With the recent upturn in China’s economic growth and mounting trade tensions we sat down with Andy Rothman, an Investment Strategist at Matthews Asia, to discuss major developments in China’s economy, its political situation, and its relations with the United States.
Q: Given the Trump administration’s new tariffs on solar panels, let’s start with U.S.-China trade relations. Do you think a trade war between the United States and China is likely? Who would win?
A: The prospects for a trade war are much lower than most people think. While Trump has blamed China for economic woes in the United States for over a decade, he did nothing on U.S.-China trade in his first year, and he’s emphasized his warm relationship with President Xi Jinping. This year I think he will talk in tough terms, but the actual measures will have only a minor impact. The Chinese will count up the costs, see that they’re small, and respond in a measured and moderate way because they don’t want a conflict.
It’s clear that Trump’s advisors do want a trade war. But he won’t actually launch one because he likes taking credit for strong U.S. equity markets, and a trade war with our largest trading partner would put that at risk. Trump also knows China would retaliate against imports of U.S. soybeans first. Most of our soybeans are grown in Republican districts, and a hit to those exports could help Democrats regain control of the House.
Trump could score the political points he believes are associated with appearing tough on trade with China without taking truly damaging actions. Small tariffs on imports of steel, aluminum and solar panels are enough to make the media say “trade war.”
Q: How would you describe the nature of the economic tensions between the United States and China?
A: I think it’s mostly politics. Since China joined the WTO, it’s been primarily a positive net outcome for U.S. consumers and workers. Some workers will always get hurt by imports; that’s unavoidable. JFK asked for legislation to protect workers when we were going to join the GATT because even back then he understood that imports would hurt some U.S. workers. The answer isn’t to block imports. It’s to help workers adjust with a social safety net and job training. We need to help people get jobs that will turn steel and aluminum into higher value-added products. It is worth noting that since China joined the WTO, hourly manufacturing wages in the United States are up by 50 percent.
This administration is obsessed with trade deficits, but 99 out of 100 economists will tell you that bilateral deficits aren’t a scorecard and don’t mean that you’re winning or losing. When our economy is strong and unemployment is low, we typically run more of a deficit because we’re consuming more.
Ultimately, we need to reduce barriers to access in China. Up until recently, we were negotiating a bilateral investment treaty (BIT) with China, but it’s been suspended for a year now. We need to get back to that.
Q: Has China been on the back foot in negotiations during this massive economic restructuring, trying to make some industries shrink and others grow?
A: Negotiating with China has proven productive in the past, and has opened markets. General Motors, for example, now gets about 20 percent of its global earnings from China. The only way to know what new market access we can achieve is to resume the BIT negotiations that began during the Obama administration.
China has made really important state-owned enterprise reform and supply-side reform in the last couple of years. We’ve complained about overcapacity in steel, and they’ve taken significant steps. They now have one million fewer steel workers than three years ago (down 25 percent), with a similar change in coal.
The positive effects of Chinese restructuring can be seen in the big improvements in corporate profitability. You now have better quality, and more efficient firms that are compliant with pollution reforms and have greater pricing power.
Profits at larger industrial firms rose 21 percent in 2017, compared to about 9 percent in 2016. Operating margins of Chinese industrial firms are at the highest levels since 2011. Capacity utilization rates are up significantly. This is one reason why our Matthews Asia China fund went up 59 percent last year. Driven by strong earnings, forward P/E ratios actually only went up from 10 to 12 last year.
This is strong evidence that supply-side reforms are really working.
Q: You’ve been on the China bull side of the story until your latest 2018 outlook. Now you’re anticipating that China will return to a slightly lower long-term trend. What is that long-term trend and what do you think will pull down growth?
A: I’m still quite bullish on China! We have to be realistic and understand that the year-over-year numbers for most parts of the Chinese economy have been slowing for many years, and that gradual deceleration will continue. But, these growth rates are now applied to a much bigger base, and are still some of the fastest growth rates in the world. China is also likely to remain the world’s best consumer story. Not only are real retail sales rising at 9 percent, but the dollar value of Chinese consumer spending should surpass the value of U.S. retail sales within a few years.
One point I always emphasize is the scope of change in China over the past couple of decades. For example, GDP growth is now primarily driven by consumption, not by investment. If you go back a decade ago, those expecting a collapse said China could not rebalance away from manufacturing and building a lot of infrastructure. China’s economic rebalancing is not done yet, but they’re moving in the right direction.
Q: Now that China’s economy and financial system are becoming more open to the world, will we see a drastically different China?
A: I think it is important to recognize that getting China into the WTO has helped many American workers and businesses. Since China joined the WTO in 2001, U.S. exports to China have grown by 500 percent, but only by 90 percent to everyone else. China is our largest trading partner; GM and Boeing sell more in China than in the United States.
However, there are still serious market access problems. Where do we want to use our political leverage with China? Do we want to focus on steel and aluminum, which are small and shrinking parts of the U.S. economy? Or, do we push China to open more in our mutual areas of growth, like pharmaceuticals and financial services and tech, to drive wealth creation in the United States? The way to do this would be through negotiations, but we’re currently not negotiating anything with Beijing.
Q: Xi is establishing an alternative political structure and economic system in contrast to the West. What about the limitations on the internet, etc. Is it an evolution?
A: China has long been a one-party authoritarian regime. What is new is that Xi has been more effective at consolidating power and getting done what he wants done.
Here, too, I’d emphasize the scope of change over the past couple of decades, particularly in what I call personal freedom, the ability of Chinese people to conduct their lives as they see fit. There has been dramatic change in this respect.
And China is more entrepreneurial. When I worked in China 30 years ago, there were no private companies, not even restaurants. Today, 85 percent of urban employment is with small, privately-owned companies. All of the new net job creation now is from small, entrepreneurial companies because state-owned enterprises are shrinking.
In my view, China is on the right track. The economy is increasingly open and entrepreneurial. Many American companies are doing well there. And most Chinese people have a standard of living that is far better than what their parents enjoyed, and most Chinese believe their kids will have an even better life.
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