."

"If mean reversion is in the offing for a post-bubble U.S. consumer … then only about 20 per cent of the correction has occurred."

Q&A with Stephen Roach

Q. You are still a long-term bull on China but the problems China now face seem to be similar to what Japan faced, i.e. the strategy of export-led growth is approaching an unsustainable phase. Why do you think China will avoid a Japanese-like period of stagnation longer term? A. In the end, it wasn't the export-led growth model that pushed Japan into the quagmire. It was the way they set their macro policies - especially monetary - in the context of their export-led growth. In particular, by allowing the build-up of enormous equity and property bubbles in the late 1980s that led to reckless behaviour by interdependent financial institutions, Japan squandered its prosperity. Sound familiar? These are lessons, in my opinion, that are more relevant for the United States than for China. The one lesson from both economies that applies to China is that imbalances - and the asset bubbles that often underpin them - are not sustainable. And the painful corollary is that the longer these imbalances are perpetuated, the tougher the endgame. China, despite its extraordinary successes over the past 30 years, will not get special dispensation from this basic macro principle. As China's Premier Wen Jiabao reiterated in early September at a conference in Dalian, its rebalancing imperatives have never been greater.

Q. You have said China needs to build out its social security safety net to get the Chinese to save less and spend more. By extension, does this mean developed countries should also roll back their safety nets to encourage saving and discourage consumption? A. I am not advocating the roll back of safety nets in the developed world -- unless they entail restrictive employment practices that add to labour costs and impair productivity growth (i.e., Germany). Nor can it be said that the developing world under-consumes and the developed world over-consumes. The main consumer that spent to excess has been the American consumer, where the safety net is actually less secure than counterparts elsewhere in the developed world. Excess U.S. consumption was more a function of bubble- and credit-dependent lifestyles - aided and abetted by over a dozen years of reckless monetary and regulatory policies. Ironically - and tragically - as many Americans squandered their income-based saving in this Era of Excess, pressures on existing safety institutions (i.e.., Social Security and private pensions) is now more acute than ever in the post-bubble period.

Q. Doesn't an enlarged social security safety net come with a host of unintended consequences that undermine growth, (i.e. work disincentives from higher taxes/benefits), a smaller role for markets in the allocation of resources, etc.? Could there be other solutions to rebalancing Chinese consumption and savings? A. I have focused on safety as a major answer to Chinese consumption because of some of the unique characteristics of the Chinese labour market - namely, job losses of over 65 million workers due to the state-owned enterprise reforms of the past 15 years, together with the elimination of the "iron rice bowl" that used to provide cradle-to-grave support for state-employed workers. The resulting job and income insecurity has been a huge shock to Chinese families that has undoubtedly played a major role in the increase in fear-driven "precautionary" saving. Professor Eswar Prasad of Cornell University estimates that the household saving rate in China rose from 27.5 per cent in 2000 to 37.5 per cent in 2008. Gallup's China Poll shows that 68 per cent of Chinese families still remain dissatisfied with their current saving positions in 2008. An expanded saving net would address these concerns head-on and go a long way in fostering a healthier macro consumption climate. But it certainly must be augmented by other pro-consumption policies - especially tax-based measures to support rural incomes and land reform.

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