What Yuan Can Do

Peterson Institute for International Economics

Pages: 200

$21.95

In a speech delivered last week,US Secretary of State Hillary Clinton observed that “America’s great challenge is not deterring any single military foe,but advancing our global leadership at a time when power is more often measured and exercised in economic terms”. Clinton may well have been reading the new book by Arvind Subramanian. In Eclipse,Subramanian argues that we are witnessing a shift in terms of economic dominance away from the US towards China and that the shift “is more imminent,more broad-based,and greater in magnitude than is currently anticipated or contemplated”.

The stock response to arguments about America’s decline is that similar claims have been made in the past — with reference to Soviet Union,Germany and Japan — and that these have turned out to be drastically wrong. Paul Kennedy’s Rise and Fall of Great Powers,which prophesied the coming decline of the US in 1988,is often presented as exhibit A of this genre. Subramanian,however,shows that China is qualitatively different from previous peer competitors to the US. He carefully constructs a quantitative index of economic dominance that underpins his claim about the economic dominance of China by 2030. He also claims that the renminbi will compete with the dollar for reserve currency status in a decade from now.

The book is conceptually innovative,empirically rich and exceptionally clear. Subramanian also wields a felicitous pen. The book is a great read even for those who might shy away from tables and regressions. But how convincing are his arguments?

There are at least four large problems with his thesis. First,there is a large conceptual problem: What exactly does economic dominance mean? Subramanian approvingly cites Robert Dahl’s definition of power as “the ability to induce another party to do something it would not otherwise do”. Economic dominance,he suggests,is about influence. But in constructing his index of economic dominance,he focuses primarily on resources. Indeed,throughout the book he keeps slipping between economic dominance as influence and resources,in other words as ends and means. However,the mere availability of resources does not automatically translate into influence. Subramanian argues that economic dominance is evident in certain institutions like the IMF,where power in the form of voting rights is based explicitly on economic factors. True enough,but the bulk of the international politics operates outside of such clearly defined institutional structures.

Nor is Subramanian particularly convincing in presenting a historical argument for the operation of economic dominance. The example that he dwells on the most is America’s economic arm-twisting of Britain during the Suez crisis of 1956. Yet his discussion of Suez overlooks the fact that the decision to fall in line with America’s diktats was taken by the British leadership because of their fear that a devaluation of the pound would be politically disastrous for them. Why they thought so remains unclear. After all,many democratically elected governments have survived and even emerged stronger from devaluations. The only two other historical examples of economic dominance he cites are of pre-revolution Cuba and Panama. But both of these were dollar economies and unsurprisingly vulnerable to American economic coercion.

Second,the composition of the index is questionable. Subramanian identifies three determinants of economic dominance: size of economy (measured as GDP),scale of trade and external finance. His discussion of first two is straightforward; although in the case of an economy like China’s it might make more sense to focus on the value-added rather than simply the overall trade figures. On the third,he argues that net creditors (suppliers of money) have power while net debtors are vulnerable. This might seem obviously true,but there are problems. For one thing,being a creditor could make a country dependent on foreign demand. For another,a systemically important importer and debtor like the US actually has considerable influence. As the Wall Street saying goes: if you owe the bank $1 million the bank has you,but if you owe the bank $1 billion you have the bank. Furthermore,it is not clear why Subramanian leaves out technological level as a variable in his index. It could be argued that it is subsumed under economic size. Yet,a large country like China could surpass the US in economic size but still remain well behind in terms of technology.

Third,the claim that the renminbi will soon compete with and even supplant the dollar as reserve currency is overblown. For this to happen,China would need a financial market that is transparent,robust and open. Such a system would deprive the Chinese government of control over the financial system — control that not only shields China from the vagaries of international financial markets but also plays a central role in its present model of economic growth. It is rather unlikely that China can undertake far-reaching financial sector reforms within the period envisaged by Subramanian.

Fourth,the book does not consider the interaction between economic and military power. Subramanian takes the conventional view that the latter flows from the former. But there is more to it. At one level,military power also underpins economic prosperity and power. The Royal Navy was a cause and not simply a consequence of Britain’s rise as the leading economic power. The US’s pattern of global military deployment is geared to upholding its economic interests. At another level,the conversion of economic resources into military power is not a straightforward process. It will be all the more complicated in the case of China,which will be the largest economy in the world by 2030 but still remain a middle-income country. There will be clear limits to the Chinese government’s ability to extract and divert resources to military purposes. Besides,the US has an extraordinary lead in terms of its military resources and technology as well as its flexible system of military alliances.

In short,this excellent book at once overstates the likely extent of China’s economic power and undervalues some of the key sources of America’s global power. Subramanian may not turn out to be as wrong as Paul Kennedy was two decades ago,but his book will deservedly attract as much attention,fame,and notoriety.