The Next America Meets the Next China
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By Stephen S. Roach
Abstract—The world’s two largest economies both face major rebalancing challenges. The United States needs to wean itself from excess consumption and subpar saving, while China needs to do the opposite—greater emphasis on private consumption and the absorption of surplus saving. These transformations are daunting but provide major opportunities for both nations. They also and entail risks—especially those of an “asymmetrical rebalancing” whereby China would move more quickly than the United States. By drawing down its surplus saving to promote internal private consumption, China would reduce its current account surplus and its related demand for dollar-denominated assets. Who would then fund the external deficits of America’s saving-short economy? And on what terms?
It is extremely rare for the world’s two most powerful nations to face tightly aligned leadership and political cycles. Yet that was precisely the case for both the United States and China in November 2012. U.S. President Barack Obama experienced a tough re-election battle at the same time that China was coming to grips with its Fifth Generation leadership transition.
Political cycles don’t always bring out the best in nations—especially when it comes to their relationships with others. In the run-up to the transitions of 2012–13, the bilateral relationship between China and the United States was subjected to major stresses and strains. China bashing became a central element of the campaign rhetoric of both Obama and his challenger, former Governor Mitt Romney. China upped the ante on the international security front, sparking tensions in both the South and East China Seas that forced an American “pivot” in its long-vital military engagement strategy in Asia.
As the dust now settles on these twin transitions, it is critical to look beyond the politi- cal posturing that has framed the U.S.-China debate in recent years. Rhetoric aside, both the United States and China face profound challenges in the years immediately ahead. Nowhere is that more evident than in the economic sphere, where two co-dependent economies face fundamental rebalancing that will entail nothing short of major role reversals. If these changes all go according to script, the United States will morph from a consumer into more of a producer. China, by contrast, will experience the opposite con- version, transitioning from a producer to a consumer. The Next America will, in effect, need to cope with the Next China—and vice versa. Yet the shifts will not be black and white. Rebalancing is not a total makeover; it is a far more subtle transformation. The goal is better balance for currently unbalanced economies. The U.S. and Chinese economies should eventually emerge from this process with broader and, therefore, more solid foundations of sustainable growth—drawing support both from consumption and production, from internal as well as from external demands.
Given the strong ties that bind them, the coming role reversals should not be viewed as threats to either nation. Instead, enormous opportunities are likely to emerge for both economies. For a growth-starved United States, China’s nascent consumer markets offer great potential as a new source of demand. That may well be the perfect spark for a re-emergent American export machine. Similarly, a rebalanced China has much to draw on from the world’s quintessential consumer—goods, services, systems, and managerial expertise. Lacking a consumer culture of its own, this could be China’s ultimate import. The challenge will be for both nations to take advantage of the re- balancing of the other, rather than get swept up in the fears of the unknown and the insidious denial of the blame-game.
While it is unrealistic to expect a perfectly synchronous and seamless rebalancing of the United States and China, the basic objectives in both cases are quite clear. While sustained economic growth remains the all-encompassing goal for both nations, the strain of growth that results from a rebalancing in China and the United States is likely to be very different than it was in the past. It will be driven more by a focus on quality rather than by a fixation on quantity. Successful execution will be the ultimate win-win. More than anything, that’s the basic point that both nations must seize as they peer into the future. And it also allows China and the United States the opportunity to lead by example—something an unbalanced and crisis-prone world sorely needs.
America’s Ultimate Export
For most of the post-World War II era, the United States has always been at or near the top of the global export sweepstakes. That changed in 2006, when China moved into first place. But the United States is still holding its own in the number two position—technically, third, if all the countries in the European Union are lumped together—hardly making it an also-ran in the global trade arena.
But a high ranking in the volume of exports is not the point for a growth-starved U.S. economy. America does not need to beat China as a trade juggernaut. Instead, the United States needs to draw more on China as a major lever for an acceleration of the growth in its exports. With American consumers tapped out after the Era of Excess and the post-bubble carnage that subsequently ensued, exports have the potential to fill an important void in the U.S. growth calculus. There is no better way for the United States to capitalize on this potential than to turn its co-dependence with China into a growth solution for its struggling economy.
China is well poised to play just such a role. For start- ers, it is now America’s third largest export market. At $104 billion in 2011, it is still well behind the United States’ NAFTA partners, Canada ($281 billion) and Mexico ($197 billion), who benefit not just from the free trade zone but also from close geographic proxim- ity and integrated production facilities of the North American supply chain. But China has widened the distance considerably from America’s fourth largest export market—Japan ($66 billion)—and is definitely on a path to close the gap with Mexico and Canada.
That’s because China is, by far, America’s fastest growing major export market. Over the 2005–09 period, U.S. exports to China expanded at a 15.6% average annual rate—more than five times the 3% average growth of U.S. exports to Canada and Mexico over the same period. By contrast, U.S. export growth gains to Japan averaged a mere 0.4% over that same time frame. Moreover, given the likely sluggish growth of European demand in the years ahead, new shortfalls can be expected to emerge in a number of other major U.S. export markets—namely, the United Kingdom (the number five ranked U.S. export market), Germany (#6), and the Netherlands (#9). Looking prospectively, the United States will want to lean all the more on China to step up and fill any voids in its export machine.
The current mix of U.S. exports to China underscores the immediate opportunities that exist. U.S.-made power generation equipment is at the top of the list, and with the exception of the agricultural category of oil seeds and oleaginous fruits (mainly soybeans), which is number two, all of the other items in the top ten are either capital equipment or natural resources. These include electrical machinery and equipment (#3), non-rail motor vehicles (#4), and aircraft (#5). Exports of optical and medical equipment are the sixth largest U.S. export to China, followed by four resource-based or commodity exports: plastics (#7), pulp and paper (#8), copper (#9), and organic chemicals (#10). Collectively, the Top Ten enumerated above accounted for fully $63 billion, or 60% of total U.S. exports to China in 2011.
Despite this large influx of goods, the vast majority of U.S. exports to China have had a negligible impact on the average Chinese consumer. With the possible exception of some $5 billion of U.S. exports of optical and medical equipment to China, which does have some obvious ties to the nation’s huge needs in the healthcare area, the bulk of America’s export business in China has been closely aligned with the investment- and export-led character of the nation’s old economic model.
Excluding $1 billion of U.S. pharmaceutical exports, the Top Ten exports of American- made consumer goods to China are, in order of importance: toys/games and sporting goods (#1), writing and art supplies (#2), records, tapes, and disks (#3), televisions, VCRs, and other video equipment (#4), toiletries and cosmetics (#5), household appliances (#6), books and printed matter (#7), jewelry (#8), furniture and household goods (#9), and artwork, antiques, and stamps (#10). Collectively, all these items add up to just $2 billion, or just 1.9%, of total U.S. exports to China in 2011. The value of the Top Ten U.S. exports going to China are a full thirty times more than the share of exports going directly to the Chinese consumer.
Significantly, the structure of U.S. exports to China is very much at odds with the break- down of U.S. trade to America’s other trading partners. Non-auto consumer products currently account for about 12% of total U.S. exports, or roughly six times the share such items have in the export mix to China. If the structure of U.S. consumer goods exports to China were in conformity with the norms of America’s other trading partners- namely at the 12% share- that alone would be worth another $10 billion of incremental shipments to the Chinese. In this case, it’s not that the U.S. companies have been denied access to Chinese consumers. More likely, this shortfall is due to the well known deficiencies of internal private consumption in China.
But the potential for growth in U.S. exports to China is actually much greater than that just outlined. It’s not so much that the United States is punching below its weight in mapping its global trade structure on to China. It’s that the coming transformation of the Next China is likely to expand the size of the playing field dramatically. That, alone, provides the Next America with an extraordinary opportunity to bring its export businesses into closer alignment with the Next China.
There are three aspects to this challenge for U.S. exporters—competiveness, market access, and vision. America’s competitive prowess is now a serious problem. After decades of neglecting investments in human and physical capital, a savings-short America has lost its competitive edge. That’s what the annual polls conducted by organizations such as the World Economic Forum indicate and that’s what America’s loss of market shares in major global export businesses also shows.[1]
Market access, at least in theory, should not be a problem insofar as its potential opportunities in China are concerned. Historically, China has been a very open economy. The import share of its GDP has averaged 28% since 2002, not only triple the historical ratio in Japan but also well above that of most major economies in the world today. With such little intrinsic aversion to foreign products, American exporters should be salivating over the growth potential in Chinese markets.
In recent years, however, market access has become an increasingly contentious issue in the bilateral debate between Washington and Beijing. The tough economic climate since 2008 has tilted the playing field of market access for both the United States and China. That was especially the case after the U.S. stimulus program of 2009, which featured a “Buy American” provision. China, as America’s largest foreign supplier, coun- tered with similar actions of its own.[2] The result was a conscious effort by the Chinese to alter government procurement practices in a fashion that favored domestic production and so-called indigenous innovation. Some progress has been made in removing these barriers to Chinese market access, but more efforts are needed. America’s competitive revival will ring hollow if its newly energized companies are unfairly closed out of markets like China.
Vision, the third dimension of a nation’s export potential, is far trickier. The key in this sense is for the United States to be forward looking and to operate in an anticipatory fashion—aiming the export growth of the Next America toward the shifting economic structure and demands of the Next China. While that future is, of course, not known with any precision, the Chinese have offered some important hints that should come in handy for the strategic thinkers and operators of the Next America.
Indeed, China’s 12th Five-Year Plan (2011–2015) is quite explicit in identifying seven new strategic emerging industries (SEI) that will feature prominently in China’s indus- trial policies over the next ten years: energy conservation, new-generation information technology, biotechnology, high-end equipment manufacturing, alternative energy, alternative materials, and autos that run on alternative energy. The government has ambitious plans to treble the GDP share of these SEIs in a relatively short period of time, from just 3% of Chinese GDP in 2010 to 15% by 2020.
The SEI play could be a very important opportunity for U.S. companies, especially if they properly prepare themselves to compete and are assisted by negotiated improvements in access to Chinese markets. These are all cutting-edge industries where rapid growth is heavily dependent on state-of-the-art research and development, together with commercially-viable technologies and processes—all of which play to some of America’s greatest strengths. Whether those gains are realized by U.S. exporters or by partnerships with Chinese companies, or some combination of the two, there is enormous upside in this key area.
Of course, the opportunities of the Next China will go well beyond its emphasis on SEIs. As the consumer base broadens and moves up the wealth scale, Chinese demand for increasingly sophisticated goods and services will only continue to grow. While China does not publish a wish list of what that might entail, the United States, as the world’s quintessential consumer society, only needs to look in the mirror to make some educated guesses. Think shelter, furniture and appliances, motor vehicles, electronics, and all the other trappings of modern consumer societies. They will all become increasingly important facets of the aspirational value proposition of the Chinese consumer.
Rest assured of one thing, however: consumer demands of the Next China will present opportunities for U.S. exporters that go well beyond the current product mix, which is heavily skewed toward low-end toys, sporting goods, and apparel. Nor are the Chinese overly parochial when it comes to brand preferences. Foreign brands have enormous appeal in China. That’s certainly true for many luxury products, where Chinese sales have taken on great importance.[3] While this trend in buying habits for wealthier Chinese may not be applicable to those in the middle of the income distribution, where the bulk of the growth in Chinese consumption will be concentrated, it speaks to the open architecture of the nation’s consumer tastes. For a Chinese economy that must have the greatest reservoir of pent-up consumer demand in history, this spells nothing but opportunity for consumer product producers around the world, especially those in the United States.
China’s Ultimate Import
Notwithstanding its predilection toward state-directed planning, China cannot simply push a button and bring its long dormant consumers to life. It needs to learn from others what it takes to build a consumer culture. Who better to teach that than the United States—long the world’s dominant consumer? Just because the United States took its consumption-led growth model to excess, doesn’t mean that it can’t offer much to the inexperienced Chinese—not just in the form of goods and services but also expertise in the systems, institutions, and service distribution networks that underpin consumer markets. This expertise could well be China’s ultimate import—and an equally important opportunity for the Next America.
Modern consumer societies, of course, encompass far more than demand for material products. Services play equally important roles in shaping lifestyles. As stressed in the 12th Five-Year Plan, services are one of the keys to China’s pro-consumption rebalancing. The development imperative of Chinese services could well provide the United States with the greatest opportunity of all. Scale—in this case, China’s lack of it—underscores the upside. At just 43% of its GDP, the services share of the Chinese economy should be, at least, in the mid-50 percent range of other comparable developing nations like India. The fact that it is not again underscores the upside as well as the opportunity for those who can help the Chinese realize this important transition.
Services are an integral part of the rebalancing strategy of the Next China. Services are not only essential as a new source of job creation and labor income generation, but they are absolutely critical to the labor absorption tactics of rural-urban migration. Urbanization on the scale that China is experiencing—and will likely continue to experience over the next twenty years—simply cannot work without rapid growth in labor-intensive services and the new employment opportunities such development implies. And to the extent that increasingly services-led growth generates more jobs per unit of output and thereby allows for a slower expansion of Chinese GDP, then resource demand, environmental degradation, and pollution all stand a much better chance of becoming more manageable in the years ahead.
But services could also be the most global piece of the development strategy for the Next China. Of course, this is very much at odds with the historical role of the services sector as largely domestic industries that were clustered around major population centers, where their customers were located. Not easily transportable, let alone tradable, services needed proximity to the local markets they served.
But two related developments have broken the mold of the long fragmented. localized services model- new IT-enabled technologies and the globalization of vast networks of multinational services providers. Beginning in the 1990s, these trends, in conjunction with deregulations in many segments of services such as finance, telecoms, and utilities, have led to a rethinking and restructuring of strategies by modern services companies around the world.[5] A new global services industry has emerged as a result, driven by large-scale networked globalized services companies that deliver localized output to a vast array of markets around the world.
China is very much a part of that vast array of services markets that is now being targeted by globalized services enterprises around the world. In fact, given the services focus of China’s new development strategy, the target is an especially attractive one. Just as China is pushing to grow its services sector, the major services providers around the world are increasingly well positioned to meet this challenge head on. China may well be the most important opportunity for services globalization for years to come. With the world’s largest services sector, the United States is in a prime position to benefit the most from such a development.[6]
Estimating China’s Services Bonanza
The potential bonanza in Chinese services could be truly extraordinary. It is possible to size up the opportunity through a combination of relatively simple extrapolations of Chinese GDP growth and targets implied by the planning process. The following scenario provides a ballpark estimate of what this might entail.
The 12th Five-Year Plan calls for a four-percentage-point increase in the services share of the Chinese GDP, from 43% in 2011 to 47% by 2015. Over the subsequent ten years of the extrapolation horizon, 2016 to 2025, it seems reasonable to anticipate further incremental expansion in the services share of the Chinese economy averaging about one percentage point of GDP per year. That would take China’s services share up to 55% by 2023—on a par with India’s current distribution. By 2025, extrapolating on the same trend would place the services share of Chinese GDP at 57%, fully fourteen percentage points higher than only fifteen years earlier in 2010.
If these extrapolations are even close to the mark, the Chinese services sector is likely to more than quadruple in size by 2025, increasing from an estimated $3.1 trillion in U.S. dollars in 2011 to $14.2 trillion by 2025. The difference between the starting point and the endpoint amounts to $11.1 trillion—a good first-order approximation of the potential bonanza likely to be generated by the expansion of an embryonic Chinese services industry over a relatively short twelve-year timeframe.
There is an important final piece to this puzzle—the portion of China’s $11 trillion services bonanza that might actually be accessible to foreign businesses, especially those in the United States. As in any country, foreign participation in Chinese services can take place in two modes—onshore or offshore. The onshore option can take a variety of forms—ranging from wholly-owned subsidiaries to minority stakes in joint ventures. The offshore option relies on cross-border connectivity, either through physical travel and in-person delivery of services or IT-enabled dissemination of services from one remote desktop to another.
It is impossible to know with any degree of precision how much of the $11 trillion China might make available to onshore or offshore foreign services providers. China would prefer, of course, that the bulk of its services sector development be executed by its own companies, employing domestic Chinese workers. But lacking experience and scale in services, those are not realistic options for a nation faced with fairly urgent rebalancing imperatives.
A helpful benchmark comes from the creative research of Georgetown University Professor J. Bradford Jensen, who has developed some new tools to measure the “trad- ability” of U.S. services in global markets.[7] His estimates suggest that a large portion of workers in the U.S. services sector toil in tradable occupations; in the broad busi- ness services category, for example, he calculates that roughly 70% of all workers are employed in tradable occupations. That is probably a reasonably good proxy for the tradability of services output as well.
A conservative application of Jensen’s U.S.-based metrics to China—in effect, cutting the U.S. tradability factor in half—suggests that the minimum opportunity for onshore and offshore foreign services companies could be in the $4 trillion range (35% of the $11 trillion). And it could be as high as $6 trillion, depending on the Chinese government’s appetite for further opening up, through reforms and deregulation, of its embryonic services sector.
If these guesstimates are in the ballpark, this is a very big deal for the rest of the world, especially for growth-starved developed economies struggling against fierce post-crisis headwinds to uncover new sources of growth. Nowhere is that opportunity greater than in the United States, the world’s preeminent services economy. The United States currently accounts for 14% of global services exports— twice the share of the next largest exporter.[9] Unlike its seemingly chronic deficits in merchandise trade, the United States has maintained consistent surpluses on ser- vices trade—strong validation of a continuing comparative advantage in services. With worldwide trade in services expanding at a 14% average annual rate over the pre-crisis 2004–08 interval, almost as fast as the 15% trend surge in tradable goods over the same period, the United States as the world’s dominant force in services is extremely well positioned to benefit from the coming services bonanza in China.
China stands much to gain from this possibility as well. U.S. services companies have much to offer China’s nascent services industries in terms of process design, scale, and professional and managerial expertise. As such, there is enormous scope for America’s global services companies to expand and partner in China, especially in transactions- intensive distribution sectors—wholesale and retail trade, domestic transportation, and supply-chain logistics—as well as in the processing segments of finance, health care, and data warehousing. Recent high-level discussions in the Strategic and Economic Dialogue between the U.S. and China have made significant progress in opening up Chinese financial services to increased foreign investment. Attention now needs to be turned to non-financial services as well.
China’s sustained rapid growth and a rebalancing toward services spell nothing but opportunity for itself and the rest of the world. China’s co-dependent partner, the United States, is especially well positioned for this development. Jensen concludes by arguing that the United States, with its well-educated and well-trained services sector workforce, has much to gain from trade liberalization in services.[10] The coming $11 trillion bonanza in Chinese services makes that point all the more compelling.
Asymmetries
The rebalancing of two co-dependent economies entails risks as well as opportunities. One such risk is that of an “asymmetrical rebalancing”—whereby one economy initiates the heavy lifting of structural change before the other. The implications of such a disconnect cannot be minimized.
Of the two, China will undoubtedly be first to adjust. In part, this is because China thinks and acts strategically. Its 12th Five-Year Plan lays out the rebalancing strategy very clearly. Focused on social stability and conditioned by pragmatism in a tough global environment, Beijing recognizes the need to shift from a model supported by external demand to one that draws much greater sustenance from internal demand. Barring a spontaneous revival in the post-crisis global economy, China has every incentive to execute the coming change with haste.
Just as the rapid-fire shocks in the United States and Europe beginning in 2008 have been wake-up calls for an externally dependent China, the coming rebalancing of the Chinese economy could ultimately be the wake-up call for the Next America. That’s not because the United States is engaged in a strategic battle for economic supremacy and wants to match China step for step in the arena of structural change. It is more a question of necessity—namely, America’s wherewithal to continue to fund its savings- short economy.
With China turning inward and deploying its surplus savings to support internal private consumption, the United States will start to lose its largest source of external capital. Under such circumstances it will be very difficult for the United States to avoid an adverse shift in the terms of its external financing—namely, a sharp increase in long- term interest rates accompanied by the possibility of a much weaker dollar. Barring the willingness of a new generous donor to step up and fill the void, the United States will have no choice other than to plug the external funding gap by boosting domestic saving. While federal deficit reduction will undoubtedly be an important part of this response, so, too, will be the likely adjustments of a savings-short American consumer.
China and the United States have pushed their economic growth models beyond the limits of sustainability. For both nations, renewed focus on structural rebalancing imperatives is vital in this post-election (U.S.), post leadership-transition (China) climate. Their coming rebalancing is the only road back to economic sanity. Under an asymmetrical rebalancing scenario that realization will most likely hit home sooner rather than later. On that critical score, the Next China has much to gain from the Next America—and vice versa. The sooner both nations put aside the confrontational political posturing of the past couple of years, the better equipped they will be to face an opportunistic future. Failure to do so could poison the well and squander the synergistic opportunities that these rebalanced economies are likely to offer each other in the years immediately ahead.
About the Author
Stephen S. Roach, a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of The Next Asia (Wiley 2009). This essay is drawn from work for his new book on the US-China economic relationship (forthcoming from Yale University Press, Fall 2013).
Endnotes
That’s certainly the verdict of the World Economic Forum’s Global Competitiveness Index, which saw the U.S. slipping further into seventh place in 2012–13, down from fifth place in 2011–12 and, in fact, continuing the general downtrend that has been evident since 2005. See Klaus Schwab (ed.), The Global Competitiveness Report: 2012–2013, World Economic Forum, Geneva, 2012.
In fact, in 2010, China countered the U.S. ‘Buy American” campaign by imposing countervailing and anti-dumping duties on U.S. exports of grain-oriented flat-rolled electrical steel products. The United States subsequently initiated a formal complaint in the WTO over this action in September 2010; in July 2012, a WTO panel ruled largely in favor of the U.S. position; the Chinese have appealed and the case remains open at the time of this writing. The details on Dispute DS5414 can be found on the Dispute Settlement database of the WTO at www.wto.org.
Arecent McKinsey study estimates that by 2015, China will account for more than 20 percent of the entire global luxury market; see Yuval Atsmon, Vinay Dixit, and Cathy Wu, “Tapping China’s Luxury-Goods Market,” McKinsey Quarterly, April 2011.
See Michael E. Porter, The Competitive Advantage of Nations, Free Press, New York, 1990.
See Stephen S. Roach, “Services Under Siege—The Restructuring Imperative,” Harvard Business Review, September-October 1991.
In 1988, the United States accounted for fully 48 percent of total G-outlays on services; see Stephen S. Roach, “Services Under Siege—The Restructuring Imperative,” ibid. OECD data suggest the U.S. share of G-7 services spending has been roughly stable in the 45 percent to 50 percent range through 2010.
See J. Bradford Jensen, Global Trade in Services: Fear, Fact, and Outsourcing, Peterson Institute for International Economics, Washington, D.C., 2011.
It is admittedly a stretch to use labor shares to draw inferences on the allocation of output for any economy; any such calculation makes important assumptions on output per worker, or productivity. It turns out, however, that this is less of a leap of faith in labor-intensive services, where productivity levels and growth both tend to be considerably below those of manufacturing. World Bank metrics on services trade restrictions suggest that China is about half as open as the United States. That would suggest cutting the employment-based tradability measure of 70 percent for the U.S. to around 35 percent as a reasonable guesstimate of the tradability of China’s $11 trillion services bonanza. At the same time, as China continues to deregulate and reform its own services sector—continuing the trends that have been in place over the past decade—there is every reason to believe that its services trade restriction metrics will begin to converge on those of the United States; in other words, China’s 35 percent tradability factor could be expected to rise toward at least 50 percent over the next fifteen to twenty years.
See U.S. International Trade Commission, Recent Trends in U.S. Services Trade: 2011 Annual Report, Publication No. 4243, July 2011.
See J. Bradford Jensen, Global Trade in Services: Fear, Fact, and Outsourcing, op. cit.