[A-List] The China Shock

["Sabri Oncu" <soncu@xxxxxxxxxxx>]

The world begins to feel the dragon's breath on its back 
Financial Times, December 13, 2005 
By Martin Wolf

Paris burned; the oil price reached new peaks; Alan Greenspan, the Federal
Reserve Board chairman, spoke of the "conundrum" of low interest rates;
global "imbalances" increased; Mexico struggled; and China's exports of
textiles and clothing came under renewed restrictions. What links these very
different events? The answer is: the China shock. The world economy is
undergoing a revolution, as a China-led Asia returns to its historic role at
the centre of affairs.

With an aggregate population of more than 3.3bn, the developing countries of
east and south Asia contain more than three times as many people as today's
high-income countries. The collapse in the cost of communications and the
worldwide opening of markets, the two driving forces behind contemporary
globalisation, multiply the impact of these numbers on the global economy. 

What does economics suggest might be the consequences of the entry of these
huge supplies of cheap and hard-working labour on to the world economy? The
answers include: a worldwide decline in the relative price of
labour-intensive goods and services; a rise in the relative price of
commodities, especially where their demand is most affected by
industrialisation; a decline in the price of unskilled labour against that
of capital, both physical and human; and an increase in global competition.

With big changes in relative prices also come large shifts in the global
distribution of income, from spenders to savers. That is at least part of
the explanation for the worldwide savings glut, the rising external
"imbalances" and Mr Greenspan's celebrated interest rate conundrum.

Note, in this light, six intriguing features of the world economy.

First, according to a stimulating book from Raphael Kaplinsky of the
Institute of Development Studies at Sussex University: "The surge in
(China's) export growth after the mid-1980s was accompanied by a significant
fall in China's terms-of-trade of around 25 per cent."* The fall in the
relative price of China's exports was greatest in its trade with Japan, the
European Union and the US, as it moved into exports of low-technology
manufactured exports. Supplying cheap manufactures is China's big benefit to
the rest of the world. But China, too, has gained, by making up in volume
for what it has lost in price.

Second, commodity prices have surged after a long period in the doldrums
(see chart). Deflated by the export prices of the high-income countries, oil
prices hit levels as high as at the peak of the second oil shock, 26 years
ago. According to the International Energy Agency, between 2002 and 2005, 43
per cent of the incremental demand for oil came from Asia including 28 per
cent from China, which was more important, on its own, than the whole of
North America. Similarly, the real price of metals has reached levels last
seen in 1989. Even the real price of foodstuffs has stabilised after a
lengthy decline.

Third, the share of profits in the value added of the business sector has
reached exceptional levels in many high-income countries (see chart).
Similarly, with few exceptions, the relative wages of unskilled workers have
been in long-term decline in these countries or, where that has been
prevented by regulations and welfare benefits, unemployment has tended to be
high. Either way, the job opportunities of unskilled workers have
deteriorated in rich countries.

Fourth, the increase in the intensity of competition in sectors open to
international competition has been a big part of the explanation for the
greater ease of achieving low inflation almost everywhere. Harvard's Kenneth
Rogoff has argued that: "As economies become more competitive, prices become
more flexible, reducing the impact of unanticipated inflation on output . .
. As a result, the central bank's anti-inflation credibility is enhanced,
and trend inflation falls."**

Fifth, high desired savings have generated exceptionally low real interest
rates. The savings are partly the result of a shift in income to three
groups of high savers: the famously thrifty populations of the Asian
export-driven economies; claimants on corporate profits; and the countries
dependent on oil exporters. Asia and the oil exporters are forecast by the
International Monetary Fund to run an aggregate current account surplus of
close to Dollars 700bn (Pounds 396bn) this year. Without the growth surge in
Asia, corporate profits and oil prices would have been lower, perhaps
considerably lower, and global current account surpluses and deficits would
also have been correspondingly smaller.

Sixth, new adjustment challenges have arisen. But the nature of those
challenges depends on whether economies are complementary to - or
competitive with - the resurgent China. Economies with a comparative
advantage in skill-intensive exports, such as Germany, benefit from the rise
of the new Asian powers, as do exporters of commodities, particularly
energy. Economies with a historic comparative advantage in labour-intensive
low- and medium-technology products, such as Mexico or much of southern
Europe and south-east Asia, suffer. But even those countries that stand to
gain from the upheaval now under way can do so only if flexible enough to
sustain high levels of employment. Where they are unable to do so, they may
see even more of their cities burning, as marginalised outsiders express
their discontent.

Let me be precise. I am not saying that the changes we are now seeing are
mainly the consequence of China's rise. Much evidence suggests, for example,
that the rise in the demand for skilled labour is driven far more by
technology than by trade. Again, China's demand has not been the sole source
of the surge in demand for oil.

Such qualifications must be made. Yet something massive is happening. Some
500 years ago, Europe began its long rise to pre-eminence. For the past two
centuries, Europe and the US, its most successful colonial offshoot, have
dominated the world. Until a generation ago, Japan alone challenged that
state of affairs. Then Hong Kong, Singapore, Taiwan and South Korea
flourished. Now, however, the colossi are on the move.

The advent of sustained and rapid economic growth in these giants will
transform the world. Indeed, it is doing so already. The impact is still
modest. It will not remain so. The challenge for the rest of the world is
not just to adapt, but to exploit the opportunities this great global
transformation will bring.

*Globalisation, Poverty and Inequality (Polity, 2005); **Globalisation and
Global Inflation, August 2003, www.imf.org.