Revolutionary China, , Complacent America


September 15, 2005; Copyright The Wall Street Journal
Are Americans missing a revolution? Across the Pacific, China’s emergence is reshaping not only trade, but also world finances, global manufacturing and the entire East Asian economy. This should naturally give rise to searching debate. But the debate we are actually having is limited to a series of complaints about currency rates, intellectual property piracy and Chinese investment intentions in the U.S. It is more a to-do list than an assessment of structural global change and what it means for America. Some of the complaints are valid. But to focus on complaints alone — even serious ones — is to risk mistaking the foothills for the Himalayas behind.
China is opening to the world, merging its low costs and vast manpower reserves with the financial and technological strengths of its wealthier neighbors. In the process, it is rapidly creating an informal “Asian Union” — a deeply integrated Asian economy with a GDP equal to America’s, a population six times as large, the technological and financial strengths of an advanced economy and the cost advantages of a developing one. This powerful competitive challenge cannot be met by protectionist legislation, penalty tariffs or bans on Chinese investment. Instead, America needs a strategic response that rethinks our own consumption and debt-led growth, addresses our competitive weaknesses and reshapes our approach to Asian trade and global financial institutions.
No country leads the world by divine right. China itself provides a sobering lesson. According to the economic historian Angus Maddison, the emperors of the Qing dynasty ruled almost a third of the world’s population and oversaw a third of world GDP. They looked back on a history of innovation, spanning the inventions of paper money, explosives, the printed book and the professional civil service. They considered their status natural and eternal. When Europe’s diplomats and merchants began to arrive in the 1790s, the emperors thought them insignificant. It was a devastating mistake. Employing superior technology and military tactics, Europe came to rule Asia in just a few decades. China’s leaders were discredited and its vassal states fell away. The ensuing period of demoralization and upheaval lasted almost two centuries.
America faces no such grim future: What we do face, however, is a substantial challenge. We have been the leading economy for a century. But other countries of similar size and potential can catch up — if they try, and we remain content with past glories. China’s economy has tripled in size since 1980 and continues to grow at 9% per year: it could equal ours by 2020. China is also climbing the tech ladder, investing in ports, coastal-road systems, telecom networks, research centers and universities. It draws $50 billion a year in foreign direct investment, and topped $60 billion in 2004. It is already getting results, first shifting from exports of light, labor-intensive manufactured goods to heavy industry and technology, and now to a new role as financier and outward investor. This is happening because China is getting some big things right; its neighbors are contributing to and benefiting from its success; and we are not keeping up. Consider three trends.
Asia is pooling its strengths. Despite America’s outsourcing debate, investment in China is predominantly an Asian phenomenon. Three-quarters of China’s $60 billion in FDI last year came from Hong Kong, Taiwan, Japan, Korea and Southeast Asia. In 2003, China’s Commerce Ministry calculated that Asian investment puts up about 20,000 “manufacturing facilities” a year. These facilities mesh China’s low costs and skilled workers with the technology and capital of its wealthier neighbors, strengthening all of Asia. China now intends to extend these relationships through formal preferential trade agreements with Asean, India, Pakistan, Australia and perhaps Japan. America’s response to date is limited to a free trade agreement with Singapore and perhaps a later accord with Thailand. Our role in the Pacific risks erosion.
Asia’s human capital is improving. The Chinese government builds about 200 new research centers a year. Since the ’80s, Chinese college enrollment has quadrupled to 20 million. And students are taking the hard subjects. The Computer Systems Policy Project notes that Chinese universities now produce 200,000 engineers a year. Japanese schools produce 100,000, and smaller economies like Taiwan, Korea, Hong Kong and Singapore are much the same. America, meanwhile, has fewer native-born technology graduates than we did 20 years ago. Only 60,000 new American engineers graduate each spring. Concurrently, new visa restrictions have impaired our ability to compensate by discouraging skilled workers, scientists and aspiring students to emigrate to the U.S. Since Sept. 11, our pool of foreign graduate-study applicants has shrunk by 30%.
Asia is saving money. Chinese families save as much as 40% of GDP. Savings rates in Korea, Taiwan, Hong Kong and Japan are also exceptionally high. Meanwhile, we are borrowing. Our savings have fallen to between 1% and 2% of GDP since 2001, a level last seen in 1934. Our economic growth rests on a consumption and shopping boom, financed by China, Korea and Japan, which has pushed up current account deficits and overseas liabilities. Public opinion polls show Americans anxious despite two years of strong growth — and rightly so.
Asia has weaknesses too, of course. Great-power relationships among China, Russia, Japan and India are uneasy. Asia’s population is aging faster than ours. China in particular faces weak finances, environmental stress, severe income inequality, widespread poverty and an uncertain rule of law. And the U.S. maintains many strengths, from a robust political system to superior universities, from sophisticated environmental and intellectual property policies to special advantages in medicine and the life sciences. But if we do not recognize our weaknesses, our strengths may not be enough.
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How should we respond? The U.S. must develop an integrated policy to address this emerging challenge in all its aspects. Perhaps we can identify four priorities.
First, we must reduce the risk of global trade and financial imbalances. America saves and exports too little and consumes too much on credit; Asia saves too much and overinvests in real estate and export industries. This pattern poses risks for both sides. Because our current-account deficit is above 6% of GDP and we are dependent on foreign capital to finance growth, we risk financial shock and face rising long-term liabilities. Asia, for its part, is building up stocks of dollars whose value is likely to fall and relies on the mood of U.S. consumers for growth. Since responsibility for the imbalances is shared, we must together reduce them. This necessitates further currency appreciation in China, deficit reduction and personal savings incentives in the U.S., and sustained liberalization in Japan and Korea.
Second, America needs to raise its game at home to remain the world’s technological leader. To this end, our tax policy needs sharpened focus on encouraging innovation. Public investment must be reshaped to improve high-tech and traditional infrastructure. Both the government and the private sector should increase investment in research, particularly in the physical and information sciences. Federal spending on basic science (excluding life sciences) has been stagnant in real terms for three decades, and since the ’70s has dropped by 37% relative to GDP. The government must also contribute to a renewal of human talent by rethinking visa policy. Waiting periods for foreign students applying to graduate schools should be cut and work-visa constraints for scientists and engineers should be eased. America also needs to create a larger network of elementary and secondary schools focused on science and technology.
Third, America’s central place in the Pacific economy must be maintained. The FTA with Singapore and the partially negotiated one with Thailand are a start, but scale matters. Regardless of the outcome of the WTO’s Doha Round, ambitious agreements should be negotiated with the major Asean countries, South Korea and Japan. In addition, strengthened economic ties with India should further ensure a robust U.S. economic presence in Asia.
Finally, American needs to restructure its economic relationship with China, and China needs to reshape its own engagement with the world. For the U.S., episodic attention to the specific issues highlighted by Congressional debates is not enough. Complaints about specific Chinese trade policies should be met through bilateral negotiations, the WTO and U.S. trade laws. Together with this must come a broad and intensified engagement with China and Asia more generally, predicated on China’s own growth, its central role in Asian integration and Asia’s larger role in the world economy. This requires not only rethinking American policy, but fundamental reform of global economic institutions, in particular the G-8, the IMF and APEC. As the world’s second-largest economy, third-largest exporter, largest destination for FDI and second-largest holder of foreign currency reserves, China should be a G-8 member, not an occasionally invited guest. Korea has an economy easily comparable to Canada or Italy, and should also be a member. The IMF quota allocation is similarly undersized. China’s share of contribution to IMF resources is 3%, a rate equal to Canada’s and not far above Belgium’s. This is far below the level of responsibility China should accept in the global financial system. APEC, too, needs a new mission, one that reignites its early vision of “free and open” trade in the Pacific and addresses four major long-term issues of common concern: energy, climate change, aging and Pacific finance.
Before all this, however, comes a first step. That is recognition by the administration, Congress, businesses and the public that we face a powerful competitive challenge, one that cannot be attributed to undervalued currencies or unfair trade. The plain fact is that our competition has gotten tougher, and we need to match it. Two hundred years ago the Chinese emperors failed. America must act now to succeed.
Ms. Barshefsky, U.S. Trade Representative from 1997 to 2001, is a lawyer in Washington. Mr. Gresser, director of trade and global markets at the Progressive Policy Institute, was policy advisor at the Office of the USTR from 1998 to 2001.

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