China is Just Catching Up

It is becoming all too fashionable these days to blame China for many of the world's problems. When it exports, China exports deflation to the rest of the world. When it imports, it exports inflation. If it uses its substantial foreign exchange reserves to purchase US treasury bonds, it is trying to gain control of US financial markets. If it contemplates selling its US treasury holdings, it is financial blackmail. The list goes on.

The world is anxious about China, sometimes understandably so. The main reason is probably rooted in the sheer scale of the country and its dizzying pace of change - 1.3bn people with a real per capita income in 2003 that was seven times the level in 1978. Another reason for global unease is that China is the only country that simultaneously competes with the US and Africa. In human resources, it is rapidly developing formidable research and development capabilities and producing high-quality graduates. Yet its vast and low-cost labour pool makes it one of the most cost-competitive business locations in the world.

There is clearly a need to put the so-called "rise of China" into appropriate perspective. First, the idea that China has "risen" is quite misleading; in fact, China has resurrected itself after being the world's largest economy throughout much of history. According to Angus Maddison, an economic historian, China accounted for one third of the world's gross domestic product in 1820 and in the 13th century was ahead of Europe in per capita income terms. Even in 1960, China was just a few years behind Japan in its technology for the machine tools industry. The point here is that China's economic achievements have not matched its vast economic potential. This is not to detract from its remarkable progress of the last 20 years, but to say that China is simply catching up with, rather than increasing, its economic potential. In 2002, in purchasing power parity terms, China's GDP accounted for 12 per cent of global GDP. In terms of exchange rates, however, this falls to 4 per cent - less than the 5 per cent claimed by China in 1952. For economic historians, one puzzle is not why China has grown so fast but why it is so poor in the first place. In Asia, China is conspicuously absent from the postwar economies that caught up with the west's living standards. This says something about the current outcry in the west over "job losses" to China. In many ways, China "lost" many of these jobs to east Asian neighbours because its leaders made terrible policy choices, embracing central planning and economic autarky before market reforms in 1978. While this does not soothe the pain of the adjustment, it clarifies why the current generation of western workers - rather than their parents - are bearing the adjustment costs associated with China's rise.

China's rapid growth has clearly brought benefits worldwide, not least the revival of Japan's economy on the back of China's surging demand. Yet western analysts remain fixated with the cost side of China's rise. This lopsided view arises partly from the difficulty of seeing the benefits while the costs remain highly visible. Take trade. Beyond the question of whether America's huge trade deficit with China actually hurts the US, China ploughs back much of its trade surpluses into US treasury bonds, which contributes to a low US interest rate environment. But few US homeowners would toast the rise of China when signing their closing documents and many would denounce China for playing unfair in its trade policies.

The third point is that China's rise is fundamentally complementary, rather than competitive, with western interests. Unlike some of its neighbours, China has chosen to rely on foreign investment more heavily than on nurturing domestic private companies as a source of development and trade. The protracted negotiations over China's accession to the World Trade Organisation and Beijing's occasional nationalistic outbursts mask the huge economic positions that foreign companies have established in China's economy. In the first three quarters of 2003, total profits from US companies' greater China operations exceeded those from Japan. In 2002, five of the top 15 exporters in China were foreign - among them, Motorola, Logitech and Dell Computer contributed to what is often billed as "China's export miracle". FDI illustrates why the benefits of China's rise are often hidden while its costs are often exaggerated. Through FDI, China runs a huge processing operation for the world on behalf of multinational corporations. This is one reason why its trade/ GDP ratio is inordinately high for a continental economy - more than 40 per cent compared with about 20 per cent for the US. While the nationality of a finished product is easily discernable, that of its individual components is not. In this regard, "Made in China" is fundamentally misleading; "Processed in China" is more accurate.

All the above points to the continuing "rise of China," but western countries could prepare better for this through rational analysis rather than hysteria and exaggeration.