• China’s economy is divided into two: state-owned and the small but growing financial market
• There has been a gradual liberalisation of China’s current account allowing Chinese companies to invest overseas
• Hong Kong is a very important pillar holding the international pricing mechanism for Chinese assets

Aside from his role as a professor and dean of Fudan University, 56-year-old Zhang Jun is also a renowned author and editor and has been active in the publishing world over the past 25 years.

The founding director of the China Center for Economic Studies, Zhang states that China’s continuous technological-driven progress would benefit the country in the long term. With innovation, China can continue to create revolutionary institutions, financing platforms and pull up its other provinces which are very much lagging behind, in terms of technology.

As for the country’s future, the professor advises that China should focus on the best education for math and physics for the country’s long-term growth towards technological innovation.

Emmanuel Daniel (ED): I’m very pleased to be able to speak to Professor Zhang Jun, the Dean of the School of Economics of Fudan University, one of the leading universities in China. He was also the recipient of the Bergson Prize by the American Association for Comparative Economic Studies for a paper published in the comparative economic studies in 2015. He has authored or edited numerous books including “Economic Transitions with Chinese Characteristics: Thirty Years of Reform and Opening Up”.

I’m really very pleased to be able to speak to you today at a time when the US-China trade relationship is at its lowest you might say or most interesting phase in its transition. Maybe as an economist, the first question to ask you, which perhaps is not covered very much in the newspapers is really: Trade imbalances, what do they actually say about the actual nature of real imbalance between nations? Is it a capital imbalance? Is it a capital account imbalance? Is it a current account imbalance? What is the trade account imbalance talk say?

Zhang Jun (ZJ): Well, by definition the trade imbalance is actually measured by the imbalance in both the current account and well, service account is another category but if you look at the current account, usually it consists of the balance between the country in terms of merchandise trade as well as the trade in services. But usually I think people are looking at the current account balance in terms of merchandise trade. So in the case of US-China conflicts in trade imbalance, I think the American side is looking very much on the merchandise trade with China. And China definitely ran a crucial amount of surplus with the US. But I think that most economists of today, even those in the US, do not believe this makes sense in the globalised world because the trade between countries today is not the trade that (it was) perhaps a half century ago.

ED: Winner takes all. It’s not a win-lose situation.

ZJ: Yes, because the company can easily dismantle the production process into different parts of the world. So when you say the trade between the two countries, what you actually mean is the trade by the companies in different locations. But the company could be the same. So, in that way, the trade surplus is recorded by customs in the traditional way, I think it does not make any more sense.

ED: And especially when you have, the production of goods now can have 16, 100, 200 components.

ZJ: Right. Actually, the trade of components in part accounted for more than half of the merchandise trade today in the world. So I think it’s either a case of the US-China input and not more.

ED: Into the value-add of the US economy.

ZJ: That’s right. And American input a lot more components from China which is made by an American company.

ED: So, as an economist, what would you like to be able to see that captures really that value-add?

ZJ: I think the economy created the term for value-added trade. The trade of the value-added. So we probably should look at how the value-added is distributed across the country. For instance, the company who made a product in the US using components and parts from different parts of the world. I think that with the case of China, because China is much more in the low end of the supply chain so China manufacture through processing of the components or parts which are perhaps imported from the US as well. So the typical case would be the mobile phone.

There’s a lot more components or parts which are manufactured by the American company rather than the Chinese. Even China put them together in an assembly line here in China to finalise the product. So I think that now economists have a capability to, I think, graph it, all the destination of the intermediate goods, who manufactured in different countries. And then we can come up with a universal map, which you can easily identify who provided what in the same product, manufactured by different countries.

ED: Now another point of clarification that I would like to have asked any economist for that matter is when we look at something called the US-China trade war, is it really a US-China trade war or is it a US-Shenzhen trade war? Because when we say manufactured, a lot of that is in the southern part of China. In the northern part of China, we’re talking a very different economy. You’re talking about state-owned enterprises. You’re talking about heavy industries and so on. Maybe even more domestic in that way. And China as a whole has become more of a consumption economy. So that’s not captured in that trade war thing. So how much of it is really well distributed as a description of the true nature of the Chinese economy?

ZJ: Well, China is a huge country.

ED: We always forget that, don’t we? It’s five times the size of the United States.

ZJ: That’s right. So we do have economies like Shenzhen which is very much driven by the technological progress or something like that. But we have a pretty large area in China crossing the different provinces which are still very much lagging behind in terms of technology. So we still do a lot of low-end manufacturing. So this is a country with a huge regional variation. So when there is a trade war between China and the US, I think they’re probably going to focus on some of the specific areas.

I think the Americans would like to see how Shenzhen and the other cities in China have been moving fast in terms of the technological ladder. They want to keep up. So I think that’s the point. It’s not simply the problems that are recorded in the custom, in a data.

ED: It’s the custom gate data, right? So, therefore as an economist, and I want to add a third component in there which is the financial profile of China. There are the issues of various provinces doing well, A-grade provinces, world-class cities and so on. And then there are provinces which are barely able to create a traction in the economy and some getting into debt which I think the PBOC has mentioned. So when you look at the overall profile of the country, how would you classify what the key issues are, as an economy in that sense? But before that, the financial profile. Because I think China is in an interesting situation where you have no current capital account convertibility. You’ve kept that to yourself a lot. So that’s both good and bad. Good because for a fast developing country you do not want to be subject to hot money and that sort of thing. But bad because you do have a market economy without really knowing the cost of money in that sense. So, talk to us a little bit about the financial market as an efficient platform for cost of funds and then go into how you would classify what the key issues are in the economy.

ZJ: Well, I think this is actually the structure issue facing China over the past 30, 40 years. Because economists have been highly divided by a part that is strongly owned by or controlled by the Chinese government, very state-owned businesses, including the banking of other financial institutions. But at the same time, I think the economy’s been liberalised a lot, which is growing a part of the economy, which is largely driven by entrepreneurial business and of personal thinking and the fessing way of doing business or something like that. So, it’s more dynamic.

So the economy’s been a combination of the state-owned dinosaur and a very small – but it’s growing – dynamic part of the economy. So every time when you’re talking about the financial system in China, I think you have to be very careful in defining which part are you talking about. Because in the system, all the banks actually are still very much dominating in the financial resources because China has a pretty high selling rate. So more selling resources have been allocated to buy state banks. But alongside, there is a growing financial market, which has been progressing very fast over the past 20 years.

But in terms of macro economy, I think the Chinese leadership is very concerned about the cross border, the mobility of capital. So we have liberalised the current account in a way that we can trade and we can receive foreign investment and Chinese companies can invest overseas. But the capital account, we do very a gradualist way to open that. For instance, we initiated the QFIIs and we actually set up the Shanghai Free-trade Zone so that we could do some of the pilot, initially, to see how that works. So this is very much a gradualist way of liberalising the financial market.

ED: But what was interesting about QFII and the Shanghai offshore market is that after the liberalisation, the inflows weren’t very much. The flows were not taking up the quotas created which then tells you that the international capital markets believe that China is either overvalued or the return on investment is not sufficient. It’s lost its glitter because it’s an expensive country now. It’s an expensive economy. It’s no longer a cheap economy.

ZJ: Right. Largely because the whole financial system is still very much halfway down in the liberalising cell. I think the trend is much clearer. China is definitely moving, it’s liberalising the financial system. But it’s not something that to be done overnight and China still keeps that in a low profile way. We can move a little bit if it’s necessary to do so. But we will not do something that we cannot understand. But if you look at what has been done over the past couple years, I think the progress has been quite amazing.

ED: So I wanted to get these initial points out of the way because I think they’re questions that have not been asked in the whole discussion. Tell me a little bit about your sense of where Hong Kong plays in the Chinese economy. Not the Hong Kong or the trouble that it’s going through right now. The Hong Kong as a capital market for China and Hong Kong as a re-export centre for China. How does that play?

ZJ: Well I think clearly the role that Hong Kong should play has been declining relatively because of the rise of men in the Chinese economy. I think there are a lot more manufacturers that have moved back to Guangdong Province since the beginning of 1980s, where Shenzhen has been rising as a manufacturing centre at the time. But I think that Hong Kong is still very much important to China, in the sense that Hong Kong is, relatively speaking, is still very much an internationalised financial centre. And I think that men in China can take advantage of having Hong Kong and Hong Kong definitely can still play the role.

ED: The reason I ask, also, is that when you look at a lot of the capital market activity in China today, the large technology companies, Tencent, Alibaba, even the banks, ICBC, they all – Alibaba is not yet – but all the rest, they are listed in Hong Kong. Hong Kong is the window to the rest of the world. And the whole innovation funding mechanism, the exit is Hong Kong. And even municipal debt is traded in Hong Kong. So Hong Kong is a very important pillar holding the international pricing mechanism for Chinese assets to Chinese capital assets in a sense. Everything by way of manufacturing has moved back but everything by way of capital is pegged in Hong Kong. So, in that regard, and it’s been many years, you do have a capital market in Shenzhen and Shanghai. You now have Hong Kong connect and yet Hong Kong still plays that role.

ZJ: That’s right. I think China really thinks that Hong Kong is pretty important right now, given the structure problem facing the Chinese men in the colony. As I said, the financial liberalisation is still very much halfway down and a gradualist approach is still being adopted by the government. So Hong Kong is still very much enjoying its unique advantage. So much internationalising and the institutional framework, including the regular framework, is still very much advanced it, relative to the men in China. So I think Hong Kong can still play a very important role.

ED: If we did not have the US-China trade war, what do you think China’s most important economic priority should be?

ZJ: I think the priority definitely should be on the issue of upgrading the structure of the economy through technological progress. I think the government really thinks that technological-driven progress would be very much important for the long-term growth of the Chinese economy. And if you look at what happened over the past year or so, the China and US conflict, I think the Chinese government once again believes that China should be moving faster on the road where technological innovation must be the top priority for the government to consider. So I think we’re going to create an institution, financing platforms, or something like that to do more, I mean to encourage more technological innovation from the bottom of the system.

ED: Right. You speak of technological innovation as if it’s not related to skills, to people. In that regard, as a professor, what do you see in terms of the skill sets that are coming through? Are you happy with the skill sets? Is it something that China still needs to import and be exposed to globally? The ability to be creative. Things like that.

ZJ: Recently, we were talking about the need for more smart people doing math and physics rather than economics and finance. We probably have some bias in the education system because we have too many smart kids eventually who pick up economics and finance for their future career. But actually, for the country in the long-term, China definitely should focus on the best education for math and physics so that we could have more smart guys that are doing the technological innovation.

I think 40 years ago when I decided which subjects I should take, at the time I think my parents and some other families for the whole China said math and physics are the most important subjects. If you do that, then you’re going to have a bright future. I think that 40 years later, perhaps we should return to that point. Because the point is it’s really important for the long-term prolonged economic growth of China.

ED: But what about the growth of the society, the sustainability of society, care, legal infrastructure, social infrastructure? Those are equally important and in fact, increasingly more important as the country becomes more affluent.

ZJ: I think everyone in this country believes, first of all, we need stability. Without stability, you can’t do anything.

ED: Social stability.

ZJ: Even with stability, I think people definitely yearn for things you just described. I think the government also understands this. But they hope that progress should have been made within the controllable stability, because without stability it’s difficult to put things down like that.

 ED: At Fudan University, what do you see taking place in terms of students coming in? How they’re motivated?  What they’re focused on? How are they different from previous cohorts of students?

ZJ: Fudan University recruits students from both local and the rest of China. So the students are coming from different parts of the country. But they’re all smart. I’ve been to Shanghai which is a metropolitan city, very much looking outward. So that could change their mind in a way that they would think the problem facing China in the context of the global economy. I think that’s a pretty good thing.  But I think the problem is that too many smart students now study finance, which is not really good for the long-term future of China.

ED: Professor Jun, thank you very much for spending time with me. Excellent.