China and India were once the richest and most populous regions of the world. In terms of per capita income they were overtaken first by Western Europe and the USA, and then by some East Asian countries such as Japan and South Korea. This process has now gone into reverse and per capita incomes in China and India are increasing rapidly. Barring some catastrophe, it seems inevitable that within a few decades China and India will once again have the largest economies in the world. Depending on how total production is measured, I predict that China will overtake the USA between 2018 and 2025, and India will overtake between 2040 and 2054.
What do these developments imply for today’s advanced economies? There has been extensive debate about China’s huge trade surplus, but in the medium term, this is likely to shrink spontaneously through a combination of domestic inflation and lower savings.
In discussing the impact of China and India it is important to distinguish between relative and absolute effects. In the military and political sphere, power derives from relative economic strength. As China and India catch up with the USA in terms of total production and technological sophistication, their military and political influence will increase accordingly.
China has recently developed its own J-20 stealth-fighter and the Dongfeng 21 D ballistic missile, which could potentially be used against American aircraft carriers in the waters close to China – but this is just the beginning. It is an explicit objective of Chinese policy to become a global military power by 2050, yet this aim is likely to be achieved well before then. India is currently less ambitious, but the underlying logic is the same. As China and India grow, their influence in international bodies like the IMF will increase and they will start to reshape world economic and financial architecture. These developments will ultimately destroy Western hegemony.
The rise of China and India will lead to the relative decline of the West, but what does this imply in absolute terms? There is no necessary correlation between absolute and relative decline. For example, Britain has been in decline as a global power for around a century, yet during this time our per capita income has risen dramatically. However, there are certain areas in which the growth of China and India may damage us. There are also potential benefits.
On the negative side are higher prices for some of our major imports and also atmospheric pollution. Over the past twenty years, advanced economies have imported vast amounts of clothing, electronic and other labour-intensive goods either produced or assembled using low-skilled Chinese labour. As China develops it is moving into more knowledge-intensive activities and within a couple of decades it may no longer be a source of cheap labour-intensive goods. Consequently, the advanced economies may be forced to switch to more expensive sources of supply, including perhaps India for a time.
It is difficult to put a figure on what the cost of such a shift will be. If all manufactured imports from China were replaced by goods costing twice as much, the total loss to advanced countries would be approximately 2% of GDP. If spread over several decades such a loss could be absorbed without much difficulty.
A more serious blow might come from higher commodity prices. World consumption of food, minerals and energy has been on a strong upward trend, due in part to increased demand in China and India. This is reflected in commodity prices which have risen dramatically over the past decade. In real terms the increase in prices has been greatest for oil and minerals. The real cost of food has also risen although it is still much lower than in 1980. Trends in energy use are reflected in C02 emissions: China is now the world’s largest emitter of C02 and Indian emissions, although much lower, are increasing fast.
Commodity prices are notoriously hard to predict. In the short-run prices are highly unstable and long-run trends are hard to identify. However, given the huge scale of future demand from China, India and other countries such as Brazil, it seems likely that real commodity prices will increase. To pay for a given volume of imported commodities, the advanced countries may have to export more of their own goods and services than they did previously. Before the crisis in 2007, the cost of imported food, fuels and minerals ranged from 4% of GDP for the USA to over 6% for Japan. The average was 5% of GDP. This would be the loss if all such imports were to double in price.
Serious shortages of food, minerals and energy would drive up prices dramatically, constrain global growth and cause serious disruption. Although past predictions of impending scarcity have often turned out to false, they may prove correct in the future.
The picture is not all gloom. As China and India develop, the global resources devoted to science and technology will increase. Many of their discoveries will diffuse throughout the rest of the world and become available for use by others. Just as China and India import technology from us today, we shall import technology on an increasing scale from them in the future. In this way, their economic development may ultimately contribute to higher living standards for us.
By increasing the global resources devoted to R&D they may also promote the discovery of technologies that are more environmentally friendly and able to mitigate the otherwise harmful effects of economic and population growth. China is already the world’s largest manufacturer of solar panels, and a joint US-Chinese research team is currently working to accelerate the development of coal liquefaction, emissions capture and carbon storage technologies. As China emerges as a great centre of science and technology, it will be taking up a role which it played centuries ago as a leading industrial innovator. India was never so important in this respect, although at one time it was an innovator in certain fields such as mathematics.
However, the entry of China and India onto the world stage will provoke structural changes which will be extremely painful for particular subgroups of people in today’s advanced economies. As China and India develop, their exports will become more sophisticated and they will become powerful competitors in areas where the existing advanced economies currently enjoy a near monopoly. This will include not just manufactured goods, but also IT-related services where India already has a strong presence. As a result, many firms in advanced economies will go out of business or be forced to shed labour in the face of this new competition. Other firms will prosper as they exploit new export markets in China and India.
As always, there will be winners and losers. The mass importation of cheap clothing and the like from China has been beneficial to consumers in the advanced economies, but it has destroyed the livelihoods of millions in those countries who used to produce such items. The off-shoring of services to India could have a similar effect in the future.
Economists tend to regard these effects as temporary adjustment costs, but the modern experience of deindustrialisation indicates that the effects of structural change may last for generations and be very painful to the communities involved. Dealing with structural change in a humane fashion may in fact be one of the greatest economic challenges posed by the renaissance of China and India.