PrefaceWhy did so many Sino-specialists see as a risk something that I saw as a nonissue and vice versa? Having worked on China for so long, I had come to recognize, as have others, its strengths and vulnerabilities. But global opinions tended to be more extreme, casting the country as either poised to take over the world or doomed to collapse.Op-eds and journal articles cannot do justice to the complexity of the issues being debated. Only a book allows one to take a deeper and more holistic approach.
Chapter 1: IntroductionMy intention is not to be comprehensive but to highlight points that affect broadly shared perceptions of China. I have long since realized, however, that one cannot expect to alter the many emotionally tinged views that many observers have adhered to for so long. But if I have managed to encourage some to think about them differently, then I will have met my aspirations.There is no direct causal relationship between China’s surpluses and America’s deficits.The economic rationale for internationalizing the renminbi is intrinsically weak and, given the structure of China’s economy, the likelihood of this happening is very low. But this objective can play the role of a Trojan horse in supporting China’s economic reforms and broader national security objectives.The general public believes that American firms are investing heavily in China, leading to loss of American jobs. Yet contrary to popular perceptions, flows of foreign direct investment (FDI) between the United States and China are abnormally low.China has become an “abnormal” great power. It is the first great power that is a developing rather than a developed country, the first to get old before it gets rich. Its weak institutions and historical legacies mean that it has more insecurities than would be expected of a great power.Policymakers in Beijing often complain that the Western media tends to “demonize” China and that judgments are impaired by unwarranted and ideological biases. But the more dispassionate observers will remind their friends in China that its discriminatory trade and investment practices and restrictions on the international media create the climate for stinging criticisms, as exemplified in the 2016 annual report of the bipartisan Congressional- Executive Commission on China which took a particularly harsh position on the government’s human rights record. The issue is not whether one should be positive or negative about China’s economy and its political and foreign policy implications but instead about fitting China into a framework that leads to a better understanding of the reality.The Western concept of an economy is based on competition among firms in open and free markets. Unique to China, local governments are also part of the competitive economic environment. Competition in China is not just the result of pressures generated by markets and firms but can also come from local government entities.What followed was a flood of articles suggesting that “global imbalances” were linked to China’s repressed consumption and obsession with investments. Even Ben Bernanke, the Federal Reserve System chief, got into the debate with an influential article arguing that China’s huge volume of savings invested in the United States— the result of its trade surplus— drove down interest rates, which then spawned America’s housing bubble and triggered the 2008 GFC. This shifted the blame for America’s financial crisis from the shoulders of its own risk- seeking banks to the excessive frugality of Chinese households.
Chapter 2: Differing Global and Regional PerceptionsThe Germany-China economic and political relationship is seen as the strongest within Europe, since Germany is by far China’s largest trading partner in the EU, and China is Germany’s largest trading partner in Asia. Moreover, China has occasionally relied on Germany to get the EU community to take its concerns seriously. Even so, polls show that the German public has been more negatively disposed toward China than other Europeans— driven by an especially hostile media.
Chapter 3: Origins of China’s Growth ModelChina has been spending over 5% of GDP annually over the past several decades on transport infrastructure— unprecedented by global standards in relation to the size of its economy.
Chapter 4: China’s Unbalanced GrowthChina’s internal imbalances would be seen not as a risk but as the unavoidable byproduct of a generally successful growth process that reflects rapid urbanization and regional specialization in production. Even a good thing can be overdone, however. State- driven investments have gone increasingly into unproductive activities as part of intermittent stimulus programs in recent years. Instead of artificially promoting investments or household consumption for the sake of rebalancing, the priority should be on raising productivity and increasing public funding for social programs to support demand. Done properly, rebalancing will evolve naturally over a decade or more as China reaches high- income status.Assume that a farmer produces rice worth 10,000 renminbi a year. After paying for inputs, he then nets 9,000 renminbi as his disposable income, out of which he saves 2,000 and spends 7,000. In the national accounts, his activity translates into a consumption share of 70% of the value of agriculture production. Now suppose that he moves to Shenzhen and gets a job with Apple to assemble iPods and is paid 30,000 renminbi a year, triple what he was formerly earning— and similar to what has been actually happening in China. Like most migrants, he saves half and consumes half— 15,000 renminbi. Apple combines his labor with capital and imported components to produce iPods worth 60,000 renminbi. His consumption as a share of industrial production is now just 25%.Labor’s share of output is much lower in industry, at around 50%, compared with nearly 90% in agriculture (comparable to the pattern in other developing countries).Consumption as a share of GDP will eventually flatten out— that is, rebalancing will occur— but this process takes decades. Rebalancing begins when the pace of rural to urban migration slows down and urban workers begin to get a larger share of the value of industrial production. This happens when labor becomes relatively scarce and wages are bid up as indicated in the Lewis turning point. It also occurs as urban workers move from jobs in manufacturing to jobs in services, since wages are a relatively larger share of the value added in services compared to manufacturing.Because migrant workers are not eligible for the usual range of urban social services due to lack of residency rights (or hukou), they end up saving a much higher proportion of their income than established urban residents.Many observers arguing that China’s growth process should be more consumption driven have not appreciated the fact that maximizing sustained growth in consumption levels over the past several decades may have necessitated a phase when the share of consumption to GDP declines. This allows for the growth of investment to exceed the growth in GDP, and if the productivity of investment is high enough, then the resulting rapid growth of GDP leads to personal consumption levels increasing steadily over time.From 1960 to 1990, the growth of real consumption expenditures in “balanced” economies like the Philippines, Mexico, and Brazil was in the range of 3– 4%. Conversely, real consumption growth in “unbalanced” economies such as China or South Korea over the same comparable period was far higher, averaging 7– 9%. The premise that more balanced growth means faster growth in consumption is simply not true.The combination of huge labor surpluses and massive investments during this rapid growth phase made it logical for wage increases to lag productivity increases. But this does not mean that such wage increases were too low in some normative sense; they were in fact quite high by historical standards and in comparison with other countries.China’s huge stimulus program in response to the GFC and more recent bouts with credit easing has led to a surge in investment into less productive activities. The solution is not, as some have suggested, to support artificially driven consumption initiatives, such as tax incentives to spur purchases of durables. Instead, the answer lies in increasing productivity and fiscal reforms.Since the GFC, the focus on the interior became an excuse for local officials in those provinces to push for investments that went beyond providing core public services to creating new cities on the premise, “If we build them, they will come.” The resulting ghost towns are now a common feature in some localities and illustrate why too much investment has been going to areas where employment growth has been limited or rates of return are lower.