What is China up to?

The emergence of China causes fears that also reflect Peking's ambiguities about the political use of its economic power. A column by Charles Wyplosz.

Charles Wyplosz
«Much will depend on how the old powers, the US and Europe, treat China, a rival that can be a partner or a foe.»

China is on its way to becoming the world’s largest economy, within ten or twenty years according to various estimates. Even though it remains poor by the standards of the developed countries, more than 1300 million people are bound to eventually churn out more goods and services than the 325 million Americans. Such a huge country is likely to produce almost everything, from low tech to the most sophisticated high tech, which is prompting fears that Chinese firms will destroy all their competitors. This is not what will happen.

To start with, like everyone else, they want to use their incomes from exporting to import the things that we produce. They are not only producers, but also customers. This is a huge market with a growing appetite for consumption. Even if they produce cars and watches, they want to own German cars and Swiss watches. The point is that we all like to choose from different brands and the old word has many brands with a global appeal.

Then, why has China been growing so fast over the last few decades? One reason is poverty, which meant rock-bottom wages, without the kind of social contributions that raise labor costs in the developed countries. Another reason was that the population was reasonably well educated, ready to absorb new knowledge. Deng Xiaoping’s liberalization made it possible to adopt the West’s technologies and the economy quickly grew. Initially, growth was based on extremely cheap labor and based on unsophisticated products. Over time, China has climbed the technology ladder. Having sent vast numbers of students to the best universities worldwide, it is now less relying on copying foreign technology. It is now at the frontier of development in some fields.

In Japan’s traces

Phenomenal growth has led to fast-rising salaries. Even so the average Chinese salary is still a fraction of those in the developed countries, which explains why there are fears that «we can’t compete with China». But, the more China grows, the higher will the salaries be and the higher the demand for social protection. Eventually, if all goes well, China will be like Japan, a rich country with high labor costs, and it will be growing only because of technological progress, like all the other developed countries.

Will all go well? China faces a huge challenge. It is not yet really a market economy. Its banks are public, the state-owned enterprises still represent a large share of economic activity and its currency is not convertible. We know from experience that state control of the economy is ineffective. State control worked well when China was poor but it increasingly constitutes a massive roadblock on the way to continuing catch-up. Shrinking the state stronghold on the economy is politically challenging because it goes against powerful interests at the heart of the political system. Indeed, Xi Jinping has all but halted this evolution. Resuming the movement is both needed and a threat to the regime. Don’t bet on a smooth ride.

The current struggle between the US and China about trade is a good illustration of problems to come. For a long time, China has played on the margins of the global trade system. It has not fully opened its economy to foreign products, it has subjected foreign investment to tight local ownership rules, it has not really protected copyrights. Trump now wants to end this exceptionalism. He does it in his own way, which is why the Europeans hesitate to support him even though they fully agree with the aims.

Military power, Belt and Road

China will probably give in, in its own way too, initially more in words than in deeds, but it cannot continue free riding for much longer. The Chinese authorities know that but they want to move very slowly because it makes matters more complicated. It risks slowing growth down and it stands to hurt vested interests. Trump, on the other hand, is in a hurry as he needs to demonstrate success in a flagship policy. The likely compromise is likely to reflect the fact that, for Trump, success is a matter of wording, as the trade negotiations with Canada and Mexico amply illustrate. The Chinese will offer a few concessions and the required language.

With its new status as a world economic power, China is now showing interest in acquiring the corresponding political status. Three aspects come into play. First is military power. It is growing rapidly but the gap with the US is and will remain large. This means that, for years to come, China will concentrate on becoming a regional power. In effect, it will challenge the US presence in the region, with worrying implications for its neighbors and for Taiwan. Second, it has embarked in a massive effort to project its economic might worldwide. Its main tool is the Belt and Road initiative. In theory, it wants to develop transport and communication lines toward its trade partners. In practice, it is using its newly-achieved clout, and the widespread anti-American sentiment, to convince governments all over the world to undertake big infrastructure projects, includes railroads, highways, telecommunications and dams.

To that effect, it offers very large loans, competing with institutions such as the World Bank or the regional development banks. This may well end up badly. Many governments are lured into borrowing too much to finance large projects with uncertain payoffs. In addition, most projects are carried out by Chinese workers and engineers, which builds resentment. Some of these governments could well become unable to serve their debts. Crises are on their way.

Peking is possibly waiting

Third, China still has to decide how it will use its status as the world’s biggest economy. Will it uphold the international order or will it try to redesign it? The signals are ambiguous. On the one hand, China is positioning itself as a defender of multilateralism against the attacks from the Trump administration. On the other hand, China is criticizing the «Western model», based on private corporate ownership, open financial markets and trading rules. The Belt and Road initiative is challenging existing multilateral organizations, the IMF is described as dominated by the US and Europe and as supporting the international domination of the dollar.

China is pushing for a wider use of its currency, while keeping it under strict control, offering credit lines to dozens of countries in direct competition with the IMF. It seems that it has not yet decided what game it will play, quite possibly waiting to see how matters evolve. It is also looking in the rear mirror as India, its regional rival, grows and is likely to have an even bigger economy one day.

The emergence of China has already changed the world, and it will continue to do so. Fears partly reflect the simple fact that we all have to adjust, and adjustment is often painful, even when it is for the better. Fears also reflect the Chinese ambiguities about the political use of its economic power. The outcome is not yet written. It will depend on how the old powers, the US and Europe, treat China, a rival that can be a partner or a foe.