Thursday, 7 February 2013

More on 1914

Yesterday, I ended by saying that the economic decline Japan and the potential economic decline of China would only lead to an 1914 style military escalation if the two countries try to fix their economic woes by expanding beyond their borders economically or politically. But I don't think this is the case. At least not necessarily. Rather than looking for solutions abroad both countries may be trying to fix their structural economic problems at home. Maybe.

China's economic success (like that of Germany) is based on large export surpluses. See this excellent analysis. But rising wages and international resistance against China's policy to artificially depress the exchange value of its currency will make this model unsustainable. Recent news stories suggest that China--unlike Germany--is preparing for the transition to a different growth model where growth is driven more by domestic demand. In addition to the rising wages, fiscal policy seems to be moving in a more redistributive direction. Taking from the rich and from corporate profits in order to give to lower income groups will result in increased domestic demand for Chinese goods. And it will lessen the pressure to enter into international conflict, political and economic.

China seems to have learned the lessons from Japan's economic decline. But it's less certain that Japan has. In the past Japan's economic success was to a large extent based on successful export industries. While the surpluses lasted the substantial profits of Japan's industry could be invested in these sectors. Today, exports are not as strong anymore and corporate profits remain unspent. As Martin Wolf suggested in yesterday's FT, the only way out of this is to change income distribution: 'The key to a better-balanced economy is taking the vast surplus profits away from a corporate oligopoly that has proved unable to use them. Corporate financial surpluses that end up in vast fiscal liabilities must be trimmed. Let the public enjoy the income, instead.'  China seems to embark on this route but it is not clear whether Japan will. The new prime minister seems to be inclined to use un-orthodox economic policy. But whether he is ready to take on corporate interests or whether he prefers to distract the public by whipping up regional conflict remains to be seen. 

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