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The usual concern about the US-China balance of economic and political power is couched in terms of our relative international payments positions. We’ve run a large current account deficit in recent years (imports above exports); they still have – by some measures – the largest current account surplus (exports above imports) even seen in a major country. They accumulate foreign assets, i.e., claims on other countries, such as the US. We issue a great deal of debt that is bought by foreigners, including China.
There are some legitimate concerns in this framing of the problem – no country can increase its net foreign debt (relative to GDP) indefinitely without facing consequences. And the Obama administration, ever since the Geithner-Clinton flipflop on China’s exchange rate policy early in 2009, seems quite captivated by this way of thinking: Will they buy our debt? Can we control our budget deficit? What happens if China dumps its dollars?.
The reason real to worry about China, however, has very little to do with external balances, China’s dollar holdings, or even capital flows. It’s about productivity and rent-seeking.
China mostly invests in activities that raise productivity, raising the amount of goods and services that they can produce. This could be manufacturing or infrastructure or various kinds of services. Agriculture lags but continues to get some new investment. And of course they pour money into education.
I’m not a fan of the Chinese way of organizing their economy or their society. They no doubt have weaknesses that will catch up with them eventually (including waves of overinvestment in some sectors), and there’s good reason to think they will be the center of a big new “Asia Century” Bubble that is just now starting to emerge.
But contrast their pattern of investment in recent years with ours. What sector in our economy has expanded more than any other? Where should you work if you want both the highest wages on average, potentially very big bonuses, and quasi-retirement by age 40? Finance.
Of course, we need finance and an important part of modern economic development involves intermediating savings and investment. The US did this well, with some bumps in the road, and built a system that worked through the 1960s or 1970s.
But finance as a share of our activities (i.e., percent of GDP) has roughly doubled in the past 40 years. What has this really added in terms of productivity? The ATM and the credit card were great breakthroughs, but they are old.
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