One of the remarkable results of the crisis has been the rebalancing of global forces from the West to the East or from the North to the South if you like. China has emerged not only as a major economy that has taken the lead in reflation, but also a pivotal nation in global negotiations. Thus we now hear of the G2, be it at Copenhagen or in G-20. China is no longer an ?emerging? economy. It has jumped straight to the top.
It is a risky thing to do but I wish to express some doubt on the China mania. If you extrapolate the recent growth rate for ever in the future then China will indeed take over the US sooner or later. But the world does not run on such smooth lines. That is the least the crisis should teach us. We should recall the way in which Japan was extrapolated during 1970s and 1980s as a miracle economy that was going to bypass the US. Japan seemed to have the winning formula with plenty of savings and a ministry?the Ministry of International Trade and Industry?which harnessed the energies of businessmen and bureaucrats to chart out future innovations. The giant names?Sony, Mitsui, Mitsubishi seemed unbeatable. The US looked tired and soon Paul Kennedy, the famous historian, was talking about the decline of American power.
But the 1980s already contained the seeds of American revival. The Silicon Valley proved to be the winning private sector venture capital solution to America?s future. Japan was to deliver the fourth generation of computers but Bill Gates beat them to it. The Japanese banks could not handle the full liberalisation of globalisation. Japan proved that it could not handle change, which it had not anticipated. It spent the next 10 years in a recession.
China shows many of the same signs. Its growth is mainly due to the harnessing of larger inputs, not so much due to technological change. Just as the USSR grew exhausted when it had used up its surplus labour, China risks the same future.
My favourite number is the Incremental Capital Output Ratio (ICOR) for China. China saves around 50% of its income and receives around 5% of FDI. It manages a 10-11% growth rate. This implies an ICOR of about 5 or 5-plus. India?s ICOR is around 4 to 4.5. In the latest reflation, China has again chosen the highly capital-intensive infrastructure sector to revive the economy. Yet again much capital is being deployed for not much growth rate.
China creates infrastructure ahead of demand and thus there is an oversupply. The implied rate of return must be pretty low, at least initially. This capital could have been deployed for domestic consumption or even needs like healthcare. But China cannot deviate from its chosen path of exports or infrastructure. The consumer sector is riddled with market uncertainty, and traders have to take risks. The Chinese planner is risk averse. The contrast with India is marked. India is niggardly with infrastructure, whose supply lags behind demand by years. But it is very keen on consumer demand as a driving force.
There are now reports that China has generated much excess capacity in steel and cement and other investment goods. The closing down of Tata?s Corus plant in Northeast England recently is a sign that steel price will collapse very soon and spread an industry-specific recession in steel. There has been an oversupply of credit and China faces the tough task of unwinding a lot of credit-fuelled asset creation.
It is quite possible that China may yet find its way out of this crisis and its own path of reflation without any mishaps. It may be that these signs of excess capacity in industries and oversupply of credit may yet be unwound with a soft landing. But doubt remains on two scores. First is the unwillingness of China?s policymakers to free the RMB, which in turn implies their reluctance to shift the emphasis to domestic consumers away from investment goods industries. I say unwillingness because I do not wish to say inability. Yet China?s macroeconomic policy remains clumsy.
The second danger is the lack of innovations. China has not put its name to any notable new products or processes. Every growth spurt in the past that has been lacking such Total Factor Productivity Growth has run out of steam. I very much think that China may join the league. Again I could be wrong, but now and then it is good to look beyond exponential growth paths.
The author is a prominent economist and Labour peer