Some recent economic data out of China suggests that the economy is gaining steam. According to both official government measures and the HSBC Purchasing Managers’ Index, the manufacturing sector expanded in August 2013. Meanwhile, the HSBC PMI measure of the service sector also showed strong growth. Overall GDP growth in the first half of 2013 was 7.6%. But the important question, according to many analysts, is not whether China is growing but how it is growing.
Any statistic is subject to many interpretations, and this seems particularly true for the Chinese economy. Where one economist sees an unsustainable and unbalanced economy, with investment outstripping consumption, another sees the same imbalance as evidence of a salubrious shift toward an urbanized and mechanized China.
What everyone agrees on is that the Chinese economy is going through far-reaching changes. The 12th Five Year Plan lays out the Chinese government’s blueprint for shifting to a sustainable growth model and avoiding the “middle income trap,” the point at which developing economies often stall out. It calls for increases in domestic consumption and the service sector, further urbanization, and investment in and development of key industries with an emphasis on innovation and clean technology.
The New York Times recently provided a look at what these changes look like on the ground. A video feature told the story of one family in the province of Shaanxi, which had moved from a rural village to a new development in Qiyan as part of a government relocation program. The family describes buying new appliances and furniture—examples of the kind of consumption called for in the 12th Five Year Plan. However, several members of the family had not yet found work. The Chinese government expects more than 20 million people per year to make a similar transition.
Stephen Roach, the former chairman of Morgan Stanley Asia and a senior fellow at the Jackson Institute for Global Affairs, explains that whether China can successfully shift its economy will have a potentially transformative impact on the rest of the world: “If China does the transformation from the producer, export-led growth model that relies on others to provide its major source of demand to more of a consumer-led model, it will become a source of growth for other countries around the world.”
Q: How do China’s economic activities affect the rest of the world?
Stephen Roach: China's been an enormous source of growth in the world economy over the last 20 years, but especially in the aftermath of the financial crisis, when the developed world, whether it's the U.S., Europe, or Japan, has really been flat on its back. And so China's been a key driver at the margin. But as they tell you in the investment business, past performance is no guarantee of a future return.
The real story is that China's going to be changing its growth model a lot over the next five to ten years and will shift from being a producer-driven economy to more of a consumer-driven economy. That will be a transformative event on a global economy, especially for growth-starved countries like the United States that need new markets to export into.
If China does the transformation from the producer, export-led growth model that relies on others to provide its major source of demand to more of a consumer-led model, it will become a source of growth for other countries around the world. This is part of the long-awaited rebalancing of an unbalanced world.
The world became overly reliant on one consumer—the American consumer—to drive aggregate demand around the world. Courtesy of the crisis and the bubbles that have burst leading into the crisis, the American consumer has really not been a factor in the last five years and is unlikely to restore its once dynamic state of demand for years to come. And to the extent that China can fill that void, that's a very powerful and important development for the global economy.
Q: What is the dynamic like now between China and the United States?
Roach: I think it's a really important and complex and increasingly troubled relationship. There's a lot of historical baggage from both sides that really colors this relationship. In the U.S., we've focused a lot on trade frictions, the value of the currency, intellectual property rights, and most recently on the cyber-hacking, cyber-terrorism issues.
On the Chinese side, they're certainly very sensitive to criticism from the outside. For over 150 years, they felt humiliated by the West. I think the West still misses China in terms of its characterization significantly. We've got to address these rather prickly aspects of the relationship before they get out of hand.
Q: How does the political climate affect the economic relationship between China and the United States?
Roach: The politics definitely intersect with the economics. A classic example is all these bills that have been introduced by the U.S. Congress, beginning in 2005, aimed at forcing the Chinese to revalue their currency, the renminbi or the yuan—whatever you want to call it. They fit some of the problems that America has created itself. By failing to save, we have to import surplus savings from abroad. We run massive current account and multilateral trade deficits.
In 2012, we had deficits with 101 different countries, yet we single out China as being the lightning rod for the American worker. We know we have a labor problem in the U.S.—we have stagnant wages, unacceptably high unemployment—and we want to blame China for that. Yet it's clearly not China's fault. If we were to close down trade with China through currency sanctions, we'd still have deficits with 100 other countries.
So China's convenient. It's a large deficit of ours, but our problems are more home grown than made in China, and the politicians certainly want to look the other way in that respect.
Q: What metrics are you looking at to predict China’s growth?
Roach: Well, I'd say the top-down metrics I focus on are twofold. One, the consumption share of the GDP. It's 35% right now, and that's literally half the ratio that we have in the United States. Over the next five to ten years, I'd like to see a shift to convergence in those ratios. The U.S. share has got to come down; the Chinese share has got to go up.
And on the services share, the Chinese economy is 43% right now. I think for an economy the scope and the size and the level of development of China, that number should be in the mid-50s. And if you take that number from 43 to the mid-50s, that, in current U.S. dollar terms, equates to an expansion of about 12 trillion U.S. dollars.
Services are increasingly tradable. America is the largest services economy in the world. It's a huge potential bonanza for U.S. services firms to take advantage of, to trade into, to invest into. And by focusing on these currency tensions, trade tensions, we run the risk of squandering that opportunity.
Q: How can China avoid the middle-income trap?
Roach: History shows that most developing economies, at least three-fourths of them—by some metrics even higher—stall out when they hit this so-called middle-income threshold of somewhere between $12- and $15,000 of income per capita. China will hit that at some point around 2015.
But history also shows that the reason economies get ensnared in the middle-income trap is because they don’t change their model. They stick with the old model that seemingly was so successful in driving early-stage development. So to avoid the trap, you’ve got to shift the model. That's why I’m optimistic that China will be an exception, because they’ve made a strategic decision. It's encapsulated in the so-called 12th Five-Year Plan, which lays out a number of incentives to transform the growth model from exports and investment-led to more of a consumer-led, services-led model.
The challenge is implementation. Will they actually have the courage and the focus to implement all of the measures they’ve addressed? I'm hopeful that they will, but the jury is out. The evidence is mixed that they’ve done enough at this point. I would concede that.
Q: What is the “next China”?
Roach: The fact is that the 30-year miracle—producer-led, manufacturing-led, construction-led—was a powerful early-stage development model, but it's not a sustainable model. And so the “next China” goes from manufacturing to services, from external to internal demand, from exports to private consumption, from energy resource, carbon-intensive, pollution-choking China to a services-led model where the carbon footprint, the resource input, is lower. It's a cleaner, lighter GDP, and it's a China that will grow more slowly because services are much more labor intensive in terms of generating jobs per unit of output than the old model.
So, I think there's a lot to be said in looking to a number of more sustainable characteristics of the “next China” than just looking back at where China's gone over the last 30 years and extrapolating that into the future.