The West will lose its grip on the world
Sunday 08 October 1995
The foreign exchanges were having a bout of pre-IMF jitters last week but in reality this meeting is (mostly) congratulations time. At the last summit the dollar was desperately weak, particularly against the yen, and was threatening to plunge Japan into the black hole of a depression akin to that which struck the US in the 1930s. Faced with this danger, the G7 quietly agreed that they - or rather the three countries which matter most, the US, Japan and Germany - would intervene to support the dollar as and when such support might be effective. They duly did. The dollar duly turned, and the panic was over.
But if that disaster seems to have been averted, there are two other particular causes for concern which deserve attention and which are being discussed here. The first is that the Japanese economic crisis may be past its worst, but the underlying weakness of its financial system remains.
The point is very simple. The Japanese banks, unlike banks in the rest of the world, have not yet been recapitalised following the splurge of dreadful lending. American and British banks managed to write off their bad debts thanks to profitable retail business. Some continental banks did the same, while others have been recapitalised by taxpayers. In Japan neither has happened. Asset prices have remained depressed and the country has not had the modest rise in inflation which has helped the balance sheets of banks in other countries.
This has two effects. First, there is an international suspicion of Japanese banks, as shown in the fact that they have to pay more than banks of other nationalities for money borrowed on the world markets. Second, since they have so much bad debt on their books, they are frightened of lending on new projects, thereby inhibiting future Japanese growth.
The other cause for concern is the relationship between saving and borrowing in the world. A report on this, commissioned last year, is about to be presented to the meetings. The substance is that the principal reason why real interest rates are so high is that governments are drawing away too large a proportion of the world's savings by running large budget deficits.
This leads to a number of problems. Quite aside from currency strains caused by the fact that people in Japan save more than people in the US, there is the wider global impact. Savings are being used by governments to fund consumption, rather than by the private sector to fund investment. In theory at least, this seems likely to curb long-term growth potential.
More immediately, there is an impact on financial markets. It may be that concern about the ability of governments to contain their debt is leading to investors demanding a premium on lending to the state, as opposed to the private sector. This may explain the persistence of a wide differential between bond and equity yields, despite falling inflation. We have got back to the 1950s in terms of inflation, but bond yields are still a couple of percentage points higher now than then. Equity yields, by contrast, have fallen as shares have soared. This raises the question about how long this disparity can persist. And if it cannot, do bond prices need to rise? Or share prices to fall?
That is for the future. Just be warned that there will be a lot more market pressure on governments to cut their deficits in the months ahead.
But if you stand back from the immediate concerns of the hothouse of an international monetary meeting, there is a further change evident this year which deserves more attention than it will get. This is the extent to which the developed world is becoming relatively less important. Most people are aware that the share of the world's population living in developed countries is shrinking. They may not be aware that the share of the world's output accounted for by these countries is falling too.
The story is told in the two graphs, taken from the IMF's new "World Economic Outlook". The output of the developing countries has been consistently higher than that of the developed since the mid 1960s, but up to now the margin has been fairly small. Looking ahead, however, it is expected to widen with developing country growth averaging about 6.5 per cent and developed less than 3 per cent to the end of the century.
So (see the bottom graph) while over the past 10 years the gap in the share of the world's total output has narrowed somewhat, the developed countries still account for more than half. Over the next 10 years, assuming growth rates of 6.5 and 2.5 per cent, the positions will reverse themselves. The developing world will actually be producing more of the world's output.
These are only projections and they may prove wrong. The "transition economies", which is IMF-speak for the former Soviet Union and Eastern Europe, are projected to grow at 6 per cent a year - which may seem over- ambitious, but actually could even underestimate their potential.
However, the broad thrust is surely right. At some stage around the middle of the next decade, the economy of the developing world will be larger than that of the developed. Of course both output per head and living standards will be lower, but it would be odd were the sheer output not to be reflected in a shift of economic influence in the world. And if that shift is not evident in 2004, wait a few years and it will be very clear indeed.
I do not think either side is at all prepared for this. Go to an international meeting and much of the chatter is about the imbalances between rich and poor. Fringe groups protest at the harshness of the structural adjustment programmes which the World Bank and IMF impose on the needy. People talk about Russia as a basket case. And within the developed countries there is a certain arrogance: they run the show now and they assume they will go on doing so.
This is not going to last. The developing countries will no longer be seen as a homogeneous group - in fact they never were, though the tag of "Third World" proved useful shorthand. Some of these countries will remain very poor; many will have become comfortably off, with perhaps the same living standards that we had in the 1950s; and a few will be seriously rich, and expect to have their views taken into account in G7 meetings.
Meanwhile, the hold on the world economy of the developed countries will become progressively less secure with each year that passes. For many people in the West, this is rather frightening: an end to a pattern of economic power which has lasted for perhaps two centuries.
I think it is to be welcomed. We should not want to pull the ladder to prosperity up behind us. And we could not, even if we wanted to. It may be an Indian summer in the capital of the US, but the climate is surely changing for the G7's authority in the world.
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