Today, we are fortunate to have a guest contribution written by Phillip Swagel, Professor in International Economic Policy at University of Maryland’s School of Public Policy, and formerly Assistant Secretary for Economic Policy at the Treasury Department (December 2006 to January 2009).
My new book with Dan Blumenthal, An Awkward Embrace: The United States and China in the 21st Century, features three potential scenarios for the future of the Chinese economy and discusses implications for U.S.-China relations. The scenarios are:
- Optimistic: China becomes wealthier and gradually becomes less authoritarian and a more responsible participant in the international system.
- Somewhat Pessimistic: China becomes rich but stays authoritarian and increasingly challenges or even threatens the United States in economic and security spheres.
- Very Pessimistic: China’s economic growth derails, leading to a period of internal instability that contributes to severe global instability.
The first scenario is a benign outcome in which the bilateral economic relationship remains strong, while there is a gradual evolution within China toward political and social freedom. China addresses its current economic challenges, including normalizing monetary policy as part of a gradual shifting in the composition of Chinese growth toward domestic demand, along with liberalized trade and financial flows. This optimistic scenario involves a renewed move toward economic reform on the part of the new Chinese leadership.
As part of reform, the Chinese Communist Party eases its hold on the economy in the spheres of information, communications, capital flows, and internal migration. This moderation comes about in part out of necessity, since greater freedom contributes to long-term economic development. An economy turning toward more knowledge-intensive activities cannot prosper when knowledge is repressed. In the best case (and thus least likely or imminent), political oppression gradually eases as well. While a multiparty democracy seems quixotic, one could imagine a situation in which Chinese citizens enjoy considerable freedom in their personal affairs even if still circumscribed political liberty. While not conforming to precepts of a western democracy, this would be a huge improvement from the situation of today.
The second scenario envisions involves a modest change in trajectory from China’s current path. China’s economic growth continues but the nation remains authoritarian without meaningful change in the political and intellectual climate. Moreover, China shifts further toward a more aggressive external posture that presents economic and security challenges for the United States and other nations such as Japan.
Economic policy changes are made cautiously in this scenario, typically only as needed to defuse growing imbalances such as in the financial system. Growth is somewhat slower than in the first scenario though still fairly robust for years into the future before eventually slowing as internal migration ends. The eventual slowdown—a sort of middle income trap—manifests in part because the failure to proceed with further political and social liberalization limits the growth of knowledge-intensive sectors and thus puts a ceiling on development. Without fundamental changes, the occurrence of an economic crisis cannot be ruled out, but this possibility is reserved for the third scenario.
This second scenario in which China muddles through economically with more illiberal internal policies presents a difficult problem for the United States. China is still growing and has mounting resources at its disposal, but rejects the “liberal international order” or at least limits its participation to the benefits it can accrue from limited trade. Of particular concern in this scenario is that problems inside China might be externalized. China, for example, might seek to force Taiwan into unification and claim additional spheres of influence for itself such as the “first island chain.” Present difficulties with Japan are thus a preview of aggressive Chinese behavior in this second scenario.
In the third and most worrisome scenario, China’s growth falters and the Chinese leadership does not act in a timely or appropriate way to stave off the ensuing economic crisis. This in turn poses a political challenge to the Chinese leadership and the rule of the Communist Party, leading to an internal crackdown and an increasingly aggressive external posture as the leadership embarks on foreign “adventurism” to distract from its domestic failings.
Economic problems could arise in China through a sudden event resulting from financial imbalances and China’s dependence on export-led growth, from inflationary pressures caused by inappropriately loose monetary policy, or from slow-building demographic pressures such as the aging of the population and the unbalanced numbers of men and women. These developments already are giving way to wrenching changes, as the culmination of the one child policy is a collapse of extended networks of cousins and the family-oriented social safety net upon which Chinese society has been built for millennia. The surplus of men leads to societal pressures from millions of men who cannot marry; in response, the regime whips up anti-foreign nationalism as a replacement for the social glue lost with the demise of the traditional Chinese family. A failure of the party leadership to adapt to such societal pressures could turn a demographic shift into an acute crisis.
Such a dire scenario would threaten the stability of the regime by upending the implicit bargain under which the Chinese Communist Party rules in exchange for ensuring continued prosperity. Social pressures would have acute security implications, possibly including sparking active conflicts or grinding global tensions. As in scenario two, this could happen if Chinese political leaders use external adventures to rally domestic support. A more aggressive China would find itself increasingly distrusted by other nations and excluded from the global economic system. This in turn would affect Chinese growth and further exacerbate external tensions.
In considering these three scenarios, the key questions for U.S. policy revolve around how to achieve the first scenario and avoid the third scenario. Much of the change must take place within China, including reforms of monetary and investment policy, removal of trade barriers, and opening the nation to free flows of capital, ideas, and political debates. On the economic side, a key U.S. contribution would be to increase U.S. national saving to reduce our dependence on foreign capital and thus to narrow our trade deficit. This would both provide a market-based impetus to move China away from export-led growth and also help avoid populist responses in both countries that could spur serious problems such as a trade war.
It is less clear how to shape China’s path when there appears to be every economic incentive for China to move toward the cooperative path of the first scenario. The United States must also take into account that economic policymaking in China is mixed together with security policymaking and that policy decisions might not reflect a full understanding of any negative impacts on other nations. Chinese involvement with Iran on energy policy is irresponsible, for example, but this could reflect a lack of understanding rather than ill intent.
Even so, it would be prudent for the United States to recognize the clear possibilities of the second and third scenarios and thus prepare for continued political and strategic tensions. How the United States should prepare to deal with China in the coming decades is the central topic of the policy conclusions of our book.
This post written by Phillip Swagel.