After 30 years of economic liberalisation and rapid growth, China is now the world's third-largest trading nation and the fourth-largest economy. In a new study for the Carnegie Endowment for International Peace, Albert Keidel, a former US treasury official, predicts that, by 2035, China will be the world's largest economy and, by 2050, will grow to twice the size of the US economy.
In 'China's Economic Rise: Fact and Fiction', Dr Keidel dispels myths about China's rise and presents a strong case for continued growth. He also makes a persuasive case for a policy of engagement and downplays the need for a sharp appreciation of the yuan. He concludes: 'Beijing now seems likely to overcome potential stumbling blocks such as economic instability, pollution, inequality, corruption and a slow pace of political reform' to become the world's largest economy. I generally agree with his analysis, but with several caveats.
First, it's very difficult to predict the path of an economy over the long term, as many unforeseen problems can arise - including policy reversals or natural disasters. What mainly will determine the path of China's development is whether Beijing follows policies that support, rather than destroy, economic freedom.
Second, I think Dr Keidel places too much faith in China's current system of market socialism and its repressed capital markets, arguing that 'China's financial system, rather than a liability, is on the whole a source of confidence in optimistic growth scenarios'. That positive assessment neglects the problem of 'forced saving' and accepts that planners somehow know better than free-market participants how best to allocate capital.
China has generated high savings rates and allocated substantial funds towards infrastructure investment, but investment decisions are often politicised and personal freedom violated in the process of 'development'. China could conserve scarce capital by attracting foreign funds to finance infrastructure. A move towards free capital markets would help China close the gap between domestic saving and investment, and thus help normalise the balance of payments.
It is not in China's interest, as a capital-poor nation, to be a net capital exporter - accumulating US$1.8 trillion of foreign exchange reserves, with a large portion invested in US government debt. Its capital markets cannot be world class until financial repression is abolished and capital freedom - along with widespread private property rights and the rule of law - instituted.