tooze crashed ch 10 the wind from the east
Chapter 10
THE WIND FROM THE EAST: CHINA
If the immediate impact of the financial crisis was to impose an uneasy truce on the old battlefields of the European cold war, the shocking realization of 2008 was how far both sides were willing to go. In Moscow, NATO’s heedless attempt at expansion and the clash with Georgia would not be forgotten. Russia had made good on Putin’s announcement at Munich that the unipolar moment was passing. And the Americans knew it was true. But when they thought of multipolarity, they did not think first and foremost of Putin’s ramshackle regime. They thought of China. And so, in fact, did Russia’s own best analysts.1 The possibility of a Sino-American crisis was obvious to both sides. And the unexpected storm in the North Atlantic financial system further heightened tension.2 But Beijing and Washington avoided disaster. Neither side wanted to take the kinds of risks that produced the violent clash in the Caucasus.
In 2008 Chinese opinion was alarmed to discover that their prized portfolio of dollar assets contained not just actual Treasurys but GSE debt, issued to finance the expansion of American mortgage lending. As in Russia, public opinion in China was indignant. Why was poor China financing America’s excess? As a sign of its impatience, Beijing allowed its spokesmen to make dramatic and unusually frank statements. If the United States allowed the GSE to fail it would be a “catastrophe,” China let it be known.3 Toward the end of 2008 the Atlantic magazine garnered an interview with a fast-talking manager of China’s sovereign wealth fund.4 The result was a startling insight into a topsy-turvy world. Over recent months, Gao Xiqing remarked, the world had watched as America, “after months and months of struggling with your own ideology, with your own pride, your self-righteousness,” had finally applied “one of the great gifts of Americans, which is that you’re pragmatic.” The Fed and the Treasury had intervened on a massive scale to stabilize the financial economy, so now, Gao quipped, when the Chinese looked to the United States, what they saw was not capitalist democracy, but “socialism with American characteristics.”
Cutting though it might have been, Gao’s analysis was not Marxist enough. It hadn’t been only ideology and vanity that stood in the way of a solution in September and October 2008. Interests had been at stake. Convening the “executive committee of the bourgeoisie” was never going to be a simple task. But, then, Gao was not a party theorist. He was an alumnus of Duke Law School and sported a CV including time spent working for Richard Nixon’s Wall Street law firm. But with or without the theory, his sense of the shifting balance of power was acute. “This generation of Americans is so used to your supremacy. Your being treated nicely by everyone. It hurts to think, Okay, now we have to be on equal footing to other people. ‘On equal footing’ would necessarily mean that sometimes you have to stoop to appear to be humble to other people. . . . The simple truth today is that your economy is built on the global economy. And it’s built on the support, the gratuitous support, of a lot of countries. So why don’t you come over and . . . I won’t say kowtow [with a laugh], but at least, be nice to the countries that lend you money. Talk to the Chinese! Talk to the Middle Easterners! And pull your troops back!”
As Barack Obama’s stunning election victory demonstrated, many Americans agreed with Gao. And, in fact, the outgoing Bush administration was doing its very best to be “nice.” What the Chinese really wanted was a total government guarantee for Fannie Mae and Freddie Mac debt. That would have had truly dramatic implications for the US government fiscal position, adding more than $5 trillion to the public debt at a stroke. Fannie Mae had been privatized during the Vietnam War for a reason. But in taking the GSE into conservatorship, Treasury Secretary Paulson did the next best thing. Even if it outraged the right wing of the Republican Party, the managerial elite knew that it was essential. Nor was President Bush too proud to phone Beijing to deliver the message personally.5
The Chinese cut back their GSE holdings but they did not offload them like Russia, they merely reduced them to their level in the summer of 2007 before Gao and his colleagues had embarked on their ill-advised program of reserve diversification. Chinese purchases of Treasurys, meanwhile, increased. China’s total holding of US securities continued to rise from $922 billion in June 2007 to $1,464 billion two years later.6 Nor was this surprising. Panic and crisis, turned US Treasurys into the most desirable asset in the world. Everyone wanted safety. Treasury prices were rising, yields soaring, so too was the dollar. If China had wanted to diversify out of its dollar assets, this was the moment to do it. There was insatiable global demand for safe dollar assets. But what the crisis revealed was that China’s options were limited. What other safe assets were there to buy? For China to have bought Japanese bonds would have created an entanglement that was potentially even more explosive. European bond markets weren’t deep enough. China and America were locked together willy-nilly. Their interdependence was structurally conditioned and this went not only for foreign investments, but for trade too.
I
Given the scale of Chinese export success and its accumulation of foreign assets, Western observers are apt to believe that China’s growth must be “export dependent.” But this is an optical illusion that reflects our recalcitrant Western-centric view. Exports are important to China, and its insertion into the world economy has transformed global trade. But even before the crisis China’s domestic economy was large and it was growing extraordinarily rapidly, far more rapidly than China’s markets abroad. China had made itself into an export champion, but in so doing it had also fostered imports—of commodities and components from Australasia, the Middle East, Africa, the rest of Asia and Latin America, as well as technology and advanced machinery from the West. A large part of the value in China’s world-beating exports was accounted for by imported raw materials and subcomponents. As a result, net exports accounted for a smaller share of Chinese GDP growth before 2008 than one might imagine. In fact, no more than one third of China’s growth from 1990 was driven by exports, with two thirds coming from domestic demand.7 This was a very different balance from that of a truly export-dependent economy, of which Germany was the quintessential example. With slow domestic investment and consumption, the vast majority of Germany’s growth after 2000 was accounted for by foreign demand. In China, far and away the main driver of growth was its enormous wave of domestic investment. As China’s cities expanded and its infrastructure modernized at a staggering rate, the physical reconstruction of the country sucked the entire Chinese economy up with it.
By 2008 the immense dynamism of China’s domestic demand and its central position as a regional trading hub in East Asia suggested to some analysts that Asia might be on the point of “decoupling” from America and Europe.8 In the spring of 2008, as the rest of the world slid toward recession, Beijing’s main worry was that China’s economy was expanding too fast. Growth in consumption was roaring along at more than 20 percent per annum. The People’s Bank of China raised interest rates and government fiscal policy was tightened to choke off the boom. Meanwhile, China’s government machine was reorganized to concentrate responsibility for more balanced national growth in centralized superministries.9 What no one reckoned with was the sheer force of the global trade collapse. Whereas in July 2008 Chinese exports were growing by 25 percent, imports by 30 percent and FDI by 65 percent per annum, six months later China’s exports were falling by 18 percent, imports by more than 40 percent and FDI by 30 percent. It was an astonishing switchback. Even if net exports normally accounted for only a third of China’s growth, the impact was severe. In the fall of 2008 South Korean and Taiwanese corporations suddenly began to shutter their Chinese operations.10 At the same time, cash-hungry Western banks such as Bank of America, UBS and RBS sold up and pulled out. But these were pinpricks when compared with the impact of falling export orders on China’s labor market. As the winter of 2008–2009 approached, 30 percent of China’s gigantic annual surge of college graduates—5.6 million per annum—were unable to find work. The reserve army of tens of millions of rural migrants fared even worse. For the Mid-Autumn Festival in October 2008, 70 million returned to their homes in the provinces, of whom only 56 million made the trip back to the cities after the break. Of those, according to World Bank estimates, 11 million were without jobs. Altogether, at least 20 million, and perhaps as many as 36 million, Chinese workers were left idle.11
Ever watchful for signs of domestic social unrest, Beijing knew that it had to react. Already on November 5 the State Council convened an emergency meeting to agree on a 4 trillion yuan ($586 billion) spending program. This amounted to a remarkable 12.5 percent of 2008 GDP. It was supplemental to existing investment plans and was to be disbursed by the end of 2010. It was the first truly large-scale fiscal response to the crisis worldwide. On Sunday, November 9, 2008, as the plan was revealed to the press, the State Council declared: “Over the past two months, the global financial crisis has been intensifying daily. . . . In expanding investment, we must be fast and heavy-handed.”12 And the declaration by the State Council was given additional force by a party instruction, Central Document No. 18, which called for a “package plan to counter the global financial crisis.” The word used to refer to the crisis-fighting measures was the old Mao-era term jihua, or plan, rather than the newfangled word for softer government programs or initiatives, guihua, which had come into widespread currency since 2006.13 Instructions to the press required reporting to “stay upbeat, to avoid panic and contribute to consumer confidence.”14
In November 2008 fiscal policy was pushed in China with the kind of urgency that the West reserved for central bank initiatives and bank bailouts. It was Tim Geithner’s “maximum force” approach but applied to public spending rather than monetary policy. The National Development and Reform Commission, the lead agency for Chinese economic policy, called on local government to “make every second count.” Central Document No. 18 shocked the local party apparatus into action. In the words of a leading American analyst, Document No. 18 “added to the sense of urgency, communicating the sense that it was OK to overturn ordinary obstacles to spending the money.” Over the days that followed, across China, provincial party meetings were hurriedly convened to “seize the favorable opportunity created by expansionary fiscal policy and the ‘appropriately loose’ monetary policy,” as one Shandong committee declared. On the evening of November 11 in Wugong County in Shaanxi Province, a “County Leadership Small Group for Implementing Central Document No. 18” was convened, to make the most of “an extremely rare and precious opportunity.” The aim, the county leadership group declared, was to “concentrate our forces and act quickly, strengthen our links with the provincial and municipal authorities, and make sure that more keypoint investment projects come to our county. . . . Getting more project funding is our top current task.” Within a year this party-led mobilization got 50 percent of China’s stimulus projects under way.
Reconstruction following the terrible Sichuan earthquake of May 2008, which had left more than seventy thousand dead and millions homeless, provided one obvious focus of attention. In the aftermath there had been an upsurge of public criticism and popular activism criticizing the inadequacy of many of China’s public buildings and demanding redress. For the party’s local leaders, crash stimulus spending offered a chance to reassert their authority.15 A wider programmatic frame was provided by the National Development and Reform Commission’s promise of “scientific developmentalism.”16 Funds were to be concentrated in ten sectors, including health care, education (particularly in the relatively deprived and politically contested western regions of China), low-income housing on the edges of China’s gigantic new cities, environmental protection, technological innovation, superhighways, urban electrification, the coal distribution network and railways. The popularly minded leadership team of President Hu Jintao had opened discussions of health-care reform already in 2005 in the wake of the SARS crisis. Something needed to be done about the glaring disparities in health coverage between rural and urban areas.17 After several years of debate, the economic emergency of 2008 swung the decision quite suddenly toward a system centered on central government spending. On April 7, 2009, Beijing announced that health insurance coverage would be extended from 30 to 90 percent of China’s population and that central funds would be allocated to pay for the construction of two thousand county hospitals and five thousand township-level clinical centers. It was the largest expansion in health-care provision in world history to date and it was “inextricably interwoven with the stimulus package.” Beijing was happy to approve spending on hospitals, clinics and public insurance subsidies “because concerns about short-run deficits” had “evaporated. . . . The economic crisis . . . opened a window in which a more aggressive fiscal approach to social policy has become possible.”18
The gigantic surge in stimulus spending also paid for what is perhaps the most spectacular infrastructure project of the last generation anywhere in the world, the construction of China’s high-speed rail network (HSR). In the first phase of Chinese growth, priority had been given to motorization and highway construction. Now rail came to the fore. After “borrowing” technology from the pioneers of HSR—Japan, Germany and France—China embarked on a program that dwarfed all previous efforts. Between 2008 and 2014 the network of rail lines suitable for traffic at speeds of 250 kilometers per hour or more was expanded from 1,000 kilometers to 11,000 kilometers. Journey times from Beijing to Shanghai were cut to 4.5 hours for an 819-mile trip, compared with the 7 hours that the Acela—the pride of America’s Amtrak—takes to cover the 454 miles from Boston to Washington, DC. Not only did China pioneer ultrafast trains capable of cruising at 360 kilometers per hour. The economies of scale opened up by the gigantic construction program also made China into the technological leader in rail-line and viaduct construction.19 Gigantic snail-like machines would lay the track in a continuous length, mile after mile, across endless arrays of standardized, prefabricated concrete pillars. According to World Bank estimates, even allowing for lower labor and land costs, China’s costs of construction were a fraction of those in Europe and North America.
Following the spectacular 2008 Olympics, the promptness and scale of China’s fiscal stimulus was further proof of the mobilizing capacity of the Communist regime. Compared with the sluggishness of many Western states, it is hard to avoid invidious comparisons. Both as presidential candidate and newly inaugurated president, Barack Obama referred frequently to China’s great strides in infrastructure.20 But this well-deserved credit should not obscure the tensions that lurked beneath the surface. In China the stimulus was deeply controversial. To many observers it seemed that, driven by a crisis in the West, the Chinese economy was being sucked in precisely the wrong direction. Was the stimulus a spectacular demonstration of state power, or further proof of the addiction of the Chinese power elite to an unsustainable growth model?21
II
China’s growth rate was the envy of the world. But at home, given the huge social and environmental costs, reviews were more mixed. The aim of the Hu Jintao leadership when it took office in November 2002 had been to give new priority to consumption and the household standard of living. After a decade of superrapid growth, the Chinese had had enough of heavy industrial development.22 But investment-driven heavy industrial growth is a hard habit to break. Five years later, in March 2007, in a remarkably frank assessment delivered to the National People’s Congress, Premier Wen Jiabao warned that “the biggest problem with China’s economy” was still that growth was “unstable, unbalanced, uncoordinated, and unsustainable.”23 When announcing its stimulus response to the 2008 crisis, Beijing pushed high-tech railways and health care as hard as it did because it wanted to escape associations with clichés of heavy industrial growth. The government was determined to avoid “frivolous or speculative investments.” “There won’t be a penny spent on enlarging mass production, or highly polluting and resource intensive sectors,” Zhang Ping, director of the National Reform and Development Commission, stressed. All its efforts would be directed so as to “target spheres that would promote and consolidate the expansion of consumer credit.”24 In December 2008 the State Council followed the November stimulus announcement with an “Opinion on Stimulating Circulation and Expanding Consumption,” itemizing twenty measures to boost consumption. China’s 220 million rural households were offered state-funded discounts on the purchase of two large household appliances, such as televisions, air conditioners, washing machines and refrigerators.25 As the average rural household earned less than 16,000 renminbi (RMB—though used interchangeably with yuan, RMB refers to the Chinese currency as such, whereas yuan are the units in which sums are measured) in 2008, buying a computer or color TV for 7,000 RMB was a big step. But over a two- to three-year time horizon, the 140 billion RMB promised by Beijing was a powerful inducement.26
The aims of China’s leadership were thus clear. And it is tempting to imagine these priorities being rolled out across the country by an all-powerful one-party state. But in practice, Chinese central government is stretched thinly across the giant bulk and complexity of the world’s most populous nation. Though responsibility for revenue collection falls heavily on central government, government expenditure directly controlled from Beijing has amounted to no more than 4 to 5 percent of GDP since the 1990s, a very small figure by comparison with its American or European counterparts. In China, 80 percent of government spending is done at the regional and local levels, where expenditure has surged between 1994 and 2008 from 8 to 18 percent of GDP, even as China’s national income quintupled.27 The regime thus operates through decentralization and indirect mechanisms, which amplify its power and extend its reach, but also distort and distend Beijing’s intentions.
Of the 4 trillion yuan stimulus announced by the center in November 2008, only 1.18 trillion yuan would be delivered directly from central funds. The rest were to come from local government, a ratio of 1:3, corresponding roughly to the general balance between central and local expenditure. It was the decentralized nature of the state apparatus that made the mobilization of the Communist Party and its nationwide apparatus so vital. Central Document No. 18 energized the networks that linked the Communist Party, local government and business interests. It was precisely this nexus that over the last generation had combined to supercharge China’s spectacular economic growth. But it was that same combination that also went a long way to explaining the lopsided character of China’s growth. To meet a central target or quota, there was always some regional highway connection, housing complex, bridge or industrial park to be built and profits to be made doing so. When the stimulus was launched it was precisely this chain reaction that worried those who advocated a more balanced model of growth. The centrally ordained stimulus would unleash the bulldozers of the infrastructure machine. The results confirmed the critics’ worst fears. In Hubei province, with a population of 57 million and a regional GDP of $225 billion in 2009, there were projects under construction by 2010 notionally costed at $363 billion.28 A further $390 billion and $450 billion were planned for 2011 and 2012. Taken at face value, this meant that a single Chinese province with a population the size of the UK and a GDP the size of Greece was engaging in a program of investment larger than any stimulus ever attempted in the United States. Across China, within a month of the State Council’s November initiative, eighteen provinces had proposed projects with a total budget of 25 trillion RMB, six times greater than the original proposed stimulus, accounting for more than 80 percent of Chinese GDP.29 Not only was this proposed spending gargantuan, but within the corporate sector, it was the State Owned Enterprises (SOE) that took charge. Since the 1990s the thrust of central policy had been to shed labor and to streamline these vehicles of Communist economic development policy.30 Now, under the sign of the stimulus, the SOEs lurched once more to the forefront of Chinese growth.
China’s Credit Stimulus, 2007-2013 (year-on-year growth rate)
Source: Yukon Huang and Canyon Bosler, “China’s Debt Dilemma,” 2014, figure 1, http://carnegieendowment.org/2014/09/18/china-s-debt-dilemma-deleveraging-while-generating-growth-pub-56579. Data: UBS.
Clearly the impetus for spending was massive. But from an economic point of view the vital question was how it was to be financed. This is the key question in any fiscal policy “stimulus.” If spending is paid for by tax increases, this negates any increase in purchasing power. Borrowing by issuing bonds will soak up private savings, which may divert the portfolios of private wealth holders away from other investments. Credit creation is the one surefire way to fund stimulus spending if the aim is immediately to revive an underemployed economy. Beijing’s stimulus was particularly effective precisely because it combined huge government spending with a spectacular loosening of monetary policy.
In China, not only were many major industrial firms state controlled but the banking sector was under the direct influence of the central bank as well.31 When it wants to control credit, the People’s Bank of China (PBoC) not only sets the interest rates. It set quotas for credit issuance for each of the major banks. To further manipulate the credit flow it can use higher or lower reserve ratios and greater degrees of “sterilization” of its foreign exchange interventions. All of these mechanisms were once commonplace in the West as well, legacies of the World War II era. But from the 1970s onward, direct regulation of bank credit was progressively abandoned in the West. In facing the 2008 crisis these tools of banking control gave Beijing remarkable leverage. In September and November of 2008 the PBoC reversed its tightening of the spring by slashing its interest rate by almost 5 percent. Then it announced that for 2009 it was doubling the banks’ lending target from 4.7 trillion RMB to 10 trillion RMB. Reserve ratios were cut by up to 25 percent for smaller banks. It was, as the PBoC’s Monetary Policy Committee declared in April 2009, an “appropriately loose monetary policy” to sustain the priorities of the stimulus.32
The banks responded. The Bank of China alone wrote 1 trillion yuan of loans in the first half of 2009, with the Agricultural Bank of China, China Construction Bank and the Industrial and Commercial Bank of China not far behind. Together in the first quarter of 2009 credit issuance came to 4.6 trillion yuan, with the top four being responsible for 3.433 trillion yuan. More new credit was issued in three months than the official fiscal stimulus would provide for the next two years. Meanwhile, provincial and city governments were enjoined to work with local banks. The main mechanism for financing their local spending were so-called city investment companies, or local government financing vehicles—the “shock troops of the stimulus.” These SPVs were endowed with parcels of municipal land against which they borrowed to fund development projects.33 Between 2008 and 2010 local government debt would rocket from 1 trillion RMB ($146 billion) to an estimated 10 trillion RMB ($1.7 trillion).34
At the height of the stimulus drive, in the first half of 2009, 7.37 trillion RMB were issued in new loans. This was a 50 percent increase on the year before, which had also been a year of booming economic activity. By the end of the year the total volume of lending hit 9.6 trillion yuan.35 If we add the government deficit at all levels to the growth in bank credit beyond the 15 percent per annum expansion that had been the norm in China over the previous years, we get a measure of the true scale of China’s stimulus. In 2009 its dimensions were extraordinary—950 billion yuan in deficit, 467 billion in additional bond finance and 5 trillion in bank loans beyond the previous growth norm, for a total stimulus of 6,487 billion RMB, or 19.3 percent of GDP.36
Big Bang: China’s Bank Lending and Fiscal Stimulus Programs, 2008–2010
Stimulus (RMB billions)
2008
2009
2010
Fiscal deficit
111
950
650
Net new bank loans
252
5070
1936
Net new bond finance
251
467
-232
Total
614
6487
2354
Stimulus (% GDP)
Fiscal deficit
0.4%
2.8%
1.6%
Net new bank loans
0.8%
15.1%
4.9%
Net new bond finance
0.8%
1.4%
-0.6%
Total
2.0%
19.3%
5.9%
Source: C. Wong, “The Fiscal Stimulus Program and Problems of Macroeconomic Management in China,” (2011), table 4, https://ora.ox.ac.uk/objects/uuid:4b8af91e-89c7-4a25-be7c-2394cd3c4e9b. Data: China Data Online.
This huge additional growth boost was delivered through a variety of channels. But it was state directed from the top down and supplemental to China’s already enormous growth rate. When the entire complex is accounted for, this was an intervention comparable in scale to anything ever undertaken in the Mao era, or under Soviet communism. The Western capitalist economies had witnessed such huge mobilizations only in times of war. The rate of investment in the Chinese economy surged toward 50 percent of GDP, a level rarely, if ever, seen before. It was enough to offset even the worst shock to global trade.37 At 9.1 percent, China’s growth rate in 2009 was barely lower than it had been in 2008 and vastly higher than anywhere else in the world. And given the size to which the Chinese economy had expanded, this was decisive. In 2009, for the first time in the modern era, it was the movement of the Chinese economy that carried the entire world economy. Together with the huge liquidity stimulus delivered by the US Federal Reserve, China’s combined fiscal and financial stimulus was the main force counteracting the global crisis. Though they were not coordinated policies, they made real the vision of a G2: China and America leading the world.
Drivers of World Growth (in percentage points)
Source: S. Barnett, “China: Size Matters,” IMF (blog), https://blogs.imf.org/2014/03/26/china-size-matters/.
III
Given the geopolitical conclusions that are apt to be drawn from China’s “overtaking” of the United States, it is worth noting that the 2008 mobilization was not part of any master plan. It was a hyperactive response to an unforeseen emergency that struck China from the outside. The origin of that negative shock was in the West. It unleashed forces within China that took its economy in directions that the Beijing leadership had been struggling to counteract and that were widely unpopular in China. And the dramatic impact of the stimulus had consequences that were political and geopolitical as well as economic.
The spectacular state action fit well within popular narratives of China’s rise. As the twenty-first century began Chinese audiences were hooked on a massive diet of TV and film offerings preoccupied with the question of the rise and fall of great powers.38 On the Internet there was a spectacular surge in public discussion of “Chinese greatness” and the “China model.”39 In the wider world, surveys conducted by the authoritative US polling center the Pew Charitable Trusts registered a dramatic shift in popular understanding of the global center of gravity. As the impact of the economic crisis sank in, the number of respondents identifying the United States as the dominant economy in the world began to decline sharply. By 2010 pluralities of respondents in both the United States and Europe would identify China as the “world’s leading economy.”40 In material terms it empowered the Communist Party and the growth coalitions built around it. Because of the decentralized nature of power, those coalitions came in different colorations, ranging from Shanghai’s hypermodernity to the neo-Maoism of Bo Xilai’s “Chongqing Model.” What was striking, however, was that these were overwhelmingly civilian coalitions. Unlike other historical examples of great growth spurts, China’s stimulus was not a military-industrial push.
Unlike subordinate parts of America’s global network, like Japan or Germany, for instance, China had a conventional view of national power. It took for granted that national autonomy implied autonomy in security policy. Given China’s booming economy, spending on defense increased with spending on everything else. Already in 1999 the military-industrial complex had been restructured to increase competition. In 2005–2006 the Chinese military formulated a major technological modernization program.41 But this was merely a recognition of how far China lagged behind. The army was oversized and underpowered in technological terms. A society entering into mass affluence as rapidly as China was doing does not offer a congenial habitat for the underpaid profession of soldiering. Rather than raw recruits, the Chinese military needed technologists, but they were scarce and expensive. China’s military equipment and infrastructure were far behind those of Western militaries and behind the standard set by China’s booming business sector. And though it was increasing rapidly in absolute terms, as a share of GDP, China’s military spending remained flat at 2 percent throughout the crisis—half the level that the United States had sustained since 9/11. As the civilian-centered stimulus program hit in 2008–2009, the share of military expenditure in total public spending halved from 12 to 6 percent.42
These facts were public knowledge, but Washington’s seismograph reacts sensitively to any challenge. When in March 2009 a flotilla of Chinese trawlers harassed an American naval reconnaissance vessel off Hainan island, the incident was promptly declared to be a sign of escalating confrontation.43 The Obama administration’s first encounters with the Chinese were frosty. Treasury Secretary Geithner provoked laughter from nationalist students at Peking University when he declared that American debt was “very safe.”44 As one American analyst remarked, “2009–2010 will be remembered as the years in which China became difficult for the world to deal with.”45 Whether this reflected geopolitical ambition was not yet clear. But as far as strategists in Washington, DC, were concerned, this was incidental.46 It was the economy itself that was decisive. Washington was convinced that China’s military potential would grow with time, as would its ambition. What underpinned both was its spectacular economic growth, and what was decisive was Beijing’s ability to control it. In this sense the financial crisis marked a moment of transition, as much on the Western side as in China itself. Given Beijing’s response to the crisis of 2008, its emergence as a decisive force in world affairs was undeniable. As was the other realization taught by 2008: If China was not export dependent, it was massively interdependent with the West. It had a measure of control but not insulation. Since the early 2000s, Washington’s ambition had been to develop China as a “responsible stakeholder” in the world economy. Now the question was reversed. In the wake of the crisis what Beijing needed to know was what to expect from America. As Gao remarked to the interviewer at the Atlantic: “Why don’t we get together and think about this? If China has $2 trillion [in US assets], Japan has almost $2 trillion, and Russia has some, and all the others, then—let’s throw away the ideological differences and think about what’s good for everyone. We can get all the relevant people together and think up what people are calling a second Bretton Woods system, like the first Bretton Woods convention did.”47
THE WIND FROM THE EAST: CHINA
If the immediate impact of the financial crisis was to impose an uneasy truce on the old battlefields of the European cold war, the shocking realization of 2008 was how far both sides were willing to go. In Moscow, NATO’s heedless attempt at expansion and the clash with Georgia would not be forgotten. Russia had made good on Putin’s announcement at Munich that the unipolar moment was passing. And the Americans knew it was true. But when they thought of multipolarity, they did not think first and foremost of Putin’s ramshackle regime. They thought of China. And so, in fact, did Russia’s own best analysts.1 The possibility of a Sino-American crisis was obvious to both sides. And the unexpected storm in the North Atlantic financial system further heightened tension.2 But Beijing and Washington avoided disaster. Neither side wanted to take the kinds of risks that produced the violent clash in the Caucasus.
In 2008 Chinese opinion was alarmed to discover that their prized portfolio of dollar assets contained not just actual Treasurys but GSE debt, issued to finance the expansion of American mortgage lending. As in Russia, public opinion in China was indignant. Why was poor China financing America’s excess? As a sign of its impatience, Beijing allowed its spokesmen to make dramatic and unusually frank statements. If the United States allowed the GSE to fail it would be a “catastrophe,” China let it be known.3 Toward the end of 2008 the Atlantic magazine garnered an interview with a fast-talking manager of China’s sovereign wealth fund.4 The result was a startling insight into a topsy-turvy world. Over recent months, Gao Xiqing remarked, the world had watched as America, “after months and months of struggling with your own ideology, with your own pride, your self-righteousness,” had finally applied “one of the great gifts of Americans, which is that you’re pragmatic.” The Fed and the Treasury had intervened on a massive scale to stabilize the financial economy, so now, Gao quipped, when the Chinese looked to the United States, what they saw was not capitalist democracy, but “socialism with American characteristics.”
Cutting though it might have been, Gao’s analysis was not Marxist enough. It hadn’t been only ideology and vanity that stood in the way of a solution in September and October 2008. Interests had been at stake. Convening the “executive committee of the bourgeoisie” was never going to be a simple task. But, then, Gao was not a party theorist. He was an alumnus of Duke Law School and sported a CV including time spent working for Richard Nixon’s Wall Street law firm. But with or without the theory, his sense of the shifting balance of power was acute. “This generation of Americans is so used to your supremacy. Your being treated nicely by everyone. It hurts to think, Okay, now we have to be on equal footing to other people. ‘On equal footing’ would necessarily mean that sometimes you have to stoop to appear to be humble to other people. . . . The simple truth today is that your economy is built on the global economy. And it’s built on the support, the gratuitous support, of a lot of countries. So why don’t you come over and . . . I won’t say kowtow [with a laugh], but at least, be nice to the countries that lend you money. Talk to the Chinese! Talk to the Middle Easterners! And pull your troops back!”
As Barack Obama’s stunning election victory demonstrated, many Americans agreed with Gao. And, in fact, the outgoing Bush administration was doing its very best to be “nice.” What the Chinese really wanted was a total government guarantee for Fannie Mae and Freddie Mac debt. That would have had truly dramatic implications for the US government fiscal position, adding more than $5 trillion to the public debt at a stroke. Fannie Mae had been privatized during the Vietnam War for a reason. But in taking the GSE into conservatorship, Treasury Secretary Paulson did the next best thing. Even if it outraged the right wing of the Republican Party, the managerial elite knew that it was essential. Nor was President Bush too proud to phone Beijing to deliver the message personally.5
The Chinese cut back their GSE holdings but they did not offload them like Russia, they merely reduced them to their level in the summer of 2007 before Gao and his colleagues had embarked on their ill-advised program of reserve diversification. Chinese purchases of Treasurys, meanwhile, increased. China’s total holding of US securities continued to rise from $922 billion in June 2007 to $1,464 billion two years later.6 Nor was this surprising. Panic and crisis, turned US Treasurys into the most desirable asset in the world. Everyone wanted safety. Treasury prices were rising, yields soaring, so too was the dollar. If China had wanted to diversify out of its dollar assets, this was the moment to do it. There was insatiable global demand for safe dollar assets. But what the crisis revealed was that China’s options were limited. What other safe assets were there to buy? For China to have bought Japanese bonds would have created an entanglement that was potentially even more explosive. European bond markets weren’t deep enough. China and America were locked together willy-nilly. Their interdependence was structurally conditioned and this went not only for foreign investments, but for trade too.
I
Given the scale of Chinese export success and its accumulation of foreign assets, Western observers are apt to believe that China’s growth must be “export dependent.” But this is an optical illusion that reflects our recalcitrant Western-centric view. Exports are important to China, and its insertion into the world economy has transformed global trade. But even before the crisis China’s domestic economy was large and it was growing extraordinarily rapidly, far more rapidly than China’s markets abroad. China had made itself into an export champion, but in so doing it had also fostered imports—of commodities and components from Australasia, the Middle East, Africa, the rest of Asia and Latin America, as well as technology and advanced machinery from the West. A large part of the value in China’s world-beating exports was accounted for by imported raw materials and subcomponents. As a result, net exports accounted for a smaller share of Chinese GDP growth before 2008 than one might imagine. In fact, no more than one third of China’s growth from 1990 was driven by exports, with two thirds coming from domestic demand.7 This was a very different balance from that of a truly export-dependent economy, of which Germany was the quintessential example. With slow domestic investment and consumption, the vast majority of Germany’s growth after 2000 was accounted for by foreign demand. In China, far and away the main driver of growth was its enormous wave of domestic investment. As China’s cities expanded and its infrastructure modernized at a staggering rate, the physical reconstruction of the country sucked the entire Chinese economy up with it.
By 2008 the immense dynamism of China’s domestic demand and its central position as a regional trading hub in East Asia suggested to some analysts that Asia might be on the point of “decoupling” from America and Europe.8 In the spring of 2008, as the rest of the world slid toward recession, Beijing’s main worry was that China’s economy was expanding too fast. Growth in consumption was roaring along at more than 20 percent per annum. The People’s Bank of China raised interest rates and government fiscal policy was tightened to choke off the boom. Meanwhile, China’s government machine was reorganized to concentrate responsibility for more balanced national growth in centralized superministries.9 What no one reckoned with was the sheer force of the global trade collapse. Whereas in July 2008 Chinese exports were growing by 25 percent, imports by 30 percent and FDI by 65 percent per annum, six months later China’s exports were falling by 18 percent, imports by more than 40 percent and FDI by 30 percent. It was an astonishing switchback. Even if net exports normally accounted for only a third of China’s growth, the impact was severe. In the fall of 2008 South Korean and Taiwanese corporations suddenly began to shutter their Chinese operations.10 At the same time, cash-hungry Western banks such as Bank of America, UBS and RBS sold up and pulled out. But these were pinpricks when compared with the impact of falling export orders on China’s labor market. As the winter of 2008–2009 approached, 30 percent of China’s gigantic annual surge of college graduates—5.6 million per annum—were unable to find work. The reserve army of tens of millions of rural migrants fared even worse. For the Mid-Autumn Festival in October 2008, 70 million returned to their homes in the provinces, of whom only 56 million made the trip back to the cities after the break. Of those, according to World Bank estimates, 11 million were without jobs. Altogether, at least 20 million, and perhaps as many as 36 million, Chinese workers were left idle.11
Ever watchful for signs of domestic social unrest, Beijing knew that it had to react. Already on November 5 the State Council convened an emergency meeting to agree on a 4 trillion yuan ($586 billion) spending program. This amounted to a remarkable 12.5 percent of 2008 GDP. It was supplemental to existing investment plans and was to be disbursed by the end of 2010. It was the first truly large-scale fiscal response to the crisis worldwide. On Sunday, November 9, 2008, as the plan was revealed to the press, the State Council declared: “Over the past two months, the global financial crisis has been intensifying daily. . . . In expanding investment, we must be fast and heavy-handed.”12 And the declaration by the State Council was given additional force by a party instruction, Central Document No. 18, which called for a “package plan to counter the global financial crisis.” The word used to refer to the crisis-fighting measures was the old Mao-era term jihua, or plan, rather than the newfangled word for softer government programs or initiatives, guihua, which had come into widespread currency since 2006.13 Instructions to the press required reporting to “stay upbeat, to avoid panic and contribute to consumer confidence.”14
In November 2008 fiscal policy was pushed in China with the kind of urgency that the West reserved for central bank initiatives and bank bailouts. It was Tim Geithner’s “maximum force” approach but applied to public spending rather than monetary policy. The National Development and Reform Commission, the lead agency for Chinese economic policy, called on local government to “make every second count.” Central Document No. 18 shocked the local party apparatus into action. In the words of a leading American analyst, Document No. 18 “added to the sense of urgency, communicating the sense that it was OK to overturn ordinary obstacles to spending the money.” Over the days that followed, across China, provincial party meetings were hurriedly convened to “seize the favorable opportunity created by expansionary fiscal policy and the ‘appropriately loose’ monetary policy,” as one Shandong committee declared. On the evening of November 11 in Wugong County in Shaanxi Province, a “County Leadership Small Group for Implementing Central Document No. 18” was convened, to make the most of “an extremely rare and precious opportunity.” The aim, the county leadership group declared, was to “concentrate our forces and act quickly, strengthen our links with the provincial and municipal authorities, and make sure that more keypoint investment projects come to our county. . . . Getting more project funding is our top current task.” Within a year this party-led mobilization got 50 percent of China’s stimulus projects under way.
Reconstruction following the terrible Sichuan earthquake of May 2008, which had left more than seventy thousand dead and millions homeless, provided one obvious focus of attention. In the aftermath there had been an upsurge of public criticism and popular activism criticizing the inadequacy of many of China’s public buildings and demanding redress. For the party’s local leaders, crash stimulus spending offered a chance to reassert their authority.15 A wider programmatic frame was provided by the National Development and Reform Commission’s promise of “scientific developmentalism.”16 Funds were to be concentrated in ten sectors, including health care, education (particularly in the relatively deprived and politically contested western regions of China), low-income housing on the edges of China’s gigantic new cities, environmental protection, technological innovation, superhighways, urban electrification, the coal distribution network and railways. The popularly minded leadership team of President Hu Jintao had opened discussions of health-care reform already in 2005 in the wake of the SARS crisis. Something needed to be done about the glaring disparities in health coverage between rural and urban areas.17 After several years of debate, the economic emergency of 2008 swung the decision quite suddenly toward a system centered on central government spending. On April 7, 2009, Beijing announced that health insurance coverage would be extended from 30 to 90 percent of China’s population and that central funds would be allocated to pay for the construction of two thousand county hospitals and five thousand township-level clinical centers. It was the largest expansion in health-care provision in world history to date and it was “inextricably interwoven with the stimulus package.” Beijing was happy to approve spending on hospitals, clinics and public insurance subsidies “because concerns about short-run deficits” had “evaporated. . . . The economic crisis . . . opened a window in which a more aggressive fiscal approach to social policy has become possible.”18
The gigantic surge in stimulus spending also paid for what is perhaps the most spectacular infrastructure project of the last generation anywhere in the world, the construction of China’s high-speed rail network (HSR). In the first phase of Chinese growth, priority had been given to motorization and highway construction. Now rail came to the fore. After “borrowing” technology from the pioneers of HSR—Japan, Germany and France—China embarked on a program that dwarfed all previous efforts. Between 2008 and 2014 the network of rail lines suitable for traffic at speeds of 250 kilometers per hour or more was expanded from 1,000 kilometers to 11,000 kilometers. Journey times from Beijing to Shanghai were cut to 4.5 hours for an 819-mile trip, compared with the 7 hours that the Acela—the pride of America’s Amtrak—takes to cover the 454 miles from Boston to Washington, DC. Not only did China pioneer ultrafast trains capable of cruising at 360 kilometers per hour. The economies of scale opened up by the gigantic construction program also made China into the technological leader in rail-line and viaduct construction.19 Gigantic snail-like machines would lay the track in a continuous length, mile after mile, across endless arrays of standardized, prefabricated concrete pillars. According to World Bank estimates, even allowing for lower labor and land costs, China’s costs of construction were a fraction of those in Europe and North America.
Following the spectacular 2008 Olympics, the promptness and scale of China’s fiscal stimulus was further proof of the mobilizing capacity of the Communist regime. Compared with the sluggishness of many Western states, it is hard to avoid invidious comparisons. Both as presidential candidate and newly inaugurated president, Barack Obama referred frequently to China’s great strides in infrastructure.20 But this well-deserved credit should not obscure the tensions that lurked beneath the surface. In China the stimulus was deeply controversial. To many observers it seemed that, driven by a crisis in the West, the Chinese economy was being sucked in precisely the wrong direction. Was the stimulus a spectacular demonstration of state power, or further proof of the addiction of the Chinese power elite to an unsustainable growth model?21
II
China’s growth rate was the envy of the world. But at home, given the huge social and environmental costs, reviews were more mixed. The aim of the Hu Jintao leadership when it took office in November 2002 had been to give new priority to consumption and the household standard of living. After a decade of superrapid growth, the Chinese had had enough of heavy industrial development.22 But investment-driven heavy industrial growth is a hard habit to break. Five years later, in March 2007, in a remarkably frank assessment delivered to the National People’s Congress, Premier Wen Jiabao warned that “the biggest problem with China’s economy” was still that growth was “unstable, unbalanced, uncoordinated, and unsustainable.”23 When announcing its stimulus response to the 2008 crisis, Beijing pushed high-tech railways and health care as hard as it did because it wanted to escape associations with clichés of heavy industrial growth. The government was determined to avoid “frivolous or speculative investments.” “There won’t be a penny spent on enlarging mass production, or highly polluting and resource intensive sectors,” Zhang Ping, director of the National Reform and Development Commission, stressed. All its efforts would be directed so as to “target spheres that would promote and consolidate the expansion of consumer credit.”24 In December 2008 the State Council followed the November stimulus announcement with an “Opinion on Stimulating Circulation and Expanding Consumption,” itemizing twenty measures to boost consumption. China’s 220 million rural households were offered state-funded discounts on the purchase of two large household appliances, such as televisions, air conditioners, washing machines and refrigerators.25 As the average rural household earned less than 16,000 renminbi (RMB—though used interchangeably with yuan, RMB refers to the Chinese currency as such, whereas yuan are the units in which sums are measured) in 2008, buying a computer or color TV for 7,000 RMB was a big step. But over a two- to three-year time horizon, the 140 billion RMB promised by Beijing was a powerful inducement.26
The aims of China’s leadership were thus clear. And it is tempting to imagine these priorities being rolled out across the country by an all-powerful one-party state. But in practice, Chinese central government is stretched thinly across the giant bulk and complexity of the world’s most populous nation. Though responsibility for revenue collection falls heavily on central government, government expenditure directly controlled from Beijing has amounted to no more than 4 to 5 percent of GDP since the 1990s, a very small figure by comparison with its American or European counterparts. In China, 80 percent of government spending is done at the regional and local levels, where expenditure has surged between 1994 and 2008 from 8 to 18 percent of GDP, even as China’s national income quintupled.27 The regime thus operates through decentralization and indirect mechanisms, which amplify its power and extend its reach, but also distort and distend Beijing’s intentions.
Of the 4 trillion yuan stimulus announced by the center in November 2008, only 1.18 trillion yuan would be delivered directly from central funds. The rest were to come from local government, a ratio of 1:3, corresponding roughly to the general balance between central and local expenditure. It was the decentralized nature of the state apparatus that made the mobilization of the Communist Party and its nationwide apparatus so vital. Central Document No. 18 energized the networks that linked the Communist Party, local government and business interests. It was precisely this nexus that over the last generation had combined to supercharge China’s spectacular economic growth. But it was that same combination that also went a long way to explaining the lopsided character of China’s growth. To meet a central target or quota, there was always some regional highway connection, housing complex, bridge or industrial park to be built and profits to be made doing so. When the stimulus was launched it was precisely this chain reaction that worried those who advocated a more balanced model of growth. The centrally ordained stimulus would unleash the bulldozers of the infrastructure machine. The results confirmed the critics’ worst fears. In Hubei province, with a population of 57 million and a regional GDP of $225 billion in 2009, there were projects under construction by 2010 notionally costed at $363 billion.28 A further $390 billion and $450 billion were planned for 2011 and 2012. Taken at face value, this meant that a single Chinese province with a population the size of the UK and a GDP the size of Greece was engaging in a program of investment larger than any stimulus ever attempted in the United States. Across China, within a month of the State Council’s November initiative, eighteen provinces had proposed projects with a total budget of 25 trillion RMB, six times greater than the original proposed stimulus, accounting for more than 80 percent of Chinese GDP.29 Not only was this proposed spending gargantuan, but within the corporate sector, it was the State Owned Enterprises (SOE) that took charge. Since the 1990s the thrust of central policy had been to shed labor and to streamline these vehicles of Communist economic development policy.30 Now, under the sign of the stimulus, the SOEs lurched once more to the forefront of Chinese growth.
China’s Credit Stimulus, 2007-2013 (year-on-year growth rate)
Source: Yukon Huang and Canyon Bosler, “China’s Debt Dilemma,” 2014, figure 1, http://carnegieendowment.org/2014/09/18/china-s-debt-dilemma-deleveraging-while-generating-growth-pub-56579. Data: UBS.
Clearly the impetus for spending was massive. But from an economic point of view the vital question was how it was to be financed. This is the key question in any fiscal policy “stimulus.” If spending is paid for by tax increases, this negates any increase in purchasing power. Borrowing by issuing bonds will soak up private savings, which may divert the portfolios of private wealth holders away from other investments. Credit creation is the one surefire way to fund stimulus spending if the aim is immediately to revive an underemployed economy. Beijing’s stimulus was particularly effective precisely because it combined huge government spending with a spectacular loosening of monetary policy.
In China, not only were many major industrial firms state controlled but the banking sector was under the direct influence of the central bank as well.31 When it wants to control credit, the People’s Bank of China (PBoC) not only sets the interest rates. It set quotas for credit issuance for each of the major banks. To further manipulate the credit flow it can use higher or lower reserve ratios and greater degrees of “sterilization” of its foreign exchange interventions. All of these mechanisms were once commonplace in the West as well, legacies of the World War II era. But from the 1970s onward, direct regulation of bank credit was progressively abandoned in the West. In facing the 2008 crisis these tools of banking control gave Beijing remarkable leverage. In September and November of 2008 the PBoC reversed its tightening of the spring by slashing its interest rate by almost 5 percent. Then it announced that for 2009 it was doubling the banks’ lending target from 4.7 trillion RMB to 10 trillion RMB. Reserve ratios were cut by up to 25 percent for smaller banks. It was, as the PBoC’s Monetary Policy Committee declared in April 2009, an “appropriately loose monetary policy” to sustain the priorities of the stimulus.32
The banks responded. The Bank of China alone wrote 1 trillion yuan of loans in the first half of 2009, with the Agricultural Bank of China, China Construction Bank and the Industrial and Commercial Bank of China not far behind. Together in the first quarter of 2009 credit issuance came to 4.6 trillion yuan, with the top four being responsible for 3.433 trillion yuan. More new credit was issued in three months than the official fiscal stimulus would provide for the next two years. Meanwhile, provincial and city governments were enjoined to work with local banks. The main mechanism for financing their local spending were so-called city investment companies, or local government financing vehicles—the “shock troops of the stimulus.” These SPVs were endowed with parcels of municipal land against which they borrowed to fund development projects.33 Between 2008 and 2010 local government debt would rocket from 1 trillion RMB ($146 billion) to an estimated 10 trillion RMB ($1.7 trillion).34
At the height of the stimulus drive, in the first half of 2009, 7.37 trillion RMB were issued in new loans. This was a 50 percent increase on the year before, which had also been a year of booming economic activity. By the end of the year the total volume of lending hit 9.6 trillion yuan.35 If we add the government deficit at all levels to the growth in bank credit beyond the 15 percent per annum expansion that had been the norm in China over the previous years, we get a measure of the true scale of China’s stimulus. In 2009 its dimensions were extraordinary—950 billion yuan in deficit, 467 billion in additional bond finance and 5 trillion in bank loans beyond the previous growth norm, for a total stimulus of 6,487 billion RMB, or 19.3 percent of GDP.36
Big Bang: China’s Bank Lending and Fiscal Stimulus Programs, 2008–2010
Stimulus (RMB billions)
2008
2009
2010
Fiscal deficit
111
950
650
Net new bank loans
252
5070
1936
Net new bond finance
251
467
-232
Total
614
6487
2354
Stimulus (% GDP)
Fiscal deficit
0.4%
2.8%
1.6%
Net new bank loans
0.8%
15.1%
4.9%
Net new bond finance
0.8%
1.4%
-0.6%
Total
2.0%
19.3%
5.9%
Source: C. Wong, “The Fiscal Stimulus Program and Problems of Macroeconomic Management in China,” (2011), table 4, https://ora.ox.ac.uk/objects/uuid:4b8af91e-89c7-4a25-be7c-2394cd3c4e9b. Data: China Data Online.
This huge additional growth boost was delivered through a variety of channels. But it was state directed from the top down and supplemental to China’s already enormous growth rate. When the entire complex is accounted for, this was an intervention comparable in scale to anything ever undertaken in the Mao era, or under Soviet communism. The Western capitalist economies had witnessed such huge mobilizations only in times of war. The rate of investment in the Chinese economy surged toward 50 percent of GDP, a level rarely, if ever, seen before. It was enough to offset even the worst shock to global trade.37 At 9.1 percent, China’s growth rate in 2009 was barely lower than it had been in 2008 and vastly higher than anywhere else in the world. And given the size to which the Chinese economy had expanded, this was decisive. In 2009, for the first time in the modern era, it was the movement of the Chinese economy that carried the entire world economy. Together with the huge liquidity stimulus delivered by the US Federal Reserve, China’s combined fiscal and financial stimulus was the main force counteracting the global crisis. Though they were not coordinated policies, they made real the vision of a G2: China and America leading the world.
Drivers of World Growth (in percentage points)
Source: S. Barnett, “China: Size Matters,” IMF (blog), https://blogs.imf.org/2014/03/26/china-size-matters/.
III
Given the geopolitical conclusions that are apt to be drawn from China’s “overtaking” of the United States, it is worth noting that the 2008 mobilization was not part of any master plan. It was a hyperactive response to an unforeseen emergency that struck China from the outside. The origin of that negative shock was in the West. It unleashed forces within China that took its economy in directions that the Beijing leadership had been struggling to counteract and that were widely unpopular in China. And the dramatic impact of the stimulus had consequences that were political and geopolitical as well as economic.
The spectacular state action fit well within popular narratives of China’s rise. As the twenty-first century began Chinese audiences were hooked on a massive diet of TV and film offerings preoccupied with the question of the rise and fall of great powers.38 On the Internet there was a spectacular surge in public discussion of “Chinese greatness” and the “China model.”39 In the wider world, surveys conducted by the authoritative US polling center the Pew Charitable Trusts registered a dramatic shift in popular understanding of the global center of gravity. As the impact of the economic crisis sank in, the number of respondents identifying the United States as the dominant economy in the world began to decline sharply. By 2010 pluralities of respondents in both the United States and Europe would identify China as the “world’s leading economy.”40 In material terms it empowered the Communist Party and the growth coalitions built around it. Because of the decentralized nature of power, those coalitions came in different colorations, ranging from Shanghai’s hypermodernity to the neo-Maoism of Bo Xilai’s “Chongqing Model.” What was striking, however, was that these were overwhelmingly civilian coalitions. Unlike other historical examples of great growth spurts, China’s stimulus was not a military-industrial push.
Unlike subordinate parts of America’s global network, like Japan or Germany, for instance, China had a conventional view of national power. It took for granted that national autonomy implied autonomy in security policy. Given China’s booming economy, spending on defense increased with spending on everything else. Already in 1999 the military-industrial complex had been restructured to increase competition. In 2005–2006 the Chinese military formulated a major technological modernization program.41 But this was merely a recognition of how far China lagged behind. The army was oversized and underpowered in technological terms. A society entering into mass affluence as rapidly as China was doing does not offer a congenial habitat for the underpaid profession of soldiering. Rather than raw recruits, the Chinese military needed technologists, but they were scarce and expensive. China’s military equipment and infrastructure were far behind those of Western militaries and behind the standard set by China’s booming business sector. And though it was increasing rapidly in absolute terms, as a share of GDP, China’s military spending remained flat at 2 percent throughout the crisis—half the level that the United States had sustained since 9/11. As the civilian-centered stimulus program hit in 2008–2009, the share of military expenditure in total public spending halved from 12 to 6 percent.42
These facts were public knowledge, but Washington’s seismograph reacts sensitively to any challenge. When in March 2009 a flotilla of Chinese trawlers harassed an American naval reconnaissance vessel off Hainan island, the incident was promptly declared to be a sign of escalating confrontation.43 The Obama administration’s first encounters with the Chinese were frosty. Treasury Secretary Geithner provoked laughter from nationalist students at Peking University when he declared that American debt was “very safe.”44 As one American analyst remarked, “2009–2010 will be remembered as the years in which China became difficult for the world to deal with.”45 Whether this reflected geopolitical ambition was not yet clear. But as far as strategists in Washington, DC, were concerned, this was incidental.46 It was the economy itself that was decisive. Washington was convinced that China’s military potential would grow with time, as would its ambition. What underpinned both was its spectacular economic growth, and what was decisive was Beijing’s ability to control it. In this sense the financial crisis marked a moment of transition, as much on the Western side as in China itself. Given Beijing’s response to the crisis of 2008, its emergence as a decisive force in world affairs was undeniable. As was the other realization taught by 2008: If China was not export dependent, it was massively interdependent with the West. It had a measure of control but not insulation. Since the early 2000s, Washington’s ambition had been to develop China as a “responsible stakeholder” in the world economy. Now the question was reversed. In the wake of the crisis what Beijing needed to know was what to expect from America. As Gao remarked to the interviewer at the Atlantic: “Why don’t we get together and think about this? If China has $2 trillion [in US assets], Japan has almost $2 trillion, and Russia has some, and all the others, then—let’s throw away the ideological differences and think about what’s good for everyone. We can get all the relevant people together and think up what people are calling a second Bretton Woods system, like the first Bretton Woods convention did.”47
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