Part 2 of a two-part blog on China’s economy. Part 1 can be found here.
At this point, projections indicate that a slowdown of China’s economic growth is nearly inevitable. This in turn will slow the growth of its share of global GDP as well as global trade — traditional measures of economic might and international presence. We must now consider what this means for China’s international economic presence and its influence on the global stage.
After having analyzed the prospect of China’s future growth in Part 1 of this blog, Part 2 turns to the question of how such a dramatic growth slowdown might impact the country’s efforts to expand its economic influence. Part 1 examined how China’s economic growth across the next 20 years will be more modest. Addressing even less predictable developments than economic growth, we will now focus on the next five years.
We can examine the impact of the economic slowdown on China’s global economic clout from a few different perspectives. China’s capacity to expand its international footprint, the internationalization of the yuan, also known as the renminbi (RMB), and the country’s role in global economic stewardship present areas in which China’s prominence will continue to rise. Other areas of international economic influence remain harder to predict.
Expanding the International Footprint
While China’s economic growth may be slowing, the economy already possesses respectable might. For instance, China is sitting on nearly $4 trillion of foreign reserves. It doesn’t require more than $1 trillion for precautionary purposes, even with conservative estimates. These reserves cannot be spent domestically without dramatically strengthening the RMB, so most of these massive reserves are available for alternative uses overseas.
This gives China a $3 trillion budget to expand its international footprint, whether that goes to foreign aid, development projects or propaganda machinery. Domestically, the government is still in a very strong position, with a debt-to-GDP ratio of only about 25 percent, and this number continues to fall due to low fiscal deficits. China has plenty of cushioning for economic hiccups or expanding in new directions, so surprise domestic challenges or new international challenges need not disrupt its growing international economic clout.
The RMB also remains very strong. While it is currently flat against the dollar, it is still up by 20 percent since the beginning of 2014 in comparison to the yen and the euro. So while the U.S. may not see a big Chinese buying spree, Europe may receive a lot of Chinese FDI.
What China lacks, though, is political goodwill. Chinese projects have become major political issues lately in Mexico and Sri Lanka, among other locations. While a mistrust of U.S. motives is nothing new in the developing world, America has always faced friendly market reception among its allies.
China, on the other hand, is perceived with distrust in almost every market. This constitutes a large difference between China’s current situation and the United States’ standing 100 years ago and explains why China has developed many of its international forays unilaterally until recently.
Internationalization of the RMB
The internationalization of a currency refers to how frequently it is used outside its own country’s borders for trade and financial transactions, as a store of value for nonresidents and as a unit of account with a relatively stable value.
With the Chinese economy as large as it is, the currency’s popularity comes as no surprise. The RMB is now the second largest currency for trade settlement, recently moving past the euro to capture 8.7 percent of cross-border transactions (versus 81 percent for the dollar). However, financial transactions are many multiples of trade transactions, so trade settlements are essentially just the minor leagues.
The RMB has strong government backing, as the People’s Bank of China expands its relationships with banks abroad to settle in RMB. Now, trade in Chinese stocks can occur via Hong Kong, and there has been a trend of experimentation with more open financial markets in special zones. China’s currency would, however, be drastically more popular for financial transactions if China didn’t have such intense capital controls.
China needs to expedite the process of getting money in and out, as well as making it easier to buy and sell securities. The country needs more debt or highly rated securities for foreigners to hold. (The U.S. has done an exemplary job on this account.) These changes will happen eventually, as they are a high priority of the government, but conservative elements in China will ensure that progress will be slow.
It is worth mentioning that the internationalization of the RMB is not a worrisome development for the U.S. The process will be gradual, and the RBM will never supplant the dollar; rather, the two currencies will merely share a stage. Ultimately, this progression will serve the U.S. well, as it is much healthier for the U.S. economy to face competition. Even in areas such as currency use, dominance breeds complacency, and this obviously constitutes a less-than-ideal situation.
Global Governance
China is frantically starting big international development banks as if they are going out of style.[1] The New Development Bank was founded last year by the BRICS group at the behest of China’s leadership, and this year it attracted an impressive founding membership base for their Asian Infrastructure Investment Bank (AIIB). The bank already had plenty of experience, since the China Development Bank manages more foreign assets than the entire balance sheet of the Asian Development Bank (ADB).
The founding of the ADB provides another useful historical comparison, but this time, China compares to Japan. When the ADB was formed in 1966, Japan was informally granted the right to select the president. At the time, Japan was only the fifth largest economy in world and the largest in Asia, just ahead of China.
China is now the second largest economy in the world, and the only one that doesn’t head a major international organization, perhaps due to a paucity of goodwill and trust. Thus, it is only natural that China would seek such a prominent leadership role. China wisely has not taken the very awkward step of asking fading powers like Japan to step aside. In addition, the U.S. Congress has effectively shot down the efforts of both the Bush and Obama administrations to provide countries like China with greater weight at the World Bank and the IMF. Hence, China using its very deep pockets to create its own institutions presents the path of least resistance.
That Europe and Japan are fading only helps China in its economic rise: Europeans can’t afford to miss the chance to cozy up to China through relatively harmless measures such as joining the AIIB. Further, these countries could use the boost that membership will give to their firms in competing for AIIB projects.
Looking Forward
China’s rise will raise many more questions that are not easily answered. Two of the most prominent sets of questions relate to global trade arrangements and international financial institutions.
How will China influence global trade norms? Will its trade pact initiatives like the Free-Trade Area of the Asia Pacific supersede efforts like the U.S.-led Trans-Pacific Partnership? China has different priorities than the U.S. in opening markets, so greater Chinese leadership will clearly impact the global trade agenda.
Will China lower global standards and best practices among the institutions of global stewardship? The Bretton Woods institutions have very high standards for labor, environment, social impact and governance. Thus far, Chinese practices are not exemplary in these areas.
Ultimately, China’s economic influence should continue growing, even if its economy slows. In a departure from the historical comparison, China may not leap to the forefront as the U.S. did during the world wars. In those times, the U.S. ascent was helped by the decimation of the European economies. China lacks those sorts of circumstances, which will hopefully never repeat themselves. Despite this, the country’s influence has yet to match its current GDP levels, so it has plenty of room to run. The momentum of its ascent to prominence should propel the agenda of Chinese leaders quite a bit further, even if the engine stalls.
Furthermore, the rise of Chinese influence need not be viewed as Chinese aggression, nor will it necessarily have detrimental outcomes for current leading countries. Rather, it is natural that prominent economies find a larger role on the global stage, just as the U.S. and Japan did previously. China’s main issue as of now is a trust deficit; if it can assure the world that its intentions are benign, it will find less resistance in its efforts to expand.
Russell Green is the Will Clayton Fellow in International Economics at the Baker Institute and a former U.S. Treasury attaché in India. This blog complements his analysis at an April 6, 2015, Baker Institute event on “Political Reform in China.”
[1] Ironically, they are. In fact, the World Bank and the ADB have been worrying about their relevance for a decade or more.