China is too big to fail

Paul

The Chinese model is not sustainable in the long run – and the global community must do all it can to help China rise again

• Kevin Gallagher
• guardian.co.uk, Monday 2 August 2010 08.00 BST
• Article history

There is no question that China's growth has been anything short of exceptional. However, that success may have run its course. China will have to rise again in order to rebalance growth while reducing inequality and environmental degradation. The plight of 1.6 billion people depends on it, and the entire world economy. The global community should do all it can to help China succeed.

Like Japan, South Korea, and others before, China has deployed a hybrid mix of state and market-led forces to globalise its economy over the past 30 years. Like its East Asian predecessors the Chinese miracle has been built on exports to the west. The results have been unprecedented, with a growth rate of approximately 10% that has lifted 566 billion people over the $1.08 "extreme poverty" threshold set by the World Bank.

Yet the Chinese model is not sustainable in the long run. It has created severe inequalities and environmental degradation and has contributed to the global imbalances that were at the root of the financial crisis. There is an across the board consensus that China needs to diversify demand toward its domestic market.

Yilmaz Akyuz, chief economist of the South Centre, estimates that close to 60% of China's imports are used in the export sector and only 15% of imports are for domestic consumption. China's share of both private consumption and wages to GDP has been falling since the 1990s. Indeed, exports may have contributed to 50% of China's pre-crisis growth.

Akyuz rightly argues that China will need to generate a higher share of wages through value-added production that lowers the foreign content of exports. Through technology upgrading, through the substitution of high technology parts and components via domestic production, through factory wage increases, through government transfers to rural households, and through other social infrastructure projects, China will adequately boost domestic demand.

China has the track record to make this happen, but it will take a lot of effort. The country has built up the most successful export machine since the industrial revolution. And China's 12.5% of GDP stimulus package was a great start in the new direction. There is no reason to believe that China's developmental state cannot be steered toward domestic markets too. Though, it is much easier to become a low-skilled manufacturing hub than a value-added high-tech hub.

Some signs are encouraging. Of course, China recently put its exchange rate back on a gradual course of appreciation. In response to mass strikes across the country, during the past month many of China's manufacturing centres have raised the minimum wage, some by up to 48%. Also this month China initiated a green car subsidy programme whereby auto companies get a subsidy for producing cleaner cars for the domestic market – a programme that not only will help domestic demand and help China move up the value chain but will help mitigate its environmental ills that cost the Chinese economy 8-10% per year of GDP and accentuate global climate change.

China's success at developmentalism and its ability to finance change by tapping over-investing state-owned enterprises and from loans backed by China's mammoth reserves make it a good bet that China can succeed again.

That is, if it is given a chance.

The US and others continue to complain that China isn't appreciating their currency or ripping open its capital markets fast enough. Foreign investors are warning that China's wage hikes may cause an investment exodus although such an overblown frenzy could disrupt markets and China's ability to stay the course. Foreign firms also decry China's "indigenous innovation" programme that will help China eventually move away from low-wage export labour and toward value added domestic consumption and consumption for balanced growth. Finally, developed countries insist on making China pay for more expensive green technologies without offering a financing mechanism.

The west can't have its cake and eat it too. The west can't tell China to increase domestic demand and rebalance its economy through domestic consumption (without increasing carbon dioxide emissions), and at the same time shun China's incremental approach to to monetary policy, strikes and wage increases, policies for financial stability, and green industrial innovation. China should be enabled to succeed. A country of 1.6 billion people that is now one of the only rudders working in the global economy is too big to fail.

http://www.guardian.co.uk/commentisfree/cifamerica/2010/aug/02/china