Hamish McRae: G20 communiqué signals transfer of power to the emerging world

Economic view

The baton is being passed. If you wanted to pick a day when the developed world accepted that economic power was shifting to the emerging nations, last Friday is as good as any.

The communiqué for the Group of Twenty (G20) meeting in Pittsburgh said that it would become the forum for global economic management. The old Group of Eight (G8), comprising the main developed nations plus Russia, is being superseded by a body representing a much wider group of countries, including the emerging giants, China, India and Brazil, and key regional players such as Indonesia, Saudi Arabia and South Africa.

For those who have been banging on about the transfer of economic power from the old world to the new, from the G7 to the Bric countries, this is tremendously encouraging. The point about effective international gatherings is that the political forum must reflect economic reality. Either this year or next, China will pass Japan to become the world's second-largest economy. It would be absurd not to include it, and the other key emerging nations, in global economic management. The G20 covers some 85 per cent of the world economy. Now I appreciate that the remaining 15 per cent matters too, but in simple power terms if the 85 per cent can agree of broad strategies the rest will benefit hugely.

Having said that, we should all be aware of the limits of top-down economic management. It would be great if we understood how growth might be best sustained in the long term, sustained being the key word, because if growth is not environmentally and socially sustainable, then the entire goal of growth becomes questionable. But even with perfect 20-20 foresight, we don't have a clear enough model of the world economy to be able to frame optimal policies. It seems to me that the function of the G20 will be the apparently modest, but actually vital, one of helping countries to avoid serious economic mistakes.

What the G20 will do, however, is to reflect the views of the emerging world more strongly, which is something we in the West will have to get used to over the next generation. Even those of us who accept this intellectually will find it hard to appreciate quite what it will mean in practice. Let me give you three examples.

First, take the relatively narrow issue of consumer standards. Europe and North America set them and the rest of the world has to follow, right? In the past, that has certainly been the case for the simple reason that a global manufacturer of say, cars, has be able to sell them in the two biggest markets, the US and the EU. But this year, for the first time, China has become a larger market for cars than the US. The recession has speeded the shift. Consumption in the developed world has slumped, while that of the emerging world has continued to rise, with only a slight check to growth. As the pattern of consumption shifts, the tastes and aspirations of these new consumers will start to dominate and global standards must take that into account. It won't happen suddenly, but over a period of years we will be nudged towards the standards set by Asia, not by Europe or the US.

Now take the somewhat wider matter of national taxation. Countries set their own tax levels and are naturally upset when their citizens find ways of avoiding them. Thus, one of the areas of progress in the past few years has been improving the standards of reporting and accounting in the various tax havens around the world. Many of these have been relatively small island states and it has been easy to encourage them, some would say bully them, to adopt global standards. Some larger countries – larger that is in terms of the size of their economies – including Switzerland, are now also moving towards adopting the international norm.

This has happened because of combined pressure from the EU and US, which have up to now called the shots. But looking ahead to a G20 world, the shots will be called by countries such as India and China. I'm not saying they will want to encourage tax-dodgers; not at all. But the ideas of this new world on appropriate levels of taxation, plus accounting and other requirements, will increasingly shape the old world. So if China, perhaps through Hong Kong, wishes to take international financial business from New York and London, it will set tax levels and regulatory procedures to encourage the business to move.

Now take a wider social issue of the role of government. We have in the West a broad consensus about the appropriate relationship between the state and the individual. True, this varies from country to country even within Europe, and there are quite a few issues on which European nations depart from the US. But the similarities are surely greater than the differences. Go to China, India, Indonesia or Brazil and the relationship is quite different. To take one simple example: in Hong Kong, the government owns all the land and leases it out to other users. (The only freehold piece of land in the territory is the plot under St John's Cathedral.) It also runs one of Hong Kong's largest industries, for the Hong Kong Jockey Club has a monopoly over gambling. That is a degree of socialism that would be unacceptable in any Western European nation, even to the Scandinavian countries where the state plays a very large role in economic activity. In Sweden during the early 1990s, the government sector accounted for 67 per cent of GDP and even now it is well above 50 per cent. But look at the size of government in Hong Kong – using this measure of the proportion of GDP. It is around 15 per cent, less than half that of the US, about one-third the level in most European nations.

So you have, in this special part of China, a completely different notion from that of any "Western" nation of where the boundary between state and individual should lie. Long before China becomes the world's largest economy, as will probably happen in about 20 years' time, its ideas of how an economy should be ordered will start to shape ours.

None of this will happen overnight. Long-term shifts of power are almost imperceptible as they happen. This shift is a bit like the ageing of populations. From one year to another, there is no noticeable change; but over a period of years, the shifts are massive. For example, people gradually become aware that the workforce is shrinking and the pressures of supporting pensioners are rising. I suppose changes to the environment are similar – with the danger being that, when we do wake up to change, it is hard to do much about it. But, as I said, if you want to take one moment when we can say the balance of economic power shifted from the old world to the new, this G20 meeting is as good as any.

The Government's wartime finance threatens to make investors freeze

What happens when quantitative easing ends? One of the effects of the G20 meeting has been to focus on the path back to normality. The practical point is: what would happen to UK gilts if the Bank of England were not propping up the market and who will buy the over £200bn of debt the Treasury will seek to issue over the next year, with the prospect of as much again for some years beyond?

There simply are not the savings available here to fund the Government, so much of it will presumably have to come from abroad. Will investors be prepared to take the exchange-rate risk, particularly since Mervyn King has been doing his best to talk down sterling on the foreign exchanges?

Sterling has not yet been as weak as it was in the spring, but there are nasty rumblings coming from the currency commentators. The dollar is also weak, so this doesn't show up on the dollar-sterling rate, but it is possible the pound might go down to parity against the euro – well below its long-term sustainable level which would have political consequences for the Government.

It is hard to know quite how fragile financial confidence in the Government is. My suspicion is that investor confidence in all governments in serious deficit is fragile and the present low rates at which they can borrow won't last beyond the winter. As rates rise, the US and particularly the UK will suffer most.

One of the odd things about markets is that they lose confidence suddenly. We saw that with the sub-prime crisis in the US. Weaknesses in the housing market were evident for months before the price of the complex sub-prime instruments collapsed. Then when they went, they fell like a stone. We have never in peacetime seen this level of gilts being issued. This is wartime finance. If investors felt there was no credible plan to cut the deficit, they might freeze. You may not like dollar assets, but who would you rather lend money to, the German government or the British one? I am afraid that is not much of a contest.