As the world’s financial leaders gather in Washington for the IMF’s annual spring meeting, their hopes — and fears — center on China. After all, China is the one country that might be able to jump-start the sputtering global economy’s recovery; and yet its own economic growth is based on a foundation that is increasingly showing signs of strain. The dilemma is that both Chinese failure and success carry risks for the world economy.
A failure scenario would be unique in post-World War II history. Because China’s economy is so large, the consequences would reverberate worldwide.
However, unlike in 2008, when the US dollar appreciated, allowing emerging markets to revive quickly, the yuan would likely depreciate should China’s economy experience a serious downturn, spreading deflation far and wide.
Other currencies might depreciate as well, some as a result of deliberate policy. Consequently, a China failure scenario could resemble the events of the 1930s, characterized by competitive devaluation and plummeting real economic activity.
However, what if China succeeds in its current transition to a consumption-based economic model? When the Chinese current-account surplus reached 10 percent of GDP in 2007, saving exceeded 50 percent of GDP and investment surpassed 40 percent of GDP. These numbers seemed far too high to be dynamically efficient or welfare enhancing.
As a result, a consensus rapidly emerged: Saving and investment should be reduced and brought into better balance. Investment should be reined in by imposing greater financial discipline on wayward public enterprises, while the social safety net should be reinforced, so that households would not have to save so much to meet the costs of having children and growing old.
Fast-forward a decade, and what can be seen? The government has built safety nets and the current-account surplus has receded, exactly as hoped. Last year, the surplus amounted to less than 3 percent of GDP, a fraction of its 2007 level.
However, this hardly validates the theory. About half of the reduction in the current-account surplus has occurred because investment has actually increased as a share of GDP. Meanwhile, there has been some decline in national saving, by perhaps 3.5 percentage points of GDP compared with 2007 (according to IMF estimates, as official data end in 2013). This reduction is quite modest compared with the 15 percentage point increase that occurred from 2000 to 2007.
Even more striking, all of this modest reduction in saving seems to have come from the corporate sector; household saving is roughly the same, relative to GDP, as it was in 2007. In other words, what went up during the boom has failed to come down. This is a real puzzle, and resolving it is important not only for China’s future, but for that of the world.
There are two broad possibilities. It could be that the theory is basically correct, but needs more time to show results. In that case, as long as China’s rulers continue to improve social safety nets, the decline in saving could match the envisaged decline in investment, keeping the current-account surplus low.
However, what happens if the theory is wrong, or incomplete? For example, the beneficial effects of safety nets on saving might have been overestimated. Or those effects might be offset by the negative effects of population aging. Over the next 15 years, the Chinese population aged 60 and above is set to increase by two-thirds. The aging workers might be saving as much as they possibly can, to build up a financial cushion for impending retirement.
If some version of this scenario is realized, the household saving rate might continue to decline only gradually. In the meantime, the government would be closing unprofitable plants, which might boost corporate saving. As a result, overall saving could remain high, even as investment falls sharply, causing the current-account surplus to surge again.
This would not be a pleasant prospect for the world economy. As China slows, so would global growth, and the remaining demand would be redistributed toward China, aggravating other nations’ already severe shortfalls. This would be very different from the previous episode of global imbalances when large Chinese current-account surpluses were at least offset to some extent by rapid growth.
In short, whereas a hard economic landing for China could spur global deflation, avoiding that outcome could mean the return of global imbalances. These are the stark possibilities that leaders need to ponder as they gather gloomily at the IMF in Washington.
Arvind Subramanian is chief economic adviser at India’s Ministry of Finance.
Copyright: Project Syndicate
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