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September 27, 2004
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7 + 1 = 8. China Will Join the Economic Group of Seven

by Michael S. Bernstam and Alvin Rabushka

On October 1, 2004, on the 55th anniversary of the founding of the Communist People's Republic of China, the born-again China will effectively join the Group of Seven major industrial economies. The event itself is low-key. China's finance minister, Jin Renqing, and governor of the People's Bank of China (the central bank), Zhou Xiaochuan, will participate, along with their counterparts from the U.S., Japan, U.K., Germany, France, Italy, and Canada, in a special meeting on global economic policies. In the words of U.S. undersecretary of the Treasury for international affairs, John B. Taylor, it is "a historic first engagement" and a "natural occurrence." It is bound to lead to China's eventual full membership in the Group of 7, making it the economic group of 8. Both the current members and China want this outcome. Otherwise this meeting would not have taken place. Its various contentious issues, such as the exchange rate of the Chinese currency, the renminbi, and protectionist trade policies of the G-7 members, could be discussed in many other formats. The natural occurrence of China's joining the G-7 could not.

A little background on the arithmetic brings Russia into the picture. The group of major Western industrial economies was founded in 1975 to coordinate economic policies in response to the oil price shock post-1973. It had five initial members: the U.S., Japan, the U.K., Germany, and France. It later incorporated Italy and Canada and became the G-7. As an unintended consequence, the Group of 7 overarched the International Monetary Fund, which had lost its raison d'etre after the abolition of the gold standard and the fixed exchange rates regime in 1971, and has dominated its policies ever since. Like any international organization and any exclusive club of unequals, the G-7 experienced many conflicting situations. In addition to economic issues per se, structural disagreements between the U.S. and France/Germany over geostrategic issues (e.g., the Soviet Union, the Cold War, the Middle East, etc.) spilled over the map of their relations in general. But the most awkward moment came in the mid-1990s when the U.S. tried to incorporate Russia. This move had no economic rationale. Russia was sliding in a continuous Great Contraction1, on the eve of the Great Default, and was the greatest international beggar. The U.S. government wanted to lend political support to the beleaguered Russian government by bestowing international recognition. The U.S. security objective was to retain influence over the Russian government by a combination of financial and political aid. One possible avenue was to incorporate post-Communist Russia into Western security alliances, such as NATO, but the U.S. and its allies did not want to take a risk of diluting military control. Also, Russia's membership was hard to reconcile with that of the Eastern European entrants. The G-7 became a vehicle of geopolitics by default, beneficial and low-cost for both the U.S. and Russia as it entailed no security risk. It entailed no substance, either, with all the ceremonial and hence political benefits.

The ingenious trick was to violate the laws of arithmetic and to design the inimitable construct 7 + 1 ≠ 8. Russia was invited as an additional but not the eighth member of the Group of Seven. It was included to take part in political discussions and excluded from economic policy discussions. Later on, it was included to take part in economic policy discussions but was excluded from making joint decisions on economic policy. Perhaps symbolically, Russia is not invited to participate in the October 1 meeting of China's initiation. And this is where the Group stands today. There is no longer a need to promote the Russian government politically and there is no prospect for Russia's convergence economically into the group of Western industrial market economies.2 Russia is still unqualified to joint the World Trade Organization, which China joined in November 2001.3 China's participation in the Group of Seven and potential membership in what will become the Group of Eight requires no arithmetic tricks. China's real GDP has increased ninefold since the abolition of central planning, thanks to the phase-in of the new-entrant market sector. Contrary to conventional appearance, China is predominantly a market economy.4 Russia's real GDP is still about 20 percent below its level before the abolition of central planning, despite an economic recovery in 1999-2004. Contrary to conventional appearance, Russia remains a predominantly socialist economy.5 This fits its outlier status of being a one that does not add to a seven to make it an eight.

That China will take its fitting place in what will become the G-8 is not the only interesting point. The next question is what will become of the G-8 thereafter. Its global role and reach are bound to increase. The influence of European members and their global agenda based on the promotion of the European-style Welfare State is bound to decline. Protectionist forces in Western industrial economies will have a harder time under China's pressure and competitive forces will gain a greater momentum. In the developing world, the paradigm of economic development of poor countries in Africa, parts of Asia, and Latin America is bound to be revamped in view of the Chinese experience. The policies of the International Monetary Fund and the World Bank in developing and post-Communist countries will be relegated to a historical footnote.



1 See From Predation to Prosperity, Addendum to Chapter 1, "The Roller-Coaster of the Russian Economy."

2 For a contrast between Russia's and China's economic systems see From Predation to Prosperity, Chapter 2 and Addendum to Chapter 4, "Fixing China's Banks, Not Russia's."

3 For a comparison between Russia and China vis-a-vis WTO qualifications, see "Market, Shmarket, WTO" on this web site. See also "Cambodia Joins the WTO."

4 From Predation to Prosperity, Chapter 2 and Addendum to Chapter 4, "Fixing China's Banks, Not Russia's."

5 From Predation to Prosperity, Chapter 1 and Addendum to Chapter 4, "Fixing China's Banks, Not Russia's."