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The Bush Institute Talks with Hank Paulson about China

May 21, 2015 7 minute Read by The Bush Institute

Henry M. Paulson, Jr. has dealt with China as both U.S. Treasury Secretary and as chairman and chief executive officer of Goldman Sachs. As Secretary of the Treasury from July 2006 to January 2009, Paulson negotiated economic reforms with China.  As head of Goldman Sachs, he helped open the door to private enterprise in China.

Now, Paulson is involved with China as founder and chairman of the Paulson Institute. Based in Chicago, the Institute focuses on China’s environmental and economic challenges.

Paulson appeared recently at the George W. Bush Presidential Center to discuss his new book, “Dealing with China.” The Bush Institute blog followed up with these questions about the evolution of China. Paulson responded via email why he thinks, among other things, that China must reboot its $10 trillion economy.

You have worked with China as both a private sector leader and Treasury Secretary.  From your point of view, how did China rise to an economic superpower so quickly?

In the early days of China’s remarkable transformation, it was impossible not to be captivated by the energy and work ethic of the Chinese people and their strong desire for change.  China’s potential really struck me when, in the early 90’s, I visited the special economic zone in Shenzhen.

There, I saw amazing entrepreneurial spirit in action. I tell the story in my new book, Dealing with China, of how the nation used landmark capital market transactions to bring in Western capital and knowhow to help unleash market forces.  I believe this spirit combined with desire on the part of the leaders to make hard, market-oriented choices to improve the welfare of its people really helped drive change and transform the country.

That said, China’s debt-fueled, investment-driven, export-led economic growth model is running out of steam.  Their continued progress in making economic reforms is urgent – for them and for the rest of the world.

Their leaders understand the magnitude of their challenge and I believe the top leaders are committed to making hard choices to allow their nation to continue to grow and prosper.  But it is difficult to reboot a $10 trillion economy.  Vested interests oppose a number of the necessary reforms.  It is in our interest to help them while be equally committed to doing what is necessary to get our own house in order.

What kind of approach do you think the United States should be taking now with China?  For example, where are opportunities for mutual benefit between the U.S. and China?

The best way to ensure healthy competition is to find ways to turn shared interests into shared successes.  Small steps – if they are concrete – can help build trust.

One clear way to accomplish this is by completing a Bilateral Investment Treaty (BIT) between the U.S. and China.  A successful BIT would require the Chinese to open up many more sectors of their economy to our companies, which would help China shift its economy toward consumer-led growth.  This would help America’s financial services, telecommunications, accounting, health care and consulting businesses.  At the same time, a BIT would almost certainly lead to increased Chinese investment in the U.S. and create more jobs.

In your book, you say that you are confident China will face a financial “reckoning,” but that it has the tools in place to avoid a far-reaching crisis.  What gives you that confidence?

I believe that China’s leaders are clear-eyed about the complex economic and social challenges their country faces.  What’s more they have the determination and political skill to advance their agenda for economic growth.

In China, the likely trigger for a crisis could be the broad-based decline in real estate.  Faced with big losses, the central government will have to step in to protect the banks and stand behind local government debts.

The key is to fix the structural flaws in the underlying economy and stave off financial system excesses before they become so big they threaten the real economy.  The leaders have put forth an economic reform plan aimed at doing just that.  They are working on a wide range of fixes, beginning with national fiscal and tax reform, but it will take years to implement.

The good news is that China has the financial capacity to deal with near-term problems, even if loan losses are great.  China’s economy has become big and diverse.  It has deep pockets and the legal authorities and political will to bail out failing financial institutions.

Beyond the economy, what about China’s environmental and water challenges?  How does that impact China and the rest of the world?

The dirty air and water in China are literally killing its people and they are demanding change.

The foul air is one of the most visible and daunting challenges China’s government must address as it confronts the increasingly dark side of its economic success.  Pell-mell growth and years of poor planning, energy inefficiency, bad regulation and lax enforcement have ravaged China’s cities and countryside.  Ground water is all but depleted, rivers and lakes are polluted – many too polluted to even be used for irrigation.

These enormous environmental and water challenges threaten China’s ability to grow and cause the leaders to be concerned about unrest and their ability to hold on to power.  But the implications go far beyond China and the rest of the world.  If China doesn’t address its environmental challenges – particularly carbon emissions – it will negatively affect everyone in every country of the world.  To that end, I founded the Paulson Institute in 2006, which is focused at the nexus of economic and environmental issues in the U.S. and China.