By Simon Johnson
WASHINGTON, DC – According to Voltaire, the Roman Empire fell “because all things fall.” It is hard to argue with this as a general statement about decline: nothing lasts forever. But it is also not very useful. In thinking, for example, about American predominance in the world today, it would be nice to know when it will decline, and whether the United States can do anything to postpone the inevitable.
Contemporary commenters despaired of the Roman Empire for several hundred years before it finally collapsed. Could America find its way to a similar extension?
In terms of providing an essential structure for discussion of this problem, Arvind Subramanian’s new book, Eclipse: Living in the Shadow of China’s Economic Dominance, is a major contribution. (Full disclosure: Subramanian and I are colleagues at the Peterson Institute for International Economics, and we have worked together on other issues.)
In particular, Subramanian develops an index of economic dominance that should become a focus of conversation anywhere that people want to think about changes in world economic leadership. There is no need to know any economics in order to be fascinated by this book: it is about power, pure and simple.
The basic facts are incontrovertible. The United Kingdom was the world’s dominant economic power from the rise of industrialization in the early nineteenth century. But it lost its predominance and was gradually eclipsed by the US, which, at least since 1945, has been the undisputed leader among market-based economies.
The US surpassed the UK in terms of industrial production as early as the end of the nineteenth century, but that was not enough to tip the balance. Economic predominance shifted only when the UK ran large current-account deficits during World Wars I and II – the country had to borrow heavily in order to finance its war effort, and imports were significantly higher than exports. Much of the world’s gold reserves ended up in the hands of the US.
This helped undermine the role of the British pound internationally and catapulted the US dollar to the fore – particularly after the Bretton Woods conference in 1944, at which it was agreed that countries would hold their reserves in dollars as well as gold.
More recently, however, it has been the Americans’ turn consistently to run large current-account deficits, buying more from the rest of the world than they earn by selling goods and services abroad. On this dimension, the US seems destined to repeat the mistake of the British.
At the same time, emerging-market countries’ per capita income has risen – as has their international role. In particular, China has followed a strategy in the past decade or so that entails running large current-account surpluses and building up foreign-exchange reserves, which are now reported to be in excess of $3 trillion. Indeed, Subramanian’s most provocative argument is that China has already surpassed the US in terms of economic dominance – but we have not yet woken up to this new reality.
The story is fascinating and well told; but there is still a great deal worth arguing. For example, did the British decline because the US could not be stopped, or because of problems within the British Empire and at home?
A few years ago, some regarded Japan as having overtaken the US. Europe also was supposedly vying for global economic dominance. Now any such claims would seem preposterous. In both cases, the credit system got out of control, with too much lending to the private sector in 1980’s Japan and excessive government borrowing during the 2000’s in the eurozone.
Similarly, it remains unclear that the Chinese development path will remain smooth. Fixed investment in China is close to 50% of GDP – which must be a world record. Credit to state firms and to households continues to grow rapidly. Isn’t this a version of exactly what derailed Japanese growth?
On the key issue of being able to issue a “reserve currency” that investors and governments want to hold, Subramanian is correct that China has many of the prerequisites in place. But it still lacks some key elements, including fully-fledged property rights. If you worry about getting your money out of a country when times turn tough, China is not an attractive place to hold your reserves.
External challenges do sometimes bring down states. But, more frequently, the big problems are internal – the regime cannot deliver growth, its legitimacy fades, and people start to head for the exits (or at least get their money out).
If the US is eclipsed any time soon, this will more likely be due to its loss of social cohesion and its dysfunctional politics. China might well step in to fill that vacuum, but that is quite different from being able to elbow America aside.