One is some of the local government-owned SOEs are the sources forovercapacity. The reason is because the local government also wants to ensure there's some degree of employment locally, and perhaps some source of taxation. The Chinese government is now going to need to start the so called supply-side economics to try to consolidate overcapacity in a number of sectors. It's going to impinge on the interests of many of these local SOEs as well as the local governments who own them.

Malcolm Riddell: When we look at the local governments, though, they have goals to meet in terms of ... I know many goals, but some of them in terms of GDP and employment. The incentive system is in place to encourage over capacity in some sense, isn't it?

Ed Tse: That was one of the root causes for this to happen, at least so far in the past.

Malcolm Riddell: Let's focus on overcapacity for a minute. Where are you seeing the greatest problems of overcapacity?

Ed Tse: By definition, if you have overcapacity, a lot of investments are actually not commercially viable. Creating a lot of products and outputs in the marketplace is ultimately not going to be put in place for use very effectively. That's causing a lot of problems, because China has become the world's largest producer for a number of commodities, but who's going to buy their products? At what price are people going to buy the products? Why should you prepare so much of, for example, low-quality steel, for example, or aluminum, or cement, and so on? It's creating a lot of harm.

Malcolm Riddell: A while ago I got a call from a hedge fund manager who said, "Why in the world is China firing up its aluminum smelters when there's already a glut on the market internationally?" I had to explain some of these principles to him as to why that probably happened. What can China do about it? It sounds like between the vested interests and the fact that the folks running the SOEs can also end up being officials again, it sounds like avery tough nut to crack. What are the government's options for taking care of overcapacity?

Ed Tse: I think you touch on a key point, is what are the metrics for measuring the performance of government officials, in particular at the local level. IfChina continues to measure only on GDP, that's a problem, because aGDP-centric mindset will drive this kind of behavior that we've seen, which led to overcapacity.

What the Chinese government is trying to do is to create a perhaps more balanced [inaudible 00:22:10]. More balance means you compare economic growth with perhaps other metrics like [inaudible 00:22:17]momentum, enhancement, and all the other relevant parameters. I think that that's critical for some of this behavior to change. The other is of course the Chinese government continues to rotate the people, as you already talk about, is to rotate people from one post to another, sometimes from governments to enterprise or sometimes from enterprise to government, and sometimes from one government to another government, local government and so on. There's another way to try to address some of these issues, but eventually it is the notion about what are the appropriate metrics for measuring performance.

Malcolm Riddell: We used to say on Wall Street that people do what you pay them to do, or what you pay them for achieving. If GDP, it's an easy metric. If you're measuring the environment, I looked at the scorecard for the other areas that have been introduced. It still seems like GDP and employment will still keep bubbling up to the top of what's on the mind of most local officials. What do you think?

Ed Tse: Absolutely. That is why it is hard to change. The idea is good, but the practicality of having a more balanced scorecard is actually pretty difficult.

Malcolm Riddell: Then other than really finding some way to put these reforms in place,what can China do about the overcapacity?

Ed Tse: The other is actually to continue to encourage and drive newer forms of employment, because as you know, one of the issues of building a lot of this repeated or repetitive investments in a lot of local places is for the local government to generate employment. Employment is good from a local government standpoint, because it generates stability.

One of the challenges, if much of the overcapacity is to be addressed,then perhaps it may lead to some issues with less stable employment inmore local places. The question is what to do with that. Of course that's a tight issue. In fact, it's not easy to address that.

Malcolm Riddell: The reason for them to is it's not just the problem of unemployment, say,the way we think of it in the West. It's because of the potential for political unrest, is that right?

Ed Tse: Could be. It could very well be, but even without the so-called political unrest, there is not a good sign of proper governance of any government if you have a high level of unemployment. It's a tough issue for China,and for the most part, any other countries in a similar situation. As you know, Malcolm, the Chinese government is now focusing a lot on entrepreneurship, on innovation, because entrepreneurship and innovation are now considered as a very reliable way to generate newforms of employment.The question is whether or not people who used to work in an aluminum smelter can go and work for a tech entrepreneurial company. That is ofcourse not that easy, but at the same time-

Malcolm Riddell: That's a little bit how Donald Trump got elected, right, talking about the folks who were displaced and who really aren't qualified for the other jobs? It's a huge challenge everywhere, really.

Ed Tse: Exactly, yes. It's the same thing, but as you know, Malcolm, the speed and intensity of development on the entrepreneur, in particular in the tech sector, in China is mind-boggling. It's growing up exponentially and a lot of opportunities now being created.

The question, as you said correctly, is whether or not people who work in the "old economy" can equally work in the new economy. That's a big question mark. Maybe some of them could, but most of them probably cannot. There's still going to be a major social challenge for the Chinese government in this transition.

Malcolm Riddell: A few years ago, the book came out When China Rules The World. I used to give a lecture called Why China Won't Rule The World. It was not[inaudible 00:26:54]. I'm pro-China, but it was based on demographics,whether or not China would be able to support the aging economy, that its economy could grow quickly enough to be able to do that. My last slide, this is before all the entrepreneurship and tech innovations, was that I have confidence in Chinese creativity. That was the word I used,rather than entrepreneurship. I think if anything's going to save them in this demographic hole they're in, it will be entrepreneurship. That's why I was so encouraged by reading your book and seeing the ways that China may be able to prosper in a global situation.

Ed Tse: I personally believe that that is probably the only way for China to continue to prosper. I think actually China has a good chance, because of the momentum and also the spread of entrepreneurship across many parts of China, and how in particular young people have really embraced it, and actually are now getting into entrepreneurship. Many of them have created quite a lot of success in the process. Not everybody will be successful, as you know, but some of them would.

I think that China as of today and in the future will now have created an environment for the young people to give it a try on entrepreneurship, andin the process creating quite enormous success and innovations along the way. I think that's partly the most exciting thing that we are now seeing coming from China.

Malcolm Riddell: Certainly in our last discussion about your great book China Disruptors,that was a terrific take-away.