Hank Paulson: China needs to reinvigorate reform

June 7, 2013: 4:56 AM ET

The former Treasury Secretary is bullish on China's economic future, but getting there won't be easy.

By David Whitford editor-at-large

Hank Paulson

Hank Paulson

FORTUNE -- Cai Hongbin, dean of the Guanghua School of Management at Peking University, has noticed a pattern in the way people respond to the stiff challenges -- social, environmental, and economic -- facing modern China: "Those who come often to China are pretty optimistic. Those who rarely or never come say China is collapsing."

Cai, needless to say, is optimistic, as were most of the panelists who took part in a conversation about China's changing economy at the 2013  Fortune Global Forum Friday morning in Chengdu. But none underestimated the enormity of the challenge that lies ahead.

"What hits me right smack between the eyes is the same thing the Chinese government knows," said former U.S. Treasury Secretary and former Goldman Sachs (GS) CEO Hank Paulson. "The current growth model is running out of gas. They're going to need to reinvigorate reform, it's clear."

China's growth rate, while still robust by global standards, has slowed dramatically since 2010; it was 7.7% in the first quarter of 2013, down from recent double digits. China is "too reliant on state-led investment and infrastructure and manufacturing," Paulson continued. "Too reliant on exports. There's not enough domestic-led growth. It needs more from the services industry."

MORE: Complete coverage of the Fortune Global Forum

Dominic Barton, global managing director at McKinsey, said he's "bullish" nevertheless, based on what he called China's "underlying force of growth" -- rapidly expanding cities. McKinsey has long predicted that China's urban population will reach one billion by 2030. The number is a "projection," not a certainty, Barton allowed; and the flood from the countryside may in fact be slowing somewhat. But China is still just at "the end of the beginning" of its urban transformation, he maintained. "This thing will still move." (See more from McKinsey on China)

How that growth is accomplished, Paulson warned, will have serious environmental implications. China has already paid a steep price for prosperity in dirty air and dirty water -- serious problems for China, and potentially catastrophic for the rest of the world unless China can somehow stop building coal-fired power plants and otherwise lessen its reliance on fossil fuels.

Paulson applauded China's new leadership for "both understanding the importance of the private sector and the need for reform" generally. But he said the government needs to be more involved, not less, when it comes safeguarding the environment. "You need to have laws, and you need to enforce them," Paulson said, adding that that's hard to do at the local level when "local leaders are focused on driving growth."

Paulson's conclusion: "The good news is that expectations [of the new leadership] are high. The bad news is that it will be almost impossible to meet those expectations. They're strong leaders. They're going to need to be very strong."

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