Stanley Fischer: The new global economic geography
Revised version of a speech by Professor Stanley Fischer, Governor of the Bank of Israel, presented
at the Federal Reserve Bank of Kansas City Conference on The New Economic Geography, Jackson
Hole, Wyoming, 25-26 August 2006.
I am grateful to conference participants for helpful comments, and to Nir Klein and Mark Nulman for their assistance.
* * *
When I first saw the title of this conference - the New Economic Geography - I thought it referred to
two branches of the economic literature that developed in the 1990s. The first, with the title of the New
Economic Geography, pioneered by Paul Krugman, Anthony Venables, Richard Baldwin and others,1
seeks to explain why and how economic activity tends to be geographically concentrated, and whether
such economic equilibria are unique and stable, or may instead be driven by history. The second is
about the impact of geography on development, work associated primarily with Jeffrey Sachs and
associates.2
However this conference is not mainly about economic geography in these senses. Rather it is about
the startlingly rapid changes in the geographical locus of global economic activity and their
consequences: about the rise of Asia, about the BRICs3, about globalization, about economic
convergence, about changes in the international financial system - in short about the history of the
world and the future of the world economy.4
I shall start by briefly discussing different aspects of these changes, and then focus on the most critical
development, the rise of Asia, especially the rise of China.
The title of this conference, the first of the Bernanke era, also reflects what a long way this premiere
international economic conference has come. In 1980, the theme of the conference was "Future
Sources of Loanable Funds for Agricultural Banks". This year it is about the economic future of the
world.
I. The changing global economic geography
There are several ways of describing the phenomenon of the change in the locus of global economic
activity. One is to talk about the rise of the BRICs and the near-BRICs. This would place the focus on
Brazil, Russia, India, and China, two and a half of which countries are in Asia, and one in Latin
America. But once one extends the group from India and China to include Russia and Brazil,
nearBRICs jostle for inclusion, for instance Mexico and South Korea. And it is then not clear where to stop.
One answer is to move from the BRICs to the non-G-7 members of the G-20. This defines a group
consisting of Argentina, Australia, Brazil, China, India, Indonesia, Mexico, Russia (a member of the
G8), Saudi Arabia, South Africa, South Korea, and Turkey - twelve in all, incidentally raising the
question of who will be the twentieth country in the G-20. This group includes countries from the
Middle East, Africa, and Latin America, and is thus geographically more representative of global
developments than are the BRICs or India and China. But the countries are diverse, and it is difficult
without going into the details of each economy to talk about their future role in the global economy,
except perhaps as the core of a new directorate for the international financial institutions.
Alternatively we could talk about globalization, or about economic convergence, and whether and how
it is happening. Or the rise of the South, except that in this case the South is mainly in the East.
I shall describe the phenomenon as the rise of Asia, primarily the rise of China and India. The
phenomenon is evident in Table 1, due to Angus Maddison. In summary, over the period 1950-2030,
the share of global GDP (measured in purchasing power (PPP) terms) produced by the United States,
Europe5 and the countries Maddison calls "other Western offshoots", Canada, Australia, and New
Zealand, is expected to decline from 70 percent to 38 percent, and the share produced by Asia to rise
from 19 to 52 percent.6
Maddison projects that by 2030 Chinese GDP will account for over 18 percent of global GDP
measured in purchasing power terms, and will have overtaken United States GDP, also measured in
PPP terms (Figure 1). India is projected to be at about half the (PPP) GDP of China.
Let me note that although I shall use the PPP numbers, they are in an important sense seriously
misleading.7 In PPP terms, World Bank data show Chinese GDP at 69 percent of US GDP in 2005.
But at market exchange rates, Chinese GDP was only 18 percent of US GDP last year (Figure 2). It is
the dollar values that represent the current weight of countries in the international economy, and we
should bear in mind that using market exchange rates, Japan has the largest economy in Asia, about
double the size of that of China. Measured at market exchange rates, Asia accounted for 25 percent of
global GDP in 2005, well below the 40 percent that PPP data imply.
The share of Asia in global population is projected to remain roughly constant over the period
19502030, rising from 55 to 58 percent (Figure 3). By contrast, the share of the current "West" (excluding
Japan) will decline from 30 to 16 percent of the global population. Global population is expected to
grow by about 20 percent in the next 25 years, and much more rapidly than that in Africa.
However measured, we are now in process in which in economic terms, the west is in relative decline,
and Asia is rising. In a longer-term perspective, this is both the rise of Asia and also the recovery of
Asia - for according to Maddison8, as late as 1820, as the Industrial Revolution was getting under
way, Asia accounted for over 70 percent of the world's population and 59 percent of world GDP.
Although I will talk mainly about China and India, it is important in considering the rise of Asia to recall
that Japan, the second largest economy in the world, has already risen. And we should also note that
less than fifteen years ago, the Asian miracle was regarded as primarily a phenomenon of Japan,
Korea, and the ASEAN countries.
In focusing on the rise of Asia, I leave out areas and issues that are extremely important for the future
of the global economy and the global polity. Among them are the economies of the Middle East, and
other challenges of development, especially in Africa, Latin America, and parts of Asia.
In discussing the rise of Asia, I will take up five issues in more detail: first, the rise of China; second,
that of India; third, regional developments; fourth, implications for the world economy; and fifth, political
implications.
II. The rise of Asia: China
How long will the rapid growth of China continue? There are important historical precedents in the
region, Japan, Korea, and the ASEAN countries.9 Their histories tell different stories: that of Japan,
5
I have taken a generous view of the extent of Europe, by including Eastern Europe and the former Soviet Union. This means
that Russia is not included in Asia for purposes of this paper, a view that is at best only half right.
6
Maddison includes parts of the Middle East, including Turkey, in Asia.
7
Why then use the PPP data? Mainly because they do take into account differences between current and likely future
exchange rates, which are relevant to future comparisons among countries; in part because they are available and are
systematic.
8
The World Economy, A Millennial Perspective, OECD, 2001, Table 3-1c (p127) and Table 1-1 (p28).
9
Maddison (2001), p.143, presents data on the growth performance of the countries of "Resurgent Asia". The average annual
growth rate of per capita PPP GDP for the period 1950-1999 of China, Hong Kong, Malaysia, Singapore, South Korea,
Taiwan (China), and Thailand was 4.4 percent. The growth rate of Chinese per capita PPP GDP was highest among the
periods shown by Maddison (1950-73, 1973-90, 1990-99) in the last decade of the twentieth century, at 6.4 percent. The
most rapid and sustained growth performance over the period was that of South Korea, which averaged 6 percent (per
capita, PPP) over the fifty years. Note that Maddison lists data for Taiwan, China separately from those of China; in
Maddison's data, in 1950 Taiwanese GDP (PPP terms) was approximately 3 percent that of China, and by 1999 it had
reached 8.5 percent of that of China.
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that almost full catch-up is possible - although it is hard to know whether we should start counting
from 1868 or from 1945; that of Korea that sustained exceptionally rapid growth is possible for over
forty years; that of ASEAN that long growth spurts are possible.
China has already been growing at rates in excess of 10 percent on average for over a quarter
century, and its policymakers have demonstrated considerable economic management skills, not least
in warding off foreign pressures for revaluation. The regional precedents suggest that China can keep
growing at very high - but declining - rates for a long while yet. Further, if the maximum potential
growth rate is related to the distance of the economy from the frontier - as determined by per capita
income levels in the most advanced economies - China's rapid growth can continue well beyond
2030, for even in 2030 according to Maddison's projections, PPP income per capita in China will be
only one quarter that in the United States. And the fact that the bulk of China's labor force remains
rural, and to a considerable extent agricultural, reinforces the view that China's Arthur Lewis type
growth process could have a long way to run.
If the Chinese economy were to continue to grow in real terms at a rate 7 percent greater than that of
the United States economy at a constant exchange rate - as it has for over twenty years - its GDP
would indeed overtake that of the United States in about another quarter century. Further the yuan is
likely to appreciate over that period relative to the dollar, ceteris paribus (i.e. with unchanged domestic
growth rates) reducing the length of the catch-up period.
But China faces considerable challenges, and the economy is unlikely to continue growing at 10
percent for another quarter century. Notable among the challenges are: exchange rate management
and realignment; financial sector reform; state enterprise reform; resource and environmental
constraints; the ageing population; developing (or redeveloping) a social safety net; reducing social
gaps, especially between country and city; and political transition.
China's exchange rate management has until now been impressive and successful from the viewpoint
of its goal of supporting export-led growth. It has come at the cost of a massive and likely to be costly
buildup of foreign exchange reserves, but so far with surprisingly low costs in terms of inflation. At
some point - perhaps because of inflationary pressures and the costs of the continuing reserve
buildup - the process of exchange rate appreciation that other countries in the region, including Japan
and Korea have experienced, will have to begin. And that will likely contribute to reducing the growth
rate of the economy in real terms.10 Given China's saving rate,11 it is likely that when the process of
secular appreciation of the yuan gets under way, the currency will appreciate at a rate that maintains a
sizeable continuing surplus in the current account, as has happened in the case of Japan.
Financial sector and state enterprise reform are closely related. One way of thinking of the occasional
recapitalizations of the banks in China is as a fiscal process, in which the banks provide loans to
enterprises that are in effect repaid by the state by later recapitalizations. It appears that progress is
being made in reforming the financial system, but as of now it remains a point of vulnerability and an
obstacle to a rapid opening of the capital account and flexibilization of the exchange rate.
China faces the problem of a rapidly ageing population. While this will be a problem from the viewpoint
of fiscal transfer programs (which however are on a proportionately much smaller scale than in richer
countries), the processes of urbanization and industrialization can continue by drawing on the massive
rural population. Environmental issues will have to be dealt with, and it is clear from the trends in
global commodity prices that China may well face continuing adverse terms of trade changes as well
as rising domestic resource costs.
Income disparities in China, between the coast and inland provinces, between the cities and the
countryside, between rich and poor, have been growing rapidly, and are receiving increasing attention
from the government. These, combined with the breakdown of the social safety net of earlier times,
produce social and political tensions that could threaten the continuation of the growth process. And
political pressures associated with the desire for democratization, which tends to rise as income levels
increase, constitute another source of tension.
The Chinese economy suffers from one disadvantage that the other Asian miracle economies did not:
it is already very large. This raises the question of whether it can continue to rely on exports to power
its growth - for the capacity of the rest of the world to absorb Chinese exports must be determined by
the global growth rate.12 The answer is that China probably cannot continue to rely on export-led
growth, and therefore that the switch to domestic demand led growth, which has been talked about for
some time, is essential if growth is to continue in the 7-10 percent per annum range.
Is China vulnerable to a 1990s style Asian financial crisis? There are some negative symptoms. The
first is a share of investment in GDP that according to the official data exceeds 40 percent. This cannot
be efficient, it must be part of the process of generating bad loans, and is reminiscent of pre-crisis
investment rates in some of the Asian crisis economies. The second is a financial system that remains
weak. But some of the vulnerabilities that led to the Asian crisis are not present: China does not have
a current account deficit; nor are there massive short-term capital flows; and capital controls appear to
be relatively effective, even if not fully watertight. Further, foreign exchange reserves are so large that
it is hard to imagine a successful attack on the currency. On balance, a 1990s style international
financial crisis appears highly unlikely.
What about other types of crises? The growth processes in Japan, Korea, and the other rapidly
growing countries of East Asia were punctuated by occasional economic crises. Since the modern
Chinese economic reform process began around the end of the 1970s, there has been only one
major economic (and political) crisis. This is an extraordinary record, even among the extraordinary
records of the neighborhood. Chinese economic management has benefited from very careful study of
the history of its neighbors, and - despite the long list of potential problems just noted - there are no
obvious sources of likely crises in the near term.
But: trees do not grow to the sky, and trends that appear inevitable at one point of time can appear
doomed from the perspective of only a decade or two later. In brief, to continue rolling out the clichés,
it is difficult to forecast, especially about the future, and it would be unwise to assume that China will
be immune to future economic crises.
Nonetheless, even if there were to be a crisis or other interruptions to growth in the future, it is on
balance reasonable to believe that Chinese growth will continue at a rate that on average well
exceeds that of countries at the current frontier of economic development - and that the Chinese
economy will be the largest in the world, measured in dollars at market exchange rates, within the
lifetimes of many in this audience today.
III. The rise of Asia: India
GDP in China and India were roughly similar in 1950.13 Since then China has grown much more
rapidly than India: India's growth spurt is both more recent and more modest than that of China. At
present Indian GDP, measured in exchange-rate mediated dollars, is approximately the same as that
of South Korea, joint third in Asia, behind Japan and China. In these terms, Indian GDP in 2005 was
$785 billion (World Bank data), twelfth largest in the world, in a group of five countries with very similar
GDPs (Brazil, South Korea, India, Mexico, and Russia, in that order).
In PPP terms, according to World Bank estimates India had the fourth largest economy in the world in
2005, almost as big as that of Japan, a bit under half the size of PPP GDP for China. And the GDP of
India has been growing at rates approaching 8 percent in recent years, less than that of China, but
nonetheless impressive. Quite possibly, if China did not exist, we would today be talking about the
Indian miracle.
India's growth prospects are enhanced by the existence of a more market-oriented financial system
than that of China, by a more flexible and well-managed exchange rate system, by a more
marketoriented monetary policy, by the existence of a legal framework that is more developed and more
predictable than that of China, and by a stable democratic political system that enables the country to
deal with social tensions within its political framework. Its growth prospects are set back by its so-far
slow pace of integration into the global economy, the slow pace of the legal process, by excessive
fiscal deficits, by the political inability to pursue the reform process with as much determination as has
China, by an extensive bureaucracy, and by excessive state regulatory intervention in the economy.
Indeed, the greatest reason to be optimistic about India's future growth process is that considering that
it has grown so well in the last 15 years without a sustained deep reform process, it will certainly do
much better if and when the reform process deepens.
While Indian growth rates have not yet reached Chinese levels, the Indian economy appears on the
whole to be more robust. India experienced a major foreign exchange crisis in 1990, one response to
which was the start of the reforms of the first half of the 1990s. Since then the exchange rate has
become more flexible, the growth rate has risen, and some reforms have continued. While no
economy is guaranteed against crises, the Indian economy looks less vulnerable to a major crisis than
it was over a decade ago. But there are anti-reform strands in Indian politics that could result in policy
changes that reduce the growth rate well below its potential.
IV. The rise of Asia: regional developments
There are already important and rapidly developing economic linkages among parts of Asia,
particularly in East Asia, where a grouping of ASEAN plus Japan, China and Korea seems to be
emerging. The politics of such a grouping are not simple, for the Japan-China relationship is evolving
as the Chinese economy grows, and as it becomes clearer that China will overtake Japan at some
point in the not too distant future. The implications of this change can be summarized by noting that
Japan is the largest shareholder in the Asian Development Bank, and by tradition appoints its head;
that the formation of an Asian Monetary Fund during the Asian crisis in 1998 was not strongly
supported by China; and that China will no doubt want to play a greater role in any future regional
institutions than it does in the ADB.
Some in East Asia talk of following the example of Europe by improving trade and financial links, and
later moving to a common market and unified financial system. It is recognized that this will take a long
time, but those involved note correctly that it took the European Union a long time to evolve to its
current condition. The European equilibrium is simplified by the fact that no single country dominates
the union, whereas China would likely be the dominant power in an East Asian union. For many years
Europe was driven by the Franco-German determination to build a structure that would prevent any
future wars; possibly East Asia could eventually be driven by a similar process of Chinese-Japanese
reconciliation, though recent trends have not been in that direction. One could imagine Japan
eventually playing a role similar to that of the United Kingdom in Europe, that is, as a leading member,
but one whose views on the nature of the organization may often differ from those of other leading
members.
At present, there is much talk of an East Asian common currency. Whether there would be a basis for
such a currency depends on how China's financial and currency management systems evolve. Since
China would eventually be dominant in an East Asian economic bloc, its preferred currency
arrangements will determine the eventual outcome. Very likely, the non-Chinese members would like
to have a common currency so as to have some impact on region-wide monetary policy, but whether
China would grant that role would be up to China. Here again one could see Japan playing an
independent role by retaining its currency, rather like the United Kingdom currently does in Europe.
Further to the west, a large economic bloc could eventually develop around India, but that prospect is
inhibited by the strained relations between India and Pakistan. The dynamics of a South Asian
economic bloc built around India would be different from those of East Asia because, unlike in the
case of China, there is no Japan - no advanced industrial economy - in the neighborhood.
V. The rise of Asia: economic implications
The rise of Asia, especially the rise of East Asia and of India, is already reshaping the world economy.
Concerns over globalization that have become so prominent a part of the economic debate in Europe
and also in the United States, focus on the impact on the wages of less skilled workers in the west of
the hundreds of millions of Chinese and also Indian workers who are entering the global labor force.
One often hears the view that "China has a comparative advantage in everything", an argument that
every economist can demolish, but doing so does not diminish the anxiety level. Part of the anxiety
must derive from the discomforts of the adjustment process forced by the dynamism of Asia; and part
must derive from the fact that the wages of unskilled workers in the west may be adversely affected by
such competition. Policy can deal with these consequences, through adjustment aid, and through
education, but unless that is done, the negative fallout from this competition will likely continue.
The last time I heard this degree of anxiety was in Asia during the Asian crisis, when many of China's
neighbors expressed the same concerns. Then I used to ask people whether they would prefer to
have a prosperous or a poor neighbor. Most opted for the prosperous neighbor, though I often had the
sense that they might prefer that their neighbor progress at a more measured pace.
By now most of the developing countries and most of China's neighbors can count the gains from
China's (and India's) booming growth. China's voracious appetite for raw materials, which has
produced a boom in commodity prices, has helped many developing countries, as well as commodity
rich industrial countries like Australia. China's investments in Africa - where Indian companies have
also long been active - have lately received media attention. China and India's energy needs have
helped push oil and other energy prices to their highest sustained levels, and have contributed to the
prosperity of energy producers in the Middle East, in Russia and central Asia, and also in Africa where
there are now many oil exporters. China's and India's energy needs have driven their oil companies
into the international arena, competing for sources of upscale oil. IBM laptops are becoming Chinese.
An Indian steel company is now the world's largest. The trends are unmistakable.
The fact that the global economy has been growing very rapidly by historical standards in the last few
years despite concerns over global imbalances, in particular that the years 2004-2006 will see high
growth rates in Latin America and Africa, is as much due to the rise of Asia as to as the global engine
of United States growth.
Asian growth has benefited greatly from the relatively open international trading system that was built
up after World War II. All the East Asian miracle economies pursued export led growth strategies, with
the bulk of the exports going to industrial countries in the west. The recent failure of the Doha Round is
deplorable, particularly if it is final, mainly because it reduces the opportunities that some of the
poorest countries would have had to export agricultural products. But opportunities to increase
industrial exports still remain open to most developing countries.
The basis for the current international economic system - and it is a system - was designed by the
victors of World War II. The implications of the rise of Asia and of emerging market countries for the
international financial system will be at the center of attention at the meetings of the IMF and World
Bank in Singapore next month. The newcomers want to play a bigger role in the international
agencies, and they should.14 It is to be hoped that the current dominant forces in the Fund and Bank
will make the necessary room, though historically the established powers have lagged in making room
for others. While the newcomers want to play a bigger role in setting the rules of the game, it is not
clear what rules they would like to change, and whether they will want radically to change the
international system. To do that, they will need to further develop the analytic capacity to formulate
proposals for change, a process that will involve strengthening research and policy research
institutions, and the mechanisms through which they affect policy.
However the impact of China and India on the international financial system does not depend mainly
on the size of their quotas in the international financial institutions. It depends more on how important
Shanghai (or Shanghai-Hong Kong) and Mumbai become as financial centers. It is very difficult to
develop a new financial center, and some - like Paris - have declined in importance relative to where
they stood a century ago. Others, like Tokyo and Hong Kong, have become important, but do not yet
compete with London and New York. If China indeed becomes the largest economy in the world, if it
develops a market-based monetary policy, if it gradually liberalizes the capital account of the balance
of payments and allows the exchange rate to float, and if it can develop the necessary legal framework
for the efficient operation of the financial markets, then there would be very good reason for
ShanghaiHong Kong to blossom as a financial center. If that were to happen, we could imagine the yuan
becoming a major international currency, along with the dollar and the euro. But that is likely to take a
long time. And it is an interesting question as to what language will be spoken in that market - I would
bet on English.
Mumbai has a language advantage, already has a market-based monetary policy and a flexible
exchange rate, has a more market-based financial system, and a more developed legal system than
has Shanghai. But the potential size of the domestic economy will probably cause Mumbai to develop
more slowly than Shanghai as an international financial center. Nonetheless there is every reason to
believe it will become an increasingly important player in the international financial markets.
VI. The rise of Asia: political implications
So far the international economic system has dealt reasonably well with its changing economic
geography. While there are major concerns about how the United States current account deficit will be
unwound, about the failure of the Doha Round, about protectionism more generally, and about the
effects of the entry of another billion low-wage workers into the international economy, the overall
impact of the rise of Asia on the international system seems to have been favorable for most other
countries. In addition, the rapid growth of Asian economies has contributed to an extremely rapid
decline in global poverty in the last quarter century.
It is easy to describe crisis scenarios, particularly with regard to the unwinding of the U.S. current
account deficit - and many delight and profit from doing so. But overall it seems that the international
economy and its market and governmental organizations have sufficient flexibility, and perhaps even
the wisdom, needed to deal with the required adjustments.
The potential political consequences of the economic rise of two more great powers, and the relative
decline of others, could be more worrying. The economic rise of both Germany and Japan in the
second half of the nineteenth century and into the twentieth century was accompanied by their
growing military might, increasing assertiveness, and, eventually, terrible wars. The rise of the Soviet
Union and of international communism was also associated with major wars and political instability, in
this case around the world.
Pax
Are we more sophisticated now than the world was a hundred years ago? How long can the
Americana continue to maintain stability in Asia? How wise will the sole superpower be in its future
dealings in Asia? How in the long run will the relationship between Russia, with its underdeveloped
and underpopulated east, and China, with its massive population directly to the south, develop? Can
China and India take their rightful places in the world and in their regions without further major military
confrontations? Does the fact that China and India are nuclear powers, and so is Pakistan, make the
situation more stable as well as more dangerous, or just more dangerous? How will a potentially
nuclear Iran influence the equilibrium? How important is the North Korean nuclear threat, and how
long will Japan be willing to remain non-nuclear in the face of that and other threats?
These questions are too complicated for economists to answer. Probably, somewhere in a parallel
universe, political scientists are discussing them. Perhaps - but not very likely - the parallelism will
extend to their concluding that the political issues are likely to be resolved peacefully, and that the
economic issues appear intractable. But whatever they conclude, the answers to these political
questions, more even than the economic issues we have been discussing, will be key to the future of
the world.
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