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US recovery and China's growth go together

By Dan Steinbock (China Daily)
Updated: 2009-01-14 07:37

For half a century, East Asia's economic miracle has served as a model of development worldwide. This growth model has been based on two preconditions.

On the one hand, it has rewarded countries and regions that managed to develop or benefit from competitive export industries - from Japan to the "tiger economies" (China's Taiwan and Hong Kong, South Korea, and Singapore), to Chinese mainland and eventually India in the 1990s.

The other precondition of the growth model has been the ability and willingness of the global economy - led by the US consumer - to absorb these exports.

The model thrived from the 1960s to the 1990s. During this period, US personal spending, adjusted for inflation, tracked the overall growth of the economy. American consumers were able and willing to buy products made in Japan, tiger economies, and Chinese mainland.

More recently, American consumers have been willing, but no longer able to buy - except by living beyond their means, subsidized by banks that are now falling apart.

That era is now history. The question is: How could export-led growth be re-ignited?

In a curious twist of history and facts, some observers argue that, like the pre-Depression United States, contemporary China should serve as the catalyst of the world economy.

During the 1920s - so the argument goes - the US exported its massive industrial overcapacity mainly to Europe, until the stock-market and banking crashes of 1929-31 undercut consumption at home and abroad. Just as foreign overconsumption had come to an end, US overproduction had to end.

Instead of engineering massive fiscal expansion to replace declining global demand, Washington hoped to create additional demand at home by discouraging Americans from buying foreign products.

As part of this strategy, the US Congress passed the notorious Smoot-Hawley Tariff Act in 1930, which sharply raised the cost of foreign imports. Congress hoped to increase the trade surplus by forcing most of the adjustment in US overcapacity onto foreigners.

Naturally, other countries refused to cooperate and retaliated by erecting their own trade barriers. As international trade plummeted, the overcapacity problem was pushed back onto the US. In the absence of sufficient expansion of demand, the nation was forced to close factories and the Great Depression ensued.

Today, the roles have been reversed. Until last year - the argument concludes - US overconsumption was fed by Chinese overproduction, until the credit crisis forced US households to cut back sharply on spending. Consequently, as the nation with the largest trade surplus, China should now play the leading role in global adjustment.

It is an intriguing argument. It also conveniently shifts the responsibility for the global financial crisis from the West to the East. But is it valid?

Since the argument is that China this year is in the same position as the US in 1929, let's take a closer look at the prosperity and exports in the two periods.

The shorthand for prosperity is gross domestic product (GDP) per capita, adjusted for purchasing power parity. In 1929, it was close to $6,899 in the US. In the US' export markets (UK, France, Germany), it was significantly lower - about 60 percent to 80 percent of the US level.

If the two periods are comparable, as the argument claims, GDP per capita in China's export markets (the US, Japan, South Korea, and Germany) should be 60 percent to 80 percent lower than in China. Yet, the reality is the reverse. In 2007, China's GDP per capita was about $2,700 - about 10 percent to 20 percent of the level of its export markets.

What about the exports? After all, the argument assumes that Chinese exporters today are as powerful as US multinationals were in the pre-Depression era.

In the 1920s, the US great exporters - General Motors, General Electric, Procter & Gamble, DuPont - were vertically integrated giants, which developed, manufactured and distributed their products. They dominated the value-added and thus most profits.

In China today, some 60 percent of exports accrue to foreign-invested enterprises. The percentage rises with the technology level. Through localization, these multinationals have been a great source of knowledge spillovers, technology transfer and employment in China. Nonetheless, most of the value-added and thus most profits accrue to these multinationals - not to China.

There are also substantial differences between the pre-Depression United States and China in this century in terms of the role of exports in the national economy. In 1929, exports accounted for about 5 to 6 percent of the US GDP. In China, exports accounted for 38 percent of the GDP in 2007.

In other words, Chinese prosperity is only a fraction of the prosperity levels of its greatest export markets. Further, foreign multinationals dominate Chinese exports, value-added and profits in China.

In 1929, the US could have changed the course of history through massive fiscal expansion to replace declining global demand. Today, China, even if it were willing to, cannot and should not be expected to play a comparable role - not yet.

Over time, China's prosperity levels will grow, in accordance with increasing productivity. However, China today is not the US in 1929. The time is different. The place is different. And the world is far more globally interdependent.

In the past, some observers claimed that China had "decoupled" from the US-led world economy. Measured in terms of exports and imports of GDP, the degree of openness of the US and Chinese economies in 2007 were 22 percent and 65 percent, respectively. China is almost three times more open. In such conditions, the "decouplement" theory is naive.

Today, plunging domestic demand in the US and China has left manufacturers in both countries plagued with overcapacity. As Chinese Premier Wen Jiabao has put it, maintaining "steady and fast growth" is the "biggest contribution" China can make to help the world overcome the current financial crisis.

In the postwar era, the US was the most outspoken advocate of international multilateral institutions and free trade. During the past eight years, the US has opted for unilateralism in security and become increasingly skeptical about free trade.

Before Christmas, in one of her last acts as US Trade Representative, Susan C. Schwab filed a sweeping petition with the World Trade Organization alleging that China illegally aids local exporters of Chinese-branded products, from appliances to apparel, with such subsidies as cash grants and cheap loans.

In the long run, such trade unilateralism could prove devastating to China, the world economy and particularly the United States.

Soon the incoming US president Barack Obama must cope with the estimated $1.2 trillion federal budget deficit. The new White House must also demonstrate global leadership to reignite growth in the world economy. That leadership is impossible without multilateral cooperation.

Today, the US' recovery, China's steady growth and the stable international environment are intertwined. The US prosperity is no longer possible without China's economic development.

The author is research director of International Business at the India, China and America Institute, an independent US think tank

(China Daily 01/14/2009 page9)