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Why China is not Japan or the USSR

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Albert Beardow.

Tiananmen Square

24-05-2013: One argument I hear from China sceptics is that we’ve seen stories of America’s being overtaken by another superpower before. In the 1950s and 1960s it was the USSR that many predicted to become the world’s dominant economy in a matter of decades. In the 1970s and 1980s, it was Japan that was on the rise. Of course, we now know that both of these were false prophecies, with both nations succumbing to their own, serious internal problems, whilst the USA continued to drive forwards. It is easy, therefore, to dismiss stories of China’s rise in a similar manner, with the expectation that China will soon crash and burn, whilst the superior institutions of the US bear out the day. Such a view is naïve. There are three fundamental reasons why we can expect the Chinese economy to overtake that of the US in the coming decades.

1)    Population

With a population less than half that of the United States, it was always going to be a long shot for the Japanese economy of the US. GDP per capita in Japan would need to be more than double that in America before Japan became the world’s predominant economic power. As it happened, Japanese GDP per capita did overtake that of the US, albeit briefly, but as a society mostly lacking in natural resources came up against technological and innovation barriers, it should have been obvious that continued high growth would be much more elusive.

China, on the other hand, has more than four times the population of the United States. Even when it does overtake the US economy, its people will be less than four times as productive and well off as those in the United States. China will remain a developing country long after it becomes the world’s economic superpower. Even today, about half of China’s population remains in the countryside, a massive source of potential labour and urbanisation to fuel China’s continued growth. Whilst I agree that it is a long struggle ahead before the Chinese GDP per capita equals that of the United States, this simply doesn’t need to happen in order for China to overtake the US on a national level.

2)    A Market Economy

Whilst the USSR had a population more similar to that of the US, its economic system was fundamentally different. For those, like myself, who subscribe to the idea that a free market capitalist system will deliver superior results to a state-planned communist economy, the idea of the Soviet Union exceeding America’s economic capacity was completely unrealistic. Those who predicted the rise of the USSR were largely those Marxists and statists with an unwarranted faith in central planning, bolstered by their belief in the stories of those Westerns, such as Lincoln Steffens and Ella Winter, who had seen a sanitised version of the Soviet Union and claimed that “it worked”.

Pudong, Shanghai - China's financial and commercial hub

Although governed by a communist party, China is anything but communist. Whilst the party might describe their economic system as “socialism with Chinese characteristics”, a more apt epithet would be “capitalism with Chinese characteristics” – a market driven economy combined with a strong, Confucian state. Starting with reforms to agriculture and the establishment of Special Economic Zones in the South, under Deng Xiaoping and his successors China experienced a massive surge in entrepreneurship and the development of a highly sophisticated, industrialised market economy. China has also embraced free trade in a way most other developing economies failed to do at an early stage - as a result, foreign trade has accounted for up to 75% of China’s GDP. Chinese companies are also poised to take to the world stage – PetroChina, ICBC and China Construction Bank are among the biggest public companies in the world. Chinese companies are innovating as well – Baidu was recently rated the 5^th most innovative company by Forbes, with Tencent not far behind, meanwhile, technology companies like Huawei and Automobile companies like Chery and Geely are poised to become big players in the global market.

Whilst it is true that state owned corporations play a much more significant role in the Chinese economy than in the West, it should be stressed that these are subject to fierce private and foreign competition, and are less like the stagnant monopolies that have been typical of Western state owned enterprises. Furthermore, Chinese government spending as a proportion of GDP is actually considerably lower than that in most Western countries – in 2011 this was 24% compared to 41% in the United States, and a higher level in most European nations. Where Chinese state does have an oversized influence is in fixed capital formation – which is really to say that the Chinese state is an investor, whilst Western states are spendthrifts. 

3)    Institutional Momentum

The final point I’d make is that economic growth isn’t only influenced by the institutions that a country has in the present, but in the way those institutions are changing. Comparing China and the US, it initially seems that the rule of law, better property protection, and government accountability make the latter a far more attractive investment destination. Yet starting from a low base, China has seen a substantial increase in the quality of its institutions, whilst those in the US have been in decline.

America in decline?

The World Economic Forum’s Global Competitiveness Index illustrates the startling changes in the perceptions of institutions in these two nations. And ultimately perceptions matter, because it is perceptions that influence investment, business and entrepreneurial decisions. Since 2006, the United States’ score for institutional quality has fallen from 5.07 to 4.59 – in the same period, China’s has risen from 3.57 to 4.22, putting it a mere nine places behind the US. In the most recent report, China now ranks better than the US in no less than seven out of twenty-two measures of institutional quality: public trust in politicians, favouritism in decisions of government officials, wastefulness of government spending, the burden of government regulation, transparency of government policymaking, business costs of terrorism, and business costs of crime and violence.

The direction of this momentum could change, and it is always possible that the US rectifies its institutional decay, whilst the Chinese state succumbs to the temptations of keeping too much power for itself. But the best indicators of whether this is likely is the political debate within a nation, and whether there is in the first stage a recognition of the problems that must be dealt with. A transition to the rule of law and an independent judiciary – which would provide a crucial boost to China’s economic prospects – is a topic of heavy debate in Beijing currently. Chinese Standing Committee member Wang Qishan has reportedly recommended Alexis de Tocqueville’s The Old Regime and the Revolution to fellow members of the politburo, in order to foster debate about the rule of law and the political challenges China will encounter. On the other hand, institutional decline is hardly a subject of discussion at all in Washington. The US seems to be blindly walking downwards, oblivious to the fundamental systemic problems that ail it.

Pax Sinica?

In 2003, Goldman Sachs predicted that the Chinese economy would overtake that of the US in 2041 – a prediction greeted with much incredulity. In 2008, they brought the date forward to 2027. The IMF now suspects that the Chinese economy will overtake the American in PPP terms by 2017. In stark contrast to the predictions about Japan and the USSR, where the date of their overtaking the US was consistently being pushed back, for China it is being moved forward at a startling speed. Of course, changes in expected growth rates could dramatically change the date of reckoning again – but it is not clear that the chances of Chinese performance being sub-par are any more than those for the United States.

Of course, China’s overtaking the USA in nominal GDP – perhaps a better measure of global economic dominance – remains slightly further away – though full convertibility of the Renminbi, which may happen as early as 2020, would significantly speed the closing of this gap. And even when China becomes the world’s leading economic power, it will still remain a developing country, with an inward focus on all the domestic problems that accompany it. This means that, whilst the Chinese will begin exerting more influence in key regions such as Africa, it will be many decades before they become a truly global hegemon in the manner of the United States or Britain before that.

So perhaps we should not fear so much the sudden rise of Chinese global power that the West is unprepared for. Perhaps what we should fear is that the United States’ global power will decline faster than China rises to replace it. What we may see in the interim is not so much bipolarity or multipolarity, but apolarity – the lack of any truly global powers with influence covering all the world’s regions. And it is precisely apolarity that allows rogue nations and non-state movements such as Islamic extremism to fill regional power vacuums.