Global: China's Global Stature
Stephen Roach (from Washington DC)
morganstanley.com
The world has long been suspicious of the Chinese growth story. That’s especially been the case over the past five years. But China has survived two critical tests over that period that should have dashed some of this skepticism. It came through the Asian financial crisis of 1997-98 with barely a scratch. And it survived a synchronous global recession in 2001 with a similar Teflon-like resilience. Yet the skeptics are still worried that China’s rapid growth dynamic is not sustainable. Some even warn of an imminent crisis in the Chinese economy. I disagree and expect the strength of the Chinese economy to continue well through 2003. Our central case calls for real GDP growth to average 7.5% for the year as a whole, an outcome that would keep China on the solid growth trajectory that it has maintained over the past decade.
There can be little doubt that China is now coming of age. While still a relatively small economy, China’s growth is now strong enough to have a major impact on the dynamics of the broader global economy. Currently, China accounts for only about 4% of a $32 trillion world economy. However, in a weakened global climate, China’s growth rate is now strong enough to have accounted for fully 17.5% of the growth in world GDP in 2002 -- second only to the growth contribution of the United States. At the same time, while China accounts for only about 5% of the world’s total manufacturing exports, it accounted for 29% of last year’s growth in such trade. In short, China is now making a highly disproportionate contribution to the growth dynamic of a sluggish world economy. That has put the world on notice that China’s global impact now needs to be taken quite seriously.
There are no guarantees that China can stay this course. In my view, the world’s most populous nation must overcome three macro challenges to get to the Promised Land of economic prosperity. First, China must address a fundamental imbalance in the mix of its economic growth -- moving away from externally-led growth toward increased support from domestic demand. Our estimates suggest that the growth in Chinese domestic demand accounted for only 26% of China’s total GDP growth last year -- a meager contribution by any standards. Moreover, this demand has been driven largely by state-sponsored infrastructure investment and foreign direct investment. China needs to focus increasingly on private consumption as a source of economic growth. That’s not easy when massive job shedding of between 6-8 million workers per year continues in state-owned enterprises (SOEs). But in the end, there is no other choice -- self-sustaining domestic demand is an essential ingredient of lasting economic prosperity. China’s contribution to the global growth dynamic has been asymmetrical thus far -- with the impetus focused more on the supply side (exports, capital formation, and industrial production) and less on the demand side (personal consumption). A move toward greater symmetry is now in order.
Arresting deflationary pressures is a second macro challenge that China faces. The Chinese CPI has been falling at nearly a 1% annual rate for the past two years, and there is good reason to believe that the official data are understating the magnitude of the decline. This, in my view, is also traceable to the deficiency of domestic demand noted above. Moreover, in a sluggish world, China’s deflation problems have also become the world’s deflation problems. As an increasingly open global economy imports ever-rising volumes of low-cost Chinese goods, the world price level moves inexorably lower. In my view, this is not China’s fault, as some have maintained. It is more reflective of the excesses of consumption for saving-short nations such as the United States. The price of America’s chronic saving shortage is a massive current-account and trade deficit. China fills this void. But that’s a double-edged sword: While low-cost Chinese goods provide a brake to the purchasing power of US consumers, they do little to push the US away from its closest brush with outright deflation in nearly half a century. Deflation is a global risk that China must increasingly be mindful of.
A third macro challenge that China faces is the need to diversify the geography of its economic base. China’s latest five-year plan is notable for its emphasis on the need to develop the western portion of this vast nation. These efforts can hardly be expected to bear fruit over night. But the Chinese leadership remains critically focused on related issues of social stability and the risks to such stability that could be brought about by widening disparities in the distribution of income between the wealthy coastal region and the considerably poorer inland rural areas. Much has been made of the some 900 million poor Chinese citizens that remain on the outside looking in. As economic development continues to surge in the coastal regions, China is facing extraordinary challenges in managing the migration and shelter associated with the massive shifts in its work force that are attracted to regions of prosperity. A geographic diversification of China’s economic base is ultimately the only viable solution to this growing dilemma. At a minimum, this will undoubtedly require massive infrastructure investment, special economic incentive zones, and the solution of a huge logistical and supply-chain management problem. These challenges can hardly be minimized.
Like any economy, China faces risks on both the upside and the downside. In my view, the upside is all about China’s steadfast commitment to reform -- a record that has been most impressive in defying the skeptics. SOE reforms continue apace, as China moves aggressively to embrace and implement its strain of “market-based socialism.” Financial sector reforms are a critical underpinning of this transition and they have also been continuing at an impressive clip. Market-based auctions of non-performing bank loans are now under way and the regulators have recently allowed foreign investors to begin purchasing controlling shares in Chinese banks. Capital markets reforms have come a long way, but more needs to be done. Especially important, in my view, will be the long-awaited introduction of a second board to the Chinese stock market, providing liquidity for private equity investors and thereby facilitating the emergence of smaller and rapidly growing companies. WTO accession, of course, is the ultimate guarantor of China’s reform process -- not only binding it to the rules-based system of the world economy but also opening China to foreign competition on a timetable that is rapid enough to put real heat on inefficient domestic enterprises.
In a challenging economic climate, most nations temper their enthusiasm for reform, shying away from the pain associated with the requisite restructuring and downsizing. That then perpetuates embedded inefficiencies, making structural rigidities all the more intractable. That’s certainly been the case in Japan and Europe in recent years. But not in China. China’s steadfast commitment to reforms is what separates it from the pack. That, alone, continues to keep me more optimistic about China than any other economy in the world.
Alas, there’s also the downside to contend with. In my view, these risks are primarily cyclical -- a by-product of China’s externally-led growth dynamic. While exports now make up 26% of the economy, the growth in China’s exports accounted for fully 74% of the total growth in Chinese GDP in 2002. Ironically, a further weakening in the value of the US dollar -- hardly a remote possibility -- could make China even more export-dependent. That could be a very destabilizing outcome for the broader global economy. As a result, a one-time resetting of the currency peg might have to be given serious consideration if the US dollar were to weaken sharply further. But the bigger risks lie with the state of the global business cycle. If history repeats itself and the world economy goes back into recession in the aftermath of the current oil shock -- an increasingly serious risk, in my view -- export-dependent economies such as China would be particularly vulnerable. As the drumbeat of war in Iraq grows louder, China must be mindful of that very risk. For that reason alone, I now believe that the risks to China’s externally-dependent economy are shifting to the downside of our upbeat growth prognosis.
Painful as they are, business cycles come and go. The benefits of structural change, by contrast, are ever lasting. In that latter vein, I believe that China’s transition and development has finally attained a critical mass. That poses the most daunting challenge of all: China must break with 5,000 years of inward-looking traditions and focus increasingly outward to understand the global implications of its extraordinary transformation. In return, the world must begin to put aside a deeply entrenched skepticism of China and take this remarkable success story seriously. History may well judge the rise of China as one of the most important catalysts in the laboratory of globalization.
(Note: This essay is based on remarks presented to: “Forecast 2003” before the United States-China Business Council on February 13, 2003, Washington, DC.)
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