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A meeting of the two largest economic powers

By Frank-Jürgen Richter

Business Times, 23 September 2015

Chinese President Xi Jinping is visiting the US and meeting US President Barack Obama in the White House this week. They met in Beijing last November when they agreed on stronger voluntary efforts against atmospheric pollution – hopes again run high for new agreements to be made. Of course there will be a public agenda, but their many aides will hold wide discussions, some will focus on trade and on the Trans-Pacific Trade Agreement.

World trade volumes faltered after the financial crash of seven years ago but there are signs of renewed optimism as earlier initiatives come into operation. The expansion of the Suez and the Panama canals are virtually complete and will allow the largest of ships to pass through. And, well-timed, more ships carrying up to 19,000 containers are being deployed, as well as massive bulk ships and car carriers like the Hoegh Autoliner that can carry 8,500 cars. They epitomise high economies of scale and a belief in the future of global trade.

Up to the 1970s the world was generally in balance with respect to trade and its monetary implications, and then gradually there was massive change. The US achieved a large deficit of US$820 billion in 1990 which has now been reduced to US$700 billion. In Europe, Germany was long its economic powerhouse and has a national trade surplus of US$50 billion. And China, which was roughly in balance until the 1990s, now has a US$90 billion surplus. Most imbalances take a few years to smooth out because they are subject to both national and international forces which take some time to work through their respective economies. National governments, officials and business leaders need to be cajoled into greater efforts, new processes and training needs to be instigated and the processes of marketing, manufacturing, transporting and selling finalised before the national finances are seen to move.

For example, in Germany with its large trade balance (which is very much greater than China’s when compared per person) it is suggested that it increase infrastructure spending, raise wages and undertake fiscal reforms to permit greater inward purchases. These changes will take time to enact. Yet we see that China has already undertaken these macro-economic suggestions – it has massively invested in all its transport systems (road, rail and air-, river- and sea-ports across the nation), in river-flow diversions (to bring more fresh water to the dry northern areas) and in housing (200 new large towns are being built). It is allowing greater inward investment and simplifying many regulations. These changes will help balance its money-trade fluctuations. The US, however, is somewhat mired in its internal politics and little will be changed to substantially alter its economic activity (which is still high as it remains the world’s largest economy) until perhaps a year after its presidential election in November 2016.

Many economists suggest that it is not the macro but the micro-economy that rules: it is the work of ordinary people that determines local wealth and thus national wealth so benefitting the balance of trade in the longer term. But a nation has to create the massive infrastructures that aid enterprise – China has followed the earlier examples of the US (1960s interstate road building) and Europe (the long-distance road and rail integration from 1990 onwards). We expect now that China will rapidly raise its productivity in its new inland development regions with everyone working smarter to live a richer life.

Total Factor Productivity (TFP) measures output against input and the efficiency of conversion. Of course it is not an exact measure but it is used to measure the relative efficiencies of nations, and over time can be used to judge how smartly entrepreneurs are working. Researching TFP at current purchasing power parity (a useful way of equating monetary exchange rates) and comparing with the US base = 1.0 we find the TFP for Germany rose steadily from the 1950s as it redeveloped after the last World War through youth education and investing in top-class machinery. By 1980 it was as efficient as the US, but has since fallen to 0.82 by 2010 (the last data year reported by FRED in St Louis, US). China on the other hand grew from a low base to reach 0.5 by about 1958, then falls a level between 0.3 and 0.4 to the present day. Last year China was the world’s largest market for industrial robots and one factory in Dongguan, perhaps extreme, has reduced its 650 workforce to 60 while its robots produce parts for mobile phones. Moving to smart working will benefit inland China and the wealth of its people.

Germany’s wealth derived within its townships and its small and medium enterprises who were administratively guided to be entrepreneurial and export-oriented developing its so-called Mittelstand. China did not permit such private SMEs until after its “opening up” from the late 1980s. The IMF notes Germany’s economic growth was almost linear from a modest base of US$ 4,300/capita in 1950 to become US$47,600/cap by 2014. China in comparison had a GDP of only US$614/cap in 1950 and has grown to US$7,600/cap by 2014 – though its base did not lift much until 1990 when further coastal Special Economic Zones (SEZ) were created. Now, with its vast new infrastructure China is well poised to re-ignite its entrepreneurial spirit, developing more goods truly made in China (not simply assembled). To do this effectively it will need to buy more high-tech engineering goods from, say, Germany so aiding the latter’s trade balance.

The meeting this month in the US between the heads of the two largest economic powers will have many beneficial outcomes for all nations. I wonder what surprises the leaders may offer to us.

The writer, Frank-Jürgen Richter, is founder and chairman of Horasis, a global visions community.