Manchurian paradox.

• Author: Roach, Stephen S.
• Position: China's economy

The Chinese word for crisis, weiji, includes elements of both danger and opportunity. This symbolic meaning has taken on especially great significance in recent years. The emergence of modern China as a global economic power can, in fact, be dated to the nation's willingness to seize critical moments of adversity. That was very much the case during the Asian financial crisis of 1997-98, which marked a critical turning point in the ascendance of China as a major economic power. And it could also be the case today.

But there is an important catch: unlike earlier crises, it is not altogether clear that China senses the gravity of the current danger. That leaves it caught in something much closer to denial--making it difficult to seize the opportunity that peril can provide.

The world is in the midst of its most wrenching financial downturn since the 1930s. From subprime to "no-prime," the once-proud icons of modern finance have all been turned inside out. An asset-dependent and increasingly integrated world has been quick to follow. The global economy is set for its first outright contraction since the end of World War II. Relative to a forty-year trend-growth rate of 3.7 percent in world output, a likely decline on the order of 1.5 percent in the world's gross domestic product (GDV) in 2009 is all the more stunning. For a $64 trillion global economy, such a shortfall translates into $3.2 trillion of foregone world GDP. Never before has the modern global economy had to come to grips with such a severe and abrupt widening in the so-called global output gap.

The Chinese leadership needs to deepen its appreciation of the global shock that is now unfolding. Only then can Beijing truly comprehend the threat this recession poses to its long-successful outward-facing economic-growth model. And yet there are worrisome signs that China just doesn't get it--that it is clinging to antiquated policy and economic-growth strategies that presuppose a classic snapback in global demand. That leaves China ill prepared for what could well be the defining feature of the postcrisis world--a U.S.-led shortfall in worldwide consumption. Chinas export-led growth model is aimed right at the heart of what could well be the new weak link in the global growth chain.

Notwithstanding these worrisome imbalances, a newly assertive China has stepped up its efforts to shape the global policy debate--warning America of fiscal excesses that could erode the value of China's investments in U.S. Treasury securities and proposing a radical revamping of the global currency system. Chinas views and voice are important and need to be heard. The world has much to gain from a sounder and more stable international financial system. But if China pushes too hard in trying to reshape international policies and institutions without attending to its own imbalances, it could trigger further instability--possibly even a dollar crisis--that would only deepen the world's malaise. In the construct of weiji, that could tip the balance from opportunity to danger. Therein lies the paradox of Chinese economic power.

Relative to all the Asian economic-development efforts since the end of World War II, China stands alone in the massive bet it has made on externally led growth. According to calculations made by the research staff of the International Monetary Fund, Chinas share of world trade increased eightfold in the twenty-five years following its economic takeoff in the early 1980s. That is more than two-to-three times the gains experienced by other Asian economies over comparable phases of their development journeys. Moreover, China upped the ante on this bet following its accession to the World Trade Organization, taking the export share of its GDP from 20 percent in 2001 to 36 percent in 2007. As the world's most open large developing economy--with exports and imports, combined, peaking at 65 percent of its GDP in 2007--China could hardly expect to get special dispensation from a global shock.

And it didn't. On the heels of a precipitous decline in exports, Chinese GDP growth slowed to 6.8 percent on a year-over-year basis in the fourth quarter of 2008, a major deceleration from the 13 percent increase in 2007. Significantly, the gain in the fourth quarter of 2008 turns out to be a number very close to "zero" if it is recalculated relative to activity in the third...