As Decade Ends, Will China’s Economic Strategy Falter?

Late last year, the National Intelligence Council delivered to president-elect Obama the fourth in a long-running series of global assessments. Entitled Global Trends 2025: A Transformed World, the new assessment had a distinctly different tone from previous installments in the series that sought to predict the state of world affairs in 2010, 2015 and 2020. Unlike the earlier assessments, the latest one no longer assumed America’s global supremacy for the foreseeable future. Instead, it warned that “In terms of size, speed, and directional flow, the global shift in relative wealth and economic power now under way — roughly from West to East — is without precedent in modern history.” The intelligence panel identified several factors driving this trend such as the increasing price of oil, but the centerpiece of its assessment was the rising economic power of China.

It was about time that the intelligence community wised up to what is going on in the global economy. In the eight years since China joined the World Trade Organization, America’s economy has lost an average of one percentage point in global GDP every year, falling from 32% of world output in 2001 to 24% in 2009. Our huge trade imbalance in manufactured goods with China isn’t the sole explanation for this precipitous drop, but it played a significant role in every negative economic development in this decade, from the sub-prime loan debacle to the slow rate of private-sector job creation to the eroding value of the dollar. So the National Intelligence Council may have been on to something when it predicted that China would gain influence at America’s expense in the years ahead.

However, anybody who follows national intelligence estimates knows that those documents tend to be trailing indicators of reality. They found that Iraq had a multifaceted nuclear-weapons program years after the program was dismantled, and later they said Iran had slowed its nuclear efforts even as those efforts were being accelerated. Given the intelligence community’s uneven track record on predictions from the Tet Offensive to the fall of the Berlin Wall to the 9-11 attacks, there is good reason to suspect that the wizards of Langley are following rather than leading in their analysis. In other words, Global Trends 2025 may be little more that a belated embrace of what has already become conventional wisdom in the popular culture. In fact, we may one day look back and realize that the assessment signaled a high-water mark in China’s influence rather than just the latest depth sounding in a constantly rising tide.

Here are a few reasons for doubting the durability of China’s economic miracle. First, the economy has grown by investing heavily in industrial infrastructure to produce exports, but there is now evidence of substantial excess capacity in industries such as steel, aluminum and paper. Second, the Communist Party’s insistence on monopolizing political discourse makes it difficult to achieve the transparency and accountability required in a modern market economy. Third, China’s western trading partners are beginning to rebel against market distortions caused by its refusal to let the yuan rise to its true value in currency exchanges. Fourth, those same trading partners are lodging an unprecedented number of actions against unfair Chinese trade practices such as dumping and restricting market access. Fifth, a combination of rising labor costs, transportation fees and unreliable quality are leading many U.S. companies to rethink the wisdom of manufacturing in China. Sixth, the U.S. government is now controlled by Democrats who do not share the Republican affinity for unfettered free trade.

The latter development is especially important, because at precisely the time that American voters were turning over the reins of power to Democrats, they were learning just how dependent the federal government’s finances had grown on Chinese credit. This is a new experience for policymakers and the public, one which they intensely dislike. If China continues manipulating its currency and restricting market access — key factors in its accumulation of vast dollar reserves — the Obama Administration will eventually lose patience and move to level the playing field. Republicans were loathe to take such actions because of their ideological commitment to free trade, but looking back over the past decade it is obvious that Beijing has taken advantage of that stance to engage in predatory trading practices.

The Obama Administration has already launched a series of initiatives to limit Chinese exports of low-cost tires, coated paper and steel products. These steps are permitted under World Trade Organization rules because of the circumstances surrounding the origination of the relevant Chinese exports. For instance, U.S. tire companies were allowed to set up plants in China with the understanding that output would be mainly for export, a government-imposed constraint that would be unthinkable in the United States. As the U.S. economy and dollar recover from their recession-induced lows, the return of high trade deficits will exacerbate already tense trade relations, making it hard for China to continue increasing the volume of its exports into the U.S. market. Over the last two decades, the various measures undertaken by U.S. administrations to stimulate growth have helped China at least as much as they have helped America. But the Reagan Revolution is now over, and the people running Washington have run out of patience with China’s self-serving trade practices.