While the West slumps, China's economy has quickly sprung back to life. What that does--and doesn't--say about the new economic order
On a steamy Saturday afternoon just outside Shanghai, Zhang Yi is in a blessedly cool General Motors showroom, kicking the tires of the company's newer models. He's not there to beat the heat. He drives a small Volkswagen and wants to upgrade. A middle manager at a state-owned steel company, Zhang has no worries about his job or China's economy. "Things are still pretty good. I have no problem now affording one of these," he says, nodding toward the array of gleaming new Buicks nearby.
There aren't a lot of places in the world these days where consumers speak with that kind of confidence. While the U.S., Japan and all of Europe are mired in the worst global recession in 30 years, China has shown a restorative strength that six months ago many doubted it had. A devastating slump in exports crippled growth late last year, but on the back of a $586 billion government-stimulus program--about 13% of GDP, spread over two years--China has snapped back. The economy grew 7.9% in the second quarter and will probably expand 8% or more this year. Evidence of increasing momentum appears almost every day. Factory production has begun to edge up, in part because Chinese consumers--unlike their shopping brethren in the developed world--continue to spend money at a healthy pace. Auto sales, helped significantly by government subsidies for small-car purchases, hit an all-time record in April and will easily surpass those in the U.S. this year. Overall, retail sales in China this year are up 16%.
The U.S., the unquestioned leader of the global economy, is in the midst of a disorienting shift in economic policy, away from the let-it-rip form of capitalism that has guided it for almost 30 years and toward more overt government control and regulation of huge swaths of the economy. That transformation is the stuff of increasingly fierce debate--between members of the Obama Administration's economic team who say government had to step in to rescue a global economy on the brink of disaster, and skeptics who believe soaring budget deficits and greater regulation will sap growth in the future. No such doubts are evident in China, where the government reacted to the crisis with alacrity, and the economy is responding in kind.
That's why, for global companies like General Motors, China is no longer the future. It's the present. Of the world's 10 biggest economies, China's is the only one that is growing. And if the trend continues, China could soon surpass Japan to become the world's second largest economy. The market capitalization of its stock markets is already bigger than Tokyo's; the Shanghai exchange has soared more than 80% this year, by far the best performance among major markets. Nations that depend on producing commodities, such as Australia and Brazil, have benefited immensely over the past six months, as demand from China has driven up the price of raw materials from iron ore to tin to copper. Helped by trade with China, Asia's export-driven economies are sputtering back to life. Overall, the International Monetary Fund (IMF) forecasts that in the three years from 2008 to 2010, China will, astonishingly, account for almost three-quarters of the world's economic growth. Not surprisingly, China has become the focus of a world that is looking for a way out of the swamp. As Shanghai-based economist Andy Xie puts it, "Everyone wants to know the same thing: Can China save the world?"
To answer that question, it's worth posing another one. Why has China's economy righted itself while the U.S. struggles? According to a recent study by the World Bank, Beijing's government spending will generate more than 80% of the country's overall economic growth this year, partly because China was already in the midst of a nationwide infrastructure program when the recession hit. Emergency spending measures passed late last year simply added to schemes already under way. In other words, the projects really were "shovel-ready," and the money hit the streets quickly--and in large dollops. Outlays on new railway construction, for example, were $41 billion last year. They will be $88 billion this year. Says a senior FORTUNE 500 executive: "In the U.S., NIMBY [not in my backyard] is still the order of the day, whereas in China it's more like IMBY. They build where they want, when they want. And they move fast."
China's recovery and growing economic importance have led some to suggest that global institutions like the Group of Eight--the U.S., the U.K., Canada, France, Germany, Italy, Japan and Russia--are becoming obsolete and that the only dialogue that really matters going forward is the conversation between the "G-2," China and the U.S. President Obama appeared to acknowledge this on July 27 when, addressing participants in high-level talks between the two countries, he said Washington's relationship with Beijing would "shape the 21st century."
What shape will it take? Beijing is just beginning to throw its weight around. China seeks--and will almost certainly soon get--greater voting rights in the IMF. In June, China agreed to buy up to $50 billion in bonds issued by the IMF to boost the fund's capacity to deal with the global financial crisis. Earlier this year, Chinese leaders, worried about the strength of the U.S. dollar and the safety of its $763.5 billion investment in U.S. Treasury Department debt, called for the creation of an alternative to the greenback as a global reserve currency. More recently, Beijing has signaled an intention to slowly establish its currency, the renminbi, as a dollar alternative in international trade by providing subsidies for Chinese companies to price their exports in renminbi. This willingness to make its positions known publicly and push other governments to see things China's way "is very different from 10 years ago, when Beijing was much quieter and more low profile," says Jun Ma, an economist at Deutsche Bank in Hong Kong.
China is increasingly open about both its ambitions and its concerns over U.S. economic policy, given its position as Washington's largest foreign creditor. Beijing never signed on to what became known in the late 1990s as the Washington Consensus on global economic policy, which called for free trade, privatization, light-touch regulation, prudent fiscal policies and--at least as many interpreted the consensus--free capital flows. In the wake of the credit meltdown, the U.S. Treasury has put forward a plan to enhance regulation of its own capital markets, but that is unlikely to prevent Beijing from continuing to push for the IMF to take a greater role in policing global markets. At its core, despite embracing many aspects of the free market, China runs a top-down, command-and-control economy, and its success so far in skating through the recession relatively cleanly may encourage other developing countries to adopt its brand of capitalism. "I have no illusions that the United States and China will agree on every issue nor choose to see the world the same way," Obama said in his July 27 speech in Washington. "But that only makes dialogue more important."
Not So Fast
Plenty of economists doubt that China's economy is as sound as it appears or that it is truly on the road to a sustained recovery. China's overall economic vigor may continue to impress, but there are questions surrounding the quality of its performance. The People's Bank of China, the central bank, is giving great gobs of money to state-owned banks that, with Beijing's forceful encouragement, are lending to state-owned companies participating in infrastructure construction. Skeptics are frightened by the amount of cash being shoveled out the doors. The central bank recently announced that new loans in June totaled $224 billion. That was more than double the previous month's amount and brought new bank lending in the first six months of the year to nearly $1.1 trillion, exceeding the total for all of 2008.
To optimists, the June data showed just how determined the Chinese government is to implement effective monetary countermeasures to fight the downturn. As Peking University finance professor Michael Pettis says, China is "throwing everything including the kitchen sink" at the problem. There's no question that as a result of the flood of financing, a lot of Chinese have jobs they otherwise wouldn't. But as Grant's Interest Rate Observer, an influential Wall Street newsletter, points out in its latest issue, "Massive injections of money and credit … are always bullish before they are bearish." The newsletter draws worrying parallels between China's current credit boom and the gush of lending that produced the U.S. housing bubble, the collapse of which devastated the financial sector and triggered the global credit crisis and current recession.
There are signs that some aspects of China's recovery are ephemeral. Part of the reason China's stock market has soared is that Chinese companies have received so much cheap financing that they have dumped proceeds into the equity market for lack of better alternatives. Andrew Barber, Asia strategist at Research Edge, an investment-research firm in New Haven, Conn., estimates that up to 30% of new bank lending this year has wound its way into equities. Why isn't the money going into new factories or businesses? The evidence suggests that in key parts of the economy, growth remains anemic, particularly the important export-manufacturing sector, which continues to suffer from the reduction in global demand. According to a report from Fitch Ratings in the U.S., Chinese lending continues to accelerate even though corporate profits overall are shrinking--which suggests China may be incubating its own financial crisis that could be triggered when the adrenaline rush of stimulus-spending wears off.
Those caveats are important, but China's technocrats are well aware of the risks they are running. "They came into this [crisis period] with eyes wide open," says Barber, recognizing that loans being granted in a relatively weak economic climate could start to go bad in droves. The country's once shaky financial sector was cleaned up several years ago--in 2007, nonperforming loans amounted to just 3% of total bank assets--and vehicles set up to deal with China's last banking crisis still exist. In other words, Beijing thinks its financial system is strong enough to handle the risks of its very loose monetary policy.
Even if China's economy continues to power ahead, it will probably not, on its own, be enough to drag the rest of the world into a recovery. Size matters. The U.S. has a $14 trillion economy; China's is $4.4 trillion. The U.S. accounted for nearly 21% of global GDP last year; China just 6.4%. Chinese consumption, in other words, is growing--but is still insufficient to lift the world's advanced economies out of recession. Consumer spending drives less than 40% of China's GDP; in the U.S. before the bust, the consumer accounted for almost 70%. With American shoppers now on the sidelines--the U.S. savings rate has soared from zero to nearly 7% in the past nine months as consumers have closed their wallets--the world desperately needs someone to step into that void.
China can certainly help. But it remains a relatively poor country, with an annual per capita income of $6,000, compared with $39,000 in the U.S. and $33,400 in the E.U. To be solidly middle class in China's big cities is to have an income of about $12,000. Brisk though auto sales may be, most Chinese still can't afford a Volkswagen or a Buick, let alone a BMW. Even as China's consumers feel richer, their share of its economy may not change much until Beijing enacts reforms to the health-care and social-security systems, steps that would give ordinary Chinese more confidence to spend rather than save. Last year, says Peking University's Pettis, China's consumption was about the equivalent of France's. No one is calling on France to save the world.
China is still most concerned with saving itself economically--not anyone else. Beijing is most unnerved by the prospect of large-scale labor unrest of the sort that resulted in the death of a steel-company executive at the hands of a mob on July 24 in northeast China. Thousands of workers had taken to the street, fearing they were about to be laid off as a result of a merger.
China may not yet be ready to take on the mantle of global economic leadership, but both its rapid growth and its enormous population mean that day will come eventually. Its influence abroad is increasing, particularly in the poorer developing world, whose leaders see it surviving the current global recession with an economic model very different from the now discredited Washington "Consensus." Barring a sudden, unexpected economic reversal, that influence is only going to grow.
Beijing's emergence poses specific challenges to the U.S. Unlike Japan and Germany--whose own economic miracles in the second half of the 20th century challenged the U.S. economically--China is neither a democracy nor a firm ally of Washington's. It's already a great power, and it has the global ambitions to match, as its efforts to secure natural resources around the world attest. Sometimes U.S. interests and China's will coincide. Sometimes they won't. Already, critics contend that Beijing's aggressive pursuit of oil, gas and minerals helps prop up any number of malign regimes, from Iran to Sudan to Burma.
For now, the most important thing the U.S. can do in response to China's continued ascent is also the most obvious: it needs to restore its own economic brand. Instead of being in the position of a supplicant, borrowing billions from Beijing and getting laughed at in the process, it needs to slash its deficit. It might also, as General Electric's chief executive, Jeff Immelt, pointed out in a recent speech, "observe the example of China." Immelt noted that China has "no intention of letting up in manufacturing in order to evolve into a service economy. They know where the money is, and they aim to get there first." His point was clear: the U.S., still the world's leading manufacturer, needs to continue to innovate if it intends to stay ahead. China's economic rise may be close to inevitable. But the U.S.'s decline is not.