China and India can make a better world

Paul Keating, The Straits Times, Asia News Network,Singapore

We are now in the 23rd year of the current long wave of economic growth. In the two previous long waves of the 20th century, 1904 to 1929 and 1947 to 1974, after about 25 years, the forces of technology which drove them and the macroeconomic conditions which sustained them, gave way to a less defined and uncertain period. During this time, no coordinated world growth was evident.

The long wave wind-down becomes apparent when productivity slows and inflation begins to accelerate, when profits shrink and employment closes down. The current long wave is unusual in that productivity has intensified as it has gone along, holding down inflation while lifting real incomes and cutting unit labor costs.

There were portents not long ago that deteriorating demographics in most Organization for Economic Cooperation and Development countries would see the real price of labor rise and, lead, in the presence of slowing productivity, to inflation. As this scenario unfolded, so the argument went, central banks would reach for the monetary lever and curb demand, so as to achieve a better balance between supply and demand.

But much of this has not come to pass. Not yet at least, because of other large and important factors at play in the world.

One is that inflationary "rich world" labor has run into a wall of deflationary supply from countries such as China and India. The outcome has been to moderate inflation globally. Developments in China and India hold out the promise of changing the patterns of earlier long waves, extending the current business cycle.

Another development concerns the aggregate imbalance between saving and spending. It is no news that we are seeing something of a paradigm shift in the price of money. Yields on United States 10-year government bonds have fallen over the past year to only 4.16 percent, compared to an average of just under 5.5 percent since the mid-1990s.

U.S. Federal Reserve chairman Alan Greenspan has encouraged the idea that there is a cyclical "global savings glut". That could in part explain the low bond yields, especially in the context of the mercantilist policies of the Chinese government and the propensity of Japan to buy dollar assets to keep its currency competitive.

Mercantilism grows from a "survival of the fittest" hoarding policy. This puts faith in national balance of payments surpluses where "state" action and state control over macroeconomic life transcend otherwise private instincts, such as to use available capital for investment in such things as housing and higher levels of consumption.

We have seen China's burgeoning output and competitiveness reflect itself in ever increasing levels of national reserves. These reserves passed the US$500 billion mark last year, and stood at $711 billion in June this year.

The peg of the yuan to the U.S. dollar in the context of a falling greenback gave China an extra competitiveness which let it dominate goods markets wherever it chose to exert itself. Coupled with the interventionist policies of the Bank of Japan in seeking to slow the dollar's slide, these two neighbors racked up a high proportion of the world's surplus savings.

Between 2002 and last year, roughly 45 percent of the net funding of the U.S. current account deficit came from central banks, predominantly in Asia. Indeed, in that period the foreign reserves of surplus countries rose by over $1.5 trillion to just under $4 trillion.

What should occur is for surplus countries to diminish their surpluses, while in deficit countries spending takes a breather to let savings catch up. This was not happening, until last month when the central bank of China announced that it would change the exchange rate regulation mechanism from a peg to the U.S. dollar to a peg to almost everything else.

Putting one's currency in the market to be priced is very much like riding the tiger's back. But if the economic fundamentals are good and the macro economy well managed, private transactions end up in balance and the arbitrage opportunity for hedge funds and the like evaporate.

On the strategic front, China is already imbibing the confidence of its growing power as it better aligns its foreign policy with its trade policies.

Much of China's confidence comes from knowing what it is. It sees itself as being at the epicenter of a growing and cooperative community of East Asian states. In this grander view it is likely that China, displaying some real magnanimity, will do more for its neighbors than its neighbors, left to themselves, would do for it. And by its wisdom, in opening itself up to the region around it and locking in structures, underwriting the longevity of its own reformation.

For instance, its encouragement in the development of ASEAN Plus 3, which is in effect, China plus 2 plus ASEAN, with now possibly Australia, shows the kind of schematic China is seeking to lay out.

You will notice in these arrangements, there is no place for the U.S. The two big dogs on this particular pavement are China and Japan, and it is they who will run it. Gradually, strategic issues will come onto the table, providing a further extension of Chinese policy ambitions.

India is a different case. It straddles the subcontinent, it has perennial tensions with Pakistan, though culturally, it seems able to work these crises through. Now, of course, both are nuclear-armed, which is a real worry.

India came up in the world recently when Prime Minister Manmohan Singh was granted U.S. technological cooperation on peaceful development of nuclear power. This was seen as the U.S. taking India more seriously, which it was. The problem is that the U.S. is ingratiating itself with India as a way of belatedly balancing off China's influence in the region.

The U.S. should have taken India more seriously many moons ago, most particularly as the Cold War ended in 1990. The U.S. has waxed and waned in its relationship with India and maybe, just maybe, it now sees the opportunity of India joining China as the other important new motor in the global economy.

India, it seems, has also decided to help itself. Its otherwise autarchic structure is giving expression to private initiative which in the past would have offended its London School of Economics precepts and public ethics. Globalization and trade are devices to accelerate national income but nothing beats helping oneself.

The economists say that population is the principal driver of GDP, and maybe that penny has dropped for U.S. policy makers.

At any rate, what is happening in India and China knows no precedence in world economic history. Two-and-a-half billion people lifting themselves from poverty, and at a solid pace. Not even in the Industrial Revolution in America in the 19th century did we see anything on this scale.

In the new international division of labor, India holds out the promise of being able to do to services markets around the world what China has done in goods markets. India's long and solid investment in education is paying off in the kind of value- added services the world is hungry for. I do not simply mean call centers. Rather, true intellectual value-adding of a kind that takes advantage of the connectivity of the Internet, telecommunications and the magic of microprocessing.

A better world order should include India and China more front and center in world affairs. Globalization is increasingly going to be a non-Western phenomenon allowing these former developing states to mark themselves out from strong positions.

The writer was prime minister of Australia from 1991 to 1996. This article is adapted from a speech he delivered by satellite to an IBM-organized forum in Singapore last Wednesday.