China, keen on great power status, must be strategic on global risks, avoiding resentment over export-led growth while rebalancing its economy.
By Stephen Roach*
The Chinese economy is at a pivotal point in its modern history. On the occasion of this 40-year anniversary of reforms and opening, it is tempting to look backward and celebrate the extraordinary accomplishments of economic development. The greater challenge is to look forward to 2050 and the aspirational goals of what the Chinese Communist Party and its leadership have dubbed as China’s New Era. Gazing that far into the future is always a leap of faith, but never more so than when China’s most important trading partner, the United States, throws down the gauntlet of a potential trade war.
The transition ahead is daunting to the say the least. On the one hand, it entails a full complement of internal adjustments aimed at the structural rebalancing of the Chinese economy – from manufacturing to services, from exports to household consumption, from surplus saving to saving absorption, and from state-directed to market-based resource allocation. Some progress on this journey is already evident. While the Chinese economy is a good deal less dependent on the vicissitudes of external demand than was the case before the 2008 global financial crisis, exports still account for fully 20 percent of the nation’s GDP, or about half the share going to household consumption. However, with consumer-led rebalancing still in its very early stages and not yet strong enough to buffer unexpected shocks elsewhere in the economy, any disruption in the global climate could prove problematic for China.
Significantly, the rebalancing of China’s internal economic structure cannot occur in a vacuum. Important shifts in the global economy and in China’s relationships with other major economies in the world also have a critical bearing on the outcome. In that vein, China has much to learn from recent developments in a volatile and crisis-torn world – including lessons from the Asian financial crisis of the late 1990s, the 2008 global financial crisis and the long string of “lost decades” in Japan, In each of these cases, the lasting impacts of volatile and destabilizing outcomes underscore both the severity and complexity of the global challenges China is likely to face in the next phase of its economic transition.
Japan, as modern Asia’s first troubled growth miracle, offers three lessons especially relevant for a debt-intensive Chinese economy: First, avoid the currency suppression of a mercantilist, export-led growth model and the trade tensions it provokes from the rest of the world. Second, do not ignore the potentially lethal interplay between asset bubbles and leverage. And third, avoid subsidizing ossified zombie companies and the risks they pose to underlying productivity growth. While China has grounds for concern on all three counts, its recent focus on deleveraging and stability – especially the establishment of a new financial stability oversight committee – are hopeful signs that it can avoid the Japan syndrome. At the same time, the recent shift in state-owned enterprise reform strategy toward the mixed ownership restructuring approach of China Unicom is worrisome in that it promotes a structure of cross shareholdings reminiscent of Japan’s keiretsus, the epicenter of that nation’s protracted post-bubble zombie problems.
Notwithstanding China’s progress on the road to rebalancing, it is still facing a legacy of pressures traceable to its original growth strategy. China’s export-led growth miracle — drawing on the strength of global demand that supported the global distribution of goods from an increasingly powerful Chinese export machine — has made it the largest exporter in the world. Unfortunately, trouble was brewing in an increasingly crisis-prone world. The underpinnings of external demand for Chinese exports turned out to be built on quicksand. Following the unprecedented 10.5 percent plunge in global trade in 2009, growth in global trade has averaged only 3 percent. China, the world’s biggest exporter, could hardly dodge that bullet. Washington’s recent imposition of tariffs has made that into an urgent reality. The Trump administration has moved from rhetoric to action in its campaign to defend US workers from the president has called “the carnage of terrible trade deals.” China is the target.
The US strategy is seriously flawed. The Trump administration, focused on reducing an outsized bilateral trade deficit with China by initiating aggressive tariffs and other sanctions, doesn’t appreciate the scope of America’s multilateral trade deficits with 102 nations. This macroeconomic imbalance stems from a shortfall in domestic saving that is about to worsen as federal budget deficits rise following the enactment of large tax cuts in late 2017. And that’s where the problem goes from bad to worse. If the United States opts for protectionism at a time when its current account and multilateral trade imbalances are likely to widen, financial markets could come under considerable pressure. And then another lesson of Japan could come back to haunt those economies that have become overly dependent on asset appreciation as the sustenance of growth.
Notwithstanding these potential risks, the broad consensus of forecasters has turned increasingly optimistic in assessing seemingly synchronous prospects for the world economy. That’s very much the view in still frothy financial markets following a brief correction in early February, with aftershocks in March. A decade after the global financial crisis, long-awaited hopes of post-crisis healing appear to have finally taken hold. Those hopes may prove short-lived, however. As central banks start to normalize monetary policy, excess liquidity will be drained from overvalued financial markets — putting pressure on asset-dependent economies, with collateral damage to major trading nations like China.
All these considerations should weigh heavily on China as it frames macroeconomic policies and reforms for the years ahead. Particularly worrisome would be a premature celebration of its New Era – hailing the final destination of a long journey without paying attention to the pitfalls that might be encountered along the way. This requires a deepening of China’s strategic approach to meeting its economic challenges, shifting its focus from the quantity to the quality of growth, from the targets of state-directed industrial policy to the forecasts of a market-driven private economy, and from imported technologies to the indigenous innovations required to escape the dreaded middle-income trap.
For 40 years, strategy has been one of China’s greatest strengths. That may be all the more essential for a nation aspiring to great power status by 2050. History tell us that nations are truly great only if they draw strength from within. Yale historian Paul Kennedy famously warned of the destabilizing interplay between shifts in relative economic power and global stability – cautioning against the temptations of geostrategic overreach without attending to the foundations of strength at home. China’s ambitious Belt and Road Initiative raises especially important questions in that context.
In the end, China’s powerful economic takeoff was a levered play on globalization, global trade and ultimately the global economy. Yet the lessons of Japan, the Asian financial crisis and the global financial crisis underscore the systemic perils of an externally focused growth strategy. In the 19th Party Congress of October 2017, President Xi Jinping and the party leadership focused attention on the “unbalanced and inadequate” characteristics that have emerged as the so-called principal contradiction of China’s great successes in the first stage of its development. Staying the old course is no longer an option for a nation and a party determined to resolve this contradiction. China’s experience over the past 20 years underscores that it should not take global risks lightly. The threat of a trade war with the United States drives this point home. For China, clarifying its new course becomes all the more urgent as a result.
*Stephen Roach, a faculty member at Yale University and former chairman of Morgan Stanley Asia, is author of Unbalanced: The Codependency of America and China (Yale University Press: 2014). This article is based on a paper prepared for the 19th Annual China Development Forum, March 24 to 26, 2018, in Beijing.