By Matt Goodman & David Parker
Beijing and Washington may disavow the term, but “G-2” is an increasingly apt description of the world’s most important economic relationship. The United States and China are now the world’s two largest economies and represent a combined total of 32 percent of global GDP. Unfortunately, these economic elephants are also among the biggest sources of uncertainty for the global growth outlook. While both governments are understandably – and rightly – focused on tackling economic challenges at home, the decisions they make will have a profound impact on each other and the rest of the world. To sustain the global recovery, only a growth strategy for each that works for both will be sufficient.
For all the noise on the presidential campaign trail, the U.S.-China economic relationship is broad and mutually beneficial. Trade flows between the two totaled $539 billion in 2011, having quadrupled over the past decade – not all of that in one direction, as U.S. exports to China have grown over 500 percent since 2000. In such a large relationship, tensions are inevitable; even with the European Union, the United States has twice as many trade disputes in the World Trade Organization as it does with China.
To be sure, Sino-American economic relations have grown more contentious of late, with over half of all bilateral trade disputes coming in the past four years. In part this reflects the end of easy gains from China’s WTO accession in 2001. American business is now increasingly concerned with China’s behind-the-border impediments – including a playing field tilted toward state-owned enterprises and restrictions on foreign investment in the Chinese market. Meanwhile, a wave of Chinese direct investment is lapping U.S. shores, promising a boost to American growth and jobs but raising both national security concerns and broader political anxieties here.
But at the heart of U.S.-Chinese economic tensions are the serious macroeconomic imbalances within and between the two countries. Only if each country does its part to address these imbalances will it be possible to maximize the long-term benefits of the U.S.-China economic relationship and minimize areas of friction.
For the United States, the immediate challenge is the looming “fiscal cliff,” the roughly $550 billion in spending cuts and tax hikes set to take effect after December 31. Avoiding recklessly driving off this cliff will be priority one following the presidential election. But whatever deficit-reduction compromise Congress agrees to will be a prelude to a much larger debate over a new U.S. growth model that depends less on government and private consumption, and more on investment and exports.
Rebalancing in the United States will have tremendous implications for the global economy. A structural shift from consumption to savings is essential for sustained U.S. growth, but will also limit the ability of the American economy to drive global demand. Moreover, reaching President Obama’s goal of doubling exports by 2015 will require U.S. producers to aggressively look abroad for new sources of demand. This in turn will require thoughtful economic statecraft to encourage complementary strategies among U.S. trading partners.
Which leads to China. The country accounted for more than a quarter of global growth from 2006 to 2011, but its export-led development model made its contribution to global demand significantly lower. As the world’s advanced economies have struggled with anemic growth, China’s disproportionate reliance on external markets has become unsustainable. Meanwhile, China faces a “middle income trap,” where the benefits it has enjoyed from a virtually inexhaustible supply of low-wage labor are dwindling, before it is able to compete with advanced countries on higher-value-added goods and services.
China can surmount these challenges and sustain respectable growth rates of 7-8 percent, but only by managing a tricky shift away from exports as the chief driver of growth and towards domestic demand, especially private consumption. A successful rebalancing would also help stabilize the global economy, providing demand to offset slower growth in U.S. consumption and deleveraging in the advanced world. The ability of the incoming Chinese leadership to effect such a shift is an open question, but Beijing is aware that a new growth model is critical to its long-term prospects; indeed this is a centerpiece of its latest five-year plan.
Where should China’s economic policymakers focus their attention and energy to best facilitate the rebalancing process? Reforming the financial system should be a top priority. The current system of controlled interest rates forces consumers to compensate for low rates of return on deposits by saving excessively. As many commentators have pointed out (including the World Bank in its landmark “China 2030” report earlier this year), liberalizing rates so that Chinese savers can enjoy higher returns and have a greater proportion of their incomes available for consumption is essential. Building deeper and more liquid capital markets, and subjecting state-owned banks to more competition from private (including foreign) financial institutions, will also help produce a more efficient allocation of capital in China and support the rebalancing process.
Comprehensive financial reform would also contribute to resolving a longstanding gripe from Washington: it should help nudge the value of the Chinese currency upward. Underdeveloped financial markets and capital controls have so far prevented the renminbi (RMB) from fully reflecting the underlying strength of the Chinese economy. Among its other benefits, financial reform would advance China’s long-term interest in promoting the RMB as a global reserve currency.
Beijing and Washington have principal responsibility for enabling their own economic transformations. But each has an interest in the success of the other, since rebalancing within each economy would produce greater balance between them. This is essential to more sustainable growth in both countries and a less friction-prone relationship. Thus cooperation is the sensible path for both. Whether through the G-20 or a de facto “G-2,” China and the United States should coordinate their rebalancing efforts in the interest of stronger and more sustainable growth – for themselves and the rest of the world.
Mr. David A. Parker is the lead researcher with the Simon Chair in Political Economy at CSIS. Mr. Matthew P. Goodman holds the William E. Simon Chair in Political Economy at CSIS. To learn more, you can find the Global Economics Monthly newsletter, where a version of this essay first appeared, here.
Matthew P. Goodman is senior vice president and William E. Simon Chair in Political Economy at CSIS, with particular emphasis on Northeast Asia.