Yale NEW Global, 18 February 2014
By Stephen S. Roach
Once again, all eyes are on China. Emerging markets are being battered in early 2014, as perceptions of resilience have given way to fears of vulnerability. And handwringing over China is one of the major reasons.
Of course, Federal Reserve tapering – reductions of the US central bank’s unprecedented liquidity injections – has also been a trigger. That makes it much tougher for emerging economies overly dependent on global capital flows – namely, India, Indonesia, Brazil, South Africa, and Turkey – to finance economic growth. But the China factor looms equally large. Longstanding concerns about the dreaded hard landing in the Chinese economy have once again intensified. If China falls, goes the argument, reverberations to other emerging markets and the rest of the global economy will be quick to follow.
While generalizations are the norm in the throes of most crises, in the end differentiation pays. Such has long been the case with China. China was Asia’s most resilient economy during the wrenching pan-regional crisis of the late 1990s and it could turn out to be just as tough today. Yes, the Chinese economy is now slowing, but the growth downshift is not well understood. A slowdown is actually a welcome development. It’s neither desirable nor feasible for China to return to the 10 percent growth trajectory that it achieved in the three decades commencing in 1980.
Yet there continues to be a superficial fixation on top line Chinese GDP growth – dwelling on a 10 percent growth machine that has slowed into the 7 to 8 percent zone, a deceleration of 25 percent in the speed of the modern world’s greatest development story. The knee-jerk reaction presumes that this downshift is but a prelude of more growth disappointments to come – especially in light of widespread fears over a longstanding list of China disaster stories, ranging from social unrest and environmental catastrophes to housing bubbles and shadow banking blowups.
While none of these concerns should be dismissed out of hand, they’re not the source of the current slowdown. At work, instead, is a long-awaited rebalancing of the Chinese economy – a major shift from export- and investment-led growth delivered by a vibrant manufacturing sector to a model much more reliant on consumer spending and services. Indeed, in 2013 the Chinese services sector actually overtook the combined shares of manufacturing and construction as the largest segment in the economy. Long dependent on 10 percent Chinese economic growth for 30 years, the United States, in particular, and the world, in general, is not prepared for the slower growth that will naturally emerge with an increasingly consumer- and services-led Next China.
That is the basic theme of my new book, Unbalanced: The Codependency of America and China. The codependency construct is, of course, rooted in the psychological pathology of human relationships, where out of need or convenience two partners draw unhealthy support from each other. Ultimately, that leads to a loss of identity that can result in frictions and the ultimate nasty breakup – unless, of course, one or both of partners becomes more self-reliant and strikes out on its own.
I argue in the book that the economic analogue applies to the United States and China. China’s export-led growth miracle couldn’t have achieved its extraordinary success starting in 1980s without the external demand from the American consumer. China also relied heavily on the US dollar to anchor its undervalued currency in order to boost its export competitiveness. The United States, for its part, drew greatly on cheap goods made in China to boost the purchasing power of hard-pressed, income-constrained consumers; it also relied on surplus Chinese saving to help fill the void of the world’s largest shortfall of domestic saving and took advantage of China’s voracious demand for US Treasury securities to help fund massive budget deficits and subsidize American interest rates.
In the end, however, this codependency was a marriage of convenience – not love. Frictions have developed between the two partners over a range of issues, including trade and currency tensions, geostrategic security frictions, intellectual property and cyberhacking disputes. And just as the psychologist would predict, one of the partners has decided to go its own way. And that, of course, is China.
For the past seven years, the Chinese leadership has debated a major shift in its growth and development strategy. It started with former Premier Wen Jiabao’s famous 2007 critique of the “Four Uns,” when he pondered the fate of a Chinese economy that he characterized as increasingly unstable, unbalanced, uncoordinated and unsustainable. That critique gave rise to the pro-consumption 12th Five-Year Plan enacted in early 2011, which provided a broad framework of structural rebalancing.
But the plan lacked teeth, specific policies that would provide impetus to rebalancing and bring the Chinese consumer to life. That shortcoming was addressed in the November 2013 Third Plenum of the 18th Party Congress. Of the some 60 reforms ratified at that meeting, the ones aimed at altering the behavioral norms of long insecure Chinese families were especially important – namely, modifications in the one-child family planning and residential permit, orhukou, systems; a shift to market-based interest rates that would boost long depressed yields for Chinese savers; and a 30 percent tax on state-owned enterprise profits that would provide funding for safety net programs such as social security and healthcare. The Third Plenum also established a new and powerful implementation mechanism – the so-called Central Leading Group for Comprehensively Deepening Reforms, headed up by Xi Jinping – that should be especially effective in putting these reforms into action.
Unbalanced was written without benefit of the knowledge of the stunning results of the Third Plenum. I had concluded that China really had no other choice than to move expeditiously to put its pro-consumption strategy into action. The Great Crisis of 2008-09 and its aftermath was an extraordinary shock to China’s external markets and ever-mounting internal imbalances – excess resource consumption, environmental degradation and pollution, mounting income inequalities, and a fear-driven surge of precautionary saving – suggested the old model was running out of time. I argued that urgent action was needed on the structural rebalancing agenda. The Third Plenum delivered on this count – and did so in a manner that was well beyond my expectations.
That, in my view, seals the fate for the codependent relationship between the United States and China. China is locked on a course that will transform it from surplus saving to saving absorption – no longer inclined to lend its capital to the United States but increasingly focused on putting its savings to work in building a social safety net and funding the wherewithal of its own populace. Long the world’s Ultimate Producer, China is now determined to emerge as consumer, too.
How will the United States, long the world’s Ultimate Consumer and still reliant on China for cheap goods and capital, respond to this transformation? I tackle the question in the final chapters of Unbalanced. For a growth-starved US economy, this could well be a critical fork in the road. One path is risky: If saving-short America stays stuck in its old ways, but finds itself without the goods and capital from China, the US will suffer higher inflation, rising interest rates and a weaker dollar. The other path is one of great opportunity: America can adopt a new growth strategy – moving away from excess consumption toward a renewal based on saving and on investing that saving in people, infrastructure and capacity. In doing so, the US can draw support from exports, especially to China – currently its third largest and most rapidly growing major export market – where demand for American-made products and services could provide an enormous bonanza for a refocused US economy.
The days of codependency are nearing an end for America and China. China is striking out on its own. If America doesn’t, there will be a serious price to pay. We can only hope that Washington seizes the moment and converts Chinese rebalancing into a new source of economic growth and prosperity. Financial markets, long fearing the worst out of China, will need to come to the same realization.
Stephen S. Roach, a faculty member at Yale University and former chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China (Yale University Press, January 2014).