Hamish McRae: The West is losing the high ground as power shifts to the emerging nations

Economic view

What will the global economy be like when the West no longer calls the shots? We will begin to get a glimpse this week at the Group of 20 meeting in London. The very fact it is 20 nations attending, rather than the eight that go to the so-called economic summits in the summer, is a symbol of the shift of power taking place; the club has had to open its doors to new members. But this is symbolism catching up with reality. You cannot credibly talk about the future of the world economy unless you include the great emerging economies, in particular the Brics: Brazil, Russia, India and China.

The president of Brazil, Luiz Inacio Lula da Silva, put the point brutally at his press conference with Gordon Brown last week, when he said that the global economic crisis was the fault of "white people with blue eyes" and that it was wrong black and indigenous people should pay for white people's mistakes.

You don't have to agree entirely with that view to accept the ideas of the Brics now matter as much as those of the G7.

For the moment, it is true, the US remains the world's largest econ-omy, Germany the largest goods exporter and the European Union its largest trading bloc. But one of the effects of this downturn, which has hit the developed world far harder than the emerging nations, has been to speed up the shift of power that was already taking place. During the 1990s the two worlds grew at around the same pace, but since then the gap has widened – a trend that has been even more marked this year. Some IMF projections claim the economies of the developed world will shrink, while, viewed as a whole, the emerging economies will continue to grow.

As a result China is now expected to pass Japan in terms of the size of its economy this year, to become the world's second largest. It passed Germany in overall size last year and may well overtake it this year to become the world's largest exporter. As you can see from the bar chart, next year the economy of Brazil will be larger than Canada's, while India's will be almost as big as Spain's.

Those figures are pretty incontrovertible. What happens thereafter is less sure, but according to the Goldman Sachs model of the Bric econo-mies, China will pass the US some time in the 2020s to become the world's largest economy, and India will pass Japan to become number three.

So what will be the consequences of this shift of power? We can see some signs already. For example, there has been the suggestion of China that the dollar should be replaced as a reserve currency. There is also the plan of a UN panel of experts to create a new global reserve currency based on the IMF's special drawing rights. Anything there is a long way off but one thing that might well happen sooner would be for China itself to diversify its reserves. At the moment it holds about $1 trillion in US government debt, which is uncomfortable for both countries, but it cannot switch debt suddenly without undermining the dollar and hence the value of its investments. Nevertheless, over time, the dollar will become less important. Another reasonably early consequence will be a shift in the balance of capital and voting power in international monetary organisations, such as the IMF and World Bank.

Such official recognition of the new order seem less important to me than the market-driven changes that are taking place. The three largest banks in the world by market capitalisation are Chinese, enabling them, if they so wished, to buy up large Western financial institutions. They don't seem to want to, and I can't say I blame them; it does not make much sense to go for slow-growing markets when you are already in a fast-growing one. Still, China will undoubtedly diversify its investment portfolio over the next few years, most probably by taking a string of strategic stakes in major businesses in America and Europe.

That will lead to a change in corporate management. As Chinese shareholders build their stakes in companies in the developed world, they will want a say in how their investments are run. The obvious parallel is the switch that took place from the 1950s onwards – from personal investors to institutional ones. The institutions did not want to run the companies, but as their holdings grew, they increasingly shaped board policy. Expect the Chinese to do the same.

India is likely to have a different sort of impact on our markets and economies. With China there is a strong element of central direction, as shown in its investments in natural resources in Africa, where it has made the strategic decision to get control of the raw materials it needs to underpin economic expansion. India, by contrast, has expanded its international footprint because its companies have decided to do so. China's policies are led by the public sector, India's by the private sector. The highest-profile event here in the UK has been the takeover by Tata of Jaguar and Land Rover, and although this has put a lot of pressure on the parent group's finances, it is not hard to feel confident in the medium term, for Tata already looks like being a better steward of these brands than the previous owner, Ford.

If Indian management does indeed succeed where American management failed, that will have knock-on effects elsewhere. It will embolden other Indian companies. It will also lead to soul-searching in the US.

That leads to a broader point, the one in effect made by President Lula. The aura of Western competence has been seriously damaged.

Western governments have in the past been a bit dismissive about the policy-makers of the emerging nations. Take the Brics. Brazil was seen as seen as being incompetent in fiscal and monetary matters; Russia was corrupt and inefficient; India was corrupt and uneven in its performance; and while China achieved many of its objectives, it fell down on human values and environmental performance.

Those at least were the charges, and this snootiness led to huge irritation in the emerging world. Now the boot is on the other foot. The smart Western bankers and politicians who lectured the lesser beings don't look so smart now. We have no right to lecture others; they, in some measure at least, have a right to lecture us.

Now I don't think you have to buy Chinese and Brazilian attitudes to the environment, or Russian and Indian ones to corruption, to acknowledge there is some justification for this irritation. A bit of humility is in order. I suggest too that we should acknowledge there are ideas of corporate management in the Brics from which we can learn. We should be open to ideas about fiscal and monetary policy. And we might even learn a thing to two about how to run banks.

Save more, relax more, spend more: the cycle to help us out of recession

British economic management is not much admired these days, witness sterling's devaluation and the failure of last week's gilt auction. We also had revised GDP figures for the final quarter of last year that showed the economy shrank by 1.6 per cent, slightly worse than previously announced. So the G20 meeting does not take place against an auspicious backdrop.

Yet it is important to put some perspective on this. Given all we know about the global recession, this is the sort of news you would expect. The GDP figures will probably be repeated for the current quarter, so the economy is still declining and has further to go. The gilt auction was troubling, because of the unbelievable amount of debt the Government will have to issue over the next few years. Capital Economics now reckons that our debt-to-GDP level will reach 100 per cent, the level it was at in the 1960s when Second World War debts still hung over us. But the idea that the country is bust is an exaggeration: we just have a decade of slog ahead to get indebtedness under control. As for sterling, provided it does not fall further (and it has come up a bit recently), an undervalued currency is helpful in a downturn.

There were other encouraging signs. The "green shoot" sightings don't make much sense, but new mortgages are slightly more available, the balance of payments deficit for last year was down to only 1.7 per cent of GDP after 3.9 per cent in 2007, and the savings ratio has shot up to just under 5 per cent – a rise that seems to me to be the most encouraging sign of all.

The point is that people are getting their finances back in order – the funds from mortgage rate cuts are being saved rather than spent. That had to happen. Once people feel their finances are under control they can relax and start spending again. Since consumption is two-thirds of the economy, that will lead us out of recession. We won't be at this point for months to come, but the rebuilding of savings is a necessary, though insufficient, condition for resumed growth.