Hamish McRae: China is a hungry teenager eating up resources – and we can't stop it

Economic Life: China becoming world economic leader is no further in the future than Major becoming PM was in the past

Friday 22 January 2010 01:00

China is now the world's second-largest economy – or rather, if it isn't, wait a few weeks and it will be. Most people are now vaguely aware that something massive is happening, a power shift that will transform the global balance of power for the rest of our lives. It is less dramatic because it is happening more gradually but is just as important as the fall of the Berlin Wall and the collapse of the Soviet empire.

And it goes on. There is a reasonable chance that the Chinese will pass the US to become the world's biggest economy within the next 20 years. On the calculations of the investment bank Goldman Sachs, it will overtake the US around 2027. In other words, China becoming world economic leader is no further in the future than John Major becoming prime minister was in the past.

Anyone following these columns will recognise this theme. It seems to me to be so important, so crucial to the understanding of the way the world is changing, that I have come back to this issue again and again. Goldman Sachs figures on the largest world economies are stunning enough since in addition to the rise of China they show India in number three slot, are only economic numbers. They don't capture the extent to which our own lives will be affected.

To give you one recent example of the change in mindset we need to make, a few years ago we looked to the US Federal Reserve to give us leading signals of the trend in global interest rates: if the US changed policy, we would follow. But last week the signal that credit would become tighter came not from the US but from China. The central bank increased the reserves that commercial banks had to hold with it, thereby starting a process that will lead to higher interest rates there and elsewhere. We have become used to the idea that global commodity and energy prices are determined by demand from China but the idea that our policy will be influenced too is quite hard to accept.

But I think it is important, given all this, to point out that China's progress is most unlikely to be straight-line and there are a number of reasons to expect that there may be a bumpy period ahead. To understand what has been happening, you have to step back 18 months. At the time of the Beijing Olympics the world was only just starting to slide into recession but the Chinese authorities were very aware that demand from what was then its principal export market, the US, was starting to flag. So it shifted output to home demand through a series of measures including a massive increase in credit and a huge fiscal boost. Relative to the size of the economy the Chinese injected more additional demand than any other country. The building boom picked up pace and a domestic consumer boom really took off. That is why China passed the US last year to become the world's largest car market. It was extraordinary. Many of us could see that the thing the country would need to do would be to reduce its dependence on the US market but the speed at which it did so was most impressive.

But now policy has to be tightened. The worry is not recession but over-heating. Fourth-quarter growth was running at 10.7 per cent annual rate. December industrial production was up 18.5 per cent year on year, while fixed-asset investment grew by 30.5 per cent. Even China cannot go on like that. Managing that transition to a more sustainable rate will be difficult and it is hard from this distance to "call" how well it will be controlled. The broad mass of comment from the financial community is positive and my instinct is to trust it. But there is a risk.

There is another longer-term issue that we should be aware of. You could sum it up in a question: might China be the next Japan? Remember how back in 1990 nearly everyone thought Japan would become the dominant economy through the 1990s? It seemed to be coping with that downturn more effectively than other developed economies and was held up as a model that Britain should follow. One of the few people who argued the reverse was Bill Emmott, then at The Economist, who wrote The Sun Also Sets, which charted the limits to Japanese power. Of course, as we now know, he was right.

There are a number of similarities between the Chinese economy now and the Japanese economy in 1990, but there are number of crucial differences. Similarities include the building of domestic production behind a wall of protectionism, having a command relationship between the authorities, the banks and major businesses, the willingness to copy foreign products (though by 1990 Japan was well past that stage), the holding down of the currency to boost exports and the more general pursuit of nationalist economic objectives.

But the differences seem to me to be far bigger. One is scale, in particular of population. China can go on growing by selling to the domestic population in a way that Japan could not. The level of economic development too is quite different. In relative terms, China is where Japan was in the 1950s rather than the 1990s. There is still a huge surplus of labour to move from the land to the cities and while eventually the one-child policy will limit the growth of the population, for the time being the labour force will continue to grow. Indeed, it seems that China is at a "sweet spot" in its growth potential, driven by its ability to adopt technical advances largely developed elsewhere, and its still-favourable demographic profile.

The prospect, therefore, is of another 10 years of rapid growth before the gallop slows to a more sedate trot. Making that transition from a big bang to more of a steady state will be tough – look how hard Japan has found it – but the transition is still some way off. Meanwhile, China will continue to affect us in a number of ways. One will be its demand for resources. I was struck when talking to a senior banker a couple of years ago. He likened China to a hungry teenager: when you are growing fast you need a lot of food. But when the country has grown up it will not need so many resources. So China was scooping up raw materials from all over the world, and in particular from Africa, but this phase would pass. That does, however, leads to a concern, for the phase has a way to run if Goldman's projections prove near the mark. So it will go on putting pressure on resources for the foreseeable future and there is nothing we can do about that.

That will not be easy to accept. The West is not used to a world where what we think does not matter. In Britain we have become more aware of the limits of our influence, but in the US (and I suppose in the EU) that is only gradually becoming apparent. Even those of us who broadly welcome the advance of China have to admit that the prospect will be a difficult one.

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