China 'can be engine of growth'

BBC News is running a series of commentaries this week by economists on the challenges facing the global financial system. Today, Linda Yueh considers the implications for China.

Linda Yueh is Fellow in Economics at St Edmund Hall, University of Oxford

The economic crisis of 2008 is rooted in the so-called "global imbalances", whereby the West borrowed too much, funded by Asian savings.

Globalised financial markets then transmitted the American led crisis around the world.

Resolving this crisis, in the least painful manner, will require rebalancing the global economy.

China is a significant source of global savings and certainly is not immune to the economic crisis which will slow its economic growth, though it is likely to weather it well.

With nearly $2 trillion in foreign exchange reserves, it is in a position to help with the credit crunch in the West as well as serve as an engine of growth as the other engine, the United States, slows to a halt.

Western governments must borrow to fund the rescue plans since raising taxes is not advisable in a downturn.

Borrowing of these magnitudes will result in future tax rises and higher interest rates which could stymie economic growth.

Instead of selling debt to China and other emerging economies, the sovereign wealth funds of these countries could invest directly in western markets.

China, and emerging economies, contributed to this crisis and are suffering the consequences

Commercial investments from emerging economies would be more palatable.

But would China, and others, permit their firms to invest freely overseas?

They will be concerned about loosening their capital controls which makes it harder to peg their currencies if capital moved freely and eroded the pegs.

By recapitalising the West, China and other emerging economies can preserve their export markets by helping the world's richest economies weather the storm and prevent a drawn out recession, or even depression.

Belt tightening by western consumers is still necessary and will happen but a long period of austerity can be avoided.

China, and emerging economies, contributed to this crisis and are suffering the consequences as their financial markets and export sectors decline. They can also help resolve it.

Linda Yueh is Fellow in Economics at St Edmund Hall, University of Oxford. She is an Associate of the Globalisation Programme of the Centre for Economic Performance at the London School of Economics and Political Science (LSE).

http://news.bbc.co.uk/2/hi/business/7676957.stm