Hard Landing, USA

China is rebalancing its economy. Why isn't America?

For those looking for problems with China's economy, there have been plenty of recent data points to choose from. The economy is slowing, foreign trade data have weakened, the latest price trends point more toward deflation than inflation, and there have been several recent squeezes in short-term bank funding markets. Then, on March 7, Chinese solar equipment maker Chaori defaulted on its bond payment. While hardly shocking for a normal economy, a default of this magnitude is a first for modern China and possibly a hint of what many fear is more corporate distress to come. Against the backdrop of still frothy housing markets -- despite an easing of home prices in February -- and a rapidly expanding shadow banking sector, these latest signs can hardly be dismissed as aberrations.

Are these early warnings of the dreaded Chinese hard landing, which would bring the country's development miracle to a sudden end, or indications of a transition to a more normal economy? Long wanting to believe the worst when it comes to China, the preponderance of opinion in the West is in the hard landing camp. It was only a matter of time, argue the China doubters, before the state-directed, non-market economy would meet its demise.  

Fortunately, the alternative view is probably closer to the mark. China's slowdown appears to be a well-orchestrated manifestation of the emergence of an increasingly services-based, consumer-led rebalancing of its economy. In 2013, the services share of gross domestic product (GDP) hit 46 percent -- the first time in modern China's history that this sector exceeded the combined portion going to manufacturing and construction. The old growth model, driven by a boom in industrial activity, is now giving way to a new and more balanced model supported by the trappings of a modern consumer society.

Services-led economies almost always grow more slowly than manufacturing-led ones. Consequently, drawing on services allows China to temper many of the pressures that stemmed from decades of double-digit growth -- excess resource consumption, environmental degradation and pollution, income inequality, and saving and trade surpluses. At the same time, a shift to services fosters more labor-intensive growth, which allows a more slowly growing China to continue to absorb surplus labor through increased employment and poverty reduction -- key to maintaining social stability. In this vein, a services-led transition of what former Premier Wen Jiabao famously called an "unbalanced, unstable, uncoordinated, and ultimately unsustainable" Chinese economy is a welcome development.  

China doubters are unprepared for this transition. The international community has long urged China to change its growth model. But now that it is doing so, the West could actually find this an uncomfortable development. Major developed economies, especially the United States, have become increasingly dependent on China as a producer of cheap goods that hard-pressed consumers need, and as a provider of cheap capital that savings-short nations require to finance outsize government budget deficits. A rebalanced China will instead use its saving surplus to support the long-awaited emergence of its own consumer society.

Of course, this dependency cuts both ways. Chinese growth and development have benefited enormously from export-led growth, which the voracious spending of the American consumer has long underpinned. And China has tied its currency to the fate of the U.S. dollar, which has fallen 24 percent against that of the United States' trading partners since 2002. That has left the renminbi well-positioned to support Chinese export competitiveness.

All this speaks of a codependency that links China and the United States in an economic marriage of convenience. Yet as I argue in my new book, Unbalanced: The Codependency of America and China, this relationship is unstable: In human behavior, as in economies, the pathological disorders of codependency can lead to a loss of identities, a blurring of distinctions between partners, frictions, and the ultimate break-up. And just as independence cures unstable codependency between humans, rebalancing is the only way out for codependent economies.

With services-led growth now on the ascendancy, the telltale signs of that rebalancing are very much evident in China in early 2014. Yet there is no such evidence of a similar transformation in the United States. In fact, the United States' post-financial crisis policy stimulus seems aimed at resurrecting the timeworn model of consumer-led growth -- the same recipe that got the U.S. economy into such trouble in the first place. The Federal Reserve's quantitative easing campaign -- liquidity injections that boost the prices of financial assets, which in turn, are expected to trickle down through wealth effects and stimulate household spending -- exemplifies this fixation on a consumer-led recovery. Yet the feeble response of consumption -- growing on average just 1 percent over the past six years -- raises serious questions about betting recovery on a sector still constrained by high debt loads and subpar saving.

As China rebalances, and the United States does not, sparks could really start to fly. An increasingly consumer-driven China will begin to draw down its surplus saving, which will narrow its current account surplus, slow the accumulation of foreign exchange reserves, and reduce China's demand for dollar-denominated assets. Shifting from surplus saving to saving absorption points to a radical about-face of China's role in its codependent relationship with the United States.

That poses a tough and very important question for the savings-short United States: Absent its biggest foreign lender -- the Chinese own about $1.3 trillion in Treasuries and about another $700 billion of government-sponsored Fannie Mae and Freddie Mac securities -- the United States may find it exceedingly difficult to stay the same profligate course it has been on for decades. Without a meaningful rebuilding of domestic savings, a slowing of Chinese lending means the U.S. economy could face stiff new headwinds in the years ahead, in the form of a weaker dollar and/or higher interest rates.

The codependency between the United States and China was a marriage not of love, but of convenience. In the aftermath of the chaotic Cultural Revolution in the late 1970s, the Chinese economy was in shambles and desperate for growth. Then paramount leader Deng Xiaoping came up with a quick and powerful answer -- "reforms and opening up" -- code words for growth driven by exports. Meanwhile, the U.S. economy in the late 1970s and early 1980s was going through stagflationary traumas, also needed a new recipe for growth. Cheap goods and inexpensive capital from China quickly emerged as key answers to the United States' growth dilemma.

But the longer it persisted, the greater the entanglement and the harder it was for each to cope without the other. Ultimately, that led to false prosperities for both economies -- bubble-prone consumption growth in the United States and a Chinese export bubble that depended on the U.S. consumption bubble. Just as a psychologist might predict, there was a blurring of identities between both economies. Who was more dependent on whom?

When the bubbles finally burst during the Great Crisis of 2008-2009, China didn't wait around to answer that question. Taking a strategic view of its growth dilemma -- an introspective assessment that the United States has long abhorred -- it moved quickly in 2011 to enact its pro-consumption 12th Five-Year Plan, and in late 2013 to ratify crucial economic reforms at the Third Plenum, an important Communist Party meeting. A dysfunctional Washington has taken the opposite approach -- failing to look to the long term while absorbing the all too frequent setbacks of near debt defaults, sequestration, a government shutdown, and other kicks of the proverbial fiscal can.

It takes two to be codependent. China is now going its own way, while the United States has yet to realize it has been scorned. China's embrace of services- and consumer-led growth speaks to a new identity for its long unbalanced economy. The United States' attempt to spur another consumption binge speaks to a tired and aging growth model. The United States can learn an important lesson from China: Rebalancing -- consuming within its means, saving more, and investing that saving in human and physical capital -- is its only viable option.

Philippe Lopez/AFP/Getty Images

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The Georgian Defense

Putin's Ukrainian gambit has transformed the geopolitical chessboard in Eastern Europe. Here's how NATO should respond.

Recent developments in Ukraine have been nothing less than astonishing -- and that's just as true of seasoned observers of Eastern Europe as it is of everyone else. Russia's bold and illegal military intervention issues a startling challenge not just to Ukrainian independence but also to the very foundations of the post-war liberal order. In such times, the West has an obligation to offer a credible and serious response to an attack on the global rules-based system. An excellent -- and overdue -- option would be to provide Georgia with a concrete and attainable pathway into the North Atlantic Treaty Organization (NATO).

As of March 11, Russian forces appear to be in full control of Ukraine's Crimean peninsula. In spite of Russian President Vladimir Putin's recent pledge to de-escalate the situation (even as he bizarrely persisted in denying the active involvement of Russian troops in Crimea), there is little evidence that Moscow intends to relinquish its grip on sovereign foreign territory. Though Russia reportedly pulled back some of its forces that were amassing near eastern Ukraine, the Kremlin clearly remains in full saber-rattling mode even outside of Ukraine, keeping many of its neighbors on edge. As Russian fleet elements conducted live fire exercises in the Baltic Sea, Moscow deployed Russian MiG-29 fighters to its airbase near Yerevan, Armenia. Turkish F-16 fighters were scrambled when a Russian spy plane probed Turkish airspace and the Kremlin proceeded with a scheduled ICBM launch test in spite of high tensions. By most estimates, this would seem to be anything but a de-escalation, despite the Kremlin's PR-friendly rhetoric.

Contrary to some characterizations, Russia's military adventurism in Ukraine is an issue of genuine geostrategic importance to the West. By seizing the sovereign territory of its neighbor -- unprovoked and based on the flimsiest of pretexts -- Moscow has effectively launched an offensive against the very fabric of the Euro-Atlantic security architecture. This system is premised on the primacy of transnational norms and supposedly guaranteed by the United States, NATO, the European Union, and other such institutions. Ukraine is not yet a member of NATO or the European Union, but it is a part of the European family, and it is entitled to both sovereignty and the right to orient its foreign policy as it sees fit.

Since the end of the Second World War, the United States and Europe have expended great resources to change the continent from a perennial international security risk -- which came to a head in both world wars -- into a sort of postmodern utopia, largely free from the Hobbesian interstate conflicts that continue to plague much of the rest of the world. But Russia's intervention challenges the integrity of the European project. An aggressive Russia, willing and free to violate its neighbors' sovereignty, would jeopardize the dream of European unity, demilitarization, and free movement. It could thrust the continent back to its historical default: fragmented, warring, and unstable.

That said, realistic policy options to address Russian aggression are scarce. Barring an unforeseen event, there is little rationale or appetite for a direct, kinetic military response. Yet even far more modest steps, such as economic sanctions or political pressure, have faced resistance within Europe. Britain, whose stiff upper lip seems to have weakened of late, refuses to countenance punitive measures that imperil the bottom line for its hedge fund managers in London. German Foreign Minister Frank-Walter Steinmeier even came out against the highly symbolic move of ejecting Russia from the G8 club of industrialized nations -- despite the absurdity of its continued membership.

A common Western economic sanctions package appears unlikely, and key European states are particularly skittish about confronting Russia directly over Ukraine. This would seem to bolster the case for a proportional but more indirect Western response to Russian aggression in Ukraine. In many respects, granting Georgia a Membership Action Plan (MAP), a roadmap for accession into NATO, fits the bill perfectly. It is at once measured as well as proactive. Such a step would demonstrate genuine Western resolve on preserving and reinforcing the Euro-Atlantic security architecture -- which have served as the pillars of the liberal international order since 1945 -- without having the appearance of deliberate escalation.

The pieces for Georgian accession are already in place. In fact, Georgia's recent progress makes it well positioned for NATO accession, independent of the Ukraine crisis. It has demonstrated its democratic credentials with a series of peaceful transfers of power. Its highly-regarded troops serve in force alongside NATO partners in Afghanistan (without national caveats). And it has made serious moves to transform its military from the conscript-dependent structure that was battered in the 2008 war with Russia into a professional, Western-style force. (In the photo above, Georgian soldiers attend a ceremony before being deployed to Afghanistan.) Just as importantly, Tbilisi has managed to moderate its relationship with Russia, enabling the restoration of limited trade and cultural exchanges that had were curtailed after the 2008 conflict. This has significantly improved the regional security situation, which only a couple of years ago seemed locked into a state of permanent hostilities with its powerful northern neighbor. As the Ukraine episode highlights, Georgia and Russia are unlikely to ever truly get along -- certainly not so long as Moscow continues to occupy legal Georgian territory -- but Tbilisi appears to be determined to rise above Russia's constant provocations.

Structurally, Georgia is also ready for a MAP. Besides the Georgians' truly outstanding contributions in Afghanistan -- not to mention their recent decision to join EU peacekeeping efforts in the Central African Republic -- Georgian forces are already being integrated into the 25,000-strong NATO rapid reaction force. That should be considered a testament to the high regard by which Georgian troops are held today. During its recent visit to Georgia, the NATO military committee, the highest military body in the alliance, offered both praise and support for ongoing Georgian defense reforms. And in a recent visit to the United States, Georgian Prime Minister Irakli Gharibashvili called on the Atlantic alliance to acknowledge Georgian progress with a MAP at the upcoming NATO summit in Britain later this year. Both the administration and a bipartisan group in Congress have signaled United States' support for a Georgian MAP.

Georgian membership makes sense. Contrary to its conventional portrayal, Georgia is in many ways already a stabilizing force in the region. In the past, Georgia's contributions to regional stability were mostly obscured by its venomous relationship with Russia, but the gradual improvement of relations are once again revealing Georgia's potential value as a regional linchpin. It is already rapidly integrating into a de facto trilateral alignment with Western-leaning Turkey and Azerbaijan, yet it also maintains good relations with neighboring Armenia. Georgia has dramatically improved ties with Israel as of late at the expense of its erstwhile friendship with Iran, but the country remains both an honest broker and an accessible meeting place for just about all of its neighbors.

In an honest assessment, Georgia is already a more than worthy candidate for the MAP. Any outstanding issues -- additional reforms, the applicability of collective defense to the breakaway regions, and the like -- are best negotiated within the framework of the MAP. The move already makes sense for NATO and it would also be an effective tool in pushing back against Russian revanchism.

Russia is often described as geostrategically "playing chess" while the West dithers over a tactical checkerboard. The analogy is as tired as it is cumbersome, but the sentiment that Moscow seems better able to exhibit strategic patience is not unwarranted. In the same vein, bringing Georgia into NATO would constitute a rare opportunity to employ an indirect but robust strategic countermove to augment the Euro-Atlantic security architecture, broadcast Western resolve at a time of declining confidence, and signal to Moscow that its aggressiveness has consequences. At the same time, it would be unlikely to stoke tensions given its indirectness and the fact that Georgian NATO membership has been promised by the alliance since its 2008 Bucharest summit.

There are certainly more direct, shorter-term measures that can and should also be adopted in response to Russian aggression in Ukraine. The most worthwhile of these would likely be to target financial and real assets of corrupt officials, known money launderers, and human rights abusers in senior positions of the Russian government and regime-connected elite. The effectiveness of such sanctions might be minimized somewhat by European reluctance to participate, but they might still provide enough leverage to minimize further catastrophe.  Strategically, the West can be proactive and forceful by keeping its promise to bring Georgia into NATO. It's an idea that is both long overdue and well-calibrated to Russia's obvious geopolitical aggression.