ALL roads, it seems, lead to China, except the ones that go to India. Tony Blair told the cabinet last week that his visit to the two countries earlier this month had convinced him of the magnitude of the challenge Britain faces from these emerging giants. There will be a lot more of this from the prime minister and Gordon Brown at the Labour party conference in Brighton this week.
In Washington this weekend, China in particular is also hard to ignore. The International Monetary Fund, in its twice-yearly world economic outlook, revised up its growth forecast for China for both this year and next, to 9% and 8.2% respectively, while it revised growth down for euroland and, even more dramatically, Britain (now put at just 1.9% and 2.2%). The way China is growing, the IMF’s numbers look a little cautious.
China has been growing at an average rate of 9.5% a year for more than two decades. It is only recently, however, that its economy has been big enough to acquire critical mass — accounting for roughly a third of global economic growth over the past two to three years.
And it is only in the past 12 to 18 months that China has begun to contribute significantly to the global economic imbalances the IMF frets about. The “bra wars” trade dispute between the European Union and China was just the tip of the iceberg. Its trade surplus this year will be roughly three times last year’s figure of $32 billion (£18 billion).
China’s might is not in doubt. The Organisation for Economic Co- operation and Development says her economy is already bigger than two of the G7 countries, Canada and Italy, and will soon overhaul Britain and France. By 2010, only America, Japan and Germany will have bigger levels of gross domestic product — and in the case of Japan and Germany, not for long. By then China will have taken its place as the world’s biggest exporter.
If these projections do not convey the full story of China’s progress, how about these statistics? Since the mid-1980s the percentage of Chinese households with colour televisions has increased from 1% to 94%, the length of the country’s paved roads has risen from 38,000 kilometres to 208,000 kilometres (and is planned to treble over the next three decades), and the number of students in higher education has gone up from 2m to at least 15m.
There are more than 360m mobile- phone subscribers and there will be many more in the not-too-distant future. Yuwa Hedrick-Wong, economic adviser to Mastercard International, predicts a rise from 65m to 650m in the number of middle-class Chinese over the next 15 years.
China raises many questions. Let me deal with one of them: that sudden surge in her external surplus this year. China accounts for a quarter of America’s trade deficit. If Chinese-EU trade tensions have been evident in recent weeks, they are as nothing compared with the potential for trouble arising from China’s growing surplus and America’s seemingly intractable deficit. Add in political undercurrents — Washington is more protectionist than Brussels — and serious dangers loom.
But China’s growing surplus also exposes some enduring myths. The first is that China’s gargantuan appetite for oil, along with the hurricanes battering America, has been the prime factor driving crude prices higher, and explains why we should look forward to an era of permanently high energy prices.
In fact, what is notable about China this year is her limited appetite for imported oil. The Paris-based International Energy Agency expects Chinese oil imports to rise by 220,000 barrels a day this year, compared with a rise of 860,000 barrels a day in 2004. China’s oil companies, unable to pass on higher crude costs because of domestic price controls, have been restricting their purchases. Indeed, the trade surplus has been helped by exports of refined products from China to other countries.
Myth Number 2 is that China’s exports are all T-shirts, trainers and other low-tech (with apologies to Nike) products. Lehman Brothers points out that while textiles have been one of the drivers of the trade surplus, so increasingly have high-tech goods such as telecommunications equipment and computers. A fifth of the trade surplus is accounted for by such items, a reminder to the world of the competitive threat China represents up and down the value chain.
The third myth is perhaps the most enduring. It is that China is essentially just a low-cost location for assembling products for the rest of the world’s consumers. The trade surplus is therefore the logical result of this. In fact, as Hedrick-Wong points out, China is neither particularly dependent on exports nor on foreign direct investment. While exports are large, about 36% of gross domestic product, so are imports, 34%. The difference puts China in a very different position to, say, Japan during its phase of dramatic export-led growth two to three decades ago.
Foreign direct investment is important, because of the technology and practices it brings to China, the world’s biggest magnet for such investment. But only an eighth of all investment in China comes from abroad. China’s growth is mainly internally generated. A study by Professor Robert Lucas of the University of Chicago found that under the extreme assumption that China was cut off from foreign trade and investment, its growth rate would be reduced by only 1%-2%. not much of a worry for an economy expanding at a rate of 9.5%.
That, of course, is not going to happen. China will remain integrated in the global economy, despite protectionist pressures. That raises the question, in turn, about who is benefiting from this expansion. George Osborne, the shadow chancellor — following in the footsteps of Blair and ahead of a visit next month by Brown — has just been to Shanghai. He said that, despite the government’s rhetoric, Britain is being left badly behind in China by our European competitors. Food for thought.
PS Professor Steve Nickell of the Bank of England’s monetary policy committee had some fun last week with the house-price doomsters, resurrecting some of their 2002 and 2003 crash predictions. I won’t name names. He, like me, didn’t expect a crash then, and doesn’t now. Indeed, there have been tentative signs of a housing pick-up, although I wouldn’t read too much into them.
Nickell, delivering the Keynes lecture at the British Academy, gave four reasons why house prices have risen and why the market may not be overvalued. Some will be familiar. The first three were: the rise in the number of double-income households; reduced levels of housebuilding relative to demand; and low interest rates and inflation. The last allows larger loans relative to income, known in the jargon as solving the problem of front-end loading.
More important, however, has been the fall in long-term real (after-inflation) interest rates. Since 1997, real rates have dropped from 4% to under 2%. Other things being equal, he argued, this could justify an increase of up to 70% in the ratio of house prices to incomes.
Nickell examined what the Bank would have had to do to prevent the housing boom’s final phase, and concludes the MPC would have had to raise rates in 2002 by three percentage points. Instead of 4%, the rate would have had to be 7% and kept there. I have no quarrel with that. What I do doubt is his assertion that this would have cut economic growth by a mere 0.5 percentage points the following year. If that’s what the Bank’s economic model shows, no wonder it has been overestimating growth. Such a rate rise — bigger than since the early 1990s — would surely have tipped us into recession.
