Debt and inequality: Why China and US must both change their ways

As the G20 summit gears up to meet next month in Seoul, South Korea, it is not surprising that the United States and China are at loggerheads. The “clash of systems” between America, (the borrower and consumer) and China, (the saver and manufacturing exporter) has generated an imbalance in the global economy that, if not corrected, threatens the peace and prosperity that has so far been achieved through globalization.

That correction cannot occur overnight and cannot be economic alone. It depends ultimately on the recalibration of democracy in both the West and East.

In China’s case, further democratization would include free labor unions and expanded rights for the rapidly growing urban middle class. Less censorship and more robust forms of political accountability would aid the reorientation of its juggernaut from export-led growth toward domestic consumption. Such changes would inevitably make the well-being of the household competitive, as a political priority, with the factory.

China might learn from the policies of Asia’s development pioneers – Japan, South Korea, or Taiwan – where income became more evenly spread as wages rose to capture productivity increases. A credible safety net was put in place with high and broad levels of investment in education to enable the next generation to move up the value-added ladder. All these neighbors of China managed a middle-income transition by establishing the reliable rule of law that made government accountable, through freer expression and some sense of social security. In a developing market, confident expectations about how society will work widely stimulate greater consumption.

In the US, political reform necessarily involves a shift away from the short-term political horizons and cultural habits of consumer democracy. Unless we can find ways to integrate the long-term perspective in governance and insulate it from immediate political pressures, it will be difficult to adopt policies that lead us back to fiscal prudence, revived productive employment, replenished savings and a middle class built on rising income instead of debt. Absent such a shift, there is certain to be a backlash against globalization – aimed with populist anger at China.

Corrective policies, in other words, must seek to undo the way American and Chinese inequalities have played off each other – a low-wage, export-led economy piling up huge reserves from overconsumption by an American middle class that fills the gap in its falling status through borrowing, at rates pushed low by flush liquidity from China and an accommodating US Federal Reserve.

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