What challenges will China's economy face under the COVID-19 epidemic? What impacts will the epidemic have on international relations, global value chains and economic trends? What adjustments can the Chinese government make to ensure economic and social stability this year?

To answer these questions, China Development Forum (CDF) launched a special column, CDF Online series, in which we will talk with forum delegates on the economic and political impacts of the virus outbreak.

Prof. Jason Furman is the former chairman of Council of Economic Advisers, President Obama’s chief economist, and the professor at John F. Kennedy School of Government, Harvard University. He is also an old friend of China Development Forum.
Recently, FANG Jin, Secretary General of the China Development Research Foundation (CDRF), had a call with Furman to discuss the economic impacts of COVID-19 epidemic on China, the United States and the whole world.

To start with, Furman expressed his blessings to China.

“Before talking about the economic impact of coronavirus, I want to say that it's first and foremost a tragedy for the humans that are affected by it.”

He thought that the impact of the epidemic on China's economy was mainly concentrated in the first quarter, and the annual economic growth rate was less than 0.5%, which would not have much impact on the global economy and China-US second-stage economic and trade negotiations.

He told Mr. Fang that he really wished China the best in its response and coping with it. And the whole world is counting on China as the front line of that response.

 Influence on the economy of China and the world
l The impact of the epidemic on China's economy should be mainly concentrated in the first quarter, and it would not have much impact on the global economy.

●For the year as a whole, it may reduce the growth rate of China by 0.3% or 0.4%, depending how the virus spreads and consumer confidence.

● Though the negative economic impact may not be completely eliminated, Chinese government is capable of keeping the growth rate decline within 0.5%.

Fang: What kind of impact do you think the epidemic will have on the global economy? 
Furman：I think it could have quite a large impact on China in the first quarter of 2020. The question is how much does it affect the economy outside of China? And how much does it affect China over the rest of the year?

I think that might be more moderate. The reasons are as following:

Oil prices are down 20% from their high. That'll help cushion the economic blow for China, which is a major oil importer. And that's a net positive for the global economy. Lower oil prices boost consumption and the positive impacts are more on importers than exporters.

Interest rates are down sharply in places like the United States, which will help boost investment.

If COVID-19 is contained, I think some of what we'll see is more of the consumption investment was shifted rather than reduced. For example, somebody didn't buy an iPhone in an Apple store in February, but they still want a phone. When May comes around, they buy the phone in May. Therefore, for the year as a whole, you make back some of what's lost in the first quarter.

I think the most likely scenario is that this is contained over time in China and around the world.

Fang: What is your assessment on the impact of this virus on China’s economy?  Furman: I think it'll be very large in the first quarter. For the year as a whole, it might be 3% or 4% off the growth rate. A lot, though, depends on how much the virus spreads, which we don't know. Also, it depends on consumer confidence, which we don't know.

But the government is responding very aggressively, both medically to contain it, and also economically to contain the damage.

We saw a decade ago a great example of a global financial crisis where China was willing to spend what it needed to make sure that it was relatively unaffected by that global financial crisis. 

Therefore, I think China has the tools to not eliminate the negative impact economically, but contain it to maybe less than half a point off the growth rate.

How should China deal with the epidemic’s effect on economy?
l A combination of fiscal policy and monetary easing are the two standard tools. But it's important that it's understood as responding to a temporary problem.

l Cutting consumer-oriented tax can help make up for the loss of the first season, as well as boosting internal demand, and contribute to long term structural adjustment.

Fang: Unlike 10 years ago, I think that right now China was basically and actually constrained. We have a much higher lever ratio than 10 years ago. We have a very large trade deficits, budget deficits and lower return on investment. Do you think China has enough weapons to deal with this situation?
Furman：I think the mistake is when China tries to use fiscal stimulus credit and boosting investment to deal with a structural decline in the growth rate.

The growth is trending down, which is a natural and normal thing for an economy as it converges. Trying to resist that natural normal potential slowing of the economy is when you run into the diminishing returns to investment and the concerns about debt.

If what you're dealing with is a temporary blow to growth, and it's on the demand side, where the problem to growth comes, rather than on the supply side, then you shouldn’t really worry that much about what the marginal efficiency of the additional investment is. The problem was a couple of years ago when China was trying to use this against a longer slowdown.

I think that investment and consumption will be delayed, but it will mostly be made up, not a hundred percent. Therefore, it would be a small negative for China for the year, a smaller negative for the global economy for the year. The biggest uncertainty of all of that is if the virus spreads rapidly. It doesn’t look like that at the moment.

I think a combination of fiscal policy and monetary easing are the two standard tools. I think it's important that it's understood as responding to a temporary problem, not trying to prop up the growth rate over the next several years, just really doing it over the 2nd and 3rd quarter of this year.

Fang: what about the three components of aggravating matt? Consumption, investment, and trade, or export, which sector do you think the government should take more action on?
Furman: I think China has been going through a slow process, but moving in the right direction of rebound towards internal demand instead of external demand, and within internal demand, rebalancing towards consumption instead of investment.

To the degree, the response to this could help with that rebalancing, that would be better. For example, consumer-oriented tax cuts to help people to go out and spend a bit more money in the remainder of this year could help make up for some of the lost demand in the beginning of the year and would be a boost to consumer spending. We did big consumer tax cuts in the United States in 2008 and 2009. We really did see consumer spending was a lot higher than it would have been as a result of those changes.

Impact on Sino-American business relations
l No long-term impact on phase two deal between US and China

l The US presidential election a source of uncertainty Fang: And what about the impact on the second phase deal between China and the US?
Furman: I think it's hugely in the interests of both countries. I would like to think that if two parties to an agreement can both be made better off, they're going to figure out a way to reach that agreement to make that. I certainly very much hope it will happen.

We're going to be in an election here in the united states for the next nine months. That's going to have all sorts of effects. We don't know who the next president is. Whoever wins, they're going to win a pretty close election.

I'm so hopeful for phase two, but I have no idea.

Fang: What’s your expectation on the 2020 US election?
Furman: I’m a big believer in markets. You can go place a bet on who will be the next president. For people who are betting money, actual real money at stake are giving about a 55% chance to Trump and a 45% chance to the Democrats. Therefore, I think President Trump is more likely to be re-elected.

However, you have to understand most of the country has made up its mind. There's a lot of states that will definitely be voting Trump. A lot of states will definitely be whoever the Democrat is. And there's only a few states that haven't made up their mind. They'll be the swing states.

I don't think it makes any sense to think when the country is so closely divided. Outlook on US economy
l There's a lot to feel positive about the economy, but it's likely to continue to slow.

●The FED is likely to keep interest rates the same.

●The trend growth of the US economy is about 1.8%. Fang: A few days ago, Trump delivered the State of the Union address. And he was boasting about how well the US economy is performing. Do you agree with this assessment? How is the US economy going on at the moment?
Furman: I think overall, the US economy is quite good. The unemployment rate is very low. There's wage growth. There's decent growth of consumer spending.

There are several things to be worried about, economic growth has slowed for two years in a row. Business investment has basically ground to a halt and isn't rising at all. Wage growth is positive, but it's barely picked up, even though the labor market is tighter. And a lot of growth last year came from a big increase in federal spending. It probably won't be repeated in future years.

Therefore, I think there's a lot to feel positive about the economy, but I do think it's slowing. It's likely to continue to slow. It's puzzling why wage gains aren't larger than they are.

Fang: Can unemployment rate go any lower? It's pretty low by historical standards.
Furman：You shouldn't ask me because I was one of the people that thought it couldn't go lower years ago, and I was proved completely wrong.

We got the latest jobs numbers this morning. The unemployment rate went up a tiny bit, but the employment rate also improved. The reason is that a lot of people who had given up looking for jobs came back into the workforce. A number of them found jobs.

It's just amazing how many Americans are out there that if the economy is good enough, they're willing to start looking for work again and come into it. And no one knows how many more of those people there are.

Fang: What is the direction of the interest rate in the US in your view.
Furman: I don't think the Fed is going to do anything this year. The defense is going to keep interest rates exactly the same. It would take a large shock of data in one or the other direction to get them to move from that. Partly they may not want to move in an election year and look like they're interfering in the election.

Also, the US economy doesn't need it. The inflation rate is below target, but not very much below target. The unemployment rate is low. The macro economy is in about as good a shape as you could have as far as the Fed is concerned. Don't touch it, just leave it alone. That's what they should do.

Fang: The GDP growth rate of America is only 2%. It's a lot lower than the 3% average of the whole 20th century despite the great depression. Do you think this is a permanent trend that the US will never get back to 3%?
Furman: I don't think there's any responsible way to predict that the US would get up to 3%.

I think ever in my own view, the trend growth is about 1.8%.

Partly, population growth has slowed. The composition of the population has shifted towards older workers. That's been something. Actually, that's even more extreme in China than it is in the United States weighing on the growth of both countries.

And then, productivity growth has slowed. It's recently rebounded, but it's rebounded to 1.8% productivity growth. With our demography, 1.8% productivity growth is consistent with the growth rate of about 1.8% as well.

I just think we have to accept that. We're rich country that's continuing to get a little bit richer each year.

Fang: But why has productivity growth slowed? I read Professor Robert Gordon’s book about the rising of US economic growth. Basically, his argument is that the rate of innovation, or major innovation has slowed down dramatically since the seventies.
Furman: I mostly agree with Robert Gordon. I think partly there was an unusually high period of productivity growth for the 1950s to the 1970s.

It is a very unique circumstances, like the inventions that we made to win World War Ⅱ. You wouldn't expect those types of innovations to continue.

We're also maybe running into diminishing returns.
If you look at something like microchips, by Moore’s law, every year and a half transistors doubles. But the number of scientists and engineers that are working on microchips has grown enormously. Each time it doubles, we keep doing it, but it takes more and more people, and more and more resources, and it's more and more expensive to keep making progress.

Therefore, I think maybe we're running into diminishing returns of innovation.

This interview has been edited for clarity and flow.