The Great Depression made the United States the world's unquestioned financial leader. The current crisis can do the same for China.
- By Harold JamesHarold James is Professor of History and International Affairs and the Claude and Lore Kelly Professor of European Studies at Princeton University. His latest book (with Markus Brunnermeier and Jean-Pierre Landau) is The Euro and the Battle of Ideas (Princeton University Press).
In the Great Depression, as in the current economic crisis, the downturn was particularly severe because of a lack of leadership in the international order. The dominant financial power of the 19th century, Britain, was financially exhausted by the First World War. The new major creditor, the United States, had emerged as a strong economic player, but did not yet have leadership committed to the maintenance of an open international economic order. The simple diagnosis was that Britain was unable to lead, and the United States unwilling.
If the scenario sounds familiar, it should. The story from the Great Depression has an uncanny echo in current debates about international economic leadership, with the United States playing the role of Britain — the exhausted debtor economy — and China taking the place of the United States as the world’s largest creditor. But if China is the America of this century, can it do a better job than the United States did in the 1930s? The way in which the emerging superpower takes to this role will determine in large part how the world will emerge from the downturn and the shape of the new global economic order that will follow.
Charles Kindleberger, the late economist, argued that the United States should have acted as a lender of last resort in the early 1930s, continuing to keep its financial markets open to investment and its market open to foreign goods, rather than heading down the path of protectionism. It should also have stimulated the world economy through countercyclical fiscal policy.
But at the time of the Great Depression, there were all kinds of convincing reasons why Americans did not want to take on the burden of a worldwide rescue. Sending more money to Europe was seen as pouring money down the drain, and after all, Europeans had fought the world war that had been the root cause of the financial mess. Economically, helping Europe would have made a great deal of sense from a long-term perspective, but politically it was a non-starter with no short-term payoff.
In the middle of the current financial crisis, a deep-pocketed China faces the same dilemma: swallow its pique and help save the same countries that got us into this situation, or look to its own short-term interests first. Today, there are increasing demands that China contribute more to internationally coordinated rescue packages through a reformed International Monetary Fund (IMF). China is also one of the few economies still growing in 2009, though most economists have reduced their estimates of growth rates. Finally, China and the United States are the only countries that are large enough, and have sufficiently well-ordered government finances, to launch major efforts at fiscal stimulation.
Beijing’s leaders might feel like they have already taken their best shot. The initial stages of the credit crunch in 2007 were managed so apparently painlessly because sovereign wealth funds (SWFs) from the Middle East, but above all from China, were willing to step in and recapitalize the debt of U.S. and European institutions. Between November 2007 and March 2008, the SWFs provided $41 billion of the $105 billion injected into major financial institutions. Had this process continued, the events of 2008 would have included problems with U.S. real estate and a severe stock market decline, but no meltdown of financial institutions.
But after March 2008, the availability of funds to prop up the global financial system shriveled up. The pivotal moment in today’s events came when the state-owned China Investment Corp. (CIC) was unwilling to go further in its exploration of buying Lehman Brothers. CIC’s turning back will be held up in the future as a moment when history could have shifted in a different direction.
Today there may be plenty of reasons why the Chinese will be tempted to pull back from their engagement with the world economy, and the external political logic sounds very much like the U.S. case of 1931. Some of the economic arguments reverberating around Beijing are very reasonable: There is a great deal of uncertainty, and the SWFs have lost a lot of money already and might lose more. China’s investments in U.S. securities in 2006 proved to be a huge costly mistake. Clearly the CIC would have initially lost further billions had it tried to rescue Lehman. Other lines of thought are more emotional and political: Might not 2008 be a righteous payback for the U.S. bungling of the 1997-1998 Asian crisis? Trying times tend to heighten paranoia.
There are also many domestic reasons why China might be wary about opening up to the global economy. The Chinese banking system is still quite opaque and might still have to wrestle with the legacy of problems of the 1990s, in particular, bad loans to big state-owned corporations that were the consequence of a political logic of directed credit. China is investing large amounts in education, but it may be more difficult to build a creative and innovative society that replicates the dynamism of the United States in the second half of the 20th century (which was fed in large part by openness, above all openness to immigration). China also faces a problem of aging and even demographic decline after the 2040s as a legacy of its one-child policy, which has also created a potentially destabilizing surplus of young males. With all these threats to stability, an authoritarian though reformist regime may find it harder to respond flexibly to popular demands and may be prone to try to mobilize a reactive nationalism to fend off challenges to its authority.
The pressure to engage in large-scale fiscal stimulation is also likely to alter the balance of China’s economic development. The Chinese model of capitalism is very different than that of the United States, and even before the economic crisis, there were two alternative models. The first was the rural, family, and small-business-based boom of the 1980s. But by the 1990s, some of the private-sector growth was being choked off by a rival vision of economic growth built around prestige projects and the large, state-owned enterprise sector. Consider Shanghai, which impressed many commentators as the most modern city in the world: Analysts of the Chinese economy have suggested it is one of the least entrepreneurial cities in China. Yasheng Huang, in his book Capitalism with Chinese Characteristics, described it as a classic industrial-policy state. The new stimulus package is likely to push the balance of Chinese development more decisively in this latter direction, toward state capitalism.
China thus has plenty of reasons why it might want to close itself off to the forces of globalization, as the United States did in the interwar years. This thinking will be reinforced by the structure and character of the international order. Again, an interwar analogy is appropriate. The United States felt uncomfortable with the international institutions of the interwar period, in part because they were aligned with the interests of the old hegemonic power, Britain. The League of Nations looked as if it was an instrument of British power. Similarly, in the modern context China worries about whether it is adequately represented in U.S.-dominated international institutions. Its influence in the IMF and World Trade Organization clearly does not correspond to its real position in the world economy and to the role that China could play in economic stabilization. Reforming international institutions is thus a key issue in deciding whether the coming geopolitical alterations will be crisis-ridden, abrupt, and disruptive, or whether a more gradual and peaceful path of adjustment can be achieved.
Just before the Asia-Europe meeting last October, President Hu Jintao stated that China would behave with a sense of responsibility. It remains to be seen what stake China really has in the survival of the global economy. As in 1931, the political arguments are all against a rescue. Only the farsighted will see that the economic case for such an operation is compelling. Much depends on the extent of China’s voice in an altered international institutional architecture.
But that voice will make demands that are increasingly difficult for the old world to accommodate, including demands for a guarantee of China’s U.S. asset holdings and suggestions for an alteration of the world’s reserve management. In proposing a global reserve currency to replace the dollar, the Chinese central bank president recently followed in the footsteps of Charles de Gaulle in the 1960s. But unlike France, China is in a much stronger position to assert its preferences for international monetary reordering.
In other words, the world may be asked to transition from an American to a Chinese model of capitalism, and as in the 1930s, that won’t be an easy switch for any of us.