A rapid recovery in China?

Business Standard, 14 October 2024

The Chinese government announced a stimulus, a `big bazooka'. The Shanghai Composite index first surged 26% and is now 19% up over a month. Does this mean that the Chinese economy is healing, and that the machinery of government stimulus will bring the economy back to health? It is unlikely.

`The China model' [EiE Ep16] is a philosophy of government control. This extends into macroeconomics. Policy makers have desired `fine tuning' of the economy. Non-traditional levers of financial policy have been used for this purpose, such as rules in the central planning system that govern credit growth and credit directed for real estate and infrastructure.

These methods are inferior to those of a market economy:

When a bad asset gets built, the NPV of revenue is below the cost of construction, and there is a loss. A loss has taken place, and all that is left is arguing over who bears the loss. Absent a well defined bankruptcy system, the loss is a sword of Damocles. There is a pall of gloom, and the wasted man-hours in politiciking, for all persons who fear being dumped with the losses.

In the past, the faulty Chinese approaches to macroeconomic policy worked less badly for two reasons. The early construction of housing and infrastructure made more sense. And, the engine of the economy -- high growth of manufacturing exports -- was purring. High growth in manufacturing exports created growing prosperity which papered over the failures of policy makers in other respects.

China's real problem is that this engine (manufacturing exports growth) is faltering. Many decades ago, China was a small country, a bit like India, with negligible share in global production. At that time, its growing exports were readily accepted by the world economy. Now, with Chinese manufacturing production at about a third of the world's total manufacturing, there is less headroom to grow. It is hard for a systemically important producer to get a doubling of exports. There was a doubling for China when they went from 16% of the world's manufacturing to 32% of the world's manufacturing. It is just not possible to get a next doubling of this share, to go to 64% of the world's manufacturing. The growth that rescued the economy when faced with macroeconomic problems in the past is just infeasible.

Into this complexity comes the shift from the second globalisation to the third globalisation [EiE Ep17]. In the second globalisation, the periphery was given free access to the core on all manner of issues including trade, FDI, technology access and financing. We are now in the third globalisation, where engagement into the core is now conditional on foreign policy and military alignment. The Russian invasion of Ukraine, over the last decade, has steadily led to Russia being cutoff from the core.

There is common sense in being kind to your customer. We in India know that services exports went up from $163 billion (2016-17) to $341 billion (2023-24), which was a huge boost to the economy. It has delivered benefits for India ranging from better lives of workers to higher tax revenues for the state. The next doubling of these revenues (i.e. an additional $341 billion per year of additional export revenues over a few years) could be the most important single force in Indian economic growth if it arises. But we should not be complacent, we should not take this next doubling for granted. We have an incentive for foreign policy and military alignment that respects the role of the West as the source of technology, entrepreneurship, financing and markets that makes Indian services exports possible.

It is surprising to see the extent to which China's famously pragmatic leadership lost sight of such common sense in the third globalisation. They defiantly stuck to a hostile position on foreign policy and military affairs. This has induced a large number of moves worldwide that hinder the ability of China to achieve technological progress and growth of exports [EiE Ep64].

We in India have lived through our own story with China, where we have seen nationalism and militarism there -- as expressed in Doklam and Galwan -- inducing a decline of the Indo-Chinese economic relationship. This small story (and India is but a small part of the world market for Chinese exports) is a microcosm where we obtain insights into how nationalism and militarism in China has induced a large number of self-defeating actions vis-a-vis the advanced economies that had once nurtured China with financing, technology, entrepreneurship and markets.

From an Indian point of view, the wise path for policy makers lies in being strategic about navigating towards a good place for India in the third globalisation. There will always be arbitrage opportunities that can be exploited for short term gains: through sanctions-busting, through trade diversion, through expropriating foreign investors like Vodafone, through withdrawing the protection of bilateral investment treaties, etc. Such thinking sounds like machismo but harms the Indian cause in the medium term. What would be best is to keep our eyes on the ball: the next $784 billion per year of (goods+services) export revenues that will come from one doubling compared with 2023-24. This requires deep integration for India into the global value chains that are centred in the advanced economies.

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