Britannia Radio

Economic View: The world's authorities must recognise the eastward shift in financial power

'Will people really buy a new car just because they're paying less tax'

Hamish McRae
Sunday, 16 November 2008

If you want one measure of the shift in global power, consider this: all the economic growth that will take place next year is forecast to come from the emerging economies, not from the present developed world. This point hangs over the Group of 20 meeting in Washington this weekend, a group that includes the main developing countries as well as the old developed ones. If you want growth, you won't find it here.

The economic background to the meeting is provided in the new International Monetary Fund forecasts for the world economy. The alarming thing is not that it is forecasting the main economies will shrink next year – most of us knew that was on the cards – but rather the scale and swiftness of the downgrade. The previous numbers were done in October, so in just a month the IMF has shifted from expecting slow growth for the major economies next year to actual contraction. The main figures are shown in the graph and for me two other points stand out: the speed of the collapse in growth and the burden now on the big emerging economies to keep the world economy moving next year.

What is happening is twofold. There is the cyclical downturn that has so expanded the lexicon of normal speech. Everyone now seems to be familiar with economic terms such as the inter-bank rate, sub-prime, toxic debt, negative equity and so on. It is only two years since someone patiently explained to me what a collateralised debt obligation was and told me that I should worry about CDOs, not hedge funds. And there is the debate about the shape of the downturn: will it be a deep "V" or a shallow "U" and so on. At any rate, that is all the stuff of the cycle.

But there is also the structural change and that is the shift to the emerging world. The cycle speeds up the structural shift. Back in the early 1990s, when the developed world experienced its last recession, the Chinese and Indian economies were tiny relative to the developed world. So the fact that China in particular was growing more swiftly than Europe or North America did not really change the power balance much. Now it alters the balance radically. This year, in all probability, China has overtaken Germany to become the world's third-largest economy; if not this year, certainly next.

So the debate that is starting in Washington, and will continue probably for the next year or so, is partly about efforts to jack up the economy now but also about how to rethink global economic management to run things better next time. Part of that will inevitably mean giving the fast-growing nations a greater say in what should be done.

As far as the next few months are concerned, this issue will be what is the most effective way to rekindle growth. Low official interest rates help and we will doubtless get lower ones yet in the UK and the eurozone. But they are already so low in the US that further cuts would not make much difference – and that leads to a further concern. Yes, the Bank of England can cut rates further, but if money is not available then there is not much point in doing so.

As far as fiscal policy is concerned, some sort of boost will happen in most economies, but there are obvious questions to ask about the wisdom of this. For example, can it really be right for the UK Government to be borrowing £100bn a year, or whatever number Alistair Darling proposes for 2009-10 in next week's pre-Budget report? And there is an even more alarming possibility – that all this additional borrowing may not be very effective.

Will people really rush out and buy a new car just because they are paying a few hundred pounds less in tax? They might be wiser to pay off their credit card bills instead. Japan's experience of running a huge fiscal deficit in the 1990s is discouraging. The country managed to postpone recession for about five years, but when it came in the late 1990s, it was a serious one. And Japan's ageing population is now saddled with the largest debts of any major developed country.

Fortunately, economies left to themselves are usually self-healing and there is therefore a reasonable hope that growth will resume in 2010. The main duty of the policy-makers is not to make matters worse. As growth does resume, however, the world will be different from the past five years. There will be obvious differences in that banks will be very cautious in their lending and companies will make sure they are bullet-proof in their finances.

Beyond this, the shift of power to Asia will mean that there will be reforms of the system itself. One idea being discussed is for China and Japan, both of which have huge reserves, to increase the funds available to the IMF, so that the IMF has more firepower to help countries in financial distress. But in the medium term, there is the question of how the central Washington-based institutions need to change their voting procedures, their management structures, their core mission and so on.

It is a huge subject and needs reflection rather than knee-jerk changes, but the bottom line is that the IMF and World Bank will have to reflect the reality of economic power now, rather than economic power a generation ago. On present trends, China overtakes the US as the world's largest economy in about 20 years' time, maybe 25, and the IMF and World Bank will have to take that on board.

Meanwhile there is one really important issue. This is how in trying to reflate the world economy we avoid making the mistakes of the past: how we avoid, for example, creating another credit bubble; or how we avoid the US being so dependent on Asian savings. There will always be some sort of economic cycle. We are not clever enough to avoid that. But we ought to be able to mitigate its most serious effects, both on the downward swing into which we are now heading, and then on the upward movement that will come, let's hope, in 2010. Memo to the world's monetary authorities: could do better.

Are we watching the last hurrah for glitzy philanthropy?

There have been so many casualties of the credit crunch that the impact on the charitable community has slipped by unnoticed. Charities that rely on endowments may be worse hit by the fall in asset prices than commercial companies. Some of the big US foundations, such as those funded by Bill and Melinda Gates and Warren Buffett, may be fine, but there will be others that are in trouble.

For example, it seems that some US universities have lost one-third of their endowment, while some providers of scholarships in Britain are having to withdraw offers as they are unable to fund them. There may be a particular problem for charities that have put money into less conventional investments, including hedge funds, but actually the pressure is pretty universal.

In the UK the loss of dividend income from the banks is particularly serious, because while foundations may be able to look through capital losses and assume that markets will eventually recover, they can't manage without dividend income if they are to maintain their present level of disbursements.

There is a further issue. Leave aside what is happening to existing endowments and ask what will happen to philanthropy generally. Will the present boom continue? A book will be published this month called Philanthrocapitalism, by Matthew Bishop of The Economist and Michael Green, a Department for International Development official writing in a personal capacity. You can catch its big idea from the sub-title: "How the rich can save the world and why we should let them".

The thesis is that very rich people can mobilise resources – not just money but skills and connections – more effectively than governments. Bill Gates' efforts to tackle malaria are a good example of this drive to fix a problem where governments and international agencies have failed. The authors argue that "a web of wealthy motivated donors has set out to change the world".

That web includes those who have created fortunes but also a supporting cast of rock and film stars (Bono and Angelina Jolie) and former politicians (Bill Clinton and Tony Blair). Though the financial resources may be small (in the US 1.67 per cent of GDP is given to charities and in the UK 0.73 per cent), the glitz gives big donors clout.

But it raises many questions. Some will worry if a few famous people should have such power. Those who welcome the phenomenon – as I do – can't help worrying that we may be seeing some high point in philanthropy and that tougher times (and higher taxes) will choke its growth. If we are moving towards an era of big government, that may leave less room for the "social investors" that Bishop and Green rightly celebrate.