Imagine having predicted in 1990 that the Japanese economy, then widely expected to overtake the US within a decade or two, would grow on average by less than 1 percent a year for the next 20 years. In the unlikely case that anyone believed you, he would probably have drawn two worrisome conclusions.
First, Japan at that time was considered the world's growth engine, and so a collapse in Japanese growth would likely throw the world into a tailspin. Second, if after several decades of robust expansion Japanese growth were suddenly to drop so dramatically, there was sure to be social and political upheaval in Japan.
Japan did grow slowly for the next 20 years, but the rest of the world did not subsequently stagnate, and the Japanese people did not rise up in anger. Today, as the Chinese economy continues to slow, the world is asking the same worried questions about China. Without a boost from the Chinese growth engine, analysts say, doesn't the global economy risk stagnating further? Can China tolerate growth below 7 percent without suffering social unrest and perhaps even revolution?
Understanding why these worries were wrong for Japan may help in understanding why they might also be wrong for China. Take the first question. Will a Chinese slowdown cause a global slowdown? Probably not. It turns out that China today, like Japan in the 1980s, is not the global engine of economic growth. It is the largest arithmetic component of global growth.
These may seem the same, but in fact are very different. What the global economy lacks today is demand, and the engine of global growth must be a source of net demand for the rest of the world. China, with its large trade surplus, clearly isn't. What matters to the rest of the world, ultimately, is not how fast China is growing, but rather how the trade account will evolve as the economy rebalances. Some analysts might argue that China's central bank purchases of US government bonds also have an important effect on the global economy by restraining US interest rates, but as I show in Chapter 8 of my book The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy (Princeton University Press, 2013), this argument is based on a fallacy. China's export of capital matters not because it affects US interest rates but because of its impact on the trade account.
An orderly rebalancing, in which China's savings rate declines steadily relative to investment, implies a contracting trade surplus that will add net demand to the world. A disorderly rebalancing might imply an explosion in the trade surplus that would weaken an already struggling global economy. Whether slowing Chinese growth is good or bad overall for the world, in other words, depends on how it affects China's balance of trade, and this depends on how swiftly and forcefully Beijing is able to constrain credit growth and rebalance the economy.
There are at least three other ways in which China's rebalancing affects the world: First, China's disproportionate demand for hard commodities, five to ten times its GDP share compared to the rest of the world, is a consequence of the country's excessive reliance on investment to generate growth. A rebalancing China means much lower investment growth, which in turn implies a dramatic drop in Chinese demand for hard commodities. This will hurt countries whose growth depends on high commodity prices, but it will help net commodity importers.
Second, China became the world's manufacturing workshop at least in part because the very mechanisms that led to unbalanced growth also increased export competitiveness - especially its undervalued currency, artificially low interest rates, and lagging wage growth. As China rebalances, by definition its export competitiveness will erode, and this will be positive for manufacturers, especially in other developing countries.