China’s fall, not its rise, is the real global threat

China’s model has its limits, and it’s unclear whether the world economy could pick up the slack
China’s fall, not its rise, is the real global threat
Beijing, China. The Asian country has build an impressive economic engine
By Bloomberg
Tue 04 Oct 2011 01:07 PM

China’s rise
to global prominence has long preoccupied the leaders of the developed world.
They should be more concerned about what happens if the country’s growth
falters.

With its
combination of cheap labour, easy money, undervalued currency, heavy investment
in manufacturing and focus on exports, the nation of 1.3 billion has built an
impressive economic engine. From 2008 through 2010, China contributed more than
40 percent of the world’s growth.

But the
Chinese model has its limits, and that has far- reaching consequences for the US
and Europe, both of which are increasingly dependent on China. The country’s
share of global exports already exceeds 10 percent, larger than that of Japan
at its peak in 1986. Barring some miracle, Chinese exporters can’t expand their
market share much further without lowering prices and wiping out their own
profits, research by economists at the International Monetary Fund suggests.
China’s dependence on exports also makes it highly vulnerable to slowing growth
in the developed world, and to rising trade tensions: The US Senate today began
debating a bill that could ultimately lead to punitive tariffs on Chinese
imports in retaliation for undervaluing its currency.

Meanwhile,
economic stress is mounting at home. Labour costs are surging as the supply of
young, capable factory workers wanes and living conditions rise along with
expectations of better wages. Cheap and abundant credit has driven over-
investment and pushed up real-estate prices to levels many families can’t
afford, adding to social tensions and possibly setting the country up for a
bust. China’s approach to managing its exchange rate is fueling inflation,
which government figures put at 6.2 percent in August.

Chinese
officials are well aware of the problems their country faces. As Premier Wen
Jiabao famously put it back in 2007, the country’s growth is “unstable,
unbalanced, uncoordinated and unsustainable.”

The
government’s aim, as laid out in its latest five-year plan, is to move away
from reliance on exports and spur Chinese consumers to spend more - an outcome
that would benefit the entire global economy by boosting China’s demand for
other countries’ goods and easing the trade imbalances that have contributed to
the developed world’s debt troubles.

The
implementation will be tricky. Getting people to spend requires the Chinese
government to eliminate many of the subsidies - including cheap labour, low
interest rates and an undervalued currency - that have fueled growth so far.
Consumers need more income, so companies will have to pay their workers more.
Consumers also need a stronger currency to boost their buying power, so
exporters will lose some of their competitive edge. Savers need to earn a high
enough return to guarantee their retirements, so banks’ and companies’
borrowing costs will rise.

Article continues on next
page…

As a
result, vast swaths of Chinese industry could be rendered unprofitable. Bad
loans could force the government to step in and recapitalize banks. Fixed
investment, which makes up 46 percent of the Chinese economy compared with only
12 percent in the US, could fall sharply, undermining the employment growth
needed to boost spending.

In
short, China’s export-driven model could fall apart before consumers are able
to pick up the slack.

In such
a crisis, China’s economic weight would become a liability. The IMF estimates
that the impact of Chinese demand on the world’s largest economies has more
than doubled over the past decade. A deteriorating outlook for Chinese imports
could send commodity prices plummeting, precipitating heavy losses for
investors and risking financial contagion.

There is
very little the leaders of the developed world can do to influence China’s
fate. Trade wars, such as the one the US Senate may be on the verge of
launching, will only make the situation worse. Instead, Europe and the US need
to focus on limiting their own vulnerability: The longer they keep growing at
rates not far above zero, the more likely it is that an unexpected shock - such
as a Chinese crisis - will tip them back into a recession.

In
Europe, leaders must move quickly to solve a deepening debt crisis and deal
with insolvent banks. In the US, they need to take radical measures, including
pumping more federal stimulus money into a stalled economy and providing debt
relief to underwater homeowners, to clear the way for renewed growth. Over the
long term, leaders on both continents need credible plans to stop debt from
growing faster than the underlying economies.

Prudence
requires being prepared for contingencies such as a bad outcome for China. If
we don’t solve our own problems soon, we won’t be ready.

(This is a Bloomberg Views piece.)

For all the latest business news from the UAE and Gulf countries, follow us on Twitter and Linkedin, like us on Facebook and subscribe to our YouTube page, which is updated daily.

Subscribe to our Newsletter

Subscribe to Arabian Business' newsletter to receive the latest breaking news and business stories in Dubai,the UAE and the GCC straight to your inbox.