Why developing countries subsidise the developed world?
In early 20th century it was primarily British capital which financed rapid investments in the US and other British colonies.
The rich country with buoyant incomes have a higher propensity to save and as the investment opportunities within their countries wither away and the rate of return on capital begins to slide, the surplus capital is invested in places with higher rates of profits. London and New York were the financial capitals directing billions of dollars along the world
A curious situation has developed in the last decade as developing countries have become net exporters of capital. In 2005, leading developing countries had current account surplus of $600 billion whereas developed economies had a current account deficit of more than $600 billion.
Obviously, the current account deficit of developed world has been fed from the surplus in the developing world. Prior to 1998, developing countries as a whole had a current account deficit.
This situation stems from export led growth of developing countries. The GDP growth in developing countries during the last decade has grown at a rate of about seven per cent. Over the last five years GDP per head in developing world has grown at an annual average of over five per cent compared with 1.9 percent in developed countries.
Exports from developing countries have been surging at an average annual rate of more than 20 per cent. The share of developing economies in the world exports has jumped to 43 per cent in 2005 form 20 per cent in 1970.
Exports from China are spurting at an annual rate of 30 per cent while those of other Asian and Latin American countries are rising at more than 15 per cent. There is a very high correlation between growth of GDP and ballooning of exports in almost all developing countries.
The most remarkable achievement of developing countries is ownership of world foreign exchange reserves. The developing countries hold 70 per cent international foreign exchange reserves whereas this level in 1950 was only 40 per cent. According to the IMF prudential rules, foreign exchange reserves should be able to finance three months of imports in view of uncertainty in foreign trade.
Developing countries’ foreign exchange reserves have surged to nine-months import level. The major holders of foreign exchange reserves are, China $1 trillion, South Korea $228 billion, Taiwan, $262 billion, India $158 billion, Hong Kong and Singapore $130 billion each. The reserves of these countries will keep on accumulating, if present policies persist.
China is the biggest squirrel of foreign exchange reserves as it is accumulating at a rate of $16 billion per month or about $190 billion per year. Similarly, the reserves of Taiwan, Hong Kong, Singapore and South Korea will keep on climbing in proportion to their current level.
The Opec countries do not publish their level of foreign exchange reserves but it is estimated that as a result of hike in oil prices to above $70 and which have currently declined to less than $60, the Opec countries are estimated to have increased their foreign exchange reserves by $250 billion.
The developing world has foreign exchange reserves of over $2 trillion. These reserves are invested in mostly in US treasury bonds and other financial instruments. The Economist correctly highlights “It seems perverse that poor countries today prefer to buy low yielding US government bonds when they could earn higher returns by investing in their own countries”.
For the developed world, it is the ideal situation. They welcome capital from the developing world and pay five per cent interest with just about three to four per cent inflation, take the same capital to the developing world and with their better management and technology make a profit of 25 per cent or more on the recycled capital of the developing world.
The losers in this perverse game are the developing countries. The biggest loser is China and the main beneficiary is the USA. China has the highest saving rate in the world. It saves 50 per cent of its GDP. Household savings provides 15 per cent, public savings provide 10 per cent and corporate savings of domestic and foreign industrial units are 25 per cent of GDP.
Even state-owned-enterprises (SOE) are churning out huge profits which are mostly re-invested and partly saved. China invests 40 per cent of its GDP or 80 per cent of its savings and the remaining 10 per cent of the GDP is converted into foreign exchange reserves by its huge current account surplus.
Previously Japan’s foreign exchange reserves were considered highest in the world but now China has overtaken Japan both in volume of exports, the size of current account surplus and consequently the level of foreign exchange reserves.
Chinese economy is the fourth biggest economy in the world in terms of dollars but second biggest in terms of purchasing power parity. Given its economic clout, China is not playing an active role in international economic order. China’s problem is that of an individual who has suddenly become rich and does not know what to do with the un-stinted wealth except to let it rust in the banks.
Firstly, China can spend more on healthcare, education, pension system and social safety nets which are starved of funds. According to Chinese economist Wu Ki, “Chinese families save money to safeguard themselves against an unreliable social security system, acute unemployment and rising education and healthcare costs.
The welfare system in terms of comprehensive health service, unemployment benefits and old age pensions do not exists in China and even if they exist, they operate at a rudimentary level. It forces Chinese, especially poor and middle class to save more for meeting the deficiencies in their social security network”.
The Chinese government should reduce its public savings and provide better social services to its people especially the poor living far from the sea board.
China gives very little Official Development Assistance (ODA) to developing countries. Its direct foreign investment in developing countries mostly in Africa linked to import of raw materials from these countries also is not very significant. Aid and investment in developing countries will give better returns than five per cent obtained from US securities.
Placing all or most of the reserves in US treasury bonds is also financially extremely risky. The dollar may depreciate by 10-20 per cent in few years as the persistent imbalance in US current account will force dollar to slide.
The developing world will suffer a capital loss of $400 billion, if the dollar slides by 20 percent and $200 billion if its slides by 10 per cent. Half of this calculated loss will be born by China and the other half by other big holders of foreign exchange reserves.
Much better to have invested this amount either at home or in developing countries or for international causes around the world. The affluence of Chinese and other holders of foreign exchange reserves should be utilised for more investment especially for providing better welfare services to its citizens and helping the cause of the sick and poor around the world rather than financing current account deficits of profligate consumers in the developed countries.
Chinese work hard to increase their exports. China has to export 80 million pairs of shoes to buy an Airbus plane. Foreign exchange earned with such gruelling work should not be transferred to rich countries so that their consumers could live beyond their means.
The present policy denies Chinese and people of other countries full fruits of their phenomenal progress and their justified, honourable and elevated place in the comity of nations.
The present policy of increasing the mountain of foreign exchange reserves involves huge capital risk for developing countries whose large chunk of population can have their lives lifted by greater domestic investment. The developing world as a whole will gain from more generous aid and investment policy of reserve rich developing countries.
— The author is former Secretary Planning