Special Economic Study

中国经济平衡发展对全球化关系重大

（美国）摩根 斯坦利公司首席经济学家 斯蒂芬·罗奇

China’s Rebalancing Imperatives:

A Giant Step for Globalization

MORGAN STANLEY RESEARCH，

Chief Economist， Stephen S. Roach，

Stephen.Roach@morganstanley.com，+1 (1)212 761 7153

December 1, 2006

What’s new: China, long the lightning rod in the globalization debate, is on the cusp of a major rebalancing. A successful Chinese rebalancing could defuse many of the mounting anti-globalization tensions.

Conclusions: China’s rebalancing imperatives are evident on several fronts: (1) Surging fixed investment is rising toward an unheard of 50% of Chinese GDP; administrative actions are starting to take hold in cooling off an overheated investment sector and unsustainably rapid growth in industrial output. (2) While exports are still surging at a 30% pace, a post-housing-bubble slowdown of US consumer demand could provide temporary cyclical relief. (3) A pro-consumer Chinese growth impetus is in the works -- but it will take considerable time to flourish. (4) In the meantime, look for slower Chinese GDP growth in the years ahead -- consistent with 7.5% average growth targeted by the government in the new 11th Five-Year Plan.

Market implications: A shift away from investment and exports should have important implications for Chinese commodity demand and an increasingly China-centric Asian supply chain. Commodity markets could correct, and China¡¯s largest trading partners -- especially Japan, Korea, and Taiwan -- could see externally-led growth weaken. China’s pro-consumption tilt could reduce its trade surplus and build-up of currency reserves.

Risks: If China does not stay the course of its rebalancing, a protectionist backlash against globalization could intensify. China would also be at increasing risk of a serious misallocation of capital that could lead to capacity overhangs and deflation. Environmental degradation would also continue in an aborted Chinese rebalancing scenario. NOTE: This Special Economic Study is based on presentations made by Mr. Roach in Beijing on November 30, 2006 at Tsinghua University and on December 1, 2006 at a Bank of China Conference, Post WTO: China and the World.

China’s Rebalancing Imperatives:

A Giant Step for Globalization

China has re-written the script of economic development. As recently as 1991, there was virtual parity between Chinese and Indian per capita GDP. Today, China¡¯s standard of living is nearly three times that of India’s. It’s not that the Indian economy has lagged. To the contrary, its 6.5% average GDP growth over the past 15 years represents a stunning acceleration from a 4.8% growth trend of the preceding decade and a half. The story hinges more on a China that has come of age ---- surging at a spectacular 10% pace over that same interval. Driven by its unrelenting pursuit of economic reforms, China’s remarkable transition from state to private ownership has become the economic development story of our lifetime.

But can China stay the course? That could well be globalization's most important question in the years ahead. In my view, China now faces an important mid-course correction on the road to reform and economic development. It has become overly reliant on fixed investment and exports as the dominant sources of growth. In 2006, these two sectors will account for about 80% of Chinese GDP (see Exhibit 1). By contrast, private consumption appears to have fallen to around 35% of GDP. This unbalanced growth dynamic represents a serious mismatch between the forces of supply, on the one hand ---- namely the rapid expansion of a powerful export production platform ---- and a shortfall of demand, as evidenced by a small and shrinking share of private consumption. Such an imbalance between supply and demand is unsustainable for any economy. For China, the excesses of open-ended investment spending pose serious risks of capacity overhangs and eventually deflation. At the same time, open-ended Chinese export growth is already risking trade frictions and protectionism from China¡¯s major trading partners ¡ª tensions that could well intensify in a post-election United States. There can be no avoiding the imperatives of a rebalancing of the Chinese economy. The growth dynamic must be tilted away from exports and investment toward private consumer demand. Not only will that assure a more sustainable outcome for Chinese economic development, but also it would be a major contribution to a more stable globalization. I am confident that China will rise to the occasion, and there are encouraging signs that such a rebalancing is now under way. In the end, China has no other choice ¡ª nor does the rest of the world.

Overheated Investment

China is intrinsically a high-investment economy. Its development focus on industrialization, urbanization, and infrastructure provides a solid rationale for a sharply elevated investment share of Chinese GDP. But China has gone too far. The legacy effects of directed lending by a highly fragmented banking system, in conjunction with state ownership that still controls at least 35% of the economy, has inhibited the development of a market-based system of capital allocation. The lack of capital market development ( especially the corporate bond market ) has compounded the problem. The result is an undisciplined investment process, which could lead to a serious misallocation of capital, to say nothing of massive overhangs of excess capacity ---- an inherently deflationary endgame. In 2005, fixed asset investment hit 45% of Chinese GDP and could rise to nearly 50% this year. Quite simply, ratios such as these are unheard of in the modern annals of economic development. A comparison with the post-World War II Japanese experience is instructive. The Japanese economy, of course, had been devastated by the conflict and faced massive rebuilding. During the 1960s (the height of Japan’s reconstruction era ) Japan recorded Chinese-style growth rates of around 11%. At no time during that period, however, did its investment share of GDP climb above 34% ---- far short of China’s current ratio (see Exhibit 2 on the following page). That raises a compelling question about the inherent efficiency of the Chinese investment process: With nearly 50% of its economy growing by nearly 30%, why is Chinese GDP expanding at only a 10% annual rate?

The Chinese leadership understands this problem and is making a determined effort to cool off an overheated investment sector. Given the fragmentation of a liquidity-swollen banking system, this is not a task that should fall on the shoulders of the central bank. Indeed, while the People’s Bank of China has raised its policy rate twice this year and increased bank reserve requirements three times, bank lending remains on a 15% growth path ¡ª well in excess of targeted objectives. The onus for investment controls has, instead, fallen largely to China¡¯s central planners and their reliance on administrative controls that have been imposed on a number of overheated sectors ¡ª namely, aluminum, steel, coal, a variety of building materials, cement, autos, and residential property. In mid-October 2006, Ma Kai, Chairman of the National Development and Reform Commission and China’s lead central planner, complained that these administrative measures haven¡¯t been nearly as effective as he had hoped. He noted that through September, fully 50% of the new investments in coking have violated the government’s recently announced edicts on overheated projects, while non-compliance ratios were as high as 42% in coal, 35% in cement, 26% in electricity, and 22% in textiles.

The NDRC now appears to be redoubling its efforts at enforcing these administrative edicts. The word appears to have finally gotten through: The pace of directed investment is now slowing. Growth in the urban piece of fixed investment spending fell to a 16.8% y-o-y comparison in October 2006 ---- a dramatic shortfall from the 28% gains of 2005 and the first nine months of 2006. From a pure arithmetic point of view, such a downshift in China’s largest sector has to have major implications for aggregate trends in GDP and overall industrial output. The latest numbers on industrial output lend credence to this view. After peaking at a 19.5% comparison in June 2006, year-over-year growth in Chinese industrial output growth has since slowed to 14.7% by October; such a deceleration is every bit as severe as that which occurred in China¡¯s last cooling-off campaign of 2004 (see Exhibit 3).

The challenge for China will be to stay the course ---- especially by maintaining tight control over investment spending through the implementation and enforcement of administrative edicts. Recent developments in the arena of political control ---- especially the upheaval at the upper echelons of the Shanghai Communist Party ---- underscore important shifts on this front as well. At the same time, China needs to keep pushing ahead on banking and capital markets reforms ---- the only hope to convert the capital allocation process from a policy-directed system to a more rational market-based process.

The Control Problem

We in the West remain biased toward looking at China through a very macro lens ---- focusing on its daunting scale and what that means for us. Ironically, that misses the basic tension that defines Chinese reform and development ---- a tug-of-war between the micro and the macro. Beijing is the center, the personification of the control mechanism that drives China’s macro story. Western impressions of China are formed by pilgrimages of the masses to the power centers of Beijing. It is the Mecca of the China story --- but it is not China. The real China exists at the provincial and local level ---- far removed from the Beijing-centric power network. Even after 28 years of extraordinary reforms, the real China remains very much a micro story ---- often times at odds with the macro story that drives Western perceptions. This is one of those times. China’s image suffers from the ---1.3 billion syndrome---- the daunting math of economic development for 20% of the world’s population. The problem with this perspective is that it portrays China as a monolithic force, driven by the presumption of a relatively seamless transition from a centrally-planned economy to a market-based system. In my view, that is the most important contradiction of the new China. While economic control was close to absolute under the old model of the state-owned economy, that is not the case under the increasingly marketized system. Instead, power has gravitated more to the provincial, city, and village levels, making macro control from Beijing exceedingly difficult (see Exhibit 4). There¡¯s nothing new, of course, about this phenomenon. There are over 5000 years of history behind the fragmentation of governance in the Middle Kingdom. But what is new is the juxtaposition between China’s persistent fragmentation and an increasingly market-based system -- a dissonance that adds considerable complexity to our understanding of recent and prospective trends in the Chinese economy.

The most visible manifestation of this fragmentation shows up in China’s runaway investment boom and the difficulty the government has in controlling it. As noted above, investment activity is driven very much at the local level, funded by a still highly-fragmented Chinese banking system. Fixated on social stability and the job creation underpinnings of such an objective, local communist party officials, through their influence on local bank branches, often have more to say about investment project approval than company management teams or credit officers in head offices of the big banks in Beijing. The impact of local banks also dwarfs the role of regulators and central bankers. The implications of this ¡°fragmentation effect--- are not lost on China’s senior policy officials. It undermines policy traction at the macro level and raises the risk of a boom-bust outcome for the investment cycle if Chinese officials were to go too far in their tightening efforts. The relatively modest firming of macro policy in the current tightening cycle reflects just such a concern, in my view. That tells me that this year¡¯s cooling off campaign may have considerably further to go. What I find particularly interesting is that Chinese municipalities are now taking it on themselves to issue regulations to cool off their overheated property markets. In other words, it¡¯s not enough for Beijing to send the message. It falls to local authorities to get the job done. Recently, Shenzhen took the lead in that regard, with a 22 June 2006 announcement of ten detailed tightening actions coming some three weeks after Beijing’s national administrative edicts. According to press accounts, while there was little response to the initial broad-based pronouncement, the Shenzhen residential property market came to a virtual standstill in response to the local actions. This is an important example of the tension between relatively impotent national tightening measures and the traction that can be achieved through local actions. The resolution of this contradiction is critical for the sustainability of Chinese economic development and reform. Fragmentation and concomitant disparities within the economy and its social structure remain salient and potentially destabilizing features of the Chinese growth experience.

China, as a whole, may average out to a 10% growth rate in any given year, but the dispersion across the nation is extraordinarily wide --- with clusters of hyper-growth at close to 20% surrounded by rural areas where growth remains relatively stagnant. Along with this dispersion in real economic activity comes an equally fragmented banking system, dominated by largely autonomous local branches. This seriously compromises the transmission of shifts in monetary policy to the real economy. If the central bank attempts to restrict bank lending by raising interest rates and reserve requirements -- as is the case at present ¡ª under the best of circumstances, a fragmented banking system can be expected to respond very unevenly. In fact, it may well take more monetary tightening to accomplish a given policy objective in a fragmented banking system than would be the case if the system was tied more closely together. Banking reform is critical to resolving this dilemma. The public listing of state-owned banks should eventually force a shift from locally-driven ¡°policy loans¡± to commercially viable credit lines. Only then can monetary policy levers be expected to have a meaningful impact on tempering the excesses of the aggregate investment cycle.

Export Perils

At the same time, China cannot afford to operate in a vacuum and allow its exports to keep surging at a 30% annual rate. This is a guaranteed recipe for trade frictions and protectionism. Protectionist pressures arising in the United States are as serious a problem as I have seen in all my years in this business. It is especially telling that they are occurring in the context of an historically low unemployment rate. These pressures are unlikely to vanish into thin air now that America¡¯s mid-term elections have come and gone. By our count, fully 27 separate pieces of anti-China trade legislation have been introduced in the US Congress since the beginning of 2005 (see Exhibit 5). Most of these bills have broad bipartisan sponsorship and are an outgrowth of the perceived plight of the American worker in this new and fast-moving era of globalization ¡ª underscored by subpar job creation and relatively stagnant real wages. With fully 25% of America¡¯s massive trade deficit traceable to the bilateral imbalance with China, Washington is convinced it has an ironclad case to hold the Chinese accountable for all that ails the American worker. Never mind that 63% of China¡¯s six-fold increase in exports over the past decade is traceable to ¡°foreign-invested enterprises¡± ¡ª in effect, Chinese subsidiaries of global multinationals and joint ventures. Never mind also that China is more of an assembly line than a factory in driving the global trade dynamic. Indeed, research by Stanford Professor Laurence Lau has shown that the domestic value-added content of Chinese exports going to the US may be no higher than 20% ¡ª with the rest coming largely from other Asian suppliers (see Lau¡¯s testimony before the US Congressional Executive Commission on China, ¡°Is China Playing by the Rules?¡± September 2003). Never mind that if Washington were to shut down trade with China completely, a saving-short US would have to source its deficit elsewhere ¡ª most likely with a higher-cost producer that would impose the functional equivalent of a tax hike on American consumers. And under those latter circumstances, of course, Washington may then find itself facing a very different attitude from its Chinese lenders. Grounded in the fuzzy logic of the blame game, Washington¡¯s scapegoating of China is a powerful source of geopolitical instability that poses a serious threat to globalization.

The global labor arbitrage is the main mechanism by which macro tensions between China and the US are transmitted into the political arena. By our calculations, in 2004, average hourly compensation in Chinese manufacturing stood at only 3% of comparable pay rates in the US. And that¡¯s after allowing for double-digit manufacturing wage inflation in China of about 12% per annum since 1999 (see Exhibit 6). It¡¯s not just that a saving-short America is sourcing an increasing portion of demand from a low-wage Chinese economy. It¡¯s that US real wages have been nearly stagnant for almost a decade ¡ª rising at slightly less than a 1% average annual rate since 1995. Near-stagnation in real wages is an especially bitter pill to swallow in that it has occurred in the context of around 3% productivity growth over the same period. The global labor arbitrage now appears to be operating mainly through the price channel (real wages) rather than through the quantity channel (hiring) ¡ª an outcome that tempers concerns over job security but heightens the angst over income insecurity. And that¡¯s where Washington¡¯s increasingly populist politicians enter the fray ¡ª pinning the blame on China as the culprit behind the squeeze on middle-class real incomes.

All this underscores the distinct possibility that the so-called ¡°win-win¡± theories of globalization are in real trouble. This basic conclusion of Ricardian comparative advantage holds that trade liberalization not only brings poor workers from the developing world into the global economic equation (win #1), but workers in the developed world then benefit by buying low-cost, high-quality goods from the developing world (win #2). However, this theory is now breaking down because of a new disruptive technology ¡ª in this case, the Internet ¡ª that has dramatically accelerated both the speed and scope of worker displacement in the developed world. It used to be that such workers would eventually ¡ª with considerable dislocational distress, to be sure ¡ª seek and secure refuge in the non-tradable segment of their economies. The shocker is that the sense of security in services has effectively broken down.

In recent years, IT-enabled connectivity has quickly migrated up the knowledge worker occupational hierarchy into once-nontradable services, denying displaced workers in the developed world the comfort (i.e., sustainable labor income generation) of enjoying the benefits of the second win of globalization. The all-powerful export dynamic is a critical aspect of the Chinese macro conundrum. Chinese exports were still surging at a 29.6% y-o-y rate in October 2006, while the export-oriented piece of industrial output was running at a 22.2% y-o-y comparison. As stressed above, Chinese exports are the lightning rod in the US protectionist debate and are also key in driving the massive and potentially destabilizing build-up of China¡¯s trade surplus and foreign exchange reserves. China knows full well that it cannot sustain 30% growth in exports ¡ª not just for economic reasons but also because of geopolitical considerations.

Recently, China moved to increase taxes on selected commodity exports ¡ª namely, alumina, copper, coal, and steel. But it is clearly wary of leaning too hard on this key sector. If US consumer demand falters ¡ª a distinct possibility in America¡¯s post-housing bubble climate, in my view ¡ª the Chinese leadership does not want to have erred on the side of compounding the problem through the use of domestic policies that might reinforce an externally-driven adjustment. The same reasoning applies to the currency issue and to China¡¯s reluctance to be too aggressive in pushing for RMB appreciation. But one thing is absolutely certain, in my view: Whether the impetus comes from within or from external pressures, the days of open-ended Chinese export growth must come to an end ¡ª and the sooner, the better.

A Pro-Consumer Growth Model

With investment and exports likely to remain under pressure in the years ahead, that puts the onus for sustained economic growth increasingly on the Chinese consumer ¡ª by far, the nation¡¯s most untapped source of economic growth (see Exhibit 7). Unlike the resource mobilization strategies that have driven investment and exports, the mystique of a consumer culture may be considerably harder to crack. China has long been the land of many consumers. Most of them are still very poor and lacking in the modern-day trappings of life. But a consumer-led mindset is definitely emerging in urban China. The key is to sustain this progress by broadening the base of Chinese household spending. With Chinese policy makers now moving to shift the mix of economic growth away from exports and investment to private consumption, the stakes of this transition are enormous ¡ª for China and the broader global economy.

Unfortunately, we don¡¯t know much about the Chinese consumer. Neither does China. The data are sketchy and there is little in the way of a meaningful history of modern-day consumption trends in the world¡¯s most populous nation. In an effort to dig deeper into this issue, I recently stumbled across an article in the Harvard Business Review that was based on a Gallup Poll of China¡¯s consumers (see W. McEwen, X. Fang, C. Zhang, and R. Burkholder, ¡°Inside the Mind of the Chinese Consumer,¡± March 2006). At first, I thought the very concept of a survey in a nation of 1.3 billion people was unfathomable. But the Gallup Organization has convinced me that they are doing a very careful job in sampling many of the most important behavioral characteristics of the Chinese consumer.

It turns out that they have been conducting comprehensive surveys of Chinese consumer attitudes since 1994. The latest poll is based on about 3,600 interviews with urban and rural respondents from around the country, selected on the basis of what Gallup calls a ¡°rigorous probability-proportional-to-size sampling design.¡± I found the results fascinating. They go a long way in adding granularity to the saga of the Chinese consumer, but they also shed considerable light on some of the nation¡¯s most important macro anomalies. The results of the Gallup Poll underscore the well-known bifurcated state of the Chinese consumer ¡ª namely, the extraordinary contrasts between those living in urban and rural locations. The income gap is especially striking ¡ª with urban income per household of about $2,950 in 2004 running three times that of rural households at $990.

What surprised me, however, was the answer to Gallup¡¯s query to Chinese households on what they felt they needed in order to ¡°get by.¡± Urban workers put the average cost of living about 10% above annual income. For rural locations, the spread of costs over household income was about 17% ¡ª underscoring the considerably greater strains on lifestyles for the 57% of the Chinese population (or some 750 million people) still residing in the countryside. Interestingly enough, these results fit quite well with the answer to a related Gallup query on personal saving. Family dissatisfaction is mounting over the amount they are able to set aside each year. In 2004, fully 68% of all Chinese in the Gallup sample were dissatisfied with their ability to save ¡ª a meaningful deterioration from the 61% reading in 1997 (see Exhibit 8).

On the surface, this may seem like a very puzzling result. China¡¯s national saving rate is close to 50% and its household sector saves about 30% out of current income. On this basis, China has, by far, the highest saving propensity of any major economy in the world. Yet the Gallup Poll shows Chinese consumers are overwhelmingly dissatisfied with their saving positions. The explanation for this apparent contradiction gets right to the heart of one of China¡¯s most vexing problems: The transition from a state-owned to a market-supported economy has led to a wholesale dismantling of the cradle-to-grave socialist support system that offered wages, shelter, medical care, education, and even food allowances for most workers.

With headcount reductions in state-owned enterprises exceeding 60 million workers since 1997 alone, job and income insecurity has become deeply embedded in the Chinese psyche as reforms continue apace. The fear of being next in the layoff queue, in conjunction with the lack of a safety net, has provided a powerful incentive for what economists call ¡°precautionary¡± saving. Until China makes meaningful progress in establishing a safety net and in uncovering new sources of job creation, I suspect dissatisfaction over saving will remain unusually high. That, alone, makes it very difficult for China to shift to a consumer-led growth model. The good news is that China¡¯s senior leadership gets it ¡ª and is now in the process of removing many of these impediments to consumer-led growth. The newly-enacted 11th Five-Year Plan places major emphasis on the expansion of China¡¯s social security system as the pillar to a new social safety net. It also provides special income support to rural areas, long the weakest link in the Chinese consumption chain. And the new plan directs support to the nation¡¯s relatively undeveloped services sector, recognizing that the intrinsic labor-intensity of services offers great potential for a new and powerful source of job creation. Only by reducing the excesses of precautionary saving can China¡¯s consumer culture truly flourish. Once that occurs, there is nothing but upside. Chinese consumption currently mmakes up less than 40% of its GDP, well below the 65% norm of most major economies. Putting it another way, 20% of the world¡¯s population accounts for only about 3% of total global consumption (see Exhibit 9). The potential for the Chinese consumer could well be one of the greatest opportunities for the global economy in the 21st century.

But that begs the biggest question of all: Can China pull it off? For generations, the world has been regaled with tales of China being the greatest consumption story in history. The math of large numbers has always been the most tantalizing aspect of the Chinese consumption story. Consider the upside if 1.3 billion people start to buy more of literally anything! To date, modern China hasn¡¯t delivered on the consumption story for good reason: The past 28 years have been dominated by an historic transition from a state-owned to a private system. As noted above, with that transition has come massive headcount reductions in state-owned enterprises that have taken a devastating toll on consumer confidence. In that critical respect, Chinese reforms have an intrinsic anti-consumption bias. The lack of a safety net and an undeveloped services sector have only exacerbated that bias. The 11th Five-Year Plan attempts to meet these challenges head-on.

The longer-term case for the Chinese consumer has never looked better. The biggest risk in all this is time ¡ª that the emergence of the Chinese consumer unfolds very, very slowly. The reason: Generational inertia could maake this a long uphill climb.Today¡¯s Chinese adults have been subjected to the life-changing shock of state-owned enterprise reform. The State that once provided the ultimate security of the ¡°iron rice bowl¡± is no longer the backstop of income and lifestyle support. It is quite possible that workers who have lived through this wrenching transition may never have the confidence to reduce precautionary saving. It¡¯s very similar to the mindset of a generation of Americans who never again bought stock after having lived through the Great Depression. Instead, it may take a new generation of Chinese consumers ¡ª lacking the painful memories of reforms ¡ª to lead the way. I am very optimistic on the prospects for the coming rebalancing of the Chinese economy and the opportunities that offers for China¡¯s consumption dynamic. But it may take a good deal longer than I suspect or than China would like. External Implications:

Commodities and Pan-Asian Trade

As China transitions from an investment- and export-led growth dynamic to a more balanced model reflecting a greater impetus from private consumption, its overall growth rate should slow. In large part, that¡¯s because for any economy consumer demand is intrinsically a much slower growing sector than investment and exports. It¡¯s also likely in this case because the pressures to cool off investment spending and exports are more immediate, while the consumer dynamic is likely to kick in with a considerable lag.

There are two external implications of this likely slowdown in the pace of Chinese GDP growth ¡ª the first being a marked downshift in global commodity demand. No economy has been more important than China in driving global commodity demand in recent years. Many believe this trend will continue indefinitely. But the Chinese leadership has reached a very different conclusion ¡ª that this seemingly insatiable demand for industrial materials is not affordable.

As such, it is now making a determined effort to shift to more of a ¡°commodity-lite¡± growth model. This could have a dramatic impact on the character of Chinese growth ¡ª with important implications for financial markets and the broader global economy. There was a major breakthrough in China¡¯s impact in shaping global commodity demand during the past three years. Not only did it emerge as the world¡¯s largest consumer of copper, nickel, and zinc, but China¡¯s commodity ¡°delta¡± ¡ª the growth of its consumption of industrial materials relative to gains elsewhere in the world ¡ª literally went off the charts. According to IMF estimates, over the 2002-05 period, China accounted for 48% of the total global growth in aluminum consumption, 51% of global growth in copper consumption, 110% of global growth in lead consumption, 87% of global growth in nickel consumption, 54% of global growth in steel, 86% of global growth in tin, an astonishing 113% of growth in world zinc consumption, and fully 30% of the total growth in world oil demand (see Exhibit 10). That¡¯s right ¡ª for lead and zinc, China¡¯s growth in domestic consumption in 2002-05 stood in sharp contrast to outright declines in consumption patterns elsewhere in the world. For a Chinese economy that accounts for only about 5% of world GDP (current dollars at market exchange rates), the impacts of China¡¯s outsize commodity delta are nothing short of staggering.

At work is a ¡°commodity-heavy¡± model of industrial-production-led growth in the Chinese economy. Driven largely by fixed investment and exports, the commodity content of Chinese GDP is much higher than would be the case in a more balanced economy. As noted above, surging growth in investment and exports has been complemented by an unrelenting push toward urbanization, infrastructure, and industrialization. These are all construction-related activities that have intrinsically high industrial materials content. The residential property boom in coastal China rounds out the picture of this nation¡¯s explosive growth in materials consumption. There is an especially tight link between homebuilding and copper. In the US, for example, the Copper Development Association estimates that 46% of total copper usage is earmarked for building construction ¡ª with about two-thirds of that total going to the homebuilding sector; the CDA estimates that the average single-family home in the US contains 440 pounds of copper. While we do not have comparable numbers for China, there is good reason to believe that the copper intensity of its building boom is every bit as great ¡ª if not greater ¡ª than that in the US.

There are two ways to look at the China commodity play: On the one hand, if China stays its present course, this commodity-heavy development model will continue to put extraordinary pressure on the supply-demand balance for a broad array of economically-sensitive industrial materials. Undoubtedly, commodity prices would continue to soar in that scenario. Conversely, China could opt to change the mix of its growth model ¡ª in part, because its commodity-intensive strain of economic growth is now having such a major impact on the prices of industrial materials that the costs of staying this course have become prohibitively expensive. In the context of this year¡¯s stunning Chinese growth surge, market participants have endorsed the former scenario; the near-parabolic increases evident in a broad array of base metals in the early months of 2006 reflected a belief that China would remain locked into a commodity-heavy growth formula. Interestingly enough, the Chinese leadership is sending a very different message. Its newly enacted 11th Five-Year Plan is framed around a rebalancing of the Chinese economy that should result in more of a commodity-lite growth model.

There are two major implications of this development insofar as China¡¯s commodity demand is concerned: One, as noted above, China¡¯s overall GDP growth rate should slow and the mix of its growth should shift away from commodity-intensive activities such as investment and exports. Largely as a result of this shifting mix, the 11th Five-Year Plan calls for a downshift of overall growth in Chinese GDP to a 7.5% average pace in the five years ending 2010 ¡ª still a vigorous gain by the standards of most economies but a marked slowdown from the 10% average growth trajectory of the past 15 years. Such a slowdown in overall economic growth, in conjunction with an important shift in the mix of that growth, underscores the distinct likelihood of a reduction in the growth of China¡¯s demand for industrial materials in the years immediately ahead.

A second factor likely to be at work is commodity conservation ¡ª in effect, retrofitting China¡¯s commodity-guzzling production platform with more commodity-efficient technologies. Oil has been singled out for special attention in this regard. China¡¯s latest economic plan contains an explicit target of reducing the energy content of Chinese GDP by 4% per year through 2010 ¡ª or fully 20% over the five-year planning horizon. For a nation that currently consumes twice as much oil per unit of GDP as the rest of the world, this goal appears eminently achievable. The Chinese do not have to reinvent the wheel in terms of developing alternative energy technologies. Instead, ¡°all¡± China needs to do is to begin replacing its existing production technologies with energy-efficient alternatives already in place elsewhere in the world. This is hardly a costless endeavor, but for a nation with the highest saving rate in the world and the largest reservoir of foreign exchange reserves, China can certainly afford to earmark a small portion of those funds toward oil conservation efforts.

Moreover, the Chinese leadership has expressed a strong desire to go well beyond energy conservation in implementing its commodity-lite growth strategy in the years ahead. In the words of NDRC Chairman Ma Kai, China¡¯s 11th Five-Year Plan also stresses measures aimed at ¡°¡­transforming economic growth from being driven by large amounts of resources consumption to being driven by the improvement of resources utilization efficiency¡± (see his 19 March 2006 speech before the China Development Forum, ¡°The 11th Five-Year Plan: Targets, Paths, and Policy Orientation¡±). This statement is a direct and very candid response to what Chairman Ma admits are a number of disturbing problems that arose during the commodity-heavy experience of the past several years ¡ª namely environmental and ecological degradation, as well as serious resource shortages and bottlenecks (see Exhibit 11). In my view, the implications are unmistakable: One of China¡¯s most powerful economic policymakers is essentially pre-announcing a major shift toward a commodity-lite growth model. Don¡¯t get me wrong: I do not want to take the image of a commodity-lite China too far. China is hardly going to disappear as a major factor influencing global commodity markets. To the contrary ¡ª it is most certainly not going to abandon its push toward the commodity-intensive endeavors of urbanization, industrialization, and expanded infrastructure.

These activities are all essential to Chinese development aspirations. But China has come to the critical realization that it simply cannot afford to stay the current course of commodity-heavy growth. The 11th Five-Year Plan is very careful in stressing that China needs to be far more judicious in managing the quality of its growth dynamic in the years immediately ahead. That means bringing an end to the days of unbalanced, open-ended growth in its industrial economy. More specifically, that implies China¡¯s commodity delta ¡ª emblematic of this nation¡¯s new role as the world¡¯s dominant driver of overall material consumption ¡ª probably hit its limit in 2005 and could well recede significantly in the years ahead.

There is an important second implication of the coming China slowdown ¡ª a likely reduction in the volume of pan-Asian trade. Over the past decade, regional economic integration has increased dramatically in Asia¡¯s major export-oriented trading economies. At the core of this trading platform is an increasingly China-centric Asian supply chain, with especially heavy involvement of Japan, Korea, and Taiwan. As can be seen in Exhibit 12, since the late 1990s, the ups and downs of Chinese imports have played an important role in driving fluctuations in pan-Asian export growth. Consequently, a slower Chinese growth dynamic as an outgrowth of the rebalancing described above is likely to have very important implications for other large economies in Asia ¡ª forcing them to embark on pro-consumption growth strategies of their own.

As China slows to a more sustainable growth rate, the supply-chain repercussions on its major trading partners cannot be minimized.

A Giant Step for Globalization

In 1990, China was the 10th largest economy in the world ¡ª today it is #4. Its four-fold increase in per capita income over the last 15 years is nothing short of astonishing. Notwithstanding this extraordinary performance, the Chinese economy is now at a critical juncture. Continued pursuit of its unbalanced growth model could not only be destabilizing to its own development objectives but could also have the potential to have a destabilizing impact on globalization. At home, China¡¯s open-ended investment boom runs the risk of excess capacity and deflation. Moreover, China¡¯s demand for infrastructure, in conjunction with explosive growth in urbanization and industrialization, fuels a voracious appetite for oil and other industrial materials ¡ª raising its own cost of doing business, to say nothing of the production costs for other commodity users around the world. Overseas, the China impact cuts two ways ¡ª enabling it to provide low-cost, high-quality goods to the rest of the world but also triggering a protectionist backlash. The longer unbalanced Chinese economic growth continues, the greater the chance a virtuous circle could become a vicious one. The coming rebalancing of the Chinese economy is an unambiguously positive development in tempering many of these concerns. As the structure of its economy tilts more toward consumption, its import propensity should rise ¡ª thereby reducing China¡¯s trade surplus and its build-up of foreign exchange reserves. These have become major sources of China¡¯s contribution to ever-mounting global imbalances over the past five years. A successful rebalancing of the Chinese economy could go a long way in alleviating these imbalances and the global tensions they have spawned. A more sustainable globalization would ensue ¡ª a most encouraging macro recipe for an unbalanced world economy.

The all-powerful multi-channel feedback mechanisms of globalization leave China with little choice, in my view. Operating through trade flows, capittal flows, information flows,the global labor arbitrage, and geopolitical pressures, China must take feedback from the rest of the world very seriously. This isn¡¯t easy for any nation. Whether it¡¯s China, the US, Japan, Europe, or even India, thee various constituents of the global village all suffer from ¡°home bias¡± ¡ª in effect, focusing more on their own individual slices of the global pie rather than on the potential for expanding the size of the entire pie.

A parochial perspective on global issues is regrettable but understandable ¡ª especially given the insecurity engendered by the hyper-speed of this IT-enabled globalization. Unlike the globalization of a century ago, which was largely concentrated in tradable manufacturing goods, this globalization involves goods and services, alike ¡ª white-collar knowledge workers as well as blue-collar factory workers. Unlike the earlier globalization, few are spared the pressures and opportunities of the new globalization. Courtesy of the explosive growth in the Internet and its associated breakthroughs in the breadth and depth of cross-border connectivity, coping with the speed dimension of this globalization could be one of the world¡¯s most daunting challenges. As a result, individual nations have a lot on their plate in confronting the pressures of globalization ¡ª making it exceedingly difficult for locally-accountable government officials and policy makers to embrace global considerations. Can an inward-looking world rise to meet this outward-looking challenge? This is a particularly vexing question for China, which has long had a hard time in assessing the ramifications of its stunning development on the rest of the world. Not only does it force China to reassess the mix of its basic sources of economic growth, but it undoubtedly entails a major rethinking of China¡¯s trade, environmental, and foreign policies. On the ever-contentious trade front ¡ª the focal point of concerns from the international community ¡ª China has already taken a huge step by binding itself to the rules-based trading system of the West through WTO accession. As disputes arise ¡ª and they most assuredly will ¡ª both China and its major trading partners share a common mechanism for resolution.

China¡¯s alleged infringement of intellectual property rights ¡ª a major sticking point for knowledge-based economies in the West ¡ª is a matter that can and should be resolved under WTO auspices. At the same, America¡¯s threat to impose tariffs on China over the currency issue does not appear to be a WTO-compliant action ¡ª suggesting that China has solid ground for recourse on this highly contentious issue. The globalization debate is not a one-way street. For its part, the rich countries of the developed world need to take a long and hard look at the role they play in perpetuating the tensions of globalization. America¡¯s extraordinary shortfall of national saving is key in that regard ¡ª it virtually guarantees ever-mounting global imbalances and large-cross-border trade deficits with low-cost, high-quality producers such as China. Similarly, the outreach of multinational corporations seeking offshore efficiency solutions in an increasingly competitive world is key in bringing the Chinese production solution into the equation. As noted above, fully 63% of China¡¯s explosive export growth over the past decade can be traced to its ¡°foreign-invested enterprises¡± ¡ª Chinese subsidiaries of multinational corporations and joint ventures. Should China be blamed for this, or should the West take a long and deep look in the mirror?

It sounds almost trite, but it¡¯s worth stressing yet again: In the end, globalization is all about shared responsibility. In particular, the world needs a much better policy architecture to deal with the stresses and strains of globalization. Developments in the spring of 2006 were actually quite encouraging in that regard: The so-called stewards of globalization ¡ª namely G-7 finance ministers and the IMF ¡ª took the laudable initiative of establishing a new framework to tackle the weighty problems of mounting imbalances head-on. The IMF has already held its first multilateral consultations on this issue ¡ª inviting China and the United States to join with representatives from Europe, Japan, and Saudi Arabia in dealing with the ever-mounting tensions between surplus and deficit nations. This is a very encouraging development for a sustainable globalization ¡ª but, alas, only a first step in that direction. Getting China ¡°right¡± could well be one of the most important steps the world can take in support of globalization. No country has dominated the tectonic shifts in the global economy as China has in recent years. No nation has made such progress in its own development campaign. No country has had a greater impact on the rest of the world. And yet no country has stirred up more angst in the broader global community. The US-Sino relationship could well be a critical test of the collective commitment a sustainable globalization requires ¡ª serving as an important example for the rest of the world in dealing with the mounting backlash against cross-border integration. From America¡¯s point of view, moving beyond the currency issue is absolutely essential. US Treasury Secretary Hank Paulson¡¯s broader ¡°framework approach¡± is encouraging in this regard, especially on the eve of the first semi-annual US-China Strategic Economic Dialogue consultations slated for December 15 in Beijing.

From China¡¯s point of view, owning up to its role in fostering bilateral tensions is equally important ¡ª especially in the areas of intellectual property rights, financial sector reforms, and the imperatives of consumer-led rebalancing. It doesn¡¯t help to frame the globalization debate in terms of ¡°win-win¡± clich¨¦s based on theoretical conjecture over the longer-term benefits of comparative advantage. There are many thorny issues in the here and now that pose major social and political threats to sustainable global growth and stable financial markets. Courtesy of the super-liquidity cycle, the world has been able to sidestep many of these imbalances and tensions over the past few years. As the excesses of the liquidity cycle fade ¡ª a question of when, not if, in my view ¡ª it will be critical for the world to get globalization right. The coming rebalancing of the Chinese economy could well be a giant step in that direction.

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