Monday, 25 April 2011


Just a few months  ago, I wrote on the prospects of China's economy when it replaced Japan as the world's second largest behind the US. Relying primarily on IMF studies that speculated how China would surpass the US economy within the next two decades, I then argued that the state-directed Chinese economy was easily leaving behind the 'neo-liberal' state-backed and managed economies of the G-8.

The IMF has now revised its forecast, arguing that in less than five years, China will be the world's largest economy, if we use purchasing power parity (PPP). It is easy to see that when PPP figures are taken into account, China has a much higher GDP than what 'real' numbers indicate in dollars. Ten years ago, the US had about 24% of the world's GDP share, while China had around 6%. In just five years, the US and China will both have about 18% each of the world's GDP, and thereafter, China will continue making inroads, while the US will be facing massive problems as one of the world's largest deficit countries.

China has enjoyed an annual average growth rate of 10% in the last 30 years, it has become the world's largest exporter and second largest importer, one of the world's largest market for foreign investment that reached $100 billion in 2010, and the world's fastest growing foreign investment country, accounting for the fastest growing foreign investment in Africa, Latin America and Asia. The more nationalistic among analysts argue that by pouring massive investments, China has been undermining the US in Latin America, EU in Africa, and Japan in Asia. In 2010, China has poured an estimated $100 billion in Latin America, or equal to the amount of incoming foreign investment in China.

While poverty in 1981 stood at 53%, it has been between 2.5 and 11% in the past five years, depending on the source. By contrast, the US has seen its poverty line remain in double digits, hovering around 14% in 2010, accompanied by a steady drop in living standards for workers and the middle class in the last 30 years.

What can the US do to catch up with China as opposed to what it will actually do are different things. Large corporate interests drive US economic policy, for it is they that fund political campaigns and pour money for lobbies. The US will not change course no matter how ominous the threat that China will become the world's number one economy. We can expect increasing government support for corporate welfare accompanied by austerity-style policies resulting in downward socioeconomic mobility. In short, continued decline of middle class and working class living standards and greater concentration of capital in the top ten percent of the population that currently owns 80% of US stocks and bonds, while the bottom 90% of the population owns just 20% of assets.

As far as monetary policy, we are unlikely to see much change there either. The overvalued dollar and undervalued yuan are part of what is at the core of IMF's new report whose purpose behind it obviously is to send the political message that austerity type measures are long overdue in US. Continuing to devalue foreign debt with an even cheaper dollar will only mean that investors will be discouraged from placing their money in US. Moreover, other reserve currencies will make it more difficult for the US to continue its current monetary policy.

It is true that the dollar is overvalued and if it were not a reserve currency it would have sunk to its proper level to reflect the real economy. However, US exports will decline if monetary policy changes rapidly and sharply. The emergence of China as the world's number one economy poses significant questions about global trade, and political and military balance of power, given that a Chinese economic superpower could only bring US-EU-Japan cooperation closer; at least that is the theory. However, China is heavily interdependent with EU, US, Japan, Russia, Australia, and Latin America. I am not sure that it is in any country's interest to try and undercut Chine through regional trade/investment blocs. Resorting to bloc trading zones would most certainly retard global trade and precipitate recession for all.

China does have structural problems that could slow its growth, in addition to social and political problems that are kept under control, but for how long? The housing market is a potential problem, as prices in major cities have exploded in the last ten years. Consumer prices have been rising faster than in the recession-ridden West, but with rapid growth inflation is unavoidable and not necessarily such a bad thing as IMF and many pro-free market economists present it. Inflation at five-six percent is not bad when growth rate is twice that rate.

The most important element in the economy is how the government will manage the economy to a slower and steadier pace so that when recession comes it is not as bad. At the same time confronting pressures for democratization from a growing middle class, dissidents, and minority ethnic groups is a greater problem than managing the domestic economy and foreign trade and investments. The Communist Party would have to change to reflect real changes in society, and so far the signs for change are not encouraging. If social uprisings begin to take hold, the Chinese economic miracle could turn into a nightmare. Just as it was a political decision to modernize the economy under capitalism was a political decision, so is social and political modernization.

Does it make it any difference if China is number one in the world, or the US, considering that capital has no nation and it flows freely between nations? Is it not true that the companies moving to China from US and other countries did so to realize greater profits, and it is corporate investors that are the real winners, instead of nation-states? Does an investor care if profits come from a multinational corporation that has operations in US or China, France or Brazil? What is at stake is the image of the US - PAX AMERICANA gone for good. Image in politics means leverage in political, investment, trade, diplomatic and other negotiations. China will have greater leverage, and US will have lesser leverage in the future.

Just as UK had to play second fiddle to the US after WWII, the US may eventually have to do the same with China. This does not necessarily have to play out like so, but short of political restructuring to end welfare capitalism; severely cut defense spending and end military adventures in the world that benefit a few corporations at the expense of the national economy; strengthen the middle class and workers through a new fiscal policy and wage policy;  the US is headed for a long decline.

The worst case scenario is that US could become entangled in a disastrous war if a reckless president decides that is the only card left to play in the face of losing the economic competitiveness in the world. From Rome to England, empires during their decline resort to war as they see it as the most direct route to power, when in fact war at such juncture hastens decline. Maybe the US empire will be the exception to the rule.

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