Since David Cameron’s conference speech in October about Britain being in a ‘global race’, many commentators have written negatively about the effects of the rise of the east. The latest example is a column by Martin Kettle for the Guardian. The common thread in all of these columns is to present globalisation and the rise of a prosperous Chinese/Indian middle-class as a challenge rather than an opportunity.
First, what Martin has got right. He says:
“We may have come out of recession again, but the idea that Britain, let alone the countries of the eurozone, can expect to see any resumption of the kind of growth rates to which we have all been accustomed since the second world war, is increasingly fanciful.”
This is partly right. We’ve gone through a debt-fuelled bubble which culminated in a large financial crash and high public debt burdens. High debt burdens are almost always associated with significantly slower economic growth over a long period. In terms of why this is the case, it doesn’t seem to be debt per se (i.e. countries which default away their debts don’t seem to have higher growth rates). It seems to be because of the policies adopted to deal with debts: higher taxes, financial repression and higher inflation. Reinhart and Rogoff say, for example:
“If the government at the same time is imposing policies that attempt to reduce its debt burden with higher taxes, a burst of unexpected inflation, or various types of financial repression, then investment may well be discouraged.”
High taxes, wealth confiscation, financial repression are not good for growth. Countries with higher debts are currently engaging in this sort of stuff. But there are other immediate problems: ill-functioning banking sectors and deliberate attempts to make energy more expensive, for example. On top of this, the euro is suffering from a competitiveness imbalance which the EU is trying to solve through internal devaluation and enforced supply-side reforms, but the gap is so big and wages so sticky that this is leading to huge pain for the southern European states. Couple all of this with high commodity and food prices and policy uncertainty in the US and you have a perfect storm for western countries.
So, the immediate prospects for growth are poor, yes. And a secondary challenge going forward comes from demographics. As our populations age, the dependent to non-dependent ratio will rise, meaning fewer resources left in the wealth-generating sectors of the economy and more being funnelled through state pensions and retirement programmes/promises. Putting the short-term debates about fiscal and monetary policy aside, real growth and prosperity improvements come from innovation induced improvements in productivity and realising the gains from trade – so fewer resources in the wealth-generating part of the economy will prove a drag on growth.
Martin is right therefore that we have no god-given right to grow, but I’d argue the reasons why we might experience slower growth going forward are to do with the demographics and policies that Western European countries have chosen to adopt. That's why those of us on the free-market side of the debate constantly argue for radical down-sizing of unnecessary government, because we believe that in the long-term high-tax, high-welfare, high-regulation government suppresses incentives and stifles innovation, leading to a slowdown in productivity and our underlying rate of growth.
But note, this has nothing to do with the shifting of power from West to East, as Martin’s column implies. The rising prosperity of China does not mean a loss of prosperity to us unless you think we are producing the same goods and services as they are, which is simply not the case. This is why I find David Cameron’s ‘global race’ talk so bizarre. A race implies having winners and losers: if China is doing better, then we must be doing worse. In trade terms this is a thoroughly mercantilist outlook, which was of course thoroughly debunked by David Hume and Adam Smith 250 years ago. They recognised, rightly, that trading through comparative advantage increases prosperity for all. If you can understand that, then it quickly follows that the rise of a large Chinese middle-class is a huge opportunity for us, not a threat. Economic evidence suggests that as people’s incomes increase, their demand for services increase much more quickly than their demand for manufactured goods. In many of these services, high-valued added manufacturing and creative industries, the UK has potential stregnths.
So while Martin may be right about Europe being likely to face slower growth in future, his implied reasoning is wrong. It will not be due to the rise of the East, but because of demographics coupled with the wrong policies. But if politicians were to implement the right policies - liberalising the productivity potential of economies, increasing retirement ages, reducing marginal tax rates, breaking down trade barriers, thorough welfare and supply-side reforms, building airports when necessary - then we'd put ourselves in the best possible position to gain hugely from the rise of China by realising the benefits from trading.