The Great Sino-Indian Alpine Tent Party of 2013

China's latest border squabble with India might seem trivial, but the consequences could set Asia on edge.

On Sunday, May 5, several dozen soldiers of China's People's Liberation Army (PLA) pulled down their tents and withdrew from disputed territory claimed and administered by India, thus ending a bizarre but tense confrontation between two of the world's largest armies. The three-week encampment by Chinese forces in the remote and desolate Depsang plain generated little comment in China but caused a political and media storm in New Delhi, where Beijing's actions were seen as a clear violation of the territorial status quo.

As the dust settles, questions remain about the motives behind the Chinese troop advancement, which came at a delicate juncture for both Sino-Indian relations and China's own evolution into a regional and global superpower. What were the Chinese security forces and their leaders thinking when they authorized the incursion? More importantly, what does this mismanaged and unnecessary provocation augur for Asia's future stability?

The PLA troops' precise motivations are hard to discern and may never be fully explained. Chinese forces might have wanted to stall the development of roads on India's side of the Line of Actual Control, as the de facto border is known. India's 2008 reactivation of a remote military airfield near Depsang -- less than 70 miles from the crucial highway connecting western China's vast, unstable regions of Xinjiang and Tibet -- may also have been viewed as threatening. Some Indian commentators claimed that the PLA's advancement was a "sincere" move resulting from different understandings of where the border lies. But that view found little sympathy in New Delhi, as images of Chinese soldiers holding banners emblazoned with "You've crossed the border, please go back" flashed across Indian television screens.

The timing is even more puzzling. China-India relations have been growing warmer; Indian Prime Minister Manmohan Singh held his first meeting with China's new president, Xi Jinping, in March, and Li Keqiang was preparing to make India the destination for his first international trip as China's premier, later in May. The diplomatic setback also followed a year of deteriorating relations between Beijing and other Asian countries, including a sharp downturn in Sino-Japanese ties, the embarrassing release of a new Chinese passport that outraged several Asian states (including India), a severe test of Beijing's relationship with Pyongyang, a diplomatic reversal in Burma, and the release of worrying information on China's cyber-espionage capabilities. Antagonizing India at this juncture seems inexplicable.

The incursion will undoubtedly provoke greater skepticism in India about China's peaceful intentions. In recent years, an aggressive China has had a poor record of managing its disputed borders. Unlike Japan or the many Southeast Asian countries, India has been reluctant to identify itself as a U.S. partner in any attempt to hedge against China's rise. Yet repeated Chinese provocations, as well as concerns about India's ability to compete economically and militarily with China, might force India's policymakers to cooperate more closely with other states that share its concerns. Moreover, India's accelerating defense modernization might produce additional confrontational Chinese responses, perpetuating a classic security dilemma.

Although the incursion may not have had domestic political implications in Beijing, it does raise worrying questions about China's ability to destabilize the region. For example, it is plausible that the PLA's advancement was the product of a simple civil-military disconnect. This is a problem that bedevils every government with a strong military, but a more transparent system of governance -- such as in the United States or, for that matter, India -- would have certainly limited the damage.

The question of transparency also cuts the other way. China cannot expect other governments to muzzle their media as it does. For example, a recent editorial in the Chinese newspaper Global Times about the incursion blamed the Indian government for "indulg[ing] Indian media habits," fomenting "border hysteria," and writing "nonsense." Instead of blaming the foreign press, it would benefit Beijing to become better attuned to public sentiment in countries like India -- not exactly its strong suit. As Harvard University professor Joseph Nye recently noted, this is not the kind of problem that can be solved with more Confucius Institutes.

As China's new leadership continues to consolidate itself, its recent missteps with India -- coming at an otherwise opportune time in bilateral relations -- ought to provoke some introspection. Many in India, as in other Asian states, are willing to cooperate with an increasingly affluent China. But actions like April's incursion will only give more weight to the perspectives represented in an influential 2012 Indian foreign-policy paper that noted: "The better way of responding to limited land-grabs by China" is to respond in kind. Surely that's not an outcome China's leaders want.

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No, the Spanish Can’t Be More German

And other myths of the euro crisis.

Everyone knows the stereotypes. Germans save for the future, while Spaniards spend everything they earn. So it's not surprising that Germany has survived the recent crisis in decent shape, while Spain is a mess, with unemployment at roughly 27 percent. If only the Spaniards had been as thrifty as the Germans, this never would have happened, right?

Wrong. The spending patterns of Spanish households did not cause the euro crisis, but were a response to the imbalances created by excess savings in Germany. Furthermore, these excess savings were not caused by the thriftiness of German households, but by policies that forced up German savings rates to levels that Europe could not absorb without creating serious imbalances.

National savings and household savings are often assumed to be the same thing, but are actually very different. The household savings rate is the share of household income -- mainly wages, investment income, and social transfers like welfare payments and pensions -- that households do not spend on consumption.

The national savings rate, on the other hand, includes not just household savings, but also the savings of governments and businesses. It is defined simply as a country's GDP minus its total consumption. While the household savings rate is determined primarily by the cultural and demographic preferences of ordinary households, the national savings rate is not. Indeed in some cases, such as China and Germany, the household share of all the goods and services a country produces, which is primarily a function of policies and economic institutions, is the main factor affecting the national savings rate.

National savings, in other words, have very little to do with household preferences and a lot to do with policy. Take China, which has by far the highest national savings rate in the world at roughly 50 percent. This is in part because Chinese households, like those of many poor countries lacking a robust social safety net, save a high proportion of their income.

But while China's savings rate is extraordinary, Chinese household savings rates are merely on the high side, and on par with other East Asian nations. Chinese households, it turns out, are not nearly as thrifty as their exceptionally high national savings rate implies. Why, then, is China's savings rate unprecedented? The main reason is the very low household income share of GDP. Chinese households retain a lower share of all the goods and services the country produces - around 50 percent -- than households in any other country in the world.

This is a consequence of policies Beijing put into place over the past two decades that goose GDP growth by constraining growth in household income. These include low wage growth, an undervalued currency, and extremely low interest rates, all of which reduce household income while subsidizing growth. As a result, the household share of China's total production of goods and services has been falling for 30 years, from 60-70 percent in the 1980s to 50 percent today. Consequently, as households earn a declining share of what China produces, they also consume a declining share. China's high savings rate, in other words, has little to do with Chinese thrift, and much more to do with policies that reduced the share of Chinese household income relative to GDP. This is also true in Germany.

In the 1990s, Germany saved too little. It ran current account deficits for much of the decade, which means it imported capital to fund domestic investment. A country's current account deficit is the difference between how much it invests and how much it saves, and Germans in the 1990s did not save enough to fund local investment.

But this changed in the first years of the last decade. An agreement among labor unions, businesses and the government to restrain wage growth in Germany caused the household income share of GDP to drop and, with it, the household consumption share. Because the relative decline in German household consumption powered a relative decline in overall German consumption, German saving rates automatically rose.

Notice that German savings rate did not rise because German households decided that they should prepare for a difficult future in the eurozone by saving more. German household preferences had almost nothing to do with it. The German savings rate rose because policies aimed at restraining wage growth and generating employment at home reduced household consumption as a share of GDP.

As national saving soared, the German economy shifted from not having enough savings to cover domestic investment needs to having such high savings that not only could it finance all of its domestic investment needs, but it had to invest abroad by exporting large and growing amounts of savings to fund foreign purchases of its excess production. As it did so its current account surplus soared, to 7.5 percent of GDP in 2007.

It is tempting to interpret Germany's actions as the kind of far-sighted and prudent actions that every country should have followed in order to keep growth rates high and workers employed, but these policies did not fix unemployment in Europe; they merely shifted unemployment from Germany to elsewhere. How? Because Germany's export of surplus savings was simply the flip side of policies that forced the country into running a current-account surplus.

To understand why, pretend that Europe consisted of only two countries: Spain and Germany. Forcing down the growth rate of German wages relative to GDP caused the household income share of GDP to drop. Unless this was matched by a decision among German households to become much less thrifty, or a decision by Berlin to sharply increase government consumption, consumption as overall share of GDP would drop. This is just another way of saying that the German national savings rate had to rise.

As German savings rose, eventually far exceeding investment, Germany had to export the difference, which its banks did largely by making loans into Spain. Declining consumption left Germany producing more goods and services than it could absorb domestically, and it exported excess production as the automatic corollary to its export of savings.

The rest of the world had to absorb excess German savings and run the current-account deficits that corresponded to Germany's surpluses because one country's trade surplus is another's deficit, and one country's export of savings is another's import. And that's exactly what happened: The eurozone countries -- in this example, Spain -- that joined the monetary union with a history of higher inflation and currency depreciation than Germany saw their trade deficits expand dramatically or their surpluses turn into large deficits shortly after the creation of the single currency.

The way in which Spain absorbed German exports of savings is at the heart of the subsequent crisis. As long as Spain -- thanks to the euro -- could not use interest rates, trade intervention, or currency depreciation to block German exports, it had no choice but to import Germany's excess, since investment and savings must balance. This meant that either Spain's investment would have to rise or its savings would have to fall, or both.

Both occurred. Spain increased investment in infrastructure and in real estate, but it seems to have done both to excess, perhaps because of the sheer amount of capital inflows -- its much- smaller economy was swamped by the large amount of German savings. After nearly a decade of inflows larger than any it had ever absorbed before, Spain, like nearly every country in history under similar circumstances, ended up with massive amounts of misallocated investment.

But this was not all. If the savings that Germany exported into Spain could not be fully absorbed by the increase in Spanish investment, the only other way to balance was with a fall in Spanish savings. There are two ways Spanish savings could have fallen. First, as Spanish manufacturers lost out to German competition, Spanish unemployment could rise and so force down the Spanish savings rate (unemployed workers still consume). Second, Spain could have reduced household savings voluntarily by increasing consumption relative to income. Higher Spanish consumption would cause enough employment growth in the services and real estate sectors to make up for declining employment in the tradable goods sector.

Not surprisingly, given the enormous optimism that accompanied the creation of the euro, the latter happened. As German money poured into Spain, helping ignite a stock and real estate boom, ordinary Spaniards, especially those who owned their own homes, began to feel wealthier than they ever had before. Thanks to this apparent increase in wealth, they reduced the amount they saved out of current income, as households around the world always do when they feel wealthier. Together the reduction in Spanish savings and the increase in Spanish investment (in infrastructure and real estate) was enough to absorb the full extent of Germany's export of excess savings. This happened in nearly all of the deficit countries in Europe.

But at what cost? The imbalance created by German policies to constrain consumption forced Spain into increasing consumption and boosting investment, much of the latter in wasted real estate projects. The moralizers who insist that Spain wasn't forced into a consumption boom --"no one put a gun to their heads and forced them to buy flat-screen TVs" is the typical criticism -- miss the point. Because Germany had to export its excess savings, Spain had no choice except to increase investment or to allow its savings to collapse, with the latter either in the form of a consumption boom or a surge in unemployment. No other option was possible.

The European crisis, in other words, had nothing to do with thrifty Germans and profligate Spaniards, but with policies aimed at boosting German employment, which also forced up German national savings rates. These excess savings had to be absorbed within Europe, and the subsequent imbalances were so large (because German's savings imbalance was so large) that they led to today's circumstances.

For this reason, forcing down the German savings rate substantially enough to give Germany a large current account deficit is the least damaging way to unwind the imbalances forced upon the region. Only in this way can countries like Spain stay within the euro while decreasing unemployment.

But lower German savings don't mean that German families should become less thrifty -- only that the average German household should be allowed to retain a much larger share of what Germany produces. If Berlin were to cut consumption taxes, or cut income taxes for the lower and middle classes, or force up wages, total German consumption would rise relative to GDP and so national savings would fall -- without requiring any change in the prudent behavior of German households.

To ask Spanish households to be more "German" by saving more is not only impractical in an economy with 27 percent unemployment (unemployed workers cannot increase their savings), it is counterproductive. Lower Spanish consumption would cause even higher Spanish unemployment, until eventually Spain would be forced to abandon the euro to regain control of its ability to absorb or reject German imbalances.

As long as it is part of the euro, Spain has no choice but to respond to changes in German savings rates. This is the way balance of payments works. Thrift has little to do with it.

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