Unbalanced: The Codependency of America and China

Unbalanced: The Codependency of America and China

Stephen Roach
Yale University Press , 2014
ISBN: 0300187173

Preface
Pages ix to xvi

China and America — or is it China versus America? The distinction lies at the core of the most important bilateral relationship of the twenty-first century. With 5,000 years of Chinese history dwarfing only about 240 years of U.S. experience, it may seem audacious to contrast such an old civilization with a relatively youthful country. But there can be no mistaking the significance of the interplay between the world’s two largest and most powerful economies. The relationship between the United States and China may hold the key to a global economy that is now in great flux.

Yet that relationship is afflicted by a unique pathology. Both nations are trapped in a web of codependency. China has turned increasingly to the United States as the sustenance of its economic development strategy. At the same time, the United States has become heavily reliant on China as a major source of its growth. Psychologists warn of the inherent instability of codependency—of a mutual pathology that only worsens over time. That warning applies equally to economies. Without treatment, codependency presents great risks to both the U.S. and Chinese economies, with enormous implications for the rest of the world.

But there is an important twist in assessing the shared pathology of the United States and China. There are no guarantees that both nations are equally afflicted. That raises the possibility of an asymmetrical coping mechanism, with one economy lapsing into more destructive behavior than the other, or even one that begins to heal before the other. Codependency does not assign equal guilt to the United States and China in perpetuating this pathology. It simply underscores the two-way character of an insidious feedback loop. How the United States responds to China bears critically on how China responds to the United States.

Two recent developments have been especially important for the codependent U.S.-Sino relationship: First came the Great Recession of 2008–9 spawned by a financial crisis unlike any other in modern times. Because it was made in America, it drew into question the strategies of many in the developing world who are tightly linked to U.S. markets. Questions arose not only because the United States was a major driver of the demand that supported most export-led economies but also because the crisis discredited America’s status as a role model.

These developments came as an especially rude awakening for China. Rapidly expanding exports have long been the most dynamic aspect of the Chinese growth equation. The crisis and its aftermath—an aftermath now glaringly punctuated by Europe’s sovereign debt crisis—are likely to have a lasting impact on the external underpinnings of the all-powerful Chinese export machine. Moreover, modern China’s stunning evolution from Soviet-style central planning to market-based socialism was shaped to an important degree by the aspirational image of the American Dream. That dream is now badly faded.

The sustainability challenges facing China didn’t arise just from its external linkages and the postcrisis dampening of external demand. There are also serious internal problems that arose from China’s own miscalculations. After more than thirty years of spectacular growth, China is now plagued by worrisome imbalances in its domestic economy—from income inequality and excess resource consumption to environmental degradation and pollution. As the Great Recession exposed America’s imbalances, it did the same for China’s.

A second recent twist in the U.S.-China relationship reflects Washington’s longstanding penchant for blaming others for problems of its own making, a deflection of responsibility that also fits the classic diagnostics of the psychologist. Twice in recent years, the U.S. Congress has come close to enacting trade sanctions against China to counter its alleged currency manipulation. Democrats and Republicans agree on very little these days, but in an era of historically high unemployment, they are united in blaming China for what ails America—namely an unprecedented shortfall of saving.

If such legislation were enacted, it would impose steep tariffs on all goods shipped from China into the United States. Not only would this deal a devastating blow to China and the rest of an increasingly China-centric Asian supply chain, it would backfire in the United States. It would do grave damage to hard-pressed American families by raising the costs of the goods that the United States imports from abroad. It could also send the dollar plunging, interest rates soaring, or both.

In a highly charged political climate, venting by the U.S. Congress is hardly unexpected. But there is no telling if or when political bluster becomes reality. If allowed to shape law, U.S.-Sino trade frictions have the potential to undo many of the most important benefits of international trade and globalization. Misdirected trade sanctions would be Washington’s biggest economic policy blunder since the Smoot-Hawley tariffs of the early 1930s. At a minimum, the unthinkable Bad Dream has now become thinkable.

How did we get to this point? How could the United States have squandered its once unchallenged global economic leadership? Is China at risk of falling into the same trap? Why is it so easy for the United States to lash out at China as a scapegoat? Is it Washington’s last gasp of hegemonic desperation? Is it a rite of passage, marking the decline of one great power and the ascendancy of another—the American century evolving into the China century? Is it the manifestation of a deep-rooted mutual misunderstanding?

These questions are part of a narrative that has been unfolding for many years. It’s hard to put a finger on how and where it all started. But there can be no mistaking the critical role played by America’s fixation on growth for the sake of growth—a mindset that ultimately became prescriptive and came to rely on asset and credit bubbles to sustain a false prosperity.

China’s dependence on America’s false prosperity is equally important. China took American growth for granted, only to ask questions later, and used the fruits of that growth as the basis of its own development strategy. Each of these trends fed the other. They allowed both nations to push the envelope on economic growth, but ultimately at great peril.

The days of false prosperity were always numbered. Underpinned by bubbles, outsize imbalances emerged. Imbalances aren’t sustainable, and most knew the end would come someday, even if they thought it was not imminent. But the crisis of 2008–9 left little doubt that such a realization could not be deferred to some distant point in the future; it had finally arrived. The bubbles that supported America’s spending binge have burst, bringing down China’s artificial export boom as well.

Yet before the Great Recession, it all seemed so sustainable. China gave Americans a way to repeal the basic laws of economics. They could live beyond their means, and that enabled the Chinese to do the same. Or so they both thought. The severe recession of 2008–9 unmasked these fantasies for both nations. China and the United States, each caught up in false prosperity, now need new recipes for sustainable economic growth.

Both nations need to learn tough and possibly painful lessons. With America reeling from postcrisis aftershocks, China can’t count on bruised and battered U.S. consumers to support its exports and sustain its seemingly invincible economic strength. Nor can America go back to its bubble economy for another fix. The crisis and its aftermath bring U.S.-China codependency into sharp focus. Each nation needs to take a hard look in its own mirror.

That won’t be easy. Denial, consistent with the pathology of codependency, runs deep in both nations. Rather than embrace the hard tasks of rebalancing and structural change, each country finds it far easier to hope for a return to the way it once was. But that is hoping against hope in an era when the script of an interdependent world has been turned inside out.

Physics teaches us that momentum is a powerful force to arrest. Psychology tells us that it is hard to break old habits. And economic experience demonstrates that structural changes tend to be painful and glacial. But time and again, history has been altered by the unexpected—geopolitical developments, natural disasters, or technological breakthroughs. Impossible as it is to predict the unexpected, it is well worth the effort to ponder what might drive the coming realignment of the world’s two largest economies.

China seems to get it. Since the days of Deng Xiaoping, one of modern China’s greatest strengths has been strategy—especially when it comes to economic policy and macromanagement. And China has recently adopted a new strategy that entails a fundamental rebalancing of its economy, shifting away from its increasingly unsustainable manufacturing-led export model toward internal private consumption and more services-led growth. That will allow China to reduce its fixation on the sheer speed of economic growth and turn its attention instead to the quality dimension of the growth experience, which it has heretofore neglected. Rebalancing offers China the opportunity to aim for a lighter, cleaner, greener, and more sustainable economy.

America doesn’t seem to get it. Strategy doesn’t come easy for a nation whose economy sits on the bedrock of the Invisible Hand. Despite the obvious warning signs of massive imbalances and the bubbles they spawned, there is a strong predisposition in the United States to resurrect the timeworn recipe of consumer-led economic growth. That would be fine if America had a solid base of income generation and tended to its competitive strengths, investing in its people and infrastructure and funding those investments with internally generated saving. But America has done none of that in recent years, making it next to impossible to recapture the magic.

Codependency is about to call America’s bluff. China is pushing ahead with rebalancing. That shift will have enormous implications for a tired U.S. growth model. As the Chinese consumer comes to life, China’s saving will decline, reducing its international current account surplus and thereby diminishing its demand for U.S. Treasuries and other dollar-based assets. As the world’s largest international borrower, a savings-short United States will have an exceedingly difficult time replacing its largest foreign lender. At a minimum, that should squeeze the terms on which America has been borrowing in international capital markets, yet another reason to underscore the potential for destabilizing risks to interest rates and the dollar. The feedback effects of such developments will only add to the stiff headwinds already constraining U.S. economic growth. Made in China, these pressures are coming—whether America likes them or not.

The United States needs to think hard about how it will respond to the Next China. Codependency frames America’s choices in a stark light. Like China, it needs to set aside the false assumptions of a now antiquated recipe for growth, and it must embrace rebalancing. A rebalanced U.S. economy, one that saves more and draws much greater support from capital spending and exports, will be well positioned to sustain growth in the years ahead. But if the United States resists that rebalancing, failing to muster the political will to pull it off, it will suffer as the Next China emerges.

Looking at this challenge through the lens of codependency offers an important ray of hope for the U.S. growth dilemma. China’s rebalancing should be seen as America’s opportunity, a basis for its long-term resurgence. A growth-starved United States simply cannot rely on another consumption binge to solve its most daunting postcrisis problem: the enormous overhang of unemployed and underemployed workers. With unusually sluggish U.S. consumption likely to remain the postcrisis norm, exports and investment—investment in its people as well as in infrastructure and new productive capacity—are the only hopes for offsetting an otherwise chronic growth shortfall.

The potential export bonanza to China is an especially important aspect of this tale of codependency. China is America’s third-largest and most rapidly growing export market. For that reason alone, any resurgence of U.S. exports depends on sharply expanded shipments of American-made goods to China. The United States offers a product line that would sell very well in the Next China—especially motor vehicles, aircraft, appliances, pharmaceuticals, and sophisticated machinery.

As with China, the trick for America lies in implementation—in case, a competitive revitalization of hollowed-out export industries as well as negotiations that focus on enhanced access to domestic Chinese markets. Polarized domestic politics only complicate this equation, especially Washington’s recent penchant for threatening China with trade sanctions. If the United States chooses that option, it is bound to evoke reciprocal actions from Beijing that would effectively foreclose American exporters’ chances to participate in the coming surge of Chinese consumption.

In the end, the psychologists probably have it right: Codependency is not a stable condition for either human beings or economies. It tends to feed on itself. While China and the United States have benefited in the past from their seemingly symbiotic relationship, they have now crossed the line of a sustainable codependency. America’s excesses have become the sustenance of China’s unsustainable development, and vice versa. This poses enormous challenges for both.

Rebalancing is the only lasting solution for unstable codependency. It will take enormous effort, self-discipline, and time. It will also require a coherent framework of action—what might even be called a strategy. China excels at that—America abhors anything that even hints of a plan. While the stakes are obviously high, this should not be seen as a race between the world’s two largest economies. The question is not how America can win against China but how it can best improve itself. The question is the same for China.

If it occurs, the coming rebalancing of the United States and China is not a big deal just for the two nations. It could be a transformational event for the world at large. At critical moments in history, a realignment of economic power has often been associated with major shifts in military might and geopolitical stability. Historian Paul Kennedy, in The Rise and Fall of the Great Powers, has argued that the ascendancy and ultimate demise of great powers reflects such tectonic shifts. Does a similar fate await a U.S.Chinese rebalancing?

Such a possibility can hardly be taken lightly. The United States, in many respects, is a good fit with the classic Kennedy example of a declining power. The imbalance between America’s unparalleled projection of its vast military power and the erosion of its domestic economic base is, in fact, quite consistent with the pattern of “geostrategic overreach” that Kennedy traces back to the crumbling of dynastic power in Europe in the early sixteenth century. Juxtaposed against the backdrop of a rising China and the aspirational, indeed nationalistic, imagery of the “China Dream” being espoused by its new leader, Xi Jinping, the two nations could well be entering an increasingly precarious phase of their codependency.

The endgame is anyone’s guess. The possibility of a major power realignment—at first economic, eventually military—can hardly be ruled out. It is safe to say that the strategic thinking and economic management skills of both the United States and China could ultimately determine whether this transition is both stable and peaceful.

While few would dispute the imperatives of a seamless rebalancing, it is naïve to take that for granted. Leaders of both nations must take the risks of economic and geopolitical instability seriously. The diagnosis of codependency prescribes its own cure—coalescing around a new identity that comes from economic realignment and rebalancing. While the U.S. and Chinese economies should emerge stronger and eventually less dependent on each other, improving the all-important relationship between them is vital to any such cure.

Yet there are grounds for serious concern on this count. The Great Recession and escalating trade tensions leave both countries on the brink of a very slippery slope. The same can be said for the confluence of the China Dream and the mounting perils of America’s savings-short economy. It will require leadership, political will, shared values, and mutual trust to establish a more sustainable relationship. Long haunted by increasingly precarious imbalances, the United States and China are now at critical junctures in their economic journeys. Can they make the leap from false prosperity to something more sustainable?

Excerpted from Unbalanced: The Codependency of America and China, by Stephen Roach, published January 2014 by Yale University Press.

Copyright ©2014 by Stephen Roach. Reprinted by permission of Yale University Press. All rights reserved.