Transcript of the Atlantic Council’s International Security Program conversation with Former Treasury Secretary Hank Paulson and Former National Security Advisor Steve Hadley on the way forward for US-China relations.


Next Steps in US-China Relations:
A Conversation with Hank Paulson and Steve Hadley

Welcome and Moderator:
Frederick Kempe,
President and CEO,
The Atlantic Council

Former Treasury Secretary Hank Paulson;
Former National Security Advisor Steve Hadley

Atlantic Council,
Washington D.C.

Date: Tuesday, July 17, 2012 

Transcript by
Federal News Service
Washington, D.C.

FREDERICK KEMPE: Good morning, everyone. Good morning, everyone, and welcome to the Atlantic Council. I’m Fred Kempe, president and CEO. As you can see by the standing-room-only audience, we have a lot of interest in our speaker – our speakers and this subject.

Thank you for being here today for what promises to be a fascinating discussion between former Treasury Secretary Hank Paulson and former National Security Adviser Steve Hadley, who are both fresh off planes from China. And they’re here to talk on the way forward for U.S.-China relations. Today’s event is part of a flagship Atlantic Council 2012 effort called The Task Ahead, meant to elevate the U.S. debate – U.S. presidential debate on international issues – not that we think the debate needs to be elevated – this year and offer policy recommendations to the winner of this November’s presidential elections.

I hope you’ll all grab copies of the Task Ahead report outside. It has foreign policy memos from a cast of – a bipartisan cast of foreign policy heavyweights on various subjects that include Secretary Madeleine Albright, Senator Chuck Hagel, General Jim Jones, General Brent Scowcroft, our International Advisory Board chairman, who we’re happy to have with us today. The memos address the most pressing issues on the foreign policy agenda, such as managing relations with Pakistan, supporting the Arab awakening, democracy promotion, preventing Iran from getting nuclear weapons, et cetera.

I’m delighted that today’s event will allow the Atlantic Council to add to the list of contributors to the Task Ahead project another illustrious author, Secretary Paulson, happier still that he chose to write on the subject of U.S.-China economic relationship. The presidential memo he is releasing today, “A New Framework for U.S.-China Economic Relations,” calls for the winner of the elections to establish a new consensus on a positive U.S.-China economic relationship and to make policy changes that bring together greater complementarity to our two economies.

I want to thank a member of the Atlantic Council board, Bruce Mosler, chairman of Cushman & Wakefield, for inspiring and supporting this effort with Atlantic Council senior adviser Harlan Ullman.

The Atlantic Council is extremely fortunate to have Secretary Paulson contribute his thoughts on this topic. In fact, there’s probably not a better American suited to address this issue. He has unmatched business, economic and strategic expertise, thanks to a distinguished career both in the private and the public sector: 30 years at Goldman Sachs culminating with his time as the bank’s chairman and CEO before President George W. Bush asked him to serve as the 74th secretary of the Treasury of the United States. His tenure as Treasury secretary will be remembered as one of the most challenging in American history. His decisive action and steady leadership stabilized financial markets at a time of acute crisis that many believe could have plunged the world economy into a second Great Depression.

But his tenure as secretary of Treasury is remembered for much more than that. He recognized the crucial role of the U.S.-China economic relationship and political relationship and what impact this could have on global peace and prosperity. The economic interdependence and strategic competition between the two countries was recognized by him as posing a particular challenge for policymakers in Beijing and Washington.

To address this challenge, President Bush established the Strategic and Economic Dialogue, which allowed Secretary Paulson, then-Secretary of State Condoleezza Rice and National Security Adviser Steve Hadley to engage their Chinese counterparts to enhance communication and foster collaboration. And this important dialogue continues to this day.

Secretary Paulson has continued to dedicate his energies to the improvement of Sino-American relations through the establishment of the Paulson Institute, located at the University of Chicago, which studies crucial questions in U.S.-China relations.

I’m delighted that Secretary Paulson will be joined in today’s discussion with his former colleague Steve Hadley. Steve is one of the United States’ most thoughtful minds and strategic minds on foreign affairs and national security. And he, as I said, is just returned from Beijing.

It’s an honor to have Steve as a member of the executive committee of the Atlantic Council board and a crucial member of the leadership team of the council’s soon-to-be-launched Scowcroft Center. He’s a founding partner at RiceHadleyGates LLC and has served multiple administrations in senior positions going back to his start in government service during the presidency of Gerald Ford.

So with that, it’s my pleasure to welcome Steve Hadley and Secretary Paulson to the stage, where they’ll engage in a discussion about the paper and many other things. Thank you very much. (Applause.)

STEPHEN HADLEY: Fred, thank you very much for that kind introduction. And it’s a pleasure for us to be with you, and Hank, it’s a pleasure for us to have you here at the Atlantic Council.

I wanted just to take a moment to set the scene a little bit. We’ve – of course, of – celebrating here the 40th anniversary of Nixon going to China. And sometimes before we look forward, it’s useful to look back and see really what has been accomplished over those 40 years since in U.S.-China relations. And just as a refresher, let me paint a little bit the situation in ’72 and then the situation as it is today.

’72, we forget that the two countries, China and the United States, were in opposite sides of a full-scale ground war in Southeast Asia. China was largely outside the international system, a member of almost none of its institutions. U.S. GDP was $1.23 trillion, representing 12.6 percent of global trade. China’s GDP was $112 billion, and it represented 0.6 percent of global trade. There were virtually no U.S. economic relations between the two – with China. Total trade was then $5 million in U.S. dollars, and there was virtually no U.S. foreign direct investment in China, virtually no exchanges between the two countries.

Now flash forward to 2012 and U.S.-China relations today. No existing military conflict or confrontation, either directly or by proxy. China is a member of nearly every major international institution and one of three now major economic power centers, the United States, Europe and China. China is now the world’s second-largest economy, a GDP of $7 trillion, $7.0 trillion, behind only the U.S. at $15 trillion. And China is currently the driver of approximately 50 percent of global economic growth. U.S.-China economic relations are strong, but changing. Two-way trade between China and the United States was over $500 billion in 2011, enormous foreign direct investment, U.S. into China, and since 2009 emerging Chinese foreign direct investment in the United States and extensive cultural exchanges between the two countries.

As Secretary Paulson points out in his paper, this progress was driven heavily by a perception that it was in the U.S. interest for China to advance economically. And U.S.-China economic relations was really heavily an engine of China economic growth. There is now some question about that, and not so much confidence in the U.S. side that what’s good for China is good for us and good for the world. And so our relations are at a new stage. And what Secretary Paulson has done in his paper is suggest how the United States-China relations should change and what should be its foundations going forward.

And so I’m going to ask Secretary Paulson to talk a little bit about that paper and his perspective. I’m going to then ask some piercing and penetrating questions – (laughter) – on that paper to try to flesh out his views, and then we will go to the audience and finish up around 12:15. So that’s the agenda for today.


HENRY PAULSON: Well, Steve, first of all, thank you very much, and Fred, thank you. You know, when I came to government, no one did more to help me get acclimated, show me the ropes, than Steve. And I tell you, you can’t have a better role model than Steve Hadley. So I’m a big admirer.

And, you know, Steve is right setting that stage. I often explain to people when they talk about the tension in the trade area, I say, that’s the good news, you know, that 40 years ago we didn’t have any tension in trade, and we didn’t have any trade, and whenever you’ve got an economic relationship, you’re going to have tension. But I do think that the – that this – to the extent this consensus is fraying, and it is fraying, I think it has to do with a number of things. I think it has to do with the success China has had economically. I think it has to do with some of the problems and issues we’ve had, and – which are causing some people to lose confidence. And again, I think that the problems we have have got nothing to do with China or very little to do with China. They – they’re – we just need to look in the mirror, and they’ll be more difficult to solve if China is having problems. But I do think that’s an issue.

And I think another issue is as China is progressing, I think more and more U.S. companies and U.S. citizens recognize they’re going to be competing selling the kinds of products and the higher-value-added products we like to sell. It – for those that don’t like getting, you know, sandals and toys from China, I think the competition in the future is – we’re going to be talking about aircraft and, you know, higher-value-added products.

But I do think, as Steve mentioned, it’s very important – there’s always going to be differences when you’re dealing with another sovereign nation. But you know, we should be – we should look at it; we should look at it clearly, and what’s in the United States’ best interest. And I think that in our best interest is having a constructive relationship with China. There will be differences in certain areas, but there’s many areas where we have mutual interest. And there’s a great opportunity in the economic area to break new ground and do things which really represented an affirmative agenda where we can do things sometimes together, sometimes separate, but which will benefit our country and the global economy, and it’ll benefit China and the global economy.

MR. HADLEY: Great. We’re going to talk a little bit about some of those areas of cooperation. Hank just got back from China, as did I. And one of the things – while we were there, there was the announcement that second quarter GDP growth in China was 7.6 percent, down from this historical average over the last 10 years. But when you talk to people there – (clears throat) – excuse me – there’s a lot of anecdotal evidence at the micro level that economic slowdown is perhaps much more severe than that, if you look at the data on output of the manufacturing section in China, for example. So one question I think a lot of us have back here is how real is that 7.6 percent, and what are the prospects for Chinese economic growth here over the next 18 months?

MR. PAULSON: Well, Steve, as you said, I just got back from China, and I spent a good deal of time not just talking to government leaders, but to people who are running the big companies there, some that were running small companies. And there’s no doubt that the economy has slowed down significantly and, in a – in a number of areas, really slowed down. And there’s a lot of anecdotal evidence in terms of what’s happened with electricity, what’s happened in a number of – in the manufacturing areas, production is way down and so on.

Now, my own best judgment is that we’re not going to see a hard landing and that what happened with China was really two things happened at once. First, they – the government took some pretty tough administrative measures to tighten up because they were concerned about real estate bubbles; they were concerned about inflation, which was a knock-on effect of the stimulus plan they had done in 2009. So they really clamped down pretty hard on lending. And that – those kicked in about the same time as you had the European economy really slow down. So those two things happened at once.

And the Chinese now recognize the problem. They’ve opened up the spigot. They’ve removed the – you know, the harsh administrative measures. And I think there’s a lot of room in their economy, unlike ours, for it to respond positively to monetary policy, loosening up lending and so on. And so I would be quite surprised if they don’t grow somewhere between 7 ½ (percent) or 8 percent this year. I think the – I think the challenge for China, the bigger challenge, is coming, you know, three to five years out with some of the challenges they have, because I think their current growth model is running out of steam, and they – and reforms have lagged. But I’m not saying it’s not – it’s not serious, and it clearly is impacting us – will impact us. That’s our fastest-growing export market.

MR. HADLEY: One of the things I want to pick up on – and if you have not got a copy of this paper and read it, it is – it’s a – it’s a terrific paper. And one of the points Hank makes in it is that the U.S. and China economies are deeply interdependent, and the U.S. economy will suffer if the Chinese economy fails to meet its economic challenges. And the converse of that is probably also true. So we are in some sense linked, these two economies.

And Hank talked about prospects for economic reform, and I – and I want to push you a little bit on those two things. One of the things I did not realize, and familiar to many of you, is how dependent the Chinese economy is on investment, and particularly investment in fixed assets. Almost 47.8 percent of the GDP is investment. Consumption is only 33 percent. And one of the thing (sic) Hank calls for in this paper is they need to move from investment-based economic growth to consumption-based economic growth. But the dilemma, I thought, was shown interestingly in Premier Wen Jiabao, who announced a stimulus package recently. And what was his stimulation – stimulus package? More investment in capital investment through state-owned enterprises to put more people to work. So Hank, when you talk about economic reform, can they – can they break out of this investment-driven economic growth, or is all this talk about transitioning to a consumer-based economy just a lot of hot air?

MR. PAULSON: Well, that’s the – and that’s the big question. That’s the big question. And there is no doubt that they have reverted to some – you know, some of their former practices, which have served them well in the past in terms of economic growth, and they’ve done something where they know they can get a quick hit in terms of economic growth. Now, I believe that they recognize that further reform is inevitable. You saw it in – you see it in their Five-Year Plan, and they generally – you know, their plans, they generally do a pretty good job of sticking to it. You saw it in the way they welcomed the World Bank study. And when you talk to leaders, you know that they – that they – that they see they need to speed up the process of reform. I think they know. You know, this – as you said, this is a $7 trillion economy. You know, between the U.S. and Europe, you got 31 trillion (dollars). I think they recognize that – you know, that they’re too big and too complex and too integrated into the global economy to be as dependent as they are on exports and, you know, low value-added, you know, energy-intensive, investment-intensive exports. They know that.

So the question is – and that’s what I was alluding to when I said I – to me, the major issue – I’m not downplaying at all the slowdown in the economy, because let me tell you, it is real right now, and they’re dealing with a real slowdown, and they’re going to do what they can. And I think that they will avoid, you know, the hard landing. And in China, if you get growth much below 7 percent – (chuckles) – it’s the equivalent of a hard landing. And – but I do think the challenge comes a number of years out, because reform in certain areas has stalled. And you hit the big – the big one with state-owned enterprises. That stalled.

MR. HADLEY: Right. And let’s talk a little bit about this. There’s been a number of reports in the press about the state-owned enterprises. And there is a narrative among some that a commitment to free enterprise, free market and a real private sector really drove reform in China till about 2005. And in 2005, it started to tail off.

And some even argue that the state-owned enterprises really have become the problem. They represent about 40 percent of nonagricultural GDP in China. And they are largely protected by their size, by the large role they play in the economy, the preferential rates they get in terms of interest – interest rates which are artificially kept low to their benefit and, as we’ve seen recently in the press, the connections they have with the families of the elites in China.

And some say that – you know, that the big barrier now to resumption of reform is the SOE, the state-owned enterprises. And the real question I think many people have is, in light of the enormous power they have, is there a chance of moving to a real more private-sector, private-enterprise based economy, or are the SOEs in a position to, if you will, strangle the reform baby in its crib?

Hank had a session over in China. And he had a list of 94 CEOs and leaders of SOEs and true private enterprises. When you talk to those leaders, Hank, what do they see the prospects of reform? And is there a way of kicking the SOEs or is really China on a new model of competition, which is competition among state-owned enterprises rather than a real viable private sector, the way we know it in this country?

MR. PAULSON: Steve, to begin with, when you – of course there are the SOEs which are the – where there’s the big central government ownership. And there – there’s, you know, somewhere less – depending on how you count them – less than 150 there and a smaller percent of GDP. But when you look at, you know, the hundred thousand-plus, when you get to the municipal government, you know, partially owned or, you know, controlled, it’s the kind of number you were talking about.

And I have always argued, and – that the private sector is really the – where the future of China lies – the Chinese economy and that the only way that the Chinese are going to be able to successfully make the transition that they’re going to need to take – make to an economy that’s much more efficient – and it is by continuing to reform the state-owned enterprises, have them compete on a level playing field without all the subsidies and the special benefits, and that if they don’t do that, that they’re not going to realize their – you know, the full potential of the economy and they’re not going to make the transition that they need to make and it’s going to be – it’s – and the people who will pay the price will be the Chinese people.

I would be cautiously optimistic that that process will continue. But I think one of the key questions is going to be, what’s going to be the role of the state going forward? What is going to be the role of the government going forward? And I just think the economy is so big and so complex right now, it’s going to be increasingly difficult to manage with this combination of administrative controls and planning and markets. And they’re going to have to let markets and the economy, you know – you know, and the private sector do more.

Now, to get to the – to what I was – what I was doing over there – and I’ll just step back and take a minute and, you know, when you – the paper which we put forward, which was, you know, an affirmative agenda, really had five cornerstones, and one of which was unlocking the potential of foreign investment or, you know, of cross investment. And to me, a big pillar of that is – from our side, would be welcoming Chinese investment in the U.S. that creates jobs.

And so when I was there talking to this group I had with me eight CEOs who – or CEOs and chairman of major successful global enterprises – three Europeans, five U.S. And each of these companies were a real leader in their industry. And China is right now – at this stage of their economic development they’re focused on building global businesses. Right now there are a lot of companies that are successful in the Chinese market, but there are very few Chinese companies, if any, that are real industry leaders globally. So they were focused on that.

And of course, when you – when the leaders of the very successful global companies were talking about what it takes to build and lead and manage a successful global business, they made the point, you need the best technology, you need the very, very best business practices as it relates to how you hire, train, develop management. You really need to give back to the countries and the communities where you do business. You need the very best environmental practices. You need to engage with local stakeholders, with politicians in the countries where you do business, with regulators.

And for a long time, I’ve said, you know, this next stage of development, where Chinese companies go out and do more globally, they’re going to be the window on which so much of the world looks at China and views China. So that was the context, but I was also – had in my mind investment because, as you said, beginning in 2009, they began to make investment. And there’s no doubt in my mind that they’re going to make a – they’re going to make a lot of foreign investment in the next 10 years. And we are lagging way behind in investment they’re making in Africa and Latin America and in Europe.

And why? Because I think they feel unwelcome here. I think they are confused by, you know, the different regulatory constraints and put off by them and, you know, don’t understand the political system and so on. And I believe very strongly it’s in our best interest to capture our fair share of that investment. And the – I know that it – foreign investment is unpopular politically, you know, in the abstract. But when you get down working with mayors and governors at the – at the subnational level, when it’s going to create jobs, it’s much more popular.

And you know, we only have – I think there’s only 4(,000) or 5,000 jobs in the United States resulting from Chinese investment here. And there’s over 5.6 million from foreign investment overall. And so – but what I came away with is they are going to invest overseas. I want to encourage, where it makes sense, to have them invest here. And I think the good news that’s going on is, despite the consensus – and I think the consensus would be – or conventional wisdom would be, it’s going to be very, very difficult for us to get our fair share of Chinese investment – that there’s – that there’s so much resistance that it’ll be very difficult.

And – but despite that, and despite obstacles in certain industries and sectors for making investment, we’ve had this last year a number of investments that have been made that – where there hasn’t been the expected political backlash and they’ve been welcomed. And there’s a – you know, four of the CEOs that were in the crowd when we – when we met with him, had all had successful investments. There’s a construction equipment manufacturer, Sany. They just announced earlier this year in Georgia with Governor Nathan Deal they’re completing the first stage of the construction of a manufacturing plant that will make construction equipment, will hire a couple hundred people.

In January, Sinopec, which is run by Fu Chengyu, announced that they were making – you know, putting $2.2 billion into five Devon Energy shale projects. So these were minority investments. They didn’t raise eyebrows but it brought welcome Chinese investment to develop shale resources in the U.S. You probably read about Wanda that – you know, Wanda is a Chinese conglomerate. And the U.S. regulators have approved the 2.6 billion (dollar) acquisition of the AMC movie theaters. And they are going to – they’re going to put more capital and work to make that profitable. Higher (ph) – you know, and the higher (ph) chairman is there. They’ve got a plan of Camden, South Carolina, again, employing Americans.

So as I look at it, this is something that we want to – we want to, you know, welcome that, and at the same time we want to be continuing to push China to create a level playing field for American companies and businesses in China.

MR. HADLEY: I was in a conference over this last week and we talked about this issue of foreign direct investment of China in the United States. And of course, we’ve been through with the Japanese case, which thought they would acquire Rockefeller Center and enraged all of America. And then they got a better idea and decided they would put auto plants in West Virginia. And suddenly, you know, when they began to employ American workers, you know, they – you know, they were everybody’s favorite neighbor. And it was just interesting.

We asked this group of Americans and Chinese, what strategy would you recommend to Chinese companies to overcome the resistance of foreign – China foreign direct investment in the United States? And they came with these six ideas. And I’d just like your reaction then I have a question on the second point.

One person said, you know, infrastructure – American desperately needs to rebuild infrastructure. So Chinese ought to make some of their financial investment in local infrastructure bonds at the state and municipal letter (ph). They ought to participate in projects to build infrastructure in the United States, employ American workers. Work at the state or local level; stay away from Washington. Partner with U.S. companies to make themselves more acceptable and be a good citizen and think about contributions to the community. Pretty good list – pretty good list.

The other thing – the seventh was on the list was reciprocity. And while maybe we should have – and be – welcome Chinese investment in the United States even if our companies are doing less well in China, the view was that’s politically unsustainable. Do the Chinese understand that there is a wide-shared perception among American companies that China is less welcoming to foreign investment, that China is favoring these emerging global players over U.S. companies and that by doing so, China is undermining one of the major constituencies for improved Chinese-U.S. relations, namely the U.S. business community? Do they understand that, and do you think there’s a prospect that they will address the constraints on U.S. investment in China?

MR. PAULSON: Well, let me first – let me first make the – a clarifying comment. The U.S. businesses that are in China, many of them are doing fabulously well – much better than any Chinese companies are doing here. So those that have come in and made investments in those sectors where they’re allowed to make investments, even though the rules don’t necessarily read that way, they’re almost granted supernational (ph) treatment, OK? And a matter of fact, some of those companies are unhappy that they’re going to be forced to compete more, OK? So that’s happening, number one.

But I think the point you’re alluding to is that the sectors they can come into are limited, OK? And we’d like to see the market opened up further and U.S. companies being able to – more of them be able to do – have the businesses themselves, without doing it on a joint-venture basis. So there’s a lot of things that would help. And I think that’s where the reciprocity comes in.

And I used to say all the time to my Chinese counterparts at the SED: Listen, I believe in trade. I believe every product we import from China is good for us. Not everybody else in the U.S. agrees with that. I believe investment is good for us. Not everybody else in the U.S. believes with that. But you would make my job a lot easier to fight to keep our markets open for you if you would keep opening your markets and reforming your markets. And I – so I do think that reciprocity is important.

And in terms of your ideas, I thought they’re all good ideas. The one thing I would say something about is infrastructure, because there’s huge interest, the Chinese, in investing in infrastructure. And we talk a lot about infrastructure here. But I don’t think it’s realistic to think Chinese are – we have a lot of capital and there’s a lot of private capital on the sidelines here. And I don’t think we should assume the Chinese will be dumb money, that they will come in and invest where U.S. companies won’t invest and where U.S. capital won’t.

And our problem with infrastructure is that we need some ways to fast-track some of these projects. You know, when it takes – with all the political risk and when it takes eight or 10 years, these projects aren’t attractive investment opportunities. So I think we need to do some reforms and make some changes before that will be successful.

And when I talk with mayors and governors, I explain there will be really good opportunities for Chinese to invest here, but don’t assume – don’t tell me, you know, in my particular state where we’ve got a bad tax situation, where we’ve – where we’ve got a bad fiscal problem, where we’ve got uncompetitive labor rates, and U.S. manufacturers have shut down because they can’t afford to manufacture here, that the Chinese will come in and manufacture. So it’s no surprise that they’re manufacturing in Georgia and Camden, South Carolina, and they’re doing other things elsewhere.

MR. HADLEY: In environments that are receptive to that kind of investment.

MR. PAULSON: Yeah, receptive – receptive.

MR. HADLEY: One of the recommendations you make in the paper is that the U.S. and China move toward bilateral trade negotiations. Is that politically sustainable at this point, in either country? How realistic is that to you?

MR. PAULSON: Well, I’ll just say, let’s not prejudge based upon where we are in a campaign, OK? So we’ve got a – so we’ve got a major campaign here. They’re going through a transition – a leadership transition there, OK? What I’m saying is if we let everything that’s a difficult – if we don’t do things that make sense economically because they’re politically unpopular, relations with China are going to be the least of our problems, when you look at some of the fundamental problems we need to deal with.

And so I just take a look at opening up bilateral trade negotiations with China. Now, the global trade round is going nowhere fast. You and I both spent a lot of time being frustrated by that when we had our turn. And so we won’t judge others, because it was just very hard to get that done. And yet, when you look at all the people we have, you know, different bilateral trade negotiations with, we have FTAs with, and when you look at the potential we’ve got – but you have be creative.

I think that we have to be prepared to grant China market economy status on a sector-by-sector basis. We need to be able to do some things that are important to them – for them. And I think they need to keep opening up their market. And I think there’s real opportunities there. I think when we talk about investment it’s very important to negotiate a bilateral investment treaty with them. You know, as I say, we have investment treaties with Moldavia. We certainly should be able to figure out how to have one with China, you know, particularly given all the investment we have there, and we need to protect our companies.

MR. HADLEY: Great. Hank, I want to address two more areas before we open it up to questions. One is, we’ve talked a lot about economic reform. We were both in China. How do you assess the political situation there in light of the Bo Xilai incident, the blind lawyer incident – Chen now here in the United States – and the upcoming leadership transition? What are the prospects for a resumption of political reform in the direction of a more open and responsive and accountable Chinese political system? And then I want to ask you a little bit about the new incoming General Secretary Xi Jinping. But first, prospects for political stability and political reform in China.

MR. PAULSON: OK. There are a – you got to remember, this is a political system that’s in the process of evolution. You know, you go back 10 years ago was the first time when it went from Jiang Zemin to Hu Jintao that a sitting leader didn’t pick his successor. And so you find that evolving, number one.

Secondly, there’s plenty of examples throughout China today – plenty of examples of dissent in the economic area leading to the government making concessions. And there’s plenty of anecdotal evidence in terms of even environmental projects were being stopped because – so my own view is that greater opening up and economic freedom and integration into the global system will inevitably – as it has in many other places – lead to more political changes and political freedom.

And I think the biggest thing that I believe that it remains to be proved is, first of all, we know – what is the primary objective of the Chinese leadership? Stability, right? That’s why economic development and creating the jobs is so important. But I think that we – you’re going to see the leaders over time come to understand that political reform and providing more liberties will be a tool that can be used to maintain stability, rather than something that will be disruptive and lead to disruption. But again, this is – this is a system that’s evolving.

And I think the thing that people don’t understand here about China is it’s a very different country than the U.S. – very diverse, very complex. We talked today about the growth and how strong they were economically. They still have, you know – you know, many, many people living on a dollar a day. And they’ve got a lot of challenges. As – you know, we have significant challenges in front of us economically. But I tell you, they’ve got, I think, more formidable challenges as a country that they need to deal with.

And so that’s – and I think one of the – one of the challenges if you – if you say what are the challenges, one of the challenges, I think, we each have. And one of the things that I talk about – one of the principles I had in the paper is increasing, each of us, our confidence in the government. You know, and for the U.S. it’s very simply the confidence that our government – federal government is able to take the actions it needs to take to strengthen and restore our economy and our competitiveness. That’s really the issue.

With China, I think the – it’s about increasing the confidence in the government in terms of transparency. Can you count on the data? And sure, it’s also – it has to do with disclosure of their companies and their accounting. But I also think a very major challenge is increasing the confidence of their government, which means really the people’s confidence that the government can address this corruption, which is infuriating so many Chinese. And with Bo Xilai, which – (inaudible) – of course, it’s doubly interesting and attention-grabbing in China and here, because it comes right during this time of transition, but also because it’s focused people on corruption and privileges of the elite.

Now, for the most part in China, where the real concern is is with local politicians at the municipal level. And you know – and it – and the real concern is about property issues, corruption and just abuses in terms of taking people’s property and how it’s sold for development. It has to do with environmental issues and those kinds of issues. So I think that’s sort of the area where most of the concern and dissent is focused.

MR. HADLEY: Finally, let me ask you about the incoming general secretary of the Communist Party, Xi Jinping. You know him; you’ve met with him. What’s he like? And you’ve set out a pretty bold vision of where China needs to go economically and politically. Do you think he shares that vision?

MR. PAULSON: Well, I’ve known him for some time, really going back to my days at Goldman Sachs. And as you’ll remember, when – in 2006 when I took the first trip as Treasury secretary, we were going to Beijing to meet with Hu and Wen and Wu Yi. And I stopped at Hangzhou to see him first.

Listen, I’m – he’s very impressive. He’s a man who understands business, understands economics. As – he is a – he is a – he’s a real presence. He’s someone that fills up a room, as you could see when he visited the U.S. He reacts really well to – you know, with people. He – you know, he just – he understands people, understands human nature. He’s got terrific people skills, strong leadership skills.

But my view is it’s going to take it – strong leadership skills, because when you look at the challenges that he and the leadership team are face, it’s – they’re going to be significant because, you know, never in the history of the world have you seen – anyone witnessed any nation so big that’s changed as much so quickly. But the expectations of the Chinese people are so high, and they’re increasing, and the demands for change are increasing.

And so to manage change on that scale, you know, it – which is – which is unprecedented, is not going to be easy, particularly when you look at what’s going on globally and you look at all the volatility globally and all the issues that you and I know that are happening across the whole range of national security, foreign policy, what’s happening in the global economy. So he will be tested, I think, in much stronger tests than the last leadership. And I’m not downplaying what they’ve accomplished over 10 years, but he will – he will have his hands full. But I think he’s up to it.

MR. HADLEY: Is he a reformist?

MR. PAULSON: Well, my view is that everyone in the very top leadership knows that China – you know, this is beyond the point of saying we – you know, they all know that they’ve gone too far to stop now. They’ve got to continue with reform. There’s no turning back. And as I said, I think that what’s happened in the U.S., what’s – you know, the really serious situation in Europe right now has just really pressed that – impressed that upon them much more. But how fast reform will proceed – it’s difficult to predict. But again, I think they understand the issues and that they know that there’s no turning back.

MR. HADLEY: Thank you, Hank.

Let’s open it up to questions from the audience. I don’t know whether there are microphones; I don’t know whether we need microphones. But yes, there are microphones deploying.

Yes, ma’am, on the aisle, in the red top.

Q: Thank you, Secretary Paulson. My name is Bi Ruong (ph) with Hong Kong Phoenix TV. I would like to seek your comment on how do you view this. During this presidential election campaign, there is a severe anti-China sentiment. Are you concerned this anti-China sentiment would affect the positive – you are calling for a positive China-U.S. economic relation. Are you concerned playing China card would lead to more trade dispute or even a trade war? Thank you.

MR. PAULSON: Is she asking how do I view the election that’s going on impacting –

MR. HADLEY: Yeah, the U.S. presidential election and anti-Chinese rhetoric in the U.S. presidential election.

MR. PAULSON: Right. Well, here’s the way I see it, and I think everybody in this room probably understands this. This is – (off mic) – election. And anti-China rhetoric plays, OK? People respond positively to it. And – but what I believe is – I don’t believe that either candidate wants to make China a focus of the campaign, because I think they know that they’re – we need to cooperate with China in a whole range of areas. But I think you need to expect that whenever events conspire to put China in the news, you’re going to hear anti-China rhetoric because the American people don’t want to hear about all the areas we need to cooperate with China in. And I think you’ve got nationalism in both countries. Nationalism plays.

And – but we also – I point this out, and I think this is very, very important. When you look at what both President Obama and Mitt Romney have – the position they’ve taken, they’ve argued for a level playing field and competition according to the global trade rules, without – you know, and being very clear that they want to do that without having a trade war. And so – and I think the key to managing this relationship over time is going to be leadership where you say, now, how do we deal with differences? How do we deal with areas where there’s a dispute? And as I said, in the economic arena the good news is we’ve got economic relations with China which benefit both countries. The bad news is there’s tension. There’s always tension.

So I’m not worried about that. I think that there’s – we have dispute resolution vehicles. We have the WTO to go to. So I think the important thing is to look through the rhetoric, to recognize that, you know, we – I’ve heard rhetoric in a good number of campaigns, looking back over the years. But I also don’t want to downplay the fact of where Steve started. To my ear, it’s not just the broad populace. But there is a more informed, knowledgeable group of business leaders, opinion leaders that are asking questions about the consensus, and is this benefiting both sides? And that was really the reason for my paper.

MR. HADLEY: Harlan Ullman.

Q: Thank you. I’m Harlan Ullman. My question has to do about whether or not we need some – to use the phrase, some big bazookas to sort out the U.S. and Chinese relationships. Your paper is entirely – is highly intelligent, reasonable and responsible. But the problem, it seems to me, is political, because on our side it doesn’t seem to me that our political system is very intelligent, reasonable or responsible.

Steve raised the issue of the Nixon Doctrine. And it seemed to me you really have two choices in how we proceed politically with China. Either we try to create the geoeconomic equivalent of Nixon’s going to China, in which the Soviet Union was the bogey, or we face really trench warfare in which we’re going to have to slug it out, because you got the extreme right in the United States who are afraid of China for military reasons and the extreme left for other reasons.

So do you see – is there a big bazooka in which we can fashion a strong argument for dealing rationally and sensibly in China, an argument which the Chinese also will accept? Or is it going to be trench warfare in the future in how we sort these relations out?

MR. PAULSON: Well, I think we need a new approach. I really do. I think the world has changed a lot, as Steve pointed out, in the last 40 years. The world’s very different; China is very different; we’re different. And you know, and as I just think about the national security issues, foreign policy issues, economic issues, the environmental issues – and I’ll say something about environmental issues – (inaudible, background noise) – in a minute – but when you – when you – when you look at those, if the U.S. and China agree, it’s going to be much easier working with other people in the rest of the world to get something done. If they don’t, it won’t.

So I really think we need to come up with – and this – my paper put forward some – an economic agenda. I think we need to go much broader than that in terms of thinking out of the box, because I think the right way to sit here looking at relations with China is this way: is to say – on almost every issue we should start by saying, what approach would be effective at getting China on side, OK?

What approach – and to do that, we can’t just statically sit here and say, here’s our one-size-fits-all. Here’s the way we look at it; here’s the way we understand it. I think to do that, you have to be aware of what’s going on inside China, because they’ve got a whole range of issues and problems. And you have to know what’s going on in China, and then I think it’s going to take really – real creativity. I don’t think we’re going to get, as you said, the big bazooka. You know, and if I had one, I wouldn’t take it out of my pocket here, but you know – but the – but I don’t think – I think it’s – but I think it’s going to take some real imagination.

Now, one of the points I made in this paper, where I was looking for areas in which there’s a common interest. And one of the things – you know, at the end of the SED we agreed to this 10-year framework on energy and the environment, because I said, here is an area where there should be less differences. We’ve got some common interests. And I think there’s room to let technology flow more freely.

And I talk in the paper about reforming a really outdated, you know, export control policy, where we can protect our national security – of course we can. And – but we could – too often there are exports that aren’t being made that are in our national interest or would create jobs in the U.S. So we could reform that.

But I also talk about a pilot project in U.S.-China, where you would have real experts, and you’d rely on scientific information and evidence in order to let technology in the clean-tech area flow more freely – because I got to tell you something. When you’ve got the two biggest economies, the two biggest importers of oil, the two biggest emitters of carbon, it’s a crime that we’re not using the very best technology and the cleanest technology.

And that’s why I’m spending so much time with the Paulson Institute on sustainable urbanization, because they’re going to have, you know, 300 million more people moving to the cities. And if they don’t get that right, it’s not going to make a lot of difference what we do here, if you have the same concern I do about climate. So I think there are some very big, important things. But we have to think outside of the box, and we have to take a different approach. We can’t use sort of the one-size-fits-all.

MR. HADLEY: (Off mic.) Admiral Keating.

Q: Hi. Tim Keating; I was a sailor for a while. (Laughter.) It’s interesting, and I think encouraging, that – unless I missed it – in an hour of very strategic discussion by two world-class thinkers, Taiwan wasn’t mentioned once. So interesting and encouraging – some of us endured the Taiwan homily every time we would go to China. Did you put up with the Taiwan homily this time? And if not, why not?

MR. PAULSON: Well, I didn’t. I’ll ask Steve, because Steve may have. I’ve – when I talk with the most senior leaders, this comes up because it’s just very important. But I think what’s happened is, through very wise policy in the U.S., you know, going through multiple administrations, we’ve been able to thread that needle and recognize, you know, this “one country, three systems” is very important to them.


MR. HADLEY: It came up. I think a lot of the heat has gone out of the issue, partly because President Ma was re-elected. He’s had an agenda of increasing cooperation economically with China and is now talking – or the issue about what they can do in the security and political side. And I think the Chinese are pretty pleased at that. They still raise the issue of Taiwan arms sales. When will you implement the original Reagan undertaking to bring them down in quantity and quality? And you know, when is that day going to come? But basically it’s been managed in a pretty constructive way.

There was one argument I heard for the first time that I think is troubling. But it tells you part of the challenge of managing this relationship. Basically he said, you know, deals were done when we are weak. We are now strong, and our interests should be given greater weight. And some of the modus vivendis that have been worked up on issues like Taiwan (arms that ?) need to change.

You know, on the one hand you see some merit to that argument, but on the other hand, if it’s a naked argument of we’re stronger and therefore people should pay us homage, you know, it plays into the Middle Kingdom, and that is going to be a fairly destructive way of framing issues, rather than areas of cooperation and managing difference.

So I think, you know, this new China is going to be hard to manage. You know, we saw two years ago a time of – where China was feeling its oats and pushed a little bit on the international system. And the international system reacted and its neighbors reacted and pushed back on China. I think that was probably useful. But we’re going to have difficult issues to manage.

The other thing that comes up all the time now and is bigger than Taiwan –

MR. PAULSON: By far.

MR. HADLEY: – is South China Sea.

MR. PAULSON: Yeah, yep.

MR. HADLEY: And the China – the U.S. narrative is – and the narrative of the countries in the region – is that China is becoming more assertive. The Chinese narrative is: We would like to put off the issue of territorial claims in the South China Sea for decades. We agree with you on freedom of navigation, that, in fact, the countries like the Philippines and Vietnam are using that issue to provoke China and to provoke a confrontation with the United States. Two very different narratives. I think that’s, in a way, going to be a bigger issue to manage, in many ways, than Taiwan. And you hear a lot about that.

Yes, ma’am.

Q: Hi, my name is – (inaudible) – from China Central Television. And some analysis say in short term the U.S. relationship will destabilize because of the U.S. campaign, especially the presidential campaign. And even though China has become a kind of scapegoat in the presidential election campaign, even the – from the currency issue to the – even though the – a lot – Ralph Lauren issue recently. So what do you think of it?

MR. HADLEY: Could I say one thing and I’ll go to Hank? Remember, this is a two-sided issue. There is a U.S. presidential campaign, and as Hank said, being tough on China is part-and-parcel of that game. There is also a Chinese political transition. And being tough on the Americans, I think, probably plays in that as well. So the tricky point we have at this point in time is that the two campaigns, our political campaign, the Chinese political transition, sort of resonate and reinforce each other in unproductive ways. And it is a management challenge on both sides.


MR. PAULSON: I’ve got nothing really to add to that. I tried to say that in answer to the last question. I answered the – answered it from the standpoint of the U.S. And there is no doubt, in my mind, that nationalistic sentiment is at least as high in China and that it plays, and that one of the things that leaders have learned, you know, is, you know, the system is still in evolution. And nationalism plays there just like it does in the U.S. And I think that it’s important to tamp it down. And – but again, my own view is that this will – you know, that this time next year we will have – the new leadership team will be in place here; we’ll have – the administration will be in place here and both sides should be looking for ways to find mutual cooperation.

MR. HADLEY: Yes, sir.

Q: Hi. Steve Winters, a local researcher. You talked about the desirability of increasing integration of China in the global system. At the moment, the U.S. government is – has been pushing very strongly for the increase in the membership of the Trans-Pacific Partnership – (inaudible) – formation Trans-Pacific Partnership. Some commentators have – feel that this has – would have the effect of isolating the Chinese. In fact, I’ve heard one commentator say that the specifics of the Trans-Pacific Partnership are written so to guarantee that China could never join that organization because of the existence of these state-owned enterprises that you mentioned. So aren’t there two things going on here? I mean, is this leading to an isolation of China? Is that U.S. policy, or how do you view these things?

MR. PAULSON: Well, I would tell you I have always thought that the Trans-Pacific Partnership is very important and a good thing for the U.S. I think we need to be strong economically, militarily, diplomatically in Asia. China has all sorts of trade negotiations going on with partners, number one. Number two, I think it would be a great thing if we could get that together and have China be part of it. And I think that – I think that should be part of U.S. policy. Number three, in terms of state-owned enterprises, I think what we need to do, which would be a very good thing, is to do the equivalent of what was done with sovereign wealth funds with the Santiago Principles. You know, China will have state-owned enterprises for a long time and we shouldn’t question that as long as they, you know, play by the WTO rules, that they are commercial enterprises, that they are run commercially, and I think it would be very useful. And I know that there’s some talk at the TPP about coming up with rules. I think the one problem is China doesn’t have a seat at the table there.

So I think we need some form, whether – you know, there’s conversations at the OECD, at the TPP – we need some forum where China’s got a seat at the table. And I think to the extent that we have some principles, I think that will greatly benefit China and these companies and it will make it easier for them to become global companies and make investments not just in the U.S. but all over the world. So again, TPP is a – is a good thing, and I don’t view it as a – as a strategy to isolate China, although I do think our relationships in the Pacific, and I’m glad it came up, doesn’t start and end with China. We’ve talked about China today. I read some remarks that Steve made – and I read everything he writes – and I read some things he did when he was in Seoul, which I thought put this whole thing in context as well as I’ve heard it, but in terms of U.S. relationships in Asia and how China fits into that.

MR. HADLEY: This came up when I was in Beijing and someone said the TPP is directed against China. And I said, why? And he said, because it includes standards that China today can’t meet. And I said, well, the TPP is a – trying to establish a strong and deep trading community. That’s a good thing. And your solution is to meet those standards because your economy would be better. Don’t think the world is going to blend down or water down all the standards to meet the lowest common denominator. It’s to set a high standard, and it’s in China’s interest to try to meet that standard and for us to try and knit together Asia comprehensively in as many good trade arrangements as we can. And that, I think, is the right answer.

Yes, sir.

Q: Terry Murphy. Secretary, a couple quick small points and a broad question. Point number one is I remember the book 20 years ago called “The Coming War with Japan.” So I think for – our Chinese friends should remember that we’ve – we tend to change our focus from time to time.

Secondly, I would say very quickly that when I first went to China, Pudong was a hugely important area. My wife went to China 10 years earlier; it was a cow field. (Chuckles.) And the gentleman who invited me to China was a 33-year-old Chinese official who had represented China in international conferences. And when he came to Washington we gave him – and he proudly posed before the White House wearing University of Michigan baseball caps and he wore the same things on the – on the Great Wall. So I think there’s a lot of goodwill that is – and he’s in charge, by the way, of branding at MOFCOM now. But I would – I would wonder, sir, whether with your influence and your stature you might be able to help the American population see just exactly how advanced China is economically, physically, to see the enormous, you know, cities that they built that we don’t really see at all. Very broad question, but Pudong is a gigantic area, which was a cow field 20 years ago.

MR. PAULSON: Yeah, yeah, I just got back from Pudong from the Chinese Executive Leadership Academy at Pudong, yeah. The – yes. When you – China is an amazing place because there’s such disparity – you know, provinces as different as Germany is from Greece, for instance. You can – when you’re in Shanghai or Beijing or, you know, you mentioned Bo Xilai – I was in Chongqing, you know, in this sustainable urbanization effort in December and met with Bo, and you look at those cities, they’re as advanced as anything you’d see anywhere. And some of their manufacturing – and it’s just terribly – it – really advanced.

But then when you go to places like – you know, I’ve been to the Qinghai province or you go to Yunnan or places, you take a look at – it’s a poor developing country. So there – it – China is an anomaly, you know. That’s why it’s so hard for Americans to understand a country which has had a history for 3,000 years, and it’s just so different in so many respects.

So never in the – when we talk about currency, I think the other thing that’s interesting: that currency didn’t come up. But when I get asked about currency, I would say that it is – people wouldn’t – and again, my view is they need to continue to reform and move the currency, and it’s very much in their best interest to do so to get where they want to get; that’s in the Chinese interest. But you wouldn’t be having the – even the currency discussion if we were talking about a developing country that had GDP per capita of wherever theirs is, you know, 5,000 (dollars) and rank number 100 in GDP per capita. But we’ve never had a – you know, a developing – and I don’t think we should call them developing; we should call them a growing country – but if we had a country that is a huge economic power and the second-largest economy in the world. So it’s just an anomaly, and that’s why it is so hard for Americans to grasp it. And we’re not particularly – you know, God bless us. We have a great country and we love it. We’re not great at understanding any country other than America. We think everybody should think the way we do, act the way we do, be just like us. And so it’s a higher hurdle for us when it – when it – than for some others when it comes to understanding China.

MR. HADLEY: Regrettably, we’re out of time. I want to thank Hank Paulson for all his time this morning, thank Fred and the Atlantic Council for sponsoring this – (applause) – and thank you all for coming. (Applause.)


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