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Jon Talton

Analysis and commentary on economic news, trends and issues, with an emphasis on Seattle and the Northwest.

August 16, 2010 at 9:20 AM

Unsustainable relationship between China and U.S. clouds both countries’ prospects

The official word that China has overtaken Japan to become the world’s second largest economy is, as The Nation’s Katrina vanden Heuvel put it, not just the story of the day but the story of the year. In the short-term, this is good news for an Asian-dependent economy such as Seattle. Longer-run, it’s impossible to say.

To be sure, China is far behind the U.S. (China’s latest GDP is $1.34 trillion in the second quarter vs. $15 trillion annually for the U.S.). But if current growth rates hold, China could reach America in a decade. Moreover, large companies nominally based in America do heavy amounts of manufacturing, and increasingly R&D and design work, in China. The same doesn’t flow the other way. Indeed, with China’s so-called indigenous innovation rules and other stealth protectionism, the country is forcing more multi-nationals to base more work there, rather than export product in. It’s part state capitalism. But it’s also the kind of policy Alexander Hamilton set up, one that was sustained by tariffs for more than another century, making the United States an economic colossus.

China has made stunning gains to recover its national greatness. But it’s had a lot of help from American companies, consumers and the U.S. government, in everything from offshoring production and jobs to the greatest borrowing binge in history. The U.S. was also pivotal in allowing China into the World Trade Organization, even though it doesn’t play by the same economic and trade rules as the West.

Unfortunately, China’s rise to power has not resulted in the kind of reset one might have expected, such as greater access for American exports or a floating currency. If anything, China’s policies are becoming more protectionist and its large state-owned companies do the bidding of the party, not the capital markets. The huge imbalances between China and America haven’t been worked out, despite a historic recession.

With Americans facing the worst unemployment situation since the Great Depression and more Americans seeing themselves as losers from “free trade,” China’s ascendancy is politically volatile. It’s difficult to see struggling Americans continuing to tolerate the status quo, however profitable it is for Big Business. Yet China holds so much U.S. debt, it has the whip hand. A vulnerable whip-hand to be sure: China desperately needs Americans to keep doing what they did: Buy Chinese products, be good debtors, etc.

One big unknown is how the world’s two biggest economies will handle discontinuity. Whatever friction sometimes happened between Washington and Tokyo, both were democracies and allies, with America having the upper hand. Washington and Beijing are competitors not only economically but geopolitically — and their interests sometimes conflict. Climate change, peak oil, competition for scarce resources including rare-earth metals, North Korea’s nuclear program, Taiwan — all have highly destabilizing potential. While America has been exhausting itself in Iraq and Afghanistan, China has been building ties around the world to lock up resources and markets. China also has its own troubles, which, given its size, would have world-shaking implications if they got out of hand.

Even the current U.S.-China economic relationship is unsustainable. But neither country is willing to change. So remember this day in history.

Today’s Econ Haiku:

Hulu IPO?

There goes the innovation

Wall Street wants the loot

Comments | More in China economy and business

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