Interview: Prof. Michael Pettis, Peking University

Michael Pettis is a Professor of Finance at Guanghua Schools of Management at Peking University in Beijing

I think there has been growing criticism for many years of a global economic system that has led inexorably to rising income inequality, growing trade and capital imbalances, and soaring debt, and, as Matt Klein and I explain in our book ("Trade Wars are Class Wars"), these are all related aspects of the same system: we cannot address one without addressing the other two. 

Because the Covid-19 pandemic has accelerated these existing trends, I think it is more obvious than ever that we need to address all three, and this almost certainly requires a greater role for the state in reversing the policies that led to such high rates of income inequality as well as in managing the unfettered capital flows that allow countries that repress wages to pass the costs on to trading partners.

There really aren't strengths and weaknesses per se. There is instead a structure of political, financial, and social institutions that under one set of conditions can lead to rapid growth and under another set can lead to stagnation or soaring debt. 

By repressing the household share of GDP to among the lowest levels in history, China is able to force up its national savings rate to the highest in history, and by corralling those savings into a highly controlled banking system, Beijing and the local governments are able to pour huge amounts of savings into pet projects. 

Three or four decades ago, when China was hugely underinvested for its level of development, this system poured money almost indiscriminately into investment into much needed infrastructure and manufacturing capacity and the economy boomed. 

After 2-3 decades of the fastest investment growth in history, however, and the highest investment share of GDP in history, Chinese investment passed the point at which the country could absorb additional investment productively, after which it need deep institutional reforms that by reversing the existing imbalances would allow Chinese workers and businesses to absorb more capital stock productively (most importantly, this required a substantial redistribution of wealth to ordinary households). 

But while Beijing has been talking about doing this for 10-15 years, it has proved institutionally too difficult to manage. What was the great institutional strength of the Chinese economy in the 1980s and 1990s, in other words, has become its weakness in the 2010s now that it is seriously overinvested, rather than underinvested.

It needs one very urgently, especially the US, which bears the "exorbitant burden" of the US dollar as the main absorber of global excess savings. 

The problem is that American policymakers doesn't want to the world to relinquish the dollar because of the political advantages it brings to Washington and the Wall Street, and the world doesn't want to give up the dollar because of the economic advantages it brings, and there is no replacement for the dollar because no other country is able and willing to pay the cost that the US must pay for dollar dominance. 

This system is unsustainable, however, and so we must decide today whether we want to take the trouble to design a new, more sustainable system, or wait until the existing system breaks down chaotically because of a unilateral decision by Washington to withdraw.

Michael Pettis is a Professor of Finance at Guanghua Schools of Management at Peking University, where he specializes in Chinese financial markets.

His new book, with the co-author Matthew C. Klein, has just been published (June 2020) by the Yale University Book: “Trade Wars are Class Wars”.