Get ready for the Next China

Jul 05, 2013

It's time for the US and China, the world's two largest economies, to get re-acquainted with each other.

By Stephen S. Roach

THE Next China is now at hand. Yet the United States remains fixated on the Old China, unprepared for major transformation in the world's second largest economy.

The US-China Strategic and Economic Dialogue, slated for July 8 to 12 in Washington, provides a major opportunity for both nations to recast what could well be the most vital economic relationship of the 21st century.

China is most assuredly on the move. The debate over a strategic shift to a more balanced consumer-led growth model is over. The focus is on implementation. The 12th Five-Year Plan laid out the strategy - three pro-consumption building blocks of services-led job growth, urbanisation-driven income leverage and a more robust social safety net. But it was tough to get the ball rolling, especially in light of the inertia of China's deeply entrenched power blocs at the local government and state-owned enterprise levels.

China's new leadership under President Xi Jinping and Premier Li Keqiang has broken the gridlock. With a series of stunning moves in the early months of their administration, China's fiscal and monetary authorities have been given new marching orders.

The growth slowdown of early 2013 has not been countered by a typical Chinese proactive fiscal stimulus. Instead, the new leadership seems content with 7.5 to 8 per cent growth in gross domestic product (GDP). Similarly, the central bank did not rush in to stem a liquidity crunch in June. Instead, it used the occasion to caution banks, especially "shadow banks", against returning to an undisciplined and excessive expansion of credit.

New leaders, new approach

THE message from this new approach to Chinese macroeconomic stabilisation policy is clear: Gone are the days of open-ended hyper growth. Significantly, this message has been reinforced by an important political overlay.

Mr Xi's rather cryptic emphasis on a "mass line" education campaign aimed at addressing problems arising from the "four winds" of formalism, bureaucracy, hedonism and extravagance underscores a new sense of political discipline directed at the Chinese Communist Party (CCP).

The CCP is being urged to realign itself with the core interests of citizens and their need for fair and stable economic underpinnings.

This new mindset works only if China changes its growth model.

A services-led growth dynamic, one of the pillars for a consumer-led Chinese economy, is consistent with a marked downshift in trend GDP growth. That's because services generate about 30 per cent more jobs per unit of Chinese output than do manufacturing and construction - allowing China to hit its all-important labour absorption and social stability goals with economic growth in the 7 to 8 per cent range rather than 10 per cent as before.

Similarly, a more disciplined and market-based allocation of credit tempers the excesses of uneconomic investments, necessary if China is to begin absorbing its surplus savings to spur consumer demand.

What does it mean for US?

WITH China's new leadership embracing a very different approach to policy and politics, it has little choice other than to move ahead aggressively in implementing its consumer-led rebalancing. The US needs to take that possibility as a given as it frames its approach to the upcoming dialogue with China.

This raises four key issues:

First, China's consumer-led growth presents the US with an important opportunity. With the American consumer on ice for more than five years - underscored by average annualised growth of just 0.9 per cent in inflation-adjusted consumption expenditures since the first quarter of 2008 - the US is in desperate need of a new source of economic growth.

China is America's third largest and most rapidly growing export market. Washington negotiators should push hard on market access, ensuring that US companies and their workers have the opportunity to capitalise on China's transformation.

Second, and related to the first point, is a potential bonanza in Chinese services. At 43 per cent of its GDP, China has the smallest services sector of any major economy in the world. Under reasonable assumptions, the scale of Chinese services could increase by around US$12 trillion by 2025. Increasingly tradable in a connected world, the coming explosion in Chinese services could translate into a windfall, up to US$6 trillion, for foreign services companies ranging from retail trade and transportation to hotels and finance.

For the US, with the world's largest and most dynamic services sector, this could be an extraordinary opportunity. US negotiators should push especially hard for access to Chinese services markets.

Third, it's high time for US negotiators to give up the ghost of Chinese currency bashing. It has been the wrong issue from the start - after all, there can be no bilateral fix for a multilateral US trade imbalance reflected in deficits with 102 different nations in 2012. That multilateral imbalance is an outgrowth of an unprecedented US savings gap - a far cry from the politically inspired charges of Chinese currency manipulation.

Moreover with the renminbi or yuan now having risen by 35 per cent since July 2005 and with China's current account surplus having shrunk to less than 3 per cent of its GDP, the argument is vacuous. The US-China strategic and economic dialogue has been hijacked by the Chinese currency issue for far too long.

Fourth, concerns over cyberattacks should be elevated immediately to a high-priority issue between the two nations. In the early June summit between President Barack Obama and President Xi, the US pushed on this point in the face of recent publicly disclosed evidence about China's aggressive cyber-hacking attacks on American military and commercial targets.

The two presidents agreed to set up a working group focused on this issue, starting with the early July dialogue.

However, since the summit, revelations of comparable efforts on the US side - namely, the so-called Prism and TAO (Tailored Access Operations) programmes of the National Security Agency as disclosed by a former NSA contract worker - have cast this contentious problem in a new light. With both nations heavily involved in cyberespionage, there can be little doubt of the urgency in dealing with this critical issue.

The Chinese and the US economies are at pivotal junctures. Both need to rebalance - China needs to save less and consume more, whereas America needs to save more and consume less.

Common challenges

AT THE same time, both need to grow enough to absorb surplus labour - the structurally unemployed in the US and a vast and impoverished rural population in China. Beijing has a strategy and a plan, and the commitment of its new leadership, to push ahead with due haste on its rebalancing agenda. Washington has none of these.

Philosophically opposed to strategy and anything that smacks of planning, the US remains steadfast in its commitment to the wisdom of the Invisible Hand. That wisdom is now in question.

But there is another twist.

As China shifts to consumer-led growth, it will start to draw down its surplus savings and current account surplus. That could lead to a reduction in its vast US$3.4 trillion (S$4.3 trillion) foreign exchange reserves, thereby dampening China's demand for dollar-based assets. Who will fund a seemingly chronic US savings shortfall - and on what terms - if America's largest foreign creditor ceases doing so?

We live in an asymmetrical world - but the asymmetrical rebalancing of two co-dependent economies could pose enormous challenges to both the US and China. The upcoming Strategic and Economic Dialogue offers an opportunity for both nations to grasp the implications of these tectonic shifts.

YALE CENTRE FOR THE STUDY OF GLOBALISATION

The writer is a faculty member at Yale University and former chairman of Morgan Stanley Asia.