G7 and China - Closer Relationship Becoming Necessary for Both

Chi Hung KWAN (Senior Fellow, Nomura Institute of Capital Markets Research)

As independence among nations deepens in the global economy, the G7 and China also need to strengthen cooperation. Although there are still cautious views within each party, and if China were to join the G7 it would need to speed up its transition toward a market economy, there is no reason for China to refuse joining the G7.

Reluctance of the US and the UK

As China has become an economic power, it can no longer be ignored in discussions of industrial adjustments and trade imbalances among major industrial countries. Realizing this, the G7 recently has attempted on several occasions to interact with China. Last year, China participated in the deputy finance ministers (G7D) meeting, and its finance minister and central bank governor have been invited to attend as guests in the G7 meeting held in Washington D.C. These events are certainly steps toward accepting China as a new member of the G7.

No consensus seems to have been formed among the current members of the G7 regarding China's membership. According to Chinese analysts, the US and the UK have been reluctant to accept China because, unlike the current G7 countries where democracy is embraced, China still maintains itself to be a communist country. On the other hand, Japan, while hoping to strengthen its ties with China, has not made its stance clear, as it is reluctant to surrender its position as the only representative from Asia. Other European countries have been said to be ready to welcome China as a member in order to dilute the influence of the US.

There are cautious views within China regarding joining the G7 for the following reasons. First, while the G7 is comprised of those most industrialized and wealthiest nations in the world, China is still a developing country. Considering the weak and subordinate position Russia is forced to play within the G8, China would be allowed only to play a minor role, with a small voice in the group. Second, since decisions by the G7 would be inclined to reflect the views of developed countries, were China to participate in making such decisions it could sour relations with developing countries. Third, there is a risk of being forced to adopt policies unfavorable to China. Thus those who oppose China’s participating to the G7 believe that joining the group would make it difficult for China to sustain economic growth.

However, there are possibilities that joining the G7 may actually benefit China. As interdependence among nations deepens in the global economy, just as the G7 needs China, China needs the G7 too.

Since Hu Jintao and Wen Jiabao took over the government, China has adopted a fundamental diplomatic principle of "peaceful rise", which is interpreted as "to seek development without conflicting with the established order." In order to pursue this policy, China inevitably needs to cooperate with the G7, which accounts for two-thirds of the world's GDP and absorbs about half of China's exports, in such areas as monetary and foreign exchange stabilization, capital flows, and energy.

The huge trade imbalance of the United States is the common and the most important issue for both the G7 and China. The trade deficit of the US in 2003 reached an historical high of 532.4 billion dollars, and the breakdown by country reveals a deficit of 124.1 billion dollars against China, far surpassing that of 66.0 billion dollars against Japan.

China has eclipsed Japan to become the country to register the largest trade deficit against the US since 2000, and the US is requesting China to revalue its currency, the yuan. On the other hand, however, a large portion of China's trade surplus against the US is recycled into the US in the form of investment in US Treasury Securities, effectively sustaining the value of the dollar and low interest rates in the United States.

But if the trade deficit of the US increases further, it could ultimately cause a sharp fall in the dollar and a surge in U.S. interest rates, which would be a serious blow not only to China but also to the global economy as a whole.

China as the third largest trading country

Similar to the case of industrialized countries, China, being a newly industrializing economy, relies heavily on imports of primary commodities and has strong concern for their price fluctuations. In particular, the recent hike of oil prices, for which China's increased demand could be a cause, could hinder China's economic growth. In order to secure stable supply of oil China will have to improve its relations with oil-producing countries while strengthening alliances with other consuming countries.

If China were to join the G7 it would gain a greater voice in global economic affairs in addition to the political powers it already has by being a permanent member of the Security Council of the UN. China's per capita GDP is merely one thousand dollars, within the range of developing economies. But as it carries a huge population of 1.3 billion, the size of its GDP is estimated to be the second largest in the world, behind only the US, in terms of purchasing power parity, and even if calculated at the official parity rate it comes in seventh place. (see table)

This year, China's trade volume is expected to top 1 trillion dollars, which should place it at number three after the US and Germany, by replacing the position held by Japan. As the high rate of growth would further advance China's position in the global economy, it could play an important role if it joins the G7.

If China were to obtain a seat in the G7 it could speak on behalf of developing countries and adapt the global economic order to more suit their needs. Through China's participation the G7 could transform its character from "the club of rich countries" to "the club of influential economies." If other members of the so-called BRICs (Brazil, Russia, India, and China) were to join the G7 in the future, the possibility for the group to function as such would further increase.

External pressures could induce benefits in the long-run

By joining the G7, however, China would be exposed directly to requests from other developed countries to change its policies. An initial focus would be the issue of foreign exchange. One of the reasons holding up China's participation in the G7 has been its policy to maintain a fixed exchange rate against the US dollar, which would inhibit policy coordination with other countries. China has also been reluctant to join the G7 because it would not want its foreign exchange policies interfered with.

But with the dollar falling against other currencies, and the rising trend in the competitiveness of Chinese products becoming real, it would become more and more difficult to maintain the current foreign exchange policy. In fact, China has made the transition to "a flexible foreign exchange system compatible with a market economy" a medium term goal to be realized once trade and capital account liberalization and soundness of the financial sector have been achieved, leaving rooms to compromise with the current G7 members.

Historical experience shows that foreign pressure, not only limited to that on foreign exchange policies, could in fact benefit China in the long run. For example, China joined the WTO only in 2001 after a very difficult and lengthy negotiation. At the time there was skepticism in China that WTO membership would seriously damage some of its industries. But China has since established its position as the factory of the world. In retrospect, WTO accession has accelerated opening up of the economy, and sped up structural reform domestically.

In a similar manner, joining the G7 is expected to provide favorable influence in enhancing the market economy and developing reliable legal systems for China. It could symbolize China's transformation from a poor country into an affluent one, just as WTO accession had marked a milestone in its pursuit of reform and liberalization. There are still obstacles ahead, but once the current members become ready to welcome China as a member of the G7, there does not seem to be any reason for China to decline the invitation.

(The original Japanese article appeared in the September 28, 2004 issue of Nihon Keizai Shimbun.)