East and west are in it together
By Martin Wolf
Published: January 18 2011 20:24
Size matters. If we look only at China’s average level of development, we see a country with much the same standard of living as Thailand. If we look only at China’s size, we see what is already the world’s second-largest economy, biggest exporter (if members of the European Union are treated as separate economies), second-largest importer and holder of the largest stock of foreign currency reserves.
China’s leaders are, naturally and rightly, focused on sustaining stability and achieving prosperity. The rest of the world is, no less naturally and rightly, wondering how China will exercise its growing power and responsibility.
Hitherto, the adjustment to China’s rise has been remarkably successful, particularly if one considers the gulf in culture, history and political systems between China and the incumbent powers.
The Chinese economy has been dynamic and increasingly market-driven. The west, in turn, has accommodated China. That was the wise thing to do.
Just contrast the devastating cost of US protectionism and the Great Depression of the interwar years with the increasingly open Chinese economy and the successful response of Chinese Keynesianism to the challenges of the recent “Great Recession”. Consider, too, China’s entry into the World Trade Organisation and the world’s impressive ability to adjust to the rapid rise in China’s trade from just 4 per cent of the world’s total a decade ago to 10 per cent today.
Both China and the west have much to be proud about. Yet this does not mean that everything has gone smoothly. On the contrary, both sides have made mistakes in managing their economic interaction.
China, for example, allowed an extraordinary surge in exports and the current account surplus to mask the development of an increasingly unbalanced domestic economy. Chinese household consumption collapsed from an already very low share of 46 per cent of gross domestic product in 2000 to a mere 35 per cent in 2008.
Partly as a result of its decision to keep the exchange rate down, China emerged as the world’s largest surplus country, with a current account surplus peaking at 11 per cent of GDP and foreign currency reserves of about 50 per cent of GDP. These were foolish investments, made as a result of foolish policies. It is absurd for China’s leaders to complain about China’s consequent (and entirely unnecessary) vulnerability to US fiscal and monetary policies.
Meanwhile, the US and a number of other western countries allowed the supply of cheap foreign savings, partly from China, to encourage a huge surge in household debt, private consumption, residential construction and financial sector leverage. While the excess savings of the emerging world were not the principal cause of the financial crisis, they were a contributory factor.
Fortunately, most of what needs to be done to achieve a better balanced and less unstable world economy is strongly in the economic interests of both sides. This is becoming ever more obvious as China struggles with inflationary pressures and the lagged effect of the surge in credit that was used to offset the downturn in exports during the crisis.
Evidently, a large real appreciation of the Chinese exchange rate is inevitable. It is also a way of facilitating a shift in the economy towards greater reliance on domestic consumption. Yet a higher nominal exchange rate would be a far better way of achieving the needed real appreciation than higher inflation.
Such an economic rebalancing is, however, merely one element in the agenda. China grapples with the challenges of achieving rapid, widely shared and environmentally sustainable growth. Meanwhile, the rest of the world must learn to adjust to China’s growing impact. In seeking to address these challenges, China and its partners need to bear two considerations firmly in mind.
First, the political and economic consequences of a breakdown in relations between China and the west would be catastrophic. At best, it would be impossible to sustain prosperity and manage the shared challenges created by the pressure of humanity on the world’s resources. At worst, it could mean war.
Second, it is crucial to strengthen still further the legitimacy and effectiveness of global governance. China may view these structures as a western invention, if not an alien imposition. But they remain the best way to manage a world in which no single country – even ones as powerful as the US or as potentially powerful as China – can achieve what it wants for its people on its own.
What, then, is the economic agenda that both sides need to tackle? This is well known: maintaining open trade; securing external adjustment; reforming the international monetary system; managing the global commons; and containing potential conflicts over access to natural resources.
As China’s president Hu Jintao visits US president Barack Obama this week, they must be aware of how much rests on their shoulders. Both countries have strong suspicions of each other. Both dislike constraints on their own freedom. Both find some aspects of the other’s behaviour unacceptable. Yet both must also be well aware that what lies ahead is a lengthy and intense relationship.
Technology and economics have made the world smaller than it has ever been before. Now China’s development is putting to an end the period of unquestioned western supremacy. East and west must co-operate, or perish.
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