Q You and your team are more optimistic than the market consensus on growth in the world’s biggest economies. Between now and 2020, you’re calling for annualised GDP growth in Japan of 2%, 3% in the US, 7% in China, and 8% in India. But why now – what’s changed?
A The most obvious thing is that Asia’s biggest three powers – China, India, and Japan – have secure, confident governments. They are all talking a good game on reform. Shinzo Abe could become the longest-serving prime minister of Japan since the 1970s. Narendra Modi’s election delivered a stable majority. And Xi Jinping has consolidated power more quickly than many expected. Put together, this stability is different and distinct from other recent periods. On top of that, the US recovery seems to have broadened and deepened. So we have political novelty in Asia and conjunctional developments in the US.
Q The data out of the US is, by and large, positive, but never consistently positive. Is 3% GDP growth really possible?
A A severe financial crisis casts a long shadow. But this will eventually pass. It is possible to be optimistic about America shrugging off its effects.
Q What is the time horizon you’re considering?
A Our thesis looks out five or six years. For all of these countries, in the early years their source of growth is cyclical recovery, led by domestic demand, which closes the output gap – the difference between actual GDP growth and potential GDP growth. Then it will become important for these governments to implement structural reforms that allow GDP to grow even faster.
Q What connection do you make between GDP growth and the stock market?
A There is a connection over time but it’s often difficult to tease out. Stock market prices often anticipate growth. We undertook analysis with the Economist Intelligence Unit to project the impact of our scenario on commodity and stock markets. If prices and exchange rates are constant, the impact on energy, food and equity markets are quite striking.
Q Perhaps, though, stock markets in all four countries have already anticipated future growth. They’re all quite expensive.
A That is most likely true for India. There was a great deal of optimism there in advance of Modi’s victory. More recently the market has plateaued as people realize that structural reform is hard to achieve. But our model projects that index levels will continue to remain high.
Q Is there anything about China’s current stock-market boom that is related to longer-term views about the economy? The general consensus would be one of slowing conditions.
A There’s no credible relationship in China between growth and the stock market. I’m not in the camp that thinks this market rally reflects great confidence in the economy. The rally may have begun as a ruling out of really bad outcomes: the bubble of pessimism popped. But if that is the case, the rally has gone past that.
Q To the extent that China’s GDP level remains propped up by fixed-asset investment, one could argue that continuing to grow GDP by 7% for the next five years is actually a sign of reform failure. What do you make of that?
A I quite strongly disagree with the view that structural reform requires growth to dip below trend. Slower growth won’t help at all. I might agree if inflation were at 4% but it’s below 2%, suggesting China is running below its potential rate of growth. Even where there is overcapacity, China still invests less per worker than the US. Prices in iron ore, steel, and cement might change but not the price level [meaning the aggregate level of prices in the economy]. Necessary changes to prices can occur without deflation.
Q Even factoring in the credit problems China faces?
A Yes. The broad stock of credit accelerated very quickly after the financial crisis but it has since returned to trend. What’s changed is that nominal GDP has fallen, so the ratio of credit to GDP looks high. The trick is to link the rate of credit growth to nominal GDP growth: there has been a decoupling between these two things, and that needs fixing. The government talks as though it understands that point.
Q How interdependent are these optimistic forecasts? How sustainable are they if one or more of these four economies doesn’t perform so well?
A Our model showed that even if only one economy is growing as fast as we’ve outlined, the others will grow at the EIU’s baseline rate, which is no disaster. China and the US have a big effect on the others, while India and Japan do not. It’s obviously easier for each to succeed if the others do too but the biggest part of their economies is domestic. The sequencing goes: if their expansive macroeconomic policies gain traction, these countries will have room to grow once domestic demand picks up; then they must continue to improve through structural reform.
Q Abe, for example, has been constantly criticised for failing to shoot his ‘third arrow’ of restructuring. You’re saying it doesn’t matter, at least not yet.
A The importance of structural reform is overstated at this stage. The Japanese cabinet’s official estimate of Japan’s output gap versus inflation suggests that if actual GDP growth met its potential, there would still be deflation. This is too conservative. The output gap is bigger than they suggest. [Meaning there is greater scope for the economy to grow.] The point is [that] there is slack in the economy.
Another point about restructuring: there is a mismatch between reforms that are politically significant and those that are economically significant. Take agriculture. There are connections between farmers and politicians but agriculture is a small sector in Japan’s economy. Conversely, efforts to improve corporate governance and to make companies more attentive to return on equity [are] already having a beneficial effect.
Q To what extent are technocrats in China relying on more open capital markets to impose discipline on lending, rather than on cleaning up the banks themselves?
A There are arguments in China that foreign capital can discipline markets but the amounts would be small. There has been a lot of talk about patient, sensible foreign capital forcing institutional changes in the stock market. But it hasn’t happened. The stock market hardly looks to have a patient, long-term investment culture. So, yes, China would like to have foreign capital in order to diversify the gene pool but it’s not decisive.
There is also a theory that constituencies within China are impressed with the idea of the renminbi as a global reserve currency, befitting the nation’s status. Some people are playing on that to further liberalise the capital account, which will make it harder for them to maintain a strict regulation of local financial markets – which ultimately makes [renminbi] liberalisation a lever to promote domestic reforms.
Q Do you think that’s true?
A As I say, it’s a theory, although China does seem invested in the idea of the [renminbi] joining the [Special Drawing Rights basket used by the International Monetary Fund] out of proportion to its importance.
Q What domestic reforms are key? Liberalising interest rates on deposits?
A I don’t think financial repression is the source of all of China’s evils, particularly given the low interest-rate environment globally. More important is what banks lend to, not the banks themselves. What matters is reforming state-owned enterprises and ending their implicit state banking and sheltering from the marketplace.
Q What aspects of SOE reform are you looking at? Officials initially seemed bent on partial privatisation but that hasn’t worked.
A Ownership matters less than competition and market structure. State ownership is fine so long as the company must compete.
Q Is there a risk that China liberalises the capital account too quickly and experiences a rush of foreign money that pushes up asset prices too fast, like in Japan in the 1980s?
A The sequencing I described – of using liberalisation as a lever – is not optimal. I’m not sure things would play out like Japan in the 1980s, but I can imagine unhappy scenarios. On the other hand, many policymakers in China feel the capital account is already quite porous. They have $3.8 trillion of foreign reserves. Caution is required. But it’s not like Chinese authorities have lacked caution. I’m not a fundamentalist about this. I’m not calling for China to throw open the doors to capital flows. The country is not short of capital, and most of its financing needs will be best served through local bank lending.
Q How relevant are big trade pacts such as the Trans-Pacific Partnership to realising the synchronous growth stories for these countries?
A Not very. For these economies the most important sectors are already relatively open. Trade deals may be politically significant. TPP could become an index of Abe’s willingness to take on vested interests but in itself it won’t transform Japan’s economy. Besides, these agreements are usually piecemeal and phased in over time, and both the hopes and the fears around them rarely materialise.
