Tuesday, January 11, 2011

The World in 2050–PwC Jan 2011 update

PricewaterhouseCoopers (PwC) has published an updated version of its earlier projections of the world economy and has ranked countries based on the size of their economy. The new update takes into account the economic shift that has occurred after the global financial crisis, which has further accelerated the shift in global economic power to the emerging economies. It compares between the seven fastest emerging economies (E7)-- China, India, Brazil, Russia, Indonesia, Mexico and Turkey-- and the G8 economies.

Measured by GDP in purchasing power parity (PPP) terms, which adjusts for price level differences across countries, the largest E7 emerging economies seem likely to be bigger than the current G7 economies by 2020, and China seems likely to have overtaken the US by that date. India could also overtake the US by 2050 on this PPP basis. GDP at PPPs is a better indicator of average living standards or volumes of outputs or inputs, because it corrects for price differences across countries at different levels of development.

The World in 2050 -- GDP at PPPs Rankings
PPP 2009 Rank Country GDP at PPP(constant 2009 US$bn) PPP 2050 Rank Country  Projected GDP at PPP(constant 2009 US$bn)
1 US 14256 1 China 59475
2 China 8888 2 India 43180
3 Japan 4138 3 US 37876
4 India 3752 4 Brazil 9762
5 Germany 2984 5 Japan 7664
6 Russia 2687 6 Russia 7559
7 UK 2257 7 Mexico 6682
8 France 2172 8 Indonesia 6205
9 Brazil 2020 9 Germany 5707
10 Italy 1922 10 UK 5628
11 Mexico 1540 11 France 5344
12 Spain 1496 12 Turkey 5298
13 South Korea 1324 13 Nigeria 4530
14 Canada 1280 14 Vietnam 3939
15 Turkey 1040 15 Italy 3798
16 Indonesia 967 16 Canada 3322
17 Australia 858 17 South Korea 3258
18 Saudi Arabia 595 18 Spain 3195
19 Argentina 586 19 Saudi Arabia 3039
20 South Africa 508 20 Argentina 2549

However, John Hawksworth and Anmol Tiwari, the authors of the report, also rank countries based on  GDP at market exchange rates (MERs), which does not correct for price differences across economies but may be more relevant for practical business purposes. Ranking with MERs show that the E7 overtaking process is slower but equally inexorable. The Chinese economy would still be likely to be larger than that of the US before 2035 and the E7 would overtake the G7 before 2040. India would be clearly the third largest economy in the world by 2050, well ahead of Japan and not too far behind the US on this MER basis. In 2009, India’s share of world GDP at MERs was just 2%. By 2050, this share could grow to around 13%. MERs factor in the likely rise in real market exchange rates in emerging economies towards their PPP rates. This could occur either through relatively higher domestic price inflation in these emerging economies, or through nominal exchange rate appreciation, or (most likely) some combination of both of these effects.

The World in 2050 -- GDP at MER Rankings
PPP 2009 Rank Country GDP at MER(constant 2009 US$bn) PPP 2050 Rank Country  Projected GDP at MER (constant 2009 US$bn)
1 US 14256 1 China 51180
2 Japan 5068 2 US 37876
3 China 4909 3 India 31313
4 Germany 3347 4 Brazil 9235
5 France 2649 5 Japan 7664
6 UK 2175 6 Russia 6112
7 Italy 2113 7 Mexico 5800
8 Brazil 1572 8 Germany 5707
9 Spain 1460 9 UK 5628
10 Canada 1336 10 Indonesia 5358
11 India 1296 11 France 5344
12 Russia 1231 12 Turkey 4659
13 Australia 925 13 Italy 3798
14 Mexico 875 14 Nigeria 3795
15 South Korea 833 15 Canada 3322
16 Turkey 617 16 Spain 3195
17 Indonesia 540 17 South Korea 2914
18 Saudi Arabia 369 18 Vietnam 2892
19 Argentina 309 19 Saudi Arabia 2708
20 South Africa 286 20 Australia 2486

This well could be a return to the historical norm:

In many ways this renewed dominance of China and India, with their much larger populations, is a return to the historical norm prior to the Industrial Revolution of the late 18th and 19th centuries that caused a shift in global economic power to Western Europe and the US – this temporary shift in power is now going into reverse. This changing world order poses both challenges and opportunities for businesses in the current advanced economies. On the one hand, competition from emerging market multinationals will increase steadily over time and the latter will move up the value chain in manufacturing and some services (including financial services given the weakness of the Western banking system after the crisis).

The report notes that India’s trend growth is expected to overtake China’s trend growth at some point during the coming decade due to India having a significantly younger and faster growing working age population than China and due to it having more potential for growth as it is starting from a lower level of economic development than China and so has more catch-up potential. However, India will only fully realize this great potential if it continues to pursue the growth-friendly economic policies of the last two decades.The authors argue that particular priorities should be in maintaining a prudent fiscal policy stance, further extending its openness to foreign trade and investment, significantly increased investment in transport and energy infrastructure, and improved educational standards, particularly for women and those in rural areas of India.

The model’s assumption is that long-term trend growth is driven by the following four factors:

  • Growth in the labor force of working age (latest UN population projections)
  • Increase in human capita (average education levels across the adult population)
  • Growth in the physical capital stock (capital investment net of depreciation)
  • TFP growth (technological progress and catching up)

In terms of per capita income, the US will still lead the way.

Currency war and the future of dollar

The one thing that could jeopardise the dollar’s dominance would be significant economic mismanagement in the US. And significant economic mismanagement is not something that can be ruled out.

The Congress and Administration have shown no willingness to take the hard decisions needed to close the budget gap. The Republicans have made themselves the party of no new taxes and mythical spending cuts. The Democrats are unable to articulate an alternative. 2011 will see another $1 trillion deficit. It is hard to imagine that 2012, an election year, will be any different. And the situation only deteriorates after that as the baby boomers retire and health care and pension costs explode.

We know just how these kind of fiscal crises play out, Europe having graciously reminded us. Previously sanguine investors wake up one morning to the fact that holding dollars is risky. They fear that the US government, unable to square the budgetary circle, will impose a withholding tax on treasury bond interest – on treasury bond interest to foreigners in particular. Bond spreads will shoot up. The dollar will tank with the rush out of the greenback.

The impact on the international system would not be pretty. The Canadian and Australian dollar exchange rates would shoot through the roof. A suddenly strong euro would nip Europe’s recovery in the bid and plunge its economy back into turmoil. Emerging markets like China, reluctant to see their exchange rates move, would see a sharp acceleration of inflation and respond with even more distortionary controls.

With exorbitant privilege comes exorbitant responsibility. Responsibility for preventing the international monetary and financial system from descending into chaos rests with the US. How much time does it have? Currency crises generally occur right before or after elections. Can you say November 2012?

More by Barry Eichengreen here. He argues that until the next currency crises arises (and an alternative currency found), dollar will remain the dominant currency at the global level because of capital controls in India and Brazil; relatively small scale of Canadian loonie and Australian dollar; and China’s capital control plus worry among investors about its opening of financial markets, enhancing their liquidity, and strengthening the rule of law. But, the dollar will be in crisis due to political economy ups and downs in the US. Eichengreen hints that it could be in November 2012, after the US presidential election.