China's biggest problem? It's turning into America.
China has problems. Its economy is slowing, its exports are falling, and U.S. dollars are fleeing its shores as its economy and various state-run enterprises pay off enormous amounts of debt overhang. But if you want a pithy, counterintuitive, big-picture phrase to sum up what's going on over there, I'd put it this way: China's problem is it's turning into America.
China remains a very poor country: Its economic output per person is still far, far, far below that of the United States. And despite the slowdown, it's still probably growing considerably faster than the U.S. has in decades. As nations develop and become richer, they go through a shift where their economy moves from being mostly manufacturing and heavy industry to being mostly services. America went through this transition decades ago, but China is still in the midst of it. And it includes a slowdown for the economy: Because you're richer, you have more wealth per person to go around, so growth qua growth becomes less important, and distribution becomes more important.
This gets us to the heart of the matter: China's inequality.
America's Gini index is 41, which is remarkably high for an advanced Western country. China's Gini is higher still, close to 55. And that's after government taxes and transfers are accounted for. The top 20 percent of China's population now claims 47 percent of all income in the country.
This is a problem because of that shift from manufacturing to services. Services are, by their nature, a lot tougher to export than manufactured goods. So if your economy leans on services, that means the demand to feed that supply — lots of everyday consumers with money to spend — has to come mainly from inside your own borders. Inequality undercuts that by making it a lot harder for the majority of the population to provide sufficient demand and consumption.
But Chinese elites are very similar to American elites. They like inequality; it gives them disproportionate wealth and power. Like America, China's government has the policy tools to squash inequality and redistribute money down the income ladder. They just don't want to do it.
What China has done instead is rely on demand from abroad — from consumers with money to burn in other, richer countries, mainly America — to extend their manufacturing economy as much as they can, and they've driven down the value of their own currency to make their exports cheaper. This is where the two countries diverge: Both face a national demand shortfall, but China has dealt with its shortfall by bleeding demand from America and making our shortfall worse. And American elites have been basically fine with this, since they've been getting rich off the newfound opportunities of global free trade.
But now the global economic slowdown means the rest of the world isn't buying Chinese exports at the rate it once was. So China's major industries have been borrowing a ton to prop up production even as global demand slumps, to prevent massive layoffs — and thus political upheaval. The country may have moved away from full-blown communism and into a more mixed economy, but it's still ruled by the Communist Party; many of the party's major players are also heads of major industries, and the central authorities can't always control them. As a result, those regional rulers have tended to run their industries more as political fiefdoms than as market operations seeking financial sustainability. So the debt has just kept piling up.
The final wrinkle is China's geopolitical ambition: It wants to become a major player in the international financial markets, and get the renminbi accepted as an international reserve currency. But this means China is going to have to shape up its behavior in the eyes of international financial authorities.
As Ben Bernanke just laid out in an article at the Brookings Institution, the combination of all these forces has backed China into a tight spot. They're trying to use monetary policy to both prop up internal demand and keep the renminbi at a particular value vis-a-vis other major currencies. But they can't do that while dollars are fleeing the country because of the debt overhang. And they can't impose capital controls to hold onto those dollars, because that wouldn't go over well internationally. Something's got to give.
The escape hatch Bernanke recommends is something he calls "targeted fiscal policy." Sounds technical, but it basically boils down to "make China's welfare state bigger and more generous." China has improved a lot in this regard: It already has a pension system, unemployment insurance, near-universal health insurance, and other income supports. But as those earlier inequality figures show, it's not enough. They need to go bigger. And while other countries like America could pursue public investment and create jobs directly, too much poorly-directed state-run industrial policy has been one of China's big problems. They need to flood their economy with specifically domestic demand, but in a bottom-up way that allows the Chinese markets and the Chinese people to evolve through the manufacturing-to-services shift in their own way.
This probably won't make China grow faster. But it would likely make the slowdown more gradual and more manageable from the standpoint of international finances. It would also allow all the various pieces of China's economy to fit together better.
The final similarity between China and America is that, of course, we've got our own national demand shortfall, and should be doing Bernanke's "targeted fiscal policy" too. (Though we have the freedom to throw in more industrial policy.) That would bring down America's inequality, and repair our chronic failure to produce enough jobs for everyone — a failure that's been exacerbated by China's currency manipulation and our resulting trade deficit.
So what's grown up between China and America in recent decades is a kind of weird symbiosis, with elites in both countries profiting at the expense of workers in both countries. But it looks like the Chinese side of that arrangement may be close to unraveling.