The Power of the Emerging World

Recently I came across a special report by the ‘Economist’ (Sept. 2006) about the changes brought in the world economy due to emergence of “emerging countries”. The report explains why some of the developing countries, especially China and India are emerging as economic powers, what implications and challenges does it create for the developed world. The report also tries to shed some light on some puzzling economic aspects found today, the main explanation being the rise of ‘emerging markets’.

The report regards the rise of emerging markets and their integration into the world economy as the biggest stimulus to the world economy, greater than industrial revolution, which involved only one- third of the population of that day. Their average growth has averaged almost 7%, well above the 2.3% growth in rich economies. The combined output of emerging economies accounts for more than half of the total world GDP in terms of purchasing power parity. Their share of world exports has jumped from 20% in 1970 to 43%. They are consuming over half of the world’s energy. And not to mention, they hold 70% of the world’s foreign exchange reserves. For the third year running, 32 biggest emerging economies have showed positive growth implying an even spread of growth. On an average, they are running much smaller deficits than the rich world.

But the most important point is that emerging economies have become more integrated into the global system of production with vast trade and capital flows. Information technology has made even the ‘non- tradables’ tradable. Hence, the actions, policies and performance of these economies will matter a lot for the old rich world.

The first puzzle being the redistribution of income from labour to capital, i. e. wages as a % of national income is declining, profits as a share of GDP are near all time high. The reason is, offshoring to low- wage countries has reduced costs for the firms. Mere possibility of shifting the production has reduced the bargaining power of the workers in rich countries. In fact, the real weekly wage of a typical American worker in the middle of the income distribution has fallen by 4% even though labour productivity has risen by 15% during the same period. In fact, this is the reason why there is a lack of support for globalization from ordinary people.

Second puzzle is unusually subdued level of inflation in recent years in developed countries. Strong growth, rising oil prices, easy monetary conditions would have implied a much higher inflation rate than what is prevailing. The primary reason being increased competition from the lower cost producers such as India, China etc. In fact, the average price of American imports from emerging Asia has fallen by over 25% since the mid- 1990s.Wage costs have gone down. In other words, inflation rates in the developed countries have become less sensitive to domestic output fluctuations.

Another puzzle is financing of American deficits by emerging economies, which was described by Kenneth Rogoff of Harvard University as “the biggest foreign- aid programme in the world history”. The flow of capital from poor countries to the richest economy in the world defies economic logic. Textbook economics says that capital should flow from rich to poor countries, i. e. the countries where capital is scarce and hence, the returns to capital would be higher. But that’s not what is happening. The poor countries today prefer to buy low- yielding American bonds when they could earn higher returns by investing in their own countries.

One important reason put forth is that the Asian countries are pursuing a deliberate policy of undervaluation to ensure strong export- led growth. Another explanation is that the fast growing poor countries tend to generate more savings. But opportunities for transferring those savings into domestic investment through financial system are limited. So saving typically exceeds investment and the country runs a current account surplus.

The rise of emerging economies has created quite a few challenges for the developed world. It has led to increased protectionist demands. But the solution is not to raise import barriers but to make labour and product market work more efficiently, speed up the shift of jobs from old industries to better paying ones and improve education and training to prepare workforce for tomorrow’s jobs. The challenge for governments is to find ways to share the fruits of globalization more fairly.