The New Agenda With China

© Institute for International Economics. All rights reserved.

The Emerging Economic Superpower

When Presidents Bill Clinton and Jiang Zemin meet in Beijing, they should begin to address one of the central issues of the early twenty-first century: the global impact of China's emergence as a world economic superpower.

China was the world's largest economy throughout most of recorded history and as recently as the late nineteenth century. The World Bank estimates that, on the basis of national purchasing power, China has already passed Germany to become the third-largest economy on the globe. It could move into second place ahead of stagnant Japan in a decade or so. China already holds the world's second-largest monetary reserves (to Japan) and is the second-largest recipient of foreign direct investment (to the United States). Some Australian and Chinese economists predict that China, even if it grows at “only” 7 percent, compared with 3 percent in the United States, will supersede the United States to again become the world's largest economy by 2020-2030.

Whatever the precise details and timing, China will obviously play an increasingly central role in the world economy. Hence, it must also play a central role in global economic management.

It has already begun to do so on financial issues, as indicated by its constructive role in limiting the spread of the current Asian crisis. It has resisted the temptation to devalue its exchange rate, which would trigger another huge spiral of currency declines throughout Asia and perhaps elsewhere, with enormous effects on markets worldwide. It has stood firmly behind Hong Kong's resolve to maintain its own currency peg despite substantial market pressures. It has maintained solid (if inevitably slowing) growth and reduced interest rates, providing a lone source of regional impetus to the Asian economy. It has sustained, indeed accelerated, the liberalization of its economy in the face of market pressures from all sides.

Moreover, China played a central role in erecting the network of financial defense mechanisms in Asia over the past few years. These arrangements proved inadequate to cope with the crisis of 1997-98 but nevertheless laid a foundation for the more substantial agreements that have now been established. China contributed $1 billion to the rescue package for Thailand (in which the United States declined to participate). These developments are stark reminders of China's importance to the world and the regional economy and promising indicators of its potential for constructive leadership even in the most difficult of situations.

Hence, China must be permitted to enter the World Trade Organization (WTO) as soon as it is ready to meet the group's rules, even if its entry is phased in over a considerable period of time. Even more importantly, China should shortly begin participating in the “finance G-7,” the club of finance ministers and central bank governors of the seven largest industrial democracies (the United States, Japan, Germany, France, Italy, the United Kingdom, and Canada), which seeks to provide essential leadership for the world economy.

We know from history that it is critically important to engage rising superpowers in the global leadership structure on a timely basis. Germany was declared a pariah by the Treaty of Versailles after the First World War and had already felt rejected by the global leadership in the late nineteenth century, with results that were disastrous in security as well as economic terms. Japan perceived similar rejection, both before and especially after the First World War, with equally calamitous consequences. A failure to integrate China now would risk repeating these historic follies, by contrast with the world's relatively successful engagement of the rising United States in the late nineteenth century and of Germany and Japan after 1945.

The Challenges Involved

But the integration of China poses three unprecedented problems. First, China is a poor country. Its per capita purchasing power is only about $2000, less than one tenth that of the present G-7, and 350 million Chinese still live below the poverty level as defined by the World Bank. Quite understandably and properly, China thinks like a poor country, while the other top economies think like rich countries. China could thus be expected to adopt a quite different perspective on some global issues.

Second, China is far from being a true market economy despite its impressive reforms and its plans to accelerate them further. The current G-7 employ various forms of capitalism, but all are fully committed to the market.

Third, China is not a democracy. All other leading economies clearly are.

China is in fact emerging as the first economic superpower in modern times that is neither rich nor fully marketized nor democratic. Hence, both the G-7 and China will have to adopt new mindsets and new mechanisms to achieve effective cooperation.

Hong Kong might be able to help this process on the Chinese side. As a part of China that is even richer and more marketized than most of the G-7, as well as partly democratic, Hong Kong has extensive familiarity with the functioning and mechanisms of the world economy. For example, it has long been a member of the WTO (and retains its independent role there now). Many Hong Kongers hope, with some reason, that China will evolve in their direction over the agreed 50-year transition period. Early engagement of China in the global economic system would provide another avenue to enable Hong Kong to support constructive evolution on the mainland as well as to achieve its own goals.

A key question is whether China wants to play a global economic leadership role. As it struggles with its internal reforms, most crucially the acknowledged imperatives of marketizing the moribund state-owned enterprises and recapitalizing the fragile banking system, there will be strong temptations to avoid international compacts and to preserve maximum domestic flexibility. This is why China has not yet made the commitments that would enable it to join the WTO.

But it is clearly in the interest of the United States and the rest of the world to encourage China to expand its international perspective as rapidly as possible. Doing so would help the reformers tilt the internal Chinese debate in directions that will minimize, if not avoid, future economic conflicts. It would encourage and perhaps accelerate the inevitable transformation of China's political regime. Our experience with postwar Japan, while far from perfect and subject to many crucial differences with the situation in China, suggests that we should make every effort to engage the rising economic superpower in global leadership institutions—including to help influence its own policy outcomes.

Is It Too Soon?

Some may regard this issue as premature. China, after all, is not yet in the WTO. Its currency is not yet fully convertible. Its economic reforms have a considerable distance yet to travel to ensure sustained growth and, in light of the weaknesses in its banking system, to avoid a repetition of the financial distress that is sweeping most of Asia.

In light of China's continued failure to democratize, its inclusion in the G-7 summits, with their far-reaching political implications, would indeed be premature. China's situation is opposite to that of Russia, whose economy is relatively unimportant on a global scale (except as a potential source of disruption), but which has been invited to the summits because of its strategic significance now that it has become at least a nascent democracy.

But the pace of China's economic advance is awesome. Its average income quadrupled over the past 17 years. It jumped from the world's 34th to 10th largest trader during that period.

These advances are likely to persist. Before the outbreak of the current crisis in the region, the World Bank believed that China's growth would continue at 8-10 percent annually. Former Premier Li Peng publicly set a goal of full marketization by 2010. As a member of the Asia Pacific Economic Cooperation (APEC) forum, China has committed to achieve “free trade and investment in the region” by no later than 2020 and has thus implicitly committed to achieve global free trade by then as well because of APEC's devotion to “open regionalism.”

Moreover, for the reasons just cited, the engagement of China with the world's economic leaders represents an enormous challenge as well as a policy imperative and will take considerable time to work out. One key purpose of proceeding now is to help China's leaders to adjust gradually to their new position and develop the necessary global viewpoints. Based on its role in the International Monetary Fund and World Bank, which it joined shortly after launching its reforms in the late 1970s, China could be expected to listen and learn for a considerable transition period. The United States and Europe provided a similar opportunity for Japan in the 1960s and early 1970s, which resulted in Tokyo's relatively smooth (if still incomplete) assimilation into the leadership structure.

The Bilateral Imbalance

In addition to these positive reasons for Presidents Clinton and Jiang to stress global economic leadership issues, the short-term bilateral concerns that have dominated the economic dimension of the relationship to date must be placed in proper perspective.

It is true that official US data suggest that our bilateral trade deficit is now worse with China than it ever became with Japan. In 1987, the ratio of our imports to exports with Japan peaked at 3:1. Hence, our exports to Japan had to rise three times as fast as our imports rose just to keep the deficit from increasing. (In fact, our exports thereafter rose six times as fast as our imports so the deficit declined modestly in dollar terms and the ratio dropped to 1.75:1 by 1996 before starting to climb again more recently.) With China now, our imports exceed our exports by a ratio of 4.5:1. The latter must therefore climb four and a half times as rapidly to avoid further deterioration of the bilateral imbalance in dollar terms.

These ratios are a more meaningful way to assess bilateral imbalances than the absolute numbers, which are now running at $40-50 billion annually with China (and more with Japan), because they better illustrate the prospects for rectifying the situation. And the bilateral imbalances, despite their limited economic relevance, are critically important in political terms because they are demonstrably the best single explanation for trade conflicts between the United States and individual Asian countries.¹

There are five mitigating considerations, however. First, all serious observers acknowledge that, just as the official Chinese data grossly underestimate China's surplus with the United States, the US data substantially overstate that imbalance. Many US “imports from China” include substantial value added in entrepôt Hong Kong. Some US “exports to Hong Kong” are actually destined for China. The US numbers currently overstate our deficit with China by about $10 billion per year,² so that the actual ratio between imports and exports is about 2.5:1 rather than 4.5:1—which is nevertheless still substantial.

Second, however, bilateral trade imbalances are far less important than global current account positions (including trade in services and goods), and viewing all economic partners together. We would hardly raise barriers to trade with Saudi Arabia because our large oil imports produce a bilateral deficit with that country. We would not want Australia to raise barriers against us because our manufactured products give us a large surplus there.

In the case of Japan, our large bilateral trade deficit does reflect the broader reality that Japan runs huge and chronic global current account surpluses that have made it by far the world's largest creditor country. By contrast, China's global current account shows a modest surplus in 1996-98 and was in large deficit as recently as 1993. Its reserves of about $130 billion, the world's second largest (to Japan), are nearly matched by its external debt of $120 billion. Hence, it cannot be viewed as a chronic surplus or creditor country, nor should it be pushed to undertake adjustment actions of the type so sorely needed in Japan. (Indeed, as already noted, the main risk on the currency front is that it might devalue rather than revalue upward.)

Third, and perhaps most important politically, 90 percent of US imports from China were previously imported from other countries and only 10 percent displace production in this country.³ China has in essence been seizing market share from other countries, especially Hong Kong and Taiwan, both of which (especially Hong Kong) have shifted much of their export production to China. The United States in fact now runs substantial bilateral surpluses with Hong Kong and our deficits with Taiwan have fallen sharply as a result. The increase in our global deficit has therefore been much more modest than the bilateral shift with China.

Fourth, a new study of The Costs of Protection in China, conducted for the Institute for International Economics by three leading Chinese economists at the independent Unirule Institute in Beijing under the guidance of noted Chinese reformer Mao Yushi, reveals that China's trade protection, while extensive in the state-controlled sector, is on a rough par with that of Japan and South Korea in overall terms. Both those countries of course have much higher income levels than China, have been members of the WTO for over three decades, and are generally considered to be much farther down the road to full marketization.

Fifth, the United States blocks a considerable volume of its own sales to China through export controls. Such controls are maintained to pursue a variety of US national security and foreign policy goals, including limitation of nuclear proliferation, blockage of the availability of “dual use” items, and expression of disapproval for the 1989 events in Tiananmen Square. Studies at the Institute for International Economics suggest that annual US exports are reduced by $3.5-13.5 billion of 1991-level exports as a result (and that there is little payoff in terms of actually achieving the foreign policy goals).⁴

China's remaining barriers to trade are formidable and, like those of any major economy, should be liberalized as quickly as possible. Bilateral trade imbalances, despite their limited economic relevance, clearly have political salience here at home. Hence, the United States should maintain its pressure on China to accelerate the opening of its economy. But any serious appraisal of the bilateral situation reinforces the conclusion that, at the upcoming summit, the United States should begin to place primary emphasis on the broad systemic question of China's growing role in the international economic order and how to manage its entry into the leadership structure thereof.

Conclusion

When Richard Nixon and Henry Kissinger met with Mao Zedong and Zhou Enlai to renew relations between the United States and China in the early 1970s, they focused on the global strategic position of the two countries. The leaders acknowledged the important differences between their nations but figured out how to cooperate effectively in the setting of the Cold War.

Presidents Clinton and Jiang must address a series of immediate bilateral issues, including pressing security and political as well as short-term economic topics, when they meet in Beijing. They should of course focus on their countries' overall strategic relationship. But now that the Cold War is over and economics has moved to or at least toward the top of the global agenda, as dramatized by the current Asian crisis and China's pivotal role in countering it, the leaders should begin to tackle China's emerging role in the global economic order.

The leaders should bring the festering issue of WTO membership to a clear resolution by agreeing on what China must do to join and by discerning, as best they can, how long it will take to get there. They should begin the process of China's entry into the “finance G-7,” perhaps augmented by bilateral US-China consultations to facilitate the process. By addressing these topics now, the two presidents could anticipate a critical set of problems that the world must face over the coming decade, help to promote a constructive evolution of both economic policy and political structure in China itself, and start building a new framework for the overall relationship between the two countries.

Notes

1. Noland, Marcus. 1997. Chasing Phantoms: The Political Economy of USTR. International Organization 51, no. 3: 365-88.

2. Lardy, Nicholas R. 1994. China in the World Economy. Washington: Institute for International Economics. Updated through 1995 by the US-China Business Council in June 1996.

3. Noland, Marcus. 1996. US-China Economic Relations, Washington: Institute for International Economics.

4. Richardson, J. David. 1993. Sizing Up U.S. Export Disincentives. Washington: Institute for International Economics.