Economic View: Meet the new contenders

Living standards in Prague will be indistinguishable from other European capitals in 10 years

Prague - This week sees the World Trade Organisation summit in Cancun, Mexico, and later this month come the annual meetings of the International Monetary Fund and World Bank in Dubai. So it is the season for thinking about both the progress and imbalances of the world economy - and, in particular, the responsibility that the rich developed world bears for these.

Prague is a good place to ponder the way in which one half of the world treats the other, for it is in the process of moving from being an outsider to an insider. Aside from tiny Slovenia, it is the richest of the countries that formally join the European Union next year. A British Council/ Foreign Policy Centre conference here has been considering, among other things, how the EU might treat its poorer neighbours better - both the countries that might join and those that probably never will. Not surprisingly, reform of the Common Agricultural Policy was raised within the first few minutes.

But there is another reason for being interested in the Czech Republic in that it makes one ask how real the apparent gaps in economic performance really are. The official GDP of the country in 2001 was $57bn (£36bn). But if that were expressed at purchasing power parity - what the money actually buys inside the country - it was $150bn, nearly three times as much. Instead of income per head being $5,500 a year, it was nearly $15,000. That is still a fair way below a country like Britain, where GDP per head (on both measures) was some $24,000, but not so far. Prague certainly does not feel poor now in the way that it did a decade ago.

This divergence is partly a function of exchange rates and partly of the different relative prices for different types of goods and services. The richer a country is, the higher the price of services (which often cannot be imported) relative to goods (which often are).

Most developing and middle-income countries cannot control their exchange rates, or at least not very effectively. But one country in the news can and does. Last week John Snow, the US Treasury Secretary, was in Beijing trying to persuade the Chinese to revalue the yuan. It is reckoned to be between 30 and 40 per cent undervalued and that, in part at least, is responsible for the $100bn trade gap between the US and China. The Chinese promised to let the currency float freely eventually, but they have said that before.

Part of the anger felt by the Americans results from the loss of jobs to China, exported often by US firms setting up plants there. But part also stems from the realisation that China is not quite the poor developing country it sometimes seems. If you rank the main world economies by GDP per head at normal exchange rates, you get the oft-quoted progression of the US, Japan, Germany the UK, France and Italy (see graph). But if you rank them by purchasing power parity, China leaps up the league table and is second only to the US. Then comes Japan, followed by India, pushing Germany down to number five. Brazil and Mexico don't quite qualify for top slots but also jump up the league.

With one disturbing exception, of which more in a moment, power is already shifting away from the rich world. The China syndrome is well known, the Indian story a little less so. Expect to hear much more of the latter as more and more IT-type jobs are exported to Bombay and Bangalore.

It is very hard to see any set of circumstances where growth in both China and India will not continue to exceed that in the developed world by a huge margin for the next couple of decades. And that divergence is not confined to the big two. The World Bank economic forecasts published last week expect 2.2 per cent growth in the US this year and 3.4 per cent next. Europe, including Britain, will grow at 0.7 per cent and 1.7 per cent. But the developing world as a whole will grow at 4.0 per cent and 4.9 per cent.

Indeed, over the past 20 years the gap between the rich world and most of the poor one seems to have started to narrow. In 1980 it was wider than at any time in human history, and of course it is still terrifyingly wide. However, there does seem to have been some sort of turning point in 1978, when the market reforms in China began.

The place where there has been little or no progress is sub-Saharan Africa. That is the exception noted above. The World Bank estimate for growth is 2.8 per cent this year, rising to 3.5 per cent next. But given the health burden caused by Aids, the high child mortality rate, and of course the low base from which that growth is starting, 3 per cent is not nearly enough to make any material change to the living conditions of millions of people. The moral, practical and financial pressure to help sub-Saharan Africa is as great as ever.

If we should not ignore economic failure, we should also not ignore economic achievement. The market reforms in Central and Eastern Europe have been a huge success. I would bet that in another 10 years' time, living standards in Prague will be indistinguishable from those in other European capitals. China's long march to prosperity will continue and it will be fully recognised as the economic giant it is becoming.

You can be appalled by the trade policies of the US, Japan and EU (who are the real trade villains, not the WTO) but still note that, despite these policies, China has managed on one measure to pass Japan as the world's second-largest economy. Actually, China could not have done this without the help of the US, both as a market and as a supplier of capital and know-how - or without the free-trade climate encouraged by the WTO.