Speeches

          I thought that I would talk about two things which are quite important in the way which China has related to the rest of the world, how it affects all of us be it in the advanced economies, in the NIEs as they are called, and in fact in the middle-income economies globally.

          When we think of China over the last 20 years or if you look at the international commentaries, two things stand out. First, China’s impact at the low-end of global manufacturing – low-wage, low-skill manufacturing. That was a major supply shock that started 25 years ago, and picked up pace in the last two decades. It was a major supply shock, the way China took over the production of a whole range of items that required discipline, good organisation on the factory floor, hard-working people but at very low wages. That’s the first thing.

          The second thing that strikes you as important in China’s relationship with the rest of the world was something that happened more recently, in the last ten years, which was the significant surplus of savings in China that made its way particularly to the US financial markets. Basically a net export of capital from China to the rest of the world, which was very unusual because this was the first time a country that had relatively low income levels, in fact very low income levels by advanced countries’ standards, was exporting a significant amount of capital to the rest of the world. As the economists tended to put it, this was capital going uphill rather than downhill as it should have been. So that is the second thing that strikes you about China’s relationship with the world economy.

          And both are seen as having been somewhat of a destabilising force in the global economy. The second especially, the surplus of savings, is viewed by some as having inflated the savings glut that led to excessively low interest rates in the US and by some accounts (which I don’t myself agree with) being responsible for laying the foundation, laying the setting, for the global financial crisis. I don’t have time to get into the reasons why I disagree with that but the description of the excess savings flowing into American financial markets was an accurate one.

          I think we are in the danger now of focusing too much on these issues of the past. We are in danger of fighting the last battle and not paying enough attention to the real challenges ahead. The real challenges coming out of the transformation of China and a whole new phase of globalisation that we are already seeing happening and which is going to pick up pace in the next ten years. On both counts – the nature of competition from China in manufacturing and second the nature of China’s savings investment-imbalance. On both counts, I think we are going to see fundamental change in the next ten years. It will mean a whole new phase of globalisation and a whole new balance in the global economy. I will elaborate briefly on both parts.

          First on the issue of competition in the global economy, something fundamental is happening in China today. We see it especially in coastal China, up and down coastal China, not just in major cities like Shanghai and Guangzhou but all the way up in Dalian, Qingdao, and down to the southern coasts. A movement that is described often in commentaries as a movement of wages, but it is really a movement of productivity. A remarkable transformation that is taking place between enterprises, workers and the way in which local government authorities interact with them that is leading to a move up the value chain of manufacturing. It is no longer just low end, it often involves more skilled workers, engineers, researchers and managers now competing at the middle and even the high end of global manufacturing.

          It is still in transition because when you go to the department stores, you still find cheap Chinese products all over the place. What we are going to see in the next 10years is China’s entry into the middle- and higher end of global manufacturing, underpinned by forces which are not new but are picking up pace. First, the fact that China has a relatively strong education system, very high degree of literacy and if you look at the latest tests in international maths and science, obviously a very high degree of competence among high-school graduates. Second, a little less apparent is the fact that China is now a major innovator. The Chinese enterprises put together are now the fourth largest internationally in applications for patents, and in fact, is rising quickly.

          Third, the fact that productivity in China still has tremendous room to catch up. Productivity levels are still quite low. If you look at it in industry, it is about 15% of America’s level of productivity or about 30% of the levels in the Asian NIEs – Taiwan, Singapore, Korea, Hong Kong. There is a tremendous scope to catch up, just by exporting, importing components, looking at buyers’ specifications – tremendous scope to catch up technology and know-how. So we are now in a new phase of productivity catch-up in China that isn’t just about bringing in unskilled workers from rural areas into cities and getting them used to the factory floor but moving up, applying knowledge. A whole string of Chinese cities are now, by international reckoning, knowledge-based cities – the where the economies are fundamentally knowledge based.

          That is the new supply shock in the global economy that is going to become more apparent in the next decade. And we all have to adjust to it – the fact that China would be not just a producer of highly competitive low-end, cheaper products but will be a major player in the middle and higher end of global manufacturing. And increasingly in services, in white-collar jobs. All forms of white-collar jobs – accountants, software engineers, architects and others. And if you put that together with what is happening in India, Brazil and the emerging world at large, you see a fundamental change taking place in the distribution of white-collar jobs in the global economy. It is no longer the reserve of the advanced economies. Cities with deep clusters of knowledge-based professionals in the emerging world are now driving a significant shift in competitiveness that we all have to get used to.

          However, I do not believe that China is going to lose competitiveness in the low-end of manufacturing very quickly. I don’t think China is close to a situation where it has an excess demand for labour. It still has a significant supply of labour in the central provinces, in the interior, in the northeast, a very significant supply of labour and it remains highly competitive at the low end. So what it means is that China is competitive up and down the ladder as it utilises more fully its labour force.

          But it is approaching a situation which should have occurred earlier had China entered global markets 50 years ago. We are now approaching a normal state of affairs where we have competitive people applying themselves in international markets, and they are earning their place up and down the ladder.

          ; The advanced economies face a particular challenge in this regard because they also have to deal with the legacy of the financial crisis – a very large stock of unemployed persons in the Europe and US especially, who will not be able to return to the old jobs that they had. Cyclical stimulus efforts – fiscal or monetary – may achieve something but they are not going to re-create the old jobs that people had before the financial crisis. So when you put together the structural challenge of China, India and the emerging world, now entering the middle and higher end of the global workforce, with the cyclical challenge of a very large stock of unemployed persons in the advanced economies, that must force policy to operate on new, more strategic terms. And force policy to think in supply-side terms, not just in demand-side terms, to re-think training for every individual worker, rethink the public school system in the US, rethink how we get productivity up in each of our economies so as to make China an opportunity and not just a challenge. That is going to be the key task for all of us in the next decade. So that is my first theme.

          The second theme is the transformation that is taking place in China that is going to change its whole-savings investment balance. What happened in the last decade was an excess of savings above investments, largely because of corporate savings and in particular because the state-owned enterprises, having made significant profits, were not required to distribute them. That led to a glut in savings that found its way to the international markets, largely through official foreign reserves and other official conduits. This is going to change, and it is going to change at the same time that the saving investment balance changes within the rest of the world. We know the story of how China is now becoming more of a consumer-led economy. Not a sudden or dramatic change, but evolutionary. They are very serious about it. It is not just the 12th Five Year Plan, it is also the whole set of policies and the whole range of public agencies – in social security, health, education – a whole range of policies at the micro-level that are leading towards to a more consumer-led society, even as it remains highly competitive in production. So savings rates in China are not going to be what they were before. The state-owned enterprises are also now being required to distribute their profits, eliminating the artificial boost in savings that existed in the last decade.

          The demographics is also compelling. By 2015, China will begin to see a decline in the younger working age population, which will then pick up pace in the 15 years after 2015. As in all societies, it will significantly reduce national savings rates. At the same time, investments will remain high. I don’t see an early end to high investment rates in China, because if you look at the continual movement of people from rural China into the cities, in fact, more than 300 million people in the next 10 years, that has to mean a tremendous demand for every form of infrastructure that you associate with cities - third-tier, fourth-tier cities – housing, commercial buildings, transport infrastructure, power, a whole range of utilities. Tremendous investment demand. So whilst it makes very interesting reading in the magazines to look at the ghost towns with lots of condominiums that are dark and empty at night, that is a short-term phenomenon. In the longer term, there is enough demand to fuel the increased supply of infrastructure in China. That means a continuing high investment rate.

          So savings are going to trend down while investments remain high. And the economists have various calculations, but it is not improbable at all that you will see a reduction in China’s surplus savings (the excess of savings over investments) of 3 to 4% of GDP at least, within 5 years. Which will significantly reduce the imbalances that we are seeing globally – the excess savings in China and the shortage of savings in US and in the rest of the advanced world. It more or less brings the imbalances back to a normal level. You can argue about the extent and the pace, but I see this as a fundamental change.

          There will be a reduction in excess savings in China and it will take place at the same time as something else happening in the rest of the world, which has to do with investment rates. Investment rates in the rest of the world are unusually low. In fact, in the advanced economies, capital expenditure is now lower as a percentage of GDP than it has ever been before. Partly for cyclical reasons following the crisis, but also because of the secular trend that has taken place over the 20 years – a reduction of investment rates in the advanced economies. And even in the emerging world outside China, when you look at Asia outside China, investments are unusually low. They never recovered following the Asian crisis, but everywhere you go, Southeast Asia and elsewhere, you now see potential for investments. If we want to achieve the rates of economic growth that everyone desires, most especially in the advanced world in order to mop up unemployment, if you want to achieve the potential of the emerging world outside China, in other words the higher rates of potential output growth needed to sustain jobs for a growing young population, there will have to be more investment.

          And higher investments in the rest of the world at the same time as a reduction in the savings surplus in China will have to mean a move towards more normal levels of interest rates. We have unusually low real interest rates globally and that is unlikely to last. I am not making a prediction for the next one or two years but if you look at it over the next five years and certainly over 10 years, it is hard to avoid the conclusion that you are going to see a significant increase in real interest rates globally. And that poses both a challenge and an opportunity. It is obviously going to be a tremendous fiscal challenge because we have most of the advanced countries now having very high public sector debts, that will now have to factor in much higher costs of debt servicing, which then impinges on their annual fiscal deficits, impinges on their savings investment balances, and compounds the problem that I was talking about because it amounts to more dis-saving in the advanced economies.

          Higher real interest rates are also an opportunity, because the artificially low interest rates currently are not helping the efficient allocation of capital, including in the emerging market world. And as China itself liberalises its financial systems, opens up progressively, it too will see a more market-related cost of capital that will be helpful in the allocation of savings to investments so as to yield the best returns and productivity.

          So that’s basically the world that we are entering. I see it as a world of opportunity, if we respond in the right way - which means responding by training our people and investing for higher productivity over the medium term.

          It is also a world in which you will no longer have capital flowing uphill, from the emerging world into the developed world. In fact the bulk of investments and savings will be taking place in the emerging market world. And that poses a real challenge of developing the capital market s of Asia in particular, including China. Developing capital markets that can efficiently allocate savings to the most productive use. We are quite far away from that situation now, quite far away from the situation where emerging financial markets can absorb savings from the rest of the world and allocate it efficiently to the best uses within Asia.

          So these are challenges, but also opportunities if we take a long-term view, take a strategic view towards this new phase of globalisation. It will be a net plus for all of us, but how we respond will determine if that is the case.

Thank you very much.