Over the next century, our bilateral relationship with China will be the most consequential the United States will have to manage. Since 1991, Henry Paulson has made over 100 trips to China and made the country a centerpiece of his distinguished career in business (CEO of Goldman Sachs & Co.) and government (Secretary of the Treasury). In his new book, Paulson describes China’s recent rise to global supremacy and the challenges that lie ahead. Foremost amongst these challenges are reform to the legal and capital market systems. The book is must reading for anyone who is interested in the United States’ “pivot to Asia.”
Paulson was educated at Dartmouth College and Harvard Business School. After a stint in the Richard Nixon administration, he joined Goldman, Sachs & Co. in 1974. Upon becoming co-head of Investment Banking at Goldman, Paulson made his first trip to China in early 1991.
During the 1990s, China was ruled by Jiang Zemin, successor to Deng Xiaoping, who had first opened up the economy to global commerce in the late 1970s. Throughout the 1990s, Jiang’s regime accelerated China’s transition to a market economy, achieving remarkable 8 percent average annual GDP growth rates.
One key to this transition was the reform of state-owned enterprises in capital-hungry industries such as telecommunications and energy. During Jiang’s tenure, Paulson and Goldman were successful in shepherding China Telecom and China National Petroleum Corporation through their IPOs. These landmark deals served as the cornerstone of the deep trust that Paulson would earn with the Chinese elite.
Paulson does not speak Mandarin or Cantonese. Therefore, one intriguing aspect of the book is his explanation of how he learned “to get things done” in China. The author stresses the limitations of the legal system and the importance of building relationships.
In China, this means realizing that the country is “a nation that is ruled by men, not laws.” Thus, one must be keenly aware that of your Chinese counterpart’s role, mannerisms, immediate needs, and long-term goals. The book contains many stories where such knowledge led to successes, and tales of frustration where it was lacking.
The author supplements this aspect of the narrative with his adroit observations about “power.” China is at once both centralized and diffuse. The Communist Party exercises political control, but its bureaucracy is maddeningly complex and its local leaders compete with the national leaders.
Paulson also explains well China’s costs and benefits of economic reform. According to Jiang’s successor, Hu Jintao, the “reform process is irreversible.” It has enabled the country to develop a massive export economy, raise hundreds of millions of people out of poverty, and create a burgeoning middle class. But the costs have been high, as tens of millions of workers and farmers have been dislocated, wealth disparities have ballooned, environmental degradation has persisted, public health has been threatened, and local governments have racked up huge debts.
In 2006, Paulson left Goldman to become the Secretary of Treasury in the George W. Bush administration. To exploit Paulson’s unique talents and experience, Bush gave him super-cabinet responsibilities over the US’s relationship with China.
With this new portfolio, Paulson established the US/China Strategic Economic Dialogue (SED), which operated as “G2″ summits held once every six months. Heavily prioritized by cabinet-level officials in both governments, the SED enhanced communications, produced an important avenue for change, and led to agreements on the environment, product safety, and the easing of trade and investment barriers. The SED proved such a success that it has been continued and expanded by President Barack Obama.
As recounted by Paulson, the relationships developed in the SED came in handy when disaster struck during the 2008 financial crisis. At the time, the Chinese owned trillions of dollars of Treasury bonds and securities in troubled US entities such as Fannie Mae, Freddie Mac, and various brokerage firms. One of the best passages in the book deals with Paulson’s efforts to calm the Chinese, dissuade them from dumping their US securities, and charting the course for recovery.
Paulson discusses several key issues that the Chinese leaders must confront if the country is to continue to prosper. One is reform of the judicial system, which has historically lacked independence, employed judges with no formal legal training, and been dominated by local party leaders. These shortcomings have produced vague laws, inconsistent “jurisprudence,” and a frustrated citizenry. In China, court judgments have typically been based on evidence presented in the backroom, not the courtroom.
As observed by the author, the current Chinese leader, Xi Jinping, has pledged to continue reforms, but has been guilty of backsliding into some of the authoritarian ways of the past. Although too recent to have been discussed in the book, Xi’s recent jailing of 300 civil rights lawyers is just another example of the party leaders’ intolerance of free speech and dissent.
Paulson condemns such heavy-handed measures as “self-defeating.” He eloquently explains that China will fall far short of its national potential unless free speech, a free press, and dissent are protected. In the big picture, he notes that “the most competitive countries encourage their people to think outside of the box. They don’t box their people in.” In cautioning Xi, Paulson writes that “in a modern economy it’s hard to be connected to the free flow of information in one part of your life and disconnected from it in another.”
Another shortcoming of the Xi regime criticized by Paulson is the slow pace of reform of the Chinese capital markets. He argues that the government needs to open its markets to more foreign firms and resist the impulse to control the market. This need was made clear in the recent stock market turmoil in China, where the government stepped in with blunt force to suspend trading, ban short-selling, and ban new IPOs. Like the preeminent economist, Burton Malkiel, Paulson believes that institutional investors will continue to spurn Chinese stocks if the government persists in controlling when they can sell.