Expert Insights: Stephen Roach

Stephen Roach is an American economist. He serves as senior fellow at Yale Law School’s Paul Tsai China Center. He was formerly chairman of Morgan Stanley Asia and chief economist at Morgan Stanley, the New York City-based global investment bank. Roach’s current research program focuses on the impacts of Asia on the broader global economy.

China’s domestic economy

China has in recent years intensified efforts to stimulate domestic consumption, an important goal given growing external threats to its export-driven growth model. But low consumption and deflation remain a persistent problem. Where do you see Chinese government efforts succeeding versus falling short in increasing Chinese people’s willingness to spend?

That’s a burning question and one that I’ve been raising for easily 15 years inside and outside of China. My simple answer is they haven’t done enough to provide a long-term sense of security for an aging nation that is lacking in a robust social safety net, mainly healthcare and retirement. They’ve taken steps to address some aspects of this, most recently by boosting subsidies for child rearing, but the steps have not been large enough to instill a greater sense of long-term security.

What are some policies that would be strong enough?

One that has not been a step in the right direction is the fixation on trade-in allowances for cars, appliances, and other consumer durables. This does nothing to alleviate long-term issues of uncertainty and insecurity. It simply moves forward spending that would have occurred in any case, just accelerating the replacement of worn-out goods.

The policies that I would favor more would be a significant increase in social security assets under management, as well as social security payouts to boost the retirement aspect of the safety net. The government has certainly moved to embrace nationwide social security, but the assets that have been committed and the payouts that have been generated, especially in light of the rapid aging and looming increases in retirement, are inadequate.

The same is true of healthcare. China now has something close to universal healthcare, but the benefit levels are far too low to provide long-term support to this key requirement of an aging society. They have moved to embrace what they call the “silver economy,” providing some support for elderly care, and yet again, the efforts fall short of what the demographic profile suggests would be appropriate.

When you look at China today — its demographic issues, underfunded social security system, property downturn — are you concerned that there is too much drag on the economy for China to get back on a stable footing in the next several years?

I’ve been certainly more optimistic than most US China watchers for a long time. I did turn cautious a couple of years ago when I warned of the potential lasting implications of the tight restrictions that were imposed on the private sector, especially the Internet platform companies and the entrepreneurial effort that was required for innovation in that space. The government has made an effort to refocus its support of the private sector and entrepreneurs, but I think the jury is still out on how compelling that support is likely to be. The government continues to have a tough time embracing the role of the private sector in shaping and guiding that economy.

The other issues — debt, property, demography, trade — those are all serious issues. They pose formidable challenges to China, but I think China has the capacity to strategically focus through its planning process in a way that allows it to successfully navigate those seemingly Japanese-like risks. But if they don’t provide more meaningful support to risk-taking entrepreneurs driving the private sector, allow the animal spirits to truly flourish in a way that is focused on the innovations of tomorrow, and instill a greater sense of confidence in Chinese consumers, then the longer-term outlook is going to be more worrisome.

This is a key point for the Chinese government to figure out — whether they are willing to let go of some of these old habits of centrally-directed, producer-oriented planning and truly allow the private sector to play a renewed, more dynamic role as it did in the early stages of reforms and opening up.

Do you think that further SOE reform is politically impossible in that it goes against the statist model? At some point in this privatization process and reviving the animal spirits, do you think China might rethink its SOE model?

There have been waves of SOE reform, especially under Zhu Rongji in the late 1990s, that have been very important. You’re correct, though, in concluding that SOE reform has slipped lower down the agenda than it has been in earlier years. To some extent, that’s just a reflection of other problems that have risen to the surface.

The one aspect of SOE reform that I have been critical of, and still am, is the notion of mixed-ownership SOE reform that was started under President Xi Jinping. To me, that approach is very Japanese-like in allowing SOEs to own shares in each other. That is strikingly reminiscent of what we saw with the Japanese keiretsu that led to the demise of corporate Japan when the equity bubble burst in the early 1990s. So, this is not the approach that I would favor.

Ultimately, SOE reform requires China’s leadership to be far more comfortable in letting go of old habits and embracing new market-driven risk philosophies. That’s just something that this government is not comfortable with for the reasons you point out.

Local governments are not receiving the tax revenues they previously did, which likely undermines the social security system. But there seems to be little sign of tax reform. Do you think that in the near to medium future, China needs to address the tax system?

We’ve all been saying that for a long time, and they have been reluctant to make radical changes in the tax system. The point on the lingering overhang in the property market is key. This is a major asset for Chinese families. Given the serious and worrisome overhang in the property market and the downward pressure on overall prices, this is clearly a major impediment to more aggressive support for consumption. However, I would still put this below the safety net point that I mentioned earlier.

And if you were to rank a list of asks?

Social safety net security is number one. It’s been at the top of my list for 15 years. China has a very high personal savings rate that reflects the excesses of fear-driven precautionary saving that are very much consistent with the inadequacy of the social safety net. Unlike America, which needs to spend less and save more, the Chinese have the opposite challenge to save less and spend more. Household saving is still an excess of 32% of GDP, which is easily more than triple that in the United States. We are different systems, but the balance between spending and saving remains a critical factor in shaping my own view of both economies.

Trade negotiations

How have domestic economic factors influenced China’s trade negotiating strategy with the United States?

A China that plays its cards right should be a huge opportunity for the United States. If China is successful in boosting consumer demand, which right now is still below 40% of its GDP, and were to get that number up into the mid or upper 50s, it would be creating the largest increment of household spending in the world. That is a huge opportunity for exporters in the United States and elsewhere in the world. This is the ultimate carrot for trade negotiations — to provide opportunities for exporters around the world, but especially in the United States.

You write that the US trade deficit with China stems from “a profound shortfall of domestic saving driven by increasingly reckless fiscal policy.” If this is the case, what should the United States do to address the domestic factors behind its trade deficit?

Other than elect a new president, which doesn’t seem to be likely, I think it’s clear that we need to control our long-term big, beautiful budget deficits far more effectively than the latest piece of legislation would lead you to believe. The Trump administration dismisses conventional estimates prepared by nonpartisan groups like the Congressional Budget Office. But there’s no question in my mind that this latest piece of legislation virtually guarantees much larger federal budget deficits than otherwise would be the case. That would lead to commensurate declines in already depressed domestic saving that would require us to import more surplus savings from abroad to fund our economy and increase the balance of payments deficit, which is already large. That, of course, would lead to higher multilateral trade deficits with around one hundred countries that we run shortfalls with.

China is still the largest piece of our outsize multilateral trade deficit. China’s portion has come down because of President Donald Trump’s tariffs. It could come down further. But tariffs at best can only address the way in which our trade deficit is distributed. They will have no impact on the overall magnitude of the multilateral trade deficit, which is still an outgrowth of our budget deficit and savings problems that I just elucidated.

Trust in the bilateral relationship

You point to peoples-based US-China engagement, like educational exchange, as one of the easiest ways to build trust in the relationship. The current US administration has pursued measures limiting this engagement, most recently threatening to restrict Chinese student visas, though Trump has flipped on this in recent statements. How do you see such measures impacting not only trust in the relationship but also the US domestic economy, which benefits greatly from overseas talent?

We need a trust-based agenda to allow us to tackle the bigger issues that have led to conflict between the United States and China. And there’s plenty of low hanging fruit that should be picked in that regard.

Increased student exchanges are near the top of the list — restarting the very successful Fulbright program would be certainly popular. Chinese students are still the largest group of foreign students studying in the United States, although the number has come way down. The allegations and animosity expressed by the Trump administration are of great concern to most of us in the education business.

There’s other low hanging fruit that can be picked apart from student exchanges — reopening some of the consulates that have been closed in both countries, Chengdu in China and Houston in the United States, increasing the number of nonstop flights between the United States and China. I still have to take some ridiculously indirect routes when I travel to China, which is both expensive and exhausting. There are a lot of easy things that can be done, and there are some tougher things that need to be done as well, but starting with student exchanges would be a very constructive step.

Do you see any common ground where the two countries can work together?

There’s an enormous agenda of mutual problems starting with climate change and spreading to global health, cyber security, and AI governance protocols. These are all big bilateral issues with global implications as well, and yet it’s extremely difficult for us to come together as global partners when we have such a strong adversarial relationship. I would also add to that the fentanyl problem, which has become a key element of contention in the current tariff war.

AI/technology competition

What are the strategic advantages that the United States and China each have in the AI race, and how might recent Trump administration policies, including allowing Nvidia’s H20 chip exports to China, impact the direction of competition?

The update on that last point is that now China apparently does not want to buy these second- or third-rate Nvidia chips. This reflects the rather insulting comments that were directed by Commerce Secretary Howard Lutnick about the fact that these are low-grade chips that we wouldn’t sell to most countries but are more than happy to dump on China.

Both countries have strong advantages in developing innovative algorithms for large language search capacity, and both countries are focused on developing and distributing the hardware associated with the processing of this functionality. The United States has the lead through Nvidia, but China is hard at work in developing domestic processing capacity. Chinese semiconductors can accomplish almost as much as what Nvidia can do, and my gut instinct is it’s only a matter of time before Chinese chips, whether they’re developed through Huawei or its subsidiaries, are able to match those of the United States.

What China has clearly demonstrated with the emergence of DeepSeek as a very powerful alternative to OpenAI’s ChatGPT is that it can provide large language model searches at a fraction of the cost and with comparable speed of response. That’s a big challenge to the high-cost AI approach in the United States. The stock market in the United States initially took that as a very worrisome development and has since shrugged that off. But ultimately, like in so many of China’s innovations, whether it’s green technologies or electric vehicles, they’re able to match the quality and certainly the scale of what we can produce in the United States and do it in an extremely cost competitive way.

We scream and yell that it’s unfair because it’s state-subsidized or reflects some of the unfair acquisition of these technologies that has long been a favorite complaint of America’s China bashers. But the bottom line is that in so many aspects of advanced technologies, China is a peer competitor with the United States, and it’s an open question of whether we are able to maintain this lead.

Various US administrations have complained about Chinese state subsidies to industry. But now the United States is effectively subsidizing Intel and suggesting it will buy stakes in other US firms. Does the US argument still hold water?

One of the main objections of the original Section 301 complaint that was produced by Trump’s first trade representative, Robert Lighthizer, in March of 2018 was that China is unique in the way it embraces state-directed industrial policy to command market share against the United States and globally. The United States, through the Biden administration’s Chips and Sciences Act as well as the Inflation Reduction Act, clearly began to embrace industrial policy with American characteristics.

The Trump administration the second time around has pushed the ball even further with not just the Intel stake but also in providing very direct guidance for American companies in the decisions they make for locating facilities offshore and around the world. The industrial policy critique, which was central to Lighthizer’s argument, has been completely undermined by America’s initiatives to roll out a version of its own.

You point to government support for basic research as a key pillar of AI innovation. In what ways is government support more impactful than private support, and how do you see the US and Chinese governments performing in this area? Which country is better positioned to win the AI race in the long run?

There could be a lot of things that affect the outcome of the AI race. But to comment on basic research, unlike private sector research, which ultimately draws support from risk-adjusted, measurable financial returns, government-funded basic research is often abstract and theoretical without any major financial return constraints. It can allow brilliant, creative, hardworking scientists to toil away in obscurity with no immediate payback but with the possibility that over time a small handful of these efforts will lead to extraordinary breakthroughs, like mRNA vaccines, the Internet itself, and quantum mechanics that lead to quantum computing.

We’ve dropped the ball on that. The federal share of spending on basic R&D has been declining in the United States now for several decades. It’s quite likely based on the slashing of scientific support, evident in the draconian budget cuts in the second Trump administration, that China is now spending more on purchasing power parity-adjusted basic research than we are. That does not bode well for the long-term innovation race, whether it’s AI or anything else US versus China. It’s a very worrisome development in the United States.