Select Committee on Treasury Fourteenth Report


The limitations of prediction

14. It is notoriously difficult to predict trends in world economic development. Globalisation has suffered significant reverses in the past, most notably during the period between the two World Wars.[42] Twenty to thirty years ago Japan seemed central to prospects for globalisation, but the Japanese economy subsequently stagnated.[43] The then Chancellor of the Exchequer pointed out to us in June 2007 that:

    Nobody would have thought in 1997 that the Chinese or the Asian effect on consumer prices would have been as big as it has been and nobody can be absolutely sure what the effect of this will be with changing Chinese labour prices and so on over the next 10 years.[44]

The difficulty of foreseeing the main trends of globalisation in recent years even a decade ago serves to highlight the dangers in making confident predictions about the future. In this chapter we explore three areas of risk relating to globalisation. We then turn to evidence on the prospects for the Chinese and Indian economies, which have been the largest single drivers of global economic growth in recent years, before making some concluding observations.

Trade and protectionism

15. A significant aspect of recent world economic growth has been the strength of the multilateral rules-based trading system, illustrated by the accession of countries such as China, Taiwan and Saudi Arabia to the World Trade Organisation.[45] Nevertheless, there are still substantial barriers to trade in processed agricultural produce and services, and agreement on the reduction of those barriers is still awaited as part of the current Doha Trade Round. Both Mr John Hawksworth of PricewaterhouseCoopers and Mr Stephen King referred to the risks to globalisation, and to open trading economies such as the United Kingdom in particular, from a growth of protectionism.[46] Mr Peter Oppenheimer of Goldman Sachs and Mr Jens Tholstrup of Oxford Analytica also highlighted the adverse effects the failure of the Doha Trade Round would have on economic growth in the poorest developing countries.[47] The Treasury has highlighted evidence of increasing use of anti-dumping measures, particularly by emerging market countries.[48] In March 2007 the then Chancellor of the Exchequer told us:

    if protectionist forces were to rise in Europe and in America and indeed in every part of the world, then the rate of world trade growth would slow, the effect on an open economy like ours would be significant, and equally of course the possibility of developing countries, which need to benefit from the opening up to trade to be able do so, would be restricted.[49]

There are signs of increasing protectionist sentiment, in Europe and, not least, in the United States of America. In the long-term, open markets best serve the interests of the global economy, and an increase in protectionist measures, and a retreat from multilateral trade agreements, would endanger the progress of globalisation and have an adverse impact on economic development in the United Kingdom and other nations.

Unwinding of global imbalances

16. Another risk to globalisation arises from a disorderly unwinding of global imbalances. The USA has maintained a strong dollar, despite a 7% current account deficit. This has been made possible by other countries, especially in Asia, buying dollar-denominated assets. A rapid fall in the value of the dollar could exert significant inflationary pressure in the USA, with adverse consequences for the global economy.[50] The Government has noted the IMF's assessment that a smooth, market-led unwinding of these imbalances is the most likely outcome.[51] Mr Hawksworth also suggested that the increased capital flows associated with globalisation meant that the world economy could cope with larger current account imbalances than in the past.[52]

17. Professor Danny Quah of the London School of Economics told us in June 2006 that he considered the risk from a disorderly unwinding of global imbalances to be huge and Professor Anton Muscatelli of the University of Glasgow saw such an unwinding as the "biggest risk" to the United Kingdom economy.[53] The Government has acknowledged the uncertainty:

    although globalisation is likely to be resilient to all but the most severe occurrence of these threats [from global imbalances] … the future is uncertain and the risks to globalisation are increasing.[54]

The Government is correct to note the risks to globalisation that would arise from a disorderly unwinding of global imbalances. While the probability of such a disorderly unwinding may seem low, its impact on the global economy, and on that of the United Kingdom in particular, would be very considerable.

Environmental pressures

18. A third area of risk to globalisation relates to environmental pressures. Economic growth in non-OECD countries, most notably China and India, is expected to lead to significant increases in global energy demand, with the non-OECD share of total energy demand projected to reach half of the global total by 2015.[55] Such increases in demand for natural resources create environmental pressures, not least relating to climate change. Professor Sen considered that international agreements on the environment had to address the problem of "historical fairness"—namely, that many developed nations attained their level of development without unduly considering the impact of their economic growth on the environment, so that it would be unfair of them subsequently to seek to restrict the growth of developing nations on the basis of environmental concerns.[56] Professor Eric Neumayer of the London School of Economics and Political Science thought that western countries including the USA had to take the lead in action on climate change.[57] We will be considering actions against climate change when we report separately on Climate change and the Stern review: the implications for HM Treasury policy on tax and the environment, but it is evident that environmental pressures have the potential to act as a constraint upon globalisation in coming years.

Prospects for the Chinese economy

19. From our visits to the USA in the current Parliament it has been evident to us that, for many in the USA, the debate about globalisation is fundamentally a debate about the economic role of and prospects for China. There are several reasons for the centrality of China from the US viewpoint. First, as we have already noted, China has been the largest single driver of global growth in recent years.[58] Second, there is a widespread view in the USA that Chinese exchange rate policy and its consequent strong trading position, are a source of global instability. Third, substantial investment in both public and private sector assets in the USA originates from China. Fourth, there is an ideological undertow to US-Chinese economic relations: China, unlike the models of the United States, the European Union and India, is not pursuing capitalism and democracy hand in hand, but promoting the former without the latter; as Mr Stephen King noted, "other countries keen to get on the development ladder will regard China as an alternative to the so-called 'Washington consensus'".[59] China has sought to strengthen its bilateral relations with African countries. We received evidence suggesting that this activity could encourage the exploitation of resources rather than creating a sustainable economic infrastructure in Africa, leading to the risk of a backlash from African countries and with potential adverse effects on economic governance.[60]

20. The continuation of the current strength of the Chinese economy is far from guaranteed. A number of structural weaknesses and risks have been identified:

  • a large role in the Chinese economy, and in the associated social welfare system, is played by State-owned enterprises which are heavily subsidised and increasingly uncompetitive;[61]
  • the Chinese banking system is burdened by its links to those State-owned enterprises;[62]
  • businesses in China could encounter difficulties in shifting from being successful mass manufacturers to becoming innovators and leaders in technology;[63]
  • weaknesses in the Chinese legal system threaten its economic growth, for example by failing to protect intellectual property rights;[64]
  • the increasing openness of the Chinese economy, particularly in terms of capital and trade flows, and the extent of its foreign direct investment make it more susceptible to global shocks;
  • growing economic and social inequality could lead to social instability, threatening economic growth;[65] and
  • the ageing population could act as a drag on Chinese growth in the longer term.[66]

21. There are reasons to believe that China may well be able to surmount or sidestep some of these difficulties and maintain high levels of economic growth, at least in the short- to medium-term. As already noted, China is making a huge investment in its future workforce through education and skills training.[67] China is now the third largest investor in research and development in the world, increasing the intellectual input into its production.[68] Sir Martin Sorrell detected a growing confidence in China, and a greater capacity to listen and learn.[69] He also pointed to the Chinese commitment to the work ethic, referring to results of surveys in different countries that had been announced at the World Economic Forum in January 2006:

    One of the questions posed to parents of children in each country in the analysis was: 'Do you think it is important to teach your children to work hard or that hard work is an important thing?' In Denmark 98% of those interviewed thought it was not important to do so. In China 98% of parents thought it was important. These are different value systems.[70]

In 2005, the Treasury predicted that "China's rapid growth in real GDP is likely to be sustained over the next couple of decades, although some deceleration from the past 9% per annum trend is likely".[71] The Treasury pointed to forecasts that China would account for 19% of global output in 2015, compared with 13% in 2003, weighted by purchasing power parities.[72] Sir Martin Sorrell pointed out that China was proving an increasingly important base for many multinational businesses.[73] In June 2007, the then Chancellor of the Exchequer told us that "I believe that the Chinese growth will almost certainly continue".[74]

Prospects for the Indian economy

22. In the near future, rates of growth in the Indian economy are forecast by the IMF to fall slightly from the rates above 9% seen in 2005 and 2006.[75] There are a number of threats to continued high levels of growth in India in the future. Mr Hawskworth thought that India's public finances and lack of infrastructure in water and energy could constrain its economic growth in the short run.[76] Mr Wolf emphasised that India was already facing severe bottlenecks in skilled labour.[77] During our visit to India, we were told that integrating India's economy with the rest of the world had made it more susceptible to external shocks.

23. However, there are significant strengths in the Indian economy which support the contention that the long-term prospects for India's economy may be brighter even than those of China. Mr Tholstrup argued that India's reliance on services could be to its advantage, reducing its need for raw materials from abroad.[78] India is an increasingly significant international investor, particularly within the United Kingdom.[79] Mr Hawksworth noted that India's working population was forecast to grow by about 1% per annum between now and 2050.[80] He thought that, provided India could maintain its growth-friendly policies, its economic prospects up to 2050 were stronger than those for China.[81]

Prospects for other economies

24. China and India are the leading lights of the latest phase of globalisation, but they are arguably simply the leaders of a wider trend for the Asian economies to play a far greater role in the world economy. Within Asia, strong growth is by no means confined to China and India: the IMF predicts average growth rates in developing Asia excluding China and India of 6.0% in 2007 and 2008.[82]

25. We were also told about many other countries, regions and economic categories of countries with encouraging prospects for growth and integration in the global economy. Mr Oppenheimer told us that Goldman Sachs argued for consideration of Brazil and Russia alongside India and China because "Brazil and Russia … like India and China … have vast populations and the ability to harness resources, both human and physical, to generate very strong growth".[83] Sir Martin Sorrell also identified Russia and Brazil, along with Indonesia, as important markets for future business expansion.[84] Energy-producing nations stand to benefit from high resource prices.[85] In the case of the Middle East, and the Gulf States in particular, economic growth is not simply the result of oil production: the Gulf is becoming a very important and fast-growing financial centre.[86] During our visit to Dubai, we learned how Dubai is developing as an international "hub" economy, connecting China and India with Europe and the east coast of the USA, and how its government is attempting to use its large Indian community to build business links with India, as well as promoting increased trade with China. The list of countries with the potential to see significant economic advances in coming years is long. Mr Oppenheimer identified Bangladesh, Egypt, Indonesia, Korea, Mexico, Nigeria, Pakistan, the Philippines, Turkey and Vietnam, for example, as countries that were embracing and benefiting from globalisation to generate very strong growth.[87]

Overall prospects

26. Some witnesses argued that the growth of India, China and other emerging economies represented a fundamental shift in the balance of power in the world economy. Mr Oppenheimer of PwC told us that "it is no longer a world economy that is dominated by the OECD economies … a broader range of economies are now important … [and] are taking an increasing share of global GDP and global trade".[88] The Government expects China and India to play a greater role in the global economy and for the G7 countries to play a smaller role in the future: by 2015, it is estimated that China and India will account for 26% of world output, and the G7 for 36%.[89] In 2003, Goldman Sachs projected the growth of various countries to 2050, with the assumption that those countries maintained and developed policies that were supportive of economic growth: China was projected to become the second largest economy in the world by around 2020 and to overtake the USA to become the world's largest economy by 2050, with India projected to be the third largest economy after China and the USA by that date.[90]

27. In the sixteenth century, China and India were the world's largest economies.[91] Sir Martin Sorrell argued that recent developments reflected a large-scale swing reversing the trend towards western dominance since the Industrial Revolution:

    Two-thirds of the [world's] population will be in Asia by 2014. I believe the shift in wealth from West to East is an inexorable process: there is a 200-year historic swing. … If you look back there are economists that have theories about long-term cyclical swings and I think most of them have stopped at 50 years. I think this is a 200-year swing … If you go back to the early 19th century, China and India accounted for about 49% of worldwide GNP. By about 2015 or 2025, or whatever the date is, China and India will yet again account for about 40% of worldwide GNP. I think this is an inexorable swing that you cannot reverse.[92]

Overall, Sir Martin Sorrell was especially pessimistic about the prospects for western Europe as a result of the growth prospects in Asia:

    I think the world is growing at three speeds: Asia and those other areas I just mentioned that have the fastest growth; the US which is middle range; and poor old western Europe, about which … I remain somewhat cynical and very concerned about. There is less significant strategic and structural change … Unless there is significant strategic and structural change, I think Western Europe will lag the other areas of the world.[93]

28. Convincing evidence is emerging that an inexorable shift in economic power from West to East is underway. It is unlikely that any national economy will follow a steady and predictable growth path over a twenty to fifty year period, but there is a strong likelihood that western economies, including that of the United Kingdom, will play a diminishing role in the global economy over time, and that China, India and other emerging nations will play a growing role. This will have policy implications because of different operating regimes in those countries. Although much public and political attention has centred on China, in the longer term, India is especially well-placed to be a powerhouse of the global economy in the middle part of the twenty-first century. The shift in economic power from West to East poses fundamental challenges for economic policy-makers in the United Kingdom in relation to communities and their economic prosperity and employment prospects.

42   See paragraph 6. Back

43   Qq 26, 303 Back

44   HC (2006-07) 299-I, Q 448 Back

45   Long-term opportunities and challenges, para 4.14, pp 50-51 Back

46   Qq 217, 25 Back

47   Qq 227, 239 Back

48   Long-term opportunities and challenges, para 4.43, p 61 Back

49   HC (2006-07) 389-II, Q 242 Back

50   HC (2005-06) 875, para 6 Back

51   Treasury Committee, Second Special Report of Session 2006-07, Globalisation: the role of the IMF: Government Response to the Committee's Ninth Report of Session 2005-06, HC 52, p 1 Back

52   Q 254 Back

53   HC (2005-06) 875, para 8 Back

54   Long-term opportunities and challenges, para 4.46, p 61 Back

55   Long-term opportunities and challenges, para 3.49, p 34 Back

56   Q 315 Back

57   Q 299 Back

58   See paragraphs 11-12. Back

59   Ev 137 Back

60   Q 239; Ev 167 Back

61   HC (2004-05) 314-i and ii, Q 15 Back

62   City of London, Scenarios for India and China 2015: Implications for the City of London, Oxford Analytica and Sami Consulting, October 2006, pp 3-4 Back

63   Q 232 Back

64   HC (2004-05) 314-i and ii, Q 19 Back

65   Qq 6, 7 Back

66   PricewaterhouseCoopers, UK Economic Outlook, March 2006, p 22 Back

67   See paragraph 11. Back

68   HC (2004-05) 314-i and ii, Q 17 and Ev 20 Back

69   Q 330 Back

70   Q 331 Back

71   HC (2004-05) 314-i and ii, Ev 49 Back

72   Ibid., Ev 51 Back

73   Q 322 Back

74   HC (2006-07) 299-I, Q 449 Back

75   WEO 2007, Table 5, p 217 Back

76   Q 231 Back

77   Q 81 Back

78   Q 233 Back

79   Long-term opportunities and challenges, para 4.17, p 51 Back

80   Q 231 Back

81   Ibid. Back

82   WEO 2007, Table 5, p 217 Back

83   Q 236 Back

84   Q 330 Back

85   Q 38 Back

86   Q 238 Back

87   Q 236 Back

88   Q 213 Back

89   Long-term global economic challenges, para 3.5, p 22 Back

90   Goldman Sachs, Dreaming with BRICs: The path to 2050, 2003 Back

91   Long-term opportunities and challenges, para 4.8, p 48 Back

92   Q 320 Back

93   Ibid. Back

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