Time to step up

At a time when countries, including China, are facing potentially large economic problems it is natural that they should look first at the home front rather than at their international role. But, given the degree of globalization in finance and trade, it may be unwise to become too focused on local issues to the exclusion of what can be done to alleviate the international problems that are rebounding on the domestic economy.

Clearly a major reduction in China’s growth rate is going to hurt everyone, so a number of countries are looking to Beijing to stimulate its domestic economy. This is not unreasonable because, though strong growth in China has acted as a major driver of global prosperity, the country’s trade and current account surpluses have become part of the global problem.

The over-consumption in the US and some other Western countries has been mirrored by underconsumption by China. In the long run, this imbalance does no one any good. China is accumulating assets – mostly US debt – of declining value, while holding down disposable incomes and depriving many citizens of reasonable access to health and other social facilities.

Change is afoot

China must face the difficult fact that, after years of export-led growth, domestic demand must become the driver, resulting in an erosion of the trade surplus. Sustaining exports by artificial means such as tax rates and fuel subsidies is not the answer. That way lies trade partner retaliation and continued international imbalances.

The transition to a domestic-driven model can be painful. So too can the need to accept sharp declines in asset prices of shares and property. But the only way the non-state sector can drive housing construction, and hence also demand for consumer durables like furniture and refrigerators, is if prices fall to affordable levels and existing inventory is sold off so that a new surge of building can start.

The government is torn between influential minority interests, including local governments which like to keep land prices high, and macroeconomic and broader public interests.

China also needs to recognize that it can play a bigger role internationally. Having lost a lot of money on investments in listed banks and private equity firms, Beijing resents suggestions that its international responsibilities include sinking more money into ailing Western institutions. However, it could be more proactive in supporting the IMF and World Bank. Both organizations need new funding to meet the sudden demands of the middle income developing countries that have been hit by the crisis.

A proactive approach may also ultimately equip China with sufficient leverage to carve out more management influence in these organizations – something it currently doesn’t really have, but to which it feels entitled.

A plan for Asia

For Asia specifically, there are four other things that China can and should do, particularly for the commodity exporting countries, which are likely to suffer more from the downturn than those like China that primarily export manufactured goods.

Firstly, it must find a way of cooperating with Japan to increase the size and effectiveness of Asian swap arrangements with the central banks of mid-sized countries that have open capital and foreign exchange markets. The likes of Thailand, Malaysia, South Korea and Indonesia require additional protection against sudden outflows resulting more from global contagion or short-term setbacks than from poor policies.

China can also start to buy the domestic currency debt of Asian countries. This would serve to reduce its own reliance on US dollar assets while making it easier for these countries to follow growth policies without worrying so much about their vulnerability to foreign exchange exposure. The idea of Thailand selling debt to the central banks of China and Japan in order to finance infrastructure has great potential.

Finally, China can help its own contracting industries, particularly those in the heavy machinery and capital goods sectors, by stepping up export financing for projects such as power stations and urban transit systems. These long-term investments are often the first to be cut when private sector money becomes less readily available and governments are forced to spend more on immediate social needs and less on long-term projects.

This crisis really is an opportunity for China.