- Pub. Date:
- Yale University Press
- Pub. Date:
- Yale University Press
- Why America saving too little and China saving too much creates mounting problems for both
- How China is planning to re-boot its economic growth model by moving from an external export-led model to one of internal consumerism with a new focus on service industries
- How America, shows a disturbing lack of strategy, preferring a short-term reactive approach over a more coherent Chinese-style planning framework
- The way out: what America could do to turn its own economic fate around and position itself for a healthy economic and political relationship with China
In the wake of the 2008 crisis, both unbalanced economies face urgent and mutually beneficial rebalancings. Unbalanced concludes with a recipe for resolving the escalating tensions of codependence. Roach argues that the Next China offers much for the Next America—and vice versa.
|Publisher:||Yale University Press|
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The Codependency of America and China
By Stephen Roach
Yale UNIVERSITY PRESSCopyright © 2014 Stephen Roach
All rights reserved.
The Political Economy of False Prosperity
In 1933, one out of every four Americans was out of work. Karl Marx appeared to be right—the capitalist model was on the brink of failure. Forty years later, China was in the throes of the Cultural Revolution and its economy was in shambles. Famines had killed thirty million of its citizens, poverty was rampant, and joblessness was soaring. Socialism wasn't the answer either.
Both nations were determined to find that ever-elusive answer. Seared by these wrenching experiences, the United States and China vowed never again to allow their economies to go to the brink. The U.S. Congress formalized this commitment with the Full Employment Act of 1946, forever enshrining maximal growth and full employment as overarching goals of public policy. In China, the pledge was implemented through an extraordinary leadership transition—the post-Mao ascendancy of Deng Xiaoping, who drove the "reforms and opening up" of the modern Chinese economy.
Two systems, two ideologies, two political frameworks. Yet out of their dissimilar origins and experiences came remarkably similar commitments: Pro-growth policies were consecrated as the elixir of prosperity.
This simple but powerful belief eventually turned seductive. When the fundamental underpinnings of growth come under pressure, as they inevitably do, social and political backlash invariably demands a new recipe for growth. That's where well-intentioned nations often get into trouble. Pressured into what can be called the political economy of false prosperity, nations are tempted to cut corners. They begin to chart perilous shortcuts to economic growth. Perhaps unwittingly at first, the United States and China both succumbed to those very temptations. Over time, as increasingly codependent economies, they relied heavily on each other to pull it off.
The Ultimate Consumer
Personal consumption is the essence of the American Dream. It has long defined the ultimate in success for the world's most powerful economy. Most of the time during the past century, that dream came true. But there were times when it didn't. And that's where our story starts. During the 1930s and 1940s, most U.S. families were forced to do without—first by the Great Depression, then by wartime mobilization and rationing. Citizens of the Land of Plenty became steeped in hardship and sacrifice.
During those two decades, purchases of cars, furniture, appliances, and even clothing were put on hold—first out of necessity, due to soaring joblessness and near economic collapse, and then out of a purposeful and noble focus on military victory. It took everything a great nation could muster to endure these pressures, and the American consumer shouldered the bulk of the burden. For twenty years, a long and steady improvement of American lifestyles was put aside. The era of sacrifice became an age of pent-up demand.
With victory came economic recovery. Factories shifted from tanks back to cars, from armaments to consumer goods. The boys came home and went to college, or back to work. The great American job machine shifted into gear, sparking a regeneration of household incomes and purchasing power that allowed consumers to start chipping away, at last, at all that pent-up demand that had been deferred during Depression and wartime.
The resurgence of jobs and consumption fed on itself—just as the new Keynesian economic analysis promised. The recovery in consumer demand pushed manufacturing plants back to full capacity—sparking an investment boom aimed at modernizing and expanding America's production platform. The powerful combination of consumer demand and business investment gave further impetus to employment and labor income—long the sustenance of vigorous growth in personal consumption. The American Dream was back.
There seemed to be no stopping the United States. There were certainly no serious threats from foreign competition. The United States was the only major industrial power to emerge largely unscathed from the war; Europe and Japan were focused on rebuilding and reconstruction. Nor were the poor developing economies a factor. The United States prospered largely as an autonomous or "closed" economic system, making most of what it consumed. Merchandise imports averaged just 3.5 percent of gross domestic product in the 1950s and 1960s. America and its workers had their home markets largely to themselves. In many respects, it was an era of sheltered innocence.
Things started to sour in the late 1960s. The war in Vietnam shattered the nation's newfound tranquility—on social, political, and economic grounds. At the same time, Washington took on the weighty responsibility of the Great Society: civil rights, poverty reduction, medical care, and retirement security. From the standpoint of macroeconomic policy, this should have been a classic "guns and butter" tradeoff—in essence, weighing a sacrifice by the private sector against extraordinary new responsibilities being taken on by the public sector. But with memories of the 1930s and 1940s still vivid, America was not in the mood for another sacrifice.
So Washington finessed the choice, funding massive new domestic programs such as Medicare while also escalating a costly war in Asia. The federal government embarked on both of these commitments without tightening its purse strings—either in fiscal or in monetary terms. This was the first in a long line of efforts to "kick the can down the road." But the economy knew better. Slack capacity vanished in both labor and product markets, and inflationary pressures started to mount.
In the early 1970s, complications intensified. The accomplishments of the first two decades of the post–World War II era instilled a false confidence in the art and practice of economic management. Inflation was incorrectly diagnosed as an administrative problem that could be addressed by a peacetime version of the wartime wage and price controls that were so successfully deployed in the 1940s. At the same time that U.S. President Richard Nixon put these controls back in place, in August 1971, he also responded to international pressures on the dollar by severing America's commitment to the gold standard—in effect, depriving U.S. economic policy of its anchor to history's most deeply entrenched store of value.
Meanwhile, America's boom was matched by comparable trends elsewhere in the global economy. A synchronous surge in worldwide economic activity in the early 1970s only intensified the inflationary pressures. Then came the Yom Kippur War of late 1973, the first oil embargo, and soaring energy prices. The kindling wood of the Great Inflation was lit, and the era of innocence became unhinged.
One policy mistake followed another. Notwithstanding soaring prices, long gas lines, and mounting wage pressures, Washington deepened its resolve in one key aspect of economic stewardship: Despite a worrisome buildup of inflationary pressures, both fiscal and monetary authorities resisted the temptation to tighten their policies. True to the Employment Act of 1946, they were unflinching in their pro-growth commitment.
This single commitment unlocks much of the story that lies ahead—not just for the United States but also for China. By erring on the side of policy accommodation, U.S. authorities thought they were protecting the American consumer as the mainstay of the modern U.S. growth miracle. Tax incentives such as the deductibility of interest paid on home mortgages and other forms of consumer credit left little doubt of Washington's pro-consumption bias. A notable lack of savings incentives, like interest rate ceilings on consumer saving accounts, only reinforced this tendency. It was all about maximizing current consumption. And it seemed to work. The U.S. economy's share of personal consumption expenditures, which had fluctuated in a tight range of 59–61 percent of gross domestic product in the 1950s and 1960s, started to drift up by the mid-1970s.
This is where the plot thickens. Beginning in the early 1980s, the traditional sources of U.S. consumer demand came under increasing pressure. Job growth slackened, as did gains in inflation-adjusted, or real, wages. Overall growth in labor incomes started to falter. The noose was tightening on the American consumer.
Even with the benefit of hindsight, it is not altogether clear what caused the squeeze on the U.S. economy's ability to boost labor income. Technological change, by substituting machines for people, and globalization, by drawing low-wage offshore labor into integrated production platforms, are high on the list of likely suspects. So, too, are demographics, especially an aging population, as well as the entry into the workforce of relatively inexperienced and low-paid female and younger workers. The demise of labor unions and the wage rigidity they stood for also squeezed worker compensation.
But the result was surprising. The squeeze in labor income did not stop the American consumer, and personal consumption continued to rise as a share of the U.S. economy. By the late 1980s the share was nearly 64 percent. This seemingly incongruous development—weak income growth and strong consumption—holds the key to America's deepest macroeconomic imbalances, such as low saving, balance of payments and international trade deficits, and a steady buildup of debt.
Unsurprisingly, the deeper the hole American families found themselves in, the more the body politic was willing to cut corners to keep the consumption miracle alive. It was less a set of specific new policies that were enacted to boost consumption than it was an overarching mindset. Monetary and fiscal policies were locked in pro-growth settings, and personal consumption was to be stimulated at all costs. And so the seeds were sown of what turned out to be a false prosperity.
It was not until the mid-1990s, however, that those seeds started to sprout and U.S. consumers figured out how to live well beyond their means, as those means were delineated by their wage incomes. Asset-based wealth creation held the key as a new source of purchasing power. First, there was the so-called wealth effect of a surging stock market. There was nothing wrong with spending stock market wealth, went the argument. It was a proxy for long-term savings generated directly through portfolio investments and indirectly via retirement funds invested in equity markets. As the stock market took off in the late 1990s, the ever-rising value of these investments was widely presumed to rest on the solid fundamentals of America's productivity resurgence stemming from miraculous breakthroughs in information technology.
The only problem was that it was a pipe dream. In 2000, the stock market surge of the late 1990s was unmasked as a bubble. Led by speculative buying in dotcom stocks, the NASDAQ composite index essentially doubled in the twelve months ending March 2000 before plunging by more than 60 percent in the following ten months. Other broader indexes, such as the S&P 500 and the Dow Jones Industrials, also surged, then suffered dramatic declines. When the equity bubble burst, the seemingly impeccable logic of the wealth effect was quickly turned inside out. Many individual investors believed that the stock market surge of the late 1990s was sustainable. The resulting wealth destruction shattered those expectations and dealt increasingly equity-dependent families a devastating blow.
After some delay, consumption growth slowed briefly in 2001, before the American consumer got a second wind from another round of even bigger bubbles—in this case, both property and credit. Courtesy of an unprecedented surge in home prices, together with the new financial technology of home equity loans and mortgage refinancing that enabled homeowners to extract unrealized capital gains from their personal residences, America's consumer spending binge resumed, stronger than ever. Excessively easy monetary policy played a key role in this phase of America's consumption binge; low interest rates fueled bubbles in property prices and mortgage credit that enabled U.S. homeowners to keep consuming well in excess of their wage incomes.
A transition from income-dependent to asset- and ultimately bubble-dependent consumption had occurred. It played a decisive role in America's reckless journey down the road of false prosperity. The blame for this detour will long be debated. But there can be no mistaking its visible manifestations.
For starters, the consumer-led tilt of the U.S. economy spiraled into rarefied territory. Personal consumption soared from 64 percent of gross domestic product in 1990 to 69 percent by 2011—a record for America and, in fact, for any nation. As before, this spending binge came against a backdrop of unusually anemic growth in labor income. Inflation-adjusted compensation paid to workers increased a cumulative total of just 18 percent over the 2002–11 period—one-fourth the average gains over comparable periods of the four earlier business cycle expansions.
This confluence of a record surge of consumption growth juxtaposed against a severe shortfall of labor income generation delineates the broad parameters of America's lapse into a false prosperity. The disturbing consequences of this mismatch were dismissed by many as benign manifestations of a New Economy. The personal savings rate fell to a post–World War II low of 2.3 percent of disposable personal income in 2005—well below the 9.3 percent norm in the final three decades of the twentieth century. Household sector indebtedness surged to a record 132 percent of disposable personal income in early 2008—well above the 43 percent average over the 1970–2000 period. And a savings-short U.S. economy, aggressively borrowing surplus savings from abroad in order to grow, ran massive current account and foreign trade deficits.
American consumers were in a league of their own. The United States, with only 4.5 percent of the world's population, spent $10.7 trillion on personal consumption in 2011, accounting for 17 percent of global consumer demand. U.S. consumption is nearly 35 percent larger than pan-European consumption, even though Europe's population is slightly larger than that of the United States. It is four times that of China and India combined, even though those countries account for close to 40 percent of the world's population, nearly nine times that of the United States.
Yet the ultimate consumer was in serious trouble. The more American families labored under mounting pressures, the greater became the temptation to uncover new—and eventually fleeting—sources of purchasing power. First the equity market, then the home—U.S. consumers became overaggressive in converting their asset holdings into purchasing power. Never mind that those sources rested on a shaky foundation of asset and credit bubbles. The political economy of false prosperity deluded a generation of Americans into believing they could pull it off. Sadly, that became an irresistible siren song for many other economies around the world, including China's.
The Ultimate Producer
On the surface, a very different story seemed to be playing out in China. The contrasts are obvious and noteworthy—a poor country versus a rich country, as well as the juxtaposition of one of the world's oldest civilizations with one of the newest. But there are also some striking parallels that connect the respective journeys taken by the United States and China since the late 1940s.
For America, the Second World War ended in a rush of victory. For China, it brought another, equally wrenching war—the civil war of the Communist Revolution—followed by the birth of a new nation. America found itself picking up the pieces as the world's strongest economy and a victorious military power. China, meanwhile, was essentially starting from scratch from the standpoints of governance, poverty reduction, economic development, and social harmony.
The first thirty years of China's journey, under the volatile and messianic leadership of Mao Zedong, were filled with chaos and turmoil. In the early years after the founding of the People's Republic of China, Mao borrowed heavily from the Stalinist economic policy template of the Soviet Union—drawing up a series of complex five-year plans that provided detailed, yet often inconsistent, sector-by-sector and industry-by-industry targets for production, investment, employment, and prices.
The plans of the 1950s and 1960s were unmitigated disasters. That was especially true of China's Second Five-Year Plan (1958–62), which featured the "Great Leap Forward." Intended to modernize China's backward and long-fragmented agricultural sector, the plan focused on the consolidation of 740,000 farm cooperatives into 26,000 communes. This was sold as a recipe for efficiency and sustenance for a Chinese population that, at the time, included some 500 million peasants.
Excerpted from Unbalanced by Stephen Roach. Copyright © 2014 Stephen Roach. Excerpted by permission of Yale UNIVERSITY PRESS.
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Table of Contents
Part 1 In the Beginning 1
1 The Political Economy of False Prosperity 4
2 Who Depends on Whom? 23
Part 2 Leadership and Power 39
3 The Boss and the Maestro: Greenspan and Zhu 43
4 The Great Stability Debate: Wen vs. Bernanke 63
5 Two Takes on Strategy Washington and the NDRC 83
Part 3 Tensions 103
6 A New Globalization 106
7 Bilateralism in a Multilateral World 125
8 The China Gripe 145
Part 4 Warning Shots 169
9 Imbalances and the Great Crisis 172
10 Smoot-Hawley Redux 190
Part 5 Resolution 209
11 Rebalancing 213
12 The Next America Meets the Next China 233
13 Codependency, the Internet, and a Dual Identity Crisis 250