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Niall Ferguson, MA, D.Phil., is the Milbank Family Senior Fellow at the Hoover Institution, Stanford University, and a senior fellow of the Center for European Studies, Harvard, where he served[…]

The country sees its relationship with the U.S. marriage on the rocks and “is actively looking, if not for another partner, then certainly for a divorce from this somewhat unreliable and spendthrift American spouse.”

Question: What factors will determine the next phase of our collective cultural evolution? 

Niall Ferguson: It still seems plausible to me that these institutions I’m describing determine success or failure, at least in the realm of economic growth and political stability. The interesting thing is that the most rapidly rising, non-Western power of our time, which is the People’s Republic of China, has adopted most, but not all of the killer applications. So they’ve certainly downloaded competition that the economy of China is a planned economy at core, but it has a market economy wrapped around that. 

They have, of course, downloaded science, and there’s no barrier to non-Western societies engaging in scientific research today. 

Modern medicine, for sure, it was an interesting feature of communist regimes that they were quite good at using modern medicine to improve welfare for large populations. 

The consumer society, well they’re getting there. It’s been a saver society until recent times, but it is now policy in Beijing to encourage consumption among ordinary Chinese and to make China less reliant on exports to Western consumers. 

And as for the work ethic, well they have that in spades, its an extraordinary phenomenon that the people who work the longest hours in the world today are in fact in East Asia and not in the West. 

The one killer app they haven’t downloaded is, of course, our political model with its emphasis on private property rights and representation of the individual. And I don’t think they’re going to. It’s pretty clearly policy in Beijing to have five out of the six off the menu, but not that crucial third killer app which ultimately produces democracy. 

So, we’re running an interesting experiment which is to see whether or not it is actually dispensable. If you’re from Singapore, you think it is and it’s clearly the orthodox view in East Asia today that you can have all these different aspects of modernity, you can have these Western institutions, but you don’t need the political one. You can have it on the basis of enlightened authoritarianism. And I’ll have to say I’m a little doubtful that that will turn out to be right because we ran this experiment actually within the West because we had free societies in the West and we had unfree societies. The West generated lots of alternatives to itself. One was communism and one was national socialism. And these alternatives failed, and pretty dismally actually. 

It seems to me—and here I’m really following the work of the great Nobel laureate, Doug North,—the institutions of freedom, political freedom and economic freedom, are indispensable for an innovative society, that you can have science without freedom, but you probably can’t have scientific innovation. You can replicate what they do in the Western laboratories, but are you actually going to have the real breakthrough? And I think you have to have the full range of freedoms to be as innovative as, say, the United States has been over the last 100 years. 

Question: Can China continue without these democratic institutions? 

Niall Ferguson: Let’s take another trip back in time. It’s 1936 and you decide to go on a trip to the Soviet Union and you’re welcomed by our hosts, and taken on a tour of some absolutely spectacular construction sites. Perhaps you go to Magnitogorsk, this sudden eruption of industrial architecture in the middle of nowhere. And you are deeply impressed by what you see. You see skyscrapers in Moscow city transformed, and you come back to New York and say, I’ve seen the future and it works. Of course, at that time, the capitalist democratic model looks pretty badly broken. You just past three years since the trough of the Great Depression and it’s by no means clear in 1936 that the United States is out of economic trouble. 

There’s a great deal of unease about the way Western democracy functions. All over Europe, democratic regimes are falling because of a lack of belief in the democratic model, most notably in Germany. 

Fast forward to now, you take the same trip; you go to Shanghai, maybe you go to Chongqing further up the Yangtze and you see most spectacular construction site and you come back and you say, I’ve sent the future and it works. It’s just a few years since the failure of Lehman Brothers and the collapse of the Western financial model and wherever you look there is disquiet about the way the democratic process works. It’s at its most acute in countries like Greece, but only because Greece is further down the line of fiscal crisis than the other western countries today. 

So, there are reasons today why you might make the same mistake that George Bernard Shaw and Sydney and Beatrice Webb made when they went to the Soviet Union. What they got wrong was that they judged by the surface at the degree to which a truly alternative model had been established. They did not see, or chose not to look at the shadow side of Stalin’s system, which of course, included a vast network of prison camps, the Gulag and an atmosphere of terror in which no individual, including members of Stalin’s own family, could feel safe. 

China today is not Stalin Soviet Union, by any means; the levels of coercion and terror are far lower, and the degree of economic freedom is far higher. But it is still a planned economy right at its core. Chongquing is not being built into the biggest and fastest growing city in Asia all by market forces, it’s the result of a command economy run out of Beijing, and there is an absence of political freedom that is very real indeed for those who chose to criticize the system. 

Now, we should therefore be careful what we wish for when we start applauding the Asian model and denigrating our own. I’m in the frontline of the people who are critical of the way the United States has handled public finance over the last decade. And it seems to me that there is an urgent need for radical reform in that area before we end up in a Greek-style mess. 

But we’ve got to be really careful here to distinguish between epiphenomena, the way in which taxes are raised and public expenditures are managed, and the core phenomenon of our constitutional order based on individual liberty and free expression. That constitutional order is way, way more important than any of the outlying issues of fiscal reform. And it is a superior constitutional order than anything else available in the world today. And I still feel convinced that the experiment of organizing an industrial society without a representative form of government will fail, as it has failed everywhere else that it’s been tried everywhere else because, as I’ve said, the Chinese are not the first to attempt breakneck industrialization without political freedom. 

Question: How will the underlying weaknesses of the Chinese system play out? 

Niall Ferguson: A parallel that I’ve drawn recently—which isn’t to everybody’s taste—is between China today and Germany 100 years ago. Let me emphasize, 100 years ago. Not in the 1930’s, in the 1910’s. A hundred years ago, Germany was one of the most dynamic societies in the world. It had a rapidly growing economy; it was leaping ahead of Britain in terms of industrial innovation; it had, already by 1910, the best universities in the world, much better than the American universities at that time incidentally; and it was also a country filled with a self-confidence that was shading into arrogance. As Germany rose, the hegemony of an English-speaking empire, Britain’s, was obviously called into question and that was something about which the Germans became more and more explicit. 

Kaiser Wilhelm II was somebody who had an uncanny ability to put his foot in his mouth, but much of what came out of that mouth about Germany’s ambitions to have a place in the sun, to have a world policy, a global policy, to have an empire and a Navy comparable in size to those of Britain, those were tings that ordinary Germans believed in too. Not all of them, but many. 

When I look at China today, I see a similar combination of rapid economic growth, impressive innovation, social transformation, but also political system that doesn’t want to change. That wants to essentially retain the institutions of 40 years ago, which was essentially what the Kaiser wanted too. And I also detect a real resemblance in the somewhat shrill nationalism that emanates from some parts of Chinese society, notably from relatively young Chinese. Its university-age Chinese who produce these rather mad patriotic videos whenever they feel that China has been slighted, whether it’s over Tibet, or Google, or whatever. 

So, there’s a Wilhelmian quality to China that takes a historian to spot and they’re doing Wilhelmian stuff. They’re terribly interested in natural resources in Africa, check that box. They’re building a much larger Navy than they’ve ever had before, check that box. They’re somewhat stridently challenging the rise of an English-speaking empire to call the shots around the world, check that box. And so on. So, it seems to me that the big challenge that the United States faces is very similar to the challenge that Britain faced 100 years ago. It’s a dynamic rival; it’s a rapidly growing rival. It’s starting to beat you on a number of different things, it’s producing way more qualified engineers than you are. And what you don’t want to admit to yourself is that this thing is not going to be in a comfortable symbiotic relationship with you indefinitely. Germany was certainly in that kind of a relationship with Britain in the 1870’s and 1880’s—trade between Britain and Germany flourished, there was all kinds of cultural exchange—but it’s not a stable marriage. 

If one rival is growing faster than the other, it is a rival, not a partner. And we are living in that transition today I think. It’s not exact, historians work with rough analogies, not with perfect matches. And there are all kinds of differences in which the cultural difference if perhaps the most important. The cultural difference between the United States and China is vastly greater than the cultural difference was a hundred years ago between Britain and Germany. They even shared members of the same royal family as their monarchs. But I think if you look at the key elements, the relationship has much in common. The economic element, the strategic element, and above all, I think there’s nationalist damage which is going to become more and more of a feature, I think, of relations between China and the United States. 

Question: How will the U.S./China relationship evolve? 

Niall Ferguson: The two things to remember about the relationship between China and the United States. One is that the demographics are about to turn against China quite sharply. The Chinese, because of the one-child policy in the Mao years and subsequently have a really serious demographic imbalance between the generations. That is going to become a major problem as the proportion of Chinese aged more than 65 soars in the next two decades. They also have a huge gender imbalance. And there are some provinces in China where male children are 20% more numerous than female children because of selective infanticide and so forth. 

The second point to remember is that the financial nexus between China and the United States is profoundly unstable. I’ve talked with my friend Moritz Schularick for three years now about Chimerica, the fusion of China and America in the economic sphere. And at the heart of that fusion was a kind of vendor finance where the Chinese lent us the money to buy their stuff. And they did this out of self-interest. At the same time, the Chinese accumulated vast quantities of U.S. dollar-denominated securities to keep their currency from appreciating. And that currency policy has produced a mountain of claims on the rest of the world. International reserves in excess of $2.4 trillion dollars, some 70% of which are in the U.S. dollar form. It’s not stable because the Chinese don’t want this mountain to get any bigger. They’ve come to terms with the fact that their currency must strengthen in the years ahead, and they’re looking for alternative routes to go down. Because if they’d just stay on this course that they’ve been on in the last 10 years, it’s pretty obvious what’s going to happen. Their U.S. dollar denominated claims at some point are going to become worth much less because the obvious way for the U.S. to get out of its financial difficulties is for the dollar to weaken and foreign claims on the U.S. to become worth less. 

So we are at a fork in the road: it’s now. I heard a Chinese economist two weeks ago say, “Our policy now is to buy no more U.S. government securities and not to sell all that we have at the same time.” Now if you think about what that means, the end of reserve accumulation by China, possibly a gradual winding down of Chinese exposure to U.S. securities, it means the end of a credit line to the United States that has been worth a awful lot to American consumers and American investors. It means that the Chinese support for the U.S. government bond prices is going. That means their price will drop, which means that U.S. interest rates will conceivably rise, and that of course, will act as a real dampener on U.S. recovery prospects when it happens. And I believe it is happening now. 

So, the big problem for the U.S. is realizing that this relationship is unwinding. When I hear American policymakers talk about this, I still hear the same riff that I was hearing two or three years ago. “They need us as much as we need them.” They can’t dispense with us as an export market, so they’re not going to risk destabilizing this relationship. I heard that just the other day at Harvard’s Kennedy School. And it’s profoundly complacent and wrong. The Chinese don’t think of it this way, they see this as a marriage on the rocks and they are actively looking, if not for another partner, then certainly for a divorce from this somewhat unreliable and spendthrift American spouse.

Recorded on April 19, 2010