Couple’s Counseling for the US and China

BEIJING – China has undoubtedly benefited from the world system created and supported by the United States. Indeed, Richard Nixon’s journey to China in 1972 opened the door for China’s return to the international community.

Most of the next two decades were a honeymoon for Sino-American relations. On the economic front, the US not only granted China most-favored-nation trade status, but also tolerated China’s mercantilist approach to international trade and finance, notably its dual-track exchange-rate regime. In the 1990’s, bilateral economic ties continued to expand. American support for China’s integration into the world system culminated with the country’s accession to the World Trade Organization in 2001. Since then, China’s exports have grown five-fold.

Of course, China’s inadequate intellectual-property protection has damaged relations (a shortcoming that may be harming Chinese firms more than US firms by deterring American – and other advanced country – companies from deploying new technologies in China). And the role of China’s state-owned enterprises and official Chinese support for technological national champions (privileged companies that almost certainly use government money carelessly) has also hurt relations.

In fact, China’s approach is akin to gambling against the odds. Successful hi-tech innovations are random events that follow the law of large numbers. When left to the market, many firms and individuals try to innovate, so the overall probability of success can increase dramatically. The market allows the law of large numbers to work, whereas concentrated government support for a few favored firms undermines it.

But neither of these flaws, nor the exchange rate, is at the root of today’s global imbalances. Consider the exchange rate. The United Kingdom maintained a current-account surplus for the century before World War I, and the US did the same for about 80 years before 1980. But neither country, apparently, did so by manipulating its exchange rate.

Moreover, the economies that managed to narrow their external gaps with the US substantially after World War II, notably Germany, Japan, South Korea, Singapore, and Taiwan, ran current-account surpluses throughout their rapid-growth periods. This contradicts American economists’ conventional wisdom that fast-growing countries should borrow today against their larger future shares in the world economy.

One possible explanation is that the relationship between GDP growth rates and a country’s current-account position is not linear. Compared to countries with very slow growth rates, countries with reasonably high growth rates should borrow. But when a country’s growth rate continues to increase, its saving rate would increase faster than its investment rate, so it is more likely to run a current-account surplus.

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