China to deal with global slowdown

By Stephen S. Roach (China Daily)
Updated: 2008-04-02 07:19

China has rewritten both the theory and history of economic development. In just 30 years, it has gone from the brink of economic collapse to the cusp of a newfound prosperity.

The author, Stephen S. Roach, chairman of Morgan Stanley Asia []

Driven by the "opening up" of a State-owned system, bold reforms have spawned an increasingly market-based economy. The results are nothing short of extraordinary. Following nearly three decades of 9.5 percent average growth in real GDP, per capita income in China now exceeds $2,000 - up more than fivefold since the early 1990s.

China owes much of its remarkable success to an outward-looking development model - heavily dependent on foreign trade and on concomitant increases in investments in infrastructure and industrialization supporting its all-powerful export platform.

Fortunately, for China, its commitment to such an externally led strain of economic growth coincided with the flourishing of a new era of globalization and a boom in the global economy. With those benefits, of course, also come risks and responsibilities.

And China now faces plenty of both as it peers into the immediate future. The export-led growth model needs rebalancing.

The leadership is the first to admit that it now needs greater focus on the development of autonomous support from internal demand - especially private consumption.

The export-led growth model also leaves China overly exposed to cyclical developments in the global economy. After riding a wave of nearly five years of the strongest growth in global activity since the early 1970s, there is now good reason for China to worry about a US-led global slowdown.

China's export-led development model has also put it in the cross-hairs of a worrisome anti-globalization backlash.

Outward tilt

Export-led growth models have long been the mainstay of economic development. Yet China has taken this approach to a new level. China's share of world trade has risen nearly eightfold since its economic take-off in 1982, according to estimates by the International Monetary Fund. This is well in excess of the norm experienced by other Asian economies over comparable periods of their economic development.

There has been an especially dramatic increase in China's outward tilt since 2000. Its share of world trade has doubled in this relatively short period. This accelerated push came at just the right time as it coincided with an especially powerful wave of world GDP growth. For that reason, alone, China could well be the greatest beneficiary of the modern wave of globalization.

Double-edged sword

What globalization giveth, it can also taketh. That is true of the global business cycle. It is also true of the world's collective commitment to the architecture of globalization. No economy has benefited more than China from the increasingly unencumbered cross-border flows of trade, capital, information, and labor. And, now, those tailwinds could well turn into headwinds. For China, the double-edged sword of globalization is both its greatest opportunity as well as its most vexing challenge.

The upside of the global business cycle has smiled very kindly on China in recent years. As world GDP grew at an average of roughly 5 percent over the 2003-07 period, Chinese export growth averaged 30 percent - nearly four times the 8 percent average gains in world trade for the whole world.

But now the smile of the global business cycle is about to turn into a frown. A US-led global downshift is very much in the cards as America feels the full force of a bursting of its enormous property bubble. The so-called subprime crisis is but one symptom of this post-bubble shakeout.

But it is not the endgame. The biggest risk is the staying power of the US consumer. Courtesy of ever-rising home prices, in conjunction with easy and relatively costless access to home equity borrowing programs, US consumers turned into asset-dependent spending machines over the past six years even as the income-based personal saving rate plunged.

With the American consumer now losing support from both the housing and credit bubbles, consumption support to the aggregate US economy is likely to turn negative. Alas, the rest of the world, including China, must pay the price for it. In January and February, overall Chinese export growth slowed to an average 16.8 percent year-on-year - down from 25.7 percent increase in 2007.

In February, Chinese exports to the US fell to a level that was 5.2 percent below the pace of the year-earlier month; averaging over the first two months of the year, Chinese exports to the US were essentially unchanged - a dramatic deceleration from the 14.4 percent increase in 2007. Industrial output growth also slowed in early 2008.

As the US recession takes hold, further downward adjustments to the all-powerful Chinese export machine can be expected.

That is not necessarily bad news for an increasingly inflation-prone Chinese economy. With the CPI surging at 8.7 percent in February, the authorities have underscored the need for slower growth to cool an overheated economy. Ironically, a slowdown in external demand may help.

Globalization backlash

Equally disconcerting for an externally oriented Chinese economy are growing signs of a backlash against globalization. That has shown up most acutely in the form of an increasingly protectionist US Congress. If the US slips into recession in 2008, unemployment will rise - putting even more pressure on the protectionist "remedy".

A weaker dollar has only increased the decibel level of the protectionist drumbeat. Moreover, with the dollar's latest downleg especially severe against the euro, European politicians have now jumped on the anti-China, renminbi appreciation bandwagon.

The rich countries have experienced a dramatic and disturbing deterioration in their income distribution. The resulting middle-class angst has triggered an outbreak of China bashing that might only get worse if America slips into recession.

Only a cycle

The world is hardly coming to an end. At work are the time-honored forces of the business cycle - driven in this case by the US recession that should inevitably be followed by recovery.

However painful, cyclical adjustments are also an opportunity. For China, it underscores the imperative of shifting its growth impetus to private consumption.

I am hopeful China will seize the moment and redouble its focus on reforms, especially those that provide support for a long-needed strain of consumer-led growth. Over the past 30 years, China has taken advantage of cyclical downturns to get its macro house in order. I suspect this will be another one of those times.

The author is chairman of Morgan Stanley Asia

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