China’s rise to global prominence has long preoccupied the leaders of the developed world. They should be more concerned about what happens if the country’s growth falters.
With
its combination of cheap labor, easy money, undervalued currency, heavy
investment in manufacturing and focus on exports, the nation of 1.3 billion has
built an impressive economic engine. From 2008 through 2010, China contributed
more than 40 percent of the world’s growth.
But
the Chinese model has its limits, and that has far- reaching consequences for
the U.S. and Europe,
both of which are increasingly dependent on China. The country’s share of
global exports already exceeds 10 percent, larger than that of Japan at its peak in 1986. Barring some miracle,
Chinese exporters can’t expand their market share much further without lowering
prices and wiping out their own profits, research by
economists at the International Monetary Fund suggests.
China’s dependence on exports also makes it highly vulnerable to slowing growth
in the developed world, and to rising trade tensions: The U.S. Senate today
began debating a bill that could ultimately lead to punitive tariffs on Chinese
imports in retaliation for undervaluing its currency.
Meanwhile,
economic stress is mounting at home. Labor costs are surging as the supply of
young, capable factory workers wanes and living
conditions rise along with expectations of better wages.
Cheap and abundant credit has driven over- investment and pushed up real-estate
prices to levels many families can’t afford, adding to social tensions and
possibly setting the country up for a bust. China’s approach to managing its exchange rate is fueling inflation,
which government figures put at 6.2 percent in August.
Well Aware
Chinese
officials are well aware of the problems their country faces. As Premier Wen Jiabao famously put it back in 2007, the
country’s growth is “unstable, unbalanced, uncoordinated and unsustainable.”
The
government’s aim, as laid out in its latest five-year plan, is to move away
from reliance on exports and spur Chinese consumers to spend more -- an outcome
that would benefit the entire global economy by boosting China’s demand for
other countries’ goods and easing the trade imbalances that have contributed to
the developed world’s debt troubles.
The
implementation will be tricky. Getting people to spend requires the Chinese
government to eliminate many of the subsidies -- including cheap labor, low interest rates and an undervalued
currency -- that have fueled growth so far. Consumers need more income, so
companies will have to pay their workers more. Consumers also need a stronger
currency to boost their buying power, so exporters will lose some of their
competitive edge. Savers need to earn a high enough return to guarantee their
retirements, so banks’ and companies’ borrowing costs will rise.
Unprofitable Industry
As
a result, vast swaths of Chinese industry could be rendered unprofitable. Bad
loans could force the government to step in and recapitalize banks. Fixed
investment, which makes up 46 percent of the Chinese economy compared with only
12 percent in the U.S., could fall sharply, undermining the employment growth
needed to boost spending.
In
short, China’s export-driven model could fall apart before consumers are able
to pick up the slack.
In
such a crisis, China’s economic weight would become a liability. The IMF estimates that
the impact of Chinese demand on the world’s largest economies has more than
doubled over the past decade. A deteriorating outlook for Chinese imports could
send commodity prices plummeting, precipitating heavy losses for investors and
risking financial contagion.
China’s Fate
There
is very little the leaders of the developed world can do to influence China’s
fate. Trade wars, such as the one the U.S.
Senate may be on the verge of launching, will only make
the situation worse. Instead, Europe and the U.S. need to focus on limiting
their own vulnerability: The longer they keep growing at rates not far above
zero, the more likely it is that an unexpected shock -- such as a Chinese
crisis -- will tip them back into a recession.
In
Europe, leaders must move quickly to solve a deepening debt crisis and deal
with insolvent banks. In the U.S., they need to take radical measures,
including pumping more federal stimulus money into a stalled economy and
providing debt relief to underwater homeowners, to clear the way for renewed
growth. Over the long term, leaders on both continents need credible plans to
stop debt from growing faster than the underlying economies.
Prudence
requires being prepared for contingencies such as a bad outcome for China. If
we don’t solve our own problems soon, we won’t be ready.
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