September 13, 2006
HP-95

Remarks by Treasury Secretary
Henry M. Paulson
on the International Economy
Treasury Department Cash Room
Washington, D.C.

One week from today, I will be in China to discuss the economic relationship between our two nations.  Today I will speak about China, and more broadly about the international economic system.  

The prosperity of the United States and China is tied together in the global economy, and how we work together on a host of bilateral and multilateral issues will have a significant impact on the health of the global economy.  

Half of all global economic growth in the last five years has come from the United States and China, and our two economies will continue to be the drivers of growth in the future.

Yet many view the growth of China and its increasing importance as the clearest and most tangible threat of globalization.  Those who welcome China's growth and integration into the world economy, as I do, should confront this argument directly.

I have spent 32 years working in financial markets, much of that time in economies around the globe, and I have learned a number of important lessons.  One lesson is that those nations that reform their economies and open themselves to competition benefit their citizens greatly.  They have better jobs, improved living standards, and greater opportunity.

At the same time, those nations that try to close themselves off from competition, hinder free markets, and fail to invest in their people, simply get left behind.  

The benefits of competition extend well beyond manufactured goods and agricultural products.  Greater efficiencies and advanced technologies in a number of services have a multiplier effect, strengthening the entire economy. 

One area where I have personal experience is in financial services where I am a strong advocate of opening up the domestic capital markets and financial systems of our trading partners to international competition.  Healthy capital markets are absolutely critical to any nation's long-term economic success.  And I don't know of a single example of a nation which has a strong financial system and strong capital markets that has not opened itself up to foreign competition.  

The U.S. experience illustrates the benefits of openness and competition.   Our economy is by far the world's strongest because it is built on openness – openness to people of all nationalities, openness to new ideas, openness to investment, and openness to competition.  It is a model that others strive to emulate.  And we aim to keep it that way.  

Our proven success has allowed us to effectively advocate free trade and open markets here in the United States and around the world.

A good illustration of the benefits of competition through trade can be found in Asia.  Thirty years ago, economist and author, Gunnar Myrdal, used Asia as a metaphor for global poverty.  But Asian nations opened their markets and allowed their businesses to compete in the world market place.  What Myrdal referred to as the Asian Drama is now the Asian miracle, with hundreds of millions of people freed from poverty.

Vietnam, where I attended the APEC meetings last week, is a case in point.  In 1986, the Vietnamese launched the Doi Moi program of economic reforms that liberalized Vietnam's economy and began to open it to foreign trade and investment.  Vietnam's trade has since grown by 20-30% per year, and the country has been second only to China in its rate of real GDP growth.  When I visited Vietnam, I spoke to its leaders, but I also spent time with young entrepreneurs and students.  They are eager to join the global economy and replicate the success of others in the region. 

We must appreciate and reinforce Vietnam's commitment to continuing economic reform, and the rules-based trading system.  I will work closely with the President, my colleagues in the Administration, and Congress to bring Vietnam into the World Trade Organization, because it is in the interest of the United States and Vietnam.

Trade is not a zero-sum game.  Rapid economic growth in Vietnam and other nations around the world benefits Americans by adding to the growth of the global economy, and over time, creating greater demand for our products and more jobs for our workers. 

Our prosperity is linked to the strength of foreign economies.  And we are adversely affected by their economic declines and financial shocks.  The Asian Financial Crisis of 1997 may have reduced growth by as much as 1 percentage point in the United States and Europe.  Financial markets also are global.  The Russian default in 1998 led to a sudden widening in credit spreads and a financial shock which contributed to the failure of the hedge fund, Long Term Capital Management, in the United States. 

There are no islands of economic stability in today's world.  Globalization and interdependence are here to stay.  No nation can turn back the clock. 

In today's interdependent world, U.S. exports and U.S. employment opportunities are affected by how well our major trading partners are doing.  When any major economy does well, its growth benefits the overall global economy.  When a major economy falters, it is a drag on global growth.   We see this illustrated by Japan, the world's second largest economy, which struggled for a decade with sluggish growth and deflation. 

Japan's economic reforms over the past five years have produced an economic recovery, and we all have benefited from the boost to global growth and the increase in Japanese import demand. Japan's reforms are not complete, and they must continue.  However, these steps demonstrate the importance of growth-enhancing reforms in major economies as an effective way to increase jobs in the United States and prosperity globally.

Economic integration makes economies more efficient, more productive, and more competitive.  Integration gives businesses greater access to markets around the world, and increases their ability to achieve economies of scale.  Global markets give consumers more choices.  And global competition helps reduce the prices of goods and services – a real benefit to those with lower incomes, whether in the United States or abroad.

Enhanced competition from global integration greatly benefits the international economic system, particularly the United States. 

The Institute for International Economics has estimated that the integration of the global economy generates an economic gain of $1 trillion to the U.S. economy, every year.  And I know from my previous life at an investment bank that global economic integration also leads to a lower cost of capital, more opportunities for investors to achieve higher returns, and more stable long-term economic growth.  This is the foundation of prosperity, jobs, and opportunity. 

Yet, despite the benefits of competition and the expansion of world trade, there are many who oppose what is commonly know as "globalization".     Ironically, this protectionist sentiment comes from many quarters in those nations – including in the United States and China – which have benefited the most from the economic growth generated by global competition. 

This widespread and growing resistance is not surprising, because the benefits of competition, while significant, are not spread evenly and competition can create losers as well as winners.

The short-term problems are more immediately visible in the form of job losses that are very real and painful.  

Protectionist policies do not work and the collateral damage from these policies is high.  By closing off competition and blocking the forces of change, protectionism reduces the losses of the present by sacrificing the opportunities of the future.   Jobs saved in the short term job are off-set by more job losses and a lower standard of living in the future.

I believe it is the responsibility of all nations to search for ways to moderate income disparities and help those who lose their jobs to international competition.   We in America must think creatively about how to assist those who fall behind.  As the President has repeatedly emphasized, the most effective method for generating new, high-quality jobs, and higher living standards, is to develop the skills and the technologies that promote economic competitiveness. This means helping people of all ages pursue first rate education and training opportunities. 

Because I care deeply about the competitiveness of the U.S. economy I will be an outspoken advocate for maintaining – and extending – free and fair trade.  The United States wants open markets.  We welcome foreign investment.  And we seek partners to join us in advancing a global agenda that will help realize the benefits of economic liberalization and competition.  We will not heed the siren songs of protectionism and isolationism.

We recognize how important it is to work with our major trading partners to revive the Doha round of trade negotiations.  And U.S. Trade Representative Susan Schwab and others are looking for creative ways to do just that.

Trade negotiations are never easy.  But the Doha round is just too important to let slip away.  We have before us an historic opportunity for the international community to join together to generate economic growth, spark development, and raise living standards across the world like no other action. 

The stakes are huge.  And they transcend the purely economic.   Closer economic ties between nations help promote international peace and prosperity by creating common interests and raising the costs of conflict.  In fact, the greatest threat today is not from conflict between states, but from instability within states, and from those states, like North Korea and Iran, which are not prepared to abide by international standards of conduct, including WMD proliferation and terrorism. 

It is also true that the hope and opportunity which can come from broad-based economic progress can foster stability within nations, diminishing the appeal of extremists and terrorists.  Greater economic freedom and more widely shared prosperity within a nation can lead to greater freedom in the political system as well – a point that has been made persuasively by my friend and author, Fareed Zakaria.  Countries that implement market-driven policies which provide their citizens greater economic freedoms, find that those citizens also naturally seek a greater stake in their political system. 

The trend towards greater public voice and democratization is clear, for instance, in rapidly growing Asian economies such as Korea, Indonesia, and others.  

Does this mean that open markets by themselves will end war, eradicate terrorism, and lead to democratic government everywhere?   No.   But it does mean that economic liberalization – with the interdependence and the growth that it brings – can play an important role in advancing the cause of peace and stability.

Against this backdrop of interdependence, China has an increasingly important role in today's global economy and its economic relationship with the United States.  In many ways, this nation's economic development – which has seen hundreds of millions of its citizens raised from poverty in just a few decades – has to be one of the most dramatic transformations in world economic history.  The Chinese people have benefited greatly from China's integration into the global economy.  China's GDP has grown 10-fold over the last 27 years, it is now the world's third largest trading nation. 

And China's incremental demand is the major factor in determining the price for a number of primary commodities, including oil.  We must realize that China is already a global economic leader.  China deserves recognition for what it has become, but at the same time, China must be more than a beneficiary of open markets.  I agree with former Deputy Secretary of State Bob Zoellick, China should be a responsible stakeholder.  As a global economic leader, China should accept its responsibility as a steward of the international system of open trade and investment.  

It must recognize its responsibility to maintain the health of the global system.  China's remarkable success since market reforms began in 1978 has led many to predict that its meteoric growth will continue indefinitely – that we can extrapolate its future growth from its past performance – as if China has somehow found a way to immunize itself from business cycles and all other economic problems.  Some fear that China will soon overtake all other economies to the detriment of the rest of the world.   To them, China has become the leading symbol of the threat posed by globalization. 

They are concerned about their jobs, and in some cases even the future capability of their nations to compete.

There are others – including many inside China – who argue that China is still a developing nation in transition, and that we must be patient as this transition unfolds.  They believe that China must slow or "manage" the transition, and limit foreign access or investment to protect domestic enterprises. 

Both these arguments miss the greater truth.  Today, China is transitioning from a planned economy to a market-driven economy and there is no doubt that this process will continue for a number of years to come.  But, because of its size and its role in world markets, China is, by definition, already a global economic leader and deserves to be recognized as a leader.  But with leadership comes responsibility.  When I go to the International Monetary Fund meetings in Singapore later this week, I will support China and other nations gaining greater representation at the IMF as part of comprehensive reform of that institution. 

In return however, we expect China to be a responsible member adhering to the spirit and letter of the rules and regulations of the IMF.  Another area where we look to Chinese leadership is for help reviving the Doha round of trade negotiations.   We would like China to be our cooperative partner in encouraging nations to lower barriers to trade.  

Because it is a global economic leader, what happens in China will affect the well being of the U.S. and the rest of the world. 

China's continued economic progress will strengthen the international economy benefiting people around the world while a hard landing or a significant slow down in the Chinese growth rate will weaken the global economy to our detriment. 

Of course, global economic leadership also brings with it responsibilities that go beyond the economic arena, including international laws and conventions on important issues ranging from human rights to non-proliferation. 

A big part of being a global economic leader is a commitment to open markets at home.  China's record of reform is remarkable by any standard.  But much remains to be done.  The tasks faced by Beijing are so daunting that the biggest risk we face is not that China will overtake the U.S., but that China won't move ahead with the reforms necessary to sustain its growth and to address the very serious problems facing the nation. 

These problems range from modernizing and reforming the rural agriculture economy, to providing an adequate pension system and other safety nets, to developing capital markets that have lagged far behind the needs of China's economy, to freeing up an inflexible currency regime that hinders the efficient allocation of capital and the achievement of balanced sustainable growth.  The Chinese economy itself is becoming increasingly difficult to manage as it becomes larger and more complex, but is still only part way between a managed and market economy.

China now faces a difficult but essential phase in its development and the reforms it must continue to pursue will not be easy.   Up to now, rapid growth has been achieved by shifting excess labor from agriculture and state-owned enterprises to market-based manufacturing.  Today, as the most obvious sources of inefficiency are disappearing, growth will depend on raising productivity which, in my judgment, will require markets to allocate capital as opposed to administrative decisions.   The Chinese have an astonishingly high savings rate – 50 percent of GDP – because Chinese households face so many uncertainties. 

China needs a more harmonious, more balanced pattern of growth that gives Chinese households more income and the confidence to spend it.

These challenges are made even more difficult by the fact that within China, as in the U.S., there are loud voices espousing anti-reform, protectionist sentiment. In China this resistance stems from a number of factors including that the benefits of this economic expansion have been spread unevenly among its citizens and that some influential people have never fully embraced the need to open up the Chinese economy to competition.

This protectionist sentiment is evidenced by increasing levels of public discontent, demonstrations, and anti-reform articles written by prominent academics.

Yet, it is impossible to overstate the importance of China moving forward with liberalization.  First and most importantly, only reform can guarantee the future growth that the Chinese people expect and deserve.  Second, liberalization sends a clear signal of China's willingness to assume its role as a global economic leader.  And third, reform will do much to ease rising anti-Chinese sentiment.

Over the last couple of years in my prior role, I was struck by the fact that some of the anti-trade sentiment manifesting itself outside our nation is turning into anti-China sentiment as more people in nations around the world are viewing China as a symbol embodying both the real and imagined downsides of global competition.  They are increasingly blaming China for economic dislocations in their nations and are increasingly viewing China with apprehension.

Similarly, I've seen that the level of anti-trade and anti-China sentiment in the United States is also significant and growing.  I believe that if China doesn't move quickly to continue reforming its economy, it will face a backlash from other international economic stakeholders. This backlash would not benefit any of us.

The United States has its own responsibility to help China continue its structural reforms and its transition to a market-driven economy that welcomes competition. 

We also have responsibilities as a stakeholder in the global system.  These include keeping our markets open to trade, to foreign investment and maintaining the flexibility and rapid productivity growth that has made us a driving force in the growth of the global economy.  We must continue to pursue policies that maintain and enhance international confidence in the U.S. economy, financial markets and U.S. securities.  

The U.S. economy and the Chinese economy are highly interdependent, and given this interdependence we have a number of potential areas of cooperation. I want to address two that are very important to me personally – energy, and the environment. 

On energy, China, which was self sufficient in oil until 1993, is now the world's second largest oil consumer behind the United States.  We clearly share an important interest in energy security with China and other nations, particularly those which are net importers of oil. 

That means developing new sources of supply, minimizing supply shocks, increasing conservation, and the developing alternative technologies.  Since much of the oil we both need is found in troubled regions of the world, China and the U.S. have common incentives to minimize regional instability while reducing our dependence on foreign oil.

There are also important opportunities to work together to preserve and protect our environment.  We only have one planet.  Air and water know nothing of national boundaries. 

And China's severe environmental hazards not only are harming the health of its people and ecosystems, they are also harming China's long term economic potential.  Economic development without regard for environmental protection is not sustainable.  A healthy environment and a strong economy are not in conflict but represent opposite sides of the same coin.  No one understands the Chinese environmental problem better, or is more concerned about it, than the Chinese people.   They have to breathe the air, drink the water, and witness the environmental degradation on a first hand basis. 

This point was driven home to me last October when I was in Beijing to co-chair a meeting of a philanthropic organization dedicated to Asian and Chinese environmental and conservation issues.  We met for part of a day to share best practices with a group of 100 leading Chinese entrepreneurs who had recently formed their own environmental NGO called Society Entrepreneur Ecology, or SEE.  They were so concerned about the quality of air they were breathing in Beijing that they got together to do something about it.  This was not a hobby. Their passion and commitment was palpable. 

This demonstrated to me in a very tangible way that the U.S. and China share the goal of creating a cleaner China and a cleaner planet. 

And we can and should be sharing technologies and best practices to protect our environment as we are through the Asia Pacific Partnership for Clean Development and Climate, along with Australia, India, Japan, and South Korea. 

This initiative, which was established last year under Secretary Rice's leadership at the State Department, is an innovative public-private partnership designed to address issues of the environment, energy security, and climate change in ways that promote sustainable development. 

While we can work together on these issues and others, China must confront its long-term structural challenges as it makes the transition to a market-driven economy. 

Without question, the nation must modernize its financial sector, open up its capital account, and move to a more consumption-based model of growth.  A competitive, well-regulated financial system and the free flow of capital will help reduce the extraordinarily high levels of precautionary savings and allocate capital to its most efficient use, which will help raise productivity and living standards.  China must also pursue fiscal and regulatory polices that address the investment/savings imbalance. 

These changes will help create the millions of jobs that China needs to generate annually, and will help create markets for U.S. exports of goods and services to China.

China faces several critical, immediate challenges.  The first is the pressing need to put in place widely-accepted, market-based tools to keep its economy from veering out of control.  A much more flexible, market-driven exchange rate along with a more nimble, self-determined monetary policy are key ingredients to stable and sustainable, non-inflationary growth. 

Accordingly, maintaining and relying on an overly rigid exchange rate and outdated administrative controls increases the risk of boom and bust cycles.  Also, to be under estimated only at China's own peril, is the fact that their currency exchange rate is increasingly being viewed by their critics as a symbol of unfair competition. 

Another pressing issue is greater protection for intellectual property rights.  China cannot achieve its goal of being a modern economy if it fails to adhere to the rule of law and fair trade and encourage the innovation that is the engine of growth for developed – and developing – economies. 

Moreover, U.S. businesses lost billions of dollars in sales last year due to the illegal acquisition and use of their copy-righted ideas and products in China. 

When I visit China in the coming days I will discuss these issues with the Chinese leadership, and I will use a Chinese saying indicating that it is for the good of both of our economies that they undertake these changes, for our economic fortunes are interconnected.  I will say: We want you to succeed.

Bigger domestic markets and more success for you mean expanded markets, a higher standard of living and more jobs in the U.S.  It also means lower prices for U.S. consumers and higher returns for U.S. investors. 

The United States has a huge stake in a prosperous, stable China – a China able and willing to play its part as a global economic leader.   We are not afraid of Chinese competition.  We welcome it. 

We want China to assume its rightful place as a responsible member of the international community.  The choices you make will affect many things from the air we breathe to price of our farm products.  And, of course, of vital importance to you is a United States of America with a healthy, growing economy which believes you are committed to being a responsible global economic leader dedicated to moving forward with your economic reform agenda and fair trade.

These reforms will not be easy, and they will take time.  This is why we must take a strategic view of our relationship with China.  Both in China and in the United States, we must not allow ourselves to be captured by harmful political rhetoric or those who engage in demagoguery.  Instead, we must realize that the U.S./Chinese relationship is truly generational and demands a long-term strategic economic engagement on our common issues of interest.