China can’t save the world economy

With US President Donald Trump dumping the Trans-Pacific Partnership (TPP) and all set to introduce tax reforms that seek to penalise imports and outsourcing, supporters of free trade would want China, the world’s second largest economy and still one of two fastest growing large economies, to fill in for the US and pull the world economy out of trouble. President Xi Xinping’s recent defence of free trade and globalisation at the World Economic Forum in Davos added credence to such hope.

Currently, the world economy is troubled by slowing demand. That leads to two questions: Can China fill in the role (of being the world’s top buyer of goods and services) that the US has been playing for decades? Will China — known for its import restricting trade policy regime — make concessions to its trading partners such as India, which has been struggling to check its rising trade deficit with it?

For more than a decade now, multi-lateral trade liberalisation has been on a pause. But China can rely on the 16-member Regional Comprehensive Economic Partnership (RCEP) which covers all major economies of Asia-Pacific region including India, Japan, Australia and New Zealand to help deal with slowing global trade at a time when the US is turning inward and enhance its pro-globalising credential.

RCEP members together account for roughly a third of the world GDP and 30 per cent of global trade.

Critics say RCEP is less ambitious and covers mostly trade in goods even though services account for a larger share in the global GDP, and global trade in services is growing faster than the trade in goods. This problem can’t be dealt with by China if it decides to play the big role. However, there are other hurdles which would be difficult to address but need to be addressed if China is to replace the US as the leader of free trade.

China, after becoming a WTO member in 2001, has benefited immensely from the opening up of new markets to its merchandise. However, it has never been much receptive to the idea of buying from outside except food, raw material/intermediates or parts and components, which are meant for further processing into exports. It has resisted imports through the use of all kinds of tariff and non-tariff barriers.

That may explain its huge trade surplus with countries such as the US, or India, another key stakeholder in the great Chinese game. The US has taken China to the WTO at least 16 times on issues ranging from illegal taxes on steel and automobiles to dumping and export quotas between 2008 and 2016 alone. China remains the top defendant in most of the cases of trade rules violation filed by India, the EU and others.

It would not be an exaggeration to say that China’s record of complying with global trade rules — a pre-requisite for playing the big ‘free-trade’ lead role — is not impressive. It has been found using export control measures to make key industrial inputs such as fluorspar and coke or rare earths expensive for competing overseas manufacturers.

It’s no secret that China subsidises its manufacturing sector by providing under-priced inputs such as industrial raw materials or electricity and cheap capital as highlighted by Usha and George Haley. Over the years, import elasticity of Chinese exports has gone down from 60 per cent in mid-1990s to 35 per cent or so at present which implies that going forward it would be buying less from outside.

The charges of currency manipulation by China — keeping the yuan artificially undervalued to make exports cheaper and imports expensive — are all well documented. The Chinese record of not letting market forces have a free hand when it comes to the determination of prices or exchange rates may explain why many regions, including the EU and the US are hesitant on according it market economy status — now a matter for WTO to settle.

Though, China at present is trying to protect its currency from sharp fluctuations that could create problems for its trading partners. Thus, the charge of currency manipulation does not hold now as strongly as in the past.

Many countries including India (and for that matter, even the US) don’t have a clue about how to deal with their high and rising trade deficits with China that they can’t ignore for long. India is therefore sitting on the decision about whether to accord market economy status to China, and is closely watching how the WTO decides on the subject, before making up its mind.

Chinese aggressive geopolitical posturing makes many countries including India, Japan, Vietnam, and to an extent, even the US uncomfortable. Most countries see China’s ‘One Road One Belt’ project with suspicion.

All these realities will put a question mark on Chinese ambition to replace the US and be the leader of the free world. Yet, a general commitment to play by accepted global trade rules will certainly help advance China’s case. To be specific, China could do the following to be more acceptable.

With China transitioning towards more consumption and services, it should be open to buy more from outside even if it means running trade deficits. However, that’s easier said than done. Given the over-capacities in its factories, slowing growth, rising debt (250 per cent of the GDP) and depreciating yuan, China will find it increasingly difficult to let imports go up at least in the short to medium term.

Full capital convertibility, allowing seamless trans-border flows of capital and letting the yuan freely float will increase international confidence in Chinese regulatory environment but that may have serious side effects — internally for its macroeconomic stability, and externally for its trading partners because of the likely further slide of the yuan which will worsen the export price competitiveness of its trading partners.

Thus, it’s difficult to think China can replace the US and pull the world economy out of trouble especially since it also has its own internal issues to deal with on priority. With Trump in the White House and rising protectionism across the rich world, global trade prospects remain as bleak as ever.

The writer is former assistant director of the Finance Commission of India

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