Toward Shifting Wealth Phase II

More than 30 years after the integration of the Asian giants with the world economy has started, it is imperative to disentangle the effects of the initial entry of China and India into world markets (Shifting Wealth I) from the development effects on low-income countries that would arise should they be able to sustain their superior growth (Shifting Wealth II). The major channels through which development effects have operated have been the global commodity markets and the intra-Asian manufacturing production networks, the associated trade and investment volumes and the indirect income effects arising from changes in relative prices (terms of trade and relative wages). Global second-order effects have been generated through the recycling of China’s current account surplus and through the associated exchange rate and interest rate effects. A superb study directed by David Lubin at Citi, just released in its series Citi GPS: Global Perspectives and Solutions[1], provides plenty of analytical and empirical material that documents China’s impact on what they still call ‘emerging markets’. While the Citi economists are quick to call China’s economy unbalanced in view of the country’s high investment rate[2], it is safe to assume that Shifting Wealth II will go along a rebalanced China that produces more sophisticated stuff and consumes more than in the recent past.

Shifting Wealth Phase I defines the initial opening of China and India to world markets which really became felt from the 1990s – a ‘one-off’ event that integrated 2 bn people or 40% of global labour force in the global market economy. China’s economic openess and manufacturing base created international trade, production and investment networks, escpecially with Asia, while its commodity intensive growth created a ‘China-commodities complex’, especially with Africa, Latin America and some OECD commodity exporters. The impact on developing countries was much deeper than just indicated by actual trade flows as higher commodity prices created very large terms of trade gains and real currency appreciations also for countries (such as Nigeria) with small China orientation in their exports. 

China and India opening to trade increased the share of workers with basic education in the world labour force and lowered the world average land/labour ratio. The relative endowments of other countries were thus shifted in the opposite directions, which tended to move their comparative advantage away from labour-intensive manufacturing (Wood and Mayer, 2012)[3]. The initial entry of China into the world markets, especially from when it joined the WTO, has been supportive of raw material prices relative to manufactures, especially manufactures that embody basic skills only.[4]. Resource based economies reaping the benefits of rapidly expanding demand in China for their commodity exports, at the same time, may also be cursed by appreciating exchange rates, rising labour costs, loss of competitiveness in manufacturing industries and other challenges brought about by the commodities boom. The biggest gains in real effective exchange rates during the 2000s (2000-2011) occurred indeed in those countries that have benefited most from China, if not through direct trade links then through gains in their terms of trade (Nigeria, Venezuela).

The counterpart to rising materials prices were drops in the price for basic-skill manufactures, a result of the  Stolper-Samuelson effect of more than 2 billion people with basic skills being simultaneously integrated into the world economy. China’s competitive threat in particular had led to widespread concerns of China deindustrialising other developing countries, concerns that were confirmed in some semi-industrialised countries such as Mexico, Thailand and South Africa while the majority of low- and middle-income enjoyed higher growth thanks to China’s growth engine[5]. However, the crowding out by China is difficult to disentangle from the limited capacity of some middle-income countries, often in Latin America to engage in a structural transformation conducive to higher productivityBy contrast, emerging Asia offers a few examples of virtuous productive transformations. The development of Asian manufacturing production chains, closely linked with Asia’s high and rising intraregional trade, as manufacturing activities shifted downstream from the more developed East Asian countries. Japan, Chinese Taipeh and Korea were the big drivers of this “downstreaming” of manufacturing. Meanwhile, China is at the heart of Asia’s intra-regional trade, with an estimated 56 percent of Asia’s exports to China being used for processing to re-export to other markets, and the rest for final demand in China,  in 2011[6].

Table 1: The Developing World’s Growing China Dependence

- change in growth rate with 1% change in China’s growth rate-

Countries	Low-Income	Middle-Income	Non-Oil	Commodity
Before 2000 After 2000	-0.26* +0.60*	+0.02 +0.64*	+0.22* +0.42*	-0.30* +0.94
------------- Total	-------------- +0.34*	-------------- +0.66*	-------------- +0.66*	------------------ +0.64*

* denotes 99% significance.

Source: Garroway, et al. (2012),  “The Renminbi and Poor-Country Growth”, The World Economy, 35.3, 273-294.

Overall, the impact of China on developing-country growth performance has been positive, regardless of the country dimension. Both low-income and middle-income countries have benefitted, as did (expectedly) oil and commodity producers but also non-oil countries. While the China-commodity complex easily explains the positive growth connection for materials-heavy countries, it can be presumed that Asia’s intraregional value-chain trade has produced the positive results for the non-oil countries.

Shifting Wealth Phase II defines a long-term process of sustained and superior growth in populous emerging countries that keep accumulating skills, capital and modern technology, build a middle-income class, switch from investment-led growth toward more consumption and export increasingly sophisticated goods and services. As emerging countries succeed in becoming advanced economies, their success will improve export opportunities for the remaining developing countries, which can lead to accelerating global growth. As countries get richer, they experience a demographic transition with a drop in fertility and young age dependence. If differentials of population growth are small between developing and advanced economies, economic development accelerates over time. Both migration and aid from rich to poor countries can support this process. Once China and India become rich and once their poor share the new wealth, over two billion more people will live in countries that import labour intensive goods and fewer in a countries that export them, opening up opportunities for other countries to fill this niche. Their initial opening may have hurt developing countries in the short term, but their sustained growth improves the long-term prospects of low-income developing countries (Chamon and Kremer, 2009)[7].

The trade patterns of rapidly growing countries tend to be quite dynamic. If factors are being accumulated at differential rates, the composition of output can change quite quickly. Given rapidly growing education and production skills in China and India (Woo, 2012)[8],   the Rybczynski theorem suggests that China and India’s skill-intensive output is rising disproportionately. Unlike low-income countries that do not compete directly with China anymore, advanced and middle-income manufacturing exporters compete directly with China in manufacturing exports. China’s average export prices (unit values) place substantial downward pressure on these countries’ prices; by contrast, there is little and melting evidence for price competition between China and low-income countries (Fu, Kaplinski and Zhang, 2012)[9]. The price competition effect of China’s exports weakened over the time period of 1989–2006, suggesting a gradual change in competition from price to nonprice factors such as quality and variety.

 If China continues to converge towards advanced-country per capita income levels, either higher real wages or real appreciation of the Chinese currency will continue to speed China’s structural upgrading. This would further soften the price pressures on low-skilled goods and on low-income countries. At the same time, technological upgrading in China would move China’s price impact from the middle-income countries to the high-income economies. Prosperity in China and other large emerging countries will improve export opportunities for the remaining developing countries, which can lead to accelerating global growth, supported by a demographic transition with a drop in fertility and young age dependence (see Chamon and Kremer 2009). China’s initial opening may have hurt some developing countries in the 1990s, but its sustained growth improves the long-term prospects of low-income developing countries. Table 2 summarises some possible global development effects of moving from Shifting Wealth Phase I to Shifting Wealth Phase II.

Table 2: The Global Development Impact: From Initial Entry to Sustained Growth Effects

Impact Channel	SW I:Entry Effects	SW I Impact on LICs + MICs	SW II: Ongoing Process	SW II Impact on LICs + MICs
Growth Engine	From G7 to China	Higher growth in LIC and MIC, oil and non-oil	Partial rebalancing of growth engine	Higher trade client diversity, while initial specialisation effects weaken
Agg Demand	Investment-led	Stimulated imports of commodities and skill-intensive	Higher consumption share, less investment	Stimulates low-skill imports, skill imports neutral, structural impact on commodity demand (iron ore, copper suffer; food crop prices stagnant/rising)
Factor Supply	Land-labour ratio lower; Skills-labour ratio lower	Better ToT for commodities and skill-intensive; Lower ToT for low-skill manufactures	Skills-labour ratio gradually rising; Land-labour ratio stagnant	Better ToT for low-skill manufactures with new supply/demand balance; Skill- and tech-intensive manufactures face lower ToTs.

The growth engine was switched from the G7 countries to China during Phase I; global rebalancing in view of a lower trade surplus in China and a move from investment driven toward consumption driven growth should imply a partial rebalancing of the growth engine for developing countries – back toward OECD countries and more toward other middle-income countries than China. This should foster trade client diversity for poor countries and attenuate hyper specialisation effects witnessed during Phase I.  The shift from investment toward consumption led growth will impact on raw material prices, with prices for industrial metals (steel, copper, zinc) slowing as the initial urbanisation and industrialisation phase comes to an end in China; the winners from this transformation will be those commodities (such as palladium and coffee) with strong linkages to rising living standards and changing tastes, or to the industrial sectors that will outperform such as autos, renewable energy or power investment[10]. The skills-labour ratio is projected to rise gradually as China approaches the Lewis turning point[11], with wage pressure starting to translate into higher prices for basic-skills goods while the evolving supply-demand balance will exert price pressures on skill and technology intensive goods.

Table 3: Spending by the Global Middle Class

- in percent of total, PPP adj. -

World Total, trillion $, PPP adj.	2010 21.9	2025 40,2
North America and Europe	64	41
Asia Pacific	24	45
Central and South America	8	8
Middle east and North Africa	3	3
Sub-Saharan Africa	1	1

Source: Kharas (2010), updated in Kharas and Rogerson (2012).

Another lasting growth driver will be the fast rising emerging-country middle class consumption (Kharas, 2010)[12]. A burgeoning middle class in dynamic developing countries will by 2025 dominate global demand for most goods and services. Using a metric of $10–100 per day in PPP terms, the developing country share of a global middle class of just under 4 billion people in 2025 (compared with 2 billion today) is projected to increase from 55% to 78%, and its spending share from 35% to 60%. The world’s consumption centre of gravity is shifting East by over 100 miles a year. By 2025, it will be over central India, with strong pulls from South-East Asia, as well as from China and India itself.  Favourable demographic trends (outside China) push developing countries to grow faster than developed countries as they are still at an early phase in their demographic transition. Global demographic shifts are inexorably changing the distribution of global economic activity. The reason for expecting an acceleration of global growth is that the share of rapidly growing economies has now risen to almost one-half of total output, while the share of slow growing countries has fallen[13]. India, although poorer than China, has a sizable middle class that could overtake China’s by 2020 (Kharas, 2010), even though India would still be much poorer than China at that time. India has a much higher share of household income in GDP, so its middle class is larger given its income level. As India has the potential to grow rapidly for some years to come, its emerging middle class will strengthen and reinforce its growth.

While the Chamon-Kremer model, the emphasis on the power of beta convergence and the new Asian middle class all emphasise the long-run benefits for low-income countries arising from market expansion in successful emerging countries, there are further channels to consider for Shifting Wealth Phase II that warrant a less exuberant view. As emphasised in Citi GPS (2012), China & Emerging Markets a weaker, more consumer-driven growth in China, linked to the rebalancing process.

The shrinking share of investment  in China’s GDP and  the rising middle class in emerging countries will favour goods and services with high income elasticities, such as tourism, cars and green energy. (Engel’s Law tells us that the absolute spending on goods with low income elasticity must not fall, just their share in overall spending). The new demand patterns in turn determine the future price developments of commodities: aluminium and palladium, heavily used in cars and power infrastructure, will fare better than copper, iron ore and zinc, the metals most leveraged to construction and fixed asset investment. The cyclical dependence – the elasticity of demand to real GDP growth, hence by extension China’s GDP growth – has been highest for metals such as aluminium, copper, nickel, zinc, iron and tin. Metal exporters Zambia and Chile export 19.3, resp. 15.1 percent of their exports to China and may suffer from weakend imports and lower prices that arise from a satiation of the investment-led urbanisationand industrialisation process in China.

Over the past fifteen years, China has shifted from a supplier of parts and components to developed countries to become the core production base for suppliers in other countries, of which mostly ASEAN countries have benefited[14]. As China’s manufacturing wage cost advantage is gradually eroding as a result of higher real effective exchange rates (through either wage inflation, nominal currency appreciation, or a combination) and as other factor inputs – real estate, capital, water and energy – become more expensive as well, it is reasonable to expect (relative, if not absolute) factor relocation away from China. Which countries might benefit? The Citi analysis relates the World Bank’s 2012 Logistics Performance Index to manufacturing unit labour costs relative to China. According to their analysis, Malaysia, Thailand, India, Philippines, Vietnam and Indonesia score well to capture a slice in the fragmented production networks that may leave China. As other developing regions perform worse, Asian regional integration is predicted to further intensify in manufactures.

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[1] Citi GPS (2012), China & Emerging Markets, 16 July: Citigroup. Note that this new Citi analysis is much less exuberant than their former report on Global Growth Generators; see Buiter, Willem, and Ebrahim Rahbari, Global Growth Generators; Moving Beyond Emerging Markets and BRICs", CEPR Policy Insight No. 55, April 2011.

[2] In ealier blog entries, I have argued that China’s growth performance has been driven by Smith-Gerschenkron-Bradford-Summers type of capital deepening, a source of growth that is not necessarily exhausted yet, certainly not in China’s Western provinces.

[3] Wood, Adrian and Jörg Mayer, “Has China de-industrialized other developing countries?”, Review of World Economics, Vol. 147, 325 – 350.

[4] Jankowska, Anna, Arne Nagengast and José Ramón Perea (2012), “The Product Space and the Middle Income Trap: Comparing Asian and Latin American Experiences”, OECD Development Centre Working Papers No. 311, May.

[5] See, for example, Greenaway, David & Mahabir, Aruneema & Milner, Chris, 2008. "Has China displaced other Asian countries' exports?," China Economic Review, Elsevier, vol. 19(2), pages 152-169, June; Kaplinski, Raphael & Morris, Mike, 2008. "Do the Asian Drivers Undermine Export-oriented Industrialization in SSA," World Development, Elsevier, vol. 36(2), pages 254-273, February;  Daniel Lederman & Marcelo Olarreaga & Eliana Rubiano, 2008. "Trade Specialization in Latin America: The Impact of China and India," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 144(2), pages 248-271, July.

[6] Citi GPS (2012), China & Emerging Markets, 16 July: Citigroup.

[7] Chamon, Marcos and Michael Kremer (2009), “Economic transformation, population growth and the long-run world income distribution”, Journal of International Economics, 79.1, September, 20-30.

[8] Woo, Jaejoon (2012), “Technological Upgrading in China and India: What Do We Know?”, OECD Development Centre Working Paper No. 308, Paris: OECD, January.

[9] Fu, X, R Kaplinski, and J Zhang (2012), “The Impact of China on Low and Middle Income Countries’ Export Prices in Industrial-Country Markets”, World Development, 40.8, August, 1483-1496.  

[10] Barclays (2012), “China’s commodity intensity: the dragon’s appetite is changing”, Cross Currents/25 April (not online).

[11] Huang Yiping and Jiang Tingsong (2010), “What Does the Lewis Turning Point Mean for China? A Computable General Equilibrium Analysis” China Center for Economic Research, Working Paper No. E2010005, Beijing: March.

[12] Kharas, Homi (2010), “The Emerging Middle Class in Developing Countries”, OECD Development Centre Working Paper No. 285, January, Paris: OECD.

[13] To be sure, there are many uncertainties surrounding this consumption-cum-demography scenario. Foremost is whether China’s middle class will develop fast enough to sustain rapid growth in China if exports start to falter. Given China’s unequal income distribution and the small current share of the middle class, it is not at all certain that this will be the case. There have been previous examples of large unequal economies failing to grow beyond middle income levels even after decades of strong performance.

[14] OECD Southeast Asian Economic Outlook 2010

MGG Public Lecture (30 July 2012, at GDI/DIE)

http://www.die-gdi.de/CMS-Homepage/openwebcms3.nsf/(ynDK_contentByKey)/MSIN-8W9H7K?Open

Shifting wealth: rising powers and the new world order (in 16 paragraphs)

1.      How has the global development scene changed by the rising powers, or as we at the OECD Development Centre call them, the convergers? It has diversified the pool of actors, aid instruments, capital, trade and tax revenues to low-income countries; it has allowed low-income countries to switch to the growth engine that works; and it has loosened up the policy and paradigm monopole once solidly occupied by the old donor cartel around Bretton Woods institutions and the DAC. While overall it has been good news for poor countries,  it has been rather bad news for aid bureaucracies, for compliance with global soft law, and for donor (& NGO) rethoric and posture.

2.      Strong shifts in net international investment positions and sustained superior growth rates of large middle-income countries are reshaping the world economy – a phenomenon the OECD Perspectives on Global Development refer to and define as “Shifting Wealth”. The recalibration of the world economy – Shifting Wealth – can be interpreted from a stock and from a flow perspective.

3.      The stock perspective: The global current account imbalances of the past decade – which to a large extent reflected a high external US saving deficit financed increasingly by China and oil exporters - have given rise to a significant shift in wealth distribution toward surplus countries linked to fossil-fuel production or high savings and exports. Rich OECD countries are being financed by countries which until recently played no substantial role as international investors. The United States is now the world’s biggest debtor. Joint with Japan, China has extended its position most as the world’s international net creditor.

4.      As long as the rising powers remain ‘immature creditors’, they retain a strong contingent currency risk incentive to switch from acquiring foreign financial to buying foreign real assets. Investment vehicles such as sovereign wealth funds that mostly (with the notable exception of Norway) originate in emerging countries have grown in asset size and prominence. Western debt relief has given way to Eastern export credits. The switch from Western to East and Southern sources of finance translates into a higher share of state-sponsored capital supply as opposed to pure private-sector sources. Many newly cash-rich countries have different political regimes from the countries that previously dominated international investment.

5.      The flow perspective:  Sustained growth that large emerging countries have experienced over the last decade have conferred them a considerable growth advantage over OECD average. The world has seen a switch in the engines of growth, since the late 1990s with a continued rise of global growth being driven from outside the OECD area. Combined with very large populations, these growth differences translate into a new world economy. From 2015, we project the non-OECD economies to exceed the OECD area in terms of PPP-adjusted GDP. The world’s economic mass – production, consumption, wealth – is moving East toward India and China, realigning with the world’s demographic mass.

6.      Apart from falling trade cost and expanding global production networks that are driving global trade, the greater role of emerging countries has induced a much finer degree of international specialisation than occurred previously when North-North trade predominated. Global trade has witnessed the return of comparative advantage in connection with Shifting Wealth. Foreign direct investment (FDI) has been a crucial vehicle in building global production chains and has been usually characterised by a predominant North-South direction, which is slowly changing direction South-South and South-North.

7.      Apart from the stock and flow definitions of Shifting Wealth, its geopolitical dimensions have moved very much into the forefront. The substitution of the G8 for the G20  as the premier global economic policy forum, the gradual rise in inclusion, representation and voice in international organisations such as the Bretton Woods institutions and higher political ‘power’ in particular of the BRICS are noted features of their shifting geopolitical stance on a global scale. However, the majority of smaller emerging countries (Colombia, Egypt, Thailand, e.g.) still submit to the Pax Americana[1], as is for example visible in the ca 60 countries that engage with the OECD in one way or other. And within the BRIC group, there are considerable economic and geopolitical divergences, with China the only true superpower.

8.      For international monetary governance, the prospect of the renminbi and perhaps other emerging-country currencies entering reserve-currency functions aside key OECD currencies has gained momentum.  In global trade policy, Shifting Wealth translates into higher retaliation and bargaining power for the rising powers. Finally, the growing importance of non-OECD countries may translate into acceptance of a different intellectual paradigm underlying cross border collective arrangements and lower effective compliance of standards and best practices defined and scripted by the advanced economies, not least in the global aid architecture. Building a Global Partnership for Effective Development Cooperation has been agreed at the High-Level Forum on Aid Effectiveness, in which governments of many emerging countries signed as donors for the first time. Note that China, India and Brazil only signed as ODA recipients as they do not accept Paris Aid Effectiveness principles to apply to South-South cooperation.

9.      Despite many assertions to the contrary, the positive growth performance of low- and middle-income countries can be explained to a large extent by China’s growth; in other words, emerging-country growth has been endogenous to China’s growth to a certain extent.  We (2012)[2]  have produce findings that do indeed suggest that poor countries, oil and non-oil, have been changing their growth locomotive during the 2000s, from the G7 countries to China. To be sure, GDP growth in itself is not of much help if it fails to bring down poverty .  The number of people living on less than 2$/day/capita started only to decline from the 2000s, in the era of Shifting Wealth.  During the period 1981 and 2008, the number of people living in extreme poverty  (1.25$/day))decline by 650 million people to 1.29 billion, despite a rise in world population by more than 2 billion people over the three decades. Most of that global poverty reduction occurred in China where the number of extreme poor melted down by half a billion. But even correcting for China, the eradication of extreme (and less extreme) poverty has gathered speed during the last decade.

10.  Taking the evidence on growth links discussed above, it is fair to say that China has not only helped reduce local, but also global poverty, despite the much-noted rise in Lewis-Kuznets type inequality in most middle-income countries. While the rise of Africa’s emerging partners has been widely analysed in terms of a scramble for African resources, the more recent rise of manufactured exports from sub-Saharan Africa to China and other emerging countries and by foreign direct investment from emerging countries that has reached Africa’s non-oil countries (in proportion to their respective GDP) not less than it reached oil and raw material producers; in contrast, OECD-country imports from Africa remains as biased towards oil as the FDI flows from OECD to Africa (AEO 2011, ch 6).

 11.  Development cooperation programmes of emerging countries, not just China, focus more on infrastructure and other structural bottlenecks to growth than DAC donors who have prioritised aid toward poverty reduction and health in the past. China, India, and Brazil in particular offer alternative modalities to finance development[3]. ODA is a component of  wider package of economic cooperation (e.g. the Chinese model of development cooperation - turnkey projects, package deals, Angola Mode). Aid is only one element of their engagement toolbox, reflecting striking differences in engagement philosophies between traditional donors and emerging partners.  This blurs the borders traditionally drawn between investment and aid; trade and aid; and between private and public sector involvement. Western “charity” focuses on “assistance” seeking poverty reduction and social welfare, but it is predicted to change toward the “Asian” model[4]. The “Asian” model for co-operation emphasises the partner’s potential and seeks mutual benefits. In fact, it quite resembles the way Japan once practiced cooperation with China[5]. Western aid emphasises policy conditionality, Eastern cooperation project selectivity and control.

12.  How then can we envisage cooperation between traditional and emerging donors going forward? Before I turn to that difficult issue, let me first quote the DAC Outreach Strategy 2008, in oder to understand how NOT to envisage that cooperation: “Outreach constitutes an essential element of the work of the DAC ... Enhanced Engagement aims to bring partners closer to the OECD and what it stands for by engaging them closely in OECD processes while supporting their own reform processes through the adoption of OECD practices, policies, guidelines or instruments.‟ Many representatives of Western donor agencies (and industry lobbies) seem to think that a new world order can be fundamentally addressed by including China and other rising powers in existing arrangements that the advanced countries have built since the Second World War. The semantic corollary of such thinking is reflected in the term ‘outreach’ for a while employed by the West when trying to establish a dialogue with the new donors. It was assumed that the new Eastern donors could be assimilated to Western-built international soft law.

13.  The world is perhaps more likely to become bipolar rather than multipolar. I personally think that the US might be the big stumbling block for cooperation between donors old and new. Hillary Clinton’s warnings on China in Africa[6] as representing the “new colonialism”, or the US push for the Trans-Pacific Partnership Agreement (TPPA) to counteract China’s ascendancy through US “economic and military statecraft”[7]  in the Pacific support my fears that the US will find it difficult to engage the rising powers in a constructive way.  The main geopolitical fault line in the next few decades will be the West and China.  Imposing our norms and standards is a non-starter simply as China, India, even Brazil will not accept standards that the West has developed over decades. In a world of increasing competition for exhaustable resources and in a world of inexhaustable protectionism, Policy Coherence for Development (PCD) will have a tough life. The current bureaucratic struggle between aid agencies – using PCD to escape their narrow aid focus through getting a voice in other cabinet issues such as education, food, trade or energy  - and those who want to mainstream development through outsourcing traditional aid items to education, trade and other ministries may turn out to be quite pointless in the era of Shifting Wealth[8].

14.  True, global soft law offers more effective ways of dealing with situations of uncertainty and diversity where hard law would fail. Soft law is easier to achieve than hard law, less expensive and more flexible, especially when actors are jealous of their autonomy.

The OECD and other international organisations have developed mechanisms to raise the compliance with soft law, the major instrument being the peer review. Under what conditions can peer review and peer pressure work in terms of bringing about compliance with a given set of standards? Factors influencing the effectiveness of peer review: value sharing; adequate commitment; mutual trust; credibility; and thightness of policing a soft-law instruments[9]. While a richer China, it is hoped, might move closer to our values, this is not a foregone conclusion. The distribution fight for nonrenewable resources acts to limit adequate commitment for effective peer reviews. And mutual trust, as seen from the Chinese perspective, has suffered not risen over the past years.

15.  In practice, peer reviews have often led to rather weak and incomplete compliance. DAC peer reviews are not excluded from this criticism. Shortcomings of peer reviews also become apparent in other organisations. The failure of IMF surveillance with respect to the US financial system in the run-up to the 2007-2009 global crisis, for instance, may point to another requirement for soft-law effectiveness: limits on the degree of political influence, especially with superpowers. Bear in mind, though, that a new world order is still likely to resort to soft law and peer reviews precisely because harder global  laws and more effective enforcement mechanisms would not be accepted.

16. Western soft law and its edifice of standards, best practices,  norms and policy ‘insights’ built up over the past 50 years was essentially formed in a market economy and in a decentralised and unauthoritarian setting. The recent Western history of development is quite different from the policy lessons and paradigms of the rising powers and low-income countries. For example, China’s practice of packaged cooperation deals in which aid cannot be isolated and computed with any precision makes transparency hard to establish; the components of the package are not individually priced and it is difficult to separate aid from economic cooperation in general. The transparency issue must be dealt with in more intelligent ways than just asking China to become a member of a joint transparency initiative as postulated by the G8 in the past.  A genuine synthesis of approaches  of packaged cooperation that the recipient countries can compare based on hard empirical evidence and social-economic cost-benefit analysis, as opposed to the inclusion of rising powers into existing fragmented Western approaches,  is required but will imply hugh changes in the behaviour of DAC actors. Are they ready?

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[1] See Thomas Fues, “Multilateral politics: At a crossroads”, D+C, No 53 (7-8), 2012, on who signed DAC agreements and who didn’t  at the Busan conference .  

[2] Garroway, Chris, Burcu Hacibedel, Helmut Reisen and Edouard Turkisch (2012), “The Renminbi and Poor-Country Growth”, The World Economy, 35.3, 273-294.

[3] See, e.g., Mwase, Nkunde, and Yongzheng Yang (2012), “BRICs’Philosophies for Development Financing and their Implications for LICs”, IMF Working Paper 12/74, March.

[4] Kharas, Homi, and Andrew Rogerson (2012), Horizon 2025: Creative Destruction in the Aid Industry, ODI, July.

[5] Dahman Saidi, Myriam and Christina Wolf (2011), “Recalibrating Development Cooperation: How Can African Countries Benefit from Emerging Partners?”, OECD Development Centre Working Paper No. 302, July.

[6] Reisen, Helmut (2011), “China, Zambia and theworldofhillaryclinton.com”, shiftingwealth.blogspot.com, 19. June.,

[7] Clinton, Hillary (2011), “America’s Pacific Century”, Foreign Policy, November. For a geopolitical analysis of the TPPA, see Kelsey, Jane (2011), “The TPPA as a Lynchpin of the US Anti-China Strategy”, scoop, 21 November: “China will be increasingly isolated, as a critical mass of APEC countries signs on to the “gold standard” deal, and may ultimately subordinate itself to the TPPA’s US-designed “international norms”.

[8] Humphrey, John (2011), “European Development Cooperation to 2020: Rising Powers and New Global Challenges”, EDC 2020.

[9] Paulo, Sebastian, and Helmut Reisen (2010), “Eastern Donors and Western Soft Law: Towards a CAC Donor Peer review of China and India?”, Development Policy Review, 28.5., 535-552.

Global Trade Patterns

Global trade has both induced and reflected Shifting Wealth in many ways. Gordon Hanson (2012) in his NBER paper “The Rise of Middle Kingdoms: Emerging Economies in Global Trade”  has recently closely examined changes in international trade associated with the integration and rise of low- and middle-income countries, for the period 1994 – 2008 when the share of developing economies in global trade more than doubled. Two properties of global trade have become apparent over the last two decades:

·         The share of trade in GDP has grown sharply for low- and middle-income countries as growth in trade advanced even more rapidly than their relative economic size; exports over GDP rose from a quarter to more than half of non-OECD GDP during 1994 – 2008.

·         The shifting pattern of global trade has involved much larger South-South (and North-South)  trade flows. Between 1994 and 2008, the South-South component of low-income country exports rose from 22 to 29 percent; the South-South component of middle-income exports rose from 33 to 46 percent during the same period.

To be sure, the growth in Southern trade has been associated with reduced trade and transport cost, WTO membership and unilateral trade reform. An important explanation, according to Hanson (2012), of why South-South commerce has surged over the last decades are expanding multi-stage global production networks. Much of the recent increase in trade appears to be the result of offshoring, with manufacturing fragmented across borders as firms have exploited comparative cost advantages[1].  Apart from falling trade cost and expanding global production networks that are driving global trade, the greater role of emerging countries has induced a much finer degree of international specialisation than occurred previously when North-North trade predominated . Hanson’s (2012) findings emphasise the return of comparative advantage in connection with Shifting Wealth: low income countries have accentuated during the past decades their net exports in three resource or labour intensive sectors – agriculture, raw materials, and apparel and shoes – and their import surpluses in other sectors. Middle income countries have turned into net exporters of electronics, increased (slightly) net exports in the primary sectors, turned into net importers in apparel/shoes and remained so in capital intensive sectors.

Graph 1: Sector Trade Shares, Middle Income Countries

Gordon Hanson (2012), “The Rise of Middle Kingdoms: Emerging Economies in Global Trade”

Foreign direct investment (FDI)  has been a crucial vehicle in building global production chains and has been usually characterised by a predominant North-South direction; indeed, FDI sourced by OECD countries and hosted by developing countries has surged during the 2000s. Like trade, FDI flows have also been growing faster than, hence rising as a fraction of, global GDP. However, while these are by now well documented facts, the rise of outward FDI by emerging countries has been less appreciated. Outflows of FDI as a share of GDP rose over the 1994 to 2008 period from 0.2 to 2.2 percent of GDP in middle income countries, fast approaching ther 3.6 percent of GDP sourced from high-income countries in 2008.

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[1] A consequence may be that gross trade flows (i.e., total exports) overstate net exports (corrected for intermediate imports), which might imply that some recent expansion of South-South trade, especially for manufactures,  is merely a statistical artifact.

Rudi Dornbusch, the Euro and the Latin Triangle

Rudi Dornbusch was born and grew up close to my birthplace in Krefeld, in today’s North-Rhine Westphalia, on 8 June 1942. Precisely 70 years ago, a reason to give this great and generous economist, who died ten years ago,  a memory. There are other reasons for me, more personal. My late aunt knew his mother quite well and always praised her Mutterwitz, if you wonder where his formidable wit and speed of mind might have originated. When Eliana Cardoso visited the OECD Development Centre in Summer 1988, she was accompanied by her husband Rudi who wanted just to have a desk and to circulate freely in Paris, in intellectually more rewarding places. (The invitation of the couple, I am afraid, turned out to be less than the Centre President had hoped for, as they left the place with a deep feeling of disappointment.) Nonetheless,  I had an opportunity to show them my Ph.D. which I had just finished at the tender age of 37, on the “Latin American Transfer Problem”, where I tried to shift the focus to the budgetary problem of public debt, away from the then common view that Latin America suffered mostly from a dollar exchange problem. Dornbusch suggested that I sent a shortened fraft to Peter Kenen, so my Ph.D turned into a Princeton Study in International Finance[1]. I guess they both liked how I used the interwar debate on Germany’s reparation problem to reinterpret the Latin American debt crisis of the 1980s.

Dornbusch’s focus on Latin American financial crises in the 1980s and 1990s provides valuable insights for today’s Europe, as highlighted by a  smart blog entry by Ed Dolan, “How the Latin Triangle Swallowed the Euro”,  based on  Dornbusch’s article[2]. In the graph borrowed from Ed Dolan, the vertical axis denotes the real exchange rate, and real wages that is, as in a fixed-currency setting appreciation lowers import cost and raises the consumption wage;  appreciation is upwards. That upward movement of real wages and exchange rates depicts the past period in Southern Europe and in countries with a hard peg to the euro, such as Estonia. The cycle begins at A, with a balanced current account and full employment (well, God bless& fulfill our assumptions!). The Eurozone brings interest convergence, rising real estate prices and rising wages; the economy shifts to B, which denotes an increasingly unsustainable deficit. And then, to quote Rudi Dornbusch, comes the crisis, eventually:

“The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought, and that’s sort of exactly the Mexican story. It took forever and then it took a night.”

With a sudden stop in external finance, and with the devaluation option off the table, the remaining alternative is a sharp turn toward fiscal austerity. In the short run, that will move the country toward point C, with falling GDP and rising unemployment. If the austerity is sufficiently stringent and kept in place long enough, nominal prices and wages may begin to fall. In principle, such an internal devaluation could move the country down along the line from C toward A. So in the “best” of worlds, with civil servants salaries cut by more than 20% and flexible labour markets, what can be achied is the recovery path of Estonia. Neither is that outlook too appealing, as Krugman has noted by pointing that only half of the slump has been recovered since the peak, nor is all the deflationary hardship to impose politically feasible in all countries. Bruening tried so, we got Hitler.

In recent weeks, when the Eurozone crisis intensified again in that cycle of extreme market stress and public intervention established by now, I have started to wonder what Dornbusch would have said and written. Dornbusch was a Eurosceptic. In “Euro Fantasies: Common Currency as Panacea”  he doubted that a common currency could work in the absence of flexible labour markets. And as a Keynesian (which he had increasingly become as his Chicago years vanished in the haze) he feared the deep recessions that the budget cuts stipulated by the Maastricht criteria would cause. He shared the scepticism with many US economists, which he classified in a way that now looks increasingly clairvoyant: “The euro: It can’t happen. It’s a bad idea. It won’t last.”[3]

 

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[1] Helmut Reisen (1989), Public Debt, External Competitiveness and Fiscal Discipline in Developing Countries, Princeton Studies in International Finance No. 66

[2] Dornbusch, Rudiger (2000), "The Latin Triangle," in Keys to Prosperity, MIT Press.

[3] See Lars Jonung and Eoin Drea (2009), “The euro: It can’t happen. It’s a bad idea. It won’t last. US economists on the EMU”, European Economy, Economic Papers # 395, December.