Emerging Markets and Global Rebalancing

Stephen DeAngelis

February 2, 2011

In two recent columns, Martin Wolf, chief economics commentator for the Financial Times, has discussed the rise of emerging market countries (specifically, China and India) and has tried to put today’s economic scene into a larger historical landscape. In his first column [“In the grip of a great convergence,” 4 January 2011], Wolf claims, “Convergent incomes and divergent growth … is the economic story of our times.” He writes:

“We are witnessing the reversal of the 19th and early 20th century era of divergent incomes. In that epoch, the peoples of western Europe and their most successful former colonies achieved a huge economic advantage over the rest of humanity. Now it is being reversed more quickly than it emerged. This is inevitable and desirable.”

Convergent income, Wolf explains, is the result of industrialization and improved productivity in emerging market countries. Countries that missed out on the first industrial revolution found their citizens’ incomes diverging from residents in developing countries. That trend has now reversed and, according to Wolf, “That is far and away the biggest single fact about our world.” He explains:

“[Based on the late Angus] Maddison’s, data, between 1980 and 2008 the ratio of Chinese output per head to that of the US rose from 6 to 22 per cent, while India’s rose from 5 to 10 per cent. Data from the Conference Boards ‘total economy database’, computed on a slightly different basis, indicate that the ratio rose from 3 to 19 per cent in China and from 3 to 7 per cent in India between the late 1970s and 2009. The comparisons are uncertain, but the direction of relative change is not.”

Why is this such a big deal? The most obvious reason is that China and India have huge populations. Increase the productivity of such large numbers of people and dramatic things have to happen. As Wolf puts it, “What is unprecedented this time is not convergence, but the scale.” Wolf notes that “rapid convergence on the productivity of advanced western economies is not unprecedented.” His primary examples are Japan, South Korea, Hong Kong, Singapore, and Taiwan. About the rise of Japan and South Korea, Wolf writes:

“After its defeat in the second world war, [Japan] restarted at about a fifth of US output per head, roughly where China is today, to reach 70 per cent in the early 1970s. It attained a peak of close to 90 per cent of US levels in 1990, when its bubble economy burst, before declining again. South Korea started at 10 per cent of US levels in the mid-1960s to reach close to 50 per cent in 1997, just before the Asian crisis, and 64 per cent in 2009.”

Discussing the potential impact of convergent incomes and divergent growth, Wolf writes:

“Suppose China were to follow Japan’s path during the 1950s and 1960s. Then it would still have 20 years of very fast growth in front of it, reaching some 70 per cent of US output per head by 2030. At that point, its economy would be a little less than three times as large as that of the US, at PPP, and larger than that of the US and western Europe combined. India is further behind. At recent rates of growth, India’s economy would be about 80 per cent of that of the US by 2030, though its gross domestic product per head would still be less than a fifth of US levels. China is today where Japan was in 1950, relative to US levels at that time. But its output per head is far higher in absolute terms, since US levels have themselves risen threefold. Today, China’s real GDP per head is roughly where Japan’s was in the mid-1960s and South Korea’s in the mid-1980s. India’s are where Japan was in the early 1950s and South Korea in the early 1970s. In short, today’s divergent rates of growth between successful emerging economies and the high-income economies reflects the speed of the convergence of incomes between them. This divergence in growth is staggering.”

Wolf is not known for writing hyperbole; so I’m sure he selected the word “staggering” very carefully. He is not claiming that China and India are going take over the world just that their growth will have a profound effect on it. As I have noted in past posts, emerging market countries fared much better than developed countries during the latest recession. As Wolf puts it, “For emerging countries, the ‘great recession’ was a blip. For high-income countries, it was calamitous.” He concludes:

“The great convergence is a world-transforming event. Today, the west – defined to include western Europe and its ‘colonial offshoots’ (the US, Canada, Australia and New Zealand) – contains 11 per cent of the world’s population. But China and India contain 37 per cent. The present position of the former group of countries will not be sustained. It is a product of the great divergence. It will end with the great convergence.”

Although he admits that the pace of convergence may vary, Wolf insists, “Powerful market and technological forces are spreading the stock of knowledge across the globe. No one doubts that Chinese and Indian people are capable of applying it.” Wolf only sees one catastrophe that can halt the rise of China and India — nuclear war. Even if unreasoned protectionism grips the world, “China and India are big enough to drive growth from their domestic markets.” His final thought:

“In the past few centuries, what was once the European and then American periphery became the core of the world economy. Now, the economies that became the periphery are re-emerging as the core. This is transforming the entire world.”

In his second article [“East and west converge on a problem,” 11 January 2011], Wolf, drawing from a book written by Ian Morris of Stanford, notes that the east and the west have seesawed in prominence throughout the course of history. He explains:

“Prof Morris … provides a fascinating account of the progress of two poles of civilisation. These are the ‘west’, the civilisations that descended from the agricultural revolution in the so-called ‘fertile crescent’ in today’s Middle East, and the ‘east’, the civilisations that descended from an independent revolution in a part of what is now China. His conclusion is that the west was somewhat more advanced than the east until the fall of the western Roman empire, behind it from then until the 18th century, and then ahead. Eastern exploitation of the ‘advantages of backwardness’, a recurring theme, suggests another reversal in the 21st century.”

The purpose of Wolf’s second article was to help explain how the “great convergence” is “going to shape the world in the 21st century.” Wolf writes that Morris’ book, Why the West Rules – For Now, is a great guide as to how the world might change. Why? Wolf explains:

“[The book] covers 16,000 years of human history. According to Professor Morris, social development is driven by ‘greedy, lazy, frightened people’ who ‘seek their own preferred balance among being comfortable, working as little as possible, and being safe’. Since human beings are clever and highly social, they invent technologies and create institutions to achieve these aims. Yet what any group of human beings is able to achieve is determined by geography. The impact of a given geography also changes: 1,000 years ago, the oceans were a barrier; 500 years ago, they were a highway. … For Prof Morris, ‘social development’ is an amalgam of four factors: energy use; urbanisation; military capacity; and information technology.”

The view that humanity has advanced on the backs of ‘greedy, lazy, frightened people’ is not only unflattering but on some level untrue. The true drivers of humanity have exploited the greedy, lazy, and fearful tendencies of others to gain power and wealth; but, they themselves could hardly be labeled either lazy or fearful — even if they were greedy. That view also dismisses the contribution of intellectuals whose primary motivation was gaining new knowledge. The world has only advanced as fast as its technology emerged and technology only emerged as fast as new knowledge was acquired. Having said that, it is hard to debate the fact that most people like to be comfortable, relaxed, and safe.

The most important point that Morris makes concerns the four factors that drive social development; namely, energy use; urbanization; military capacity; and information technology. In numerous past posts dealing with development, I have made the point that development relies heavily on the generation of electrical power. Vaclav Smil, in his book Prime Movers of Globalization, makes a similar point about harnessing energy, but he focuses on internal-combustion engines [“Engines of Commerce,” by Nick Schulz, Wall Street Journal, 1 December 2010]. Schulz writes:

“These two internal-combustion engines—diesel and turbine—soon became ‘prime movers’ as Mr. Smil dubs them. They are now the ‘indispensable driving forces of the global economy.’ Without them, ‘trade would not have achieved its truly planetwide scope or have done so at such massive scales, at such rapid speed, and at such affordable costs.'”

Wolf also calls the harnessing of energy “fundamental” to development. He writes:

“The capture of energy is a necessary condition for existence; the more complex and advanced the society the more energy it captures. This is why ‘industrial revolution’ is a misnomer for what happened two centuries ago. It was an energy revolution: we learnt how to exploit fossilised sunlight. Energy and ideas are the twin bases of our civilisation. Prof Morris’s measures of social development and ‘energy capture’ closely coincide with each other.”

Wolf then refers to a number of charts about energy and development (click to enlarge). He writes:

Energy and development

“We can notice three … things. First, western energy capture was the same in 1700 of the common era as it had been in 100, while China’s reached its pre-modern apogee in the 12th century. Second, energy capture and social development have exploded over the past two centuries. Finally, the east’s use has been rising very rapidly. An analysis, from the development centre of the Organisation for Economic Co-operation and Development, argues that convergence has been changing the global balance of supply and demand for resources. This is shown in recent rises in the real prices of metals and energy. The International Energy Agency points out that global primary energy demand could rise by another 50 per cent by 2035. Without a big change in the energy intensity of production, that is what the economic convergence we see has to mean: if all of humanity used the same energy per head as the rich countries do today, consumption of commercial energy would be three times what it is now (see charts).”

Wolf notes that “the growth of China and India has directly helped exporters of resources and purchasers of labour-intensive products. Resource-rich countries have been big winners from the first of these effects.” It might be more correct to say that elites in resource-rich countries have been big winners. Many resource-rich nations have been led by corrupt regimes that have siphoned off or misspent monies received from commodity exports. Wolf also concludes that “consumers in rich countries are the big winners” as purchasers of labor-intensive products from China and India. He continues:

“In addition, among one of the more surprising consequences has been that desired savings have risen faster than investment, so generating the ‘savings glut’ and downward pressure on real rates of interest. Important though these effects are, they do at least reflect positive-sum developments: rising prosperity and widening opportunity.”

Some analysts are now questioning whether we are headed into an era of deglobalization. In a post entitled Is Globalization Retreating?, I argued that globalization is likely to continue because of the “rising prosperity and widening opportunity” that it provides. Deglobalization is based on fear globalization is based on hope. Most of the fear is generated by people who see globalization as a zero-sum game (a lot of people fighting for finite resources). Although globalization has generated enormous amounts of wealth (a non-zero sum outcome), Wolf reminds us that there are some challenges “where zero-sum outcomes are more likely” — namely, natural resources and political power. He continues:

“The biggest question of the 21st century may be whether resources prove to be binding constraints once again, as they so often proved to be, prior to 1800. Will ingenuity continue to overcome scarcity, or not? If the answer is ‘yes’, all of humanity might come to enjoy the historically unprecedented lifestyles of today’s most favoured people. If the answer is ‘no’, we might, instead, fall prey to what Prof Morris calls the ‘five horsemen of the apocalypse’ – climate change, famine, state failure, migration and disease. Moreover, even if these problems are soluble, it may take a far higher level of political co-operation than is available to do so. This is particularly true where economic growth creates global externalities, climate change being the biggest challenge of this kind.”

I’m generally an optimist when it comes answering the question — “will ingenuity continue to overcome scarcity?” That doesn’t mean there won’t be pain associated with that ingenuity. Some resources are finite (i.e., not renewable) and we must get much better at recovering and recycling those resources. Ingenuity will also help us use those resources more wisely. I’m not quite as optimistic about how mankind will deal with the use of political power. As you will read below, Wolf seems to believe that only world government (at least some limited form of it) will be necessary to deal with global challenges. I don’t agree that world government — even a limited one — is the answer. Fortunately, I’m not too concerned that a world government will emerge since the trend is headed in the opposite direction. We have been increasing rather than reducing the number of national governments around the globe since the end of the Second World War (the splitting of Sudan being the latest case). Nevertheless, Wolf writes:

“Now that we have the capacity to destroy civilisation, relations among powerful states have become perilous. After the use of the atomic bomb, Albert Einstein argued that ‘the only salvation for civilisation and the human race lies in the creation of world government’. Einstein was condemned as naive but his comment might still be true. The ‘great convergence’ is an epoch-making transformation. It is the spread of the energy-abundant economy to much of humanity. But if we do not manage the consequent pressure on resources, it may end in misery; and if we do not manage the shifts in power, it may end in war. One of Prof Morris’s most optimistic views is that each age gets the thought it needs. Given the speed of change, will it come soon enough?”

Let’s hope that Professor Morris is right. International cooperation is in everyone’s overall best interests. Such cooperation always involves some compromise and there will be winners and losers on specific issues. In the long run, however, the scales generally balance out and the world is a better place for it. Such cooperation, however, takes leadership and, as I’ve previously written [see The Need for Global Leadership and Still Searching for Global Leadership], such leadership is currently hard to find.