HASHEM PESARAN, professor of economics, USC Dornsife.
This op-ed originally appeared in The Sunday Times.
The British economy is experiencing a double-dip recession, the leading eurozone economies and Japan are stagnant and the American economy is slowing down. At the same time, emerging economies such as China and India continue to show impressive growth.
This divide in the fortunes of the industrialised and emerging economies is not new. Over the past two decades China’s importance has increased dramatically. While world trade has grown by about 40% from the mid-1990s, China’s trade has more than doubled during the same period.
It has not been alone. India, Brazil and a number of other emerging economies have also been enjoying growth rates well in excess of those experienced by the main industrialised countries. During the past decade China, India and Brazil have been growing at, respectively, about 10%, 7.5% and 3.5% annually, compared with 1.5% in America, 1.3% in Britain, 1.1% in the euro area and 0.6% in Japan.
These impressive growth rates in China and India have not been matched by their financial and capital market developments, however. The renminbi and rupee remain non-convertible internationally. The Chinese and Indian stock markets remain underdeveloped and are not integrated with the economies of the rest of the world. There are no long-term bond markets in China or India and their money markets are largely regulated.
This has placed further strains on financial markets in the developed world, mainly in America, Britain and the eurozone. Surplus funds from China, India and other emerging economies (primarily leading oil exporters) have been the main source of cheap liquidity in the world economy, fuelling the lax credit conditions that prevailed in these markets in the years leading to the 2008 credit crunch and the ensuing recession.
As a result we have seen significant increases in the integration of financial markets and a consequent rise in the risk of financial crises.
This large sustained imbalance between real and financial sectors in emerging economies has to be addressed if we are to reduce the chances of future crises. The development of financial centres in China and other emerging markets has to be made a top priority. More regulations and better monitoring of financial markets in the developed economies, while clearly needed, will not be sufficient in an integrated global economy where 50% of world output is produced by countries without any developed financial markets.
The absence of such financial centres in the emerging economies is likely to place undue pressure on the industrialised countries and bias their economic development towards financial services and away from manufacturing and trade. This process also distorts the geographical growth patterns within the industrialised economies with financial services being concentrated in one or two cities such as London, New York and Chicago.
A new global growth strategy that focuses on the development of financial centres in fast-growing economies such as China and India should, in due course, help to foster a more geographically balanced development of countries (such as Britain) that have been the recipient of a significant part of financial surpluses from these emerging economies.
Supporting the development of financial centres in China and India could enhance the position of Britain in the global economy. The development would not, as many might fear, threaten the position of London as a world financial centre, but instead would enhance it.
Britain’s banks and financial agencies can spearhead the investment needed in the emerging markets — a kind of “outsourcing” of the financial activities of the City of London. At the same time there must be “insourcing” of some of the manufacturing and service activities that are currently outsourced. This can be done by investing in infrastructure away from London, to the north of Britain especially, and spending more on the education and skill retraining that are badly needed if the labour force is to adapt to fast-changing technology.
The rapid growth of financial centres in Britain and America has been largely mirroring the underdevelopment of such centres in the fast-growing emerging economies. It is time to reverse the process and move the industrialised economies from finance to production. This will help China and India to develop their financial centres so they can receive better returns on their hard-earned surpluses.