US-China tensions push S. Korea to find middle way

The US and China trade disputes are unlikely to fade, whoever wins the Nov. 3 US presidential election, and South Korea needs to find a middle way between the world’s two biggest economies, while easing tensions with Japan, said Adam Posen, president of the Peterson Institute for International Economics (PIIE).

 "What your policymakers should do if Trump or Biden escalates conflict with China ... you’re just going to have to try to find a middle way," he told The Korea Economic Daily in recent videoconferencing and email interviews.

“The middle way means you clearly have a military tie to the US and that’s not negotiable, but you’re not going to give up economic ties to China. There will be no simple one-time resolution, but it’s doable,” said Posen, a renowned macroeconomist. He has been leading the PIIE, a non-profit think tank based in Washington DC, since 2013.

Posen also advised South Korea to ease ongoing tensions with Japan, as well as joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). The partnership, led by Japan, is a free trade agreement between Australia, Brunei Darussalam, Canada, Chile, Japan, Malaysia, Mexico, Peru, New Zealand, Singapore and Vietnam.

The following is the edited transcript of the interview:

▶ How do you see the US economy? Is a V-shape recovery highly likely, as President Trump says?

“It’s unrealistic to look at a V-shape. I think the odds of a double-dip recession are very low. I use a slightly more complicated image to explain what’s going on. I call it a reverse checkmark. Things go down very quickly, they go back up at half the rate they went down and then they flatten out. What's important is at what level they flattened out. I think the odds of us staying for a long period below where we started, where we were before the pandemic, is high.”

▶ The US stock market recovered from Covid-19 recently. Do you think there is a dangerous gap between the real economy and the stock market?

“I think there's a gap, but it's in no sense dangerous. It only would be dangerous if policy makers targeted the stock market and they're not. The stock market is doing much better than the real economy because the companies that are listed on the stock market represent a particular sample of the US economy. “

▶ You mean small- and medium-sized companies are suffering more from the Covid-19 impact than the big companies listed on the stock market?

“Right.”

▶ Do you think the Fed in the US should consider negative interest rates to cope with a potential recession?

“The Chair Powell and Vice Chair Clarida have been clear that that's not currently under discussion, that they don't tend to use it. And I think they're right. There is nothing that negative rates can do that quantitative easing can’t do. Moreover QE has some side effects, but we know negative rates potentially have big negative effects on the financial system, particularly banks, pension funds and insurance companies. We also know that the biggest risk now is not from monetary policy but from fiscal policy; if they fail to pass an additional stimulus package, that's a problem."

▶ The US Congress and the Trump administration have failed to reach a stimulus package. What impact do you think that has on the economy?

“I think if they pass something either now or in January or February, we will still avoid a recession. More than a few months is harder."

▶ How big should the additional stimulus package be to avoid recession?

“Probably anything on the order of a trillion dollars plus or minus is plenty. The Democratic House of Representatives is now talking about $2.2 trillion, which to me is probably a little too large right now, but most important is where it goes. It should go to the unemployed and it should go to state and local governments.”

▶ How likely is the risk of the US facing Japanification?

“If you mean by Japanification a long period of slow growth, low interest rates, little inflation, we're already there. But I don’t use the term because Japanification is misleading as it implies it's a syndrome that happened to Japan, but didn't happen to others. I use the term Secular Stagnation, as Larry Summers does, rather than Japanification, and both the US and Japan have secular stagnation."

▶ How can we escape secular stagnation?

“The best thing is to buy lottery tickets for the next big technology, meaning invest in R&D and human capital – to increase competition for incumbent businesses, and to increase the labor share of national income.”

▶ There is a concern about federal debt. The Congressional Budget Office (CBO) recently predicted that the federal debt-to-GDP ratio would be expected to reach 195% in 2050 from 79% last year.

“We have to worry about three pieces of it. First, the trend going up; debt going up that high is based on the assumption that we can't get growth to resume, that growth will remain slow for a very long time. That may be realistic. The problem is lack of growth, not too much debt."

"The second reason we have to worry is because if interest rates start going up, then more of our debt gets spent on paying back interest rather than spent on people or investment. So, I would prefer to see the debt-to-GDP levels stabilized in the next few years so that we don’t end up wasting too much money on interest payments, but it’s not an urgent crisis."

“Then the third reason to worry about the debt is what it represents about our politics – that we have repeatedly cut taxes, particularly under Republican presidents, and not paid for it, and the tax cuts have not generated the economic or revenue growth that the Republicans claim they would. So, we have a revenue gap and if the next administration, the next Congress, more importantly, raises revenue, raises taxes going forward, that would be a good thing.”

▶ There is a concern that Korea will soon facing a rising government debt-to-GDP ratio.

"Again, what matters is that you spend the money wisely and that you don’t spend too much on interest payments."

▶ What is the wise way to spend government money?

"Generally speaking, the wise way is to put money towards things that the private sector won’t provide and that have returns over a long time. So, not so much transfers, but things called investment. Does the private sector provide enough education? Probably not. Does the private sector provide enough roads and infrastructure? Probably not. These are things which government should spend on."

▶ Can you elaborate on what you mean by transfers?

"Transfers are direct payments to individuals, such as the social programs. It only includes grants, not loans. It only includes after-tax – so a tax rebate or deduction does not count as a transfer."

▶ What do you think of the stimulus checks given to Americans during the pandemic?

"Stimulus checks were absolutely necessary and very productive when faced with a temporary shock. They have maintained the level of critical consumption, and they prevented most, but not all, of the people affected by the economic contraction from being impoverished. But they cannot go on indefinitely and should not, when the economy recovers."

▶ President Trump once said he could completely cut off relations with China. Does decoupling make sense?

"I don't think decoupling makes sense. It obviously would be very economically costly in the short term, but it doesn't make sense for three other reasons. 

"First, the amount of intrusion the US government would need to have in everyone's lives to truly decouple would be very large. We saw this with the TikTok deal. The US government should not be getting involved in those kinds of decisions unless they really have to. It is a chance to increase corruption. It is a deterrent to investment. It's bad.

"The second reason why I don't think decoupling make sense is because it's not just that we're avoiding costs, it's that we have gains from trade with China and investment in China.

"The third reason and most important reason why decoupling wouldn't help is, it wouldn’t affect China in a way that helps the US. It might slow their economic progress, it might cause harm to some Chinese companies and technologies, but it also might raise the likelihood of military conflict with China. It might make them more aggressive, more angry in ways that are not helpful to the US and it might drive them out of international agreements and relationships where the US can influence them."

▶ Then how do you think the US should tackle China’s unfair trade practices?

"The first and best way to tackle the unfair trade subsidies is to pursue agreements with our major economic allies to tell China ‘You can’t do that.’ It would be done in a global or at least multilateral and transparent way. That would be more effective than the general use of tariffs on an arbitrary basis, unilaterally, by the US."

▶ Last year, you described the US-China trade war as "Economic Afghanistan."

“The reason I thought it was analogous to Afghanistan is it's a war, a conflict that US is choosing to pursue, wasting a lot of treasure and blood, and not having a clear goal for the end of the conflict. Instead, you have a very high likelihood that the conflict just goes on and on and on. That's what I meant and I think it's still true. The Trump administration doesn’t have a clear idea of what they want to get in the end."

▶ Do you think the US can get a phase two deal if President Trump wins the election?

"I am certain that if President Trump wins the election, there will be a phase two deal and it will be just as meaningless as the phase one deal was."

▶ What if Biden wins?

"I don't think things will change very much on some of the trade conflict, clearly Biden and most of the Congressional Democrats distrust China at least as much as Trump does. And many of the Congressional Democrats and Biden are more concerned about human rights than Trump is. So, they've got more reason to distrust the Chinese leadership. 

"I think Biden is much more likely to pursue joint efforts with allies to come up with a rule-based response to China, but the overall relationship will continue to be bad."

▶ In light of Present Trump threatening to decouple with China, what advice do you give to Korean policymakers?

"What your policymakers should do if Trump or Biden escalates conflict with China, if they decouple more – I think like Singapore, Japan, and Australia do – you’re just going to have to try to find a middle way. The middle way means you clearly have a military tie to the US and that’s not negotiable, but you’re not going to give up on economic ties to China."

"There will be no simple one-time resolution, but it’s doable. I think it would be more doable if Korea and Japan can resolve some of the current tensions between them. And I think it would be more doable if South Korea joined the CPTPP."

▶ So we can assume it's risky to rely heavily on China economically as pressures and tensions are mounting from the US side?

“That's just a fact. Even with Biden, that's not going to change. I mean, the one thing that is likely to continue is the US government's emphasis on trying to limit how much technology transfer goes to China and isolate, decouple, from specific big companies like Huawei. I'm not saying this is a good thing, but the reality is there’s huge support for that in both Houses of Congress from both parties. This is not just Trump.”

Write to Yong-seok Ju at hohoboy@hankyung.com
Yeonhee Kim edited this article