Tests for China-cen­tric world econ­omy

Although the global growth cli­mate seems to have im­proved re­cently, this is no time for com­pla­cency

China Daily European Weekly - - Cover Story | Comment - By STEPHEN ROACH Stephen S. Roach, a fac­ulty mem­ber at Yale Uni­ver­sity and for­mer chair­man of Mor­gan Stan­ley Asia, is the au­thor of Un­bal­anced: The Code­pen­dency of Amer­ica and China. The views do not nec­es­sar­ily re­flect those of China Daily.

China re­mains the world’s most pow­er­ful growth en­gine. Even in the face of its re­cent down­shift from 30 years of 10 per­cent growth from 1980 to 2010, China has con­tin­ued to play a dis­pro­por­tion­ate role in driv­ing the world econ­omy. Since 2010, Chi­nese GDP growth has av­er­aged 7.5 per­cent — fully 2.1 times the global av­er­age.

This im­pe­tus is likely to per­sist for the fore­see­able fu­ture. If China holds in the 6 to 7 per­cent growth range over the next few years — a rea­son­able prog­no­sis, in my view — it will con­tinue to out­dis­tance the rest of the world by a wide mar­gin. In that case, China will ac­count for slightly more than 30 per­cent of to­tal global growth in 2019 (as mea­sured on a pur­chas­ing power par­ity ba­sis). That would mean its con­tri­bu­tion would be about 67 per­cent greater than the com­bined growth of the United States and the Euro­pean Union, even if the lat­ter two economies in­creased some­what more rapidly than ex­pected in 2019 (2.5 per­cent in the US and 2 per­cent in the EU in 2019), and China slows to the lower end of ex­pec­ta­tions (6 per­cent). In­deed, in the ab­sence of China’s di­min­ish­ing but still pow­er­ful growth as­sis­tance, the world econ­omy would be strug­gling.

While there is cur­rently a gen­eral sense of op­ti­mism re­gard­ing the global eco­nomic out­look, re­cent ex­pe­ri­ence sug­gests it pays to be mind­ful of ever-present risks. This is es­pe­cially true of ma­jor ad­vanced economies, which have strug­gled might­ily since the fi­nan­cial cri­sis and re­ces­sion of 2008-09. But it is also the case for China, which re­mains tightly linked to the rest of the world.

Of course, now there is hope that the worst is fi­nally over. The US is a prom­i­nent case in point, with new­found op­ti­mism par­tic­u­larly ev­i­dent in the af­ter­math of two quar­ters of 3.2 per­cent GDP growth (in the mid­dle quar­ters of 2017), fol­lowed by the re­cent en­act­ment of a ma­jor mul­ti­year tax cut. But there are three key risks on the down­side: First, for a fully-em­ployed US econ­omy, the nor­mal­iza­tion of mone­tary pol­icy is now likely to be ex­e­cuted more quickly in the face of a large fis­cal stim­u­lus. Sec­ond, the un­wind­ing of eight years of un­con­ven­tional mone­tary ac­com­mo­da­tion will re­duce the liq­uid­ity sup­port to an over­val­ued US stock mar­ket, which is cur­rently trad­ing at a cycli­cally ad­justed price-to-earn­ings ra­tio only ex­ceeded in 2000 and 1929 over its long his­tory of more than 135 years. Third, the pos­si­bil­ity of a sharp cor­rec­tion in US fi­nan­cial as­sets — stocks and over­val­ued bonds alike — poses a se­ri­ous threat to an as­set-de­pen­dent real econ­omy that has been ar­ti­fi­cially sup­ported by the liq­uid­ity in­jec­tions of un­con­ven­tional mone­tary stim­u­lus.

There are also rea­sons to be con­cerned about the out­look for Europe and Ja­pan — even though re­cent trends in these ar­eas also look some­what more en­cour­ag­ing. Im­paired pro­duc­tiv­ity growth is a com­mon theme for both economies, and a per­sis­tent prob­lem in the United States as well. Since 2010, pro­duc­tiv­ity in the ad­vanced economies has fallen well short of its pre-cri­sis trend. With­out sup­port from pro­duc­tiv­ity, out­put growth in­vari­ably faces stiff head­winds. Re­cent In­ter­na­tional Mone­tary Fund re­search sug­gests that about 40 per­cent of the short­fall in post-cri­sis out­put growth in the ad­vanced economies is trace­able to a pro­tracted slow­down in to­tal (mul­ti­fac­tor) pro­duc­tiv­ity growth.

In a weak pro­duc­tiv­ity cli­mate, any ac­cel­er­a­tion in GDP growth, such as the mod­est pickup that ap­peared to be un­fold­ing in late 2017, is likely to be only tran­si­tory, in­evitably re­turn­ing to its un­der­ly­ing slug­gish trend. The only way to avoid that “growth fade” is for na­tions to em­brace struc­tural re­form im­per­a­tives — all the more ur­gent in light of stiff de­mo­graphic head­winds through­out the in­dus­trial world. The pol­icy recipe is hardly a se­cret: in­no­va­tion, tech­no­log­i­cal change, hu­man cap­i­tal and trade lib­er­al­iza­tion. In the ab­sence of more ef­fi­cient eco­nomic struc­tures, even the last­ing growth div­i­dends of in­fra­struc­ture and other in­vest­ment spend­ing ac­tiv­ity will be lim­ited.

Ja­pan is the poster child for failed struc­tural re­forms. Af­ter nearly three “lost decades,” the re­cent mod­est pickup in the Ja­pa­nese econ­omy has sparked op­ti­mism that its long night­mare is over. How­ever, with struc­tural re­forms stymied by spe­cial in­ter­est pol­i­tics — es­pe­cially Ja­pa­nese la­bor mar­ket re­forms — the “third ar­row” of the Abe­nomics strat­egy has never been suc­cess­fully im­ple­mented. As a con­se­quence, Ja­pa­nese growth should fade quickly in 2018.

Europe’s long-dys­func­tional mone­tary union poses a sim­i­lar chal­lenge to the seem­ingly en­cour­ag­ing pickup in that re­gion’s econ­omy — es­pe­cially with pro­duc­tiv­ity growth hav­ing been cut in half in the af­ter­math of the fi­nan­cial cri­sis of 2007-08 rel­a­tive to an al­ready slug­gish pre-cri­sis trend of just 1 per­cent (ac­cord­ing to the lat­est re­search of the Euro­pean Com­mis­sion). With­out a mean­ing­ful pro­duc­tiv­ity pickup — par­tic­u­larly tough for long-scle­rotic Euro­pean la­bor mar­kets — a growth fade is also in­evitable in Europe.

Nor should the United States be spared the same fate from pro­duc­tiv­ity head­winds that are likely to con­tinue to af­flict Ja­pan and Europe. Not­with­stand­ing the un­sub­stan­ti­ated and highly politi­cized claims of sup­ply-siders, a large body of macroe­co­nomic the­ory and em­pir­i­cal ev­i­dence points to lit­tle re­la­tion­ship be­tween cor­po­rate tax cuts (like those just en­acted) and in­vest­ment, in­no­va­tion and pro­duc­tiv­ity. In light of the down­side cycli­cal risks to the US econ­omy noted above, Amer­ica’s lin­ger­ing struc­tural head­winds are all the more prob­lem­atic.

All this poses great chal­lenges to China. Its 30-year growth mir­a­cle was a lev­ered play on ex­ports, ex­ter­nal de­mand and glob­al­iza­tion. Over the past 10 years, China has learned many tough lessons about ex­ces­sive de­pen­dence on the broader global econ­omy. A cri­sis-in­duced col­lapse of global trade, fol­lowed by an ane­mic re­cov­ery, has been crit­i­cal in driv­ing China’s re­bal­anc­ing agenda away from ex­ter­nal de­pen­dence to­ward in­ter­nal de­mand — es­pe­cially house­hold con­sump­tion. But this is a long and ar­du­ous process that re­mains in­com­plete and, there­fore, has yet to in­su­late China from tough global con­di­tions.

In­deed, while the ex­port share of China’s GDP has come down sharply since 2007, it still stands at 20 per­cent — dou­ble the por­tion of 1986. Mean­while, house­hold con­sump­tion re­mains dis­ap­point­ingly weak at less than 40 per­cent of GDP. By de­fault, such in­com­plete re­bal­anc­ing has left ex­port-de­pen­dent China with lit­tle choice other than to rely on fixed in­vest­ment to hit its growth tar­gets, with debt-in­ten­sive, State-owned en­ter­prises tak­ing the lead in pro­vid­ing this im­pe­tus.

The re­sults of the an­nual Cen­tral Eco­nomic Work Con­fer­ence held in De­cem­ber un­der­score the del­i­cate bal­anc­ing act of a Chi­nese pol­icy strat­egy that is at­tempt­ing to ad­dress a mul­ti­plic­ity of risks, chal­lenges and op­por­tu­ni­ties — from mone­tary and fis­cal pol­icy co­or­di­na­tion and cur­rency flex­i­bil­ity to prop­erty mar­ket ex­cesses and delever­ag­ing. Mean­while, the struc­tural re­form agenda, which is so crit­i­cal to China’s own pro­duc­tiv­ity chal­lenges, con­tin­ues to be dom­i­nated by sup­ply-side ini­tia­tives, with only min­i­mal em­pha­sis on de­mand-side sup­port to house­hold con­sump­tion.

Not only does China face the pos­si­bil­ity of re­newed chal­lenges from the global busi­ness cy­cle, but it also must con­tend with the ex­is­ten­tial threats of de­glob­al­iza­tion and pro­tec­tion­ism. A mus­cu­lar “Amer­ica First” se­cu­rity ap­proach un­veiled by the Trump ad­min­is­tra­tion is a po­ten­tial game-changer. China is no longer viewed as a “re­spon­si­ble stake­holder” by the US in geo-strate­gic terms, but now lumped to­gether with Rus­sia, is char­ac­ter­ized as more of a com­pet­i­tive threat that “… chal­lenge(s) Amer­i­can power, in­flu­ence and in­ter­ests, at­tempt­ing to erode Amer­i­can se­cu­rity and pros­per­ity.” It re­mains to be seen if this shift in Amer­ica’s ap­proach to China will usher in broad-based trade sanc­tions that could well spark a trade war be­tween the world’s two largest economies. At a min­i­mum, the odds of such an out­come are cer­tainly in­creas­ing.

Nor should China be­lieve that it can sim­ply turn the other cheek and forge a new type of glob­al­iza­tion through its Belt and Road Ini­tia­tive in an ef­fort to en­gage the world on dif­fer­ent terms. While there can be no mis­tak­ing the po­ten­tial scope of this ini­tia­tive, the plan­ning, fund­ing and con­struc­tion lags of Belt and Road do not sug­gest any im­me­di­ate im­pe­tus to China or to pan-re­gional growth. More­over, the Belt and Road routes run through some of the most po­lit­i­cally un­sta­ble na­tions in the world: 28 of the 64 Belt and Road par­tic­i­pat­ing na­tions are in Cen­tral Asia, the Mid­dle East and North Africa and South Asia, where po­lit­i­cal sta­bil­ity, as mea­sured by World Bank Gov­er­nance In­di­ca­tors, is col­lec­tively in the 28th per­centile of some 213 coun­tries around the world.

Yes, the global growth cli­mate seems to have im­proved re­cently. Con­di­tions are de­picted as strong and syn­chro­nous, with frothy fi­nan­cial mar­kets pro­vid­ing the ic­ing on the cake. Don’t be fooled — a decade of tough global prob­lems has not mirac­u­lously van­ished into thin air. And, as al­ways, new prob­lems ap­pear to be on the hori­zon. This is no time for com­pla­cency — es­pe­cially for China, with its in­com­plete re­bal­anc­ing.


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