Keynote Speech at 2011 Tsinghua Management Global Forum

By John L. Thornton

October 25, 2011

"China in the world” and “China’s role in the 21st century” are twin themes discussed vigorously inside and outside China. After three decades of growth that has transformed the country in every respect, China today exerts more influence on the global economy than at any point in its modern history and more impact on diplomacy and security in the region than at any time since the apex of the Qing Dynasty. China’s transformation still has a long way to travel. In attempting to rebalance its economy toward a more equitable, sustainable, consumption and innovation-led growth model, China is entering one of the most challenging and decisive phases of Deng Xiaoping’s reform and opening era. This pivotal transition will be led, beginning next year, by a new generation of Chinese leaders.

The most significant external factor determining the nature and scope of China’s international role is its relationship with the United States. Conversely, the major challenge of the next decades for U.S. economic and foreign policy will be how the U.S. deals with a rising China. America is in the midst of its own painful economic transition and could experience a significant political shift in next year’s presidential election. Populist movements from both the right and left, such as the Tea Party and Occupy Wall Street, reflect disillusionment with the state of the country and growing calls for more functional and accountable political and economic leaders.

For many compelling reasons, the parallel economic transitions underway in China and America should be complementary and mutually reinforcing. Both very much need the other’s economic rebalancing to succeed. And yet, due to reasons of history, culture, politics and, at times, the pursuit of narrow national interests by both sides, China and the U.S. are still far from forming the kind of partnership and relationship of trust that would make it easier for both to succeed and, in so doing, lay the foundation for a better world in the years and decades to come.

China is not only the second largest economy in the world, but also its second most important and consequential power. The last few centuries have been favorable for the West. In 1970, the U.S. and the European Union countries accounted for more than 60% of the world economy. By contrast, China, already the most populous nation in the world, accounted for less than one percent of global GDP.

Since then, the situation has undergone a radical transformation. Today, China produces more than 7% of the world’s economic output. And the trend is accelerating. In 2010, China again grew the fastest of any major nation. U.S. growth came in 127th in the world. At the time of the Iraq War in 2003, the U.S. economy was eight times the size of China’s; today it is three.

The stark contrast is not limited to the relationship between China and America. Rather the two largest economies are representative of a broader shift of historic proportions taking place between the so-called advanced economies and the emerging ones. Last year, emerging economies, led by China, accounted for almost ¾ of the world’s GDP growth. In purchasing power parity terms, they will soon count for over half of the global economy – something that has not happened for several centuries.

The rise of emerging economies is also rapidly restructuring global trade. A decade ago, over 2/3 of all copper was consumed by the U.S. and other developed countries. Copper consumption five years from now is expected to be more than double that of a decade ago, but over 80% will be consumed by China and other emerging economies. The same pattern holds true for most every natural resource or commodity.

Several centuries of Western preeminence in various spheres are coming to an end. My friend, Fareed Zakaria, calls it “the Rise of the Rest.” The world that is emerging is one in which the gap between the have and have-not nations will be smaller. Handled properly, this is indisputably a good thing. Putting things in perspective, it is useful to recall that the West’s dominance of global resources and productive forces has spanned a relatively brief period of history. The 19th and 20th centuries were the exception to the general rule: for eighteen of the last twenty centuries, China was the largest economy in the world by some margin. At the end of the 18th century, during Qianlong’s reign, China accounted for a third of the world’s economy.

History teaches us that periods of great transitions such as these can be perilous. Established powers are rarely willing to cede benefits and monopolies they have enjoyed for so long, while emerging powers chafe when they feel their growth and influence are being stifled. We can see aspects of this worrying dynamic in the relationship between the U.S. and China. While the two largest economies are highly interdependent, there is a serious deficit of understanding and trust between the two countries leaders and peoples. In China, Currency Wars, with its tale of Western conspiracies to keep China down, was an instant bestseller. In the U.S., we have seen a rise in literature about the “China threat” that predicts inevitable conflict between the U.S. and China with titles such as How China’s Growing Prosperity Threatens the American Way of Life and The China Threat: How the People’s Republic Targets America.

Foreign direct investment is a good example where the lack of trust has concrete consequences for both sides. FDI has been an important engine of Chinese growth. A record $105 billion in FDI entered China last year. In the U.S. President Obama’s Council on Jobs and Competitiveness has called for attracting $1 trillion in foreign investment over five years as a way to create much needed jobs. Yet CEOs in both countries lament the difficulties in investing in the other.

Both the U.S. and China need to understand that the economic relationship between them is no longer one of one side selling and the other side buying. During the January State Visit of President Hu to the U.S., I was asked to help organize and chair a meeting of Chinese and American CEOs presided over by Presidents Hu and Obama. Zhang Ruimin, the founder of Haier, described to the two leaders a successful partnership with General Electric that was representative of the complementarity of relationships that could and should exist between many American and Chinese firms. GE had tried for many years without much success to sell white goods in China. Then two years ago, GE asked Haier to act as its distributor in China. In the first month of the arrangement, more GE white goods were sold in China than in the previous 18 months. Subsequently, GE and Haier reached agreement for Haier to manufacture GE-branded products at its plant in South Carolina. Zhang Ruimin told this story to underscore for the leaders that this kind of complementarity and enduring partnership between U.S. and Chinese business was a better way to think about commercial relationships between companies from the two countries and should be the model for economic ties between the two countries.

Unfortunately, such success stories are still not well known in either country and, when it comes to the economic relationship, as in so many other areas of US-China relations, each side mirrors the other’s hesitancy. Caution breeds caution; distrust engenders more distrust; finger-pointing goes in both directions; fears are confirmed; marginal voices in both countries receive undue attention across the ocean.

The only way to break a cycle of distrust is for the two countries to move meaningfully in tandem. Although there are tensions between the U.S. and China on some issues that are real and substantial, there are more tensions based on a lack of understanding rather than a true conflict of interests. We cannot forever wait for the other to make the first gesture. We need to take steps jointly to create a new kind of interaction, a new dynamic. In order to do so, as an initial step, we need to start with a more accurate and sympathetic understanding of each other’s respective situation and challenges. If we can achieve this, my own belief from splitting time between the two countries for many years, is that both sides will come to the realization that their situations are fundamentally complementary – that neither China nor the United States can hope to succeed without the help of the other.

The starting point for building mutual empathy between China and the U.S. is to understand that the two countries, in many respects, are undergoing similarly daunting transitions.

In China, there are at least two major shifts taking place. One is political and generational and will start next fall. The 5th Generation of Party and Government leaders who will succeed Hu Jintao and Wen Jiabao and their colleagues are a particularly able and experienced group. Anyone who has had meaningful exposure to them cannot help but have been struck by their clarity of purpose, their determination in where they want to take the country and their openness to ideas and advice that can assist them in executing on their priorities. They will be presiding over a society and a set of challenges that are larger and more complex than their predecessors faced.

The second transition is from an export-led, labor-intensive, fixed investment economic growth model to one driven by domestic consumption and innovation. It is a painful process that will last at least a generation. But based on my interactions with officials at various levels and sectors, I am convinced of the commitment to the necessity of this transformation. Premier Wen Jiabao said it unequivocally at the last National People’s Congress: "China's economy needs to be quickly put on the path of domestic growth driven by innovation."

The Twelfth Five Year Plan adopted at the same NPC is meant to be the blueprint for the country’s new path. Accelerating what has already been history’s largest and fastest mass migration to the cities will be central to the government’s efforts to raise living standards and consumption. People who live in cities tend to earn more and consume more than those who live in the countryside. Vice Premier Li Keqiang has said urbanization will be the “strategic focus” of the government’s efforts to expand domestic demand. The census released in April showed that half of China’s 1.34 billion people will soon be living in cities. This compares to about 1/5 of the population in 1982 when China’s reforms were getting underway. China is experiencing a societal transformation that took a century in the West and four or five decades in Japan and Korea on a far smaller scale. It is also the most intensively managed of history’s major migrations as entire new cities are built to house the new urbanites.

The five-year plan also advances policies meant to narrow the gap between rich and poor. The minimum wage is meant to increase significantly. A basic pension plan will be extended to all rural residents and 350 million urban residents. Thirty six million new apartments are planned for low income families. Focusing more on the quality of growth than simply the rate, the new plan lowers the target GDP growth rate to 7 percent from the previous plan’s 7.5.

Chinese leaders have also made clear that they intend to make technological innovation a pillar of the country’s next phase of development. The new five-year plan designates seven “Strategic Emerging Industries” to receive preferential incentives. These industries are meant to be the backbone of China’s future economy and also ones in which Chinese companies can grow into global leaders. The list makes evident the scale of the country’s ambition: biotechnology, new energy, high-end equipment manufacturing, energy conservation and environmental protection, clean energy vehicles, new materials, and next-generation information technology. These sectors, which now contribute about 5% of GDP, are expected to account for 8% by 2015.

The test, of course, will be in the execution, and previous five-year plans have not always been very good predictors in that regard. The actual GDP growth rate for the period of the last plan was not 7.5%, but nearly 11%. Despite repeated calls from leaders in recent years to rebalance the economy, consumption’s portion of GDP is actually 10% lower now than it was ten years ago. Cynicism about ‘low-income’ housing is rife at a time when an explosion in property prices has left many in the middle class wondering if they will ever be able to afford a home. On innovation, China has to date produced few world leading technology companies.

The government will also be navigating this enormous transition while trying to ameliorate and balance a host of serious problems that have arisen as a consequence of growth: inflation, a potential property bubble, the increasing income divide, corruption, the environmental cost of unchecked development, managing a floating population of migrant workers larger than the entire populations of Russia or Japan. Premier Wen has said China’s economic growth is “unstable, unbalanced, uncoordinated and unsustainable.” He has also said that there is a need for greater public accountability and supervision of the government’s work and effectiveness. Despite the breakneck pace of growth, people are worried. Anecdotally, it is not difficult to find families who are saving even more of their income as an insurance policy for a hard-to-predict future. More of those who can afford it appear to be buying real estate overseas.

Nonetheless, I remain a believer that China’s inherent strengths outweigh its weaknesses. The emerging middle class and the potential domestic market it represents are perhaps the country’s most obvious economic advantages. China’s investment in infrastructure over the past twenty years has left it with some of the world’s best networks of airports, highways, ports, and railways – all of which are significant multipliers of growth. The culture of entrepreneurship is a core Chinese quality. Inspired by the Robin Li’s and Jack Ma’s, young Tsinghua graduates dream of creating and building the next Baidu or Alibaba. The Chinese emphasis on education is world renown. And, finally, China benefits materially from the very perception of China’s rise. In global trade and investment, perception is often reality, and China’s rise makes more people want to do business with it, to invest in it, which further helps China’s growth – creating the virtuous cycle we see today.

In addition, there are compelling reasons to believe the commitment of the government to restructuring may be stronger this time around. Foremost, the plummet in Chinese exports during the global financial crisis and the resulting layoffs of millions of factory workers brought home the urgent need to transition to a more balanced growth structure.

Across the Pacific, the United States is undergoing its own significant set of economic and political transitions. Three years after the near-death experience of 2008, America remains in the worst economic slump since the Great Depression. More than 25 million working-age Americans are unemployed or underemployed. The employment-to-population ratio is at an historic low of 58 percent. The European sovereign debt crisis, if not successfully addressed, threatens to throw the US, as well as much of the rest of the world, into another recession and make the current, painful unemployment situation even worse. Over the long run, deep structural deficits in government spending and trade cast a shadow on whether and when the U.S. economy can return to robust growth and job creation. America will soon be spending more on interest on the national debt than on national defense.

America is also undergoing its own political transitions. If the state of the American economy is very bad, the state of the American political system may be even worse. The partisan gap between Democrats and Republicans has grown wider than at any time since the end of the 19th century. When the economic stimulus bill sponsored by the Obama Administration was taken up by the House of Representatives in 2009, 244 Democrats voted for the bill but not one – not one – Republican congressman voted in favor. Contrast this to how our political system worked in the past. The Social Security Act became law in 1935 when 81 of the 102 Republican members of the House of Representatives supported Democrat Franklin Roosevelt. In 1965, a majority of Republican congressmen supported Democrat Lyndon Johnson and voted in favor of the establishment of Medicare.

The partisanship, rancor, abandonment of mutual civility and, most important, the resulting gridlock and inability to address the nation’s pressing problems have deep societal consequences. The American public’s confidence in its leaders is at an all time low. In a recent poll, more than 4 out of 5 Americans said government ethics and corruption were an important problem for the country and almost as many said government and big business worked together in ways that hurt consumers and investors.

The other American political transition is of course the election next year. Whichever Republican nominee stands against President Obama, it is certain that the economy will dominate the election. As a result, there is a possibility that China and its impact on the American economy could become a significant presidential election issue.

And yet no sensible person should or will count America out. America’s resilience and ability to respond to crises are recurrent themes of its history. Once we return to a more serious, consensus-seeking public discourse and make the collective sacrifices necessary to overcome the current challenges, America’s abiding strengths will again be evident. No other society matches its openness and creativity. It is rich in both natural and human resources. Its science and technology, universities and ability to innovate are in a category of one. We only have to look at the companies and business models that dominate the Internet – which has reshaped society and economies more than any other single factor of the past twenty years – to realize that they are almost all American. No other country has as dynamic a private sector – a naturally occurring, distinctively American culture of entrepreneurship incubated by a mature civil society and the rule of law.

Finally, America has its immigrants. Immigration and, equally important, a singular ability to assimilate immigrants and their children into mainstream society enables the U.S. to draw the best minds from around the world and keep them. Visit the main IBM research facility north of New York City and you will discover that of the 2,000 Ph.D. scientists and engineers who do their research there – and, by the way, produce more patents than any other company in the world – half are from China, India and the rest of Asia. It is a situation you will not find anywhere else in the world.

On the merits, the parallel economic transitions that are ongoing in China and the U.S. should be complementary and mutually reinforcing. For numerous compelling reasons, each country needs the other’s cooperation – and the other’s success – for its own economic rebalancing to succeed.

China very much needs the U.S. A crisis in the American economy and a resulting collapse in the dollar would diminish much of the value of China’s holdings of U.S. Treasuries. Even more damaging would be a lasting collapse in American demand for Chinese products, since China will still need to rely on exports to cushion the impact during the difficult transition to a domestic consumption-led economy.

The US needs China. With the artificial demand created by the housing and financial bubbles no longer available, America needs a new engine to return to growth. China’s emerging middle class – and, over the long term, the emerging middle classes of India, Brazil, Indonesia and the rest of the emerging economies – represent the best opportunity for increases in American exports large enough to help revitalize the economy. Some 240 million Chinese, 1/5 of the population, are in the middle class already, and this group is growing one percent a year. The Chinese middle class family, however, consumes less than 20% of what an American family consumes. If the potential of this growing middle class can be released, it could have a profound positive impact on the global economy, not only that of the U.S. A recent study by McKinsey predicts that, if the right policies are adopted, China could add an additional $1.9 trillion to global consumption by 2025 – a figure significantly larger than India’s current GDP.

Serious people in both countries know that there are no realistic scenarios involving the U.S. and China in which one loses while the other wins. Secretary of State Hillary Clinton noted recently that while “there is no handbook for the evolving U.S.-China relationship…the stakes are much too high for us to fail.” Cooperation and partnership between the two countries is not a matter of choice, but of necessity.

And yet, despite the compelling arguments in favor of working together, there is no guarantee of success. Singapore’s founder, Lee Kuan Yew, in my view, the statesman who best understands China and its evolving position in the world, last week in a speech in Washington, summed up the challenge of US-China relations this way: “China is a heavyweight. America will have to adjust its posture and policies as a consequence of this rise. Does it need to be confrontational? Usually, in history, when a new power emerges to challenge the supremacy of the incumbent, war is likely. This is no longer possible when both China and the US have nuclear armaments. It is my belief that the Chinese are in no hurry to displace the US as the number one power in the world and to carry the burden that is part and parcel of that position…To grow, China needs American markets, American investments and, with it, American technology. China also wants to send thousands of her students to American universities and research institutions to work and learn the kind of intellectual milieu that enables Americans to be so innovative and creative. At present, both [the US and China] realize that they must work at the relationship. Americans have to eventually share their pre-eminent position with China.”

In 1978, Deng Xiaoping called on the Chinese people to do two things: “Emancipate the mind. Seek truth from facts.” He was asking the country’s leaders and its people to return to the pragmatism and empiricism that had historically been hallmarks of China’s culture and its success. This simple, profound appeal became the basis for the policies that have brought China to where it is today. It is advice that is equally relevant in considering China’s new international role. Both China and the international community need to emancipate themselves from attitudes and patterns of behavior that no longer serve a purpose and to seek practical, more rewarding ways of relating to each other. This is especially true of China and America.