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The Rise of China

Eclipse: Living in the Shadow of China's Economic Dominance by Arvind Subramanian (Washington: Peterson Institute for International Economics), 2011; pp xvii + 216, price not indicated.

The Rise of China

Nitin Desai

A
n eclipse is a totally predictable c elestial event determined precisely by the Newtonian motions of the earth and the moon around the sun. Arvind Subramanian’s book Eclipse can be thought of as the economic equivalent of celestial mechanics in that it applies the algebra of exponential economic growth to come up with a forecast that China will displace the United States (US) as numero uno in the global economic power game by 2030.

The centrepiece of his thesis is the convergence of low income and high income countries and a pace of convergence determined by the distance from the standard of living frontier. The argument for this is the “flat earth” thesis of Thomas Friedman, that productivity enhancing i nnovations travel virtually costless across national boundaries, provided that some preconditions of human skills and openness to trade are present. An older argument for convergence is that capitalism needs it for its own survival; but in that case it will never allow convergence to erode its own power!

Subramanian’s argument is based on some fairly straightforward analysis of historical growth patterns. He defines global economic dominance in terms of the size of an economy, measured in terms of gross domestic product (GDP) at purchasing power parity, international trade and net capital exports, all measured as ratios to the world totals. He argues that other elements that determine economic dominance, like technology or human capital, are likely to be correlated with these and need not be independently considered. He defends his index on the ground that it does a good job in identifying dominating powers in the 1870-2010 period.

Having defined the index, he bravely projects it forward to the present on the basis of assumptions that, according to him understate China’s growth and capital exporting potential. His trade projections

Economic & Political Weekly

EPW
novemBER 19, 2011

book review

Eclipse: Living in the Shadow of China’s Economic Dominance by Arvind Subramanian

(Washington: Peterson Institute for International Economics), 2011; pp xvii + 216, price not indicated.

are derived from his GDP projections as they came out of a gravity model for predicting trade flows. As is usual with this type of exercise he tests for robustness by tweaking the growth rate differential, which is the key to his projections, up or down.

The more novel element in his projection of Chinese dominance is the thesis that the renminbi will displace the dollar as a reserve currency within the next 20 years. This is based on the argument that the dominant economic power’s currency becomes the preferred reserve currency some time after the power has reached undisputed dominance. He does some vigorous scouring of historical data and analogies to suggest that the lag is around 10 years and that means that if history is any guide the renminbi will rule much sooner than expected.

Relying on Historical Analogy

Subramanian’s arguments rest heavily on historical analogy. But as he himself recognises we live “…in a fuzzier, more muddled world with history supplying only imperfect analogies and providing limited guidance” (p 154). What are the possible reasons for a departure from these Newtonian predictions of Chinese dominance that according to him is imminent, broad-based and as substantial as United Kingdom dominance in the heyday of empire and US dominance after the second world war?

China’s trade dependence is a constraint on power as much as an opportunity for exercising it. Its industrial capa cities produce products to meet demand in countries much richer than it is now or will be even 20 years from now. Much of this capacity is

vol xlvi no 47

in the hands of multi nationals that may not be willing to switch to catering to the demands of the lower income Chinese consumer. It also needs trade to obtain the many raw materials it lacks. Even now Chi

na needs access to other countries markets and resources.

The US is less vulnerable. It is rich in r esources or has control over low-cost r esources in other countries. Its control of west Asian oil, based on its security umbrella for the sheikhdoms and for Israel, is a big part of this advantage. It has a large domestic market and has always been an innovating society. It does not need the world to the extent to which the world needed it and this shows up in trade proportions that are lower than what Subramanian’s Newtonian dynamics would predict.

Subramanian also underestimates the role of technology as the basis of US dominance. In fact, boom years in the US economy seem to coincide with the spread of some game changing innovation in products or processes. There are a few references to technological prowess in the book and Subramanian seems to count on the larger number of engineers in China as a sufficient ground for believing that technological dependence will not stand in the way of global dominance. If only it were so simple India would also be there vying for a share in global power. China is moving into a phase where it has to make a transition from low income to middle income status. Reverse engineering will not be enough. It needs to become a product and process innovator. But the fact is that it does not have an ecosystem for innovation capable of allowing mavericks like Steve Jobs to flourish.

The big one, however, is the forecast that the renminbi will become a reserve currency. Subramanian’s arguments rest heavily on the association between reserve status with GDP, trade and net creditor positions. For the renminbi to become a reserve currency China would have to give up a mercantilist policy of an undervalued exchange rate, reform its financial sector so that it can provide globally competitive financial services and open its financial sector to foreign investment. Subramanian seems to think that China is

BOOK REVIEW

ready for this and will do so initially through enclaves in Hong Kong and Shanghai. But the fact is that the high rates of investment in China have led also to poorly performing loans in the balance sheets of banks and that clean up could take even longer than the sub-prime clean up in the US. The impact of a quicker rise in the exchange rate also may exert an influence on domestic jobs that the regime may not be ready to accept.

The choice of the currency in which you will have an open position or in which you would prefer to hold your assets is increasingly influenced by capital flows. Many more businesses now have capital assets and liabilities in currencies other than their home currency. Even their transactions demand for currencies reflects these capital account commitments. This is a change from the past when the scale of capital transactions was much smaller. The availability of efficient and deep financial markets is a necessity for coping with these large flows. Chinese banks and finance companies are nowhere near the point at which they can offer a borrower or lender in another country the sort of services that New York or even London can offer.

There are other factors that may slow the rise of China like political upheavals in the struggle for democracy and social i ssues like ageing. But these go beyond the framework of reference of Subramanian’s study. Basically, Subramanian measures the power potential of a country. Translating this potential into dominance requires institutions that can mobilise domestic society and polity around the goal of dominance and the diplomatic and military capacity to project this globally. These d imensions are barely touched in Subramanian’s book.

Assuming that China has what it takes to exercise global dominance, Subramanian’s answer to this is to coax China into multilateralism. His preferred institution for this is the World Trade Organisation rather than the International Monetary Fund (IMF), even though his book begins and ends with the fantasy of a Chinese managing director of the IMF reading the riot act to a US President accompanied by the legislative heads of both parties!

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Tethering China to multilateralism amounts to a demand for socialising China and for Mao Tse Tung’s successors to take on the responsibility for managing an open and liberal capitalist world system. According to Subramanian they may do this on their own if his projections of overwhelming Chinese power are right, with the US as part of a G-2 if the inertia in the global power system slows down China’s rise or with the G-20 in tow if China sees some practical or ideological value in multilateralism. But this type of transformation of an avowedly communist state is only possible if the Chinese political system goes through the sort of upheaval that the erstwhile Soviet Union went through from the mid-1980s onwards. The results of such a jasmine revolution could disrupt China’s long march to dominance as much as perestroika and glasnost did to their northern neighbour.

One can be sceptical about the pace at which China will rise; but that it will b ecome an increasingly powerful player in shaping global economic relations is inevitable. So also is the diminution of

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www.sagepub.inLos Angeles „ London „ New Delhi „ Singapore „Washington DC

novemBER 19, 2011 vol xlvi no 47

EPW
Economic Political Weekly

BOOK REVIEW

US power. What does this mean for the rest of us? Subramanian’s book has the subtitle “Living in the Shadow of China’s Economic Dominance”. So presumably China is the Rahu that is gobbling up the sun that is the US and dimming the prospects for all of us! But is that the case? Should the world fear Chinese dominance? May be geopolitical factors make Chinese dominance less welcome to India. But that is no reason for it to be the

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-cat’s paw of the US in delaying the rise of China. If one reads the long litany of US high-handedness when it ran the global system the polite Confucian mandarins of China may be a welcome change from the aggressive evangelicals from the north Atlantic.

The answer for India and the rest of the world marginalised by the emergence of the G-2 lies in containing both of them. The imminent end of the hegemony of

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--one superpower provides an opening for pursuing the path of robust and equitable multilateralism that Subramanian recommends. So India and the rest of the world should pursue this fast before another hegemonic superpower consolidates its position.

Nitin Desai (nitin-desai@hotmail.com) is chairman of the board of governors, Institute of Economic Growth, Delhi.

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Economic Political Weekly

EPW
novemBER 19, 2011 vol xlvi no 47

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