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Macroeconomic & Geopolitical

What Do We Really Want From China? And What Can We Reasonably Expect?

4 October 2019 - 3 min read

Even an unexpected trade deal this week between the U.S. and China will not alter the trajectory of two alternate political, economic and social models coming to terms with each other as a fresh decade dawns.

Barring yet another jarring twist of fate, this week’s headlines will take stock of U.S.-China trade relations following another visit to Washington by a senior Chinese delegation. Investors will focus on anything in the tone from either side that might recalibrate the odds of tariffs on $160 billion of mainly consumer imports on December 15.

Markets may rise and fall, but the impact will always be brief. Even an unexpected deal will not alter the trajectory of two alternate political, economic and social models coming to terms with each other as a fresh decade dawns. A talented workforce comprising one in five humans who benefit from massive government subsidies, a favorable exchange rate and thoughtful central planning will naturally reshape traditional economic patterns.

Setting aside deep differences over democracy, citizens’ rights and the South China Sea, investors need to look past current headlines to understand what the world’s market economies should want from China to ensure global growth that is as strong and sustainable as possible.

The Current Asks

The Trump Administration’s tough talk and quick deployment of tariffs clearly got Beijing’s attention, but so far there’s little to show in changed behavior. Leaving aside a critique of the Administration’s tactics, part of the problem may be that its demands have been both too small and too big at the same time.

The focus on Chinese commitments to buy U.S. agricultural exports seems barely a temporary solution to help redress a bilateral goods deficit. Meanwhile, the currency complaints are long out-of-date, with recent interventions actually intended to slow the weakening renminbi.

At the same time, Washington has pressed to end coordinated government support for Chinese firms, including its Made in China 2025 program that is intended to support global leadership in areas from artificial intelligence to aeronautics to biomedicines. These require fundamental changes in China’s political structure and hardly seem likely.

“Setting aside deep differences over democracy, citizens’ rights and the South China Sea, investors need to look past current headlines to understand what the world’s market economies should want from China to ensure global growth that is as strong and sustainable as possible.”

Realistic Expectations

So if investors want a global economy where growth is more stable, balanced and sustainable, what should be our top asks?

First, of course, would be a more level playing field to tap into growing Chinese markets. Beijing has been demonstratively pressing ahead with plans to broaden access to its financial markets in spite of recent trade friction. It has even cut tariffs to some trading partners to offset the added costs of tariffs on U.S. products. Nevertheless, it’s hard to describe Chinese markets as “open” and the capital account remains mostly closed.

Of greater concern may be China’s active efforts at import substitution in manufacturing. Even if officials play down “Made in China 2025,” the efforts to advance these key sectors continue. China’s current import of manufactured goods, as economist Brad Setser has argued, suggests a troubling pattern of what he calls “deglobalization.”

GROSS SAVING AS A % OF GDPGROSS SAVING AS A % OF GDPSource: Bloomberg as of OCTOBER 4, 2019

Second, China’s national savings rate of 46% of GDP is more than twice the global average and introduces real growth risks that transcend its borders. The combination of an ageing population and legacy of a one-child policy has led households to sock away as much money as possible for retirement. Historically, such distortions have contributed to a large current account surplus that has undercut global demand. Consider for a moment that China’s GDP per capita ranks near Brazil, but its consumption per capita is closer to Nigeria.

More recently, external accounts have returned closer to balance, but the excess savings have fueled an unsustainable investment boom. A more reliable Chinese social safety net that allows increased household consumption would do more for global growth than any trade understanding.

Third on most wish lists must be a more transparent and sustainable financial system. The government recognized these risks when it reined in informal credit growth last year, but the IMF continues to urge progress on boosting bank capital, improving regulation and ending implicit guarantees for state-owned enterprises.

The risks of the Chinese financial system are no longer restricted to China alone. Not only is a healthy Chinese economy crucial to sustainable global growth, but its outward financial flows are increasingly important. It’s tempting to say that the next global financial crisis could start in China unless reforms bring more transparency and stability.

None of these changes will be easy or quick, but progress toward any of them would be far more consequential than the issues the trade teams will discuss this week. For now, Beijing and Washington seem locked in a relationship that includes tariffs. Investors will need to look beyond these escalating exchanges for signs of durable Chinese reforms that may deliver stronger and more sustainable global growth.

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