Summary: The authors examine how the economic interactions between rapidly emerging China and the rest of the world may evolve over the coming two decades. They discuss China's growth potential, drawing a parallel between China's rise and the historical rise of Britain, Japan and the United States. Barring major disruptions, they contend, China could become one of the world's largest economies, if not the largest, by the year 2020. Industrial countries, especially Japan and the US , are expected to benefit because their trade structure complements China's. Developing countries, especially exporters of labor-intensive manufactured products, are likely to be put under competitive pressure. The authors argue that it would be advantageous for China to embark on the traditional strategy of a follower country -- that is, to run current account deficits and use foreign resources to supplement domestic investment. Should foreign direct investment continue at its recent rate, China may have to cope with overfinancing of its current account deficits. The authors argue for a development strategy that projects a sustainable growth rate with somewhat higher current account deficits and, therefore, somewhat higher levels of consumption and lower domestic savings, and a toning down of a policy bias that favors coastal regions. Such a strategy would lift consumption standards more rapidly. It would also defuse some of the social tensions generated by the unequal development of different regions. As for the country's vulnerability to the external environment, the authors argue that in the long run China is resilient in the face of adverse external developments, especially those coming from outside Asia. In the short term, however, adverse external shocks could threaten the macroeconomic stability important to reform. A simulation analysis of China's loss of most-favored-nation status in the US confirms this assertion. The authors conclude that preserving openness is in China's best interest and that the US in particular stands to gain much in the longer run if it maintains open trade relations with China. Adversarial US policies could encourage China, Japan and other Asian countries to prefer intraregional trade, possibly excluding the US from full participation in what is bound to be the world's most dynamic growth pole.
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