The balance of power is tipping inevitably towards China

Western democracies approach the Paris summit as though they are still in control of the world’s destiny. But while they – we – are still important, the baton of power is gradually being passed to the emerging world, and particularly to China. It is the world’s largest emitter of carbon dioxide, and the emerging economies as a whole contribute double the carbon emissions of the entire developed world.

As it happens, this week has seen yet another milestone along the path to China becoming the world’s largest economy: the inclusion of the yuan in the IMF’s basket of currencies, to become the third largest after the dollar and the euro. This basket, called Special Drawing Rights, reflects the changing importance of different currencies in world trade, and has not been revised since 1999 with the formation of the euro. At the moment, the dollar accounts for 41.9 per cent of the basket, the euro 37.4 per cent, sterling 11.3 per cent and the yen 9.4 per cent. Next October they yuan will enter with a 10.9 per cent share. To make way for it, the share of the dollar will barely change but that of the euro will fall to 30.9 per cent, while the yen will come down to 8.3 per cent and sterling to 8.1 per cent. If China is the big gainer, Europe (lumping the euro and sterling together) is the big loser.

The addition of the yuan is partly symbolic and partly practical. Gradually, the world’s central banks are expected to shift their foreign currency reserve holdings into yuan. Gradually, it will become a major currency in world trade – with more deals denominated in it rather than dollars.

There are other milestones which China has passed or is about to pass along the way. It has the world’s largest foreign currency reserves; indeed, according to calculations by Bloomberg, larger reserves (excluding gold) than the next five countries combined. It has the second largest military budget after the US, more than France, Britain, Germany and Italy put together. And at the United Nations it is proposed that its share of the budget will rise to 7.9 per cent, which, if approved, will make it the third largest contributor after the US and Japan.

What should we make of all this? In one sense these are different examples of the way in which China is flexing its muscles, gaining what it sees as its proper recognition as a great global force, and committing to history its “century of humiliation” that began in the middle years of the 19th century. It may seem strange that events such as the defeats in Opium Wars should still loom large in the public consciousness but as any sensitive visitor to mainland China will acknowledge, the memories of these still linger.

This sensitivity will, I expect, show up in the Paris talks over the next two weeks. China will do whatever it has to do to tackle its environmental problems, you could say its potential environmental catastrophe, as and when it decides to do so, not because it is lectured by what it sees as hypocritical Western politicians. That it is why it (and India) put emphasis on cumulative carbon emissions rather than current ones.

But there is another way of looking at the growing footprint of China, which is to see the country as wanting to become more “normal”. Normal, in a political context, means playing a full and appropriately important role in international institutions, such as the IMF and UN. That is happening. But it also has to become more normal in an economic context, and that is much harder.

The problem, in a nutshell, is that while the balance of the economy has shifted towards the market sector, and while its most vibrant parts are privately owned, much of the activity remains within the planned economy. Private consumption is still much smaller than in any western economy – less than 40 per cent of GDP vis-à-vis more than 60 per cent – and investment particularly in infrastructure correspondingly larger. The supply of credit is still in practice controlled by the state. The result is a two-tier economy. All economies are part-public, part-private, but the balance in China, despite all its reforms, remains quite different to that of the developed world.

There is no ideal path, no model, for moving a command economy towards a private one. The three obvious models, Hong Kong, Singapore and Taiwan, don’t help much, for though Hong Kong in particular has been a beacon for southern China, all of these are tiny relative to China. Their combined population is equivalent to 3 per cent of the People’s Republic.

There is a model of how not to make the transition, which is Russia. And there is a model of a neighbour that seemed to be racing ahead then got stuck, which is Japan. But the first 40 years of China’s true great leap forward, as opposed to the abortive one under Chairman Mao, have been on balance a triumph. The costs of that advance – particularly the environmental impacts – have now become more and more evident, and the next stage is accordingly much harder.

The success or otherwise of that transition will be the great economic story of the world for the next couple of decades. China will make that transition because it has to, but the bumpier the ride, the more unsettled we will be. The slight shading down of Chinese growth this year, and hence demand for imports of raw materials, has certainly unsettled world commodity and energy markets.

The difficulty for the West is to accept that, while we are important and will remain so, our influence in the world is gradually waning. There is also the shift between the US and Europe, reflected in those changes in IMF quotas, with the former retaining much of its importance and the latter steadily losing it. That is not so much because the US is unified and Europe not; it is more because the US is growing solidly and much of Europe isn’t.

As the weight of economic power shifts, political power will follow. And as for China, we should listen to what it says in Paris, and accept that its perceived self-interest will drive its policies – not whatever we urge it to do.