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No going back

17 January 2013 By Edward Hadas

China’s growth is disrupting the world order. It’s not just the size of the economy, set to surpass that of the euro zone around 2017, according to Axa Investment Management. Nor is it the country’s rapid growth. It is more the way China has made three big accepted ideas about development seem wrong. The effects could be temporary – or disastrous.

Mercantilism redux

As Harvard economist Dani Rodrik points out, China has rehabilitated some of the basic principles of mercantilism, the school of economics which calls for governments to control trade, support domestic industry and run trade surpluses. China has thrived by following much of the mercantilist recipe, which has involved accumulating around $3 trillion of foreign currency reserves.

From the mercantilist perspective, this accumulation makes perfect sense. The reserves have put China in a strong position in international negotiations while the under-valued currency which produced them has encouraged investment and created jobs. China has grown so large and influential under this strategy that it has become harder for enthusiasts for free markets and free trade to argue convincingly that their model is the right one.

It also leaves the world with a financial problem. China’s trillions have mostly been invested in government debt rather than in productive assets. Directly or indirectly, the steady wave of careless Chinese funds probably helped nurture the financial excess which led to the last crisis. While Chinese trade has become more balanced, the numbers remain huge: the 2012 surplus was $231 billion, enough to create waves in the markets.

Rich and poor

Ever since the industrial revolution, political authority and economic clout have gone together. First the UK, then the United States and more recently Japan have combined economic influence with high average incomes, sophisticated institutions and mastery of advanced technology. China breaks the mould.

The People’s Republic is more poor than rich. The GDP of $8400 per person makes it less well off than Albania and Bulgaria, let alone the $48,000 per person GDP of the United States. China also lacks some rich country traits: strong and honest institutions, world-leading research and the ability to lead the globe in technology and design.

The result is a paradox. China has the combination of absolute size and growth momentum which makes it the reference customer for everything from oil to the most advanced telecoms. But it does not have the expertise to take global leadership. In the past, economic reach like China’s would have been accompanied by a strong and confident military, but the Chinese armed forces are short on skills, equipment and purpose.

Lost leadership

Previous world economic leaders came with a strong belief that their culture had something to offer the world. In that sense, the American way of life was a worthy successor to the British belief in a natural ability to rule justly. The Japanese were more insular and insecure, but at least offered a cult of manufacturing expertise.

China, by contrast, is lost. The ruling Communist Party has no consistent ideology. The pre-communist Middle Kingdom’s sense of superiority has been discredited by centuries of decline. The result is a government which is powerful but lacks a popular mandate.

Indeed, the greatest threat to the People’s Republic’s uninterrupted growth may be that the government will be unable to retain the people’s support. The world is stuck with a rudderless leader.

Forward into the dark

It is churlish to begrudge the enrichment of China, even if the rest of the world might wish China’s economic trajectory had been different.
But it is rational to worry. Mercantilism could lead to global resentment or further financial disruptions. Trade-related wars were common in the first mercantilist era. Leadership vacuums are sometimes filled by dangerous people and ideas. China’s cultural and political gaps in the 19th century allowed the messianic Taiping rebellion, with an estimated death toll of 20 million.

The question is whether the novelties in China’s model will continue to be successful. The risks of failure increase as China’s GDP grows. So do the disruptions that would be caused by that failure. And by blazing a new path of development, China’s continued success presents the world with an equally tough challenge.



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