Commentary: Does It Matter If China Catches Up To The U.S.?

History says it won't -- if political stability allows trade to flow freely

The spectacular rise of China -- and to a lesser extent, India -- is one of the great events in economic history. If the current rate of expansion continues, in a mere 10 years China will be the largest economy, followed by the U.S. and India. The last time the world economic order was so dramatically transformed, the U.S. was the muscular newcomer. In 1820 the collection of former British colonies had a significantly smaller economy than any of the leading European countries. In 1913, on the eve of World War I, the U.S. was the clear global leader, with double the output of its nearest rival.

Looking back, the explosive growth of the U.S. carries two lessons for today. First, the rise of a new economic power can help lift the entire global economy. From 1820 to 1913 the average income in Western Europe rose almost as fast as in America. There was an easy flow of goods, capital, and ideas across national borders. Innovations that originated in the U.S., such as the telephone, were quickly picked up on the other side of the Atlantic, while other technologies, such as the internal combustion engine, made their first appearance in Europe and spread back to the U.S. In brief, global trade and technological progress was a win-win proposition, not a zero-sum game.

But post-1913 history yields a second, equally important message: The benefits of trade are vulnerable to political and financial turmoil. Europe and the U.S. could prosper together only as long as the global trade and financial system was humming. First the Continent was devastated by the two world wars. Then high tariffs and national hostility fragmented European markets while impeding the adoption of new U.S. production techniques such as Henry Ford's assembly lines for autos. The result: The U.S. leaped ahead economically. In 1913 per-capita incomes in the U.S. and Britain were roughly equal. By 1950 the U.S. standard of living was almost 40% higher.

Of course there are many differences between the U.S. of the 1800s and China today. For one, China's rise is more spectacular, with per-capita gross domestic product increasing about 8% per year for the past 25 years. By comparison, the strongest average per-capita growth for the U.S. for any 25-year period since 1830 was less than 4% per year. Moreover, China has built its success on its export machine while the U.S. thrived mainly because of its vibrant domestic market.

The past does illuminate what can happen when a new economic superpower enters the scene. From 1820 to 1913, as America rose to economic preeminence, GDP per person rose at an average rate of about 1.5% per year -- enough to quadruple real incomes for the average American. But that didn't come at Europe's expense. Over this stretch GDP per capita in Britain, France, and Germany rose at roughly a 1.1%-to-1.3% annual average pace. That was slower than in the U.S., but it was enough to triple real incomes in those countries.

Part of what fueled these gains was the ability of Europe and the U.S. to feed off each other's technological advances, boosting global growth. The first successful transatlantic telegraph cable laid in 1866 was, for example, a joint venture of U.S. and British investors. The telephone was invented in Boston by Alexander Graham Bell in March, 1876. It was first exhibited in Britain a mere six months later, and the first British phone company was started in 1878. Similarly, Thomas A. Edison opened up the first permanent electric power station in the U.S. in New York in September, 1882. But eight months before that, Edison had started operating an electric power station in London.

So Far So Good

The close links between the U.S. and Europe fostered growth in both regions then, but how is trade affecting the U.S. today? Just as Europe prospered in the 1800s despite the rise of America, the U.S. is faring relatively well now, in a world where manufacturing jobs are moving in droves to China and white-collar jobs are outsourced to India. GDP per person in the U.S., adjusted for inflation, is up 6% since 2000 despite a recession, the terrorist attacks of September 11, 2001, and a massive trade deficit that is subtracted from GDP.

Surprisingly, real wages are up as well, as inexpensive goods from China hold down inflation and help paychecks go further. According to the latest figures from the Bureau of Labor Statistics, real wages of private-sector workers are up 3.3% since 2000. At the high end, real wages rose 5.1% for managers and 3.1% for professionals despite the recession and pressure from information-technology jobs transferring out of the country. At the less-skilled end, over the past four years there has been a 4.1% real wage increase for clerical and administrative support workers, a 3.2% gain for less-skilled blue-collar workers, and a 6.7% jump for traditionally low-paid health-care workers. These are solid improvements, even compared with the boom years of 1996 to 2000, when private-sector wages showed a 5.4% increase.

As for innovation, the U.S. still has a comparative advantage in key areas such as biotechnology and finance. Biotech, which many believe could fuel the next global boom, is still concentrated in the U.S. And the American financial system, far deeper and more robust than its fragile Chinese counterpart, is much better suited to be the global financial hub.

But as history shows, in periods of political, economic, or military turmoil, the free flow of goods, capital, and ideas can get choked off. And some countries feel the pain more than others. Europe found that out during World War I and the Great Depression. While America was developing mass production and a domestic automobile industry, "Europe was distracted by wars and interwar economic chaos," writes economist Robert J. Gordon of Northwestern University. The result: The U.S. grew while Europe stagnated. From 1913 to 1950, U.S. GDP per person rose 1.6% per year -- as fast as in the previous 100 years -- while Europe struggled with a meager 0.8% annual gain.

Similarly, the shift of manufacturing to China would not be a problem under ordinary circumstances. But it does make the U.S. more vulnerable to political and financial shocks to the global trading system in new ways. Those disruptions could be widespread terrorist attacks that disrupt transpacific shipping, a sudden run on the dollar that forces the Chinese central bank to stop buying Treasury bonds, or even the collapse of the Chinese banking system, which is burdened with huge amounts of bad loans. Any of these could reduce the flow of goods from Chinese factories to the U.S.

The bottom line is in many ways a simple one: The ever-strengthening nexus between the U.S. and Chinese economies is a good thing for both countries -- as long as trade is not interrupted. In 1914 European countries simply didn't understand how much their prosperity depended on a stable and open global trading economy. That's a mistake the U.S. cannot afford to make today.

By Michael J. Mandel

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