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China-Africa and an Economic Transformation$

Arkebe Oqubay and Justin Yifu Lin

Print publication date: 2019

Print ISBN-13: 9780198830504

Published to Oxford Scholarship Online: June 2019

DOI: 10.1093/oso/9780198830504.001.0001

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The Meanings and Global Externalities of China’s Economic Emergence

The Meanings and Global Externalities of China’s Economic Emergence

Chapter:
(p.35) Chapter 3 The Meanings and Global Externalities of China’s Economic Emergence
Source:
China-Africa and an Economic Transformation
Author(s):

Célestin Monga

Publisher:
Oxford University Press
DOI:10.1093/oso/9780198830504.003.0003

Abstract and Keywords

The Chinese economy has become a multifaceted global public good. Even as China carefully and gradually rebalances its growth model from export-led to domestic consumption, it will also help address issues of global imbalances. Still, during that internal adjustment process, China will absorb increasingly large quantities of exports from around the world—including from developing countries that can strategically position themselves to competitively supply goods and services in light manufacturing and low-skilled industries which China dominated at earlier stages of its economic take-off. China’s industrial upgrading strategies, which reflect changes in its endowment structure, have defied mainstream economic prescriptions. The country’s stubbornness in designing and implementing steadfastly policy frameworks that identify potentially competitive industries and facilitate their emergence (while accounting for social and political constraints and realities) could provide useful blueprints for other developing countries. This chapter highlights several global externalities of China’s economy, and examines the opportunities and challenges they present. It also discusses some of China’s major macroeconomic risks and possible negative externalities to the world economy.

Keywords:   Chinese economy, global public goods, renminbi, China debt, China growth model

3.1 Introduction

On 30 June 1984, Deng Xiaoping, who had been anointed as the de facto leader of the Communist Party of China, boldly articulated the reasons why his country would rely on a new ideological framework and adopt a development path quite different from previous practice. He explained the rationale for ‘building a socialism with specifically Chinese character.’ He said:

At the founding of the People’s Republic [in 1949], we inherited from old China a ruined economy with virtually no industry. There was a shortage of grain, inflation was acute, and the economy was in chaos. But we solved the problems of feeding and employing the population, stabilized commodity price and unified financial and economic work, and the economy rapidly recovered. On this foundation we started large-scale reconstruction. What did we rely on? We relied on Marxism and socialism. But by Marxism we mean Marxism that is integrated with Chinese conditions, and by socialism we mean a socialism that is tailored to Chinese conditions and has a specifically Chinese character.1

Deng’s confident and positive assessment of China’s economic performance, so early into the implementation of his reform programme, was dismissed by many analysts who had in mind the heavy human, political, economic, and social costs of the Cultural Revolution, which many researchers estimated had durably impoverished and weakened China during the twentieth century. With hindsight, it is now clear that Deng’s optimistic comments were based (p.36) on a long view of history (the ‘longue durée,’ as Fernand Braudel stated it), and reflected the strong belief that an audacious aggiornamento of socialist ideals with capitalist instruments in the new reality of an increasingly interconnected world was the appropriate balancing act to give China a chance to rejuvenate its economy while remaining true to its philosophical soul—and to its rejection of social divisions and deep inequality.

On 16 November 2009, United States president Barack Obama visited China for the first time in his life. He praised a ‘majestic country’ and claimed to see in Shanghai the growth that had caught the attention of the world. He said:

China has lifted hundreds of millions of people out of poverty—an accomplishment unparalleled in human history—while playing a larger role in global events…There is a Chinese proverb: ‘consider the past and you shall know the future’. Surely, we have known setbacks and challenges over the past 30 years. Our relationship has not been without disagreements and difficulty. But the notion that we must be adversaries is not predestined—not when we consider the past. Indeed, because of our cooperation, both the U.S. and China are more prosperous and more secure.2

(Obama, 2009)

Obama’s seemingly innocuous statement generated controversy in America where many felt offended by such words from the ‘leader of the free world’ challenging the permanent supremacy of the United States as the only ‘indispensable nation’. It asserted that China’s emergence as a major economic superpower was nothing to be surprised about: in each period of human history, there have been successful cities and nations in the development of capitalism, ‘world-economies’ (‘économie-monde’) as Braudel (1958) put it, and China today just happens to be one of these ordinary phenomena.

Yet China’s economic emergence in the late twentieth century has been anything but banal. In fact, the pace, depth, scope, and ramifications of China’s economic transformation since 1979 are indeed unique in economic history. With 9.6 per cent annual growth for nearly four decades, China lifted over 700 million people out of poverty in just one generation and become the second-largest economy in the world. Widely seen as a place of failed economic experiments for centuries and until only three decades ago, China is now projected to soon become the largest economy in the world and to dominate the global scene for the foreseeable future. In a world of frequent global economic and financial crises, constant social tensions and conflicts fuelled by poverty, inequities, large-scale unemployment, despair, and big (p.37) waves of illegal migrations, China’s economic transformation and stable performance have resonance and meanings well beyond its borders and neighbourhood: ‘As China’s domestic market continues to grow, so, too, does its economic power and ability to set global rules’ (Spence, 2017).

This chapter posits that the Chinese economy has become a multifaceted global public good. Section 3.2 highlights several global externalities of China’s economy, and examines the opportunities and challenges they present. We then discuss some of China’s major macroeconomic risks and possible negative externalities to the world economy before offering concluding remarks.

3.2 The Chinese Economy as a Global Public Good

Public goods have long been part of the analytical frameworks used by researchers for the economic analysis of government policy at the national level. With the acceleration of globalization, it has become increasingly clear that issues once viewed as national policy are actually issues of transnational importance and concern. For instance, it is widely recognized that carbon emissions and global warming not only affect the nation involved in their production, but also impact significantly on other nations. Likewise, with increased global mobility, communicable diseases are problems against which no single country can implement an effective national strategy to protect the health of its population.

Making the case that the Chinese economy has become something of a global public good requires some conceptual justification before evidence is provided to support this statement. Global public goods are often narrowly defined as ‘goods with benefits and/or costs that potentially extend to all countries, people, and generations. Global public goods are in a dual sense public: they are public as opposed to private; and they are global as opposed to national. Like publicness in general, globalness is in most instances a matter of policy choice’ (Kaul and Mendoza, 2003). In that sense, ‘few global public goods are global and public by nature. The ozone layer is one of these few naturally global and public goods. Most other global public goods are national public goods that have become interlinked in the wake of increasing openness of borders and as a result of increasing international regime formation and policy harmonization behind national borders’ (Kaul and Mendoza, 2003).

A broader definition of global public goods, used in this chapter, is the one provided by the International Task Force on Global Public Goods: ‘issues that are broadly conceived as important to the international community, that for the most part cannot or will not be adequately addressed by individual (p.38) countries acting alone and that are defined through a broad international consensus or a legitimate process of decision-making’ (2006: 13).3

Global public goods have shared benefits and costs across boundaries, with two characteristics: first, they produce benefits that are impossible to prevent everyone from enjoying, or costs which no one can avoid (non-rivalry). Second, consumption by any one individual or nation does not detract from that of another (non-excludability). Typical examples of such ‘pure’ public goods are air quality or control of epidemic diseases. If only one of these characteristics is satisfied, public goods are said to be impure, which is the way the Chinese economy is analyzed in this chapter. Thanks to its size and performance, China has been contributing about one-third of global growth, constantly expanding global demand, and therefore driving the world quest for prosperity, social inclusion, and social peace. It has become indeed an impure global public good.

China’s economic transition started in the late 1970s at a time when the world economy was undergoing profound transformations. The most important change was the unilateral decision by the United States to end the international monetary system set up after World War II (Bretton Woods system) and to end dollar convertibility to gold.4 That decision abruptly changed the rules of global finance and world trade, and laid the grounds for the reshaping of the global economy. The end of the old international system was accelerated with the subsequent oil price shocks (1973 and 1979), which foreshadowed not just bad news (an international debt crisis in the 1980s) but (p.39) also the (re)birth of a multipolar world, exemplified by the rise of Japan and other East Asian economies.

China initiated its process of structural change in an era marked by continuous disruptions which also brought new opportunities. Technological advances, and innovations in satellite communications and shipping, made it economical for manufacturing industries to shift from high-wage developed countries to Asia’s low-wage economies:

Advanced economies moved up the value chain with successful high-tech and service sectors, especially financial services. Emerging economies in Asia began to industrialise rapidly and demanded access to developed economy markets during the 1986 Uruguay round—an attractive proposition for western companies. Consumers in developed economies benefited from lower manufacturing prices. The US accrued huge trade deficits as the world invested its savings in US Treasury securities.

(Desai, 2018)

China’s economic development strategy took advantage of the new global conditions and focused on export-led growth based on the country’s comparative advantage. Like all socialist and many developing economies in previous decades, China had pursued the goal of building modern, capital-intensive industries through investment-led growth in the 1950s to the 1970s. While there had been some visible successes, productivity levels had remained very low and that strategy was inconsistent with China’s endowment structure of low capital and large supply of labour and land. In fact, given the country’s low-income and weak fiscal base at the time, the modernization strategy could only be implemented with soft budget constraints, financial repression, which created major economic distortions, pervasive rent-seeking practices, and inefficiencies. Serious macroeconomic instability could only be contained by excessive state interventions in the economy.

With GDP per capita standing at only US$154 in 1979, the authorities changed gear to successfully reposition China in the post-Bretton Woods global economy. They initially targeted the industries more in tune with the country’s comparative advantage and endowment structure at that time. In 1979 primary and processed primary goods accounted for more than 75 per cent of China’s exports, which spurred growth, brought much-needed foreign reserves and fiscal revenues, and created employment to absorb the large and still largely low-skilled labour force. However, close attention was paid to the economy’s evolving endowment structure and comparative advantage, and a carefully designed industrial upgrading strategy was adopted to stimulate the production of more sophisticated export goods, at a realistic pace. By 2009 the share of manufactured goods had increased to more than 95 per cent. ‘Moreover, China’s manufactured exports upgraded from simple toys, textiles, (p.40) and other cheap products in the 1980s and 1990s to high-value and technologically sophisticated machinery and information and communication technology products in the 2000s’ (Lin, 2011a speech). Table 3.1 provides some indication of China’s changing endowment structure: in 1990, the footwear industry was the most important export, representing 15.5 per cent of the total. Sophisticated, capital-intensive industries such as electrical machinery, apparatus, and appliances, and machinery other than electric accounted for 10.8 per cent of total exports. By 2016, they represented 7.5 per cent and 42 per cent of exports, respectively.

Table 3.1. China’s merchandise exports

Top ten product groups exported in 2017 and trends in exports over 1990–2016

Country

1990

2000

2010

2016

billions of US$

Electrical machinery, apparatus, and appliances

3.96

41.50

361.63

549.06

Machinery, other than electric

2.72

25.89

309.29

330.62

Footwear

9.61

36.00

129.24

157.32

Miscellaneous manufactured articles, nes

3.92

27.49

113.63

151.98

Textile yarn, fabrics, made up articles, etc.

7.20

16.08

76.33

103.95

Road motor vehicles

4.07

8.89

87.46

91.13

Manufactures of metal, nes

1.43

8.00

51.09

75.51

Scientific and control instruments, photographic goods, clocks

1.30

8.26

52.87

68.27

Furniture

0.32

4.59

39.26

56.11

Iron and steel

1.28

4.92

38.64

55.63

Total Exports

62.09

249.20

1,577.76

2,097.64

Percentage of total exports (%)

Electrical machinery, apparatus, and appliances

6.4

16.7

22.9

26.2

Machinery, other than electric

4.4

10.4

19.6

15.8

Footwear

15.5

14.4

8.2

7.5

Miscellaneous manufactured articles, nes

6.3

11.0

7.2

7.2

Textile yarn, fabrics, made up articles, etc.

11.6

6.5

4.8

5.0

Road motor vehicles

6.5

3.6

5.5

4.3

Manufactures of metal, nes

2.3

3.2

3.2

3.6

Scientific and control instruments, photographic goods, clocks

2.1

3.3

3.4

3.3

Furniture

0.5

1.8

2.5

2.7

Iron and steel

2.1

2.0

2.4

2.7

Total Exports

100.0

100.0

100.0

100.0

Source: World Bank World Development Indicators, July 2018

The export-led strategy designed and implemented to reflect the gradually evolving endowment structure paid off handsomely, not just for China but also for the world economy. With 9.6 per cent annual growth for nearly four decades, China has lifted over 700 million people out of poverty in just one generation, moving from US$154 GDP per capita in 1979 to about US$9,000 in 2017 in a country of 1.3 billion people—and becoming the second-largest economy in the world.

(p.41) China’s contribution to global GDP growth rose from just 2 per cent in 1979 to about 27 per cent in 2017 (World Bank data—see Figures 3.1 and 3.2).5

The Meanings and Global Externalities of China’s Economic Emergence

Figure 3.1. Contribution to global growth, 1980–2017, top five countries (US$, current prices)

Source: World Development Indicators, World Bank (2018)

The Meanings and Global Externalities of China’s Economic Emergence

Figure 3.2. Contribution to global growth, 1960–2017, top five countries (US$, current prices)

Source: World Development Indicators, World Bank (2018)

As of 2018, China’s economy was larger than the entire Eurozone, two-and-a-half times larger than Japan’s, and five times larger than India’s. Perhaps even more impressive is the fact that in just one year, say 2017, China’s economy expanded by US$1.5 trillion in nominal terms, which is a truly remarkable performance. As observed by O’Neill, ‘it essentially created a new economy the size of South Korea, twice the size of Switzerland, and three times the size of Sweden’ (O’Neill, 2018).

By lifting itself so rapidly out of low-income status, China has become a major source of global demand and an important market for its trading partners around the world. While China has expanded its exports in recent decades, it has also imported goods and services from all regions of the world. In 1970, its imports amounted to US$2.3 billion (an amount lower than (p.42) in 1960). In 2017, China’s imports amounted to US$1.8 trillion, or 10.2 per cent of the world’s imports (Table 3.2).

Table 3.2. China’s imports, 1960–2017

Top ten importers in 2017 and trends in imports over 1960–2017

Country

1960

1970

1980

1990

2000

2005

2010

2015

2016

2017*

billions of US$

United States

16.4

42.4

257.0

517.0

1,259.3

1,732.7

1,969.2

2,315.3

2,250.2

N.A

China

2.6

2.3

19.9

53.3

225.1

660.0

1,396.2

1,679.6

1,587.9

1,841.9

Germany

10.2

29.9

188.0

355.7

497.2

777.1

1,054.8

1,051.4

1,055.7

1,167.0

United Kingdom

13.0

21.9

115.5

223.0

348.1

519.3

591.1

626.4

636.4

644.1

Japan

4.5

18.9

141.3

235.4

379.5

515.9

694.1

648.0

607.6

671.9

France

6.3

19.1

134.9

234.4

338.9

504.1

611.1

573.4

572.2

624.7

Hong Kong SAR, China

1.0

2.9

23.0

84.7

214.0

300.2

441.4

559.4

547.3

589.9

Netherlands

5.4

15.7

78.0

126.1

218.3

363.8

516.4

512.4

505.1

574.3

Canada

6.1

14.3

62.5

123.2

244.8

322.4

402.7

429.0

413.0

441.7

Italy

4.7

15.0

100.7

182.0

238.8

384.8

487.0

411.1

406.9

452.6

World

130.6

316.9

2,018.9

3,566.9

6,691.5

10,835.1

15,490.7

16,767.5

16,283.1

18,133.2

Percentage share of World (%)

United States

12.5

13.4

12.7

14.5

18.8

16.0

12.7

13.8

13.8

N.A

China

2.0

0.7

1.0

1.5

3.4

6.1

9.0

10.0

9.8

10.2

Germany

7.8

9.5

9.3

10.0

7.4

7.2

6.8

6.3

6.5

6.4

United Kingdom

10.0

6.9

5.7

6.3

5.2

4.8

3.8

3.7

3.9

3.6

Japan

3.4

6.0

7.0

6.6

5.7

4.8

4.5

3.9

3.7

3.7

France

4.8

6.0

6.7

6.6

5.1

4.7

3.9

3.4

3.5

3.4

Hong Kong SAR, China

0.8

0.9

1.1

2.4

3.2

2.8

2.8

3.3

3.4

3.3

Netherlands

4.1

5.0

3.9

3.5

3.3

3.4

3.3

3.1

3.1

3.2

Canada

4.6

4.5

3.1

3.5

3.7

3.0

2.6

2.6

2.5

2.4

Italy

3.6

4.7

5.0

5.1

3.6

3.6

3.1

2.5

2.5

2.5

World

100.0

100.0

100.0

100.0

100.0

100.0

100.0

100.0

100.0

100.0

Source: World Bank World Development Indicators, July 2018

Second, China has become, in some ways, the financier of choice if not of last resort for several major high-income countries. China holds the world’s largest foreign-exchange reserves and regularly assesses its strategy for investing them. For instance, China is the single biggest foreign holder of US government debt. China has also been purchasing large amounts of bonds from other Western countries and therefore financing their fiscal deficits at low costs. Most of China’s holdings are in long-term securities with maturities over one year. The US economy and the world economy benefit enormously from such massive and relatively cheap financing from China.

There are legitimate concerns in policy circles that China could try to use its position as the biggest foreign creditor of the United States as leverage in a stand-off on trade issues or other political disagreements. A decision to slow or halt purchases of US Treasuries could indeed disrupt bond markets around the world, with repercussions on interest rates and economic cycles everywhere.

So far, such fears have not materialized, and for good reasons. However, China’s Treasury purchases are driven by its trade deficit with the United States, using dollars acquired from sales of goods to the United States to buy (p.43) (p.44) the bonds. The decision to sell or even stop purchases would negatively affect the value of China’s large portfolio of US government debt. Therefore, it would not serve China’s interest to sell its US bond holdings in mass quantities as a threat, while maintaining such a large position that would be hurt by the move. In fact, beyond the issue of bond holdings, the US and the Chinese economies have become so mutually dependent that unilateral policies by one country aiming at sanctioning the other would be costly even before retaliation (Monga, 2012).

Third, even as China carefully and gradually rebalances its growth model from export-led to domestic consumption (Figure 3.3), it will also help address issues of global imbalances. Still, during that internal adjustment process, China will absorb increasingly large quantities of exports from around the world6—including from developing countries that can strategically position themselves to competitively supply goods and services in light manufacturing and low-skilled industries which China dominated at earlier stages of its economic take-off.

The Meanings and Global Externalities of China’s Economic Emergence

Figure 3.3. China: Structure of demand, 1970–2017 (percentage of nominal GDP)

Source: Statistics Department, AfDB, based on United Nations data

In addition to becoming a large and growing market for developing-country exports, China provides new financial, commercial, and managerial resources, and new opportunities to speed up the industrialization of the latecomers. (p.45) China is already funding infrastructure investment around the world,7 and successfully relocating some of its labour-intensive industries to lower-wage countries (Lin, 2012; Oqubay, 2015). The upcoming economic ‘graduation’ of large emerging countries such as China, Brazil, Indonesia, or India from low-wage, labour-intensive industries will open up enormous growth and job-creation opportunities for low-income countries—provided that they can organize themselves to attract those jobs with more competitive wages and lower transaction costs.

Beyond its new status as a major investor and trade partner (with no political or even policy conditionality to its loans) to high-, middle-, and low-income countries around the world, China’s financing, under the right circumstances, comes with valuable ideas, knowledge, and experience, which can foster and sustain learning—especially in African countries. Learning and knowledge transfer often takes place in special economic zones and industrial parks, which generate Marshallian externalities (Monga, 2013a, 2013b; Zeng, 2011; Zhang, 2017).

These attributes of the Chinese economy as an impure global public good also imply possible negative externalities for the world economy, which are discussed in Section 3.3.

3.3 Potential Negative Externalities and Mitigation Factors

The flip side of being a global public good which has brought enormous economic development opportunities to the world is that the Chinese economy also carries potential risks to other nations. It is therefore understandable that researchers and policymakers around the world have been monitoring and even anticipating some of the negative externalities which may be caused by unpleasant economic developments in China. Perhaps unsurprisingly, much of the intellectual and policy discussions about the global ‘economic threats’ posed by China have been fuelled by fears and pessimism, consistent with the primal and persistent scepticism about the country’s trajectory as an enormous and unprecedented experiment in economic and social transformation. This section briefly assesses some of the key issues which deserve serious consideration.

The first scenario which would be of global concern is a sustained slowdown in investment in China, with important implications for global demand and the world economy. During China’s initial phase of economic development (p.46) and for decades (say from the 1980s through much of the 2000s), export-led growth was the country’s winning economic formula. The 2008 financial crisis forced all major economic players to change their growth models: the so-called Great Recession led to a substantial decline in China’s net exports, which the authorities analyzed as permanent. China’s response to the global financial and economic downturn was a very robust and sustained investment programme amounting to about 12.5 per cent of GDP: ‘probably the biggest ever peacetime stimulus’, as Wolf (2018) put it. The rapid investment surge, carefully targeted to productive infrastructure and competitive industries and sectors, was a major growth driver for China and for the world economy post 2008.

Maintaining China’s investment rate at such high levels (above 50 per cent of GDP on average in the period 2008–18) is unsustainable, and a change in the country’s growth model (‘rebalancing’) will be needed to ensure a soft landing, and stability in global output. Fears of a hard-landing scenario due to a sharp reduction in investment have intensified after some researchers warned that the quality of investment in China has been declining (Chen and Kang, 2018).

However, the declining trend in China’s incremental capital-output ratio (ICOR), often interpreted by some analysts as evidence of the ineffectiveness of investment in the country, is misleading. It is based on the unrealistic assumption that the relationship between investment and growth is linear over the short to the medium term.8 Without the theoretical assumption of linearity, the ICOR is not a constant and therefore, the relationship between investment and growth is also not a linear one.

In addition, variations in the ICOR do not necessarily represent changes in the quality of investment. Easterly offers the example of a Solow-type neoclassical model in which an exogenous increase in investment raises growth temporarily during the transition from one steady state to another. In such a model there is no permanent causal relationship between investment and growth. Under such circumstances, the ICOR reflects much more than quality of investment: ‘The measured ICOR during the transition is higher, the higher is the initial level of the investment rate and the lower is the change in the investment rate. Also, the ICOR is higher in steady state the lower is the population growth rate. None of these factors reflect “quality of investment”’ (Easterly, 2003: 31–2). In fact, all the other important inputs (p.47) identified by endogenous growth theories (physical capital, new technology, human capital, intermediate new goods, managerial know-how, social capital, etc.) would substantially change the ICOR. As a result, the relationship between investment and growth would be unstable and non-linear, and ICOR would not measure ‘investment quality’.

Finally, China’s lower growth rate after its economy had steadily risen to become the second-largest in the world and has approached the global technological frontier should not be used mechanically to compute an ICOR and interpret it as evidence of inefficiency in credit and investment. An elephant growing in size at 6.5 per cent a year is still more impressive than a cat growing at 10 per cent.

While the efficiency of investment in China cannot be measured in a rising ICOR, one should still consider the global economic implications of a substantial and permanent slowdown in investment, not just for China but for the world economy. Conventional wisdom among mainstream researchers has been that rebalancing of the Chinese economy should take place so that growth is mainly driven by domestic consumption and not by investment (Chen and Kang, 2018). Yet it is also acknowledged that too rapid an adjustment could generate an outright recession in China and in many other countries.

If there is a clear policy lesson from the history of the forty-year period 1979–2018, it is the quasi-certitude that the Chinese authorities will not let such a scenario occur. The deceleration in Chinese exports to high-income countries and the need to keep the trade surplus at manageable levels have led the authorities to pursue their prudent strategy for rebalancing growth. Thanks to a tightly coordinated set of macroeconomic policies (fiscal and monetary), rebalancing has already been occurring but at a carefully choreographed pace—see Figure 3.4. As explained by Lin (2011b): ‘Much is said about stimulating consumption, but the process should be balanced between consumption and continuing strong growth in investment. The latter is critical for industrial upgrading and sustainable increases of per capita income, as well as developing green economy sectors and investing in environmental protection.’

The Meanings and Global Externalities of China’s Economic Emergence

Figure 3.4. Demand contributions to GDP growth (percentage points)

Source: Statistics Department, AfDB, based on United Nations data

The second economic issue facing China and of great interest to other nations is the size of its debt, the pace of accumulation of financial liabilities, and the risks that it entails. High debt is a global concern,9 and China is better placed (p.48) than most countries to handle hers. Still, it requires close monitoring. Prior to the 2008 global financial crisis, China’s debt was already higher than the average for emerging economies. But it was manageable given the country’s rapid growth rates for several decades.

The current much higher trend in indebtedness truly began with the 2008 Great Recession. Strong investment and output performance in China in response to the crisis era was supported by rapid credit growth, which also led to high debt, mainly to non-financial corporations (Figure 3.5) and to off-balance-sheet local government financing vehicles—another issue of global importance.

The Meanings and Global Externalities of China’s Economic Emergence

Figure 3.5. China: Total debt to GDP, 1995–2017

Source: IIF

This has led some researchers to raise concerns about financial stability which could be costly to the world economy, and to even warn that a financial crisis could be looming (Wolf, 2018). Such concerns are based on historical experience, which shows that very rapid credit growth is typically not sustainable and often ends with financial crises (Gourinchas and Obstfeld, 2012) and/or slowdowns in growth (Eggerston and Krugman, 2012; Jones et al., 2018).

Credit cycles can indeed stimulate excessive risk-taking and leverage, which tend to artificially accelerate asset appreciation during the growth period but also to worsen asset depreciations in downturns. According to Chan and Kang:

International experience suggests that China’s current credit trajectory is dangerous with increasing risks of a disruptive adjustment and/or a marked growth slowdown. To find analogues for China, we identified 43 cases of credit booms in which the credit-to-GDP ratio increased by more than 30 percentage points over (p.49) a 5-year period. Among these, only five ended without a major growth slowdown or a financial crisis in the immediate aftermath. However, once considering country-specific factors, these five countries provide little comfort. In addition, all credit booms that began when the ratios were above 100 per cent—as in China’s case—ended badly.

(Chen and Kang, 2018: 8)10

However, China’s economic trajectory and performance in the forty-year period 1979–2018 shows that historical precedents do not apply: the empirical regularities of booms and busts observed elsewhere and appearing in cross-country regression analyses on the likelihood of financial crises and sharp growth slowdowns. Debt and currency crises typically occur in emerging economies with a dual problem: excessive government spending to fund unproductive investment or consumption and other generous, untargeted transfer policies, with heavy reliance on foreign lenders to support such profligate habits; and large borrowing in foreign currencies—when the US (p.50) Federal Reserve raises interest rates and pushes up the value of the dollar, dollar debts are difficult to pay back and foreign investors start to flee, causing currency crises. Some policymakers make these two problems (excessive public spending that fuels inflation and large dollar-denominated external debt) worse by setting domestic interest rates at artificially low levels (financial repression).

China is clearly not in a ‘typical’ emerging-country situation. Unlike others, it has strong external accounts: it does not run a chronic trade deficit, does not rely on imports for most of its raw materials, and does not have to borrow large amounts in dollars to finance its purchases abroad. China has a strong external position (large current account surpluses and low external debt), a relatively closed capital account, a very effective central bank which can provide liquidity and implement capital controls effectively, high domestic savings and strong corporate balance sheets, and ample fiscal space. None of the countries which suffered banking and financial crises had such a combination of policy buffers.11

While these country-specific factors make China less vulnerable to traditional emerging-economy debt crises, its economy may be suffering from a strong dollar for other reasons: the post-2008 stimulus led to large amounts of domestic loans—including to households and firms interested in higher returns. Besides striving to ensure that interest rate differentials between China and the United States are minimized to limit incentives for capital flight, monetary authorities in Beijing will be maintaining tight currency controls for the foreseeable future. However, in the medium and long term, China’s main economic policy to maintain macroeconomic stability, sustain growth beyond upper-middle-income status, and honour its role as the main engine of global growth, will be to pursue the carefully targeted industrial upgrading which has allowed the country to remain true to its evolving comparative advantage and endowment structure.

A third major source of uncertainty for the world economy, which could arise from China’s status as a global public good, has to do with the stability of the renminbi. A recurrent fear among policymakers and researchers around the world is whether the authorities in Beijing may decide to ‘weaponize’ the national currency by actively orchestrating depreciations as a way to maintain export competitiveness in trade wars with other major economies (mainly the United States and the European Union) or with neighbouring countries. Besides weakening China’s publicly stated commitment to globalization and the credibility of its leaders on the global economic scene,12 such an obvious (p.51) change in exchange rate strategy would trigger beggar-thy-neighbour tactics and contagion across the Asia region where China is currently asserting its economic and political leadership. The end result of these ‘currency wars’ would be detrimental to everyone.

Even without active attempts by the Chinese central bank to systematically influence the renminbi exchange rate vis-à-vis major currencies, market forces can provoke similar movements, with considerable potential consequences for the world economy. A sustained appreciation of the renminbi not accompanied by productivity increases in China would reflect a loss of competitiveness for the country contributing most of global growth. This would result in lower than expected global demand, growth below potential in China, and fewer opportunities to absorb imports—including from developing countries relying on China for a substantial share of their external demand and export revenues.

On the other hand, sustained depreciation of the renminbi due to market forces also poses serious threats domestically and globally. It would signal vulnerabilities within the Chinese economy—and weaken the renminbi’s status/credibility as an anchor of stability in Asia and beyond. Each of the three main policy options to address such a problem would carry costs and risks for China and the world economy. First, central bank interventions to buy dollars and sell renminbi require using foreign currency reserves, whose high volume is a signature asset for the Chinese economy. Using reserves to boost the value of the renminbi carries psychological costs (as it is seen as reflecting excessive fears of capital flight) and therefore cannot be an easy decision. Moreover, the resources used by the central bank to protect the renminbi would be in diminution of China’s ‘war chest’ and global financial influence—lessening its ability to finance fiscal deficits and help macroeconomic stabilization elsewhere through the buying of bonds and other treasury bills. A financially weaker Chinese central bank would not be good news for the world economy.

The second tool for shoring up the renminbi in case of depreciation would be to raise domestic interest rates and make the currency more attractive relative to the dollar. While this would strengthen the renminbi (especially when the convergence in US and Chinese bond yields has contributed to capital flows), it would also slow down domestic credit, investment, and growth. Yet the world economy needs a continuously growing Chinese economy.

The third policy option to withstand depreciation would be the use of capital controls—including stricter administrative limits on fund outflows. It is generally an effective tool where it can be enforced, especially over short periods of time, before investors figure out ways of circumventing it. It would run countercurrent to China’s stated goal of making the renminbi an international currency. Meanwhile, the dollar, its main competitor, is sought after by economic agents around the world: despite a declining share of world GDP (p.52) from a peak of 32 per cent in 2001 to 23 per cent in 2018, the United States still enjoys the enormous privilege of having its currency used for more than 60 per cent of the foreign reserves held by central banks around the world. Therefore, a major drawback of using stringent capital controls for too long would be a loss of credibility in the ability of policymakers to move markets through signalling, and unnecessary delays in the implementation of the strategy for making the renminbi a global currency. Ultimately, keeping the renminbi generally stable is in China’s interest and in the interest of the global economy.

Political-economy risks from within China represent a fourth topic of concern to the global economy. Perhaps the most recurrent warning about China is the risk of social disruptions and a disorderly political transition there, with important potential repercussions for the world economy. China’s growth model based on a consistent strategy that follows comparative advantage and reflects a constantly changing endowment structure has already generated inequality, with the Gini coefficient rising from less than 30 per cent in the 1970s to above 40 per cent. With industrial upgrading, the economy is becoming less labour dependent and more capital and technology dependent. This trend fuels income disparities, as poor people draw their incomes mainly from labour, whereas the rich rely more on capital and technology.

Inequality is also worsened by the movement of some workers to new sectors where they first have higher productivity and higher incomes. According to Spence (2007):

The result is a pronounced tendency for income inequality to rise, and for an extended period. While this is a natural consequence of the process, it presents a challenge. Excessive inequality of income and wealth is not only a normative problem in most societies; it is also socially and politically disruptive and can threaten the support for the policies and public sector investments that in part sustain the growth process. As a result it needs to be mitigated through the redistribution of income or other important services such as health care, education and pensions, and by ensuring that access to infrastructure (clean water, transportation, power) is reasonably equitable.

With the implementation of robust infrastructure programmes across the country, the Chinese government has been largely successful in mitigating the important social risks due to persistently high levels of inequality.

Many experts also doubt that a country with such a large population, growing fast from low to upper-middle income, and on its way to high income, would be able to maintain intact the authoritarian political system under which it has been operating for so long. Economic prosperity brings additional human needs beyond income and material welfare, and also new conceptions of individual freedom and new social demands, which would be (p.53) impossible for the Chinese Communist Party to accommodate within its current structure and mode of functioning. Speculation and dark predictions from the Cassandras typically refer to the 1989 Tiananmen revolt as an indication that the quest for Western-style, multi-party politics and ‘democratization’ is an inescapable trajectory for China, especially in an era of enhanced globalization and global citizenship fostered by the development across boundaries of social media and other technological innovation.

The socio-political threat from within—which could be triggered by a large number of low-skilled workers left unemployed by industrial restructuring, the burst of a real-estate bubble leading to a major financial crisis, uncontrolled social unrest, and new political demands that exceed the political supply from existing institutions—has been the subject of debate and even tensions among Chinese political leaders for decades. They have always understood the critical importance of maintaining social peace, even when this meant implementing economic policies that were viewed from afar as second best. The dual economic development strategy adopted after the transition was a major commitment to mitigate the risks of costly social disruptions.

On the one hand, the authorities focused on improving productivity by providing market incentives in the gradual liberalization of agriculture, and by allowing the workers in collective farms and state-owned firms to be residual claimants and to set the prices for selling at the market after delivering the quota obligations to the state at fixed prices (Lin, 1992). Because of the urgent need to create employment—including for low-skilled workers—policymakers in China also embarked upon a controlled capitalist path by opening up some of the previously repressed labour-intensive industries in which it had comparative advantage: entry barriers were lifted, joint ventures encouraged, and foreign direct investment welcomed, if not actively sought.

On the other hand, China maintained strong financial support and protectionist measures to shield from competition many economically non-viable firms operating in priority sectors with large numbers of workers. The economic and political pay-offs were enormous: China went through its transition from communism to a market economy without suffering the heavy social costs of enterprise restructuring and industrial reconfigurations. In addition, the development of labour-intensive industries in newly liberalized sectors absorbed labour and led to sustained growth, which eventually allowed for smooth reforms in the old, low-productivity sectors (Lin, 2009, 2011b).

It seems logical that China’s continuing economic progress in income per capita and into the club of advanced economies will eventually translate into new political demands for its citizens. But the nature, scope, and manifestation of these demands are likely to remain country specific, and beyond scholarly speculation. The quest for freedom and for more legitimate modes of (p.54) governance are universal values but China’s socio-political itinerary need not to be similar to what was observed in Western countries. The Chinese authorities have always given priority to political stability and social peace, which they consider prerequisites to economic performance.13 They have also stressed meritocracy and competition within the Communist Party as a more ‘objective’ way of organizing economic and political governance.14 In any case, international measures of good governance remain largely based on subjective perception indicators. Figure 3.6 shows that they are correlated with income per capita, with China below the logarithmic trend line (large dark dot).

The Meanings and Global Externalities of China’s Economic Emergence

Figure 3.6. Income and governance, 2016

Source: World Development Indicators, World Bank

The fact that China’s governance indicators remain quite low despite its rapid and sustained growth rate and it is ranked below countries with poor growth records mainly reflects conceptual issues and methodological biases in the empirical tools used (Lin and Monga, 2017). It may only be a matter of time before China’s ranking improves on these perception indicators. (p.55)

3.4 Conclusion

For several decades, China has been an enormously positive contributor to the world economy and to world stability and peace—an impure global public good. Its industrial upgrading strategies, which reflect changes in its endowment structure, have defied mainstream economic prescriptions. Its stubbornness in designing and implementing steadfastly policy frameworks that identify potentially competitive industries and facilitate their emergence (while accounting for social and political constraints and realities) could provide useful blueprints for all developing countries.

Because of the size of its economy, China has become the anchor of the international financial system, a magnet for global trade and investment, while positioning itself as an intellectual and policy model for other developing countries where leaders are convinced that they can replicate its success. China’s continuous dominance will extend into the foreseeable future. Still, the manageability of its domestic issues (pace of the rebalancing of its growth model, domestic debt, inequality, and potential political-economy issues) are of great importance for the many economies whose imports and financing flows depend on it. It is therefore not surprising that fears arise regularly about China’s ability to maintain its spectacular performance in an era of increased volatility of national economic policies while also entering a level of development that takes its industries, firms, institutions, and capabilities much closer to the challenges of the global technological frontier. Even its own political leaders have expressed concerns about the enormity of the country’s economic challenges.15 This chapter has argued that the Chinese economy deserves careful and constant analysis and monitoring.

 

References

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Notes:

(1) Remarks at the talk with the Japanese delegation to the second session of the Council of Sino-Japanese Non-Governmental Persons, in Deng (1994), pp. 72–3.

(2) In 1979, trade of goods and services between the United States and China stood at about US$5 billion. In 2017, it had risen to US$712 billion (source: US Bureau of Economic Analysis https://www.bea.gov/data/intl-trade-investment/international-trade-goods-and-services). In many ways, the two leading economies in the world have become so mutually dependent that neither one would truly benefit from a sustained trade war. See Monga (2012) for a theoretical framework of economic interdependence between the economies of the United States and China.

(3) The International Task Force also provides definitions of various categories of public goods: A local public good benefits [or costs] all the members of a local community, possibly to include the citizens of more than one country. A national public good benefits [or costs] all the citizens of a state. A domestic public good benefits [or costs] all the members of a community situated within a single state. National public goods are domestic public goods, but domestic public goods need not be national public goods. A regional public good benefits [or costs] countries belonging to a geographic territory. A global public good benefits [or costs] all countries and, therefore, all persons.

An international public good benefits [or costs] more than one country. Global and regional public goods are both international public goods. However, some international public goods may be neither regional nor global. The public good of collective defence under NATO, for example, applies to North America and Europe. See Hartley and Sandler (1999) and Marè (1988).

(4) At the Bretton Woods Conference, forty-four countries agreed to keep their currencies fixed (but adjustable in exceptional situations) to the dollar, and the dollar fixed to gold. The United States committed to keeping the dollar price of gold fixed and had to adjust the supply of dollars to maintain confidence in future gold convertibility. The system became operational in 1958 and worked reasonably well, as the United States held about three-quarters of the world’s official gold reserves and the system seemed secure. Japan and Europe were still rebuilding their post-war economies and demand for US goods and services—and dollars—was high. But in the 1960s, when European and Japanese exports became more competitive and the US share of world output decreased, it quickly appeared that there was lower demand for dollars, which made gold more desirable. Because the gold supply had increased only marginally, there were more foreign-held dollars than the United States had gold. The United States became vulnerable to a run on gold and there was a loss of confidence in the US government’s ability to meet its obligations, thereby threatening both the dollar’s position as reserve currency and the overall Bretton Woods system. Hence the decision by the Nixon administration to abandon the dollar–gold link.

(5) The World Bank bases its calculations on GDP at constant 2010 US$. Real GDP data for all countries are rebased on a common base year, 2010, and calculated at constant 2010 US$. Aggregate growth for the world or a region is calculated by summing the individual country GDPs at constant 2010 US$ and computing the percentage change. Data is available in the WDI for a longer period, 1960–2017. Other institutions such as the African Development Bank and the IMF use individual country growth rates weighted by GDP based on purchasing-power-parity (PPP) valuation of country GDP, which yields an even bigger contribution of the Chinese economy to world growth. Data is available in the IMF WEO database over the period 1980–2018.

(6) On 30 March 2018, Chinese foreign minister Wang Yi was quoted by Reuters as stating that ‘China will import $8 trillion of goods and attract $600 billion of foreign investment in the next five years’.

(7) It should be noted that Hurtley et al. (2018) argue that China’s Belt and Road Initiative—which plans to invest as much as US$8 trillion in infrastructure projects across Europe, Africa, and Asia—raises serious concerns about sovereign debt sustainability in eight countries it funds.

(8) Such an assumption is derived from the Leontief production function or fixed-proportions production function, which implies the factors of production will be used in fixed (technologically pre-determined) proportions, as there is no substitutability between factors. Solow (1957) and other researchers have shown that it is an unrealistic assumption. For instance, Easterly (2003) notes that: ‘In labor-abundant Ethiopia, roads are built with labor crews breaking up rocks with picks. In labor-scarce New York, roads are built with many fewer laborers driving heavy equipment.’

(9) At US$164 trillion in 2016 (225 per cent of the world’s GDP), global total debt (public and private) stood at historic highs among advanced and emerging market economies. The world was 12 per cent deeper in debt than the previous peak in 2009 at the height of the global financial crisis, with China as a driving force. As of end 2016, governments around the world have accumulated US$63 trillion in total public debt, with the United States holding 31.8 per cent of it, followed by Japan (18.5 per cent share) while China, Italy, and France holding shares of 7.9 per cent, 3.9 per cent, and 3.8 per cent. These five countries together hold a total of US$ 41.6 per cent of world debt, equivalent to 66 per cent of total world debt. Source: IMF (2008) Fiscal Monitor.

(10) To try to assess the sustainability and potential risks from China’s credit boom, Chen and Kang (2018) use a standard time-series model of private credit determinants. Using data from quarterly observations during nearly a decade, they find that loose monetary policy has been a key driver of rapid credit growth, but also that industrial structure matters a lot: more credit has flown into the provinces relying on fixed asset investment—especially infrastructure investment. For example, average bank loan growth for five provinces with heavy exposure to mining sectors (Heilungjiang, Jilin, Liaoning, Shanxi, and Inner Mongolia) was higher than national growth rate by 3 percentage points in 2015 despite slower deposit growth and lower GDP growth.

(11) I refer here to the US savings and loan crisis in the 1980s and to Japan’s 1997 banking crisis.

(12) At the 2017 World Economic Forum in Davos (Switzerland), President Xi Jinping declared that China would not engage in currency wars.

(13) When Communist Party leader Zhao Ziyang opposed the use of force to stop demonstrations in Tiananmen Square in 1989, Deng Xiaoping sacked him and appointed Jiang Zemin to succeed him (Vogel, 2013).

(14) In 2016 China’s Communist Party (CPC) issued a widely distributed cartoon explaining how leaders are selected at all levels in the country. The preface reads that the CPC ‘has always attached importance to the selection and appointment of leading officials, as it bears on not only the Party’s capacity to govern, but also the quality of its governing, its successes, and its failures. For this reason, the CPC is constantly striving to improve the system and procedures for the selection and appointment of Party and government leading officials, making it more standardized, scientific, and democratic.’ See http://www.idcpc.org.cn/english/picgroup/201605/t20160503_82487.html.

(15) In 2007, China’s prime minister Wen Jiabao declared that his country’s growth was ‘unstable, unbalanced, uncoordinated, and unsustainable’ (quoted by Wolf, 2018). Despite such a sombre assessment, China went on to average about 8 per cent GDP growth in the following decade.