The Impact of the Emerging Powers on the World Economy (ARI)

The Impact of the Emerging Powers on the World Economy (ARI)

Theme: The emerging powers that have burst onto the world economic scene are causing an unprecedented structural change. This ARI looks at its main implications.

Summary: This ARI examines the economic and political implications of the rise of emerging powers in the world economy. It gives a brief overview of how their weight and influence have evolved in recent years and analyses their impact in terms of macroeconomics and trade, and their effect on wages and capital in various sectors. Finally, it notes the impact this process will have on the Spanish economy and the challenges the latter will face.


The rise of emerging powers in general and the so-called BRIC countries (Brazil, Russia, India and China) in particular in the world economy has dealt a shock of enormous proportions, triggering major changes on the world economic stage. A reconfiguration of the geography of world production is underway. Important changes are also taking place in patterns of trade and financial exchanges, and in the ways energy is consumed. In fact, it looks as if the classical distinction between centre and periphery as espoused 50 years ago by the theoreticians of structuralism is finally becoming obsolete.

In order to understand the magnitude of these changes, it is enough to note that the entry of China and India into the global production system is having a greater impact than that of the US into the world economy in the 19th century. Back then, the change altered the geopolitical balance of power in a significant way. So it is to be expected that in the next few decades the main emerging countries will ‘force’ (in a best case scenario they will do so peacefully) through reforms in the institutions of global governance.

This ARI examines the economic and political implications of the rise of the emerging powers, which we will call ‘BRIC+’. After giving a brief overview of the main aspects of this structural economic change, the article analyses some of the effects on macroeconomic policy, with special attention on new patterns of global trade and what they mean for neo-protectionism in advanced countries. Finally, the paper looks at the impact of this process on the Spanish economy, stressing the new opportunities these markets provide and the policies needed to take advantage of them.

The Numbers Involved in the Change
All of the studies that make forecasts of economic growth agree that the changes we have been witnessing in recent years are just the tip of the iceberg. According to estimates by the World Bank, the International Monetary Fund and the Goldman Sachs investment bank (which came up with the BRIC concept in 2003), in the next few decades the emerging economies of Asia, Eastern Europe, Latin America and Africa will continue to grow at least as fast as they have in recent years. China and Russia will slow down starting in 2020, mainly because of aging populations, but India and other emerging Asian Powers will accelerate their growth (see Pablo Bustelo, The Economic Rise of China and India and its Implications for Spain, Working Paper nr 31/2007, Elcano Royal Institute). However, there is already enough data to discern a structural transformation in the world economy.

The increase in the weight of the BRIC+ countries in the world economy is unprecedented. Whereas just 30 years ago they accounted for 34% of global GDP – measured in purchasing power parity – today they exceed 50% (the figure is 30% if calculated at market exchange rates). Furthermore, they generate 45% of world exports, hold 75% of central bank reserves, consume more than half of the world’s energy and accounted for 80% of the rise in world oil demand during the last five years, which explains the spectacular increase in petroleum prices. Since 2003 their production has grown 35% while that of developed countries has gone up just 13%.

Their financial markets have not remained on the sidelines amid all this dynamism and are now attracting many investors from wealthy countries. Thus, in the past five years their stock markets have risen an average of 400% in US dollars (in Brazil the figure is 900%) whereas in the same period the S&P 500 index in the US, for instance, has grown just 70%. Finally, multinational companies from the BRIC+ countries have started acquiring assets beyond these countries’ borders. In 2007 they invested more than US$70 billion abroad, US$55 billion of it in developed countries (these figures do not include investments in controversial sovereign wealth funds in emerging nations, which are also acquiring assets in wealthy countries, although in a less transparent way.) This scenario is seen in one last figure that is rather anecdotal but illustrative: 80% of the world’s construction cranes are now in China, and a quarter of them in just one city, Shanghai.

Effects on the World Economy
The dynamics outlined above are causing major economic change. On the one hand, new macroeconomic phenomena are emerging, most of them positive. At the same time revenue is being redistributed (both among countries and among individuals within each country); in other words, the rise of the emerging countries creates winners and losers that fuel international geopolitical tensions and defensive, neo-protectionist policies in advanced countries. Let’s look at the most important ones.

In the first place, the main sources of world demand now come from the BRIC+ countries, which have overshadowed wealthy countries. This diversification of sources of growth has made it possible to ease the world economic cycle and given rise in recent years to the period known as one of ‘great moderation’, characterised by stable growth, low volatility and large capacity for national economies to adapt to adverse economic shocks. Thus, according to figures from the IMF, world economic growth in the past five years has averaged 4.9%, even though advanced countries have grown on average just 2.6%. What is even more positive is that current financial turmoil –triggered by the sub-prime mortgage crisis in the US– does not appear to be having a significant effect on emerging economies. So people are now talking about a de-coupling of the global economic cycle; in other words, even if US economic growth declines (or even slips into recession) the emerging economies are not overly affected, which avoids a global slowdown. Many now see a global economy that finally does not depend on just one driver.

In this context, in the past five years world per capita income has grown more than 3%, faster than in the golden era of capitalism after World War II (1950-73) and perhaps more quickly than in any other period of history. This growth is having important effects on development levels and the reduction of poverty. The Millennium Objectives might be fulfilled in 2015 thanks to the BRIC+ countries, especially the Asian ones. Even Africa, which will not meet those goals and remains the continent most left out of globalisation, is managing to take advantage of the favourable economic situation and for the past five years has grown at an average rate of 5.5%, especially because of the rise in the prices of raw materials that many African countries export. Meanwhile, there has begun to emerge what the World Bank calls the new, global middle class, which in the next 20 years could total one billion people, mainly Chinese and Indians. This is a new group of consumers with enough income to acquire goods and services with high added-value that are produced (and conceived) in developed countries, mainly by leading multinational companies. This entails an unprecedented increase in the potential market for those companies which are best positioned.

Secondly, the entry of the BRIC+ countries in the world system of production is causing a structural change in the provision of and relationship between productive factors at the world level, and this is modifying their relative prices; in other words, wages and business profits. In order to understand what is happening, it is enough to think in terms of a simple rule of economics: in just a few years the global labour supply has doubled, rising by 1.5 billion people. But as emerging countries are relatively more abundant in labour –mainly unskilled– than in capital, they have not been able to contribute a significant amount of capital to the whole of the world economy (much less double the world supply of capital). Therefore, the effect of their international insertion has been a reduction in the global ratio between capital and labour, which leads to downward pressure on wages and upward pressure on return on investment (see Ferrán Casadevall & Clara Crespo, “Was Marx Right?”, ARI nº 65/2007, Elcano Royal Institute).

At the same time this phenomenon has diverse effects. On the positive side, and from the macroeconomic standpoint, the BRIC+ countries with their low wages and strong exports of manufactured goods and services at relatively low prices –which are also aided by exchange rates that in some cases are undervalued– have helped contain inflation at the global level, even with rises in oil prices. This has allowed central banks in developed countries to keep interest rates lower than they would were it not for the emerging economies. This in turn has made for greater liquidity and growth at the world level.

But this downward pressure on wages is having major adverse effects on workers in developed countries, especially those with low or medium-level skills who are employed in sectors that compete directly with imports from the emerging countries. This greater competition is also heightening economic insecurity in wealthy countries because sometimes the rise in imports increases unemployment rather than reduce real wage levels, especially in those countries in which labour markets are less flexible (like continental Europe). This undermines social cohesion and fuels protectionist sentiment and a rejection of globalisation. In fact, even though consumers in advanced countries can buy cheaper goods thanks to imports from the emerging countries, polls show they are less and less in favour of free trade because they feel it destroys the social contract on which co-existence is based, especially if there are no social safety nets to compensate those who come out on the losing end (see Ismael Sanz & Ferrán Martínez i Coma, “Support for Globalization and the Welfare State”, ARI nº 129/2006, Elcano Royal Institute; and Kenneth Scheve & Matthew Slaughter, “A New Deal for Globalization”, Foreign Affairs, July/August 2007).

So far, the sectors most affected by competition from the BRIC+ countries have been textiles, footwear, toys, automobiles and even industrial goods of medium added-value or which have been standardised, such as appliances and hardware (naturally, the effect varies from country to country depending on its productive structure. For instance, the Portuguese textile industry is suffering much more than Spain’s). Furthermore, industries in some developed countries are watching with alarm as China manages to raise the added-value of its exports with great speed, which means that medium- or high-level technology sectors (both goods and services), that believed they were immune from foreign competition, are in fact beginning to be exposed. Also, new technologies have made possible that some services which in the past were not marketable internationally now are. This boosts competition the most standardised segments providing services of medium added-value, such as computer services, some financial services, banking or telecommunications, and even medical radiology services (for now the US electorate has proved to be more worried by outsourcing of services than people in the EU). We must also note that the impact of increased competition is not only being noticed in developed countries. Many developing countries with higher labour costs than the emerging Asian ones, such as the nations of the Maghreb, are seeing how their products are losing price competitiveness in the international markets.


Challenges and Opportunities for Spain
Spain, like other developed countries, must accept the fact that these structural economic changes are not going to reverse and will even become more intense in the future. In fact, Spain must realise that to some extent the changes stem from the liberalisation policies promoted by advanced countries in the last few decades, although they have also been strengthened by the technological revolution and domestic economic reforms in developing countries. Therefore, it is necessary to face two challenges. The first is defensive: ease the cost of the internal adjustment that the rise of the BRIC+ countries is making necessary in Spain’s economy and society. The second is of an offensive nature, and involves getting companies and workers to take advantage of the new opportunities offered by emerging markets.

The first challenge lies in acknowledging that many traditional sectors that are intensive in unskilled labour and compete with imports from the BRIC+ nations will not be viable in the future. This will make it necessary to facilitate the transition from Spain’s current production model to another which is based more on knowledge and greater productivity. It is also essential to enact government policies that will compensate individuals who stand to lose the most in this necessary process of transition and accelerate the process of productive re-conversion to those sectors which are viable over the long term. Only in this way can one counter the lack of support for globalisation and growing protectionism that is spreading through advanced societies. Therefore, government networks providing social protection should serve to reduce uncertainty and growing economic insecurity. But they should not keep afloat sectors which cannot compete globally and drain resources which could be invested in knowledge-intense activities, which provide the greatest opportunities for Spain and the rest of the developed countries.

The second challenge is to utilise government policy in a way that facilitates companies’ access to the enormous markets of the BRIC+ countries. In recent years the Spanish economy has made a great effort at internationalisation, as a result of which many of its companies are well-placed to face this challenge. They have increased their flexibility and capacity for responding to change, now produce goods and services that are intensive in –or which incorporate– knowledge and technology and have managed to fragment their production lines in order to cash in on the new opportunities. The sectors providing the greatest opportunities are banking and financial services, telecommunications and computer services, infrastructure, transport, energy, petrochemicals, some segments of the food and agriculture market, and cultural services, to name just a few. But in order for more Spanish companies to serve these markets in which they face competition from other multinational companies, more intense and fluid cooperation is needed between government authorities and companies: together they must design adequate incentive structures to promote the applications of investment in research, development and innovation.

Finally, Spain should strive to assert itself more and more in the economic institutions of global governance, in a context in which advanced countries are losing influence. This will only be possible with a tight-knit EU that speaks with just one voice. The new EU reform treaty signed in Lisbon allows Europeans to be a bit more optimistic in this regard.

Federico Steinberg
Analyst at the Elcano Royal Institute and Professor at Madrid’s Universidad Autónoma