Friday, December 31, 2010

Longer-term consequences
Author:Y.V. Reddy(Former RBI governor)

As economic activity shifts to developing countries, there will be a greater diversity in the socio-cultural and political systems among these countries, and between them and the developed nations.

It is very difficult to visualise at this stage the longer-term consequences of the recent international financial turmoil. However, some broad generalisation could be attempted.

First, there is likely to be a shift in economic activity from the advanced economies in the West to the emerging market economies in Asia. Economic activity will be characterised by the supply of large labour force and the demand that would be arising out of the improvements in the standards of living of the large working population which is likely to be concentrated in developing countries, and in particular, Asia.

However, it must be recognised that entry of a large working force in these economies brings with it several challenges. These include acquiring skills to be globally competitive, improving the urban infrastructure, enhancing public health and medical facilities, and above all, managing the large scale migration of people from rural to urban areas.

It is unlikely that for the foreseeable future, the per capita income of the developing countries would surpass the per capita income of advanced economies. Hence, there is need for moderation in the euphoria about shift of economic power to the developing countries and Asia.

Second, the dominance of advanced economies in financial sector is not easy to challenge because of the concentration of technology, infrastructure like credit rating agencies and news agencies, and human skills. Hong Kong, Shanghai and Singapore, or Dubai, may pose a challenge but is unlikely that they will surpass the combination of New York, London and Frankfurt, for several decades. However, change in ownership of these institutions in favour of developing economies is feasible, but change in their location is difficult.

Dollar dominance

Third, the international monetary system is characterised by the dominance of dollar as a reserve currency. Currently, the major currencies which have characteristics of reserve currency are Euro and Yen. To a marginal extent, currencies of countries, such as Canada and Australia are also utilised as reserve currencies.

It is clear that the dominance of the dollar may reduce over a period (though in the short term it continues to be safe-haven in times of uncertainties), but it is unlikely that any other currency will replace dollar as the most dominant currency for world trading and financial transactions.

The pre-conditions for currency of a developing country to be considered as a reserve currency are open capital account and acceptability to the private sector participants. The latter would require a confidence in the capacity of the economy of the country concerned to withstand global shocks.

Recent events have shown that Euro zone itself is finding it difficult to withstand shocks while Japan had to intervene in forex markets.

Fourth, the importance of a country in global economy also requires leadership in science and ideas. Further, innovation is different from adaptation. The existing lead for advanced economies in these intellectual property related issues, as for instance, the think-tanks, is significant. It requires almost a generation to bridge such gaps, unless significant public policy initiatives, and to some extent, private sector contribution are forthcoming.

Multi-polar world

It is interesting to note that the contribution of Indian private corporate sector to educational institutions such as Stanford, Cornell and Harvard University in the recent years is perhaps hundreds or even thousand times more than its contribution to the universities in India (it was recently announced that Premji Foundation is investing in education, especially in rural and school education, which is laudable, but the point on support to universities in India remains valid).

One Indian corporate house has given $50 million for a building in an Ivy League university. This is a reflection on the confidence levels of the developing economies in their own educational infrastructure.

Fifth, it is interesting to recall that for several decades after the Second World War, we had a bi-polar world, with developing countries being described as the Third World. After the break-up of the erstwhile USSR, the world was broadly divided into developed and developing, with emerging market economies being treated as a sub-set of developing economies.

Currently, the world appears to be moving in the direction of a spectrum where it will be increasingly difficult to draw a rigid line between developed and developing countries.

Finally, it is useful to note that a shift in economic importance that happened after World War II was from the UK and Europe to the US. There were significant common cultural traditions between the two regions.

However, as economic activity shifts in future to developing countries, especially Asia, there will be a greater diversity in the socio-cultural and, perhaps, political systems among these countries, and between Europe, the UK, the US and these countries. In brief, in the longer term, the world will see a significant diversity in the set of countries with global economic significance.

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