Get Ready for the Next China

Foreign investors and governments must prepare to deal with China's new economic goals. Under new leaders, China is shifting toward a stable consumer-led growth model, away from production and rapid growth, writes Stephen S. Roach, Yale professor, author and former chairman of Morgan Stanley Asia. New policies emphasize discipline in politics and finance. Also, the country’s service sector is the smallest among major economies, and Roach explains that “services generate about 30 percent more jobs per unit of Chinese output than do manufacturing and construction – allowing China to hit its all-important labor absorption and social stability goals.” China’s investment in services could reduce its investment in US debt. The US-China Strategic and Economic Dialogue is July 8 to 12. China has a deliberate strategy for rebalancing while the US does not. Roach urges the US to organize itself around priorities, stepping back from demands on currency revaluation while focusing on gaining access to China’s bound-to-grow service markets. – YaleGlobal

Get Ready for the Next China

The US must adjust as China’s new economy shifts towards consumer-led growth and services
Stephen S. Roach
Tuesday, July 2, 2013

NEW HAVEN: The Next China is now at hand. Yet the United States remains fixated on the Old China, unprepared for major transformation in the world’s second largest economy. The US-China Strategic and Economic Dialogue slated July 10 to 11 in Washington, DC, provides a major opportunity for both nations to recast what could well be the most vital economic relationship of the 21st century.

China is most assuredly on the move. The debate over a strategic shift to a more balanced consumer-led growth model is over. The focus is on implementation. The 12th Five-Year Plan laid out the strategy – three pro-consumption building blocks of services-led job growth, urbanization-driven income leverage and a more robust social-safety net. But it was tough to get the ball rolling, especially in light of the inertia of China’s deeply entrenched power blocs at the local government and state-owned enterprise levels.

China’s new leadership under President Xi Jinping and Premier Li Keiqang has broken the gridlock. With a series of stunning moves in the early months of their administration, China’s fiscal and monetary authorities have been given new marching orders. The growth slowdown of early 2013 has not been countered by a typical Chinese proactive fiscal stimulus. Instead, the new leadership seems content with 7.5 to 8 percent growth in gross domestic product.  Similarly, the central bank did not rush in to stem a liquidity crunch in June. Instead, it used the occasion to caution banks, especially “shadow banks,” against returning to an undisciplined and excessive expansion of credit. 

The message from this new approach to Chinese macroeconomic stabilization policy is clear: Gone are the days of open-ended hyper growth. Significantly, this message has been reinforced by an important political overlay. Xi’s rather cryptic emphasis on a “mass line” education campaign aimed at addressing problems arising from the “four winds” of formalism, bureaucracy, hedonism and extravagance underscores a new sense of political discipline directed at the Chinese Communist Party. The CCP is being urged to realign itself with the core interests of citizens and their need for fair and stable economic underpinnings.

This new mindset works only if China changes its growth model. A services-led growth dynamic, one of the pillars for a consumer-led Chinese economy, is consistent with a marked downshift in trend GDP growth. That’s because services generate about 30 percent more jobs per unit of Chinese output than do manufacturing and construction – allowing China to hit its all-important labor absorption and social stability goals with economic growth in the 7 to 8 percent range rather than 10 percent as before. Similarly, a more disciplined and market-based allocation of credit tempers the excesses of uneconomic investments, necessary if China is to begin absorbing its surplus saving to spur consumer demand.

With China’s new leadership embracing a very different approach to policy and politics, it has little choice other than to move ahead aggressively in implementing its consumer-led rebalancing.  The United States needs to take that possibility as a given as it frames its approach to the upcoming dialogue with China. This raises four key issues:

  • First, China’s consumer-led growth presents the United States with an important opportunity. With the American consumer on ice for more than five years – underscored by average annualized growth of just 0.9 percent in inflation-adjusted consumption expenditures since the first quarter of 2008 – the US is in desperate need of a new source of economic growth. China is America’s third largest and most rapidly growing export market. Washington negotiators should push hard on market access, ensuring that US companies and their workers have the opportunity to capitalize on China’s transformation. 

  • Second, and related to the first point, is a potential bonanza in Chinese services. At 43 percent of its GDP, China has the smallest services sector of any major economy in the world. Under reasonable assumptions, the scale of Chinese services could increase by around $12 trillion by 2025. Increasingly tradable in a connected world, the coming explosion in Chinese services could translate into a windfall, up to $6 trillion, for foreign services companies from retail trade and transportation to hotels and finance. For the United States, with the world’s largest and most dynamic services sector, this could be an extraordinary opportunity. US negotiators should push especially hard for access to Chinese services markets.

  • Third, it’s high time for US negotiators to give up the ghost of Chinese currency bashing. It has been the wrong issue from the start – after all, there can be no bilateral fix for a multilateral US trade imbalance reflected in deficits with 102 different nations in 2012. That multilateral imbalance is an outgrowth of an unprecedented US saving gap – a far cry from the politically inspired charges of Chinese currency manipulation. Moreover with the renminbi now having risen by 35 percent since July 2005 and with China’s current account surplus having shrunk to less than 3 percent of its GDP, the argument is vacuous. The US-China strategic and economic dialogue has been hijacked by the Chinese currency issue for far too long.

  • Fourth, concerns over cyberattacks should be elevated immediately to a high-priority issue between the two nations. In the early June summit between Obama and Xi, the US pushed on this point in the face of recent publicly disclosed evidence about China’s aggressive cyberhacking attacks on US military and commercial targets. The two presidents agreed to set up a working group focused on this issue, starting with the early July dialogue.  However, since the summit, revelations of comparable efforts on the US side – namely, the so-called PRISM and TAO (Tailored Access Operations) programs of the National Security Agency as disclosed by a former NSA contract worker – have cast this contentious problem in a new light. With both nations heavily involved in cyberespionage, there can be little doubt of the urgency in dealing with this critical issue.

The Chinese and the US economies are at pivotal junctures. Both need to rebalance – China needs to save less and consume more whereas America needs to save more and consume less. At the same time, both need to grow enough to absorb surplus labor – the structurally unemployed in the United States and a vast and impoverished rural population in China. China has a strategy and a plan, and the commitment of its new leadership, to push ahead with due haste on its rebalancing agenda. The United States has none of these. 

Philosophically opposed to strategy and anything that smacks of planning, the United States remains steadfast in its commitment to the wisdom of the Invisible Hand. That wisdom is now in question.

But there is another twist. As China shifts to consumer-led growth, it will start to draw down its surplus saving and current-account surplus. That could lead to a reduction in its vast $3.4 trillion foreign exchange reserves, thereby dampening China’s demand for dollar-based assets. Who will fund a seemingly chronic US saving shortfall – and on what terms – if America’s largest foreign creditor ceases doing so?

We live in an asymmetrical world – but the asymmetrical rebalancing of two codependent economies could pose enormous challenges to both the United States and China. The upcoming Strategic and Economic Dialogue offers an opportunity for both nations to grasp the implications of these tectonic shifts.


Stephen S. Roach, a faculty member at Yale University and former chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China (Yale University Press, forthcoming in January 2014).
Copyright © 2013 The Whitney and Betty MacMillan Center for International and Area Studies at Yale