China’s century or America’s?

Author: Barry Eichengreen, UC Berkeley

Everyone by now has grown accustomed to, if not physically weary of, articles extolling China’s economic dynamism and rehearsing America’s decline.

While the US is only starting to recover from its most serious recession in nearly 80 years, China glided through the global financial crisis largely unscathed. Even if China’s economic growth now slows to 7.5 per cent, as anticipated in the government’s latest official growth forecast, this figure will still be triple the rate of growth in the US, where post-crisis economic expansion remains subdued. It will not be long before China overtakes the US in sheer economic size. And with this reversal of economic fortune will also come a reversal of political fortune, as China assumes the leading role on the global geopolitical stage. The 21st century, in this view, will be China’s century.

Yet one also hears hints of a very different narrative, in which the US is poised to experience an economic resurgence and China is about to hit the wall. In this view, the Chinese model of export-led growth fueled by cheap labor has run its course. At home, in China, there is pressure for the fruits of productivity growth to be shared more widely. Abroad, companies like Apple feel pressure to accede to improved pay and conditions in the Chinese factories where their products are assembled. China, as a result, is seeing its labor costs rise and export competitiveness decline. In this view, the trade deficit recorded in February is only the first of many.

Increased consumption by Chinese households could eventually substitute for slowing export growth, but spending habits are slow to change. Chinese spending is currently depressed by weak property prices, which augurs badly for state-linked construction companies, local governments and banks. China will be lucky to hit its 7.5 per cent growth target this year, the skeptics contend, and its growth rate will step down further after that, to as little as 3 per cent if über-bears like Beijing University professor Michael Pettis are to be believed.

In the US, meanwhile, there has been a string of positive monthly employment reports (the disappointing early April employment growth report notwithstanding). The Bureau of Economic Analysis reported that Gross Domestic Income grew by an impressive 4.4 per cent in the fourth quarter of 2011. Manufacturing production, in particular, has grown robustly, underscoring recent optimism about the ‘re-onshoring’ of previously offshored manufacturing jobs.

American manufacturing, in other words, is back. US companies have taken the recession as an opportunity to streamline their operations and boost their productivity. The automotive companies, which three years ago were on the verge of bankruptcy, can now barely keep pace with demand. The US is the world leader in the application of computing power and artificial intelligence to leading-edge consumer goods — instead of a chicken in every pot, the US now has an iPhone in every car. China has nothing remotely resembling America’s dynamic start-up culture. Its role, instead, is as a consumer of products that exemplify US ingenuity, not as a developer of such products — not now or anytime soon.

So is the era of Chinese ascendency and US decline now over? Will the 21st century be America’s, not China’s? To this contrarian view I would say: not so fast. Chinese growth may be slowing, but Beijing still has ample room for manoeuvre and plenty of policy levers to pull — from reducing reserve requirements for banks to increasing infrastructure spending — to prevent its economy from slowing excessively. Labour costs may be rising on the coast, but there remains abundant cheap labour in the interior of the country. And slowly but steadily, Chinese producers are moving upmarket into the production of more sophisticated goods, such as wind turbines and solar panels, which rely on skilled workers with knowledge of advanced technology, not merely low labour costs.

And while the recovery in the US now appears secure, it will be an anaemic recovery at best. No one expects the US to match the 4.4 per cent growth of gross domestic income experienced in the fourth quarter of 2011, which was heavily driven by inventory restocking, or for growth to exceed 2.5 per cent in the medium term. Housing prices continue to weaken, weighing on consumer sentiment. The productivity miracle set in train by the great recession may be starting to fade. And while high-tech innovations may mean high profits for the firms producing them, there is little evidence they are boosting economy-wide productivity or generating the large number of good, middle-class jobs that the US so desperately needs.

Perhaps most disturbingly, the political gridlock preventing the US from dealing with its medium-term fiscal challenges shows no sign of loosening. This may change after the November 2012 presidential election. Then again, it may not.

Chinese policy makers need to acknowledge and address the major challenges that face their economy, while US officials deserve recognition for the positive achievements of the last three years. But none of this changes the fact that China will continue to close the relative GDP gap. The prerequisites for it doing so remain firmly in place. The 21st century is likely to be China’s after all.

Barry Eichengreen is George C. Pardee and Helen N. Pardee Professor of Economics and Political Science at the University of California, Berkeley.

This post is part of the series on the Asian Century which feeds into the Australian government White Paper on Australia in the Asian Century.

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