The world today seems to move from crisis to crisis: wars, natural disasters, stalling growth, runaway inflation, climate deterioration, rising inequality, and more. The term 'Permacrisis' describes “an extended period of instability and insecurity, especially one resulting from a series of catastrophic events” by Collins Dictionary. It is also the name of the world-renowned economist and Nobel laureate Michael Spence’s most recent book 'Permacrisis: A Plan to Fix a Fractured World', co-authored with Gordon Brown and Mohaned A El-Erian.
Most crises are not random, isolated incidents.
Most crises are not random, isolated incidents. As Spence puts it, they are results of a policy failure in addressing the underlying trends that lead to a crisis, and world fragmentation is such a trend. Tensions between the US and China have escalated along with restrictions on trade and other areas, leaving major economic, market and social consequences for the international community.
In the 'Permacrisis' spirit, we asked Spence about what can be done about the forces of deglobalization. He sees US-China decoupling as having a detrimental impact on the world and believes the two countries can and must work together to advance growth, equity, and sustainability.
Can you give an overview of the Chinese economy and its current strengths and weaknesses?
The Chinese economy has distinct strengths and weaknesses, but it is slowing dramatically currently. While deceleration is happening everywhere in the world, most of what is now slowing China down is from imbalances within the economy. Structural issues such as weakness in household consumption and private investment must be addressed before overall growth can be restored.
China has the resources to prop up the slowing economy if it wants to However, the issue has been enthusiastically debated within the central government. I am with the camp that believes pulling the stimulus lever too hard could mean making investments that at best have very low returns in absolute and social terms, and at worst could even aggravate the current situation. With aggregate debt-to-GDP at 280%, China’s debt position is high – but not ridiculous – and is in line with many developed economies.
A lot has been written in the media on shorter-term challenges, such as the precarious finances of municipal governments, high youth unemployment as well as protracted weakness, excess capacity, and over-indebtedness in the real estate sector. Next to these immediate headlines, however, exports have held up reasonably well despite the diversification and relocation of supply chains. away from China. There is broad wariness among multinational companies with relying on a single source of production, be it China or somewhere else, but China will nevertheless take a hit. That said, these problems to me are not insoluble.
To a great extent, the longer-term secular issues have more serious implications, and businesses holding back from investing for the future is a distress signal. A dramatic drop in private sector investment, which reflects a distinct loss of confidence, is the unfortunate result of the government’s sometimes ambiguous communication and ambivalent approach to the private sector. While there has been some recent improvement, the on-and-off pattern and mixed messages from officials did little to restore business sentiment or encourage investment in some of the most dynamic parts of the economy. Needless to say, it takes time to build up confidence; there is no simple economic switch the government can flick on.
Another major issue is domestic consumption. Chinese household wealth is in large part tied up in real estate, and the prolonged housing downturn has a direct impact on the family balance sheet and hence willingness to spend. The frugality presents considerable challenges to China’s transition from the old growth model (reliant on significant direct investment from the central government) to a middle-income economy (where consumer spending drives healthy growth).
Chinese household spending currently hovers around 40% of GDP, compared to over 60% for the US and UK.
Chinese household spending currently hovers around 40% of GDP, compared to over 60% for the US and UK. This is not strong enough to drive the Chinese economy forward. Not only is the savings rate very high relative to developed markets, but disposable income also only makes up about 60% of the overall national income. More complete social security benefits such as social insurance, public services, and retirement schemes could help lower savings, but it is not likely to improve the national income structure.
How to redistribute national income across households, companies, and government is something China needs to work on. Making sure households don’t get the short end of the stick is easier said than done. Case in point: The government owns over 80% of the state-owned enterprises, extending state control over 30-50% of the country’s corporate income.
As geopolitical tensions between the US and China stay elevated, the economies are headed toward decoupling. You have called this “a distinctly suboptimal and perilous course.” Can you elaborate?
Although the topic is a moving target, the relationship between the US and China is mostly symmetric. Both countries are focused on security – whether it is in the form of energy, economic, industrial or foreign policy.
I tend to be an optimist, however. Pragmatism can exist side-by-side with national interests, as long as officials from both sides continue to talk to each other. There are conflicts that seem irreconcilable, but I believe there are many more areas where China and the US can still work together. Various science disciplines come to mind. And then there is climate change, where active participation and commitment from both countries is absolutely crucial in moving the world forward. A climate change solution must be international; one without either country is impractical at best and unworkable at worst.
Science and new technologies are transforming the world we live in, and the exchange of ideas among scientists, technologists and academics must be reestablished and restored. Trust has eroded between the two countries over the years, but Chinese and American policymakers should build a foundation for cooperation to contain the spillover from the existing fights. I believe it can be done with a fair amount of determination and pragmatism.
In the context of American politics, unfortunately, any type of cooperative actions can be interpreted as being soft on China and will probably run into some roadblocks, which could take us beyond what you might call the “rational degrees of separation.” Trump-era tariffs aside, economic advisors in the Biden administration do not think tariff on toys is critical to national security.
Ultimately, China is too large of an economy to cast aside – or to delete from an asset allocation decision. There are incredible investment opportunities, powered by a massive amount of human capital and government funding. The second highest number of unicorn start-ups in the world and successes in digital medical sciences and energy transition/transformation are just some examples. It is possible to invest in these opportunities without taking on extraordinary risks.
How can global institutions and multilateral organizations evolve to meet the varying agendas of the US, China and other major players?
Major multilateral institutions are losing credibility and impact – and possibly funding – and it is a crisis that China and the US must tackle together. Most of the so-called Bretton Woods institutions such as the World Trade Organization (WTO), World Bank, International Monetary Fund (IMF) were established in the post-war years, along with the United Nations (UN). However, nationalism and unilateralism have been on the rise in recent years, calling multilateralism into question.
But it is not just a matter of ideology. China takes issue with its representation and influence in these institutions. Many of the developing economies have grown bigger and more powerful from 30 years ago, and they want their fair share of influence. For example, Belgium at present should not have a larger share than Indonesia or India. And the days of the US and Europe taking turns in appointing directors for these institutions should end. It also does not help that China and other developing markets are often at odds with the US approach, most notably with some of the Ukraine war related sanctions. All in all, a more balanced and objective representation reflecting the changes in the global economy is long overdue in these organizations.
That is not to say the world can do without these imperfect multilateral institutions. My "Permacrisis" coauthor Gordon Brown has repeatedly and eloquently argued that today’s world is more complicated and fragmented with these big global problems to solve, we need global solutions that everybody is in on. We need the IMF, WTO, and the likes to help the world meet the challenges head on.
There is also no harm in having a plethora of multilateral institutions . For example, the New Development Bank (NDB), formerly known as the BRICS Development Bank, has an important role to play as a targeted lender alongside the World Bank. Leaving these organizations undercapitalized, or ignoring them when it is convenient, is self-defeating.
Toward net zero, the coordinated work of multilateral lenders can contribute to meaningful progress. The World Bank has recently formalized its commitment with a new vision statement: “To create a world free of poverty – on a livable planet.” The bank’s president Ajay Banga is looking for ways to incentivize an exit from coal and fund climate investments as part of the energy transition, and these could include cheaper and longer maturity loans as well as other instruments. By absorbing some of the idiosyncratic risks that stop private capital at the door, these measures could create an attractive climate investment atmosphere in underfunded places like sub-Sahara Africa.
How does industrial policy play into the US and China’s dominance in the global climate economy?
China and the US are well capitalized, and their early and sustained investment has made them leaders in different parts of the energy transition, as well as competitors. However, government subsidies on both sides have been a controversial topic, often criticized as an affront to international trade agreements.
Industrial policy has always been considered interventionist, though I believe in some cases it can be essential to a country’s long-term economic survival and development. There have been successful and failed examples in the past. China as a developing country has spent heavily to develop and grow many sectors and industries, dominating renewable energy such as the manufacturing of solar panels and electric vehicles. On the other hand, the US has always invested heavily in science and technology, particularly in military and space programs, but last year’s Inflation Reduction Act contained clean energy incentives that irked the European trading partners.
Industrial policy has always been considered interventionist, though I believe in some cases it can be essential to a country’s long-term economic survival and development.
The challenge of working through these differences will always remain as global interdependence shifts. China and the US should acknowledge any step back in fair trade, even if it is done in the name of moving closer to net zero, and work toward a compromise. I hope a pragmatic solution will eventually allow the two countries to make progress on separate tracks and somehow lead the world to a better place in the future.
Are China and US in an AI arms race? How does generative AI affect overall productivity growth? Could we see a similar hollowing out of service industries to the one we saw play out in manufacturing that shook certain regions and sectors?
Productivity growth has been in a decline for the past two decades. Global growth stayed strong nonetheless because China and other emerging economies dramatically expanded production capacity and kept inflation in check by bringing inexpensive goods to the world. But as inflationary pressure built in the past few years – made worse by COVID and supply chain issues – global growth slowed. Supply side forces held down productivity: populations aged, workforces shrank, and dependency ratios increased, in a world that has become more fragmented.
The most stunning aspect of generative AI is that it is (almost) a general -purpose technology. Taking a step closer to artificial general intelligence, advanced large language models (LLMs) that power generative AI are so versatile they can respond to questions from the Italian Renaissance to inflation expectations, and from coding to poetry, without needing explicit prompts or instructions. AI can switch subjects like a person.
Secondly, technical training and skills are not required, and anyone including a robot can ask a question. LLMs are designed to respond to ordinary language, making them radically more accessible than older AI models.
Generative AI can do a lot, from predicting the 3D structures of every protein to beating the best professional players in the game of Go, so it just might be able to lift the world economy out of its productivity lull. The technological innovations can transform the supply side of the economy, should they become more affordable and distributed around the world. However, while the potential economic benefits can be great, AI’s immediate impact is mostly in the information economy instead of the real economy.
In terms of China and the US, both countries have the resources and talent to take generative AI further. To train advanced LLMs is a costly undertaking that requires a tremendous amount of computing power, and China and the US are home to the AI platform companies that have made defining breakthroughs.
The US is a clear leader in generative AI today, with China as a second. There is no close third. The US ban and restrictions on the export of several types of high-performance semiconductor chips to China should hold China back for the time being. Companies that make semiconductors at this level – capable of training neural networks on enormous datasets that are needed for advanced LLMs – are an exclusive club. But China will catch up. I believe they will be strong competitors with each other in generative AI over the long run.
The restricted flows of technology and capital between the two countries as well as with the world stands in the way of AI transforming the global economy. The use of scientific and technological tools should be geared toward supporting progress that could contribute to the greater good. These new barriers to international diffusion concern me more than which country will be the eventual winner of the AI arms race.
A few final words
The state of the world is uncertain courtesy of cascading crises. Forces to decouple or deglobalize have been gaining pace, undermining the cooperation needed to address current crises and protect against future ones.
US and China remain key to global affairs and geopolitics, so together they must find a way of achieving some sort of competitive coexistence. Encouragingly, signs of a thawing in tensions could be emerging. As President Xi recently told several US senators in Beijing, “I have said many times, including to several presidents, we have 1,000 reasons to improve China-US relations, but not one reason to ruin them.” The recent summit meeting between Presidents Joe Biden and Xi Jinping provides some hope too, with progress made on a number of fronts – not least climate change.
It is more important than ever to learn from mistakes of the past and misguided approaches in handling crises and try to propose achievable solutions. With a pragmatic approach, China and the US can underwrite world progress together.
The China complex
The China complex
This special edition of Panorama is dedicated to China and offers a richer way of looking at it from the geopolitical, sustainable, economic and market lenses.
About the author
Head of Investments
Barry Gill, Head of Investments at UBS Asset Management since Nov. 2019. Previously, he was Head of Active Equities at UBS AM. Barry joined O'Connor in 2012, overseeing long/short strategy. Prior to that, he led UBS IB's Fundamental Investment Group (Americas). In 2000, Barry relocated to the US, rebuilding Equities' long/short efforts post-O'Connor. He held leadership roles in London, including co-heading Pan-European Sector Trading. Barry started his career as a graduate trainee at SBC in '95.
External to UBS
Professor Michael Spence won the Nobel Prize in 2001, for his work in the field of information economics. He is the Philip H. Knight Professor Emeritus of Management in the Graduate School of Business at Stanford University, a Senior Fellow of the Hoover Institution at Stanford and a Distinguished Visiting Fellow of the Council on Foreign Relations. He is an Adjunct Professor at Bocconi University in Milan, and an Honorary Fellow of Magdalen College, Oxford University.
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