Why China Must Change

Thomas I. Palley
November 28, 2005

Dr. Thomas Palley was chief economist of the US–China Economic and Security Review Commission. Prior to joining the Commission, he was director of the Open Society Institute’s Globalization Reform Project. He has written for The Atlantic Monthly, American Prospect and The Nation magazines. He can be reached at www.thomaspalley.com.

For the past five years, the global economy has been flying on one engine. That engine is the U.S. consumer who has been on a consumption binge financed by borrowing—in turn backed by a housing price bubble. This situation poses the threat of a serious hard landing when that engine eventually stalls, as it must. Ever-inflating house prices and rising debt-to-income levels are not sustainable. And as the late Herbert Stein, chairman of President Nixon’s Council of Economic Advisers, wryly observed: “If something cannot go on forever, it will stop.”

This view, regarding the global economy’s excessive dependence on the United States and the financial fragility of the U.S. economy, is not just held by progressive economists. It is also shared by Wall Street. Thus, Stephen Roach, chief economist for Morgan Stanley, recently wrote in the Financial Times (Nov. 4, 2005): “there is now about a forty percent probability of a hard landing in the next twelve months.” And in a research brief, Roach singles out China as being particularly dependent on the U.S.: “China’s export prowess is balanced on the head of a pin—a pin made in America. Fully thirty-five percent of Chinese exports go to the United States.”