Saturday, May 28, 2011

East moves west - more than a miner miracle

You'd need to be living under a rock not to have heard that the world's centre of economic gravity is moving from west to east - towards us. But most of us are yet to appreciate the full ramifications of this change in the globe's economic geography.

The shift is occurring because of the re-emergence of China and India as major economic powers. Why re-emergence? Because in the 18th century - before the West's industrial revolution - the two accounted for almost half of gross world product.

By 1990, China and India's share of world gross domestic product was down to less than a 10th. Today it's about a fifth and expected to be more than a quarter by the end of this decade. By 2030 it may be as much as a third.

Everyone knows the rapid industrialisation and urbanisation of these two countries is the cause of our present resources boom. But as Treasury points out in its annual sermon (otherwise known as budget statement No. 4), there's more to it.

''As China and India continue to develop, the growing cities now driving demand for Australia's mineral resources will be populated by an increasingly wealthy and upwardly mobile middle class, with incomes and tastes to match,'' Treasury says.

''Increasing consumer purchasing power and changing spending patterns will open up new, often unforeseen, opportunities for Australia - well beyond those flowing from the current mining boom.''

One study has estimated that the number of middle-class consumers in Asia could increase by more than 1.2 billion people by 2020. If so, these projections would mean that by the end of this decade Asia would have more middle-class consumers than the rest of the world combined, with China surpassing the United States as the world's single largest middle-class market in terms of dollars.

By 2030, with India following China's lead, the world could have gone from mostly poor to mostly middle class, with two-thirds of the world's middle-class consumers living in our region.

(Like all projections by economists, this one confidently assumes the natural resources and ecosystem services needed to make this possible will be readily obtained - presumably, from another planet. But let's not allow ecological realities to spoil our happy economic analysis.)

In poor countries, spending on basic goods typically accounts for quite a high share of GDP, with household incomes barely covering the necessities of life. Then, in the early stages of economic development, a surge in investment spending causes consumption's share of GDP to fall quite sharply.

In time, however, continued growth allows a larger middle class to devote more money to purchasing luxury goods and services, both in absolute terms and as a share of household spending. As a result, consumer spending's share of GDP recovers as economies reach middle-income status.

China's consumption-to-GDP ratio has declined markedly in recent decades, reaching a low of only 35 per cent in 2009. (Our proportion is about 55 per cent, which is lower than it used to be because of our much higher investment in new mining capacity.)

But China is fast approaching income levels where consumption often turns, and the Chinese government is focused on reforms to foster higher growth in household incomes and to rebalance the economy towards domestic demand. So Treasury says there's considerable scope for a strong rise in the consumption ratio in the medium term.

We know from the earlier experience of countries such as Japan and South Korea in travelling down this road that as the amount of consumer spending grows its composition changes. As they become more affluent, people devote a higher proportion of their spending to services and consumer durables.

The early stages of such a shift are already evident in China. Since the early 1990s, its urban households have devoted a declining proportion of their spending to food and increasing proportions to medical services, transport and communication, and education, recreation and culture.

If you divide urban households into four groups according to their incomes, you find that, as incomes rise, households devote smaller and smaller proportions to food, and bigger and bigger proportions to services.

Urban households constitute a large and growing proportion of China's 400 million households (Australia has 8.5 million). Just over the past 10 years, the proportion of urban households owning a car has gone from virtually none to 12 per cent. The proportion owning microwave ovens has gone from 16 per cent to 58 per cent.

And get this: the number of computers owned per 100 households has gone from eight to 70, while the number of mobile phones has gone from 16 to 188. So ''new technology'' goods are spreading faster than household appliances.

On the ladder of goods and services to which people with growing incomes aspire, after consumer durables come culture, tourism and advanced education.

On overseas tourism, China and India's sheer population size mean they're starting to overtake those countries formerly dominant in providing tourists, the US, Britain and Japan. In 1995, about 4.5 million people from mainland China and 3 million from India travelled abroad for business and leisure.

By 2009, China's travellers had increased tenfold to 48 million, meaning it was close to catching up with the US and Britain. India had experienced a three- to four-fold increase to 11 million travellers a year.

And all this before the rise of the middle class has really got going.

Australia, of course, is already getting its cut. China and India's share of our education exports has risen sharply. China's share of our wine exports is now five times larger than it was five years ago. Tourist arrivals from China have more than trebled in the past decade - overtaking Japan in 2008-09 - and are catching up with those from the US.

Of course, not all the opportunities created by Asia's rising middle class will fall within areas of our comparative advantage. And to maximise even those opportunities that do fit our bill we'll need to continue to change and innovate. Competition with other countries will be fierce. As their own education systems improve, a smaller proportion of Chinese and Indians may seek education abroad.

And Treasury says it's not possible to forecast the exact mix of goods and services that will be demanded, let alone the shape of the global economy that will best service these demands. You can say that again.