Will China Eclipse the USA and Dominate the World?

Virmani (2005), concluded that "the (current) unipolar world will be transformed into a bipolar world during the first quarter of this century and into a tri polar one (China, USA, India) during the second quarter of the century."  This was based on construction of a simple new Index of Power Potential (VIPP), which took account of a country's size and technological competence measured succinctly by per capita GDP, and projection of the underlying economic/demographic variables.  These projections have been updated and refined in a series of subsequent papers and books(2006, 2009).*  My latest projections for VIPP indicate that China's Power Potential (or economic power) will equal that of the USA around 2025 and exceed it by 2030, while India's will attain the US level around 2045.  Does this mean that China will 'Eclipse' the USA or Dominate the World? Not necessarily, for two reasons.
   Firstly my analysis of the Cold War period, based on the same index, shows that at the peak of its power in the 1980s the USSR had about 25% of the power potential (VIPP) of the USA. Yet the World power structure was Bipolar and considered by everyone to be so.  Second overall power depends both on economic power and Strategic power (strategic technology and assets, including arms, nuclear and aero space) which have to be factored in to get an index of overall power (VIP).  Though China will eventually catch up with the USA on this front this will happen at least a decade or two after it equals the USA's economic power.  Based on these three factors, I conclude that the World's power structure is likely to  become Bipolar, with two superpowers  (USA-China) around 2025 and to become tri-plolar, with three super powers (US, China, India) around 2035-40.
    The greater uncertainty about the latter arises from a fourth ingredient in global power. The motivation of the country (its intellectuals, government, politicians), to obtain and use global power (the 'Will to Power").  Both the USA and China have this 'will' as did the USSR, and therefore the US will eventually do all in its power to maintain its strategic lead, not least by resisting by countering China's strategy of acquiring technology by every conceivable means.  On the other hand it is not clear that India has this global motivation!  If it develops the 'will' then India will become a 'super power' by 2035, if not then it may not happen till a decade later.
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*See earlier blogs or  https://sites.google.com/site/drarvindvirmani/

A Simple, Transparent Quota Formula For IMF

There is widespread agreement that a new quota formula for the IMF must be simple and transparent. The simplest and most transparent formula is one with a single variable, the share of country GDP in total GDP.  This will still require agreement on whether we should use GDP at purchasing power parity (PPP), which measures the relative weight of countries' in the real world economy, or GDP at Market exchange rates (MER) which some believe is a better reflection of the financial clout of countries.  A realistic and practical solution to this would be a blend of the two measures with the ratio decided by a tussle between the Low Income (LICs) and Middle Income countries (MICs) favouring PPP, on one side and the High income countries (HICs) on the other favouring MER. A simple calculation illustrates the why!

The impact of a change in the shares of GDP PPP for the four major groupings defined by the WDI (LICs, MIC-lower, MIC-upper and HICs) are shown (for 2009) in the table below:

Table: Shares of countries in total blended GDP (and quota)
Share of GDP PPP in blend=>	0%	50%	100%
High Income countries	70.8%	62.4%	55.4%
Upper Middle Income countries	14.0%	16.6%	18.8%
Lower Middle Income countries	14.5%	20.0%	24.5%
Lower Income countries	0.7%	1.0%	1.3%

Thus in going from 0% of GDP PPP in the blend, to 100%, the Low Income Countrie's quota share goes up by 90%, that of the Lower middle income countries' goes up by 63% and that of the Upper Middle income countries' by 17%. The High income countries' quota declines by 20%.  Consequently the High income countries favour a low proportion of GDP PPP in the blend, while it is in the interest of the rest to have a high proportion. As the rich countries of Europe (with 25% or so of the vote) have a veto on such a major decision, thier willingness to loose some vote power will be critical to the sucess of such a reform!

      The final issue would be whether or not to average the GDP over three years as is done for the GDP blend in the current formula. It is argued that a country GDP may have declined in that year because of a negative shock.  As the averging process delays adjustment to the latest economic position it favours slow growing economies at the expense of the more dynamic economies. A simple practical compromise, that would address both arguments, is to take the higher (maximum) of the 3 year average and the latest year.

    This simple solution could be achieved quickly and without laboured arguments, which everyone can see are designed to favour ones own country, allowing the IMF to focus unitedly on the revived crises in the rich countries (US, Euro area).

IMF: Equity based global institution or systemically important financial institution

   The IMF is an equity based financial institution with countries as share holders, who are represented on the IMF board by elected Executive Directors (except 5 heriditary 'peers'). It is important to understand the differences and similarities with private financial institutions, so as to adopt practices from the latter to increase efficency.  One of the most fundamental differences is that IMF shares are not tradable but assigned to member countries by means of a Quota formula. The quota formula determines the maximum share holding and vote share of individual countries, though a country can in principle, not take up its full entitlement if it does not have the funds or is not interested in the higher vote share.  A related difference is that all loans made by the IMF (its principle financial expendiduteres)  have to be approved by the executive board. These differences are (except the heriditary rights) appropriate for a global economic institution!

    In other respects there is nothing in the "articles of agreement of the IMF" preventing it from acting like a systemically important private financial institution, only self imposed restrictions/practices that can and should be changed. The IMF should use a mix of equity and market debt (borrowing from private global markets) to carry out its primary work of lending to countries in need of liquidity support.  A debt-equity ratio of 4:1 (say) would be quite consistent with a safe conservative financial institution, while allowing the IMFs lending resources to be five time its equity base.  As a macroprudential policy the approved debt;equity ratio could be allowed to vary around a mean value depending on the state of the Global economy.  Thus the debt:equity limit would be allowed to rise automatically during the upside and peak of the cycle and fall on the downside and trough of the cycle.  This would add a global automatic stabiliser to the World economy and also allow the IMF to respond more flexibly and quickly to liquidity crises arising from financial crises.
   There would be no need for special arrangements such as NAP/NAB that have been criticised as 'government bail outs' and give rise to a replay of governance and control issues that should be settled once and all through a modern, 21st century quota formula.  One welcome outcome would be to subject IMF lending, which is professedly for meeting liquidity problems, to some market discipline. This is particularly important for lending to countries who are likely to remain on the border line of solvency (below or above), even if stringint policy reforms are carried out (conditionality).  This reform would also allow the total resource requirements of the fund to be easily met by relatively small adjustments (up or down) in the total outstanding equity, as is routinely done in private institutions.
    Traditionally the IMF quota has also determined access to IMF loan funds.  Since the start of the global financial crisis the link between the IMF quota and the maximum allowed borrowing from it has been decisively broken. Many countries have recieved loans of 100s of per cent's their quota while some have recieved loans of 1000s of per cent's their quota.  Thus the link between the quota and access (borrowing limit) has been decisively broken.  The argument that as a matter of principle the quota formula must have variables determining access is not credibile given this recent history.  More important is the practical link between GDP and these new loan levels, which has clear implications for raising the weight of GDP in the formula. 

The Sudoku of India's Economic Growth

In the Sudoku (2009) I showed how India's 1990s economic reforms raised the underlying/potential growth rate of the Indian economy to a rnage of 8.5 to 9.0. I also said that this growth could (not would) be maintained for several decades provided economic reforms continued at the average rate seen since 1991.    The analysis of high growth economies has shown that numerous countries attaned high growth for 3 to 5 years (shooting stars) but only a handfull have been able to sustain it for two decades (HGEs).  These (HGEs) were countries that reacted quickly to adverse developments and shocks to the economy, by removing impediments to growth and stimulating new drivers to take the place of declining ones.  Thus there was a great danger of complacency  (Eco Survey 2008-9) and inaction on the policy front that would result in  a slowing down of India's growth below its potential. Unfortunately this what seems to have happened, with a resultant slowdown in growth below 8% and likely hood of further slowdown, unless policy reforms resume.  Despite the highly unfavourable global situation, I still believe that policy reforms, several of which have been on the table, can reverse the decline and put the economy back on the high growth path.

Comment on "So-called export led growth", by Jie Yang, IMF WP/08/220

Yang has a different definition of “export led ” than one has always used (which one always thought was the standard one). Our definition is in terms of policy bias ( tax-subsidy, exchange rate) towards exports as against a tax-subsidy-exchange regime that is neutral between imports and exports.  The question is whether government deliberately attempts to promote exports (through fair and foul means) or has a neutral policy regime!   The second stage of this analysis is to see which of the export oriented regimes were successful in raising export growth and GDP growth.  Those that are successful would be termed as following an export led growth strategy, regardless of what happens to the exchange rate!  In fact a depreciation of the exchange rate may be a precursor to or part and parcel of a biased policy regime promoting exports.  In fact the time pattern would be important. For instance successful high growth countries may gradually move from export bias to a neutral policy regime, with depreciation in the former period and appreciation thereafter, where the latter is an outcome of the success of the earlier policy!

    
Productivity increases will result in the Balassa-Samuelson effect (tradable productivity growth higher -> appreciation) and inverse Balassa-Samuelson effect (non-tradable prdoctivity growth higher -> depreciation) depending on which sector has faster productivity change.  An interesting emperical observation in the paper is that about half the high growth economies (as per Yang's definition) had an appreciation while a smaller number had a depreciation.  This aspect needs to be investigated further however, by relating it to the policy regime they had (in terms of export bias) and the time pattern of exchange rate changes.

Fiscal Debt Sustainability

In my 25 years of interaction with multilateral financial institutions on fiscal issues, I have repeatedly made the following points (which remain valid till today): 1) That the simple rule that growth rate must be more than the real interest rate is a good guide to ensuring that debt GDP ratio declines over time. (2) Theory does not tell us what level of the debt-GDP ratio is optimal. A number of factors are important for judging whether this level is too high. Among these are, (a) The asset owned or the net debt-GDP ratio. In other words a country with a lower debt, net of assets, can sustain a higher gross debt-GDP ratio.  Given the financial innovation over the last 25 years, it is also necessary to emphasise that the liquidity, maturity structure and uncertainty/risk associated with the assets also matters! A further implication is that debt incurred for investment is more sustainable than if used for consumption and transfers. (b) The manner of financing of the debt, in particular the proportion financed by domestic as against foreign capita/savings.  Thus countries with higher private domestic saving rates can sustain a higher level of debt to GDP and vice versa! (c) The demand conditions in the economy relative to potential supply.  An economy sufferring from lack of effective demand (virtually all advanced economies today), need to balance policy measure to ensure medium-long run debt reduction, with investment in public and quasi public goods in the short run to ensure effective demand.  If this is not done, growth will suffer and debt-GDP ratios will end up higher than they could be!  However, in economies suffering from excess demand (several Emerging economies today) and inflation, immediate fiscal (expenditure) contraction can allow a more relaxed monetary policy that will sustain growth and accelerate debt reduction. 

Emerging Economies need Domestic Reforms

In June this year, I concluded that the USA and EU were heading towards a lost decade, because their political systems had kept them dealing fully with the financial crises (web site).  The social-political developments in Italy and the US since then have raised the risks of a double dip.  Given this background can the Emerging economies (China, India, Brazil, Russia et al) maintain the growth differential? My answer is, 'Yes, if they take urgent steps to remove domestic constraint to growth and to stimulate domestic drivers of growth.' For China this means re-orienting its economy towards lower party-State controlled profits, higher wages and private consumption, greater public expenditures on social services (as against manufacturing investment) and slower export growth-appreciated exchange rate.  For India it means a faster reduction of the fiscal deficit, and a step-up of the pace of policy-regulatory reforms. In particular four broad reform areas have the potential of both accelerating growth and reducing inequality: (1) Urban planning, land use and urban infrastructure(water, sewage, public transport, parking), (2) Food supply chain modernization (FDI in retail trade). (3) Oil-energy policy and regulation (price distorting to direct  subsidies, regulated benchmark competition in electricity). (4) Skill development founded on high quality basic education (3 R s).  Similarly, if  Brazil, Russia, Indonesia and other large EMs can put their domestic house in order, they can collectively survive the growth slowdown and heightened risk emanating from the USA and Europe