Magnificent seven ride into the sunset

The Group of Seven (plus Russia) economic summit in Denver may not be about economics at all - it is about politics - but it nevertheless provides a good excuse to take stock of the state of the world economy. It does, after all, look very different from Denver than it does from, say, Paris or Bonn, let alone Sao Paulo or Shanghai.

Viewed from the Rocky Mountains all is swinging along just fine. There is a high degree of self-confidence in the US at the moment, which you can see in the level of the stock market and the surveys of the sentiments of both consumers and companies. This is partly a cyclical phenomenon, driven by the fact that the US is now seven years into its economic expansion, whereas continental Europe and Japan are much further back in the cycle. But it also reflects a perception of the success of the US economy in developing an entirely new economic sector: the fruits of the invention of the PC, the Internet, and the associated technologies.

Go back 15 years and there was a real fear that Japanese technology would dominate the world in the 1990s, for that was where all the new developments seemed to be coming from. That fear now seems almost ridiculous: Americans reckon, with some justification, that they have won the technological battle. If Japan (and other east Asian countries) make much of the hardware of this new technology, that is fine because the added value is increasingly in the software, at which the States excels. In any case, in one of the most important areas of the hardware - top-of-the-range chips - the US has increased its dominance as the years have rolled by.

A rather different sort of self-confidence is directed towards Europe. Continental European economies have just as much difficulty when competing against the US in these new technologies as does Japan, but the US was never worried about Europe on this score. Instead the US feared Europe would become a more effective competitor in the upper and middle-range engineering technologies, such as the Airbus aircraft maker. That has also changed; Europe is still seen as a fierce competitor, but the continent's record on job creation and unemployment has been so poor that the US is much less concerned generally.

This shift in attitude is both understandable and in many respects justified. It reflects an awareness that the things that people worried about in the early 1980s, such as the decline in employment in manufacturing, were a necessary part of structural change. The share of employment in manufacturing in the US has fallen further and faster than in the European Union or Japan (see the graph on the left) yet the US has been more successful at creating new jobs. Those additional jobs have of course been in the service sector, which has grown everywhere, but fastest in the US.

There has, however, been a price and you can see that in the other graph. There has over the decade to 1995 been some widening in income differentials in the US, measured by looking at the ratio between the highest and lowest deciles. There has also been a widening in Britain, France, Italy and Sweden, but a narrowing in Canada, Japan and Germany. There is no clear link here between differentials and unemployment, for while the US and UK have been successful in bringing unemployment down, France has not. What is perhaps more notable is that the spread is not really very wide: a ratio of between just over four (the US) and almost exactly three (Sweden). The "feel" of the countries would suggest a much greater differential: the US emphasis on equality of opportunity rather than equality of outcome, and the Swedish commitment to an egalitarian society. Nevertheless, the idea that countries have a hard choice between higher unemployment and greater disparities of income seems valid.

This leads to the big issue of globalisation. The UBS economic team, which produced that income dispersion table in a recent newsletter, ponders whether we are in the early stages of a sustained political backlash against globalisation. Whether globalisation is to blame for the apparent choice between widening differentials and rising unemployment is far from clear. Certainly in some industries employment in developed countries has been cut by competition from lower-wage economies, either from rising imports or the shifting of production overseas. But the numbers are quite small. The IMF's latest World Economic Outlook carried a study on the challenges of globalisation in which it concluded that trade generally accounted for only 10-20 per cent of the rise in wage differentials. Imports from low-wage economies account for only 3-8 per cent of GDP.

So there must be other factors at work. There may be some relationship with deindustrialisation, but it is hard to pick out any clear pattern, partly because the term "service industry" covers such a wide variety of different types of job. The IMF points out that in the US and the UK there has been a sharp rise in the pay of people at the very top end of the scale, which suggests great competition in the marketplace for people who are particularly highly skilled. Technology seems to have moved in a way which has increased the need for particular skills and hence the rewards for them.

If this is right, then the real culprit is technology, not globalisation. The cure must surely be upskilling the workforce as far as possible, rather than trying to restrict imports, or cut the mobility of capital. This - in broad terms - is the theme behind the UK initiative on jobs at the summit, but of course does not chime with the French approach gradually emerging from the new government there.

Behind all this is an even bigger issue, the relationship between the present developed world and the new developing countries. We still think of G7, or G8 now that Russia is becoming a member, though that is more for political reasons than economic ones. But in reality China is already a larger economy than Japan and India is larger than France. At some stage in the first decade of the next century the total output of the developing countries will exceed that of the present developed ones. At some stage during second decade of the century China will surpass the US in its overall output, though output per head will remain much lower. Managing the relationship between the present developed world and the new one is surely the most important single issue over these two decades, more important even than incorporating Russia back into the global economy.

We do not really have mechanisms to handle what will be a very difficult task. The US negotiates unilaterally with China; so does the EU; so does Japan. The same applies to India. There are other global institutions such as the World Trade Organisation, the IMF and the World Bank, but the very fact that there seems to be a need for a G7 suggests that to get things done you need a smaller unit. Rationally there should be a G6, made up of the US, China, Japan, the European Union, India and Russia. Providing the economic relationship between those players is managed sensibly, then everything else falls into place. The threat to the free passage of trade and finance comes not from within the present G7, not between the present developed countries at all, but rather between what might be called the old rich and the new rich. Old money frequently feels uncomfortable about new, and a newly-rich China will be a prickly partner.

So, aside from that question of unemployment in continental Europe, all may appear pretty satisfactory in the world economy. If you are an American, seeing unemployment at its lowest for a generation, things are great. But there is a new tension round the corner resulting from a seismic shift in power - a shift in power away from the attendees in Denver. Copyright: IOS & Bloomberg