While you can’t judge a book by its cover, the artwork adorning David Shambaugh’s “China’s Future” says it all: It transmogrifies the national flag into a giant question mark.
No question matters more to economists, businesspeople or the next U.S. president than where the most populous nation might find itself, say, five years from now. Its answer holds the key to everything from global growth to geopolitics to investment returns to climate change. And Shambaugh’s crack at offering one is anything but comforting.
China probably won’t collapse, the long-time Sinologist concludes. But it’s already ensnared in the dreaded “middle-income trap” President Xi Jinping pledged to avoid. That’s when a developing nation reaches a relatively comfortable per-capita-income level (say, $10,000), but can’t make the great leap forward into the big leagues of wider prosperity. And for Xi’s China, it’s a crisis all its own.
No major economy, Shambaugh argues, has ever escaped from the trap without democratizing. The Communist Party’s legitimacy rests on its ability to generate rapid growth and higher living standards. As incomes rise, 1.4 billion Chinese have fewer incentives to head to Tiananmen Square with protest placards. But 2016 arguably marks an inflection point in China’s development as slowing growth fans grievances, threatens civil unrest and puts greater pressure on Xi’s government to think more of the short-term than the long-term.
How Xi handles the critical juncture at which Beijing finds itself is anyone’s guess. It’s doubtful even China’s strongest leader since Deng Xiaoping — if not Mao Zedong — knows which policy direction Beijing will take over the next year or two. Xi’s team is making it up as it goes along. There are no precedents on which to draw. No top-five economy has ever tried to change growth engines in mid-flight, never mind an opaque one-party system struggling to hide its cracks in a hyperconnected, 24/7-news-cycle world with governments, hedge funds and pundits second-guessing its every move.
Yet if Xi is looking for a model to emulate at this disorienting moment, South Korea could be it.
Amid all the soul searching about South Korea’s own trajectory these days — tepid growth and waning competitiveness — it’s easy to forget how far it’s come. In the early 1960s, per-capita income on the war-ravaged peninsula was in African territory. In 1970, incomes lagged those of Malaysia by about $120 annually. Today, South Korea’s per capita income is about $27,000, more than twice that of Malaysia.
South Korea still has a long way to go, but what did it get right that China hasn’t? From the earliest days of its postwar development, South Korea was determined to build homegrown, globally competitive industries that manufactured their own products under their own brands. While the North veered in the direction of East Germany (and then some), the South went the West German route. Instead of the “Miracle on the Rhine,” Korean dictator Park Chung-hee set the stage for a “Miracle on the Han” by championing a handful of corporate groups with names like Hyundai and Samsung.
Just as China is very big on five-year plans, postwar South Korea also set goals in similar increments. It invested aggressively in education, built social safety nets, increased productivity and reduced official corruption. The Organization for Economic Cooperation and Development has long held South Korea up as “an illustrative example of how Asia’s newly-industrialized countries put in place policies to support diversification and productive upgrading.”
In 2012, the year Xi took the reins in Beijing, OECD economists Anna Jankowska, Arne Nagengast and Jose Ramon Perea argued that “Korea’s capacity to benefit from trade-led growth in high connectivity and value-added sectors relied heavily on implementing the right combination of productive and complimentary policies.
“As Korea moved through its successive five-year plans for economic development beginning in the 1960s, its productive development policies targeted light manufacturing; then heavy chemicals, iron and steel; followed by shipbuilding and heavy machinery; and then electronics and knowledge-intensive industries.
“Throughout these productive phases, Korea aligned complimentary policies to meet particular industry needs.”
South Korea reduced the government’s role in the economy, supported the development of small-and-midsize companies and moved beyond devaluing its way to growth, thus altering incentive dynamics. Banks were empowered to allocate credit more productively, while companies had no choice but to move up the value curve and become more efficient. The real secret to its success, though, was investing in human capital.
It’s something Xi should be studying as growth sputters, incomes stagnate and the foreign companies that once rushed to China eye alternatives. China’s economic hardware — airports, bridges, roads, dams and power grids — is state of the art. Yet the software needed to create new cutting-edge industries, generate tens of millions of new services jobs and move beyond smokestack industries blacking the skies is lacking. A key stumbling block: the giant, politically-coddled state-owned enterprises that tower over the economy and stymie structural reform.
As the middle-income trap ensnares Beijing, the party’s ability to respond is trapped by a number of idiosyncrasies. In a Wall Street Journal op-ed earlier this month, Shambaugh listed five: China’s economic elites have one foot out the door as risks mounts; far from democratization, repression is increasing; political will is weak at all levels of government; corruption remains as rampant as ever throughout society and at all levels; and local officials and state-owned enterprises are blocking reforms at every turn.
Of course, South Korea has its own growing pains. The family-owned conglomerates, or chaebol, that Park championed in the 1960s are still too dominant today. It’s a fascinating historical bookend that his daughter, President Park Geun-hye, is now trying to curb those same giants decades later — and much too slowly for comfort. South Korea’s household debt bubble and high youth unemployment also are reasons for concern. Having beaten the middle-income trap, South Korea is struggling to avoid a higher-income one.
Even so, Xi could do a lot worse than study South Korea’s past successes and current vulnerabilities. Granted, very different scale; China’s population is 28 times South Korea’s. Faced with a lack of precedents, and mounting questions about China’s future, Xi would be wise to learn from South Korea’s journey.
William Pesek, executive editor of Barron’s Asia, is based in Tokyo and writes on Asian economics, markets and politics. www.barronsasia.com
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