Is China the New America?

The Great Depression made the United States the world's unquestioned financial leader. The current crisis can do the same for China.

In the Great Depression, as in the current economic crisis, the downturn was particularly severe because of a lack of leadership in the international order. The dominant financial power of the 19th century, Britain, was financially exhausted by the First World War. The new major creditor, the United States, had emerged as a strong economic player, but did not yet have leadership committed to the maintenance of an open international economic order. The simple diagnosis was that Britain was unable to lead, and the United States unwilling.

If the scenario sounds familiar, it should. The story from the Great Depression has an uncanny echo in current debates about international economic leadership, with the United States playing the role of Britain -- the exhausted debtor economy -- and China taking the place of the United States as the world's largest creditor. But if China is the America of this century, can it do a better job than the United States did in the 1930s? The way in which the emerging superpower takes to this role will determine in large part how the world will emerge from the downturn and the shape of the new global economic order that will follow.

Charles Kindleberger, the late economist, argued that the United States should have acted as a lender of last resort in the early 1930s, continuing to keep its financial markets open to investment and its market open to foreign goods, rather than heading down the path of protectionism. It should also have stimulated the world economy through countercyclical fiscal policy.

But at the time of the Great Depression, there were all kinds of convincing reasons why Americans did not want to take on the burden of a worldwide rescue. Sending more money to Europe was seen as pouring money down the drain, and after all, Europeans had fought the world war that had been the root cause of the financial mess. Economically, helping Europe would have made a great deal of sense from a long-term perspective, but politically it was a non-starter with no short-term payoff.

In the middle of the current financial crisis, a deep-pocketed China faces the same dilemma: swallow its pique and help save the same countries that got us into this situation, or look to its own short-term interests first. Today, there are increasing demands that China contribute more to internationally coordinated rescue packages through a reformed International Monetary Fund (IMF). China is also one of the few economies still growing in 2009, though most economists have reduced their estimates of growth rates. Finally, China and the United States are the only countries that are large enough, and have sufficiently well-ordered government finances, to launch major efforts at fiscal stimulation.

Beijing's leaders might feel like they have already taken their best shot. The initial stages of the credit crunch in 2007 were managed so apparently painlessly because sovereign wealth funds (SWFs) from the Middle East, but above all from China, were willing to step in and recapitalize the debt of U.S. and European institutions. Between November 2007 and March 2008, the SWFs provided $41 billion of the $105 billion injected into major financial institutions. Had this process continued, the events of 2008 would have included problems with U.S. real estate and a severe stock market decline, but no meltdown of financial institutions.

But after March 2008, the availability of funds to prop up the global financial system shriveled up. The pivotal moment in today's events came when the state-owned China Investment Corp. (CIC) was unwilling to go further in its exploration of buying Lehman Brothers. CIC's turning back will be held up in the future as a moment when history could have shifted in a different direction.

Today there may be plenty of reasons why the Chinese will be tempted to pull back from their engagement with the world economy, and the external political logic sounds very much like the U.S. case of 1931. Some of the economic arguments reverberating around Beijing are very reasonable: There is a great deal of uncertainty, and the SWFs have lost a lot of money already and might lose more. China's investments in U.S. securities in 2006 proved to be a huge costly mistake. Clearly the CIC would have initially lost further billions had it tried to rescue Lehman. Other lines of thought are more emotional and political: Might not 2008 be a righteous payback for the U.S. bungling of the 1997-1998 Asian crisis? Trying times tend to heighten paranoia.

There are also many domestic reasons why China might be wary about opening up to the global economy. The Chinese banking system is still quite opaque and might still have to wrestle with the legacy of problems of the 1990s, in particular, bad loans to big state-owned corporations that were the consequence of a political logic of directed credit. China is investing large amounts in education, but it may be more difficult to build a creative and innovative society that replicates the dynamism of the United States in the second half of the 20th century (which was fed in large part by openness, above all openness to immigration). China also faces a problem of aging and even demographic decline after the 2040s as a legacy of its one-child policy, which has also created a potentially destabilizing surplus of young males. With all these threats to stability, an authoritarian though reformist regime may find it harder to respond flexibly to popular demands and may be prone to try to mobilize a reactive nationalism to fend off challenges to its authority.

The pressure to engage in large-scale fiscal stimulation is also likely to alter the balance of China's economic development. The Chinese model of capitalism is very different than that of the United States, and even before the economic crisis, there were two alternative models. The first was the rural, family, and small-business-based boom of the 1980s. But by the 1990s, some of the private-sector growth was being choked off by a rival vision of economic growth built around prestige projects and the large, state-owned enterprise sector. Consider Shanghai, which impressed many commentators as the most modern city in the world: Analysts of the Chinese economy have suggested it is one of the least entrepreneurial cities in China. Yasheng Huang, in his book Capitalism with Chinese Characteristics, described it as a classic industrial-policy state. The new stimulus package is likely to push the balance of Chinese development more decisively in this latter direction, toward state capitalism.

China thus has plenty of reasons why it might want to close itself off to the forces of globalization, as the United States did in the interwar years. This thinking will be reinforced by the structure and character of the international order. Again, an interwar analogy is appropriate. The United States felt uncomfortable with the international institutions of the interwar period, in part because they were aligned with the interests of the old hegemonic power, Britain. The League of Nations looked as if it was an instrument of British power. Similarly, in the modern context China worries about whether it is adequately represented in U.S.-dominated international institutions. Its influence in the IMF and World Trade Organization clearly does not correspond to its real position in the world economy and to the role that China could play in economic stabilization. Reforming international institutions is thus a key issue in deciding whether the coming geopolitical alterations will be crisis-ridden, abrupt, and disruptive, or whether a more gradual and peaceful path of adjustment can be achieved.

Just before the Asia-Europe meeting last October, President Hu Jintao stated that China would behave with a sense of responsibility. It remains to be seen what stake China really has in the survival of the global economy. As in 1931, the political arguments are all against a rescue. Only the farsighted will see that the economic case for such an operation is compelling. Much depends on the extent of China's voice in an altered international institutional architecture.

But that voice will make demands that are increasingly difficult for the old world to accommodate, including demands for a guarantee of China's U.S. asset holdings and suggestions for an alteration of the world's reserve management. In proposing a global reserve currency to replace the dollar, the Chinese central bank president recently followed in the footsteps of Charles de Gaulle in the 1960s. But unlike France, China is in a much stronger position to assert its preferences for international monetary reordering.

In other words, the world may be asked to transition from an American to a Chinese model of capitalism, and as in the 1930s, that won't be an easy switch for any of us.



Medvedev Makes His Move

Dmitry Medvedev has been president of Russia for almost a year. Is he now planning to take power?

When Vladimir Putin stepped down as president of Russia last May, he left little to chance. Just as his predecessor Boris Yeltsin had anointed him, Putin made sure that his loyal protg of 20 years, Dmitry Medvedev, would take his place. Putin took the helm of the country's dominant political party, United Russia, and then, as prime minister, expanded that position far beyond what the Constitution envisions. Although Putin rearranged the musical chairs, he continued to call the tune. Until now.

So long as Russia's oil-fueled prosperity soared, people accepted Putin's implicit bargain: government corruption and constricted civil rights in exchange for rising living standards. But today, with Russia's economy in shambles, this social contract is fraying. Ordinary Russians are already taking to the streets demanding the type of change Putin is unlikely to deliver. He epitomizes the KGB old guard who got Russia into this mess. Sooner or later, he will become the Russian financial crash's most prominent victim.

Medvedev, a lawyer by training and instinct, offers perhaps the only realistic hope of turning Russia around, but he can't operate freely while Putin is still effectively in charge. Seemingly aware of this, Medvedev has, in recent weeks, taken steps to distance himself from his mentor and might be setting the stage to force him out of government.

When Medvedev became president in May 2008, the world economic situation seemed stable. Oil was more than $140 a barrel and Russian political leaders were riding high. With living standards rising for most Russians, political elites enjoyed the luxury of not having to make hard choices.

By late 2008, though, the global financial crisis was in full swing. The Russian leadership was slow to grasp it, blaming the West for its profligacy and suggesting that Russia would be immune. Soon, however, the country experienced a triple shock: oil dipped below $40 a barrel, demand for Russian exports sank precipitously, and Western financial institutions began calling in their loans.

By February 2009, the ruble had depreciated to 36 rubles to the dollar, illustrating the ongoing loss of faith in the Russian economy. As a result, the cost of dollar-denominated imports increased substantially. The official unemployment rate hit 8.1 percent, and most observers project further increases in the near term. Not surprisingly, public approval of the country's political leadership fell. Although public opinion polls do not yet show massive discontent or unrest, they do show a pronounced downward shift.

Medvedev has always styled himself as something of a reformer. As the crisis has worsened, the president has been especially careful to distance himself from Putin. Policy differences between the two men -- on the response to the financial crisis, the locus of prosecutorial power, the use of force against protesters, the tenure of judges in the courts, and the definition of treason, among others -- are serious and growing.

The stylistic gap is also expanding. Medvedev has made official statements on the assassinations of human rights advocates Anna Politkovskaya, Stanislav Markelov, and Anastasia Baburova that differ markedly in tone and substance from Putin's responses. Medvedev strikes a different, less nationalistic, and more tolerant tone than Putin on questions of Islam and national security.

These differences are fundamental to each man's character. Putin, after all, is the product of the KGB, the government-sanctioned plutocracy, and the Cold War. Medvedev is the son of the Russian intelligentsia, the legal academy, and the post-Soviet world of global integration and opportunity. Although they have worked closely together for 20 years, they are quite different, and in the context of a political rivalry, have different constituencies.

Russians have noticed the widening split. In February, the weekly business publication Kommersant-Vlast printed a collection of opinions titled Will Medvedev Sack Putin? Is It Time for Prime Minister Putin to Answer for Results of Anti-Crisis Efforts? Although the discussion does not provide a definitive answer, simply posing the question is provocative in a country where the government has muzzled the press for years. Meanwhile, Medvedev's popularity is growing. According to a February 2009 national survey, 73 percent of those polled said they trust him, compared with 56 percent in 2006. Although it is impossible to predict what will happen, one thing is certain: The current power dynamic is shifting, and shifting fast. If the trend continues, Medvedev will undoubtedly begin asking himself why he is still playing second fiddle.

Of course, it's one thing to make soothing reformist noises; capitalizing on the resulting public accolades is quite another. The prime minister is undoubtedly a cunning adversary, but he does have vulnerabilities. For instance, Medvedev could be laying the groundwork for a move against Putin by making his war on legal nihilism and corruption the centerpiece of his domestic policy. In May 2008, he started a campaign to create new laws and structures against corruption. This is nothing new, every Russian leader publicly reviles corruption while doing little or nothing to check it, if not in fact reveling in it.

In the Putin era, though, the scale of corruption has mushroomed without any real oversight from law enforcement, the legislature, the media, or civil society. What's more, the prime minister and his closest allies are implicated. Stanislav Belkovsky, the Russian political analyst and insider, gave sensational interviews in November 2007 to Die Welt and The Guardian, stating that Putin was worth approximately $40 billion. He said Putin was the beneficial owner of 37 percent of Surgutneftegaz ($18 billion), 4.5 percent of Gazprom ($13 billion), and half of a Swiss-based oil-trading company Gunvor ($10 billion).* If true, this fortune would make Putin one of the richest people in Europe and probably the world. It would also make him one of the most corrupt. While in good economic times most Russians were content to look the other way, in these bad times, they may demand more accountability.

So for Medvedev, the new anticorruption law, which he shepherded through the Duma in December 2008, presents a potential opportunity to intimidate Putin and his supporters. The legislation prohibits conflicts of interest, requires government workers to report income and property, and mandates them to report on coworker noncompliance. It is tailor-made for a behind-the-scenes assault on Putin's power and legitimacy. Most of Putin's friends and allies throughout government and major corporations would no doubt find it challenging to provide full asset disclosure and transparency about conflicts of interest. With a new anticorruption law in his arsenal, Medvedev has a weapon of choice.

Although legislators attempted to water down certain provisions and postpone the law's taking force, Medvedev prevented substantive changes to the legislation. Medvedev's visible, personal involvement in this anticorruption effort suggests that it may be different from past shams.

On the personnel front, Medvedev is also distinguishing himself from Putin, appointing 1,000 new top managers to fill key government positions. This recruitment drive, announced last summer, is a response to the difficulties the state is facing in identifying and recruiting competent personnel for public service. It also highlights the lack of a proper recruitment system for government posts and the need for a new generation of managers to replace the Soviet era nomenklatura.

Notably, Medvedev has reached out to communists, nationalists, and liberals alike to create the pool of potential applicants rather than giving preference to United Russia. Although some of the Golden 1,000 were prominent during Putin's presidency, the list does not appear to contain close Putin advisors. With these appointments, Medvedev is placing himself at the vanguard of a generational shift in Russia's political leadership.

Interestingly, Putin may have sealed his own fate years ago by establishing a legal precedent for his own ouster. Shortly after Yeltsin transferred temporary presidential responsibilities to Putin on December 31, 1999, Putin issued Presidential Decree 1763, granting Yeltsin and his family lifelong immunity from criminal prosecution, administrative sanction, arrest, detention, and interrogation. If push comes to shove, it's not far-fetched to imagine Medvedev offering the very same arrangement to Putin.

If the two leaders cannot work out a quiet deal, then Medvedev might decide to use the new anticorruption law against a proxy. He would likely choose someone reasonably close to Putin with a similar KGB or law enforcement background: in Russian parlance, a silovik. The government would prosecute a current or former official for failure to disclose accurate income and asset statements, report subordinate noncompliance, or identify conflicts of interest. Once the government started such a prosecution for corruption, the message to Putin supporters would be clear: Watch out or you could be next.

Why would Medvedev turn on his political godfather? For political survival for the government, himself, and even Putin. Unless there is some fall guy for Russia's economic fiasco, the whole regime could topple. Counting on Russians' weariness with tumult and revolution, Medvedev may hope that dumping Putin will be enough to keep the system intact.

The time is close when Medvedev is likely to offer Putin a deal he can't refuse. This true power shift, unlike the symbolic one last May, might be Russia's best hope to navigate peacefully its deepening economic and political crisis.

*Editors Note: The original version of this article stated that Gunvor is run by a former St. Petersburg KGB agent. Gunvor strongly denies this. An attorney for the firms cofounder writes, Mr Putin does not own any part of Gunvor nor is he a beneficiary of its activities; and our client, Mr. Timtchenko, was not part of the KGB.