Wednesday, November 26, 2014

China’s Growth Puzzle

NEW HAVEN – Once again, all eyes are on emerging markets. Long the darlings of the global growth sweepstakes, they are being battered in early 2014. Perceptions of resilience have given way to fears of vulnerability.

The US Federal Reserve’s tapering of its unprecedented liquidity injections has been an obvious and important trigger. Emerging economies that are overly dependent on global capital flows – particularly India, Indonesia, Brazil, South Africa, and Turkey – are finding it tougher to finance economic growth. But handwringing over China looms equally large. Long-standing concerns about the Chinese economy’s dreaded “hard landing” have intensified.

In the throes of crisis, generalization is the norm; in the end, however, it pays to differentiate. Unlike the deficit-prone emerging economies that are now in trouble – whose imbalances are strikingly reminiscent of those in the Asian economies that were hit by the late-1990’s financial crisis – China runs a current-account surplus. As a result, there is no risk of portfolio outflows resulting from the Fed’s tapering of its monthly asset purchases. And, of course, China’s outsize backstop of $3.8 trillion in foreign-exchange reserves provides ample insurance in the event of intensified financial contagion.

Yes, China’s economy is now slowing; but the significance of this is not well understood. The downturn has nothing to do with problems in other emerging economies; in fact, it is a welcome development. It is neither desirable nor feasible for China to return to the trajectory of 10% annual growth that it achieved in the three decades after 1980.

Yet a superficial fixation on China’s headline GDP growth persists, so that a 25% deceleration, to a 7-8% annual rate, is perceived as somehow heralding the end of the modern world’s greatest development story. This knee-jerk reaction presumes that China’s current slowdown is but a prelude to more growth disappointments to come – a presumption that reflects widespread and longstanding fears of a broad array of disaster scenarios, ranging from social unrest and environmental catastrophes to housing bubbles and shadow-banking blow-ups.

While these concerns should not be dismissed out of hand, none of them is the source of the current slowdown. Instead, lower growth rates are the natural result of the long-awaited rebalancing of the Chinese economy.

In other words, what we are witnessing is the effect of a major shift from hyper-growth led by exports and investment (thanks to a vibrant manufacturing sector) to a model that is much more reliant on the slower but steadier growth dynamic of consumer spending and services. Indeed, in 2013, the Chinese services sector became the economy’s largest, surpassing the combined share of the manufacturing and construction sectors.

The problem, as I argue in my new book, Unbalanced: The Codependency of America and China, is not with China, but with the world – and the United States, in particular – which is not prepared for the slower growth that China’s successful rebalancing implies.

The codependency construct is rooted in the psychopathology of human relationships whereby two partners, whether out of need or convenience, draw unhealthy support from each other. Ultimately, codependency leads to a loss of identity, serious frictions, and often a nasty breakup – unless one or both of the partners becomes more self-reliant and strikes out on his or her own.

The economic analogue of codependency applies especially well to the US and China. China’s export-led growth miracle would not have started in the 1980’s without the American consumer. And China relied heavily on the US dollar to anchor its undervalued currency, allowing it to boost its export competitiveness.

The US, for its part, relied on cheap goods made in China to stretch hard-pressed consumers’ purchasing power. It also became dependent on China’s savings surplus to finance its own savings shortfall (the world’s largest), and took advantage of China’s voracious demand for US Treasury securities to help fund massive budget deficits and subsidize low domestic interest rates.

In the end, however, this codependency was a marriage of convenience, not of love. Frictions between the two partners have developed over a wide range of issues, including trade, the renminbi’s exchange rate, regional security, intellectual property, and cyber attacks, among others. And, just as a psychologist would predict, one of the partners, China, has decided to go its own way.

China’s rebalancing will enable it to absorb its surplus savings, which will be put to work building a social safety net and boosting Chinese households’ wherewithal. As a result, China will no longer be inclined to lend its capital to the US.

For a growth-starved US economy, the transformation of its codependent partner could well be a fork in the road. One path is quite risky: If America remains stuck in its under-saving ways but finds itself without Chinese goods and capital, it will suffer higher inflation, rising interest rates, and a weaker dollar. The other path holds great opportunity: America can adopt a new growth strategy – moving away from excess consumption toward a model based on saving and investing in people, infrastructure, and capacity. In doing so, the US could draw support from exports, especially to a rebalanced China – currently its third-largest and fastest-growing major export market.

Compared with other emerging economies, China is cut from a different cloth. China emerged from the late-1990’s Asian financial crisis as the region’s most resilient economy, and I suspect the same will be true this time. Differentiation matters – for China, Asia, and the rest of the global economy.

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    1. CommentedProcyon Mukherjee

      The classical definition holds good but in different ways for U.S. and China:
      C + I + G + (X - M) = GDP, where C = Personal Consumption Expenditures, I = Gross Private Fixed Investment, G = Government Expenditures and Investment, X = Net Exports , M = Net Imports
      For China the Investment component is 46% of the GDP, while for U.S. it is a paltry 12.8%, while consumption is 70%. Gross capital formation for China is 49% of the GDP, which for U.S. is 19%, which perhaps is a pointer that U.S. keeps on accumulating capital that exceeds its investments in U.S. by a whopping margin.
      The re-balancing that Mr. Roach is indicating is not only going to be a credible option, but actually one of the most desirable options that would help to re-balance the world’s two extremes, one that consumes its way into a growing un-sustainability and the other whose immense appetite for investment is perhaps on a sabbatical that could bring peril to the rest of the world.

    2. CommentedBernard Barisic

      How is it possible, based on the experts, that China unlike any other developed or emerging economy in recent history is immune a crisis that has befallen all the others.
      In a past life I ran the China NDF book for a British bank and know full well how China wants its cake and eat it too. They are deft manipulators of the currency, the economy and worst of all their own people. I think its this ultimate control that the experts admire but couch it in economic terms. Unless the Chinese DNA is different from the rest of the world they will have an economic day of reckoning just like the rest of world. It may just take a little longer because their choke hold is so firm.

    3. Portrait of Michael Heller

      CommentedMichael Heller

      It’s fast becoming a habit, but I must remind the author - Stephen Roach in this case - that China faces a major internal obstacle which (habitually) escapes the notice of western economists. The Chinese call it ‘communism’, they are very quaintly devoted to it, and as a regular reader of translations of China Communist Party statements to Chinese people I can tell you it looks remarkably similar to the cold war version. Western economists need to reeducate ever so slightly themselves (cultural revolution style) by finding 5 minutes to read political economy and tweak the brain back into cold war setting prior to writing anything on Chinese economy. Having said that, however, I am long time admirer of Stephen Roach and heartily endorse his proposal for USA flexible adaptation via reorientation to savings and investment over consumption. For that to work -- if the USA is to export to China -- Obama will need to give one of his dearly loved rousing speeches. Unusually, though, Obama will speak of the need for more competitive labour markets and wage rates.

    4. CommentedC Jared

      No longer inclined to lend it's capital? And the option for the Chinese is what? To balance it's current account...this can only benefit both the US and the world.

    5. CommentedC Jared

      Yes... they run a current account surplus. Which represents a metric of the needed change. And until the reserve position is reversed, this can be added to the metric. These two things are negatives, Mr Roach. Not positives.

    6. CommentedJoshua Ioji Konov

      The info and the expo are very comprehensive: China's approach in economics I called Market Development verses the Economic Growth of almost everyone else...