Energy Issues in U.S.-PRC Relations

May 9, 2005

Unedited transcript prepared from a tape recording.

Proceedings:
MR. DeMUTH:  [In progress] --of the American Enterprise Institute, and before I say another word, I want to say a few words about simultaneous translation.  You should all have devices unless you are bilingual, and the devices are available in the anteroom if you didn't pick them up.  They're very simple to operate.  They are already on.  There is an on-off button, but they are already on.  On one side is a volume control, on the other side is a channel control.  If you wish to listen in Chinese, choose channel 5.  If you wish to listen in English, choose channel 6.

[Pause.]

MR. GLASSMAN:  I'm delighted to welcome you all here to this conference on Energy Issues in U.S.-PRC Relations which is a part of the Third Annual Meeting being held among the scholars of the American Enterprise Institute and the Central Committee Party School of the Peoples Republic of China which is being held in Washington today.

A few brief words of introduction.  Party school is a term with a very different meaning in China than it has in the United States of America.

[Laughter.]

MR. GLASSMAN:  The Party School in China is the senior research and teaching organization of the Central Committee of the Communist Party of the Peoples Republic of China.  It has been in existence throughout contemporary history on the Chinese Mainland, and the school plays three important roles.  First, all senior and middle-level officials of the Chinese government, both the central government and the provincial and local governments, attend courses at the Party School.  They do so at the beginning of their careers and they come back for continuing education as their careers progress.

Secondly, the Party School engages in research and publications in the manner of research universities around the world.  Third, it has a special responsibility for providing policy advice to the Chinese government.

I should say in that connection that the individuals here who are speaking on the panel and who are members of the Party School are not the government.  They do not speak for the government.  They are not advancing or defending Chinese government policies.  They speak as scholars who operate very close to the grain of practical politics, just as those at the American Enterprise Institute do vis-a-vis U.S. policy, but their opinions and positions are their own.

The role of the Party School has evolved as the politics and policies of the government has.  The motto of Deng Xiaoping, the famous revolutionary motto, is now inscribed in Chinese characters on a large stone monument as you enter the campus of the school in Beijing, and that motto is "Truth Through Facts."  "Truth Through Facts" could also be the motto of the American Enterprise Institute.  We have found in our 3 years, first 2 years ago in Washington, secondly, last year at just this time where a delegation of five individuals from AEI were hosted most generously by the Party School in Beijing, Shanghai and also in Western and Southern China, that our mutual explorations of economic and policy issues facing the PRC and the USA guided by a commitment to "Truth Through Facts" have been highly productive and enlightening.

We will be meeting later today among ourselves discussing issues in U.S.-PRC political and strategic relations, financial and economic issues, issues about the role of the government in a market economy.  But for this morning's session, we will be discussing the, if you'll excuse the pun, front-burner issue of energy issues in U.S.-PRC relations.

I'm delighted that my colleague James K. Glassman has agreed to chair this discussion.

But before turning things over to Jim and his panelists, I would like to call upon my counterpart from the Party School, the school's Provost and Academic Dean, Xingshan Li, for a few comments of welcome.  Dean Li, if you please.

MR. LI:  [Remarks in Chinese.]

[Applause.]

MR. GLASSMAN:  Thank you, Dean Li for preaching a gospel of cooperation.

Daniel Yergin, the chairman of Cambridge Energy Associates and winner of the Pulitzer Price for his book Prize, a history of the oil industry, is actually sitting down front.  In the current issue of Fortune he writes that "the global oil industry was not prepared for last year's supercharged increase in demand.  Global growth jumped 5 percent which increased daily oil usage by 2.5 million barrels, more than double the average annual growth between 1994 and 2003."  So no wonder oil prices rose.

"Of those 2-1/2 million extra barrels, 500,000 barrels of demand, of 20 percent, originated in the United States, but 930,000 barrels, or nearly 40 percent, came from China.  Not just for automobile fuel, but to generate electric power in the face of coal shortages," writes Dan Yergin.  "China is in shock from becoming so dependent on the world oil market so fast.  What of the consequences of that spike in demand in the face of constraints on supply in so many parts of the world including the United States?  More generally, what should China do to meet its energy needs and what will be the consequences of the actions that China will take?
What should the United States do, if anything, to help?"

We will hear this morning from Zhenhua Zhao, Professor of Economics at the Party School of the Central Committee of the Chinese Communist Party.  Professor Zhao's research focus is market economy reform and macroeconomics, and we look forward to hearing from him.

Afterwards, we will have commentary from a distinguished panel.  Spencer Abraham, who served as Secretary of Energy in the first term of George W. Bush's administration.  From 1995 to 2001 he was U.S. Senator from Michigan, the only Arab American in that chamber.  Senator Abraham is now a distinguished visiting fellow at the Hoover Institution.

Kevin Hassett at the far end is a resident scholar and Director of Economic Policy Studies at the American Enterprise Institute.  Before that, he was a senior economist at the Federal Reserve.  He is a frequent adviser on tax and other matters to the Bush administration and to Congress.

After Kevin the next speaker will be Xiaojun Ma, a Professor of International Political Science at the Central Committee Party School.  He is a board member of the Southeast Asia Study Association and principal investigator of the International Crisis Management Study.

Finally, New Gingrich who is a Senior Fellow at AEI.  He served in the U.S. House of Representatives for 20 years and was Speaker of the House from 1995 to 1999.  He is a former history professor with wide-ranging interests especially in history, politics and technology.  His most recent book is Winning the Future: the 21st Century Contract With America.  After we hear from the commentors, we will have questions from the floor.

Before we begin, I would like to make a very brief comment.  Energy is, as Professor Li just said, the driving force of the modern economy.  It is essential economic growth, and when we talk about energy at this juncture in history, we mean the fossil fuels, oil, natural gas and coal.  That will probably change, but not for a long while.

The reason for the power of energy is simple:  a little of it goes a long way to boost an economy.  Energy is no different from any other resource.  It's price is subject to the laws of supply and demand, and lately demand has been rising in the face of supply constraints imposed by governments and by geopolitical conditions.

This is not, however, a question of exhaustion of resources.  As the late Julian Simon wrote very daringly in 1981, when we look at the statistical history of energy supplies, we see that the trend has been toward plenty rather than towards scarcity.  The Stone Age did not end with the exhaustion of stones, and similarly, the oil age will not end with the exhaustion of oil, but well before.

In this area, Chinese and American interests, aspirations and attitudes coincide.  Businesses and individuals in democratic market economies constantly search for ways to use energy more efficiently and with less damage to the environment.  That's what people naturally want, without government intervention.  But we will use more energy, that is a fact, and we should not be ashamed of energy use.

Consider this:  between 1970 and 2003, GDP in the United States grew 176 percent, and vehicle miles increased 155 percent.  Over that period, energy consumption grew only 45 percent, and total emissions of six principal air pollutants dropped by 51 percent.  There is no reason that China cannot repeat such success.  And, yes, the word is success.  Indeed, China should be able to do even better faster, benefiting from the knowledge of technology and public policies that have gone before.

Professor Zhenhua Zhao Central Party School and, all the speakers will speak from the table.  Professor Zhao?

MR. ZHAO:  [Remarks in Chinese.]

[Applause.]

[End of tape 1A, begin tape 1B.]

MR. GLASSMAN:  Thank you, Professor Zhao.
Spencer Abraham, the former Secretary of Energy?

MR. ABRAHAM:  Jim, thank you very much, and let me thank the American Enterprise Institute for hosting the event here, and we welcome our guests from China to this function.

We talk about today an issue of I think immense magnitude in terms of future economic challenges facing both of our countries and the world as well.

I think maybe to put this in a broader context, it's important to not only appreciate the growth in energy demand and the challenges facing the Peoples Republic of China, but also the world as a whole.  Recent estimates suggest that in the next 20 years the growth in the demand for oil, today about 83 to 84 million barrels a day, will escalate by the year 2025 to somewhere in the range of 121 to 130 million barrels.  The estimate over that same period of time is that the demand for electricity will increase worldwide by approximately 100 percent and 125 percent in developing countries.  The demand for natural gas will over that same period of time increase by some 67 percent.

I know of no one who today can accurately predict, in fact, I know very few people who even can come close to road mapping the pathways forward in any of these areas to meet this worldwide projected demand.  The growth in oil alone that I mentioned of some 40 million net increased barrels today is extremely difficult to chart if you look at the current world marketplace.  We estimate that, of course, some of the existing sources will begin to reduce in terms of their productivity.  That means that our overall gross increase will have to approximate 50 to 60 million barrels a day.  While we can see how to get part of that, I think, looking in such areas as the Middle East, Russia, the Caspian region, West Africa, it is certainly going to be a daunting challenge.

What does this all mean?  It means that obviously the tight markets that we have been experiencing worldwide which has driven prices higher are going to continue, and those tight markets are made more challenging because of external factors that are going on worldwide as well.  We've heard discussion already today about the environmental issues that the Peoples Republic of China is looking at and trying to weigh as it addresses its challenges.  We are doing the same in America, as are other countries.  That means constraints on the supply side of this equation, making it more difficult to meet the growing demand.

I think that we also should expect that the traditional analysis of energy markets or market generally, that higher prices will lead to corrections on both the demand and supply side may be a little less effective and less applicable to this marketplace for the reasons I mentioned with respect to supply, that is, the self-constraints that I think are likely to be imposed by countries worldwide dealing with environmental concerns primarily.  But also because I think there will be less of a response on the demand side to higher prices particularly in the developing countries of the world.

In these countries, what we see, of course, is a real transformation not just of economies but of lifestyles and of cultures.  With those transformations, with the movement of hundreds of millions of people over the next two decades into the middle class, I think we can anticipate that the demand for the kinds of things that we associate with that movement up the socioeconomic ladder, the demand for appliances, for motor vehicles, for the sorts of energy-using products that we associate with this, is going to probably mean less of a correction on the demand side as well.

Where does that all lead us?  Certainly, in the United States and in China it leads both of our countries to a real series of challenges in terms of trying to address these tight markets.  The obvious prognosis is that America and China will become the dominant energy players of the next 20 years and beyond worldwide.  It means that we'll be key players in terms of the worldwide race to secure energy sources and energy resources.  It will mean that we will become, of course, ultimately the two largest importers.  We will see North America and Asia become, obviously, the key regions in this challenge ahead.

As Dan Yergin recently pointed out in a speech he made that I attended, the growth in demand in Asia for energy is such that last year was the first year, that is, 2004, in which North American oil consumption was lower than that in Asia.  I see that pattern continuing into the future.

What does it mean for China?  I think it means, obviously, that China will become a key player in the international energy marketplace even more than it is today.  We will see, obviously, a lot more international investment and activity on the part of the Peoples Republic as well as the companies that operate there.  Already we're seeing a great deal of activity in such places as the Middle East, and most recently in Canada where I think we'll see a real escalation of relationships on the energy front between China and the energy companies of Canada.

That, of course, will on the one hand mean a greater deal of influence for China in these markets in these regions.  It also will mean as we've learned in America that there will be a growing dependence on those regions and the politics that will take place in those regions themselves.  As that importation level increases, then obviously the byplay between China and the countries in which it is involved in international energy partnerships will become more critical.

What I thought I'd focus on today in terms of a summation of sorts is to talk a little bit about where the United States and China together can address some of the challenges confronting each of us.

I start from the vantage point of the work I've done over the last couple of years at the Department of Energy.  We saw these trends some years back.  We began talking with our counterparts in the Peoples Republic and in the government agencies with which we worked and concluded that there was an opportunity here to go beyond simply an international competition between two giant energy using countries to find common ground for cooperation on the kinds of things that would enable both countries to more effectively meet the growth in their energy demand.

One of the things which we launched and which is now beginning to take some very positive steps forward was a U.S.-China Energy Working Group between the U.S. Department of Energy and various key counterpart agencies in the Peoples Republic in Beijing.  We also have developed a joint venture to assist in the work that will be done to try to make the 2008 Beijing Olympics a green Olympics, and are contributing to that effort both on the technology side and on the counseling and advisory side.

We also have been contributing and working with various agencies of the government of China to try to assist them specifically with work on energy efficiency and new energy efficiency technologies.

I think this all forms the foundation for an even more robust kind of relationship going forward.  In fact, literally just in the last few days, a project line that we began as part of this process has now moved to the next step and that for the first time we now have a representative of the United States Department of Energy who has now taken up residence in Beijing who will literally open a U.S. Department of Energy office there to work with our counterparts to try to facilitate a stronger relationship.

What might this relationship focus on?  Last year speaking at Tsinghua University I talked about some of the areas of cooperation that I think would be cornerstones for our joint ventures, and primarily focus on the area of technology development.  All of these trends that I mentioned in terms of the demand for traditional energy sources are ones that are constrained obviously by a variety of physical and political factors.  The only way to break out of the kind of straightjacket to some extent that all countries face in this respect is through new technology.  It's my view that there are some very attractive areas for collaboration between the United States and China on energy technology.

First, I would mention the area of renewable energy.  We too share an interest in trying to make renewable energy sources more available and less expensive to employ and deploy.  I think in particular the wind energy area offers an opportunity for some technology collaboration as well as perhaps the sharing of existing technology expertise.  I think a second area is clean coal technology.  This is an area that is important to both countries because we each have large reserves of coal, and I think the chance for us to employ it fully is dependent on our ability to master some of the new technologies that are being developed from coal gasification which, obviously stands at the top of this list, to carbon sequestration.  In fact, the United States and the Peoples Republic are two of about a dozen countries who have now formed a leadership forum to work together to research carbon sequestration technology.

A third area that I think offers great promise is one I mentioned already that's begun a little bit, and that's in the area of energy efficiency.  I think we in the United States have had some excellent success of late in terms of a variety of new developments in this area particularly with respect to building technologies.  Indeed, the project that I went to Beijing about a year and a half ago to be part of a ribbon cutting ceremony on was for a building technology center there to begin looking at how new forms of building materials as well as just strategies can reduce the energy overhead involved in buildings as well as housing.

Another area that is very promising is hydrogen.  As I think many of you know, we at the Department of Energy launched an extremely ambitious program in 2003 to try to accelerate the research in the area of hydrogen technology, the storage of hydrogen, the development of hydrogen fuel cells, the production of hydrogen, and the infrastructure it would take to translate into ultimately a motor vehicle fleet in this country and theoretically in other countries as well that could be competitive and functionally equivalent to internal combustion engines but operating with hydrogen fuel cells.

I think this is an area where both countries stand to gain a lot through collaboration.  Again, we have already begun a program in this respect that has a multinational element to it.  About 13 countries as well as the E.U are participants in the program called the International Partnership for the Hydrogen Economy.  That partnership allows the member countries of which, as I say, China and the U.S. are both members, to partner on specific project areas of common interest, and I would suggest this would be one area which has great potential, obviously, to be beneficial to each nation.

Lastly, I would talk about fundamental technologies involved in the development of energy, enhanced recovery technologies and others, that offer us the ability to stretch the existing resources we have further.

All of these are areas that are ones that I see evolving in the next decade or so in both countries, but where working together we have the opportunity to stretch scarce resources further as well as take advantage of a specific scientific expertise that each country would bring to the table.

I think all of that is pretty darn important because when you look at the overall numbers that I mentioned at the outset, it's obvious that a world marketplace that becomes almost totally fixated on using oil and natural gas as the principal sources of new power generation of to operate motor vehicles is a world that is headed in a very worrisome direction.  What I would argue is that fuel diversity is imperative.  It's critical to keep the coal that we have in abundance in play which is why the clean coal technology is important.  It's very important to see if we can make some significant breakthrough in renewables and hydrogen, some of these newer sources.

I want to close on this, and it's important, that we understand that it is virtually impossible to meet the growth in demand we're talking about if nuclear energy does not play a much more robust role worldwide over the next half-century.

In China, as I think many know, there is a specific effort now being launched to bring a significant number of new nuclear power plants into service over the next decade and a half.  I think it is a very important contribution to the world debate on nuclear power, and I think that it hopefully will encourage other nations, both the United States and others, who have not added to their nuclear fleets in recent decades to reexamine this issue.

It seems to me inconceivable that the world will meet the kinds of emission targets that are being focused on, whether it's the Kyoto targets or the President's carbon intensity target that we've set here in the United States, or any others, or that countries who are not subject to Kyoto but who have an interest as China does in reducing its emissions, can possibly have the economic growth that is contemplated right now, whether it's, again the United States, China, Europe or any place, have economic growth and emission reductions unless nuclear power plays a much more dominant role.  There I would say is again a possible area of future cooperation between our two countries.

That's the overview from the perspective that I've had over the last few years.  I think it's a very optimistic situation in terms of the prospects for this kind of cooperation, and I think events like today are excellent chances for us to outline those possibilities and to move forward.  Thanks, Jim, for having me here today.

[Applause.]

MR. GLASSMAN:  Thank you, Senator, and you raised some very important points that I hope we'll have time to talk about.

Kevin Hassett, Director of Economic Policy Studies, at AEI.

MR. HASSETT:  There's a risk when we talk about energy to get excessively malthusian, to worry that somehow we're just going to hit the end of the road or the edge of the Earth and fall off.  I think that part of the reason why malthusian tendencies are especially potent with regard to energy is that energy is legitimately important, and historically bad economic things have happened when energy have spiked.

As we start to think about what it means to enter this new world where Asian demand for energy is bigger than that of the United States, where undoubtedly the price spike that we saw in the last year was as much related to strong growth in Asia as anything else, that we need to think about why it is that energy is so important in the economy and what kind of challenges that imposes on us going forward.

I can say that the punch line of my talk is going to be that if you let prices adjust, energy prices just went up, then everything else takes care of itself and you don't need government to tell people what to do, we don't need to launch into aggressive campaigns to research this or that or to encourage energy conservation or anything else, that the price itself will do that better than anything else.

Will high energy demand from Asia and elsewhere kill economic growth?  Are we about to hit some kind of malthusian end of the road on energy just because a couple billion people in Asia are consuming so much energy?

The fact is, if you look at U.S. history, oil spikes do cause recessions, so energy prices are important, and I'm going to show you a chart in a minute.  But the fact is that the economic literature has found that oil prices affect the economy in a very strange, asymmetric way.  Sharp increases reduce growth a lot, but sharp declines don't increase growth at all.  In fact, the effect is also somewhat discontinuous.  If you move the oil price 3 or 4 percent or 5 percent, then you can't find any effect of that on growth; you really need a spike to make something happen.

This chart right here which I hope is legible helps you see the main point in the economic literature which is that there is this apparent nonlinear response to the economy to oil prices.  When the spoke by 10 percent or more, then we have a recession.  The headline of this chart is Oil Price Recession, Batting Average is .900.  So 9 out of 10 we had an oil price spike either during or just before a recession.

Interestingly, we've had another spike at the end of the sample that's not charted here because we don't have a recession yet.  If you go back and look at the spikes that caused recessions, generally they were supply disruptions.  The Arabs and the Israelis will have a war and will shut the Suez Canal or something like that or there will be an embargo, and then the price will go up a lot and economic activity will go down a lot.

The interesting thing about this episode of high prices is that it undoubtedly came not because of a supply disruption, but because of soaring demand, so it's a different kind of price spike and that explains why we haven't had a recession, at least now yet.

Why is it you get a recession?  If you look at the share of energy and value added, it's not that big.  If you increase the price of oil 10 or 15 percent, why is it that we get a recession out of that?  Bill Gale of Brookings and I recently wrote a paper where we tried to explore why it is that output declines after you get a sharp oil price spike.  We found very strong evidence I would think that the transmission mechanism is actually in the U.S. economy through business-fixed investment.

This is an important link for understanding why it is that energy prices are so important in the short-run, because that link helps us understand why it is in the long-run they're not so important, because things will adjust to make them less important.

So what happens?  What happens is, if we have an energy shock to the U.S. economy, business-fixed investment drops a lot, about 10 percent right away.  This is a chart that shows what happens if we have the price shock in the first year based on an econometric model that Bill Gale and I developed.  What happens is it drops down and then goes through a normal business cycle up and down.  People who have seen these impulse responses know that that's the normal pattern, but business-fixed investment drops about 10 percent, and after a little bit of fluctuation stays down for a while but ends up back where it was and output follows along the same pattern.  This is a slightly different scale so you can see the output pattern.

Why is it that investment drops when we get an oil price spike?  I think that the evidence is pretty clear that what's happening is that uncertainty over the future path of prices causes firms to hold off purchasing new capital.  So if prices go up 20 percent all of a sudden, then you think should I buy a hybrid Honda now, or maybe if prices are going to go back down, I should buy an SUV.  While you're wondering whether the price is permanent or not, then you're in an area of inaction that's clearly evidenced in the data.  In our paper, Bill and I go down into detail about what kinds of things are they holding off and find evidence that it's the kind of things that you would expect if you believe a story like this.

As the price path resolves itself, then the problem dissipates.  So if the price stays high, then we buy Hondas, and if the price goes back down, then we buy SUVs.  Higher permanent prices lead to big investments, in fact, in the long-run in more efficient equipment.

Again, why is it that you get a recession when you have an oil price spike?  It's because if the price goes up a lot, people wonder whether it's permanent or not and they decide they want to wait for their big capital purchases until that uncertainty is resolved.  This temporary uncertainty causes a recession, but it doesn't mean that if we double the price of oil and leave it there forever that we're doomed to have a recession forever.

It would seem to me that too often the rhetoric about what's it going to be like in the future with China demanding so much oil seems to intuit from the recession-oil link that really bad economic times are ahead, but that need not be the case at all.  Indeed, if you have higher prices, then people will adjust and buy the efficient stuff.

In fact, one way you can see how these forces work in the current episode is that since the price spike recently seems to be associated with a very high global demand that's likely to persist, then I would argue that market participants are rationally saying that the higher price of oil is a permanent thing and we'd better start acting accordingly right now.  So they are actually buying the hybrid Hondas instead of the SUVs immediately because there is not a temporary supply disruption driving the price spike now, but, rather, what might be a permanent increase in demand.

Why is it that GDP growth has stayed surprisingly high even though the energy prices have spiked as much as we've seen in the past when we've had recessions?  It's because the model is working and people think it's a permanent increase or more or less a long-lasting one and are investing in new efficient stuff accordingly.

So the long-run need not be gloomy.  Higher prices will guide firms and individuals to rational investment decisions and increased demand for other sources of energy, too, because if it's oil then the price of that is high.  There is no reason to expect that the long-run output path is going to be dramatically different or lower because of costly energy.

But it doesn't mean that the world is the same.  For example, monetary policy is much different now.  If we think that inflation is higher because the price of oil is going up a lot because of growth in Asia, then the Federal Reserve can fight inflation all it wants through that channel, but they'd have to hammer the U.S. economy into oblivion in order to stop it because the U.S. demand for oil is no longer such a large share of global demand that if you hurt growth in the U.S. you can expect inflation to go down.

That doesn't mean to me that there aren't challenges, but it does mean that you can get carried away worried about these long-run projections of Chinese demand for oil somehow strangling the economy.  You get short-run changes when prices spike, but in the long-run things work themselves out because there are many dimensions along which optimizing individuals can adjust in order to make sure that they're doing the right thing given the higher prices.

While there might be environmental reasons why governments want to effect pollution by taxing more heavily things that output more pollution and so on, there is a role for government.  I don't think that the crisis atmosphere that I sense somewhat in the remarks that preceded me, we're growing so much, we have all this demand coming and the world is going to come to an end because we're not going to possibly have enough energy is misplaced, that as the prices go up, people will adjust their behavior and that's the mechanism we should rely on, not a lot of research by governments.  Thank you.

[Applause.]

MR. GLASSMAN:  First some applause.  Thank you, Kevin.  Let me ask you two quick questions.  First of all, the recessions that you showed, the nine recessions that were preceded by an oil spike, they were also preceded by a monetary policy that might not have been the best; is that correct?

MR. HASSETT:  I don't know if that's fair because the Federal Reserve's job is to fight inflation, and when you have a big supply shock that drives up prices, it's very difficult to say exactly what the Federal Reserve should do in that circumstance because you're going to cause a big decline in output if you're going to try to reduce inflation, but if you don't, then the credibility of the Fed in fighting inflation is lower.

Given the complexity of the problem, I don't think it's fair to say that Federal Reserve policy has caused the recessions, but it is generally true that tightening in response to higher inflation with the oil price spike is something that exacerbates the decline as well.

I could also add that the higher short-term interest rates figure prominently in investment decisions as well.  Firms look at their cost of capital if the Fed raises shorter-term interest rates and they think I don't want to buy machines, so it does magnify that effect as well.  It magnifies it, but I don't think you could say that it's an error that caused them.

MR. GLASSMAN:  As to the second question which you partially addressed, Secretary Abraham said that there may be something special going on here as a result of let's just say globalization.  On the supply side he said there are self-constraints, or maybe we should call them governmental constraints, on supply due to environmental concerns, and I think you addressed that.

MR. HASSETT:  Yes.

MR. GLASSMAN:  But he also said that there is less response on the demand side to higher prices as, for example, developing nations begin to enjoy the bounty of prosperity; do you agree with that?

MR. HASSETT:  It will be in the price.  If the price goes to 30 or to 40 for a barrel of oil and people don't reduce their consumption, then that's why it goes to 50.  The price tells us what the balance is, and whether the demand for oil in the world right now is more or less elastic than it was 10 years ago, seems to me it must be more because it's just so much easier to substitute technologies and so on than it used to be.  That's something I would defer maybe to Mr. Yergin who might be a person who would know something about that.

MR. GLASSMAN:  Thank you.  We'll now hear from Professor Ma of the Central Party School.

MR. MA:  [Remarks in Chinese.]

[End of tape 1B, begin tape 2A.]

[In progress.] [Applause.]

MR. GLASSMAN:  Thank you, Professor Ma.  If you look at your watch, you'll see it's 11:30 which was the time we were going to end, but we're not going to end.  Newt Gingrich will speak now.  We'll go over a bit so that we can have some questions.  It has been a fascinating discussion.

Newt Gingrich is a Senior Fellow at AEI and former Speaker of the U.S. House of Representatives.

MR. GINGRICH:  Thank you very much, Jim.  Let me start by thanking the Party School and thanking Professors Zhao and Ma for their presentations in particular, and I appreciate very much, Mr. Secretary, you coming and sharing with us, and it's always tremendous to be here with Jim Glassman and Kevin Hassett who have had some of the most interesting analytical approaches to technology and markets in recent times.  I'm also delighted, Dan Yergin, that you can be with us today.

My role is largely to be here as an historian.  Let me put this in context.  From an American perspective, it is good for China and India to become wealthy.  It creates a better, more stable planet, but has implications.  I think it's important to start with that.

There is nothing threatening inherently about China and India becoming dramatically wealthier.  It is a good thing.  In fact, I think the 21st century will be the century of the reemergence of Asia.  Prior to 1800, China historically was about 35 percent of the world's GDP, and there is no reason to believe that in a long period of peace and trade that China and India won't both become dramatically larger players in the world than they have been in the last 300 years.

I am concerned about a couple of things.  Let me start by saying that there is a very profound argument captured in part by Dan Yergin in his other book, The Commanding Heights, between a static and a dynamic way of thinking about the world.  Technological change and fluctuations in markets frighten bureaucrats and academics and confuse news media and politicians.  Malthus warned that Britain would start starving because you couldn't possibly import enough food.  He has been wrong now for 200 years.  This has no effect on bureaucratic analyses which are malthusian, including oil.

Jim Glassman asked Kevin Hassett about price, and I was surprised that Kevin didn't make the obvious point, if oil rises in price and stays, it's because somewhere in the world there is someone who values oil enough to pay that much.  I'm not sure there's a natural price of oil, gold or whatever you want to buy.  I would point out to that coffee which is a commodity which has been dropping in price for farmers for at least 50 years is now a social status symbol artificially rising in price in the U.S. to such a degree that McDonald's is about to introduce a $2 cup of specialized coffee in order to recapture the boutique market that has been a hallmark of a very, very successful American company.  Prices aren't necessarily political or rational, but they're good responses of value as defined by consumers.

Let me carry that a step further.  It's the natural pattern of science- and technology-based entrepreneurial free markets to produce more goods with more choices of higher quality at lower cost.  I want to repeat this because this is so outside the framework of all modern political debate that it needs to be repeated every day in health care, in energy, and in virtually every topic.  It is the natural pattern of a science- and technology-based entrepreneurial free market to produce more choices of higher quality at lower cost.

If that's true, and I would argue in the next 25 years largely thanks to the contribution of China and India, you'll see more scientific change than you've seen in the last 100 years.  I think this is a literal number because there more scientists alive than in all of previous human history.  They're connected by the Internet and cell phone.  They're then connected by venture capital and licensing.  And they're then connected to production in Asia.  So it's inconceivable to me that you won't have at least four times the rate of change we've had up until now.

If that's true, then rising prices for oil will send a signal on both the production side not just of oil but of energy in general and on the consumption side, and those signals will lead an amazing number of people to invent substitutes both on production and on use and the market will rebalance.

There are some caveats to that.  Let me say I am personally shaped by my experience as an environmental studies teacher in the early 1970s using the Club of Rome's limits to growth which forecast that we would run out of oil before the end of the century and we would all be walking around or using wood stoves or something, and it was just totally wrong.

In fact, in the early 1980s, the price of oil crashed as a function of deliberate geopolitical strategy as Peter Schweitzer has recorded in two books because Ronald Reagan set out to destroy the Soviet empire by shattering its only source of hard currency and formed an alliance with the Saudis to dump oil on the market at the cost domestically to Reagan's Oil Patch supporters.  They artificially drove down the price of oil and starved the Soviet Union which disappeared 11 years later.  Policies do matter, and you don't have linear projections.

Here are my concerns.  The first is, because policies matter, I would cite South Korea and Ghana which both had the same per capita income in 1960.  I would cite Juan Peron's astonishing achievement of deindustrializing Argentina and one of the great understudied acts of political destruction.  I think there is a very grave danger of politicians doing really destructive things in a temporary crisis because they want to avoid the pain before the next election, or in the case of a dictatorship like China, they want to avoid the riots.  Therefore, they do things in the long-run that are very destructive but in the short-run sound good.

Secondly, I think we have to examine whether or not in Peter Drucker's term we're entering a discontinuity.  We've been in discontinuities before.  We've moved from a wood-based economy in London to a coal-based economy which ultimately led to the invention of the railroad.  We moved from coal as a source ship fuel on the late 19th century to oil which had enormous implications for the Royal Navy, the U.S. Navy, the Japanese Navy and others.

I suspect at one level we're entering a discontinuity, and I always combine China with India.  I actually think the focus on East Asia I say to my friends from East Asia is slightly overdone.  I think when you come China and India you really see the growth pattern of the next 30 years and it does seem to me this is a new pressure on pricing and on supply that is probably a discontinuity.

I would question in that context whether East Asian leadership in a world market can be more than of limited value.  That is, I think it's a useful thing to do, but I don't believe that the East Asian countries if they cooperate without understanding that that cooperation is inside a much, much bigger world market, are in fact decisive.

I do think there are probably over time technological and entrepreneurial fixes, particularly if the politicians don't stop it.  I do worry a lot about the politicians stopping it.  The fact is, historically if politicians create the right incentives and the right investment strategy, they can actually accelerate the development of the future.  If you look at the rise of aviation in the 1920s and 1930s, it was clearly sponsored by government.  If you look at the transcontinental railroad in the U.S., it was clearly sponsored by the government and the right policies accelerate a better future, the wrong policies make pain more likely.

I also think it's also very important to raise the security issue, and I particularly appreciate Professor Ma describing some of this.

I would say, first of all, his point is oil is more than economic is exactly right.  It is impossible to read Ereay's (ph) translation of the Japanese Imperial Minutes in 1941 without understanding that the Japanese absolutely felt that their survival as a country was at stake once the U.S. cut off the sale of oil and that they felt they had no choice except to launch the Southern War.  I am not defending the Japanese, obviously as an American.  I think that they were strategically insane the way they did it because they guaranteed that we would never quit until we defeated them.

But from their perspective, oil was life and death, and I think in that sense there's a great challenge for the U.S. and China, and I want to be as clear as Professor Ma was.  Challenge comes in two places.  The first is for China to legitimately project naval power to protect the flow of oil to China, will inevitably be seen as a threat because naval staffs analyze capabilities, not intentions, and if you build a large enough navy to protect your oil supply all the way from the Persian Gulf to China, by definition you would have built a large enough navy that we will have to respond, and you'll just have to take that into account.

Your other choice is to say like the Japanese, the South Koreans and a lot of other people, sign a deal with the U.S., have us protect your oil supply, and as long as we keep our word, don't worry about it.  That's point one.  Because I do think we will have a countervailing tendency to do whatever we have to to invest resources to overmatch your navy.

Point two is do not underestimate the danger of a sudden disruption that no one could have imagined.  In 1898, the British collided with the French at Fashoda, and there was the last great threat of a French-English war, a tradition which went back at that point almost 1,000 years.

Within 4 years, the British had signed an alliance with Japan and had begun to move towards entente with France, and had decided Germany was a threat.  The reason was the building of the German Navy.

By 1914, the British felt threatened enough that in response to the attack on Belgium, they went into a war they had no intention of going into one week earlier.  It changed overnight.

The other threat is the one that Professor Ma courageously raised, and that is Taiwan, and I would only make this point about Taiwan.  With all due respect to all of the eloquent speeches I've heard over the years, I'm not suggesting in any way to meddle in Chinese internal affairs.  A Chinese effort to militarily coerce 24 million free people would almost certainly be interpreted if it were overt and military as the equivalent of the remilitarization of the Rhineland in 1936 or the occupation of Belgium in 1914.  The view would be that a China so aggressive that it would conquer 24 million people militarily is a China better stopped now than later.

What has to happen, and I think this is the most dangerous single problem over the next 20 years, because if the Chinese people and the American people grow closer together and if we learn to respect each other and work with each other, the future of the human race is terrific.  If we collide in a big way, it will be a mess, a mess comparable to the two World Wars.

It's a very, very dangerous thing.  I appreciate Professor Ma raising it.  My hope is that we will somehow talk our way past it for another 20 years and let people gradually have the kind of conversations that occurred in the last week in China and let people gradually find a way to solve their problem.  But I would not understate how dangerous it would be, nor would I understand the point you made which is as you become more dependent on external supplies and as your industry becomes more dependent on selling to external markets, the natural response may not be military.  It may be to move in a variety of ways that are stunningly painful and that then lead to a much bigger conflict.  So I do think that's the one thing that could mess every projection we currently have.

This has been a very helpful conversation, and I appreciate very much your taking the time to come and to be with us.

[Applause.]

MR. GLASSMAN:  Thank you, Newt Gingrich.  You always make these issues clear and exciting, and thank you.

I want to go back to something else that Professor Ma said.  I'm looking at the paper, but he brought it up more briefly.  As he stated, we had a very brief conversation this morning over breakfast, and that is the U.S. control of global energy resources.  To quote from the paper, "Lording it over the world is the U.S.'s guide of action.  Reinforcing its control of global energy resources is a way for the U.S. to contain other countries' challenges.  To reinforce its control of oil production, the U.S. initiated the Iraqi war and fought with Russia for oil at the Caspian Sea."

I'd like to call on Dan Yergin who's sitting in the front row, if he doesn't mind, to respond to the notion that the United States has control of global energy resources.  We've heard here about the power of supply and demand and the power of other political forces.  Dan Yergin, if you don't mind, if you could respond to that.

MR. YERGIN:  First of all, let me add that this has been an excellent panel that I think has really provided a very strong perspective on these issues.

Maybe I could make just a couple points that get right to that.  One, I think Mr. Ma did raise that question about blame and I think rightly said that there's a tendency to say that either China or the United States or somebody else is responsible for what's happening in the oil market today, and of course, the reason as Kevin suggested is that it's globalization and strong economic growth.

I think this panel is about better understanding and I think your question suggests that there's a lot of room for misunderstanding because the common interests are so strong from sufficient supply, sufficient investment, what Spencer Abraham said, the scale of the challenge in terms of what needs to be done over the next few years, and security which gets to your question.

It does seem that where oil and energy are a rub between our two countries or when they get caught up in larger foreign policy questions of which if you look down the road probably Iran is the most vivid, but in terms of the geopolitics, I think oil and geopolitics do go very closely together as does natural gas, but it's important to have a proper perspective.

As to the notion that the U.S. controls the oil industry, I think perspective is important.  There are supermajors in the world oil industry today.  Three of them are not U.S.  They're based in Europe.  It is striking that something like 80 percent of U.S. oil comes either from the United States or the Western Hemisphere, so I think that would be the answer.

Mr. Li raised the question that people talk about the Chinese threat in terms of oil, and I'd like to say a word about that which is, again, I think you need to bring that into perspective.  I think Mr. Ma referred to the fact that he has been the teacher of the heads of several of the Chinese oil companies, and I think it's often not perceived the degree to which China has made a decision to work through global markets on oil through three major oil companies that are partly government-owned, but partly also owned by the pension funds of people in this room because they've done IPOs on the international markets, and to borrow from Deng Xiaoping might be called international oil companies with Chinese characteristics.

I think that the solution to these problems and these challenges are through markets, technology and time.  I think that the stability and security of supplies are really foundations for a healthy world economy, and that's why it's so manifestly in the interests of both countries and thus this panel.  Thank you.

MR. GLASSMAN:  Thank you very much.  Questions from the floor, please?

MR. STARKS:  My name is Patrick Starks (ph).  I'm  Ph.D. student at the University of Oklahoma writing a dissertation on Chinese overseas resource investment, particularly the state-owned petroleum enterprises.  The panel spoke about the United States and China cooperating together.

My question to any of you is how can we cooperate together when you look at the Chinese state-owned petroleum enterprises moving into traditional U.S. supply markets like Venezuela or Canada?  But also the Chinese state-owned petroleum enterprises are moving into areas that are states of concern of the U.S. government's perspective in terms of Syria, Sudan and places like Iran where China is tying up long-term contracts.

My question is, how can we cooperate without having conflict when you see these sorts of trends occurring in the global marketplace in terms of Chinese state-owned petroleum enterprises push into their resource acquisition strategy?

MR. GLASSMAN:  There may be two separate issues here.  Should we be concerned that the Chinese are moving into Venezuela or Canada, traditionally suppliers to the United States, or does that make any difference?  And then the other question about Syria, Sudan and Iran.  Would anyone like to answer that?

MR. ABRAHAM:  It's not as if China is the only country in the world who is involved in energy deals in these regions.  Japan, for instance, is involved in developing an energy deal in Iran.  Russia is involved.  In the case of Japan, that's oil.  In the case of Russia it's nuclear power.  Obviously there are going to be areas in which the political views or policies of countries are not connected.

What I think you're going to see on the actual international front is more joint ventures between companies.  The United States government doesn't do international energy investment, it's companies, and I think you're going to see more international collaboration on energy projects.  But I do think you're going to see more cooperation between governments on the technology side as I outlined because there's a natural advantage to some of that kind of work.

Will there be pressure points?  Sure.  There are pressure points, though, between U.S. policy and other countries who are involved in energy development and exploration in parts of the world where there's tension between the U.S. and that part of the world.

MR. GLASSMAN:  I think we're going to have to call it quits here, unfortunately, because we're very close to noon.

I want to thank the panelists for an excellent.  A lot of questions were raised that clearly we don't have time to answer but will be discussed here and in China over the next many weeks.

I want to thank our Chinese guests for making excellent presentations and in the audience as well.  Thank you.

[Applause.]

[END OF TAPED RECORDING.]