Ifo Viewpoint No. 110: Panta Rhei

Panta rhei. Everything flows. This Greek aphorism often comes to mind when I think of the economic and political changes in my lifetime. They seemed as impossible before they occurred as they have felt natural in retrospect. Communism fell. Germany was united. The United States elected a black man president. And now we are in a phase in which Asia is catching up with the West and American hegemony is being challenged.
Hans-Werner Sinn
Munich, 20 November, 2009

While American casino capitalism has collapsed, and America’s European economic satellites are suffering, China seems to be taking advantage of the situation, increasing its trade surplus in the midst of the global economic crisis. Indeed, in the first four months of this year, China became the world’s leading goods exporter, overtaking Germany, the previous champion.

It is true that in other economic terms, China still lags far behind. Although China accounts for 20% of the world’s population, its share of global GDP currently is only 7%. By contrast, the United States and the EU account for 54% of global GDP, despite having only 12% of the world’s population.

But these figures are changing rapidly, owing to China’s exuberant growth. From 1995 to 2008, China’s economy grew by 229%, while the world economy grew by 63%, the US by 45%, and 27-member European Union by only 37%. It may be difficult for China to ever match the success of a small Asian country like Singapore, which has already overtaken the US in terms of GDP per capita as measured by purchasing power parity. Yet China will undoubtedly become the world’s largest economic power in the foreseeable future. To achieve this leadership position, it needs less than a quarter of US per capita GDP, because its population is more than four times larger.

The forces of globalization that were liberated by the fall of Communism have created a better world, with rapid economic convergence and shrinking inequality. The proportion of people living below the World Bank’s poverty line of $1.25 a day shrank from 52% in 1981 to only 25% in 2005. More than 50% of the world’s population is now considered middle class, with a living standard above the average of the developed countries’ poverty lines ($8.2 at 1996 PPP prices). And the worldwide Gini coefficient of inter-country inequality fell from 0.653 to 0.556 from 1980 to 2007, owing largely to the astounding performance of the emerging countries, particularly China and India.

The development of the world has not been without problems, however. Carbon-dioxide emissions have been growing fast, fossil-fuel resources are being depleted rapidly, and global warming has accelerated. Even if the US embraces the Kyoto Protocol under President Barack Obama, the world’s temperature will break the record of the last 800,000 years in the next 30 years.

Moreover, huge waves of migrants from developing countries to OECD countries challenge the assimilation capacity of the latter and deprive the former of its educated work force. In the US and Germany, 13% of the population is foreign born, as are 8% of France inhabitants and 10% of Britain’s. Unskilled migrants tend to come to Europe, where they burden the welfare state, and skilled migrants are lured to the US, although they are urgently needed at home. The brain drain is a problem not only for South America west of the Andes and many African countries, but also for Turkey, Italy, Britain, the Balkan countries, Germany, and Finland.

Migration from developing countries partly reflects a problem that also triggered the current financial crisis: international capital flowed in the wrong direction. In recent years, the US absorbed half the world’s capital exports, while China provided one-fifth of the total. In 2007 alone, the US imported $790 billion of capital, while the emerging and developing countries exported $714 billion.

This made it possible for US households to stop saving and enjoy an exorbitant consumption level, but it stood on its head the conventional wisdom that capital should flow from rich to poor countries, where it can more productively be invested. Since the world will not continue to provide the US with goods in exchange for dubious financial securities, Americans will have to leave their dream world. They will have to brace themselves for an extensive period of diminished expectations that will last much longer than the next economic boom, and that will require substantial structural changes in the US economy.

In the next few decades, the biggest challenge for the world will be peace, because the changing economic power structure will require corresponding political changes, which the US, as the incumbent superpower, will not easily accept. The situation is similar to Germany’s challenge to British geopolitical hegemony in the nineteenth century, when the German economy blossomed. The resulting political tensions led to a second Thirty Years’ War that brought Western civilization to the brink of collapse. It can only be hoped that the political leaders who shape the course of the twenty-first century will be wise enough to avoid such an outcome.

Hans-Werner Sinn
Professor for Economics and Public Finance
President of the Ifo Institute

Published as "Verheißung und Gefahr des globalen Wandels“, Börsen-Zeitung, No. 167, 2 September 2009, p. 6.