China: Economic Superpower or Free Rider?
According to popular lore, China is on the cusp of assuming the mantle of global economic leadership from the United States. In the minds of many folks, the U.S.-led global financial crisis-cum-global recession is hard and indisputable evidence of this seminal shift. As the dust settles from the crisis, China's economy is now among the strongest in the world, the U.S. economy among the weakest. Game over - China is bound to lead, America and Europe destined to lag, right?
Not so fast.
China's economic rise notwithstanding, there are fundamental questions that loom large over the Middle Kingdom and the world at large. To whit, when it comes to being the steward of the global economy, is China up for the task? Is Beijing ready to take the lead in promoting global growth not just for China but for the world at large? Is the nation willing to revamp its growth model, reducing its dependence on exports in favor of more consumption-led growth? More broadly, think the Doha trading round, an agreement on global climate change, aid and assistance to the world's poorest nations - is China ready to step to the forefront and use its commensurate economic influence to effect change for the good of the global commons?
I have many doubts. Juxtaposed against China's rising economic stature is the lingering mindset and influence of China's modern architect of economic reform, Deng Xiaoping. It was Deng who famously warned the nation to "observe calmly; secure our position; cope with affairs calmly; hide our capacities and bide our time; be good at maintaining a low profile; and never claim leadership."
Deng's manifesto runs counter to the common consensus that China is ready and willing to lead the global economy. Re-confirming Deng's views, a prominent Chinese scholar, Professor Song Xinning of the United Nations University, made the same basic argument at a recent forum in Brussels hosted by the German Marshal Fund. I was one of the panelists and was mildly surprised by the professor's belief that China was not prepared to lead the world. More worrisome was the professor's idea of China being a "free-rider."
Not surprisingly, exhibit one of China's "free-riding" revolved around the nation's heavily managed exchange rate regime, with the renminbi relatively pegged to the U.S. dollar. This policy has triggered concerns across Asia and Europe since as the greenback has weakened this year, so has China's currency. The upshot - China has effectively shifted the burden of the dollar adjustment on to other nations, notably developing Asia and Europe.
The dangers associated with this strategy are two-fold: the longer China resists an appreciation of its currency - justified in large part by the nation's massive reserve pool, $2.3 trillion in September - the greater the risks of rising global protectionism. Remarkably, the past year has been relatively free of blatant measures to restrict trade, an unexpected development given the severity of the global recession. However, that could change if China's cheap currency strategy causes the nation's current account surplus to continue to rise. This, along with stubbornly high unemployment rates in Europe and other parts of Asia could invite a new round of global protectionism or trigger similar moves a la Vietnam. The latter, in the face of tough Chinese competition, recently opted for a 5.5% devaluation of the dong.
Second, the longer China maintains an inflexible exchange rate, the longer it will take to rebalance the composition of global growth. Consumption in China alone will not offset weaker spending in the U.S., although there is little doubt that among the surplus nations, China has to take a prominent role in spending. If the Middle Kingdom leads - consuming more, exporting less - other nations will follow as well as, helping the U.S. and other deficit nations shift towards more export-led growth.
The Bottom Line
China's exchange rate policy remains a key known unknown as the New Year dawns. On China's resistance to adjust its exchange rate, Martin Wolf of the Financial Times recently opined that "we are watching a slow-motion train wreck."
Time will tell how all of this plays out. China is emerging as a legitimate economic superpower. However, when it comes to exchange rate policy, the country remains a "free rider." The latter raises multiple questions regarding China's willingness to lead the global economy.
The views expressed in GMF publications and commentary are the views of the author alone.