China: Globalization’s Lynchpin

Stephen DeAngelis

November 3, 2008

China has known for some time that it needs to rely less on exports and develop a growing domestic market. Although it has made some progress along those lines, it has tried to milk the export cow as long as it could. As a result, the current financial crisis has caused significant economic woes for Chinese companies primarily reliant on exports [“China, an Engine of Growth, Faces a Global Slump,” by Jim Yardley and Keith Bradsher, New York Times, 23 October 2008].

“For three decades, China has fueled its remarkable economic rise by becoming the world’s workshop and unleashing a flood of low-priced exports. But faced with a possible global recession and weakening demand for Chinese exports, the question now is whether the ruling Communist Party can prevent the financial crisis from derailing the country’s economic miracle. This question is pressing not just for China but also for the rest of the world. American officials and many economists say continued Chinese growth is vital to the global economy as the United States and Europe face severe downturns. Yet to navigate the crisis, many analysts say, China will need to recalibrate its economic model, stoke domestic investment with heavy government spending and promote policies to increase consumer demand in a nation known for high savings rates.”

Encouraging domestic consumption and decreasing savings rates requires walking a fine and dangerous line. It was domestic consumption maintained by credit that started the financial crisis in the United States. Yardley and Bradsher believe it is a good time for Chinese leaders to reconsider the road ahead because it falls near the anniversary of policy decisions that started them on the road to global economic influence.

“The global crisis is also arising at a politically resonant moment for China. This month is the 30th anniversary of the reform policies that first ignited its market-oriented growth, a milestone that has raised inevitable questions about the next steps China must take to become a fully modern economic and political power. At the geopolitical level, China would seem well positioned to expand its influence. It sits on $1.9 trillion in foreign exchange reserves, accumulated from giant trade surpluses and heavy foreign investment in China, and it could acquire discounted stakes in Western banks and industrial companies. But for now, most analysts say China’s top priority is protecting its own economy. Chinese leaders say the domestic financial system is largely insulated from the global crisis — China’s banks remain domestically focused and have relatively small exposure to toxic securities sold by American and European banks. But economic growth has fallen to the lowest level in five years, unemployment is a growing concern, and scores of factories are closing in the country’s export region. Domestic stock exchanges have lost 65 percent of their value, and real estate sales have plummeted.”

The reason for these dire economic consequences is that Chinese companies have built their empires on exports. With exports waning, their futures look less bright — unless they can help turn the domestic Chinese economy around. Yardley and Bradsher continue:

“China still seems likely to avoid an outright recession, but a significantly slower growth would pose a political challenge for the Communist Party, which derives much of its legitimacy from delivering jobs and increasing wealth. Conventional wisdom holds that China’s output must grow at a minimum of 8 percent for the economy to produce enough jobs to absorb increases in the working-age population, and many economists expect growth to drop below that level next year. Just last week, thousands of unemployed workers protested outside closed toy factories in Guangdong Province, the country’s export hub. Slightly more than half the country’s toy exporters shut down in the first seven months of this year, mostly small companies that struggled to cope with new safety standards as well as weakening Western demand, according to China’s customs agency.”

Some companies deserve to go out of business. Certainly businesses producing faulty and dangerous products should be driven from the marketplace. Only strong (well managed) businesses have a long-term chance to thrive in a globalized world. The challenge for China (like many other countries) is creating new jobs as well as replacing lost jobs — and doing it all in a slow economic environment.

“Already, Chinese leaders are preparing a response that could resemble the government spending spree from 1998 to 2000 that is credited with helping China avoid the worst of the Asian financial crisis that broke out in 1997. Former Prime Minister Zhu Rongji poured billions of dollars into flood control, road building and new airport projects to stimulate economic output. Much of that infrastructure is now considered essential to China’s competitive advantage as a manufacturing exporter. Today, improvements are needed in railroads and the electrical power grid. But China’s most conspicuous needs are the softer side of a modern economy — a health care network, lower tuition and fees for schools and universities and improvement in the rudimentary social safety net, economists say. Such steps are seen as crucial if China is to give consumers — especially working-class urban residents and the 800 million people still classified as peasants — the confidence to spend rather than increase their savings.”

Analysts, however, note that increasing spending on infrastructure gets harder with time. The most obvious reason is that with so much of China’s infrastructure recently constructed selecting which infrastructure to tackle next is a trickier problem. Many of the Chinese who need jobs are not necessarily well-suited for the kinds of jobs that would be created by government “make work” projects. Stimulating consumer buying (and, thus, creating jobs in the civilian sector) is a much better course of action.

“David H. McCormick, the under secretary for international affairs at the Treasury Department, said in a telephone interview that Chinese officials understood that the sheer size of their economy, combined with weakening demand overseas, meant that increasing demand for goods and services within China would be in China’s own interest. ‘They can’t count on exports being such a driver of their economy going forward,’ he said. To date, the most significant new measure is the land reform announced [in mid-October]. Full details of the program are still unclear, but the plan allows farmers for the first time to lease or transfer their land-use rights, a landmark step in what is still nominally a socialist country. Economists say they believe that the measure will improve the rural economy, though few predict sudden benefits. To raise rural incomes more rapidly, the top Chinese economic planning agency on Monday raised the minimum purchase price of wheat by up to 15 percent beginning next year.”

Helping impoverished peasants living rural areas to lift themselves into a viable middle class is a great idea, but a difficult objective to achieve.

“Transforming the countryside and creating a nation of consumers is likely to prove at least as arduous as turning China into a manufacturing giant. In recent years, President Hu Jintao and Prime Minister Wen Jiabao have eliminated the ancient agricultural tax and increased spending on rural initiatives. Yet the rural-urban income gap has continued to worsen. Today, China still has more than 500 million people living on less than $2 a day; nationwide per capita income is only about $2,000. The social safety net remains so inadequate that most peasants save their spare earnings to protect against a medical crisis or as a thin cushion for old age. Andy Rothman, a longtime analyst at CLSA Asia-Pacific Markets, an investment bank, said that the government had been promoting domestic consumption for years but that by necessity it was a gradual process and not one that could provide a quick fix to a global slowdown.”

If China remains relatively strong during this economic downturn, it has a chance to increase its already considerable international influence — not simply because it holds so much foreign capital but because it could provide much needed financial leadership.

“From a geopolitical standpoint, China would seem to have an opportunity to fill a void created by an ailing West, especially given the country’s huge foreign exchange holdings. President Asif Ali Zardari of Pakistan visited Beijing this month in search of a financial edge to help his country stave off bankruptcy — an overture that could become more common as China is perceived as sitting on a money pot. More pertinent to the United States is whether China will re-examine its strategy of financing American debt. Chinese experts say that the American and Chinese economies are so intertwined that Chinese leaders will not make any abrupt changes in their policy of directing the bulk of China’s foreign currency reserves to dollar-denominated assets. The United States Treasury secretary, Henry M. Paulson, Jr., and other senior American officials have been in almost daily contact with their Chinese counterparts. ‘China, with the responsibility of a big country, will not make trouble for international financial markets,’ said Hu Angang, a Chinese economist who is the director of the Center for China Studies at Tsinghua University. “The Chinese government is very rational and flexible, and very clearly recognizes any policy does not just influence domestic markets but also global markets.’ Some Chinese experts are suggesting that China could use more of its foreign reserves to purchase stocks in Western companies and even as leverage to gain positions on corporate boards. Doing so, these experts say, would allow China to develop expertise and gain more experience in global business.”

The willingness of China to play a role similar to the one that United States has played for the last half-century should be looked on positively. Unfortunately, there are many conservatives in the United States who remain bent on seeing China as America’s next great adversary. They may very well prevent the Chinese from investing in the American economy.

“China was stung when a state-owned Chinese petrochemical company tried and failed to purchase Unocal, an American oil company, and that it would be cautious in making any moves deemed politically risky. Domestic pressures also exist; public criticism has erupted after some investments by the country’s sovereign wealth fund lost money. No one is yet certain when the global financial system will stabilize, but the crisis has convinced many economic analysts that the system itself will be re-examined. The financial crisis is ‘a ground-shaking event, but people are going to stick to the same system,’ said Wang Tao, chief of the China economic research unit for UBS Securities. ‘But they are going to think about how to reform the system, and China will probably have a stronger voice than before.’ In recent years, some Chinese experts have written analyses about the inevitability of an American decline and how China must prepare to manage it. But in the face of the current crisis, most Chinese analysts say China is nowhere near ready yet to stand as a superpower.”

The more that China can be drawn into the international system (and away from the temptation of creating an alternative Asian economic system) the better the world will be. The West will be watching closely to see if Chinese leaders react responsibly and creatively to the current situation. If they do, then globalization has an excellent chance of continuing to help bring millions of more out of poverty.