Hard Landing, USA
China is rebalancing its economy. Why isn't America?
For those looking for problems with China’s economy, there have been plenty of recent data points to choose from. The economy is slowing, foreign trade data have weakened, the latest price trends point more toward deflation than inflation, and there have been several recent squeezes in short-term bank funding markets. Then, on March 7, Chinese solar equipment maker Chaori defaulted on its bond payment. While hardly shocking for a normal economy, a default of this magnitude is a first for modern China and possibly a hint of what many fear is more corporate distress to come. Against the backdrop of still frothy housing markets — despite an easing of home prices in February — and a rapidly expanding shadow banking sector, these latest signs can hardly be dismissed as aberrations.
Are these early warnings of the dreaded Chinese hard landing, which would bring the country’s development miracle to a sudden end, or indications of a transition to a more normal economy? Long wanting to believe the worst when it comes to China, the preponderance of opinion in the West is in the hard landing camp. It was only a matter of time, argue the China doubters, before the state-directed, non-market economy would meet its demise.
Fortunately, the alternative view is probably closer to the mark. China’s slowdown appears to be a well-orchestrated manifestation of the emergence of an increasingly services-based, consumer-led rebalancing of its economy. In 2013, the services share of gross domestic product (GDP) hit 46 percent — the first time in modern China’s history that this sector exceeded the combined portion going to manufacturing and construction. The old growth model, driven by a boom in industrial activity, is now giving way to a new and more balanced model supported by the trappings of a modern consumer society.
Services-led economies almost always grow more slowly than manufacturing-led ones. Consequently, drawing on services allows China to temper many of the pressures that stemmed from decades of double-digit growth — excess resource consumption, environmental degradation and pollution, income inequality, and saving and trade surpluses. At the same time, a shift to services fosters more labor-intensive growth, which allows a more slowly growing China to continue to absorb surplus labor through increased employment and poverty reduction — key to maintaining social stability. In this vein, a services-led transition of what former Premier Wen Jiabao famously called an "unbalanced, unstable, uncoordinated, and ultimately unsustainable" Chinese economy is a welcome development.
China doubters are unprepared for this transition. The international community has long urged China to change its growth model. But now that it is doing so, the West could actually find this an uncomfortable development. Major developed economies, especially the United States, have become increasingly dependent on China as a producer of cheap goods that hard-pressed consumers need, and as a provider of cheap capital that savings-short nations require to finance outsize government budget deficits. A rebalanced China will instead use its saving surplus to support the long-awaited emergence of its own consumer society.
Of course, this dependency cuts both ways. Chinese growth and development have benefited enormously from export-led growth, which the voracious spending of the American consumer has long underpinned. And China has tied its currency to the fate of the U.S. dollar, which has fallen 24 percent against that of the United States’ trading partners since 2002. That has left the renminbi well-positioned to support Chinese export competitiveness.
All this speaks of a codependency that links China and the United States in an economic marriage of convenience. Yet as I argue in my new book, Unbalanced: The Codependency of America and China, this relationship is unstable: In human behavior, as in economies, the pathological disorders of codependency can lead to a loss of identities, a blurring of distinctions between partners, frictions, and the ultimate break-up. And just as independence cures unstable codependency between humans, rebalancing is the only way out for codependent economies.
With services-led growth now on the ascendancy, the telltale signs of that rebalancing are very much evident in China in early 2014. Yet there is no such evidence of a similar transformation in the United States. In fact, the United States’ post-financial crisis policy stimulus seems aimed at resurrecting the timeworn model of consumer-led growth — the same recipe that got the U.S. economy into such trouble in the first place. The Federal Reserve’s quantitative easing campaign — liquidity injections that boost the prices of financial assets, which in turn, are expected to trickle down through wealth effects and stimulate household spending — exemplifies this fixation on a consumer-led recovery. Yet the feeble response of consumption — growing on average just 1 percent over the past six years — raises serious questions about betting recovery on a sector still constrained by high debt loads and subpar saving.
As China rebalances, and the United States does not, sparks could really start to fly. An increasingly consumer-driven China will begin to draw down its surplus saving, which will narrow its current account surplus, slow the accumulation of foreign exchange reserves, and reduce China’s demand for dollar-denominated assets. Shifting from surplus saving to saving absorption points to a radical about-face of China’s role in its codependent relationship with the United States.
That poses a tough and very important question for the savings-short United States: Absent its biggest foreign lender — the Chinese own about $1.3 trillion in Treasuries and about another $700 billion of government-sponsored Fannie Mae and Freddie Mac securities — the United States may find it exceedingly difficult to stay the same profligate course it has been on for decades. Without a meaningful rebuilding of domestic savings, a slowing of Chinese lending means the U.S. economy could face stiff new headwinds in the years ahead, in the form of a weaker dollar and/or higher interest rates.
The codependency between the United States and China was a marriage not of love, but of convenience. In the aftermath of the chaotic Cultural Revolution in the late 1970s, the Chinese economy was in shambles and desperate for growth. Then paramount leader Deng Xiaoping came up with a quick and powerful answer — "reforms and opening up" — code words for growth driven by exports. Meanwhile, the U.S. economy in the late 1970s and early 1980s was going through stagflationary traumas, also needed a new recipe for growth. Cheap goods and inexpensive capital from China quickly emerged as key answers to the United States’ growth dilemma.
But the longer it persisted, the greater the entanglement and the harder it was for each to cope without the other. Ultimately, that led to false prosperities for both economies — bubble-prone consumption growth in the United States and a Chinese export bubble that depended on the U.S. consumption bubble. Just as a psychologist might predict, there was a blurring of identities between both economies. Who was more dependent on whom?
When the bubbles finally burst during the Great Crisis of 2008-2009, China didn’t wait around to answer that question. Taking a strategic view of its growth dilemma — an introspective assessment that the United States has long abhorred — it moved quickly in 2011 to enact its pro-consumption 12th Five-Year Plan, and in late 2013 to ratify crucial economic reforms at the Third Plenum, an important Communist Party meeting. A dysfunctional Washington has taken the opposite approach — failing to look to the long term while absorbing the all too frequent setbacks of near debt defaults, sequestration, a government shutdown, and other kicks of the proverbial fiscal can.
It takes two to be codependent. China is now going its own way, while the United States has yet to realize it has been scorned. China’s embrace of services- and consumer-led growth speaks to a new identity for its long unbalanced economy. The United States’ attempt to spur another consumption binge speaks to a tired and aging growth model. The United States can learn an important lesson from China: Rebalancing — consuming within its means, saving more, and investing that saving in human and physical capital — is its only viable option.