At first glance, it may not seem that China is really engaged in an arms race with the US. After all, China’s official defense budget for this year – at roughly $175 billion – amounts to just one-quarter of the $700 billion budget approved by the US Congress. But China’s actual military spending is estimated to be much higher than the official budget: according to the Stockholm International Peace Research Institute, China spent some $228 billion on its military last year, roughly 150% of the official figure of $151 billion.
In any case, the issue is not the amount of money China spends on guns per se, but rather the consistent rise in military expenditure, which implies that the country is prepared to engage in a long-term war of attrition with the US. Yet China’s economy is not equipped to generate sufficient resources to support the level of spending that victory on this front would require.
If China had a sustainable growth model underpinning a highly efficient economy, it might be able to afford a moderate arms race with the US. But it has neither.
On the macro level, China’s growth is likely to continue to decelerate, owing to
- rapid population aging,
- high debt levels,
- maturity mismatches, and the
- escalating trade war
that the US has initiated. All of this will drain the CPC’s limited resources. For example, as the old-age dependency ratio rises, so will health-care and pension costs.
Moreover, while the Chinese economy may be far more efficient than the Soviet economy was, it is nowhere near as efficient as that of the US. The main reason for this is the enduring clout of China’s state-owned enterprises (SOEs), which consume half of the country’s total bank credit, but contribute only 20% of value-added and employment.1
.. The problem for the CPC is that SOEs play a vital role in sustaining one-party rule, as they are used both to reward loyalists and to facilitate government intervention on behalf of official macroeconomic targets.
Dismantling these bloated and inefficient firms would thus amount to political suicide. Yet protecting them may merely delay the inevitable, because the longer they are allowed to suck scarce resources out of the economy, the more unaffordable an arms race with the US will become – and the greater the challenge to the CPC’s authority will become.
The second lesson that China’s leaders have failed to appreciate adequately is the need to avoid imperial overreach. About a decade ago, with massive trade surpluses bringing in a surfeit of hard currency, the Chinese government began to take on costly overseas commitments and subsidize deadbeat “allies.”
Exhibit A is the much-touted Belt and Road Initiative (BRI), a $1 trillion program focused on the debt-financed construction of infrastructure in developing countries. Despite early signs of trouble – which, together with the Soviet Union’s experience, should give the CPC pause – China seems to be determined to push ahead with the BRI, which the country’s leaders have established as a pillar of their new “grand strategy.”
An even more egregious example of imperial overreach is China’s generous aid to countries – from Cambodia to Venezuela to Russia – that offer little in return. According to AidData at the College of William and Mary, from 2000 to 2014, Cambodia, Cameroon, Côte d’Ivoire, Cuba, Ethiopia, and Zimbabwe together received $24.4 billion in Chinese grants or heavily subsidized loans. Over the same period, Angola, Laos, Pakistan, Russia, Turkmenistan, and Venezuela received $98.2 billion.1
Now, China has pledged to provide $62 billion in loans for the “China-Pakistan Economic Corridor.” That program will help Pakistan confront its looming balance-of-payments crisis; but it will also drain the Chinese government’s coffers at a time when trade protectionism threatens their replenishment.
Like the Soviet Union, China is paying through the nose for a few friends, gaining only limited benefits while becoming increasingly entrenched in an unsustainable arms race. The Sino-American Cold War has barely started, yet China is already on track to lose.
Debating Piketty’s theories on ‘Capital’ and inequality
- Kevin Hasset argues that inequality is not rising because of government transfer programs (that he likely does not favor).
- Heather Boushey argues that Kevin Hassett starts from economic models that don’t match reality, rather than the data.
The Global Impact of a Chinese Recession
Most economic forecasts suggest that a recession in China will hurt everyone, but that the pain would be more regionally confined than would be the case for a deep recession in the United States. Unfortunately, that may be wishful thinking.
CAMBRIDGE – When China finally has its inevitable growth recession – which will almost surely be amplified by a financial crisis, given the economy’s massive leverage – how will the rest of world be affected? With US President Donald Trump’s trade war hitting China just as growth was already slowing, this is no idle question.
.. First, the effect on international capital markets could be vastly greater than Chinese capital market linkages would suggest. However jittery global investors may be about prospects for profit growth, a hit to Chinese growth would make things a lot worse. Although it is true that the US is still by far the biggest importer of final consumption goods (a large share of Chinese manufacturing imports are intermediate goods that end up being embodied in exports to the US and Europe), foreign firms nonetheless still enjoy huge profits on sales in China.
Investors today are also concerned about rising interest rates, which not only put a damper on consumption and investment, but also reduce the market value of companies (particularly tech firms) whose valuations depend heavily on profit growth far in the future. A Chinese recession could again make the situation worse.
.. High Asian saving rates over the past two decades have been a significant factor in the low overall level of real (inflation-adjusted) interest rates in both the United States and Europe, thanks to the fact that underdeveloped Asian capital markets simply cannot constructively absorb the surplus savings.
.. instead of leading to lower global real interest rates, a Chinese slowdown that spreads across Asia could paradoxically lead to higher interest rates elsewhere – especially if a second Asian financial crisis leads to a sharp draw-down of central bank reserves. Thus, for global capital markets, a Chinese recession could easily prove to be a double whammy.
.. a significant rise in global interest rates would be much worse. Eurozone leaders, particularly German Chancellor Angela Merkel, get less credit than they deserve for holding together the politically and economically fragile single currency against steep economic and political odds. But their task would have been well-nigh impossible but for the ultra-low global interest rates
.. Today, however, debt levels have risen significantly, and a sharp rise in global real interest rates would almost certainly extend today’s brewing crises beyond the handful of countries (including Argentina and Turkey) that have already been hit.
.. Nor is the US immune. For the moment, the US can finance its trillion-dollar deficits at relatively low cost. But the relatively short-term duration of its borrowing – under four years if one integrates the Treasury and Federal Reserve balance sheets – means that a rise in interest rates would soon cause debt service to crowd out needed expenditures in other areas. At the same time, Trump’s trade war also threatens to undermine the US economy’s dynamism.
.. Its somewhat arbitrary and politically driven nature makes it at least as harmful to US growth as the regulations Trump has so proudly eliminated. Those who assumed that Trump’s stance on trade was mostly campaign bluster should be worried.
.. A recession in China, amplified by a financial crisis, would constitute the third leg of the debt supercycle that began in the US in 2008 and moved to Europe in 2010. Up to this point, the Chinese authorities have done a remarkable job in postponing the inevitable slowdown. Unfortunately, when the downturn arrives, the world is likely to discover that China’s economy matters even more than most people thought.
Geopolitics Trumps the Markets
America led a 30-year hiatus from history. It was nice while it lasted, but it’s over.
That crashing sound you heard in world markets last week wasn’t just a correction. It was the sound of the end of an age.
During the long era of relatively stable international relations that succeeded the Cold War, markets enjoyed an environment uniquely conducive to economic growth.
.. The results were extraordinary. Between 1990 and 2017, world-wide gross domestic product rose from $23.4 trillion to $80.1 trillion, the value of world trade grew even faster, more than a billion people escaped poverty, and infant-mortality rates decreased by more than 50%. The number of people with telephone service grew roughly 10-fold.
This hiatus from history was, by most measures of human flourishing, a glorious era. Now it has come to an end, or at least a pause, and the world is beginning to see what that means.
.. the basic elements of economic globalization appeared firmly in place.
- Russia, the most obvious challenger to the geopolitical order, was an insignificant and diminishing player economically.
- And China, notwithstanding its rapid economic growth and its anxiety about American military power, was unlikely to challenge the economic basis of its own success. Geopolitics might have been back, but that wasn’t an issue for markets.
That complacency was misplaced. The return of geopolitics means the basic framework for economic policy has changed. In periods of great-power rivalry, national leaders must often put geopolitical goals ahead of economic ones. Bismarck’s Germany could have saved money buying armaments from Britain, but building a domestic arms industry was worth the cost. If the U.S. is in a serious strategic competition with China, an American president might well be willing to sacrifice some economic growth to banish China from important supply chains.
,, by invoking “national security,” the Trump administration has found a legal basis, with roots in the Cold War and even earlier, to assert sweeping powers over the nation’s commerce. It has upended a generation of U.S. trade policy in a dramatically short period of time.
.. The new era of geopolitics is unlikely to be an era of small government.
.. The Trump administration is
- reversing some of the regulatory excesses of the Obama era, and
- the president’s judicial appointees are prepared to rein in the administrative state.
.. A recalibration of the U.S.-China relationship was likely inevitable as the world’s oldest civilization became an economic superpower.
Hillary Clinton, who as secretary of state clashed with Mr. Obama over the need for a tougher approach to China, would not be a popular figure in Beijing if she had won the 2016 election.