Time to accommodate China to benefit all

Men talk as they are seen reflected in a window of a building at the Pudong financial district in Shanghai in this March 18, 2014. [Photo/Agencies]

Economists are divided over China's economic future. Optimists emphasize its capacity for learning and rapid accumulation of human capital. Pessimists focus on the rapid decline of its demographic dividend, its high debt-to-GDP ratio, the contraction of its export markets, and its industrial overcapacity. But both groups neglect a more fundamental determinant of China's economic prospects: the world order.

So can China sustain rapid GDP growth within the confines of the current global order, including its trade rules? Or must the current US-dominated order change drastically to accommodate China's continued economic rise? The answer remains unclear.

One way that China is attempting to find out is by pushing to have the renminbi added to the basket of currencies that determine the value of the International Monetary Fund's reserve asset, the Special Drawing Right. That basket now comprises the US dollar, the euro, the British pound and the Japanese yen.

The SDR issue was the audience's main concern when IMF Managing Director Christine Lagarde spoke in Shanghai in April. Her stance - that it is just a matter of time before the renminbi is added to the basket - drew considerable media attention. (Regrettably, though, the media read too much into her statement.)

The IMF is expected to vote on the renminbi's inclusion in the SDR at its regular five-year review of the SDR basket's composition this October. But even if, unlike in 2010, a majority votes to add the renminbi to the basket, the United States may use its veto power. Such an outcome would not be surprising, given that US opposition (though in Congress, not within the Barack Obama administration) blocked the reforms, agreed in 2010, to increase China's voting power in the IMF.

Limited use of the SDR implies that adding the renminbi would be a largely symbolic move; but it would be a powerful symbol to the extent that it would serve as a kind of endorsement of the currency for global use. Such an outcome would not only advance the renminbi's internationalization; it would also provide insight into just how much room there is for China within the existing global economic order.

So far, it seems that there is not enough. China remains subject to US monetary policy. If the Fed raises interest rates, China must follow suit to keep capital from flowing out despite the negative impact of higher interest rates on domestic growth. Given the US dollar's dominance in international transactions, Chinese companies investing abroad also face risks associated with exchange rate fluctuations.

China has faced major challenges within the existing global system as it tries to carve out a role befitting its economic might. That may explain why, with its "Belt and Road Initiative" and the establishment of the Asian Infrastructure Investment Bank, China is increasingly attempting to recast the world order - in particular, the monetary and trading systems - on its own terms.

The AIIB has proved appealing to even major powers like France, Germany and the United Kingdom, reflecting a growing awareness of the US-dominated order's diminishing returns. From China's perspective, sustained domestic economic growth seems unlikely within the existing global system - a challenge that Japan and the other East Asian economies did not encounter during their economic rise. Indeed, the only country that has encountered it is the US, when it replaced the UK as the world's dominant economic power before World War II. Fortunately, that precedent is one of accommodation and peaceful transition.

China does need to further reform its financial sector in order to eliminate distortions in resource allocation and stem the economy's slowdown. But Chinese leaders' refusal to pursue export-boosting currency depreciation, even in the face of decelerating growth, suggests they are willing to make the needed sacrifices to secure the renminbi's international role and, with it, long-term economic growth and prosperity.

Whether or not the renminbi is added to the SDR basket in October, a gradual transformation of the global system to accommodate China seems all but inevitable.

The author is a professor of economics at and director of China Center for Economic Studies, Fudan University, Shanghai.

Project Syndicate