With their GDP expanding rapidly, both China and India (who account for 38 % of the word population) have the potential to become leading economic powers in the decades to come.
China is already the fourth economic power (and even the second if one computes GDP on a purchasing power parity basis) and India’s working population will be the strongest and the youngest in the world in 2020.
How is Europe, as compared with the US, adjusting to this spectacular change in the world economy ?
In touching briefly on this wide and complex subject, I shall focus on three main topics :
1. immediate reactions from Europe and the US on trade issues ;
2. medium term perspective : how are Europe and the US preparing for the challenges posed by the very low unit labour costs prevailing in the two rapidly integrating Asian countries ?
3. globalization is a two way process. Many stumbling blocks are still to be removed on both sides.
I. Immediate reactions on trade issues :
1. China seems to attract more protectionist reactions from the US than from Europe :
Indeed, the rising trade surplus of China vis a vis the US (close to 200 billions dollars in 2005) is significantly higher than the one with the eurozone (51,8 billion euros in 2004). And Europe, contrary to the US, has no external global imbalance. But the European trade deficit with China is rising fast (from 31,8 billion euros in 2002 to 73 billion -estimates- in 2005).
Perhaps more significantly, the share of Chinese goods in total US imports has increased dramatically (from 8,6 % in 2000 to 13,8 % in 2004), while the figures are respectively 2,8 % and 4,2 % for the European Union.
Still, Europe has not witnessed the type of “Schumer amendment” reactions that one can observe in the US (although there have been limited European quota restrictions, for example, on clothing goods in 2005 and shoes and auto parts more recently).
It is likely that the structure of European exports to China (where capital goods, -aircraft, transportation, energy equipment…- feature predominantly) explains, to some extent, this difference in trade deficits as well as in reactions (the US exports being more geared to services, finance, electronics… for which China’s market is more difficult to access).
But Europe is not monolithic in this respect. Germany -followed by Sweden and Italy- has been the best performer during the period 2000-2005 (it has actually gained significant market shares -more than China- in the most dynamic sectors of manufactured exports), while France has lost market shares. The biggest “losers” have been the UK (nearly as bad as the US). See table I appended.
Be it as it may, Europeans do not generally consider that the exchange rate is a major political issue, although the undervalued Yuan affects the European economy in the same way as it does the US (even more so, because of the weakening of the dollar against the euro which has compounded competitive conditions in Europe).
As a side remark, I would like to observe that many European economists doubt whether a re-evaluation of the Yuan (barring an extreme adjustment) would impact significantly the US-Chinese trade relations. Indeed the US industrial manufacturing output -which has shed a large part of its traditional production- proved to be very rigid since the mid 90’s and has not reacted much to increases in domestic demand. How would it react to a change in the Chinese exchange rate? The answer is not obvious. It may well be that an increase in domestic demand in China (which would, in principle, be encouraged by an appreciation of the Yuan that would tend to reduce prices and boost households incomes) would, eventually, be met by an increase in Chinese production and not by an increase in US exports, given the over-investment and the low costs of the Chinese economy.
But this is not to say that exchange rate flexibility and adjustments are not called for. They are. However, one should not overestimate their impact.
2. India is a different case in point :
Contrary to China, India is running since 2004 a current account deficit which amounted to 13,5 billion dollars in 2005 (i.e. close to 2 % of GDP) and is projected to reach 3 % of GDP in 2006/2007. Furthermore, its trade integration is significantly lesser than the one of China .
Therefore, India is not seen as a threat but as a country that is opening up gradually and where European exports and FDI are developing.
The public debate is more in the field of services off shored to India -which has a highly qualified and skilled English speaking labour force- by multinational corporations (in all sectors and in particular in investment banking ). Here, it is Europe that seems to react with more anxiety than the US.
But a recent study by the McKinsey Global Institute (MGI) shows that service off shoring has a strong potential to increase value, not only for the emerging countries where jobs are created, but also for the countries that outsource. In 2003 and 2004, the MGI has published reports that suggest that the US derives more positive benefits from services outsourced than Germany. This is mainly because labour market flexibility and adaptability are much higher in the US . From 1992 to 2000, service off shoring accounted for around 11 % of the productivity growth in the US manufacturing industries.
This is an illustration of the fact that the economic impact of globalization in industrialized countries is all the more significant and a matter of concern where economic reforms are lagging.
II. A medium term perspective : Europe and the US face the challenge of low wages in China and in India :1. The challenge :
These two emerging countries are a huge reservoir of cheap and hard working labour. The supply of that labour force entering the international “tradable” economy has trebled over the last three decades. This gives China and India a significant comparative advantage over more mature economies with high wages , but also over other emerging economies with somewhat higher labour costs .
The case of Turkey is interesting in this regard. In 2005, Turkish exports of textile garments have proven resilient and have increased by 4 % in volume terms. However, imports of textile items in Turkey have increased significantly faster (+ 10 % in volume terms). These trends have considerably accelerated over the first months of 2006. Indeed, the period January-February 2006 compared with January-February 2005, one can observe – 15 % for Turkish exports of textile garments versus + 44 % for similar imports. This evolution suggests that competition on external markets is getting more intense and that the Turkish industry of textile intermediary products is under severe competition on its domestic market. More generally, the trade deficit of Turkey vis à vis Chine has considerably increased, reaching 6,3 billions US dollars in 2005 (versus 1,2 Billion US dollars in 2000).
But the world is not perfectly integrated and a number of countries and regions with relatively high wages will continue to thrive, whilst compensation costs, especially of skilled labour, will inevitably increase over time in emerging countries. This is already happening in Central and Eastern Europe where a shift of FDI-production is taking place towards Asian countries. And this is starting to happen even in China where one has observed recently a “double digit” increase in labour costs, compounded by higher energy costs. Beneficiaries of Chinese rising prices in the textile sector are India, Bangladesh and Cambodia .
It remains that labour cost differentials are staggering : average unit labour costs per hour in China accounted for 60 cents in 2002 against 24 $ in Germany (who remains nonetheless the strongest exporter of manufactured goods in the world), 22 $ in the US and 17 $ in France.
How should high income countries react to this formidable shock ?
2. The answers :
The protectionist temptation is present everywhere, in the US as well as in Europe (albeit perhaps less politically vocal in the latter).
But we know that this answer is not the proper one : blocking or taxing imports of cheaper foreign goods in order to keep high standards of living at home, is not a lasting solution.
The true solution, for high income countries, is to focus on productivity gains, on high value added industries and services, innovation, human capital and technology. Even in the textile industry, which is one of the first hit by far East Asian competition, traditional producers are not condemned. Italy, France, Spain and others have shown that quality, design, reactivity, are the keys to resilience. This is, of course, also true for a country like Turkey.
There is no doubt, of course, that the industrialized countries will suffer (and are suffering) from a lessening of job opportunities in labour intense manufacturing industries while they benefit from the lower costs of imported goods. It is also true that high income countries will also be negatively affected by rising costs of commodities (themselves influenced by the high growth of emerging countries).
The challenge for the higher income countries is, thus, to promote innovation, research, energy conservation, skilled labour (including selective immigration), training, and to orient unskilled workers towards non tradable goods and services. Policies should encourage domestic consumption of non tradable goods and services and discourage unskilled labour immigration, as well as they should reduce taxes on unskilled labour incomes….
Here also, we see that the adjustment process much depends on governments ability to reform. In this respect, the fact that structural reforms in Europe (Lisbon Agenda) are lagging will only compound the consequences of the impact of globalization.
The US, because of the adaptability of its economy, its high productivity growth, and its strong domestic demand as well as its ability to borrow abroad in its own currency and its apparent indifference to external imbalances may well be better placed than Europe in this respect. The US, in spite of its major losses in world exports has maintained a much more dynamic economy (4,7 % unemployment and a 3,5 % growth rate) than Europe (more than 10 % unemployment and a growth rate of 1,5 to 2 %).
However, US growing imbalances cannot continue for ever and the very large portion of the US public debt held by the Chinese authorities adds a potential element of vulnerability and political tension between the two countries.
III. But globalization is a two way process. Many stumbling blocks are still to be removed on both sides :1. Competition is moving toward high technology :
The problem is getting more complex : indeed, countries like China and India are not only destined to export cheap consumer goods. They also are joining the group of high technology producers and exporters, and are determined to be present worldwide on all the segments of the production chain.
China is intensifying its efforts to expend its investments aboard : in Africa, in Asia, in Latin America, with the aim of securing its sources of commodity and of diversifying its export markets.
This growing technological intensity of industries in China and India is under way . Many equipment contracts won by western firms include clauses on the transfer of technological know-how. Joint ventures and partnerships have accelerated this evolution : they are actually the new form of technological transfer. This phenomenon sometimes generates reactions particularly in Europe where high technology is very much the core of its exports.
A recent example of dilemmas faced by large companies and of their different reactions to this phenomenon is provided by the bidding process in China related to four 3rd generation nuclear plants. Westinghouse appears as having a competitive edge, basically because it seems ready to sell the know-how pertaining to this new technology which will allow China to produce the next wave of those reactors. The French company, Areva, doesn’t seem to wish to make that concession, because it wants to keep its technological advantage for other developing markets.
Be it as it may, transfers of technology are taking place constantly (automotive industry, energy, aircraft, high speed trains…). The growing competition in these industrial fields of excellency and innovation, which were (up to now) the core of the European comparative advantage, is bound to lead to some protective reactions, although many multinational companies understand that partnerships are inevitable and desirable. In this respect, one should have in mind that a large part of Chinese exports to the US and other countries is produced by Japanese and western firms operating in China .
One can also observe defensive reactions vis a vis certain takeovers attempted by emerging markets firms (Mittal Steel of India on ARCELOR, CNOOC of China on UNOCAL,…). But there is no doubt that such foreign direct investment initiatives from emerging countries will intensify in the future. Why, indeed, should these countries export and keep their money in US Treasury instruments, while they could make a more productive and strategic use of their surpluses ? However, tensions will inevitably occur and one should not underestimate their political dimension.
2. The globalization process must function both ways :
Similar protective reactions are also manifest in emerging countries themselves. India and China are opening up to foreign direct investment , but there are still significant limitations to foreign investment and to open trade (i.e. unfair “local content “ rules through complex tariff systems) in some of those countries. One can also observe negative reactions especially in China, to what is sometimes perceived as a takeover of important economic sectors by foreign, and in particular Japanese, companies.
These reactions are not surprising. Indeed, one should not underestimate the impact of globalization and liberalization on the emerging economies themselves.
Multinational companies are already widely integrated : barring strategic dilemmas on technological transfer as noted above, they tend to choose, on a “ricardian” basis, the most efficient sites for their production units and they outsource and off shore according to a global strategy based on maximized profits. But governments have the tough responsibility to manage politically the domestic consequences of the formidable transformation that is taking place in international competition and that is far from having exhausted its consequences. Let us hope that the benefits stemming form open trade -even if they are not evenly distributed, even if positive (indirect) benefits are sometimes difficult to detect, even if certain groups and sectors are bound to lose at some point in time- will be the predominant element in decisions taken by governments.
In this respect, a meaningful progress in the Doha Round -based on a balanced set of measures pertaining to goods but also to services- would give the right signal. India, still a deep rural country, rightly insists, for example, on the necessary elimination of agricultural subsidies granted to their producers both by the US and in the European Union. But what is also needed is a move towards the liberalization of services (investments, telecoms, finance, transparency in public bidding, protection of intellectual property), and the fight against counterfeiting....
Therefore, structural reforms and initiatives are called for on both sides.
