QZ & A

Hank Paulson on the Chinese economy, Xi Jinping, and what Americans don’t get about China

“We really need to recalibrate our policy toward China.”
“We really need to recalibrate our policy toward China.”
Image: Reuters//Lucy Nicholson
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For the last two decades, China’s rise could be explained in a string of cliches: explosive growth, strong one-party rule, and fledgling diplomatic clout. This era of simplicity is over now. The economy is slowing, and while cronyism is eroding the Communist Party’s authority, the country wields ever-more clout abroad.

China’s handling of these new complexities bears huge consequences for the rest of the world—a point that former US treasury secretary Henry M. Paulson Jr. drives home in his new book, Dealing with China: An Insider Unmasks the New Economic Superpower.

Charting the evolution of China’s state-controlled capitalism and its implications for Western political leaders, Paulson’s book draws on his conversations with Chinese political and business elite logged during his days as CEO of Goldman Sachs (1999-2006), when he helped finance China’s embrace of global capitalism; as treasury secretary (2006-2009), when he shepherded Sino-US relations through the global financial crisis; and in his time thereafter running the Paulson Institute, a policy group he started in part to build East-West relations.

Paulson sat down with Quartz at the Asia Society in New York to share his views on China’s economy, the leadership of president Xi Jinping, and some of his behind-the-scenes anecdotes of how Chinese leaders confronted the 2008 global financial crisis. (This transcript has been lightly edited for length and clarity.)

On China’s challenges, corruption, and lack of consensus

Quartz: What are the biggest challenges currently confronting China?

Paulson: I’ve sure tried to cover that in my book because China faces enormous challenges right now.

The biggest challenges are rebooting the economy—its economic model is running out of steam—coming up with a new urbanization model, curbing corruption, working to curb pollution, dealing with food security issues, property reform, and income disparity, which is creating social distress.

To do all this, the vehicle Xi is using is a party that’s rife with corruption. And he’s doing this all without the modern institutions you need to govern a society like this—without a legal system, without a rule of law.

How well prepared do you think China’s leaders are to take on these challenges?

Well, I think that Xi has obviously laid out a very, very ambitious agenda. And he’s taken ownership—he has formed special groups to lead the reform and he heads up every one of them. But I believe that it’s going to take years to accomplish, because this is a country where there’s no consensus with regards to the most difficult reforms.

It’s going to take [Xi] a while to consolidate the power he needs to get people in the key jobs that are going to allow him to accomplish the reforms. I’m cautiously optimistic that [he] will succeed, but right now there is no real consensus behind a number of these [issues].

There’s a misconception in the US that somehow or another in the Chinese system, the top guy can say, “I want to do this,” and everyone falls in line. Even though we have a very different political system here, both countries face a problem of vested interests resisting reforms—particularly economic reforms, which are very necessary to keep our economy strong.

On the apparently paradoxical aims of Chinese president Xi Jinping

You’re one of the few people who actually knows Xi and has a relationship with him. Is there anything that surprises you about how he’s chosen to lead?

I knew before he assumed his position that he was a strong leader, that he had a rare set of political skills, that he was unusually candid and unscripted. But I think I—or anyone else—had to be surprised by the scope of what Xi has laid out. I don’t think ever in the history of the whole world have you seen a leader try to make as extensive changes as he’s making on such a massive scale.

I think to many of us as Americans it seems inconsistent to say, with regard to the economy, we need a new economic model where the market needs to be decisive, we need to free up bigger parts of the economy to market reforms and have there be more flexibility and economic freedom, while at the same time constraining the media and being much tougher on the internet and tightening up on the political system. What I think Americans need to understand is, to Xi, that doesn’t seem like a paradox, because he views the Communist Party as the source of stability in China, and that is the organization he’s going to use to drive the reforms.

This is a leader who has really consolidated power quicker than anyone since Deng [Xiaoping, who led China from 1978-1992], maybe since Mao [Zedong, who governed from 1949-1976]. And he seems to be the most ideological leader since Mao. I’m not sure that is something that many outsiders would have suspected. He’s also very direct in being clear that he is not aspiring to transform China into having a Western-style, multiparty democracy, or Western values.

On whether a strong China helps or hurts the United States

Can you talk a little about what inspired you to write Dealing with China?

The reason I wrote the book is that I feel very strongly that this is by far the most important bilateral relationship the US has. It’s hard to think of a major challenge in the world today—whether it’s sustaining economic growth, dealing with climate change, maintaining peace and stability—that isn’t going to be easier if we’ve got the US and China working together, and that isn’t going to be more difficult if we have the US and China working at cross-purposes.

But while I might have said the same thing 10 years ago, what we’re seeing happening today is that, as China has emerged as a more formidable competitor and is asserting itself more on the global stage, the traditional consensus that the rise of China is good for the US is breaking down. So we really need to recalibrate our policy toward China. We’re going to be competing with them at the same time as we’re partnering and cooperating with them. It’s important that the competition not be debilitating, destructive competition ultimately leading to conflict.

The question I get a lot is, “Are you concerned that [China has] a better form of capitalism, or that they’re going to eat our lunch, or that they’re going to out-compete us?” What I continually tell them is, “Don’t be afraid of competition.” That’s where you started with your first question, so you obviously understand that you can make as big of a mistake overestimating China and exaggerating their strength as you can in underestimating their potential. This is a country that’s got big challenges, and it’s important that they meet a number of them or it will hurt us and the rest of the world.

The only threat to US predominance is our own political system, if it prevents us from working together to restore the competitiveness of the US economy. Our own economic strength is going to be determined by what we do. That’s an important message in my book.

On China’s contribution to the rescue of Fannie and Freddie, and the importance of setting a good example

Turning to China’s debt problems—in particular, the state’s need to remove its “implicit guarantee” of local government debt—have China’s leaders ever asked you about your decision in September 2008 to let Lehman Brothers fail?

I would just say this, which I explained to them: I didn’t have a decision to make with Lehman. What I have explained to them is we always believed Lehman was systemically important. Unfortunately, we didn’t have a buyer for Lehman like we did for the other investment bank, Bear Stearns.

In Dealing with China, I have a chapter called “A Global Reckoning,” which tells the story of the financial crisis through the eyes of the Chinese. There were a number of lessons there. One of the real advantages [I had was] as a banker, I worked with a number of the same people that are now senior leaders in China, [helping on] some of their economic reforms and on the first [major overseas Chinese] IPO, which was China Mobile, and on [China’s] first bank IPO. This history of working with them [led to] a level of confidence that I think really helped going into the crisis.

There’s a story I tell about being in China in mid-August of 2008—that was two weeks before we had to step in and put Fannie Mae and Freddie Mac into conservatorship. It took my breath away when I learned from the Chinese that the Russians had approached them and said, “Why don’t we sell some Fannie and Freddie shares?” [Russian officials have denied that this happened; had a dumping of the securities ensued, it would have complicated the US government’s plans for bailing out the mortgage finance giants.] The Chinese obviously didn’t go along with it, and we were able to put Fannie and Freddie into conservatorship and avoid catastrophe.

There’s another anecdote about the financial crisis that to me is very important because it demonstrates how important preserving our economic strength is, and how a good part of leading economically is leading by example. In dealing with China, I recount the story that in June of 2008—so right in the middle of the financial crisis, when my counterpart was Wang Qishan, who’s now on the standing committee [of China’s cabinet]—[Wang] was in the US and I was pressing them to open up their banking system and open up their economy to more competition. He says to me, “Hank, it’s going to be very difficult to do this now because you were our teacher—and our teacher doesn’t look very smart!”

It makes you realize what happens to your standing in the world when you slip up, and how people want to pattern themselves after successful economies and financial systems. Now, I had plenty of responses about how we’re transparent, we shine a light on our mistakes, we moved quickly to clean up the mess, that there were a lot of good lessons that China could learn from what we did. One of the lessons was that they shouldn’t hold back on reforms and competition, and they need a healthy, vibrant financial system to pursue their economic reforms.

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