Hamish McRae: China and India show us the way

The evidence of the shift of power becomes harder and harder to deny

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Just about every day some piece of news comes along that highlights how the balance of the world economy shifts a little further – away from the developed world and towards the emerging economies. This morning it is some calculations by the National Institute that China will this year become the world's largest importer, and will become the world's largest economy within a decade.

That is an even swifter shift than that envisaged by Goldman Sachs in its renowned report on the BRICs, the acronym it coined to bring together the four largest emerging economies of Brazil, Russia, India and China. If the NIESR proves right, the defining moment of the decade we have just entered will be the US ceding its position as the world's largest economy, a place it has held for more than a century. When that happens it changes everything.

Deep down most of us can't quite believe it will happen, perhaps because it forces us to rethink all our embedded ideas about global leadership, the importance of the North American/European consensus on democracy, the market economy, the rule of law and so on. But the evidence of the shift of power becomes harder and harder to deny.

As it happens, the OECD's report on China was out yesterday and it too has a startling comment. It is that China could well overtake the US to become the leading producer of manufactured goods in the next five to seven years.

There was, however, something else in the comments of the NIESR and the OECD that affects us more immediately. It is the extent to which the economic recovery has been driven by policy in China and the reason why China could afford to do it. The country has had a massive fiscal stimulus, far larger than that which the countries of the West put into action, and this seems to have worked most effectively. The Chinese were able to do so, partly by a huge infrastructural investment programme but also by switching production for export to supplying the domestic market, because financially both public finances and the balance of payments were very strong.

Total debt in China, that is including government debt, personal debt and company debt, is only 159 per cent of GDP – with the government part of that only 25 per cent of GDP. By contrast total US debt is 300 per cent of GDP, while here it is 466 per cent of GDP.

China also had leeway on its balance of payments. During the boom it had a surplus of around 12 per cent of GDP. That has come down closer to 9 per cent, which is still extremely high, but at least Chinese imports have risen somewhat, so some sort of correction has begun.

Unfortunately for the West, more than half of those imports have come from other countries in Asia. Just 1 per cent of Chinese imports come from the UK and only another 7 to 8 per cent from the US. So there has been an Asian recovery, not yet a European or North American one. Indeed it is not even right to talk of Asian "recovery" because there wasn't any recession in many countries. The other giant, India kept growing at around 6 per cent a year, while Russia, which is of course part Asian, has also just reported growth of some 6 per cent in 2009.

So what lessons should we take away from all this, once we have got over the shock that we – and I don't just mean Britain – have messed up big time?

I think the first lesson is that, if a country has a strong budgetary position, it really can do things that will help iron out the economic cycle. Actually there was an example of that here during the early years of the Gordon Brown chancellorship. By building up fiscal surpluses during the late 1990s, he was able to offset the fall in demand that hit other developed economies after the collapse of the dot-com boom. As a result the UK kept growth while other countries dipped into recession.

There is a moral there for our next government. So much of the current debate in the UK is how quickly to get back to balance (and by the way, the NIESR believes the present government's plans to do so are inadequate). Surely the debate ought to be about how to run a surplus during the coming expansion, so that we have some firepower come the next recession.

Secondly, we need to think about saving, not just as a government but as a society. I heard a statistic that I can't quite believe but which would fit in with what we know about about China. It was that, a couple of years ago, only 25 per cent of homes were bought with a mortgage. The rest were bought with cash. Maybe the latest construction boom has had more of an injection of loan finance, but you see the point. A society that saves before it spends is inherently more robust when bad times come along than one that has no savings.

Third, we need to prepare ourselves for a policy change in Asia. The coming rise in interest rates that will sweep over the world will start in Asia. There have been little hints already. A couple of weeks ago China increased the reserve requirements it puts on banks. At the end of last week India did much the same. In both cases this is seen as a prelude to tighter money worldwide. We like to think of ourselves having discretion to fix interest rates. That, after all, is what the Bank of England's monetary committee spends its time doing. But it has to act within a global context. Just as governments cannot runs deficits that the markets deem unsustainable – look at the plight of Greece – central banks cannot hold interest rates down if they want to retain credibility.

Remember, a country in deficit needs to attract savings from the rest of the world and those savers need to be persuaded that they are not chucking their money away. Maybe the US can go its own way – though I increasingly doubt that – but the rest of us can't.

We here in the UK don't need to see our plight in apocalyptic terms. We still have options. The large economies of Continental Europe still have some leeway to determine their own policies, particularly Germany, which has been relatively disciplined with its public finances. And the US, despite its gradual relative decline in economic importance, still has a huge reservoir of human and technical capital from which it can draw. But every day that passes, we all slip a little in the world pecking order and we had better think hard about why that is happening and what we might do to slow the shift.

h.mcrae@independent.co.uk

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