China’s two big challenges

Author: Editors, East Asia Forum

Asia’s — and China’s — path to prosperity is not going to be easy. China’s neighbours in Northeast Asia managed to succeed in joining the club of high income countries and the rest of East Asia is trying to emulate that. But there’s no automatic route to the top.

The impact of the rise of South Korea, Taiwan and Singapore on their neighbours was significant enough but their impact globally was not large. Japan had a much bigger effect and jolted the system. There were the well-known tensions with the United States and other major industrial countries as it took away trade share from the established powers. But through its postwar rise, Japan had a pacifist constitution and its security and defence was dependent on the United States — the tensions were mostly confined to trade.

China’s rise is another story. While only recently having achieved middle-income status, the sheer scale of the country means its impact on global economic and political power is system-changing.

China’s aggregate economic growth has slowed to below 7 per cent — as it must in order to sustain quality growth as its people become richer. But it still adds the largest increment to global output each year and is likely to for a least another decade or so.

China faces the challenge of trying to reach high income status plus the additional challenge of inevitably disrupting the global system on the way there. How that is managed depends as much on the United States, and on China’s neighbours, as it does on China itself.

Most of the world’s population lives in middle-income countries — neither very rich nor very poor. While middle-income countries are full of economic opportunities, the way to higher incomes and living standards is not straightforward. The term ‘middle income trap’, coined a decade ago, describes the hazards. The aphorism caught on, a worry for policymakers and a puzzle for debate among analysts.

To get out of the middle-income trap, countries have to shift from low-skilled to high-skilled, innovative growth industries. That seems simple enough, but what do they need to do to make that transition?

Education, how it’s delivered and to whom are clearly critical parts of the story, but how is an innovative economy created? Putting the right institutions in place is at the heart of long-run improvement in living standards. But the institutions that helped poor countries reach middle income are not necessarily those needed to grow out of the trap.

As innovation takes a more central role, institutions that constrain economic (and perhaps political) freedoms, for example, are not likely to foster creativity or entrepreneurship.

Middle income can be achieved through adopting other people’s technology and creating policy settings that reap the benefits from specialising in international markets. Beyond middle income, the institutional foundations for open financial markets, governance intolerant of economic patronage and supportive of risk-taking and entrepreneurship are required. Demography also has far-reaching consequences for the trajectory of national incomes. A rising young labour force is a valuable but fleeting asset. Ageing populations present unprecedented challenges, even those at the top like Japan.

This week we launch the latest issue of East Asia Forum Quarterly, entitled Stuck in the middle?

To avoid being stuck in the middle, countries need economic and political freedoms, a highly educated and innovative workforce, openness to trade, investment and ideas. The evidence points to many necessary but not sufficient conditions. Making the changes to meet these conditions is tough.

China has an additional challenge. Even though it is not yet rich, China’s scale means it is already the second largest economy in the world. It has long ceased to be a price-taker in the international economy and has now become an international price-maker. Its actions cause international reactions. China’s business-as-usual growth has also changed the structure of global economic and political power. In political and security terms, it’s a force almost whatever it does, militarily.

China is now better represented in global economic governance in the economic sphere. It is at the table of the global economic steering committee in the G20 and its interests are better represented in the IMF. Exercising these new responsibilities will not be easy. Steering and projecting those interests will be a big learning process.

While the liberal international economic order is dynamic and open, and the established powers are gradually making a place for China within it, it’s not all been plain sailing. And the economic dimension of accommodating China within the global system appears easy compared to the political dimension. Figuring out how to respond to China’s political power is another matter.

For the past few years, Hugh White has been pointing out that as much as we might all want the current status quo to continue, it can’t. He confronts us with the question that most prefer to avoid, or worse, pretend doesn’t exist.

In this week’s lead essay, from the EAFQ’s Asian Review section, White states bluntly that ‘[w]e delude ourselves if we imagine that Asia could be transformed economically by the biggest shift in the distribution of wealth in history without also being transformed politically and strategically’. Given China’s growth, ‘we will have a new regional order whether we like it or not’, he says. The challenge is to transition to it without conflict. Like much of the rest of the world, he would like to see the peace and prosperity in the region continue as it has in the postwar period: thanks to US primacy and the security it has provided. White is clear that ‘US leadership has served the region well and no one wants to live under China’s shadow’.

Some may disagree that we will have a new regional order. But China, White points out, ‘no longer accepts American leadership as the foundation of the regional strategic order’. ‘Asia’s leaders’, White suggests, ‘have to start thinking about how the inevitable transformation of the regional order can be managed peacefully’.

A peaceful and stable Asia-Pacific region is yet another necessary condition for China to achieve its high income goal. In its march towards high income, the external geopolitical and security environment might be what China has the least control over. Each country in Asia will play its own role in the transition to a new regional order, peaceful or otherwise. They are all players in the high-stakes game between China and the United States, so it’s important to think hard about what they bring to it.

The EAF Editorial Group is comprised of Peter Drysdale, Shiro Armstrong, Ben Ascione, Ryan Manuel and Jillian Mowbray-Tsutsumi and is located in the Crawford School of Public Policy in the ANU College of Asia and the Pacific.