US must brace it­self for los­ing No. 1 sta­tus

The Chi­nese and US economies are now fairly evenly matched, but with a big­ger pop­u­la­tion China has more room to grow

The Hindu Business Line - - THINK - NOAH SMITH AP BLOOMBERG

What a dif­fer­ence two decades makes. In 1997, China’s gross do­mes­tic prod­uct was about 11 per cent of the US’s. By 2017, it was up to 63 per cent: But this over­states the dif­fer­ence in liv­ing stan­dards be­tween the two coun­tries, since prices are gen­er­ally lower in China. In pur­chas­ing­power-par­ity terms, China’s econ­omy be­came the world’s largest in about 2013.

So which coun­try’s econ­omy is re­ally big­ger? The truth prob­a­bly lies some­where be­tween these two fig­ures. If China were to abol­ish its cap­i­tal con­trols and open its cur­rency to for­eign spec­u­la­tion, there’s a good chance the yuan would rise in value, bring­ing China’s GDP at mar­ket-ex­change rates closer to its PPP num­bers. In other words, the economies of China and the US are now fairly evenly matched in size. But with four times the US pop­u­la­tion, China has more room to grow. And China is al­ready the world’s largest man­u­fac­turer and big­gest ex­porter.

In other words, if it’s not al­ready the world’s dom­i­nant eco­nomic power, China soon will be. But what does this mean? What are the im­pli­ca­tions of Chi­nese eco­nomic dom­i­nance, for the world and for US pol­icy?

The big­gest ef­fect will be that China be­comes the lead­ing ben­e­fi­ciary of what econ­o­mists call ag­glom­er­a­tion ef­fects. Ag­glom­er­a­tion refers to the ten­dency of busi­nesses to clus­ter to­gether in the same re­gion, be­cause one com­pany’s work­ers are an­other’s cus­tomers. As econ­o­mists Paul Krug­man, Masahisa Fu­jita and An­thony Ven­ables showed two decades ago, ag­glom­er­a­tion can bring big ben­e­fits to what­ever re­gion has the dens­est con­cen­tra­tion of eco­nomic ac­tiv­ity. In­creas­ingly, that re­gion is China rather than the US.

China is where the big­gest mar­kets are, so that’s where multi­na­tional com­pa­nies want to build their fac­to­ries and of­fices. That in turn leads to whole sup­ply chains mi­grat­ing to China, as com­pa­nies try to lo­cate near their up­stream sup­pli­ers and down­stream cus­tomers. This process is ac­cel­er­ated by US dom­i­nance

an­other phe­nom­e­non known as clus­ter­ing ef­fects, the col­lec­tion of a huge repos­i­tory of man­u­fac­tur­ing tal­ent and know-how in Chi­nese cities. China’s gen­eral hos­til­ity to for­eign com­pa­nies will slow this process, but the grav­i­ta­tional pull of the world’s big­gest econ­omy will be hard to re­sist.

This also means that Pres­i­dent Don­ald Trump will be fight­ing an up­hill bat­tle in his trade war against China. To push a com­pany to move out of China, US tar­iffs would have to be very high, since they will have to over­come not just labour-cost dif­fer­ences be­tween the two coun­tries but the pull of the Chi­nese mar­ket, the con­cen­tra­tion of man­u­fac­tur­ing know-how and the ex­is­tence of sta­ble sup­ply chains.

An­other re­sult of China’s new eco­nomic heft is that the web of in­sti­tu­tions that the US built to reg­u­late the global econ­omy after World War II will be in­creas­ingly ir­rel­e­vant and tooth­less. The World Bank, for ex­am­ple, which lends money to poor coun­tries, is al­ready find­ing it­self side­lined as Chi­nese loans pour into de­vel­op­ing na­tions.

Dol­lar’s hege­mony

One of the most im­por­tant US-led eco­nomic in­sti­tu­tions is the dol­lar it­self. For decades, the dol­lar has func­tioned as the world’s re­serve cur­rency. Some be­lieve this has put strains on the US econ­omy, be­cause the in­creas­ing de­mand for dol­lars tends to make the cur­rency more ex­pen­sive, con­tribut­ing to per­sis­tent US trade deficits.

If this the­ory is right, then as China’s econ­omy grows, the US will be less able to han­dle the cap­i­tal in­flows that are nec­es­sary to re­main the world’s re­serve cur­rency. It would seem like a good idea for China to shoul­der some of the bur­den of be­ing the global re­serve cur­rency, just as the US took over this duty from the UK a cen­tury ago.

The fi­nal im­pact of China’s eco­nomic rise is geopo­lit­i­cal. Coun­tries that once would cater to the US in mil­i­tary and po­lit­i­cal mat­ters in or­der to se­cure ac­cess to US mar­kets will now be tempted to switch their al­le­giance to China. This pres­sure will be es­pe­cially acute for East Asian coun­tries that are close to Chi­nese mar­kets.

The US, of course, could have acted to counter or slow this process by es­tab­lish­ing a trad­ing bloc with other East Asian coun­tries that ex­cluded the Chi­nese. Pres­i­dent Barack Obama tried to do ex­actly this with the Trans-Pa­cific Part­ner­ship, but Trump killed that deal as soon as he came into of­fice.

So the fact that China is now or will soon be the world’s big­gest econ­omy mat­ters a lot. It means the US can no longer de­pend as much on its large mar­kets to se­cure in­vest­ment or geopo­lit­i­cal fealty. Un­less China makes se­vere mis­steps in the near fu­ture it will en­joy many of the ben­e­fits that once flowed to its chief ri­val.

Flag­ging prospects

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