CHALLENGE EUROPEDragons, elephants and tigers: adjusting to the new global reality

Esko Aho José Manuel BarrosoUmmu Salma Bava Axel BerkofskyKarishma Bhansali-Mehta Carlos Buhigas SchubertDuncan Freeman Claudio GruaFrancesco Guerrera Pascal LamyCholsoo Lho Augusto Lopez-ClarosHans Martens Hanns MaullPramit Mitra Melissa MurphyYukio Okamoto Kristina PerssonAndreas Schleicher Karine Tremblay

September 2006

In strategic partnership with the King Baudouin Foundation and the Compagnia di San Paolo

With the support of the European Commission

CHALLENGE EUROPE ISSUE 15

Dragons, elephants and tigers:adjusting to the new global reality

Esko Aho José Manuel BarrosoUmmu Salma Bava Axel BerkofskyKarishma Bhansali-Mehta Carlos Buhigas SchubertDuncan Freeman Claudio GruaFrancesco Guerrera Pascal LamyCholsoo Lho Augusto Lopez-ClarosHans Martens Hanns MaullPramit Mitra Melissa MurphyYukio Okamoto Kristina PerssonAndreas Schleicher Karine Tremblay

EPC Working Papers represent the views of the authors and not necessarily those of the EPC.

September 2006

ISSN-1783-2462

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06 Table of contents

About the authors 4

Foreword 6by Jacki Davis

Introduction 8by Francesco Guerrera

I. THE CHALLENGE FACING EUROPE

Globalisation: an opportunity to raise Europe’s growth and prosperity 13by José Manuel Barroso

Challenging European innovation policy 19by Esko Aho

Education and the knowledge economy in Europe and Asia 24by Andreas Schleicher and Karine Tremblay

Living in the past? 37by Hans Martens

Can globalisation work without Europe? 42by Carlos Buhigas Schubert

II. THE RISE OF THE DRAGON, ELEPHANT AND TIGERS

China’s steady rise to the economic super league 47by Duncan Freeman

The Indian economy – its rise and challenges 54by Karishma Bhansali-Mehta

At a crossroads: the transition towards globalisation 61by Cholsoo Lho

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06Setting the stage for sustainable growth 69by Augusto Lopez-Claros

III. INTERNATIONAL RELATIONS

The rise of Asian economies and the WTO: back to the future 78by Pascal Lamy

Why Europe must hang together 84by Hanns W. Maull

Great expectations: what Asia wants from Europe 90by Ummu Salma Bava

IV. ASIAN INTEGRATION: PROSPECTS AND CHALLENGES

Is Europe a model for Asian economic integration? 96by Claudio Grua

Asia’s faltering steps towards political integration 102by Axel Berkofsky

V. HOW OTHERS ARE RESPONDING TO THE CHALLENGE

Taming the dragon and marching in step with the elephant 108by Pramit Mitra and Melissa Murphy

Japan and the new Asian reality 114by Yukio Okamoto

VI. GLOBALISATION WITH A SMILE?

The communications challenge 122by Kristina Persson

ANNEX: KEY FACTS AND FIGURES 128

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06 About the authors

Esko Aho is a former Prime Minister of Finland and chaired a group of fourindependent experts which submitted a report on European innovation policy,Creating an innovative Europe, to the European Commission in January 2006.

José Manuel Barroso is the President of the European Commission.

Ummu Salma Bava is Associate Professor, Centre for European Studies, atthe School of International Studies, Jawaharlal Nehru University, India.

Axel Berkofsky is an Associate Policy Analyst at the European Policy Centre.

Karishma Bhansali-Mehta is a journalist with the Brussels-based IndiaNews in Europe Programme (INEP).

Carlos Buhigas Schubert is a Policy Analyst at the European Policy Centre.

Duncan Freeman is a lecturer at the Brussels Institute of ContemporaryChinese Studies (BICCS).

Claudio Grua is an Assistant Professor and lecturer in the Economics ofEuropean Integration at the University of Turin.

Francesco Guerrera is the US Business Editor of the Financial Times.

Pascal Lamy is the Director-General of the World Trade Organization.

Cholsoo Lho is the Director of the Center for Global Cooperation at theSamsung Economic Research Institute (SERI).

Augusto Lopez-Claros is the Chief Economist and Director of the GlobalCompetitiveness Programme at the World Economic Forum.

Hans Martens is the Chief Executive of the European Policy Centre.

Hanns W. Maull is Professor of Foreign Policy and International Relations atthe University of Trier, Germany.

Pramit Mitra is a Research Associate, South Asia Program, at the Center forStrategic and International Studies (CSIS).

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06Melissa Murphy is a Research Associate, Freeman Chair in China Studies, at the CSIS.

Yukio Okamoto is the President of Okamoto Associates, Inc., a politicalmanagement consultancy, and was a Special Advisor to Prime MinistersRyutaro Hashimoto and Junichiro Koizumi.

Kristina Persson is the Deputy Governor of the Swedish Central Bank.

Andreas Schleicher is the Head of the Indicators and Analysis Division,Directorate for Education at the Organisation for Economic Co-operationand Development (OECD).

Karine Tremblay works in the Indicators and Analysis Division, Directoratefor Education, at the OECD.

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06 Foreword

by Jacki Davis

When European Union leaders met in 2000 to launch the Lisbon Agenda,with the ambitious goal of making the EU the “most competitive anddynamic knowledge-based economy in the world” by 2010, all eyes wereon the United States.

The debate, both in the run-up to the Lisbon Summit and ever since, has beendominated by comparisons between the economic performance on either sideof the Atlantic. The over-arching aim of the targets the Union set itself then wasalso clear: to enable the Union to catch up with – and then surpass – the US.

Since then, policy-makers, the business community and the media havetended to focus on the shortcomings of the Lisbon Strategy: why, six yearsinto the process, so little has been achieved and why Europe’s politicians arestill failing to match their lofty rhetoric at the EU’s top table with concreteprogress on the ground.

Far less attention has been paid to the fact that, while Europe has beenpreoccupied with its internal problems in living up to the commitments madeby its leaders and considering what can be done to improve delivery over thenext four years, the world outside has changed and the goalposts have moved.

Europe is only belatedly waking up to the fact that the real challenge is nowcoming from the economic superstars in Asia: the fiery Chinese dragon, themighty Indian elephant and the roaring tigers.

It has been a rude awakening for many: opinion polls show that while someEU Member States – mostly on Europe’s northern rim – have embraced thechallenge and generally have a positive attitude towards the opportunitiesoffered by globalisation, many others see it only as a threat.

In this issue of Challenge Europe, leading experts on the politics andeconomics of both Asia and Europe explore the nature of that challenge,examine the key reasons for the recent success of the Asian economies,consider whether it is sustainable in the long run, assess its likely impact onboth Asia and the EU, and set out what Europe must do to ensure that it canrespond to the challenge – making the most of the opportunities it createsand minimising the threats to its own economic well-being.

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06These articles make it clear that it is not only Europe which needs to adjustto the new global reality. The US is also having to adapt, as is Asia’straditional economic powerhouse – Japan. The rising Asian economiesthemselves also face some pressing challenges if they are to sustain theimpressive growth which has propelled some of them into the economicsuper league and is fuelling China and India’s ambitions to become greatworld powers.

However, this does not mean that Europe can simply watch and wait to seewhat happens. Asia’s economic achievements to date have alreadyprofoundly changed the geopolitical landscape, and the genie cannot be putback in the bottle.

Many of the issues raised in this publication are constantly under discussionat the European Policy Centre (EPC) within the framework of a number ofour work programmes: EU and Asia, Growth and Jobs, and EuropeanSecurity and Global Governance, in particular. These discussions willcontinue, with a view to contributing constructively and substantively to theongoing debate.

For, as the EPC’s Chief Executive Hans Martens points out: “Standing stillwhile the world is changing is not the answer.” Indeed, trying to do so risksundermining support for the whole process of European integration in thelong run.

The EU must be seen as part of the solution to the challenges posed byglobalisation, not part of the problem.

Jacki Davis is Head of Communications at the European Policy Centre andEditor of Challenge Europe.

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06 Introduction

by Francesco Guerrera

In hindsight, Lisbon was a bad choice.

The Portuguese capital’s position on the western edge of the continent madeit a poor launch pad for the EU’s much-vaunted plan to rid its economies ofinefficiencies and enhance their productivity. Furthermore, while most ofthe rhetoric about the ‘Lisbon Agenda’ trumpeted efforts to catch up with theUnited States, an economic miracle of much bigger proportions was takingplace, quite literally, behind Europe’s back.

The emergence of Asia has been the defining economic issue of the modernera. In a relatively short period of time, countries that had been devastatedby a virulent financial crisis rose from the dead to become, first, crucialtrading partners and, more recently, powerful economic threats to the‘developed’ West.

How has that been possible? And will the next steps in Asia’s rapiddevelopment present an even bigger threat to the US and Europe?

Both questions have as many answers as there are countries in Asia. More thanany other part of the world, Asia is the sum of widely-differing historical, social,political and economic factors. The region contains both the world’s largestdemocracy (India) and its most despotic regime (North Korea). It boasts theworld’s two largest countries (China and India) and one of the smallest (Bhutan).

On the religious and cultural front, the EU’s current agonising over relations withTurkey pales into insignificance when compared with Asia’s cacophony. Theregion is home to the most populous Muslim and Hindu countries (Indonesiaand India), and it is rare to find an Asian country where several religions andtribes do not rub shoulders (and sometime trade blows) with one another.

Such mind-boggling diversity is even more apparent in the economic sphere.With China’s giant leaps forward hogging the limelight, it is easy to forget thatAsia’s ‘emerging markets’ have already produced five high-income economies:Hong Kong, Japan, Singapore, South Korea and Taiwan.

Similarly, India’s remarkable economic successes should not hide the factthat incomes in the country are still only some 10% of those in the top

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06regional economies – a plight shared by Cambodia, Laos, Pakistan andVietnam among others.

But despite the huge intra-regional differences, it is possible to chart thecourse of Asia’s rise and identify its key patterns.

The first, overriding consideration is that the region has been the engine ofglobal economic growth over the past decade and is likely to keep motoringin the foreseeable future.

Asia’s economic expansion has followed an almost linear trajectory, asidefrom the huge downward turn of the 1997/98 financial crisis. According tothe World Bank, real GDP per head in Asia grew by about 3% a year in the1970s, accelerated to nearly 5% per year in the following decade andreached 5.4% by the 1990s.

Indeed, Asia is the only region in the world whose growth after the 1973 oilshock was faster than before that momentous event, which suggests thosewho predicted that the new millennium would herald the dawn of an ‘Asiancentury’ have so far been spot on.

This year, the International Monetary Fund (IMF) expects Asia to record GDP growth of nearly 7% – a figure that rises to 8% if Japan, which is still struggling to get out of a 14-year long recession, is excluded. As a result, Asia’s contribution to world growth in 2006 will equal those of the North American Free Trade Association (NAFTA) and EU countries put together.

The reason for this dramatic rise in Asia’s influence on the world economycan be summarised in one word: trade.

In 1963, Asia accounted for a mere 10% of world merchandise exports.Today, that figure has more than doubled, with the export-driven Asianeconomies taking advantage of the globalisation of consumer goods and theincreasing liberalisation of trade flows.

Europe has not been immune to the mercantilist policies of modern Asia.Imports from Asia grew at an average yearly rate of 17.5% between 1994and 2004, according to the Organisation for Economic Co-operation and Development (OECD), dwarfing the 8% annual growth of trade in theother direction.

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06 The obvious reason for this phenomenon – and the one most often cited by populist politicians in Europe – is that Asia’s cheap labour gives its companies an unfair advantage over rivals in the developed, andunionised, world.

Only the first part of this statement is true. Chinese workers’ average wagesare about 3% of those paid to their counterparts in the US and Europe, andeven in richer countries such as Singapore and South Korea, wages are onlyaround a third of those in developed nations.

But that is only half of the story. Asia is able to export its way to growthbecause of two crucial factors: huge demand for cheaper goods fromWestern consumers and undervalued exchange rates.

The first point deals with the argument about Asian companies’ ‘unfair’ advantage. If anything, the region’s vast pool of cheap labour enables European and US consumers to get a better deal. European and US companies are also able to cut costs by moving theirmanufacturing operations to Asia – as even a cursory look at the ‘Made in’labels on products found in hypermarkets such as Carrefour or Wal-Martwill confirm.

But the other reason why Asian goods sell so well is that regional currenciestend to be undervalued. Using a strategy perfected by some Europeancountries (notably Italy in the pre-euro days), Asian monetary authorities maketheir countries’ exports even more keenly-priced by keeping currenciesartificially low.

The flip-side of these policies is an astonishing accumulation rate of foreignreserves. By selling domestic currencies in exchange for dollars and euros,Asian central banks have stockpiled more foreign currency than they knowwhat to do with. Perhaps because of this, they have been recycling reservesinto low-yielding instruments such as US Treasury bonds and, to a lesserextent, European government debt.

This strategy will not help Asia to provide for its ageing population anddefuse its very own pensions’ time-bomb, but it is a crucial determinant ofthe region’s rising importance to the global economy.

By becoming the world’s most important lender, Asia has inextricably linkedits fortunes to those of the Western economies: it would only take a mere

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06hint that the region’s central banks were fed up with buying US Treasurybonds to precipitate a crisis in the dollar and fixed-income markets. That iswhy, despite its bombastic pronouncements, the US administration knowsthat it has little leverage on the Chinese government over the thorny issue ofa revaluation of the renminbi.

Yet, the issues raised by Asia’s undervalued exchange rates highlight thebigger question facing the region: is the breakneck growth of the pastdecades sustainable?

The doubters argue that the economic policies behind the Asian miraclecontain the seeds of their own destruction.

An over-reliance on exports, rising inflationary pressures, increasing social andpolitical tensions, and China’s ’hollowing out’ of the rest of the region – suckingin foreign investment and manufacturing at the expense of other countries – areall mentioned as factors that could derail Asia’s development.

There is little doubt that Asian policy-makers face unprecedented challengesover the next few years, particularly because the region will no longer begrowing from a small base. It is difficult to see how Asian economies cankeep expanding at the current rate, especially if the US economy slowsdown, if domestic consumers do not ditch their world-beating saving ratesand begin consuming, or if companies fail to improve their (generally) poorcorporate governance and invest more in technology and humandevelopment – investment which has been conspicuous by its absenceduring the past few years.

But it would be naïve of Europe and the US to underestimate the progressmade by the Asian economies over the past few years. The crucial differencebetween now and just before the Asian financial crisis, for example, is thatthe region’s economies, companies and consumers are in great shape.

The explosion in exports and the huge influx of capital, both from reserveaccumulation and direct investment by overseas companies, mean that thecapital and current account deficits seen in the run-up to the crisis havebeen replaced by massive surpluses.

Asian citizens’ penchant for stashing away their earnings for a rainy day maybe stifling domestic consumption, but it does have the advantage of creatinga buffer against a sudden downturn.

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On the microeconomic front, companies’ balance sheets have been restoredto health by years of surging profits and relatively prudent cash-flowmanagement. Indeed, the long period of low interest rates has helped manyAsian companies to regroup and learn how to brave financial marketswithout fear of crippling debt-repayments or an investors’ flight.

As for China’s alleged ‘hollowing out’ of smaller countries in the region, it isworth noting that intra-regional trade has grown in the past few years. Expertsare divided on the issue, but one popular theory is that Asian companies, muchlike their Western counterparts, are using China as an assembly point beforesending their goods abroad – a sign that they are benefiting from the country’slow manufacturing costs rather than hurting because of them.

But even if South-east Asia were to languish in China’s shadow, there is at leastone country whose economic and political development is not influenced byBeijing’s whims.

India’s focus on privately-owned companies in the service sector – principally,but not only, business outsourcing and information technology – is a reminderthat Asia is not exclusively a haven of cheap manufacturing. In many ways, itis India, rather than China, which presents Asia with the most optimistic viewof its future – a future where regional economies are able to move up thefamed ‘value chain’, shifting from making cheap goods to ever moresophisticated and expensive products and services.

In some industries, this is already happening. Microsoft’s reliance on Indianengineers has been well documented, South Korean groups such asSamsung and LG Electronics dominate the global market for homeelectronics, and Lenovo, a state-controlled Chinese group, bought thepersonal computer business of none other than IBM last year.

With Japan – still the world’s second-largest economy despite years ofstagnation – showing signs of stirring from its decade-long slumber, thefuture looks bright for Asia. European and US policy-makers can rant, rave and promise to kick-start their economies, but no amount ofscaremongering or ten-year plans can hide the fact that the economic centreof gravity is moving inexorably eastwards.

Francesco Guerrera is the US Business Editor of the Financial Times.Previously, he was the newspaper’s Asia financial correspondent.

I. THE CHALLENGE FACING EUROPE

Globalisation: an opportunity to raise Europe’s growthand prosperity

by José Manuel Barroso

Europe, and indeed the rest of the world, is adjusting to globalisation. In recentyears, the rise of new trade partners – China, India and other emergingeconomies – has resulted in large benefits for consumers and business. But ithas also heightened concerns about the viability of our industries andultimately our lifestyles.

How to address these? What is clear is that globalisation cannot be ignored.Europe cannot walk away or hide from it. We must face up to it, and turn itto our advantage. That means, as the European Commission said at theHampton Court Summit last October, adjusting our policies to preserve andpromote our values.

To maximise the benefits from an open Europe in a globalised world, it is necessary to put in place policies that increase the emphasis on highvalue-added economic activities and, at the same time, ensure that there isproper support for those who are experiencing adjustment losses. Europe’spolicy should be to engage actively in globalisation, while developingpolicies that help the adjustment to a globalised world.

The (new) challenges from globalisation

The challenges the EU is facing from globalisation have stirred heated publicdebates, centred on threats of job losses due to delocalisation, off-shoring,outsourcing and the like. People often perceive the costs of globalisationmore than they do the potential benefits.

These concerns are not new. However, more recently, a number of factorsappear to have heightened public concerns about the negative impact ofeconomic openness:

■ Emergence of new players: The pace of international economic integrationaccelerated in the second half of the 1990s, with new key economic playersfrom Asia, particularly China and India, emerging on the world trading scene.

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06 These new Asian trading partners are endowed with a large labour force, lowlabour costs and relatively high technical capacities. These are sometimesinherited from their industrial past, sometimes stimulated by an activeindustrial policy, as well as from opening their doors to world markets. Alower wage than elsewhere is an even more attractive competitiveness factorif it comes with a well-educated labour force. The annual output and qualityof science and engineering graduates from India and China have beenincreasing rapidly, and are now comparable to advanced countries.

■ More sectors affected: The advance in information and communicationtechnologies has led to a fundamental change in the tradeability of service-sector jobs. Many jobs previously considered as being located in shelteredsectors of the economy are now exposed to international competition.While manufacturing outsourcing primarily affected blue-collar jobs,services outsourcing is likely to affect white-collar workers; and the servicessector makes up the bulk of employment in the EU.

So there are risks, but there are also substantial benefits from globalisation.So far, it has resulted in significant improvements in Europe’s internationaltrade performance and in its prosperity. Studies1 show that Europe’scomparative advantage has been strengthened in several sectors due to globalisation – pharmaceuticals, mechanical engineering, aircraftproduction, cars, scientific instruments. These sectors account for themajority of EU industrial employment and value-added.

In relation to the trade in services, Europe has seen significant gains with theopening up of international markets. However, globalisation has also resultedin a changing pattern of specialisation. There are sectors which used to enjoy,but have now lost, comparative advantage from the globalisation process,such as leather, footwear and metal products. These cannot be ignored.

Europe’s integration in the world economy

It is clear that Europe needs to do more to fully realise the potential gains fromglobalisation. Europe is increasingly integrated in the global economy, and ismaintaining its position in world markets – not least due to enlargement – but itis investing and trading less in the fast-growing emerging economies.

While EU trade has remained in broad balance with the rest of the world,changes to its overall market position indicate large and rising deficits with Asia.In addition, it risks losing its attractiveness as a location for new investment. As

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06China offers access to large markets and a huge base of well-developed andlower-priced human capital, it is currently attracting a large share of new ForeignDirect Investment (FDI). Even with respect to research and developmentinvestments, the EU seems to be losing its attractiveness relative to the US andother third countries. China in particular has rapidly climbed up the list ofprospective locations for R&D.

Moreover, compared to its developed-economy competitors, Europe’sinnovation performance remains insufficient, being specialised in sectorsthat do not require high skills and high technology.

This has to change. Competing effectively on international markets,characterised by increases in both global competition and the speed oftechnological change, requires countries to take advantage of the increasingrewards from innovation.

The challenges which Europe faces will become amplified as the largeemerging economies’ exports increasingly move up the value chain. Thosecountries are also stepping up their investment in R&D. So I welcome thedecision of the Finnish Presidency to make innovation the central theme ofits informal summit in October. The Commission will draw up a paper tosteer the discussion there.

Finally, Europe needs to be able to adapt better to changed economiccircumstances. To realise the gains from trade, it is necessary to move factorsof production swiftly to sectors where the economy has a comparativeadvantage, and where they can be put to most efficient use. Europe needsto ensure that its labour and product markets are better able to allowresources to go where they are most productive.

The policy response

Reaping the potential gains from globalisation will entail furtherspecialisation, innovation and diversification. This will induce changes inemployment patterns. That will lead to turbulence: the reallocation ofresources generates, almost inevitably, short-term frictions.

This is particularly the case in labour markets, as it can be hard for people toacquire additional skills and/or to move between jobs, sectors, occupations andregions. From this perspective, finding an adequate response to globalisationshould best be seen as being part of the broader policy challenge for dynamic

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06 economies to cope successfully with structural economic change. The EU andits Member States need to equip Europe’s citizens to deal with this change.

In view of the above, the EU needs to: (i) attract new investment; (ii) exploitthe advantages world markets offer; and (iii) manage the consequences ofproduction being outsourced or delocalised.

So Europe needs to develop policies to achieve this. Policy should beforward-looking and support an open Europe. The European economy is inextricably linked to the world economy and it is essential for European firms to be able to access international markets to remaincompetitive. Policy-makers should aim at putting in place the conditionsthat enable Europe to maximise the benefits from globalisation andminimise the turbulence caused by change.

To achieve this, the European economy needs to be able to adapt. So policyshould have two goals: (i) improving competitiveness; and (ii) facilitatingtransition. This requires a coherent and consistent policy approach,coordinated across the different policy areas and policy levels (EU andMember States). Comprehensive reform programmes (like the LisbonStrategy) are likely to be more effective than piecemeal strategies.

Building a sustainable competitive position

The EU must enhance its ability to create new jobs, since only producinggoods and services which reflect traditional comparative advantage will not be sustainable in the long run. Moving to new, high value-addedactivities requires a dynamic framework where innovation and R&D,fostered by excellent education systems, can spur productivity and job growth.

This is not just true for adjusting to globalisation. It is also true for dealingwith other shocks such as technological change. In both cases, it fits withinthe recently-revised Lisbon Strategy for growth and employment.

■ Providing a dynamic European market: Ultimately, companies locatewhere the market is. Providing firms with access to a growing and dynamicmarket is therefore the best way to ensure that Europe remains the locationof choice. More can be done to deliver a truly dynamic Single Market acrossthe manufacturing and service sectors. That is part of the ‘Citizens’ Agenda’which the Commission launched on 10 May.

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06■ Improving Europe’s sustainable comparative advantage, preferably inhigh value-added production: Policies can help by putting in place an environment conducive to firms exploiting such markets. Beyondresearch, development and education policies supporting the developmentof science and technology capabilities, this also requires policies that ensure the right framework conditions to bring innovations to the marketand to capture the value from those innovations. A competition policy toensure open markets and transparent intellectual property rights’ regimes is also pivotal.

■ Improving Europe’s ability to adapt and adjust to shocks: Restructuringand relocation are integral parts of dynamic, open economies. Affectedworkers and regions need to be able to adapt and adjust quickly. They needmore support to do this. Labour market regulations, training and educationpolicy, immigration and tax policies can all be brought on board to improvethe EU’s flexibility and adaptive capacity. The EU’s financial instruments, inparticular the Structural Funds and the European Social Fund, areincreasingly focused on the delivery of these objectives.

■ Improving Europe’s ability to reap the full benefits from a dynamicglobal market: For this, European firms need open access to pivotal markets.Trade policy has a key role in ensuring an open trading system at the globallevel via both multilateral and regional agreements, as well as protectingintellectual property rights in the broad sense.

Facilitating transition and adjustment to shocks

Globalisation creates wealth and jobs in Europe, as elsewhere. But policiesare needed to facilitate transition. In this context, the Commission hasproposed, and the European Council agreed on, the establishment of aGlobalisation Fund. It provides a European sign of solidarity from the manywho benefit from openness to help those who face the sudden shock oflosing their jobs.

The Fund will provide grants to help reintegrate workers into the labourmarket. It aims to finance an array of personalised support services tailoredto meet the specific needs of the workers affected by trade-relatedredundancies. It combines active measures such as job-search assistancewith in-work temporary allowances. The new Fund complements existingCommunity policies aimed at anticipating and accompanying firms andregions which are restructuring.

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Conclusion

The framework outlined above will help enable Europe to reap the benefitsof globalisation, while aiding adjustment to it. This is essential to helpEurope’s citizens and businesses, improving efficiency and leading to moreequitable outcomes, which constitute the basis of support for economicopenness and free trade.

José Manuel Barroso is the President of the European Commission.

Endnote

1. The estimates in question refer to a recent study by Goldman Sachs, Global Economics Paper No. 142, 6 July2006, ‘Europe in a Globalized World: Winners and Losers’, analysing the incorporation of Brazil, Russia, Indiaand China into the world trading system in recent years. For other studies, providing similar analysis, see a.o.EC-BEPA (2006) EU competitiveness and Industrial Location, ISBN 92-79-00421-2.

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Challenging European innovation policy

by Esko Aho

The EU is in the middle of a serious identity crisis – not, I believe, as a resultof the enlargement process or the difficulties with the ratification of the Constitutional Treaty, but rather because the world has changed dramatically.

Globalisation, together with the information technology revolution, hascreated a new political and economic environment, and the challenges weface today are radically different from those of ten years ago.

It has been very difficult for Europeans to accept this. We all too easily regardchange as a direct threat to our own achievements, rather than seeing it as anew and great opportunity. We do not want to believe that globalisation isabout competition and winning. It is a race towards the top, not the bottom.

The EU needs collective power. It is even more important, however, todecide what to do with it. The Union is currently paying too much attentionto issues beyond its control or to those where its guidance is not needed atall. Simultaneously, it suffers from significant inefficiency in tackling theissues it was originally established to address and where it can play a majorrole in promoting success and welfare on our continent.

The strength of science, technology and innovation will determine Europe’sfuture. By becoming a world leader in these areas, we can maintain our highwelfare and social protection standards. This would secure our position as aglobal economic and political player.

This, in a nutshell, is the critical challenge for Europe.

The Lisbon Strategy as a cure

The Lisbon Strategy agreed in 2000 includes correct but ambiguousobjectives. Unfortunately, the great words spoken by EU leaders then havenot been translated into great actions. If the present trend continues, Europewill not be able to challenge the United States’ economic performance andcompetitiveness. Worse still, there are already signs that the emerging Asianeconomies could surpass Europe and relegate it to the status of a third-gradeglobal power.

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06 The underlying factor behind these changes is very simple. The US and themajor Asian economies, in particular China, have succeeded to a significantlygreater extent than Europe in taking advantage of the enormous opportunitiesderived from globalisation and the information technology revolution.

China is leading the world in industrial production, and will become aglobal factory. The US is top of the league for R&D and marketing.Unfortunately, Europe is not leading the way in any key areas of globalcompetition.

At its inception, the Lisbon Strategy aimed to achieve a rapid improvement inEurope’s performance to make it the most dynamic and competitive region inthe world. However, Europe’s relative position has weakened rather thanstrengthened since the strategy was adopted at the Lisbon European Councilin 2000 because of poor implementation.

Europe’s main weaknesses

In the years between the World War II and the two oil crises in the 1970s,Europe’s productivity rates caught up with those in the US economy.However, since the mid-1990s, the productivity gap between the two hasstarted to grow again.

The main reason for this has been Europe’s weakness in applying newinformation and communication technologies. Even those Member Stateswhich have succeeded in developing their ICT sectors are rather weak inICT applications. The growing European deficit in investment in R&D is alsocausing major problems. Global European companies allocate substantialresources to R&D, but an increasing share of that funding is directed towardscountries outside the EU.

Europe still has its own industrial strengths, but these are mainly in low-growth areas which have less potential to deliver improvements in productivity and competitiveness. Consequently, Europe has a low shareof the market for fast-growing high-tech sectors. It is also alreadyexperiencing the multi-level impact of population ageing – a demographicrevolution which will make it even more difficult for Europe to respond to global competition.

No matter how effective a cure is, it will not help if the patient is reluctantto take it.

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06Changing direction

The critical challenges described above are closely linked with the Europeansocial model. This has been a great success story: economic growth andwelfare in Europe after World War II was based on the creation of a welfaresociety, with governments allocating substantial funding to education, publicservices and social security, which in turn acted as a trigger for improvedindustrial competitiveness.

However, the European social model is now in trouble. Low economicgrowth, budgetary deficits and high unemployment rates are all clear signalsthat it is not functioning properly anymore.

It is unrealistic to assume that we can reverse or postpone the globalisationprocess; we just have to try to adjust to it. It is equally unrealistic to assumethat our competitors will fail and we will definitely win.

It is not a question of values, but rather of mechanisms and methods.Equality and justice are still valid targets, but these can no longer beachieved by applying existing policies. We cannot plan or control the futureanymore. We now need to focus on improving our knowledge base and ourability to introduce structural changes. This would enable us to adjust oursocial and economic structures quickly and flexibly to meet new challenges.

When reconstructing and reforming Europe, we will have to rely more onmarket forces and competition than we did in the past.

European decision-makers have tried to ‘sell’ the Lisbon Strategy to the publicby promising that, through economic reform, we can maintain the socialmodel. That may sound convincing, but it is, in fact, totally unrealistic.Creating an innovative Europe requires mobility, not stability.

Science, technology and innovation

A global information society should be based on science, technology andinnovation. Those nations and regions that perform best in education,research and technology will therefore also be most successful in rising tothe challenge of global competition.

This challenge was recognised in the Lisbon Strategy. However, Europeans haveso far not been willing to implement the required reforms and make the

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06 necessary policy adjustments. It has been politically more rewarding to protectold, existing structures than to create new ones and invest for the future.

The Barcelona European Council in March 2002 set a precise target ofincreasing funding for R&D in the EU to 3% of GDP by 2010; a target theUnion will fail to reach. Within the EU-15, national funding for R&D as apercentage of GDP grew only marginally from 1.87% in 2000 to 1.95% in2004. If current trends continue, China will spend a higher percentage of itsGDP on R&D than the EU by 2010.

Time for action

Time is not on our side. Indeed, demographic challenges mean that it willbecome even more difficult to implement urgent but politically-risky reforms infuture. The only alternative is to devise an effective reform package, not justsingle reforms.

Simultaneous and synchronised measures are needed both to strengthenpublic and private demand for new innovative products and services, and tosecure sufficient funding for education, research and technology. This reformpackage should address four key issues:

1. It is essential to create early markets for innovative and R&D-based products and services. The current plight of the European pharmaceuticalindustry is an unfortunate example of what happens when this fails.

2. Europe needs more funding for science and technology. The 3% of GDP target is a very good indicator of how well the EU and its MemberStates are doing in creating a globally-competitive infrastructure and environment for achieving its innovation goals.

3. Measures are needed to promote mobility. An information society cannotbe established just by providing money for education and research. Human and financial capacity must also be transferred from the resource-based to the knowledge-based society.

4. Risk-taking and entrepreneurship are crucial to create an innovative Europe. Encouraging entrepreneurship and granting funding for riskybusinesses is therefore key.

Together, these four elements add up to a reform package which requires

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06just as strong a commitment from Member States to deliver results as theentire internal market programme.

Taking the lead

The Finnish Presidency of the EU has launched an active debate on theseissues. It is a debate that cannot be conducted in the abstract – its objectiveshave to respond to existing circumstances and realities in Europe and theworld.

It is difficult to find any other initiative which would to do more to achievethis than speeding up the implementation of the Lisbon Strategy. Based onits own experience and accomplishments, Finland should act as an initiator,as its economy and society provide an excellent example of how to achievesuccess by taking advantage of the opportunities offered by globalisationand the information technology revolution.

For Finland, the EU Presidency provides an historic opportunity to restartand push forward the process of implementing the Lisbon Strategy. This will,more than any other single initiative, determine the future direction of theEU and all Europeans. We therefore need action before it is too late.

Esko Aho is a former Prime Minister of Finland and chaired a group of fourindependent experts which submitted a report on European innovationpolicy, Creating an innovative Europe, to the European Commission inJanuary 2006.

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06 Education and the knowledge economy in Europeand Asia

by Andreas Schleicher and Karine Tremblay

Introduction

When EU leaders set the goal of making Europe “the most competitive and dynamic knowledge-based economy in the world” by 2010 at theLisbon Summit in 2000, they were acknowledging that the most effectivemodern economies will be those that produce the most information andknowledge – and make it easily accessible to the greatest number ofindividuals and enterprises.

They also acknowledged that education is central to reaching these goals bysetting a series of educational targets to be met by the same deadline.1 Yetsome of these targets have already been surpassed, not just by some EUMember States but also by major East Asian countries. This will significantlychange the global supply of knowledge and skills in the years to come.

This paper therefore measures educational performance in Europe not justagainst Europe’s own targets, but also against the benchmarks set by today’sbest-performing education systems.

The ‘flat world’ and its impact on educational opportunities

Organisation for Economic Co-operation and Development (OECD) educationindicators show – consistently and over time – that individuals and countriesthat invest heavily in education and skills benefit economically and sociallyfrom that choice.

It is also noteworthy that in most of the OECD countries which have seen thegreatest expansion in tertiary education, graduates’ incomes have risen inrecent decades. This suggests that an increase in the number of ‘knowledgeworkers’ does not necessarily mean that their pay levels fall in the way theydo for low-skilled workers.

Human capital is now also a major factor driving economic growth andbroader social outcomes, both in the world’s most advanced economies andin those experiencing rapid development. Improved education boostseconomic growth by increasing labour productivity and technological

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06progress. Within the OECD area, one extra year of formal education canraise economic output in the long term by 3-6%.2

Technological developments also play a key role in economic and socialdevelopment, and this interacts closely with educational progress, not just because tomorrow’s knowledge workers and innovators require high levels of education, but also because a highly-educated workforce is aprerequisite for adopting new technologies throughout the economy, andthereby increasing total productivity.

Together, skills and technology have profoundly changed economies andsocieties, as Thomas Friedman describes so eloquently in his book TheWorld Is Flat, which has inspired much of this paper.3 The world is nowwired so that all work that can be digitised, automatised and outsourced canbe done by the most effective and competitive individuals or enterprises,wherever they are based.

The impact of these developments on Europe and its education systems wasmagnified by the collapse of communism in the Soviet Union, India’s turnaway from economic self-sufficiency, and China’s shift to market capitalism.This allowed another three to four billion people in countries and regionslike China, India, the Russian Federation, Eastern Europe, Latin America andCentral Asia, who had previously been locked out of the global economy, tocollaborate and compete with everyone else.

Initially, Europe found itself competing mainly with countries which offeredlow skills at low costs, which led to rising unemployment among lower-skilledworkers in Europe.4 Entire industries also disappeared as IT made them superfluous.

Clearly, these developments also created opportunities for Europeancountries by opening up giant new markets, but generally this only led tobetter employment opportunities and higher earnings for the better skilled,as the related low-skilled jobs were largely created in the countries wherethese new markets were located.

More significantly, the number of highly-qualified workers has increasedrapidly in countries like China and India, and the massive investment inskills in these countries suggests that competition through lower productioncosts may be merely a transitional strategy for both countries on their wayto matching the Western world at the top of the product range.

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06 International comparisons illustrate the pace at which education systemshave responded to the increase in demand for better qualifications.

Two generations ago, the US was well ahead of everyone else, and itseconomic success today derives at least in part from its first-mover advantagein this area. However, while the US ranked number one in the 1960s in termsof the proportion of individuals successfully completing secondary school, ithad fallen to ninth place by the 1990s – not because US graduation rates haddropped, but because they had risen so much faster elsewhere.

The trend in tertiary qualifications is similar. Today, all OECD members areproducing more college graduates than in 1960, but the pace of change hasvaried widely, with most of Europe’s major economies – including France,Italy and the UK – just holding their ground or, in the case of Germany,falling significantly behind.

Differences in educational achievement between countries are likely to widenin the future. Traditionally, the US has led in tertiary-level enrolment, and itsposition remains strong. But in the Nordic countries, more than two-thirds ofupper secondary school-leavers now enter higher education institutions,significantly more than in the US and almost double the level in France and Germany – a sign that these two countries, which make up 35% of theEU-25’s €11.6 trillion economy, are no longer among the world leaders indeveloping advanced knowledge and skills.

Asia’s booming education sector

Both Europe and the US find themselves increasingly outrun by countries inEast Asia. The example of Korea illustrates what can be done: just twogenerations ago, its living standards were equivalent to those of today’sAfghanistan and it was among the lowest educational performers amongOECD countries. Today, 97% of all Korean 25- to 34-year-olds havecompleted upper secondary education – the highest rate among the principalindustrialised countries.

Many factors helped Korea achieve this dramatic transformation. Perhapsmost importantly, its society and educators never tolerated the kind of systemic and structural barriers that have hindered learning andreinforced inequities in Europe. When demand for education began tooutpace supply, class sizes and school hours were extended, and parentscomplemented public provision with high levels of private investment.

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06Korea’s experience is not unique. Japan has progressed at a similar pace andnow boasts one of the world’s best-performing education systems, and manyof the emerging Asian economies are following with a time lag.

For example, between 1990 and 2005, the rate of progression in China fromprimary to lower secondary school increased from 75% to over 98%, fromlower to upper secondary education from 41% to 70%,5 and from seniorhigh school to tertiary education from 27% to 76%.6

In many Asian countries, the combined effect of growing populations and risingaccess to education has resulted in a dramatic increase in student numbers andwill eventually result in increased attainment rates. Between 1995 and 2004alone, the number of students attending university more than doubled in Chinaand Malaysia, and rose by 83% in Thailand and 51% in India.

Graduation rates in China and India may remain well below the OECDaverage, but the sheer size of their populations at upper secondary andtertiary level translates into a vast graduate output in absolute terms: in2005, China produced 10.8 million upper secondary graduates, two and ahalf times the number in EU countries; it has also surpassed the Union forthe number of tertiary graduates, with 4.4 million compared to 2.5 millionin the EU (although a significant proportion of the Chinese qualificationsresult from shorter vocationally-oriented programmes and major qualitychallenges remain).7 In 2003, India also produced nearly as many uppersecondary graduates as the EU countries.

In the Asian countries examined here, tertiary students are also more likely tomajor in mathematics, sciences, computing and engineering – the subjectsmost relevant to research, innovation and technological advance. This suggeststhat in the future, the graduates who are the cornerstone of economicprosperity in knowledge-based economies will originate disproportionatelyfrom China and India.

It also suggests that the time when OECD countries competed mostly with countries that offered low-skilled work at low wages is past. Today,countries like China or India are starting to deliver high skills at moderatecost and at an ever-increasing pace, and European countries cannot switch off the pressures that result from this, except at great cost to their own economic well-being. There are plenty of examples of Europeancountries that have stagnated over the last century by trying to preserve their systems and jobs by keeping the rest of the world out.

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06 However, major challenges also lie ahead for the emerging Asian countries. Forexample, the strength of many Asian school systems – providing generallymeritocratic access to educational opportunities through a rigorous examinationsystem – comes at the heavy price of preventing schools from focusing on theskills that will matter in tomorrow’s labour markets. While such systems workwell as long as the primary objective is to identify and select a small elite oftalented individuals, they are much less suitable when the objective shifts toraising overall levels of human capital.

Last but not least, continued educational expansion will, in many Asiancountries, require huge and sustained financial investment.

Competing for the best

The demand for highly-skilled workers and growing concerns about ageingpopulations have translated into a global competition for talent. Traditionally,European economies have been concerned about a ‘brain drain’ to the US,resulting from attractive earnings and flexible labour markets in US researchand academia.8 In recent years, however, the focus has partially shifted fromretaining European talent to competing for highly-skilled individuals fromemerging Asian economies.9

In the EU, 700,000 additional researchers will be required merely to reachthe Lisbon research goals in 2010 and, given the trends outlined above, it is unlikely that EU education systems will be able to supply all of them – suggesting further immigration on a massive scale will be needed.Most EU countries have therefore begun reviewing their immigrationlegislation to encourage graduates to settle and, in some cases, to recruitlarge numbers of international students with a view to granting themresident status when they complete their studies.

Particular attention is focused on Chinese and Indian students because oftheir sheer numbers, prompting a huge increase in the number enrolledabroad. This increase has benefited both the EU and the US, but while theUnion’s relative share of Chinese students grew noticeably between 1998and 2003, from 16% to 25%, that of the US dropped from 51% to 34%.However, the EU was less successful in attracting Indian students, with 70%still preferring to study in the US.

India is now reaping the benefits of its early investment in education. In 1951, it set up the first of seven Indian Institutes of Technology (IIT) and

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06hundreds of thousands of Indians have since competed to study at these IITs and their private-sector equivalents. Given India’s population size, thiscompetition has created a phenomenal knowledge meritocracy producingworld-class graduates.

Because India’s economy could not, until recently, provide adequate jobsfor most of those talented engineers, Europe and the US bought much of itsbrainpower.10 But with technology flattening the world at a breathtakingspeed, the time when the only route to success for these students lay inemigrating to Europe and the US is coming to an end. The real challenge forEurope is therefore to prepare for future competition from Asian economiesin the knowledge sector itself.

Europe’s quality challenge

Europe’s capacity to compete in the global knowledge economy willdepend on whether its higher education institutions can meet the fast-growing demand for high-level skills. That, in turn, will hinge on significantimprovements in the quality of schooling and a more equitable distributionof learning opportunities.

Time is running out and the clock keeps ticking. Every 48 seconds, onestudent in Europe leaves school without completing an upper secondaryqualification and with a gloomy outlook for the future: on average, 20% ofadults without upper secondary qualifications earn half or less than half thenational median earnings. Italy is the only European country where morethan 5% of adults are found in the group whose average earnings exceedtwice the country median. Moreover, the penalties for not obtaining strongbaseline qualifications continue to rise year after year.

The OECD’s Programme for International Student Assessment (PISA) nowmakes it possible to regularly and directly compare the quality ofeducational outcomes in the countries that make up almost 90% of theworld economy.

The latest PISA assessment in 2003 focused on students’ capacity to analyse,reason and communicate effectively as they posed, solved and interpretedmathematical problems in a variety of situations.11 Although sucheducational goals are emphasised in most of Europe’s curricula, the 2003PISA assessment showed that many 15-year-olds in some of Europe’s largesteconomies performed below the OECD average, as did many in the US.

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06 Moreover, 20% of European 15-year-olds – and more than a quarter in Italy,Portugal and Turkey – performed at Level 1 or below on the PISA scale. Theytherefore risk failing to acquire the baseline mathematical skills that willenable them to expand their horizons in their further schooling and beyondin their professional and personal lives.

In contrast, all the participating East Asian countries were among the top tenperformers in mathematics, and most of them in reading literacy as well.Furthermore, most succeed without leaving many students behind and arethus utilising their human potential much more effectively than their Europeancounterparts. It is therefore realistic to predict that tomorrow’s highly-skilledjobs in innovation and R&D – and the high wages that go with them – will berelocated to Asia unless the EU and US make significant progress.

Indisputably, Europe still has some of the world’s best schools and schoolingsystems. Finnish students topped the PISA assessment for the second time in2003, showing that excellence throughout European school systems is anattainable goal, and at reasonable cost.

However, most of the world’s most successful education systems, includingFinland’s, have something in common: they have all shifted the focus awayfrom control over the resources and educational content and towardoutcomes; from ‘hit and miss’ teaching policies to establishing universallyhigh standards; from uniform systems to embracing diversity andindividualised learning; from focusing on provision to focusing on choice;and from talking about equity to delivering it.

Most importantly, they have emphasised the creation of a ‘knowledge-rich’education system in which teachers and school principals act as partnersand have the authority to act, the necessary information to do so and accessto effective support systems to assist them in implementing change.

No doubt there are also important challenges ahead for the East Asian educationsystems. At a time when the future success of school students will derive largelyfrom their capacity to expand their horizons and continue learning throughoutlife, students not only need to acquire strong subject-matter skills but alsopositive attitudes and effective learning strategies.

This is an area where most of the East Asian school systems performedcomparatively poorly. For example, despite Japan’s strong performance inmathematics, only about one-quarter of its 15-year-olds say they enjoy

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studying the subject – roughly half the proportion found in Denmark, thecountry with the strongest results in this respect.

Some argue that what counts is what students know and not their interest in the subject. However, the PISA data reveal that the relationship betweenmotivation and performance is as strong in Japan as it is in Denmark.Furthermore, 15-year-olds in many Asian countries struggle to see the relevanceof the mathematics taught in their schools to their future lives.

At university level, the strong performance of Chinese and Indian graduatesin highly-skilled occupations in the West suggests that both countries canprovide high-quality education in large quantities.

But Chinese universities face major challenges too, partly because of bigdifferences in the quality of tertiary institutions and their insufficient emphasison job-related education. This results partly from insufficient investment ineducation facilities and resources other than staff, but equally from theChinese tradition of valuing theory over application-oriented training.

The fact that the country’s top graduates still find better job opportunitiesoutside China also means that, in the face of rapidly-rising demands forhighly-skilled individuals, key industries are already reporting significantshortages of individuals with the kind of qualifications they need. China isunlikely to address this by simply churning out more of the same graduates.However, the examples of Japan and Korea suggest that these challengescan be overcome if the right strategic decisions are made in time.

Europe’s equity challenge

Many European education systems make ambitious claims about equality inlearning opportunities. But here lies their biggest disappointment. The PISAstudy reveals that social background plays a larger role in determining astudent’s performance in countries such as Germany, France and Italy than inthe US, and socio-economic inequalities are greater in both Europe and theUS than in any of the Asian countries for which comparable data are available.

This means that Europeans from disadvantaged socio-economic backgroundsdo not receive the same educational opportunities as children from rich andmiddle-class families. In many countries, the data suggest that Europeanschools actually reinforce existing socio-economic inequities. In other words,the policies pursued are failing to meet their stated objectives.

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06 The German school system, for example, divides children as young as ten intovocational or academic streams, and the children of parents in white-collar,highly-skilled occupations are still four times more likely to enrol in tracksleading to universities than those of parents working in blue-collar or low-skilled occupations, even if they perform equally well at an early age.

Europe has managed to get by with these kinds of education systems for solong because in the last century, when industrial mass production wasdominant, they achieved their goal: namely to equip a large group of mass-production workers with baseline qualifications and focus resourceson a small elite who could innovate. This was adequate when there wereplenty of jobs requiring only baseline qualifications, but it no longer worksin the flat world.

In contrast, five out of the six East and South-east Asian countries for whichPISA data are available are among the ten countries where social backgroundhas the smallest impact on student success – clear evidence that theseeducation systems create true meritocracies that maximise the human potentialof their countries much more effectively than most European countries do.

In China and India, access to education is still limited and, if improvements inthe quality of educational provision continue to be financed largely throughtuition and other fees, major challenges for equality in educational opportunitiesare inevitable. However, the examples of Hong Kong, Japan and Korea suggestthat, once overall levels of investment in education rise, Asian countries will bemore capable of addressing the equity challenge than most EU Member States.

Finally, initial education alone is not enough to meet the rising and changingdemand for skills. Promoting ‘lifelong learning’ has therefore become acentral plank of the Lisbon Agenda, and rightly so. However, this remains farfrom a reality in many countries: while over 40% of the labour force inDenmark, Finland, Sweden, Switzerland and the US enrol in job-relatededucation and training each year, fewer than 10% do so in Greece,Hungary, Italy, Portugal and Spain.

What is more, it is a mistake to promote lifelong learning as a substitute forstrong primary education. People who depend most on post-school educationand training opportunities, such as the unemployed or those with low-skilledjobs, get the fewest training opportunities, with those who did not completeupper secondary education on average less than half as likely to be found inpost-school education and training programmes in most European countries.

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06More worrying still is the sizeable proportion of young people with lowlevels of education who are neither in work or education. More than 10% of 15-19-year-olds in Italy, the Slovak Republic and Turkey are in thistragic situation.

Europe’s ambition challenge

The outsourcing of manufacturing or services from Europe or North Americato countries like China and India is not just motivated by the availability ofcheaper and more efficient services, but also by improved quality andproductivity. To some extent, this is explained by the fact that low-wage, low-prestige jobs in Europe easily translate into high-wage, high-prestige jobsin countries with generally lower income levels, filled by highly-educated andmotivated workers.

However, there is more to it than this. Perhaps the most serious challengefor Europe is its population’s lack of ambition. In countries like China, Japanand Korea, students, parents and teachers, whatever their socio-economicbackground, invest time and resources in achieving the most they can atschool and in university, well aware that this is the most powerful lever fortheir own future success and that of their country.

PISA not only measures school performance, but also asks 15-year-oldsabout their educational expectations. In all Asian countries with availabledata, students have very high levels of tertiary aspirations, with about 60-70% expecting to reach this level in Japan, Hong-Kong, Macao and Thailand, and 95% in Korea. In stark contrast, only half of Europe’s 15-year-olds expect to get a tertiary qualification. This derives in part from the lack of social inclusiveness in many European education systems: the difference between aspirations of students from the top andbottom quartiles of the socio-economic index is significantly smaller in mostAsian countries than in Europe.

International comparisons also show that many Asian countries investconsiderably more in students’ learning time: Chinese 15-year-old studentsspent an average of nearly 3,000 hours in learning activities in 2002 (inschool, extra tutoring classes or doing homework) – nearly twice as much astheir peers in OECD countries.12 Investment in learning both inside andoutside school also tends to be high in other Asian countries.13

Certainly, more of the same may not always be associated with better results:

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Canada, Finland, Japan and the Netherlands have achieved high levels ofstudent performance with 1,170 hours or less learning time, and countrieslike Greece, Hungary, Italy, Spain and Turkey perform below average despitehigh investments in learning time. However, the willingness to make theeffort is a necessary prerequisite for success.

The highly-competitive nature of East Asian education systems, combinedwith teachers’ exceedingly high expectations, puts extraordinary pressureon students, who suffer generally high levels of anxiety. However, theyreceive a great deal of support from teachers – much more than in all ofEurope’s major economies. The lack of ambition combined with a lack ofsupport in the European education system is a precarious starting point forthe future success of its people.

Conclusion

Europe’s education systems will have to make considerable headway if theyare to meet the demands of modern society. Some of these changes requireadditional investment, particularly in the early years of schooling, but moremoney alone will not guarantee strong results.

Put simply, EU countries must develop more challenging and supportivelearning environments, and become more flexible and effective inimproving learning outcomes. They must also scale back the inherent class bias and sometimes catastrophically regressive way of fundingeducation – taxing the poor to subsidise educational opportunity for the rich – in existing systems.

The differential educational expansion both within Europe and across theworld described in this paper is likely to widen in the future, especially atuniversity level.

In Northern European countries, more than two-thirds of today’s school-leavers enter higher education institutions, but France and Germanyare stuck at little more than half those levels. The Nordic countries’ successresults from massive public spending on higher education that pays highdividends to both individuals and society.

East Asian countries and the US have improved access to higher educationby making students pay for part of their education costs. In contrast, mostcontinental European countries hold back their universities by neither

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06making the required public investments nor allowing them to charge tuitionfees. European countries tend to argue against fees on equity grounds, butsome of these same countries charge fees for early childhood education,where equity really is at stake.

Europe’s universities are unlikely to catch up unless its governments createand maintain a system of diverse, sustainable, and high-quality institutionswith the freedom to respond to demand and accountability for the outcomesthey produce.

Europe must ensure that tertiary educational systems are managed in waysthat improve access and enhance quality. It also needs to implementfinancing and student-support policies which mobilise public and private funding in ways that better reflect the social and private benefits of tertiary education.

In summary, international comparisons underline the significant challengesthat lie ahead for Europe, but they also show that some of these challengeshave been successfully met by East Asian countries which started from muchtougher positions.

The yardstick for European countries should be the most successfuleducation systems, not the Lisbon goals – and they will not simply need tomatch their performance but do better if their citizens want to continuejustifying higher wages.

A start lies in accepting international benchmarking in educationalperformance as a basis for improvement, rather than seeking reasons whyEuropean countries cannot be compared with the rest of the world. Theworld is indifferent to tradition and past reputations, unforgiving of frailtyand ignorant of custom or practice.

Success will go to those individuals and countries which are swift to adapt,slow to complain and open to change. The task for European governmentswill be to ensure that EU countries also rise to this challenge.

Andreas Schleicher is Head of the Indicators and Analysis Division,Directorate for Education, Organisation for Economic Co-operation andDevelopment (OECD). Karine Tremblay works in the Indicators andAnalysis Division, Directorate for Education, OECD.

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06 Endnotes

1. The targets set by the European Council were to reduce the number of early school-leavers to no more than10%; increase the number of graduates in mathematics, science and technology by 15%, reach upper-secondarycompletion rates of 85% by 2010; reduce the number of low-achieving 15-year-olds in reading literacy by at least20%; and reach a target of 12.5% engaging in lifelong learning.2. OECD (2005b) Education at a Glance: OECD Indicators – 2005 Edition. Paris: OECD.3. T. Friedman (2005) The World I s Flat – A Brief History of the Twenty-First Century. New York: Farrar, Straus and Giroux.4. See endnote 2.5. Chinese Ministry of Education, Department of Planning (2006) Essential statistics of education in China. Beijing.6. OECD/UIS (2005) Education trends in perspective – Analysis of the World Education Indicators. Paris.7. See endnotes 2 and 5.8. M.Cervantes and D.Guellec (2002) ‘The brain drain: old myths, new realities’, OECD Observer, May 2002;European Commission (2003) The brain drain – Emigration flows for qualified scientists. Brussels.9. OECD (2005) Trends in in International Migration – 2004 Edition. Paris.10. See endnote 3.11. OECD (2004) Learning for Tomorrow’s World – First Results from PISA 2003. Paris.12. G. Zhen (2006) Survey on Chinese students’ learning time in third year junior high schools. ShanghaiJiao Tong University mimeo.13. See endnote 11.

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06Living in the past?

by Hans Martens

In the Fifties and Sixties, the first Japanese cars arrived in Europe, followedby motorcycles, cameras and a whole host of other things that used to be ‘European’.

Europe’s first reaction was to dismiss the challenge they posed to its industryon the grounds that these cheap Asian imitations would have no future. Itssecond was a growing fear of competition, as it became clear that Europeanconsumers regarded these Japanese imports as good value for money. Thethird was a phase of co-existence, where Japan became both a competitorand a potential market for European companies.

The emergence of this new rival from the East had a significant impact on the economies of Western Europe. For the most open – the UK inparticular – competition from Japan more or less wiped out the nationalmotor industry, paving the way for a transition from manufacturing to aservice economy. Other, less liberal economies, such as those of France andGermany, continued to focus on manufacturing and succeeded indeveloping and improving products that could compete in the newenvironment – but not without dramatically restructuring the sectors mostexposed to the new competition.

The situation facing Europe today, with the dramatic rise of the new Asiandragons, elephants and tigers, is not fundamentally different, but it is on amuch greater scale. It also presents a far more wide-ranging challenge,forcing Europe to compete on basic products as well as very sophisticatedones with a high knowledge content.

Threat or opportunity?

Global competition can be seen as an opportunity or as a threat. The truth is,of course, that it is both.

However, the attitudes of European societies towards the challenges it poseswill be important in determining whether global competition becomes moreof an opportunity than a threat for them. Attitudes are important because apositive approach demonstrates a readiness to make the changes necessaryto create the opportunities.

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06 Globalisation, fuelled by liberalisation of the international regime for trade andinvestment, creates wealth – both in theory and in practice. An increase in thesupply of products at ever-lower prices benefits consumers and all those whogain directly or indirectly from new global markets, in Europe and beyond.

Even for those who lose their jobs because of new global competition, thepicture is not necessarily as black as it is painted. If losing your job becauseof global competition gives you the opportunity to get a new and better one,then it can, in fact, be a positive experience.

So why is it that in some EU Member States (particularly France), globalisationis almost always referred to only in disparaging terms as the process of‘delocalisation’ (i.e. the outsourcing of jobs to low-cost countries like those inAsia)? Why do some countries in Europe focus almost entirely on the negativeaspects of globalisation and rarely look at its positive effects?

A large part of the explanation lies in the degree to which a society is willingand able to adapt to the changing economic and social environment.

In today’s world of global competition, everyone has to demonstrate agility,from individual workers to companies and whole nations. Standing stillwhile the world is changing is not the answer, not least because it createsbottlenecks in the labour market. What has happened in Germany, forexample, where there are many unfilled job vacancies despite a very highlevel of unemployment generally, demonstrates the perils of inaction.

European models

Surveys of people’s attitudes towards globalisation all point in the samedirection: those living in countries on the northern rim of Europe generallytake a balanced view of the positive and negative sides of globalisation, witha preference for seeing the phenomenon as an opportunity. Countries furthersouth, together with some of the new EU Member States, are much morenegative.

This is linked very strongly to the economic and social sub-models inEurope. Countries on the northern rim generally take a liberal approachtowards managing their economies. They are in favour of free trade andinvestment, and opening up their economies, and have little appetite forstate intervention or state subsidies to ailing industries. They also gave up onthe idea that manufacturing was the core of their economies some years

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06ago, and have demonstrated their flexibility in turning into service- andknowledge-based economies.

As mentioned above, the first wave of global competition did not result in afundamental shift away from manufacturing in Southern European countries.Surveys show that people living in these Member States generally have arather negative view of globalisation and their governments tend to beinterventionist and protective.

All this, coupled with somewhat inflexible labour markets and persistentlyhigh unemployment rates, makes it difficult for societies and individuals inmany of these countries to show the necessary agility to respond to the newthreats to their manufacturing base.

In the light of all this, it is no wonder that globalisation – and Polishplumbers – are seen as a threat.

EU integration at risk

This division in Europe between a generally-liberal North (with lowunemployment and a rather positive attitude towards globalisation) and aconservative Central and Southern Europe (with high unemployment and arather negative view of globalisation) matters for Europe and for the EU.

Why? Because clinging to outdated models and lacking the courage both tointroduce the necessary reforms and give the public a balanced view ofglobalisation puts European integration at risk.

While many reasons have been given for the French Non to theConstitutional Treaty in 2005, it is clear that a fear of globalisation was amajor factor – and there is a clear risk that this could spill over and have asignificant impact on the debates over other important EU policies, such astrade policy and reform of the Common Agricultural Policy.

Such attitudes may also raise questions about fundamental aspects ofcompetition policy, including mergers and acquisitions and state aid. Theyhave certainly already raised a number of questions relating to the core ofeconomic cooperation in Europe: the internal market. The reaction to recentmergers and takeovers in the energy sector was an example of this,prompting questions as to whether countries in the middle and south ofEurope genuinely want a properly-functioning internal market.

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06 The opposition to modernising the single market by giving it a real servicesdimension came mostly from core continental countries in Europe. Theopposition to the liberalisation of utilities (services of general interest) comesmostly from the same countries.

Making the internal market work

When it comes to implementing internal market legislation, EuropeanCommission ‘scoreboards’ always show northern EU Member States at the topof the list (with the exception of UK’s rather mediocre performance). Theinfringement statistics tell the same story: in October 2005, Denmark, Finland,Ireland, Luxembourg, the Netherlands and Sweden were all facing less than51 infringement cases, while France, Germany, Spain and Italy had more than100 pending – with Italy topping the list with a staggering 157.

Worse still, the EU has had an agreed framework for structural reform inEurope – known as the Lisbon process – since 2000.

This should have provided the impetus for action in those countries which were lagging furthest behind in introducing the reforms needed tomake their economies more competitive. However, it comes as no real surprise that those which have done most to adapt to the changingcircumstances – countries like Denmark and Finland – were also top of the league for implementing ‘Lisbon directives’ in June 2005, and that France and Germany shared 17th place, with Spain languishing evenfurther behind in 20th place. The general trends in relation to structuralreform (which is the whole point of the Lisbon process) point more or lessin the same direction.

The reluctance to implement internal market rules correctly and within theagreed deadline, the lack of willingness to make structural changes toeconomies and the failure to communicate a balanced view ofglobalisation, are therefore matters of serious concern.

It is understandable that fear of globalisation is relatively high in many of thecountries which joined the EU in May 2004. They have benefited hugelyfrom being the Union’s new low-wage economies and therefore a preferredtarget for EU-15 companies looking to outsource their manufacturing.

But they are now waking up to the fact that this may not last. They are likelyto discover that they were, to a large extent, only a staging post in the

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06outsourcing process, and that a significant chunk of future investments willmove even further east.

So for them too, standing still is not the answer. Instead, this threat shouldgive them an incentive to modernise their economies still further, with astronger push to implement the Lisbon guidelines for structural reform.

Living in the past may seem more comfortable than living in the present orthe future. Clearly, 20-30 years ago, France, Germany and their neighbourswere the powerhouses of Europe. They were in the vanguard of industrialdevelopment, and had an economic and social model that provided thenecessary stability.

However, that was in the era of limited global competition and a limitedneed for change – and those days are gone. These countries have beenpaying the price for looking backwards instead of forwards over the lastdecade or so, with stubbornly high unemployment and increasinglydissatisfied populations making structural reform politically very difficult.

It is time to realise that the Asian dragons, elephants and tigers are here tostay, and that the only way to respond to the challenge – and reap itspotential benefits – is for countries to modernise their economies, and develop the necessary agility and flexibility to cope in today’s fast-moving world.

It is, of course, tempting to go on living in the past, but it is not the answer.

Hans Martens is the Chief Executive of the European Policy Centre.

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06 Can globalisation work without Europe?

by Carlos Buhigas Schubert

In recent years, Europe has faced an ever-growing barrage of questions abouthow – if at all – it can rise to the challenges posed by globalisation.

Many of the comparative analyses, media commentaries and politicaldebates on this issue highlight, in a somewhat apocalyptic manner, theunavoidable challenge coming from Asia, with ever-bleaker warnings aboutthe threat to Europe and the consequent need for greater competitiveness.Not surprisingly, this has led to growing fears among the public that Europe’sdays are numbered.

But is this really true? Or is it equally legitimate to look at this question theother way round: i.e. can globalisation work without Europe?

The dire warnings about Europe’s ‘inevitable’ decline are all too frequentlybased on just a handful of statistics: differences in relative economic growth rates, the low cost of labour in Asia, the demographic decline in Europe, etc.

There is no doubt that most of the Asian countries are economic success stories.This does not necessarily mean that all of them have achieved high-qualitygrowth, but it is undeniable that the region’s performance has been impressive,with sustained economic growth over the last three decades.

This contrasts with the situation in some of the EU’s Member States, which are not only experiencing very slow growth but are also sufferingfrom a worrying lack of political leadership and a strong reluctance among the public to make the shift in mindset needed to respond to today’s challenges.

All this conjures up a striking image of an old and slow Europe beingchallenged by the young and energetic Asian economies.

There is some truth in this. In terms of population size, no other region inthe world will be able to compete with Asia. However, the EU-USrelationship remains the engine of the global economy: to give just oneexample, US investment flows to Denmark between 2000 and 2003 werealmost three times greater than those to India.1

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06Globalisation is also much more complex than the sum of a number of generaleconomic trends. This article deconstructs some of the generalisations we seein this debate and argues that the EU has an enormous role to play in theglobalisation process – if it chooses to do so.

Beyond economics

An element of drama is certainly helpful both to the media and oppositionparties in capturing the public’s attention, and a few economic indicatorsalways come in handy as a shorthand way to describe situations. However,even if they are useful and necessary, they cannot be used in isolation toexplain how globalisation is evolving or justify particular responses to it. The‘China and India are conquering us’ debate therefore requires someclarification – and there are two main assumptions which need revisiting.

The first is that the trends which have been identified will remain unchangedforever: relative economic growth in Asia will always remain as high; Asianlabour will always be ‘low cost’; and demographic decline is only a problemfor Europe. The first two will, inevitably, need to find their limits if the systemis not to crack from within. In relation to the third, it is rarely mentioned thatdemographic decline is inevitable across the globe.

The second is that increased prosperity in other parts of the world will inevitablyundermine Europe’s prosperity. This has two dangerous implications: firstly, itsuggests that better living standards elsewhere in the world are not desirable forEurope; and secondly, that Europe does not benefit from increased levels ofdevelopment in other parts of the world.

Both assumptions are very misleading, yet all too often feed collectivethinking on this issue, leading to dramatically different perceptions. Somesee the different regions of the world as being in conflict (the success ofothers is thus a threat to our competitiveness, security and prosperity), whileothers believe there is plenty to be gained from well-managedinterdependence and cooperation (an approach which has been the drivingforce for European integration since the 1950s).

Understanding further globalisation

Today’s world is one of changing structures and brand new forms of socialinteraction which are challenging the traditional ways in which societiesorganise themselves. Until now, very few resources have been dedicated to

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06 analysing this aspect of globalisation; indeed, it seems to have beendeliberately ignored by some.

These are the real challenges of globalisation: the erosion of nationalborders through the multiplication of economic, social and informationnetworks; the globalisation of culture; the challenges posed by increasinglymulticultural societies; the need to respect human rights in all our activities; the management of international economic and politicalinterdependence; the reconciliation of the national and international public interest, etc.

Ultimately, the real ‘winners’ from globalisation will be mixed and well-educated societies which are able to unlock their potential and adaptto new circumstances; have well-functioning and trusted democraticsystems; and can create an environment in which people are able to handleadvances in technology, show the necessary flexibility, embrace culturalfreedom and recognise that everyone has a collective responsibility toimprove society.

This generally leads to the question: which countries are they? It is, however,a mistake to view the argument in these terms. Different perceptions of theworld and globalisation exist – and are likely to increase – within countriesas well as between them.

Is Europe living up to the challenges?

The EU’s biggest challenge now is to give itself a clear voice in the world – anduse this to foster more inclusive globalisation.

A reckless and short-sighted approach, in which economic growth becomesthe only – and unquestionable – goal, risks backfiring and this will happensooner rather than later. There are plenty of examples of unmanaged growththat ended abruptly in financial crises or increased levels of internationaltension and confrontation.

There are four key areas where the EU’s achievements may hold lessons forthe rest of the world in confronting the globalisation challenge.

First, the Union’s experience underlines the importance of establishingpermanent dialogue as a new form of politics. Even if the search for consensusmay be painfully slow, it is invaluable in creating an atmosphere of collective

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06peace and prosperity. This is something which, inexplicably, Europeanpoliticians often play down, but their experiences could provide some excellentlessons for improving the global landscape.

Second, it is vital to recognise that competition does not equal confrontation.In a globalised world, a race to the bottom for economic survival needs to beavoided. Our collective well-being depends on creating and maintainingprosperity and trust, not only within countries but also across borders.

Third, leaving aside the general debate about competitiveness versussustainability, many of the EU’s Member States provide excellent examples ofhow to ensure high-quality growth. They have a long tradition of designingbalanced strategies for managing human, physical and natural resources,combined with democratic frameworks that ensure opportunities for all.2

Finally, it is essential to recognise that interdependence fosters stability onthe international scene. The evolution of the Union is the best example ofthis: could any other body have managed the admission of ten newcountries into its ranks in May 2004 as successfully as Europe did? The EU’spursuit of effective multilateralism also demonstrates that it can play acrucial role on the world stage.

Having said that, there are some factors which could seriously undermineEurope’s position in the world:

1. The slowdown of convergence within the EU. The increasing trend towards economic nationalism in some Member States is feeding fears about globalisation and needs to be corrected urgently.

2. The general lack of political leadership to take the Union to the next stageof development and increasing doubts among Europeans about what theEU stands for.

3. A lack of coherence in foreign policy, with duplication and competitionfor power unnecessarily undermining Europe’s credibility, effectivenessand reputation.

4. The EU’s tendency to be the “accidental player”3 in global governance.‘Soft power’ is a valuable tool, but it needs to be used and explainedmore forcefully. Otherwise, the Union risks being left behind by majoreconomic shifts that may fundamentally change geopolitical relations.

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06 Conclusion

In an increasingly multipolar world, globalisation is ever-more multi-facetedand increases the pressure for closer contacts between people. The forces ofeconomic competition will certainly determine, to a significant extent, howthose contacts evolve, but those who think that globalisation is only abouteconomics may be in for a surprise.

Globalisation will progressively erode the ability of individual countries torespond to collective challenges single-handedly and, if it is not well managed,make it harder for the world to respond to destabilising or threateningdevelopments: extreme poverty and new diseases, falling social investment,accelerating migration, tougher competition for energy supplies and a greaterburden on the environment, and increasing distrust, to name just a few.

Dialogue is necessary – and a willingness to establish permanent mechanismsfor conducting that dialogue is essential. The EU has huge potential to providea lead in creating a more stable process of globalisation from which everyonecan benefit. Its role and leadership are therefore crucial. However, it needs tomake sure that it has the will and the strength to provide it. The impressionsso far are not encouraging.

Carlos Buhigas Schubert is a Policy Analyst at the European Policy Centre.

Endnotes

1. Daniel S. Hamilton and Joseph P. Quinlan (2004) Partners in prosperity, the changing geography of thetransatlantic economy. John Hopkins University, School of Advanced International Studies (SAIS).2. The World Bank (2000) The quality of growth. Oxford: Oxford University Press.3. This term was used by Jean Pissani-Ferry in a paper entitled ‘The Accidental Player: the EU and the globaleconomy’ given at the Indian Council for Research on International Economic Relations, Delhi, 25November 2005.

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06II. THE RISE OF THE DRAGON, ELEPHANT AND TIGERS

China’s steady rise to the economic super league

by Duncan Freeman

The European Commission’s forecast last year that China would soon bespending more than the EU on research and development captured headlinesacross Europe.

This prediction attracted so much attention in part because it appeared to illustrate the long-term threat from China, and in part because ithighlighted the Union’s failure to meet even its own Lisbon Agenda goals – let alone any external challenges such as those from rising economicpowers in Asia.

In 2003, the EU spent 1.93% of its GDP on R&D, compared to China’s1.31%. But the tables are turning: while the proportion of GDP that Chinaspent on R&D rose by 10% a year between 1997 and 2002, the Union onlymanaged an annual increase of 0.7%. On current trends, the EU will notmeet its target of increasing R&D spending to 3% of GDP by 2010 and willbe overtaken by China by the end of the decade.

These forecasts appear to encapsulate the threat to Europe from the rise of the Chinese economy, not only in low-end products like textiles and shoes, but also in high-technology sectors. However, as is almost always the case in relation to China, these figures can be read in more than one way.

Even after more than two decades of very high growth, China’s economy is still much smaller than the Union’s, so its actual spending on R&D remains only a fraction of the EU’s. However, given that the Chineseeconomy is growing far faster than Europe’s, real spending on R&D is also growing far more rapidly than the percentage of GDP alone would indicate.

It is not only the government which is investing more in R&D. There has alsobeen a growing influx of Western multinationals setting up research centresin China, taking advantage of far lower costs than in their home countries.One company’s threat is another’s opportunity.

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06 The story behind the headlines

The headline statistics focusing on one aspect of the economy do not tell thewhole story. R&D spending will not, of course, be the only factor which determines the success or failure of either the Chinese or theEuropean economy.

China’s economic achievements are undeniable and its increasing impact on the global economy cannot be ignored. Since Deng Xiaoping launched the process of economic reform in 1978, China’s GDP has risen by an average of more than 9% a year. In 1980, it accounted for just 3.2% of world output; by 2005, this had increased to 13.5%. Between 1983 and 2004,its share of world exports increased from 1.2% to 6.7% and its share of importsfrom 1.1% to 6.1%.

On most measures of welfare, the Chinese people have benefited from thisincrease in output and incomes, which has lifted many millions out ofpoverty. According to the World Bank, the percentage of China’s populationliving in poverty fell from 53% in 1981 to 8% in 2001.

This does not mean, of course, that everyone has suddenly become well off. However, the country does now have many of the features of a Western consumer society, with ownership of ‘basic’ consumer goods – such as washing machines (95.9 per 100 urban households in2004), colour televisions (133.4 per 100 households), and fixed-linetelephones (96.4 per 100 households) – now almost universal in cities.

However, low living standards remain the norm in much of rural China and there are big differences even in urban areas: in 2004 there were 33.1 computers per 100 households, but only 5.6 among the lowestincome group and 74.3 among the highest; and 111.4 mobile phones per100 households, but only 37.4 among the lowest income group and 180among the highest.

Despite this self-evident success and the now general belief that China is a rising economic power, there is little consensus on the precise state of the country’s economy. Even within China itself, there is an ongoing debate over the extent to which the economy is overheating and what, if anything, should be done about this; and over precisely where reform has led the Chinese economy and what the next steps should be.

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06While one can say with certainty where the Chinese economy has come from,it is not so clear where it stands now and the future has many unknowns.

Economic reform – Chinese style

China has been transformed by a lengthy process of gradual reform from asocialist planned economy, albeit a significantly different one from those inthe former Soviet Union and Eastern Europe.

Most features of the socialist economy have disappeared, or their role hasbeen drastically reduced. There are no mandatory production plans; almostall prices are no longer set by the state; and state-owned enterprises, whichonce dominated the economy, now only account for a fraction of output.China has also acquired many of the features of a market economy, such asstock exchanges and other financial markets. There is a growing diversity offorms of ownership and the private sector is now the fastest-growing part ofthe Chinese economy.

However, this does not mean that China has been transformed into aneconomy just like those in Europe. Despite media stories about how Chinais becoming a capitalist country, the reality is far more complex and cannotbe fitted into neat categories.

The main shareholders of a large proportion of Chinese companies(including those listed on the stock market) are still state entities, and state authorities and the Communist Party continue to play an important rolein the economy – and not only through the ownership of enterprises. Evenif formal plans have disappeared, both government officials and CommunistParty committees still set economic policies in a way which often amountsto direct interference in the management of companies.

While most observers agree that China remains an economy in transitionfrom a planned to a market economy, there is less consensus on where thattransition is leading. For all the Chinese government’s efforts to persuade the EU and US to award it Market Economy Status – and its success inpersuading many governments to do so – Beijing itself still officially definesthe Chinese system as a socialist market economy.

The confusion is not just one of labels. It also has practical implications. Thefact that China’s economy is different from the usual model of a marketeconomy is hardly surprising. While it is willing to listen to advice from

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06 outsiders and learn from other countries’ experiences, Beijing has generally followed its own counsel in deciding exactly how to reform its economy.

Growing at a measured pace

Unlike many of the states of the former Soviet Union and its satellites, whichapplied the ‘big bang’ reform prescribed by Western economists and then suffered an economic collapse from which they are still only slowly recovering, China has reformed its economy at a measured pace,bringing consistent growth and welfare improvements to large sections of the population.

Its reforms have succeeded in unlocking the potential growth that had beenrestrained by the planned economy, while avoiding wholesale economicdislocation. Not only has output risen, but productivity (even in its much-criticised state-owned enterprises) has also increased.

One of the most remarkable success stories of the last 25 years has been the degree to which China has been integrated into the international economy. Much of its economic growth is export-driven and well over half of its exports now come from enterprises funded by foreign investments.

China’s ability to export and attract foreign investment has been crucial toits impressive economic performance. As a result, it is now part of anincreasingly integrated East Asian economy, which is also tied closely to theeconomies of Europe and the US through trade and investment.

Reform was a necessary pre-condition for the economic successes whichfollowed. By the late 1970s, the Chinese economy had reached a dead-endfollowing the chaos of the Cultural Revolution years and the subsequentstagnation. Since then, Beijing’s approach to reform – starting with the rural economy and then expanding to other sectors with cautiouspragmatism – has been an important contributor to the remarkable resultsthat followed the initial successes.

Chinese ‘reform and opening’

However, reform is not the only reason for China’s economic success. TheChinese almost always describe the process that has been under way since 1978

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06as ‘reform and opening’, with the latter playing a critical role in boosting growth.Externally, China has benefited from a combination of circumstances whichhave contributed to the success of the reforms pursued within the country – mostnotably, the reduction of trade barriers and the expansion of international tradeover the last two decades, with trade tending to follow increasing internationalflows of investment.

The simultaneous drive by an increasing number of companies in advancedeconomies to seek low-cost bases also hugely increased the flows of foreigninvestment into China. It has also benefited from the advances made byother Asian economies which had already passed through the early stages ofindustrial development.

Next steps

Economic reform has enabled China to make the most of the opportunitiesthat all of this has created.

However, its economic successes have certainly not solved all of itseconomic problems. The reform process itself has generated newchallenges, and the current debate over future reforms is being fuelled bythe need to address a number of pressing issues.

Most of these are widely known. They include the weakness of the bankingsystem (notably, its lending policies and consequent bad loans to state-owned enterprises); the still-unresolved problem of how to reform thecountry’s state-owned enterprises; the poor performance of the agriculturalsector and the rural economy in general; the lack of proper welfare andhealth systems; regional economic disparities and growing incomeinequality; and environmental degradation.

It is a long list, and each of these issues on its own presents a major policychallenge. Together, they represent an enormously complex knot of problems.

Even after a series of reforms and the decline in their share of the economy’s output, state-owned enterprises remain at the core of thestructural problems in the Chinese economy. Although their performancehas improved, and many have been closed or (more often) converted to other forms of ownership with the loss of millions of jobs, they still remain much less efficient than their non-state counterparts, and a largeproportion continue to run up huge losses.

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06 Despite this, they continue to absorb most bank credit, which is often given for policy rather than economic reasons and accounts for a highpercentage of bad loans. Hence, their under-performance is linked to the unresolved problems facing the banking system. The fact that companies make investments on grounds that have little to do with market logic, financed by loans that are not made on commercial grounds, means that many sectors are plagued by overcapacity and poorly-performing companies.

The lack of welfare safety nets is also connected to the reform of state-owned enterprises, as the state has yet to develop a universal system toreplace the welfare functions that these enterprises once undertook, but nolonger provide.

Conclusions

If China poses challenges for Europe, they are far less than those China itself faces. The problems facing Beijing are complex and, in many cases,require policy-makers to strike a difficult balance between priorities thatencompasses more than economics alone.

Until now, the Chinese government has shown the flexibility required to keepthe reform process moving forward and the economy expanding. Rapidgrowth has allowed Beijing to postpone some difficult decisions, but this hasmeant that some problems, notably in the banking sector, have multipliedrather than diminished.

In the past, the reform process created enough winners across Chinese society to achieve a broad level of support from the population. Now there is a risk that further reforms, or failure to implement reform, may createenough losers – in the form of former employees of state-owned enterpriseswho have lost their jobs and pensions or farm workers who see their land appropriated illegally for local officials’ schemes – to undermine thewhole project.

The Chinese economy has shown considerable capacity to adapt, as has the country’s leadership and its people. This ability will continue to be tested.

The government is attempting to cool the current overheating of theeconomy. It is also seeking to redirect policy away from achieving growth

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06above all else and towards dealing with some of the problems the countryfaces, while also pushing ahead with further reforms. China’s ability tosustain its recent success will depend above all on the policies thegovernment adopts to tackle the many challenges it faces.

Duncan Freeman is a lecturer at the Brussels Institute of ContemporaryChinese Studies (BICCS).

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06 The Indian economy – its rise and challenges

by Karishma Bhansali-Mehta

In January 2006, Delhi took the World Economic Forum in Davos by stormwith a highly successful national branding campaign under the simpleslogan: ‘India everywhere’.

The external payments crisis of 1990 may have been a cruel legacy of acontrolled post-independence regime, but it was also a blessing in disguisefor India’s 1.1 billion population.

Until then, the country had suffered under a confused economic model ofidealistic socialist planning combined with unproductive private-sectorreform. In response to the crisis, the then Finance Minister, now PrimeMinister, Manmohan Singh ushered in an era of liberalisation in 1991.

Present-day India’s strength lies in its democratic political and constitutionalinstitutions, its enviable electoral system and sound rule of law. Reforms invirtually all sectors of the economy, but above all those which facilitatedprivatisation, foreign trade and Foreign Direct Investment (FDI), have madetoday’s India an indispensable part of every multinational’s global strategy.

India’s capital markets are now open and foreign institutional investors arekey players in the Mumbai Stock Exchange. The Indian index, Sensex, hassurged to above 9,000 points. Over the last two years alone, the index hasrisen by 100%, reflecting just how buoyant the Indian economy is.

Foreign exchange controls have also been eased. The Indian rupee, which wasfloated in March 1993, has demonstrated remarkable stability against the dollarand transactions are conducted at a market-determined rate of exchange.

On the domestic front, state ownership of many enterprises has beensignificantly diluted, despite protests from the communist members of theUnited Progressive Alliance (UPA) government.

Capitalising on new technology

India has used the results of liberalisation to exploit its wealth of technically-adept, English-speaking talent in the high technology field and become amajor contender on the global stage.

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06Today’s India boasts a youth-driven IT industry which is the envy of theworld. Fed by the monotonous task of fixing the Y2K millennium bug, thesector flourished and was given an additional boost when America’sdot.com bubble burst, prompting US firms to slash their IT budgets andoutsource the work to India.

Last year, the industry generated US$36 billion – nearly 5% of the country’sGDP. It is now expanding from its original hub in Bangalore to areas near Delhi, Mumbai, Chennai and Pune. A joint study by the industry’slobbying organisation, Nasscom and McKinsey has estimated that, to date, only one-ninth of India’s IT potential and one-twelfth of its BusinessProcess Outsourcing (BPO) ability has been tapped. India’s BPO exportrevenue is forecast to grow from $5.2 billion in 2005 to $25 billion in 2010,and is expected to service areas ranging from the media and law to clinicaltrials and medicine.

India’s success is born of capitalising on high technology and high-valueservices and products, instead of simply relying on low-cost production andcheap labour, as China has done. It has produced winners in pharmaceuticals,steel, cement and automotive parts, and its exports are growing by 24% on ayear-on-year basis. Indian car makers such as Bharat Forge are exporting themajority of their production, and Mercedes cars manufactured in India arebeing sent to Germany.

The tables have turned right across industry. One of the major achievementsof the reform process has been the growth of Indian joint ventures abroad.The Ministry of Finance has reported phenomenal growth in India’s overseasinvestment – of around $11 billion between April 1996 and July 2004 – andan UNCTAD report in 2004 highlighted the fact that Indian companies wereinvolved in 182 overseas mergers and acquisitions in 2002-2003, comparedwith just 60 between 1996-1999.

Now India’s entrepreneurs have gone one step further, sending their home-grown brands across the world. Continental Europe is reeling fromwhat has become popularly known as the ‘Indian invasion’.

India’s natural affinity with the UK is fading as it spans the entire continentlooking for opportunities for takeovers, ranging from Belgian gearboxcompanies and German generic drugs manufacturers to French champagneproducers and European steel makers. Between April and June 2005, Indiancompanies acquired 26 firms abroad, and Indian foreign investment in

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06 Europe reached $3.5 billion (€2.8 billion) in 2005, with 33% of this directedtowards Belgium.

However, while India’s star may be shining brightly beyond its borders, itsgrowth is mainly driven by domestic demand – in contrast to China’s purelyexport-led economy – and the government is working to ensure that thebenefits of this growth trickle down to Indian consumers.

Its strategy seems to be working. India’s population saves nearly 29% of thecountry’s GDP, and this figure is expected to rise to 34% in the next five toseven years. Consumer demand for goods is also soaring: to take just oneexample, the country’s emerging middle-class consumer market of 330million people is absorbing five million mobile phones a month. (It took twoyears to sell the same number of handsets to Denmark.)

To satisfy this seemingly-insatiable demand, Nokia recruited 42,000 peopleand opened a new production facility just outside Chennai last year. India,along with Brazil and Russia, is also LG Electronics’ ‘second equal market’behind China, accounting for 5% of the electronics giant’s global turnover.

There is no doubt that the Indian economy has taken off, with GDP growthrates averaging nearly 11% per annum for the last three years (once theagricultural sector, which is crawling along at 4%, is taken out of the equation).

The key question now is whether it can maintain its high growth path andsoar still higher to catch up with – and even surpass – its gigantic neighbour,and lift its complex, socially-diverse society out of poverty.

To this end, Finance Minister Shri Palaniappan Chidambaram and PrimeMinister Singh are firmly committed to turning India into a manufacturinghub; a move which will be essential to sustain rapid, high growth andprovide opportunities for the eight million youngsters who enter the jobsmarket every year.

Reforming India’s infrastructure

However, behind the glossy façade of spectacular growth rates andambitious future plans lies a worrying problem: India’s woeful infrastructure.

This is the biggest bottleneck in the Indian growth story, with the shortage ofpower demanding particularly urgent attention: 56% of Indian households

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06have no power connections and shortages are all too common in Indianvillages, which are home to two-thirds of the population. India needs anadditional 100,000 megawatts of power by 2012, requiring a mind-boggling$200 billion investment.

Indian roads and buildings look ramshackle compared with China’s gleaminghighways and skyscrapers, and the country can be a logistical nightmare forcargo carriers. The Economist recently highlighted the case of a cargocontainer which took eight days to travel a distance of 2,150 kms betweenMumbai and Kolkata, with 32 hours spent waiting at toll booths andcheckpoints along the way.

Air travel is facing similar pressures: India’s airports are not equipped tocope with the 25% rise in domestic air travel every year, or to accommodatenew air carriers entering the market.

Labour-intensive and service industries alike are affected by the problemscaused by all this. IT hubs like Bangalore are languishing under thegovernment’s sheer neglect of the city. Mumbai, the commercial andfinancial heart of India, was paralysed for a week last year after thecatastrophic flooding caused by unprecedented rainfall. A staggering 1,400people die every year on Mumbai’s commuter railways and it can take abusinessman working on a time-sensitive deal up to two hours to reach thefinancial district from the airport. A third of Indian villages are notconnected to major cities by proper roads.

The government has promised to invest $11 billion in road connections forall villages with populations of more than 1,000 by 2009 – and financialanalyst Morgan Stanley has estimated it will cost nearly ten times that much($100 billion) to give India the infrastructure it needs for its economy togrow by 9% a year until 2010.

But spending on infrastructure currently constitutes only 3.5% of GDP ($21 billion), with India’s fiscal deficit swallowing up resources which couldotherwise be used for productive investment.

In spite of a well-regulated financial and banking system, there is a shortageof investment funding as banks continue to extend credit to unproductiveand loss-making sectors. A McKinsey study argues that bank reform couldfree up $48 billion of capital (more than 6% of GDP) and raise the growthrate by 2.5 percentage points a year.

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06 Mr Chidambaram has stressed the importance of financial sector reform tosustain growth. He has also promised to wipe out the revenue deficit andbring the fiscal deficit down to 0.3% by 2008-2009.

The current government also appears to be firmly committed to makinginfrastructure a priority. Around 4.2 kilometers of world-class roads are being built every day and Indian ports have already benefited greatlyfrom privatisation.

Despite communist protests, Mumbai and Delhi airports have beenprivatised, green-field airports are planned for Hyderabad and Bangalore,and there are proposals in the pipeline for more at Chennai and Kolkata,plus 30 airports in non-metropolitan areas. In addition, the country’s firstcargo airport facility is due to be constructed in Nagpur, with thegovernment aiming to finance the new airports entirely through FDI byoffering 100% tax-exemption rates.

The finance minister told foreign investors in Brussels recently that thecountry’s infrastructure “is a deficit for India but an opportunity forinvestors”, and the prime minister has appealed for FDI worth $150 billion.(India currently only receives 0.8% of the world total.)

Poor infrastructure goes hand-in-hand with archaic labour laws, red tape,bureaucracy and corruption that plague the government at the state level.

India ranked 116 out of 155 countries in a World Bank survey measuring theease of doing business – 56 places below Pakistan and 25 below China. Thisreflects, in part, the fact that government approaches vary from state to state:some (like Tamil Nadu) welcome investors, while the red tape in others (likeUttar Pradesh, with a population of 170 million) puts them off.

India also still lacks a completely-unified single market and, until last year,poor government was compounded by indirect tax disincentives (cascadingimport and excise duties) in the manufacturing sector.

Last year, the government introduced Value Added Tax (VAT) at a centrally-set rate. It also announced a transition to a national goods and services tax, and is committed to a gradual reduction in customs duties.While this is expected to make things easier for business and increaseefficiency, large states like Uttar Pradesh have not yet implemented the new VAT regime.

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06Overcoming the manpower 'bottleneck'

The country faces another potential bottleneck which has recently becomethe subject of intense debate.

India’s acclaimed IT industry employs only 1.3 million youngsters out of apotential 400 million, and the Nasscom-McKinsey 2005 Report predicts thatIT and BPO firms will face a shortfall of around 500,000 graduates with thenecessary skills by 2010.

While top-tier colleges like the world-famous Indian Institutes of Technology(IITs) produce exceptional talent, tertiary education levels in the countryvary and are struggling to cope with the surge in demand.

India’s manufacturing sector contributes a much higher share of GDP than IT(16%), is the source of 53% of exports and attracts four-fifths of foreigninvestment. However, it fails to attract young talented professionals, who preferthe more glamorous IT world. Salary costs are mounting as manufacturingcompetes with services for white-collar professionals.

Educational policies in India have to be understood in the context of thecountry’s complex social structure, which has evolved over 5,000 years.

Its unequal caste system is subject to political manipulation for votes. Seatsin colleges have always been reserved for the backward ‘scheduled castes’.The IITs are now being threatened by more positive discrimination, withproposals to ‘reserve’ half of the places in centrally-financed institutions.

Even more lamentable is India’s basic primary education. Around 60% ofthe youngsters who are expected to feed the Indian economy until 2050 hailfrom Uttar Pradesh and three other northern states with substandardeducation systems. The official national literacy rate of 61% includes manywho can only write their names.

Indian agriculture, which accounts for 24% of GDP, is heavily dependant onthe monsoons, although significant public funding is now being ploughedinto the sector to make it less rain-dependent, with the aim of bringing tenmillion hectares of land under irrigation in the next five years.

Half of India’s workforce lives in its villages, largely removed from themodern-day world. Now Indian business has woken up to the fact that villages

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06 are a vital and neglected part of the supply chain, and private companies suchas Reliance have taken it upon themselves “to bring the world to the Indianfarmer” – a task that no government has yet accomplished. It is trying toextend the Internet to India’s villages: so far, 6,000 of them have beenprovided with computers and Internet connections.

Unleashing the elephant

The Indian elephant has indeed been unleashed, but government restraintsare preventing it from running wild. Signs of India’s boom are everywhere;sceptics have become believers as the country’s economy has continued togrow at a sustained level of 8.1% for the past three years. The strongfundamentals that have secured Indian businesses a permanent niche inworld markets are incontestable. It is clear, however, that India still has a lotof catching up to do.

Provided that the government stands by its commitment to furtherliberalisation and privatisation in the face of communist opposition, and thatthere is adequate investment in agriculture and infrastructure, the economycould grow at a rate of 10% of GDP. Only exogenous shocks like escalatingoil prices and rising interest rates can nibble away its growth.

A focused Indian finance minister’s message to Brussels at a European PolicyCentre Briefing in June was loud and clear: the Indian government cannot affordto be complacent and the EU cannot afford to sideline India any longer.

It is time for the Union to shift its attention from the fiery dragon to themighty elephant.

Karishma Bhansali-Mehta is a journalist with the Brussels-based IndiaNews in Europe Programme (INEP).

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06At a crossroads: the transition towards globalisation

by Cholsoo Lho

Not so long ago, few people would have predicted that the Asian economicregion would command as much attention as it does today. Nor would many have believed that it would produce so many economic superstars in such record time, while also propelling many others towards the major league.

In the 20th century, Asia struggled through at least three major wars and anunprecedented economic crisis in near-successive decades – World War IIin the 1940s, the Korean War in the 1950s, the Vietnamese War in the 1960sand 1970s, and the financial crisis of 1997 – which left many Asian nationseconomically devastated.

With the exception of Japan, most of Asia was regarded as economicallyfragile, politically corrupt and run by self-serving dictators until the start of the 1980s.

It might be assumed that the new Asian ‘tigers’ have since either followed in Japan’s footsteps, or at least share an abundance of similar traits. But as Francesco Guerrera so aptly points out in the introduction to this publication, the region is home to a mixture of nations with distinctly-contrasting political systems, languages, cultural backgrounds and natural resources.

When demographics are taken into account, the difference becomes even more pronounced. While China and Japan are both economic giants,the former – covering 9.6 million sq. km and with roughly 1.3 billioninhabitants – is about 25 times larger than the latter, and its population is ten times greater.

There are big differences too among the newly-industrialised economies: SouthKorea’s population (48 million) is larger than that of Hong Kong, Singapore andTaiwan put together; and Indonesia alone has more inhabitants (245 million)than France, Germany, Italy and the UK combined. The significance of this willbecome more apparent towards the latter part of this article.

So how has such a diverse region which has been through so many upheavalsproduced such a record number of ‘tigers’ and economic miracles, and is it

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06 likely to continue doing so? In short, are the accolades of the past anyindication of further success in the future?

A brief study of South Korea’s economic situation, with references to otherAsian economies where relevant, is telling. A major thrust of this article isthat Korea’s success to date, as well as that of other Asian economies, is theresult of top-down leadership and the skillful development and deploymentof human capital in a variety of crucial economic sectors. But it also raisesthe question of whether this formula will continue to work in the future.

Stages of Korea’s economic development

Former South Korean President Park Chung Hee laid the foundations forsustained economic growth during his 18-year rule, from 1961 to 1979, througha combination of political authoritarianism and strategic economic initiatives.

Abject poverty and the immediate threat from North Korea provided a firmbasis for the authoritarian implementation of policies, while economicmeasures focused on fundamental objectives such as rural development andself-sufficiency in food, education, labour mobilisation, infrastructuraldevelopment and an industrialisation that was geared towards exports andforeign earnings in order to sustain growth.

Previous South Korean governments in the years after the country’sliberation from Japan in 1945 had failed to tackle fundamental problems. Itremained a poor and largely agrarian state, even when communist NorthKorea had begun to industrialise. For President Park, economicmodernisation and national development – in the face of a stronger NorthKorea, which would have won the Korean War in 1950 had the US notintervened – was a ‘do or die’ proposition.

With hindsight, the most impressive achievements of the Park Chung Hee erawere the organisation of a disciplined military and workforce, the creation ofa corporate structure and technocrats, and the appointments of educated elitesto key positions of leadership in government and state enterprises.

This organisation of human capital led to the successful five-year EconomicDevelopment Plans and the nationwide Saemaul Rural Development Plan;the creation of a pool of skilled construction workers; the establishment ofa modern transportation infrastructure; and the transition from lightindustries to more value-added heavy industries.

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06Having taken charge of one of the poorest nations in Asia in 1961, President Parkincreased South Korea’s per capita income 20-fold to $1,700 – outperformingthe North Korean economy – by the time his tenure was abruptly ended by hisassassination in 1979. Government departments such as the Economic PlanningBoard, the Ministry of Finance, and the Ministry of Trade and Industry werecreated under his leadership, and Korea’s corporate heavyweights – such asSamsung, Hyundai and LG Electronics – all took root while he was in office.

These economic policies remained unchanged under Mr Park’s successor,President Chun Doo Hwan, between 1980 and 1987. Supported by afavorable global climate of low interest and exchange rates and low oilprices, they delivered an historic economic performance which saw thecountry’s GDP more than double to $140 billion and per capita income riseto $3,400 in just seven years.

It was against this backdrop that Korea stepped onto the world stage as adynamic and newly-industrialising power when it hosted the 1988 SummerOlympics in Seoul.

From boom to bust

President Chun’s administration also made strenuous efforts to boosttechnology-intensive industries and encourage large-scale public andprivate investment in research and development.

This gave South Korea the launch pad to venture into the semiconductorbusiness at the start of the 1980s, laying the groundwork for eventual globalleadership in a number of IT products and industries.

Successive administrations also gave top priority to building more R&Dcentres, focusing on high-technology areas, expanding scientificprogrammes and increasing the number of students studying science inuniversities nationwide.

Consequently, it was not just the IT industries which benefited. The emphasison higher education and the accumulating pool of skilled labourers,engineers and scientists translated into rapid technological advances in arange of industries from the automotive sector to shipbuilding and steel.

While financial, legal, medical and other major services seemingly madeless visible progress, high-tech manufacturing and industrial production

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06 continued to notch up impressive gains and accounted for 40% of SouthKorea’s GDP of $800 billion by December 2005.

However, the end of the 1990s and the start of the second millenniumwitnessed one of the most turbulent periods in Korean economic history.

Barely a year after ascending to coveted membership of the Organisation forEconomic Co-operation and Development (OECD) in 1996, the country’seconomy nearly went bankrupt during the 1997 financial crisis – saved onlyby a last-minute $58 billion loan from the International Monetary Fund, thebiggest bail-out in IMF history.

Three years later, the bursting of the IT bubble on a global scale obliteratedthe value of investments in a multitude of venture capital and Internet start-ups. This was immediately followed by the bursting of the stock marketbubble in 2001 and the credit card bubble in 2003, following seriousoveruse of personal credit cards which almost bankrupted many card-issuing firms.

With consumer confidence at persistent lows, South Korea’s real GDPgrowth has generally hovered between 3-5% over the past five years, withthe bulk of this coming from a good export performance. The Bank of Koreahas forecast that the economy will grow by 5% this year, but other financialinstitutions are less optimistic.

Relevance to other Asian economies

While economic models and experiences vary, there are also some strikingsimilarities between South Korea and other successful Asian economies:

■ In nearly all of them, economic development began with strong, authoritativeleaders and a firm government-led strategy;

■ The eradication of rural poverty and moves towards self-sufficiency infood were regarded as fundamental prerequisites for development;

■ The importance of education at all levels was strongly emphasised tofoster the development of a skilled workforce;

■ High levels of savings and capital were invested in export-orientedindustries which boosted regional trade and increased earnings;

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06■ Economic progress has gone hand in hand with rising literacy rates, withthe advanced economies of Asia almost on a par with the West and thenewly-industrialising Asian economies not all that far behind;

■ The number of Internet users and citizens with access to personalcomputers is rising rapidly in Asia, with Japan, Korea, Singapore and Taiwansurpassing many Western economies when it comes to the ratio of Internetusers to population, broadband penetration, blogging, digital mobileInternet and broadcasting.

All of these factors together have helped to push Hong Kong, Singapore andTaiwan to economic stardom, while Malaysia, Thailand and Vietnamcontinue to demonstrate promising growth. How all of this translates intoeconomic success in the information age remains to be seen, but the initialsigns are positive.

A December 2005 study of 22 countries by Goldman Sachs economistspredicted that South Korea will become the ninth largest economy – withthe third highest per capita income – by 2025, in a group of nations which includes members of the G-7, the BRIC (Brazil, Russia, India and China) and the ‘N-11’ economies (‘Next-11’ countries are roughlydefined as success stories or developing countries with a substantialpopulation which have the potential to have an impact on the global economy).

A Growth Environment Score (GES), which ranks countries in terms of their ability to fulfil their growth potential over time, put Korea in third place, behind the US and Germany and ahead of the rest of the G-7 nations, including Japan and the UK, all the BRICs and the rest of the N-11s. The ranking was based on 13 variables in four categories, covering macroeconomic, technological, human capital and political factors.

All this suggests that South Korea will become a significant economic powerwithin the next two decades. This may seem surprising, but then who wouldhave predicted 20 years ago that it would be where it is now?

However, significant challenges lie ahead. An A.T.Kearney/Foreign Policyreport ranking countries on the basis of economic integration, technologicalconnectivity, personal contact and political engagement puts South Koreabelow all of the G-7 nations, Singapore (ranked first) and Malaysia.

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06 Other indicators that measure factors such as quality of life, the cost ofliving, the quality of schools and medical facilities – all of which areimportant to attract Foreign Direct Investment (FDI) and transform countriesinto international hubs – plus negative factors like crime and corruption,suggest Seoul has a good deal more to do if it is to make the grade.

There are also potential external risks, such as a slowdown in the US and/orChina’s economy, increases in energy and raw material prices, tradedisputes and the escalating threat from North Korea, which could seriouslyundermine the economic outlook.

What lies in the future?

South Korea is at a crossroads. Having risen to unprecedented economiclevels, it has critical choices to make if it wants to play a key role in today’sglobalised world.

While it has grown significantly in economic size and in the quality of itsoutput, it has yet to create a proper economic infrastructure which will be ableto interact with – and benefit from – other globally-advanced economies.

This is demonstrated by the fact that services only account for 56% of itsGDP – far lower than the 70% or higher in most advanced economies. Inaddition, the quality of the service sector needs to be vastly improved. Whilethe banking industry has been reformed, the insurance, securities,investment banking and fund management sectors still need to besignificantly upgraded. The same is true for legal, medical andpharmaceutical services, which are relatively underdeveloped, and for otherservice sectors protected from foreign competition.

The current strategy of finding new markets for manufactured goods, lower-costproduction and R&D centres will be important as China and the other Asianeconomies begin to move up the learning curve. But this game will be playedout in different ways as large companies from less developed countries begin toacquire, or merge with, established firms in more advanced economies.

India’s Mittal Steel’s recent merger with Arcelor to become the dominantglobal steel producer, Lenovo’s acquisition of IBM’s personal computer unitand Shanghai Automotive Industry Corporation’s takeover of SsangyongMotors (South Korea’s fourth largest car manufacturer) are just a fewexamples of this growing trend.

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06Moreover, with foreign reserves of nearly $2.5 trillion held by a select groupof Asian economies (including South Korea, with nearly $250 billion), thistrend is expected to accelerate – and will be further stimulated by theincreasing prospect of Free Trade Area (FTA) agreements with other countries.

However, no serious transformation is pain-free and South Korea needs to analyse closely the benefits of such agreements with the advancedWestern economies.

The value of human capital and education cannot be exaggerated, since thistranslates directly into greater service, innovation and technologicalcapabilities. This is especially true as countries around the world prepare for thenext big growth challenge: to transform themselves into knowledge economies.

With no natural resources, South Korea’s path to future growth will largelybe determined by the value of its human capital. It needs to pursue adecisive path towards globalisation and promote government policies thatencourage competition and innovation, attracting the best domestic andinternational minds and investments, in order to emerge as a crediblecompetitor in the international arena.

A multitude of studies1 collectively emphasise that an educated population,access to information, IT and communications infrastructure, innovation,urbanisation and globalisation are paramount for sustainable economic growth.

Asia already outnumbers both North America and Western Europe in termsof Internet and broadband subscriptions. As China, India and other rapidly-developing economies in South-east Asia become even more wired, theadvanced Western economies may not have as long a lead-time as theymight previously have assumed.

Just as Google, eBay, AOL, Yahoo, Oracle, even Apple and Microsoft haveall exploded onto the world stage from nowhere in the very recent past, it ishighly likely that Internet and communications giants will begin sproutingoutside the US – as Infosys, Softbank, China Telecom, PCCW, among others,have already demonstrated.

The primacy of the individual – not just corporations – as a focal point ofinnovation has also become a pivotal factor in the information age. As investorsaggressively seek human talent around the world to find – and fund – the nextSergey Brinn, Jerry Yang, Steve Jobs or Bill Gates, they might find what they are

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06 looking for among the youngsters now growing up in Bangkok, Kuala Lampur,Mumbai, Shanghai or Seoul.

Cholsoo Lho is the Director of the Center for Global Cooperation at theSamsung Economic Research Institute (SERI).

Endnote

1. See, for example, The War for Talent (McKinsey & Company), Global Innovation Outlook (IBM), GlobalEconomics Paper No. 134 (Goldman Sachs), The Evolving Global Talent Pool (Levin Institute – StateUniversity of New York), Knowledge for Development (World Bank Institute) and Mapping the Global Future(US National Intelligence Council)

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06Setting the stage for sustainable growth

by Augusto Lopez-Claros

Chinese challenges

Coming up with adequate adjectives to characterise China’s economicperformance over the past decade and a half is a challenging task.

‘Impressive’ and ‘spectacular’ are words often used by normally cautiousacademics and development experts, and policy-makers all over the worldare watching its progress with awed admiration.

China’s economic growth rate has not fallen below 7.5% since 1990, andthe logic of compounded growth rates tells us that a 7% growth rate doublesthe size of an economy every ten years. This suggests that China willovertake Germany in less than a decade to become the world’s third largesteconomy and will catch up with Japan by around 2020.

This impressive performance has turned the Chinese economy into animportant contributor to global growth, a major force in commoditymarkets, the most important destination for Foreign Direct Investment (FDI)and an emerging power in international trade – in 1984, Chinese exportswere less than 1% of total world trade; 20 years later, they accounted formore than 5%.

So if the intent of China’s strengthened reform effort over the last 15 yearswas to contribute to its integration into the global economy, it hassucceeded well beyond anyone’s expectations.

For much of this period, Chinese growth was overwhelmingly led by domesticdemand, and thus did not contribute to the global trade imbalances whichhave done so much in the past to create tensions between some of the globaleconomy’s key players. Indeed, in 2003, net exports were actually negativeand have only more recently swung into substantial surplus.

While the above trends have all contributed to increase the importance of the Chinese economy – which, by 2005, accounted for some 5% ofglobal GDP – they have also pulled hundreds of millions of people out of poverty, and given them enhanced opportunities and improved living standards.

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06 This is perhaps the most important achievement of the last 20 years because,in the end, the primary aim of economic policy is to help improve livingstandards and give people the opportunities for self-development whichcome with growing prosperity. Challenges, however, remain.

The international economy has a vital interest in seeing high economic growthrates in China well into the future. For this reason, it is essential to maintainthe reform effort while at the same time addressing these emerging challenges.Effective diagnosis combined with timely policy interventions should go along way towards ensuring that the favourable trends of recent years continue.

Improving the social infrastructure

One of the more noticeable recent trends in China has been the massiveshift of rural populations to urban areas. In 1980, these were home to lessthan 20% of the total population; by 2000, this had risen to 33% (up fromabout 190 million to more than 420 million).

These internal migratory flows accounted for at least a few percentagepoints of the high annual GDP growth rates seen during this period, sincelabour productivity in urban areas is much higher. This trend is expected tocontinue and will require careful management, for several reasons.

First, Chinese unemployment rates have been rising steadily. The officialstatistics only count registered urban unemployed and exclude millions oflay-offs from state-owned enterprises. There have been transitory increasesin unemployment linked to the inevitable, and much-needed, restructuringof the enterprise sector, and this has necessitated the introduction ofunemployment compensation schemes and, more generally, safety nets tomitigate the impact of these adjustments.

Like other industrialised countries, China will also have to make provisionsfor its ageing population by developing efficient and modern systems ofsocial protection, particularly pensions. This, in turn, will have budgetaryimplications. By 2030, China’s urban population may well exceed 1 billion.Well before the country reaches this threshold, a well-functioning and well-funded social infrastructure will be a political necessity, especially ifthe current rural-urban income disparities continue to widen.

Indeed, China’s political stability will hinge on the speed with which thegovernment can make progress in this area, at a time when rising protectionist

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06sentiment against booming Chinese exports is beginning to create a morechallenging external environment.

Continuing with fiscal consolidation

The Chinese authorities have long recognised the importance of cautiousmanagement of public sector resources.

However, their policy of aiming to keep the fiscal deficit unchanged innominal terms (thus implying a reduction in the deficit in relation to GDP)may require some modification if it becomes evident that additionalresources are needed to address ongoing problems in the banking sector,finance pensions and the growing demand for other social services, andmeet the financial costs of restructuring state-owned enterprises.

A flexible approach will be necessary to manage these challengesefficiently, and the authorities should be ready to strengthen their fiscal effortin the light of changing conditions. Some countries may need to build upbudget surpluses gradually – and China could well be one of them.

Reforming the banking sector

All transition economies have had to confront the problems which arise in countries where the banking sector has long been dominated by publicly-owned financial institutions, often operating in an environment where profitability is unduly dependent on close relations with the governmentand where, therefore, banks have not learned to price risk appropriately.

Much remains to be done in China to establish a sound, well-capitalisedand competitive banking system. The regulatory regime must be improved,the monetary authorities’ supervisory capacities enhanced, and the legalframework for bankruptcy procedures and creditor rights modernised.

A strategy will also be needed to clarify the ownership structure of state-ownedbanks. In particular, the authorities may well have to recognise that as trade andinvestment continue to grow and further open up the economy to the rest ofthe world, banks will be under increasing pressure to operate on a commercialbasis, subject to the good discipline of international competition.

It is difficult to exaggerate the importance of all this. There are too manyexamples of countries where inadequate attention to a growing stock of

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06 non-performing loans, or too liberal an approach to capital injections instate-owned banks without commensurate improvements in efficiency andmanagement, have been counterproductive. This has resulted in additionalpressures on the budget through the rapid growth of quasi-fiscal liabilities ofthe financial sector – a trap China should avoid.

Managing the growth process

A vigorous debate is under way about the risks that rapid growth rates mightpose for macroeconomic stability.

China’s relatively good inflation performance and the slack in the labourmarkets may suggest that growth can be sustained in the 9%-plus range.However, in recent years, credit growth has reached extremely high levelsat times, leading to consensus that managing the growth process in a waythat preserves and builds upon the important gains of the past is a keypriority for policy-makers.

This view has been buttressed by a growing perception that rapid growth is leading to a sharp deterioration in the environment, with unforeseenconsequences for public health.

However, monetary policy measures – interest rate and reserve requirementincreases – are not likely to be enough. There may well be a role for fiscalpolicy as well, to withdraw stimulus from the economy. Fortunately, withone of the lowest revenue-to-GDP ratios in the world, China hasconsiderable room for manoeuvre and should not hesitate to use it.

Beyond this, further structural reforms – particularly to boost competition,reduce the barriers faced by entrepreneurs, and increase transparency andthe rule of law – will help to make the Chinese economy more flexible andenhance its response to change.

The competitiveness indicators compiled by the World Economic Forum(WEF) suggest that improvements in the quality of the institutionalenvironment, particularly in public sector institutions, would go a long waytoward boosting Chinese competitiveness and enhancing the chances ofsustainable growth.

China is now a key pivot of the global economy, and its role in boostingAsian growth prospects is crucial. Sound macroeconomic management will

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06benefit not only China itself, but also the many other countries whoseprosperity depends in no small measure on its performance.

The most successful companies in the world are those that have managedrapid growth and swift change – two key characteristics of China in recentyears – through better use of early warning systems, changes to achieve moresustainable paths to growth and the introduction of systems of shared power,diminishing the risks associated with over-centralised decision-making. Chinacan learn important lessons in this respect from the business world.

A maturing global partner?

There is growing recognition that international cooperation is needed toconfront the many challenges facing humanity today, both in the economicand political arena. Globalisation has gradually eroded the ability ofsovereign states to deal with problems which, because of growinginterdependence, have acquired a large international dimension.

It is therefore obvious that addressing many of these challenges – frommanaging the global environment to improving the international financialarchitecture, and tackling nuclear proliferation, terrorism, drug traffickingand the spread of infectious diseases – will require a major strengthening ofthe mechanisms of international cooperation.

China’s role in this process is likely to be key, partly because it is the most populous nation on earth and partly because, if it continues on the path of sustained high growth, this will guarantee its rightful place as one of a handful of international economic heavyweights.

Its chances of helping to shape the global agenda will be enhanced if thegovernment sets in motion political reform processes as the 21st centurycounterpart to the impressive economic reforms of the past two decades,which have done so much to boost Chinese living standards. A China whichgradually gives a political voice to its people can only enhance its ability toplay a pivotal role in the search for solutions to the challenges confrontingus all in the coming years.

India’s rising star1

India’s recent economic success is beyond doubt and is reflected in GDPgrowth rates of close to 8% over the past three years – an important

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06 achievement that has led to a substantial reduction in poverty.2 The keyquestion now is whether it will be able to sustain and, indeed, accelerate itsperformance over the next decade.

Just as China has benefited from a massive process of urbanisation, India has asimilar ‘structural’ feature likely to boost growth: its favourable demographics.For the next 20 years, the working-age population will rise and India will haveto find ways to bring its masses of poor young people into the mainstream, andboost productivity through increased spending on education and improving thequality of its educational institutions.

The quality of India’s business environment has improved significantly inrecent years. In everything from the levels of company spending on researchand development to the prevalence of foreign technology licensing, thesophistication of financial markets and the greater openness in the economyassociated with a much more sensible approach to trade, India has madetangible progress over the past decade.

There is no doubt that the better growth performance seen during this periodreflects these improvements in the policy framework and the institutionalenvironment. However, to quicken the pace of growth to, say, 8% per yearon a sustained basis, a number of weaknesses will have to be addressed.

Boosting education

India still suffers from high illiteracy rates and relatively low enrolment rateson every rung of the educational ladder. Urgent changes are particularlyneeded at primary and secondary level, but even tertiary enrolment rates arelow by international standards: India ranks 91st among the 117 countriescovered in the WEF’s Global Competitiveness Report.

India will have to educate and train its young people so they can join the labourforce with usable skills, particularly in sectors where it has potential comparativeadvantage. World demand for outsourcing is expected to rise in the comingyears as communications costs continue to fall. For India to be able to take fulladvantage of these opportunities, it will have to improve its workforce’s skills.

Dilapidated infrastructure

The government has identified glaring weaknesses in India’s infrastructure:its roads, ports, airports and power generation are all in a sorry state of

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06disrepair. Some progress had been made in improving the telecomsinfrastructure, but major investments are needed across the board to sustainand, indeed, increase inflows of FDI to much higher levels.

The government would like to attract $150 billion of FDI during the nextdecade, but there is little chance of this purely on the strength of India’slarge and growing market. Its infrastructure will have to be upgraded tocreate a friendlier environment for investment. Whether these plans are fullyrealised will, in turn, be linked to a major improvement in the country’spublic finances.

A culture of red tape

The extent of bureaucratic red tape and excessive regulation remains a seriousproblem in India. There is a pervasive culture of government intervention andcontrol, which adds to business costs, hampers small- and medium-sizedenterprises (SMEs) and can be best characterised as ‘self-inflicted injuries’; i.e. things that developing countries do to themselves which are of littlediscernible value other than to make life difficult for business.

India has made progress in this area in the past decade, but not nearlyenough. According to the World Bank’s Doing Business Report 2005, itranks 103 in the world for the time it takes to start a new business.

Managing public finances

India has a serious fiscal deficit problem. Essentially, it has been runningdeficits of some 10% of GDP for the last several years, among the highest in the world.

India’s public debt level, at 83% of GDP, is already very high both byemerging market and developed economies’ standards. The revenue-to-debtratio is among the highest in the world, due to India’s very narrow revenuebase: it collects only about 19% of GDP in revenues, compared to some26% of GDP for developing countries and much higher levels still forindustrial countries with widespread safety nets.

In an attempt to bring about some measure of medium-term fiscaladjustment, the government introduced a Fiscal Responsibility BudgetManagement Act (FRBMA) in 2003 which establishes a deficit reductionpath to 2009. However, it has some flaws. First, it applies only to the central

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06 government when, in fact, about half of the deficit problem lies with thestates. Second, it does not establish any penalties and/or sanctions for thosewho stray from this path. All of this is important for a number of reasons.

First, the bulk of the public debt is denominated in rupees. The markets seethis as positive, since it isolates the country from exchange-rate risk.However, the size of the debt means the banking system is essentiallyplaying the role of cashier to the government. It taps household savings, andthen finances the government and sits on several hundred billion dollars ofgovernment paper.

This is a profitable, safe business for the banks, which do not have to worryexcessively about the SMEs which need finance to grow, or about enhancingtheir own capacity to price risk – why should they if they have, in thegovernment, a large, reliable client?

India is unlikely to see 8% growth on a sustained basis without a thrivingfinancial sector channelling household savings into productive private-sector investments – and this will not happen unless the government curbsits own appetite for savings. Furthermore, the huge stock of governmentsecurities sitting in the banks’ balance sheets is vulnerable to interest raterisk and, thus, potential capital losses.

Finally, India’s good growth performance provides an ideal context for fiscaladjustment, whether in the form of higher taxes, lower expenditures, or somecombination thereof. A growing economy provides the cushion, in politicaleconomy terms, for belt-tightening. The alternative is to do it in the middle ofan economic downturn or a crisis, and this is traditionally more difficult.

Fiscal discipline is always difficult in a multiparty democracy, particularlyone with the high levels of poverty still seen in India. Without doubt, thedeficit is a drag on the economy; a much lower deficit would have producedhigher growth rates and higher levels of revenue, boosting the government’sability to respond to pressing social needs. So, perversely, lack of fiscaldiscipline is having the opposite of the intended effect – by reducing growth,it has turned into an anti-poor measure.

Should we worry?

China and India together account for more than 100% of the reduction inworld poverty over the past decade.3 This is an impressive achievement and

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06represents an unambiguous improvement in global welfare. This paper hasattempted to highlight the policy reforms needed to safeguard and sustainthe growth that has been the engine of poverty alleviation.

High and sustained growth is not inevitable; both countries havevulnerabilities – some institutional, some demographic – often stemmingfrom decades of economic mismanagement and the time that was lost inpursuing idle dreams with huge welfare costs, particularly in China.

Policy-makers in both countries will have to remain vigilant. The increasingcomplexity of the global economy, and the myriad institutions andrelationships that underpin it, mean that no country’s future prosperity isassured. Missteps are possible.

There are many risks that could potentially threaten a rosy growth scenario – fartoo many to enumerate here. But the likely benefits to China and India from animproved policy environment are likely to be enormous, with enduringconsequences for the rest of the world.

Augusto Lopez-Claros is the Chief Economist and Director of the GlobalCompetitiveness Programme at the World Economic Forum.

Endnotes

1. This section draws from the World Economic Forum’s Global Competitiveness Report 2005-2006, Palgrave Macmillan.2. India’s average annual real GDP growth during the period 1990-2004 has been about 5.7%, compared toclose to 9% in China. So, during this period, Indian GDP doubled but Chinese GDP tripled. Not surprisingly,China has much lower infant mortality, higher life expectancy and lower illiteracy rates than India.3. This is because poverty in Africa has increased in absolute numbers.

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06 III. INTERNATIONAL RELATIONS

The rise of Asian economies and the WTO: back to the future

by Pascal Lamy

Ganesh, the Hindu god of wisdom, has an elephant’s head; he is the masterof intellect and wisdom. A white elephant is considered holy in Thailand.The tiger and the dragon are two of the Chinese zodiac animals.

Tiger people are difficult to resist, for they are magnetic characters and theirnatural air of authority confers a certain prestige on them. They aretempestuous yet calm, warm-hearted yet fearsome, courageous in the faceof danger yet yielding and soft in mysterious, unexpected places.

In the Chinese zodiac, the dragon is magnificent, flamboyant, attractive andfull of vitality and strength. Usually depicted as long, snake-like creatureswith numerous claws, dragons have long been the symbol of auspiciouspower in Chinese folklore and art. Tigers have always been an eternal rivalto the dragon, thus an old Chinese saying to describe equal rivals is:“Dragon versus Tiger”.

So what do elephants, tigers and dragons have in common? All three arepowerful Asian symbols of strength, power and prestige – adjectives whichcan be used to describe the changes that Asia is undergoing.

Asia’s return to the centre stage

It is always good to look back on history to find answers to the many questions we ask ourselves today, and the topic of this article is no exception.

Looking back, we see that Asia has the longest and most prosperous historyin humankind. For decades, it has been the single most important drivingforce in the international economy.

A study published by the Organisation for Economic Co-operation and Development (OECD) in 2001 shows that between 1500 and the early phase of industrialisation in the West around 1820, Asia’s share of

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06the world population and output was close to 70%. China alone accountedfor one-third of the world’s output even as late as 1870.

However, after 1870, Asia’s share of global output decreased sharply up to1950, when it reached a record low of 18.5%. There were many reasons forthis sharp decline, including the rise of the United States and Europe’s leadin the industrialisation process.

After World War II, Asia’s share of global output continued to decline untilthe 1960s, as European trade recovered very fast while some Asian countrieswere pursuing inward-looking development policies. As a result, by 1973, itwas about the same as in 1929 (close to 15%).

However, between 1973 and 1993, it increased in a strong and steady way.This recovery was driven first and foremost by Japan and later on by thenewly-industrialised Asian countries, also known as the ‘Asian Tigers’. Chinaonly started to contribute to this from the 1980s onwards.

We can therefore safely say that the rise of Asia we are witnessing today isnot an unknown phenomenon, but rather a return to the past.

Why Asia’s rise is good news

With the rise of Asian economies, a new engine of growth for the worldeconomy has been switched on. For the last 50 years, growth has largelybeen in the hands of the US and European economies. Today, China, andvery soon India, will play a similar role.

With these new engines, the airplane can not only fly higher and faster, but will also be safer if and when any of the engines fails to work. A prosperous Asia can therefore contribute to making the world more stable.

The rise of Asia means more exports to the world, but it also offers new market opportunities for the rest of the world. With the rise in the Asian population’s standards of living, this region is providing new market access to products and services for the rest of the world: among the world’s top ten importers in 2005, six were from Asia: namely China, Japan, Hong Kong China, Korea, Singapore and Chinese Taipei. Their import growth averaged around 15%, with India alone witnessing anincrease of 35%.

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06 A fast-growing Asia is also good to promote South-South trade. Asia isgradually turning into an important export destination for other developingcountries, especially the world’s poorest ones.

While the EU and the US remain the biggest markets for exports from the Least Developed Countries (LDCs), many Asian countries arebecoming important export destinations too. Among the top ten markets for LDC exports between 1995 and 2004, seven were from Asia: namelyChina, Thailand, Japan, India, Chinese Taipei, Korea and Singapore.

This increasing economic power has given Asian countries greater clout on the international trade scene, and the last ten years have witnessed theirincreasingly active and more confident participation on the international stage.

In the World Trade Organization, India has traditionally been a major player,Japan has been a member of the QUAD (EU, US, China and Japan) for yearsand China joined in at the end of 2001. South-east Asian countries play animportant role through the ASEAN group of nations.

Asian countries are also playing an important role in the ongoing DohaRound negotiations. India and China are key members of G20 and G33, two groups of developing countries which are at the heart of the negotiations onagriculture. Japan, Korea and Chinese Taipei are key members of the G10, agroup of WTO members favouring multifunctionality of agriculture. HongKong, Japan, and Korea are known as friends of the system and have takenthe lead on issues such as anti-dumping or services.

Asian countries are also very visible in other areas of the negotiations such as trade facilitation, fishery subsidies and industrial tariffs. Their views, though seldom collectively expressed – due to diverse interests in these different areas – carry a lot of weight within the membership.

In sum, the old tigers, elephants and dragons are key players in thenegotiations aimed at reaching an ambitious and balanced outcome of theDoha Round.

Trade has brought prosperity to Asia

Rising prosperity in the global economy has long been closely associatedwith strong growth in international trade. History attests that when nationsturn inward-looking and erect high walls against international trade,

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06stagnation and decline typically follow, which is what happened during theMing Dynasty in China in the mid-15th century.

In the last two decades, as trade has blossomed, we have witnessed risingincomes and falling poverty in Asia. While the link between trade and growth has been – and remains – a highly-debated issue, Asia has seen the rapid growth in trade bring large investments, technology upgrades,knowledge spill-over, and higher productivity and living standards. Inaddition, the social impact of trade-led growth on job creation has beengenerally positive.

The WTO Doha Round is important for the region. Asian countries haveembraced an outward-oriented strategy, relying heavily on North Americanand European markets. Their interaction with the rest of the world is huge.

Asia, as the main beneficiary of global trade liberalisation, therefore has ahuge stake in maintaining an open, fair and transparent multilateral trading system. Countries in the region have interests in almost all the areasunder negotiation: reducing agricultural subsidies, eliminating high tariffsand tariff peaks in industrial and agricultural tariffs, and liberalising trade inservices, are of particular importance to Asia.

Further improvements on anti-dumping are also of common interest to Asian economies. Furthermore, a successful Doha Round will facilitate thedomestic reforms which have been undertaken by many countries in the region.

As one of the most open regions in the world, whose outward-orienteddevelopment strategy has been highly successful, Asian countries can andshould play a more proactive role and contribute significantly to reachingan ambitious and balanced Doha outcome.

Implications for the WTO

The global trading system is undergoing a period of transition. Shifting economic circumstances, major advances in technology and the emergence of new players on the global scene all underscore that we are on the verge of big changes.

We have a quite different multilateral trading system today compared to thatof 20 years ago. Our membership is not only expanding, but we are alsoexperiencing gradual changes in the way we do business.

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06 India, China, Brazil or South Africa are now playing a much more active role on the global trading scene, like that traditionally played by theUnited States, the European Communities, Japan, Canada or Australia: theyhave now become crucial players in the trade rule-making process.

The system needs to adjust to these new developments. As time passes, theorganisation’s culture will also have to change to become more universaland reflect cultural diversity. This is a good change in my view and, bymaking it, the WTO can become truly global.

Of course, the magnitude of developments in Asia – in particular China – hascaused some concerns among the rest of the WTO’s membership. Theseconcerns are understandable, but should not be exaggerated.

Should we be so concerned about the dragons, elephants and tigers? Myanswer is no. There is plenty of room for all to co-exist under the same roof.The WTO offers a multilateral rules-based system, with all its memberssubject to a set of common rules and all of them committed to keeping theirmarkets open and providing market-access opportunities to each other in anon-discriminatory manner. This is what I call a win-win game.

WTO trade statistics show that Asian countries’ imports and exports are roughlybalanced. For example, China exported $762 billion worth of goods andimported $660 billion worth in 2005. During the same period, four ‘tigers’exported $731 billion worth and imported $676 billion worth, and Indiaexported $90 billion worth and imported $132 billion worth.

But the dragons, elephants and tigers could play an even more active role – or even a leadership role – in pushing forward tradeliberalisation, depending on how they decide to liberalise their own economies.

In the ongoing Doha Round negotiations, Asian economies, especially Indiaand some ASEAN countries, could make greater efforts to reduce the levels of their bound tariffs, which are still two to three times higher than their average applied rates. This will not only substantially enhancetransparency and predictability, but also boost confidence among tradingpartners and investors.

As an example of a successful development model in the developing world, Asian economies are also in a good position to act as a bridge

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06between developed and developing countries, and share their developmentexperience with other developing countries which are still searching for asuitable path for development.

Although every country’s situation is unique, I still believe that some of theirsuccessful development strategies and know-how are based on universalvalues and have implications which others can learn from.

Conclusion

After two centuries, the dragons, elephants and tigers are coming back onto the world’s centre stage.

Their success stories are examples of an intelligent combination of gooddevelopment strategies, hard-working people, and a well-functioning globalpolitical and trade environment.

A successful Asia can contribute to the healthy development of the worldeconomy, and play an increasingly important role in the WTO. At the sametime, it can also help other developing countries through experience-sharingand technical assistance.

The world is changing and so must we.

Pascal Lamy is the Director-General of the World Trade Organization.

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06 Why Europe must hang together

by Hanns W. Maull

In history, the rise of Great Powers has often been accompanied by war – aswith the rise of Athens; or, later, Rome in the Mediterranean; or Germany in Europe in the late 19th and early 20th century. Indeed, war has been one way of handling the shifting economic and political dynamics ininternational relations.

Yet there is nothing inevitable or pre-ordained about this: the rise of newpowers simply implies a need to manage associated new conflicts by thoseconcerned. This can indeed be done through war, but there are also muchbetter, peaceful ways to do so.

Moreover, in historical terms, the rise of Asia has few, if any, directprecedents, for we are now witnessing the simultaneous rise of two major powers with very different characteristics, as well as their rapid integration into a world economy characterised by the globalisation of production (where different parts of a final product are made in different places and then assembled somewhere else again) – and hence interdependence.

We should therefore not be overly-concerned about dubious lessons from history, but rather about how the established powers, together with thenewcomers, will manage the new international order resulting from the rise of Asia.

Europe will not be the only – and probably not even the main – player inthis context. Still, the rise of China and India is bound to have far-reachingimplications for the EU’s Common Foreign and Security Policy, and it couldeven lead to Europe´s marginalisation in world politics.

In any case, Asia will assume much greater importance in the Union’sexternal relations than before. Since the early 1990s, the EU has recognisedthe importance of what was happening in Pacific Asia, and has tried torespond by intensifying and upgrading its bilateral relations with the regionand its key players.

This process will no doubt continue: we will see a further proliferation ofcooperation agreements, in which the word ‘strategic’ will feature even

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06more frequently than it already does. However, economic issues willcontinue to dominate bilateral relations, both creating new opportunitiesand causing new problems for the EU.

Most of those problems will be of a secondary order, but some may wellraise more fundamental issues for European external economic policies. Forwhile there can be little doubt that the rise of China and India – and withthem, much of Pacific Asia – will continue for the next two decades, thereis considerably greater uncertainty over what kind of world, what kind ofinternational order, they will grow into.

The present order has enabled China and India – and much of East Asiabesides – to develop and grow at an historically-unprecedented speed,catapulting large parts of their societies from abject poverty into advancedindustrial production and the lifestyle of wealthy, globalised middle classeswithin one generation.

The international economic and political arrangements and institutionswhich today represent this order may not always have offered a level playingfield for those outside the small circle of rich industrialised countries whichfounded and adapted them, but they did provide ample opportunities forthose determined to play the system. Through their strategies of export-ledgrowth, Japan, most other Pacific Asian countries and then China haveexploited it to their own – and the world’s – advantage.

Can this continue? The greatest uncertainties in this respect do not surroundIndia, nor even China (although some ecologically- or socio-politically-inducedruptures there are certainly conceivable, they are unlikely to throw China off itsgrowth path for long). The real question mark hangs over the United States.

The US – a key player

Ultimately, it is America which holds together the present internationaleconomic and security order. From the beginning of the Cold War andbeyond its demise, the US has been serving as the (free) world’s governmentby default.1 The EU has been acting broadly as its junior partner – no less,but also not much more.

Yet America´s internationalism has become jaded in recent years: nudgedforward by Congress, US economic multilateralism has often been ratherpredatory and sometimes quite blatantly deficient, while American

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06 international security policies have recently tended to undermine, rather thanto enhance, the structures and institutions of regional and international order.

In the coming years, America is likely to go through a traumatic post-Iraqphase, which may well further dent its willingness to underwriteinternational institutions and lead arrangements for global order.

For sure, America will want to remain a Pacific power and continue to playa key role in East Asia – but will it really be able to muster not only themilitary power, but also the diplomatic skill and political astuteness, to hangon to this position against the background of fundamental shifts in theregional power equation? Even if it does, will it find the strength anddetermination to continue to uphold the kind of international order in whichChina and India have been able to rise peacefully?

At this point, the implications of Asia’s new importance in world affairs forEuropean foreign policy could become serious, and potentially very tricky.If US leadership begins to wobble while China and India continue to gainin importance, it will no longer suffice for the EU to serve as a junior partnerin America’s collective world government.

Rather, the Union will then face a choice between: a) going it alone; b)assuming a world leadership role in continuing and developing its own,peculiarly ‘post-modern’ approach to international relations; or c) joiningone of the other ‘great powers’ in an alliance as a means to hold its ground.

Initially, this last approach would presumably be mostly about defendingEuropean economic and social interests, but in the longer run it might wellcome to include political and security relations as the world drifts back intoa new phase of power politics.

The most obvious partner in such an alliance would again be the US, as thedominant economic, military and political power in the Atlantic world, but(unlike the one founded in 1955, with the entry of Germany and Italy intoNATO) this Atlantic alliance would not be about establishing a new,democratic international order built on open markets, but rather an alliancewith the twin aims of providing socio-economic protection and balancingthe weight of China in world politics.

This would, in turn, probably hasten the deepening of regionalism in EastAsia and could well also consolidate Chinese-Indian cooperation.

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06International regimes and institutions would lose what influence they wereleft with; the world would disintegrate, for all practical purposes, into (atbest) loosely- and precariously-connected regional blocks.

Since such a world would be unable to cope politically with themultifaceted global challenges confronting mankind – such as poverty,environmental destruction, terrorism, weapons of mass destruction anddisease – it would also be much more violent and troubled.

All conceivable alternative EU alignments (for example, with China, India,Japan or Russia) not only seem much less likely, but would also face similarrisks. On the other hand, if the EU opted for ‘splendid isolation’, it wouldalmost certainly end up being completely marginalised and risk becomingthe Latin America of the 2020s.

European leadership for a new order

The most promising route therefore seems to be one which would be also themost demanding: assuming leadership in collective efforts to build a new,sustainable international order on the foundations of what we have today.

This would imply transforming today’s European exceptionalism intotomorrow’s norm: the way the EU regulates its internal affairs and creates acollective capacity to act through political integration would provide themodel for organising future world affairs. In other words, European modesof governance would be reconstructed, or rather recreated (for there wouldobviously have to be important functional modifications, as well as hugely-divergent forms and institutions), at the global level.

Today, Europe is exceptional in its acceptance of new, integrated forms ofregional governance. European integration critically rests on a creativeredefinition of national sovereignty, which allows for sovereignty to bebroken down into functional segments which can then be transferred tosupranational political institutions – those of the EU – and reassembled intoa meaningful, coherent and consistent capacity for collective action, bothwithin and beyond Europe’s boundaries.

This quantum leap which lies at the heart of the European experience since1945 now needs to be injected into world politics: there can be no doubtthat the world will need more, rather than less, capacity to create andsustain political order as a prerequisite for coping with the challenges of the

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06 future. But who could work towards such an objective except theEuropeans, who know the benefits accruing from a willingness toreconceptualise sovereignty from their own experience?

Perhaps the US could do it again, as it did in the late 1940s and early 1950sor the early 1990s? In the 1940s, by a stroke of political genius and with muchuseful (if involuntary) help from the Soviet Union, America recognised thepotential of setting up a cooperative world order built around internationallaw, international institutions and the core values of democracy, prosperityand human rights. In the early 1990s, Washington was again wise enough toadapt and develop this order further to include the old enemies througheconomic cooperation and cooperative security efforts.

Yet, despite all these magnificent efforts to build a global ‘empire for liberty’,American foreign policy has remained firmly modern, rather than post-modern.It has usually shied away from accepting that the rules and regulations it did somuch to set up apply to it as well.

Persuading Washington to accept such a political quantum leap and commititself to engaging permanently with international arrangements andinstitutions will take considerable persuasive power and political efforts.Who but Europe might America be prepared to listen to in such a context?

China and India are also quintessentially modern ‘sovereignist’ powers.They both have learned painfully about the importance of asserting theirsovereignty and autonomy against outside encroachment, and they naturallyshow little inclination to reconsider this position. Yet there are two importantforces pulling them in this direction which could make them amenable toreviewing their stance.

The first force is regional: China especially, but also India, recognise theimportance of regional cooperation as a means to stabilise their ownenvironment. Beijing has recently even taken a number of significantinitiatives to advance regional cooperation in East Asia, such as the ASEAN-China Free Trade Area, the Six-Party Talks about the North Korean nuclearprogramme or the Shanghai Cooperation Organisation. The imperative ofregional cooperation could thus foster a willingness both in China and inIndia to go beyond cooperation, both regionally and globally.

The second force will be problems – such as terrorism, SARS or environmentaldegradation – whose containment will require broad and deep international

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06cooperation. China, in particular, seems likely to be confronted with suchproblems sooner rather than later and – as in the case of SARS – it will haveto learn to accept intrusive international cooperation as the only way forward.

Everything suggests that we live in a post-modern, globalised world whichneeds a post-modern political framework; in that sense, the EU has the goodfortune to be ahead of the game.

Turning challenges into assets

Yet turning this asset into a real advantage in international relations willrequire the EU to push for a fundamental transformation of the internationalorder – an order attractive enough for China and India to join, yet resilientenough to sustain the additional weight of two big new kids on the block.

What the EU will need to this end is a Common Foreign and Security Policywhich lives up to its name: that is to say, one with a true capacity to actcollectively, through effective coordination of the foreign policy efforts ofthe European institutions and all the Member States, in order to produce apolicy where they are all pulling in the same direction.

While the Union will no doubt continue to need military instruments forforeign policy purposes, the truly critical resource will not be militarycapability but political resolve and a willingness to accept what America´sfirst President George Washington once said in similarly criticalcircumstances: “Now, gentlemen, we will have to hang together, or we willmost assuredly hang separately!”

Hanns W. Maull is Professor of Foreign Policy and International Relationsat the University of Trier, Germany.

Endnote

1. This argument is made forcefully in Michael Mandelbaum (2005) The Case for Goliath: How America Actsas the World´s Government in the Twenty-first Century. New York: Public Affairs Books.

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06 Great expectations: what Asia wants from Europe

by Ummu Salma Bava

Globalisation and fragmentation – the two important forces at play today – arehaving a profound impact on world politics.

Globalisation has made the world more economically- and technologically-interdependent than at any other time in history. It has thus eroded thecapacity and power of states to control events and force particular outcomes.1

Given the large asymmetry between countries’ economic, military andpolitical potential, and their capabilities and capacity, this raises keyquestions about how they respond to globalisation and whether individualstates have the capacity to manage this process successfully.

Today, in the era of global production and the spread of neo-liberal marketideologies,2 we are witnessing the ‘dollarisation of the globe’.3 Globalisationis creating a ‘runaway world’ in which the dollar has an impact well beyondthe economy,4 and we are confronted with what Seyom Brown describes asa “widening gap” between the aspirations of the people and the ability ofthe state to deliver.5

The figures speak for themselves – the dragon, elephant and tigers are on thesuper-economic growth highway, leaving the industrialised world behind. Pastpredictions of the coming Asian century appear ever closer to the mark.

The global economy is witnessing a resurgence from the South. Economicreform is paying handsome dividends in China, India, Korea, Taiwan andVietnam. In the past, acquiring military power was the way to become asuperpower. Now, however, for at least two of the most populous countriesin the world – China and India – a growing economy is the new mantra forachieving superpower status.

The US and the EU are falling behind in the competitiveness stakes,especially in manufacturing and services – two key areas where China andIndia now dominate the field.

The economic rise of China, India and the Asian tigers has not only transformedthe region, but also the entire global economy. An increasingly-networkedsystem of trade, investment and production now covers the large Asian

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06landmass, creating one of the largest middle-class populations in this part of theworld. This is fuelling new political aspirations and goals, both within eachcountry and among the ruling elite at the regional and global level.

This growth in political power is not an afterthought or side effect of theprocess: the economy is driving this new political role for both China and India. With ‘brand China’ gaining higher visibility, followed by ‘brandIndia’, it was significant that in the 2003 European Security Strategy, bothcountries were identified as “key international players” critical to meetingthe challenges and objectives identified in the document.

New alliances and partnerships

The post-Cold War period has also opened up space for new alliances and partnerships.

However, the dragon, the elephant and the Asian tigers have very differentpolitical systems and their geography, histories and cultures have given themvery distinct identities. There is no simple answer to the question ‘what dothey want from the EU?’ Their approaches have to be understood in thecontext of their past relationships with the Union, and their regional andglobal aspirations and ambitions.

China’s unprecedented and lengthy economic growth has prompted many debates about whether it will be an amenable partner for othercountries, a challenger or a competitor. In fact, its rise has been peaceful,and it has established cordial and good relations with all its neighbours. It is involved in all the regional organisations in Asia and is spearheading the Shanghai Cooperation Organisation’s efforts to expand its influence inCentral Asia.

This nuanced diplomacy has paid off. China is at the core of the South-eastAsian region and the emerging core of the North Asian region, although itson-off relationship with Japan remains a major problem.

As well as promoting a multipolar world order at the global level, China has established itself as the undisputed leader at regional level. Thus, at international level, the interaction between China and the EU (with China now the Union’s second largest trade partner) is seen asbeneficial in establishing a world order in which no one country enjoys adominant position.

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06 The EU-China relationship must also be seen in the context of the othercritical actor in this triangle – the United States.

For all the convergence between China and the EU on the desirability of amultipolar world order, it became clear during the debate over whether theembargo on arms sales to China should be lifted that the EU could not cuta deal with the Chinese while keeping the US on the sidelines – or rather,that the US wielded more power and influence, and was therefore able toprevent the EU from ending the ban.

Chinese foreign policy has effectively used a ‘soft power’ approach toenhance and portray its image globally.

Many writers point out that China and India will soon have a much greaterglobal orbit and influence, and that they are not going to play by the oldrules of the game. China, in particular, is emerging as a world leader andexpanding its political influence across Asia and South America, and isstriving to become the ‘partner of choice’ for Africa.6

As the US National Intelligence Council stated in its report on Mapping theGlobal Future: “The likely emergence of China and India, as well as others,as new major global players – similar to the advent of a united Germany inthe 19th century and a powerful United States in the early 20th century – willtransform the geopolitical landscape, with impacts potentially as dramaticas those in the previous two centuries. In the same way that commentatorsrefer to the 1900s as the ‘American century’, the 21st century may be the timewhen Asia, led by China and India, comes into its own.”7

So how does the mighty elephant appear next to the fiery dragon?

The end of Cold War and the collapse of the Soviet Union had profoundsecurity implications for India.8 In the immediate aftermath of the Cold War,Delhi tried to develop a policy to fit a system which was no longerconditioned by the actions of two superpowers grappling for power andinfluence across the world. This changed the nature of all India’s partnershipswith other countries, as well as presenting it with many new opportunities.

India looking outward

India has a long and varied relationship with Europe and growing EU-Indiaties have added another dimension to this.

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06The relationship gathered momentum with the launch of the EU-Indiasummits in 2000 and reached a high point when the two embarked on aStrategic Partnership in 2004 and adopted a joint action plan in 2005.

The Union wants to bring its relationship with India up to “the same parity,density and quality” as those it has with other strategic partners. As a seniorEuropean Commission source told a newspaper in India: “In doing this, weare recognising that India is gaining in real importance for the EU. Beforewe looked more to China, and saw India rather as a leader in the developingworld. Now it’s an equal partner.”9

Undoubtedly, this is driven by the fact that the once sleepy Indian economyis fast emerging as the second major international economic driver. This hasgiven India tremendous confidence to pursue a more outward-lookingforeign policy.

Although the relationship with the EU is important for India – not leastbecause the Union is its biggest trading partner – Indian foreign policy isalso aimed at seeking new partnerships and a new role.

Nothing encapsulates this better than the transformation of the US-Indian relationship. After spending the best part of half a century as‘estranged democracies’, they have moved towards becoming ‘engageddemocracies’.10 Many analysts have interpreted this as evidence that the US increasingly views India as a geopolitical counterweight to China inAsia. But the real test will be whether the relationship can be transformedinto an enduring partnership.

The world’s dominant power is undoubtedly showing a much greaterinterest in India – an interest that survived India’s challenge to the nuclear regime.

However, while China has been relatively successful in securing peace on itsperiphery, India’s neighbours still tie it down and have not automaticallyaccepted its leadership in a region still caught up in the dynamics of conflict.

It would, however, be unfair to India to go on analysing its domesticdevelopments and international engagement within the Cold War framework.

India’s rapid economic growth, expanding middle class and a newassertiveness in its foreign policy all portend to a change in the way the

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06 country is conducting business,11 with the interaction between domestic andinternational politics prompting a transformation in its identity.

The firebrand leader of the developing world is no longer shy about openlystating which side of the divide it wants to be on. Its pursuit of a permanentseat in the United Nations Security Council along with Brazil, Germany andJapan attests to its new aspirations, which envisage a role for the Asianelephant on the global as well as the regional stage.

China and India: partners or competitors?

The Asian tigers face a different situation to China and India. Theirgeographical and population size will always limit what they can do andhow much influence they can wield beyond the economic realm, althoughTaiwan holds a very significant political card which automatically engagesthe US in the region.

Despite this, the East Asian area has witnessed a steadily growing Chineseinfluence and presence, reflecting the nuanced diplomatic approach Beijinghas used to draw in the tigers and keep them engaged. However, both Taiwanand Japan pose a challenge to Chinese diplomacy. Managing the relationshipwith both is like walking a tightrope at times, but no country in the regionwants to escalate the situation, and everyone is watching and waiting.

Both China and India have aspirations to be great powers, and this is driving them to enhance their capabilities and capacities. However, thisalone will not be enough to turn them into great powers. It is how they translate this into practical policy to serve their interests which is ofcritical importance.

The rapid internal transformation under way in both countries also riskscreating domestic turbulence and threatening their security. Managing the external aspirations of the state and meeting the domestic aspirations of the people will be the biggest challenge for both – and this is one area where India, with its democratic polity and institutions, has a head-startover China.

While the EU is the major trading partner for both China and India, it is theUS which has the far greater presence in Asia today – more than in any otherregion except its own. Furthermore, the US is expanding its activities in Asia,not only with military bases in Pakistan but in a variety of other ways as well.

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06In contrast, the EU is a post-modern entity: state-like but not a state. It is clearthat the emerging powers are more likely to follow the US foreign policymodel than that of the EU, although they may not subscribe to everything theUS does. This makes it legitimate to ask what the EU can do to provide analternative effective foreign policy strategy for these emerging powers.

In the long term, will the Chinese dragon and Indian elephant be partnersor competitors? Or will this be the moment when the European modelprovides a template for cooperation between these countries?

Ummu Salma Bava is Associate Professor, Centre for European Studies,School of International Studies, Jawaharlal Nehru University, India.

Endnotes

1. For an overview of the process of globalisation and geopolitical forces over the last 150 years see BrianW. Blouet (2001) Geopolitcs and Globalization in the Twentieth Century. London: Reaktion Books.2. Ibid. p.4.3. Peter A. Chalk, ‘ “Grey Area Phenomena” and Human Security’ in William Tow, Ramesh Thakur and In-TaekHyun (ed.) (2004) Asia's Emerging Regional Order. Reconciling Traditional and Human Security. New Delhi:Manas. p.128.4. Anthony Giddens (2000) Runaway World: How Globalization is Reshaping Our Lives. New York.5. Seyom Brown ‘World interests and the Changing Dimensions of Security’, in Michael T. Klare and YogeshChandrani (eds.) World Security: Challenges for a New Century, 3rd edn. New York: St. Martin's Press. pp. 3-4.6. Eamonn Kelly ‘Five Centuries of the Future’, The Scottish Parliament Futures Event, 6 December 2004.7. See Rising Powers: The Changing Geopolitical landscape. In National Intelligence Council, Mapping theGlobal Future, Report of the National Intelligence Council's 2020 Project. www.fora.gov/2020/202.pdf8. Walter Andersen ‘Recent trends in Indian Foreign Policy’, Asian Survey, Vol. 41, No.5, 2000. pp.765-776.9. As quoted in www.timesofoman.com/newsdetails.asp?newsid=468510. Dennis Kux (1992) India and the United States: Estranged Democracies, 1941-1991. Washington, DC:National Defense University Press. For official recognition of the new partnership see, Richard Boucher ‘NewDirections in U.S.-India Relations’, Press Statement, India Business Council, Washington, DC, 19 June 2001.11. C. Raja Mohan (2003). Crossing the Rubicon. The Shaping of India’s New Foreign Policy. New Delhi: Viking.

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06 IV. ASIAN INTEGRATION: PROSPECTS AND CHALLENGES

Is Europe a model for Asian economic integration?

by Claudio Grua

The first attempt to launch a forum for regional cooperation betweencountries in Asia dates back to 1967, with the creation of the Association ofSoutheast Asian Nations (ASEAN).

It began with just five member countries (Indonesia, Malaysia, Philippines,Singapore and Thailand), and was progressively enlarged to include Brunei in1984, Vietnam in 1995, Laos and Myanmar in 1997, and Cambodia in 1999.

Initial efforts to foster economic cooperation foundered in 1976, but wererevived in 1991 and have now spawned a far more ambitious project: anASEAN Economic Community (AEC). Since 2002, negotiations have beenheld with the aim of extending this economic cooperation to other Asiancountries such as China, India, Japan and Korea, plus Australia and NewZealand. In 2006, these efforts began to bear fruit, with the signing of aseries of ‘Framework Agreements on Comprehensive EconomicCooperation’ – the most recent being that with China in June 2006.

Alongside this, there is a growing debate about the EU-Asia economicrelationship. This led, in September 2005, to the establishment of an ASEAN-EU Vision Group with a mandate to study – and make recommendations for – among other issues, a possible ASEAN-EU Free Trade Area.

This Group submitted its first report to a meeting between ASEAN economicministers and EU Trade Commissioner Peter Mandelson in May 2006. This isjust the latest step in the on-going ASEAN and EU cooperation, whichincludes economic and technical cooperation through the ASEAN-EUProgramme for Regional Integration Support (APRIS).

Economic regional integration in Asia has now progressed far enough forsome to suggest that the region is ready for monetary integration through thecreation of a regional currency unit, modelled on the European ECU, theforerunner of the euro. This proposal, made at the May meeting of the AsianDevelopment Bank in Hyderabad, builds on a Thai government initiative in2003 to create a regional reserve bond in dollars.

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06Although recent Asian economic integration appears to have followed the European experience, in the early years at least, the two processes were very different.

European integration began with the creation of a customs union, which (aspredicted by economic theory) developed a powerful force known as the spill-over effect. This led to both further economic integration (by widening anddeepening economic integration within the region) and to greater institutionalintegration, since wider and deeper economic integration required MemberStates to develop a stronger, more formalised form of political cooperation.

In economic terms, the EU began as a Common Market, which developedinto a Single Market, and then led to an Economic and Monetary Unionwith a single currency. The institutional framework established by the 1957Treaty of Rome has also developed gradually over the last 50 years,culminating in the Constitutional Treaty which was rejected by French andDutch voters in referenda in 2005.

In Asia, economic and institutional progress has been much slower. The veryrecent project to create an AEC is the only initiative that can be comparedwith the European Economic Community, while the institutional frameworkis limited to a formal summit once a year (since 2001) and periodic meetingsof economic ministers.

However, more recently, Asia appears to have followed a similar pattern ofwidening and deepening its economic and monetary integration: the debateamong countries in the region today is about common rules to governmarkets and the need for common programmes to boost regional economicdevelopment – i.e. it is no longer just about free trade, but has gone muchfurther, most notably with the proposal to create a common currency unit.

Political cooperation is also deepening, albeit slowly. As mentioned above,the summits have been formalised and are annual three-day events. Theseusually include an internal meeting, an ASEAN Regional Forum, a meetingof the six ASEAN Dialogue Partners – ASEAN plus China, Japan, SouthKorea, Australia, New Zealand and India – and, at the last formal meeting inKuala Lumpur in December 2005, the first ASEAN-Russia Summit.

All this, coupled with ASEAN-EU cooperation, suggests there is a will amongAsian countries to follow the European model of regional integration, at leastas far as economic matters are concerned.

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06 Since the World Trade Organization was created, the traditional driving forcebehind customs unions has been progressively eroded. These were once seenas a way to (at least partially) isolate a regional market through commonexternal tariffs in order to foster internal trade, but in the current climate theyno longer represent a decisive step towards economic integration.

It is far more important now to define: a) common rules to govern the market;b) similar quality, safety and environmental standards; c) common rules for thefinancial markets; and d) common programmes for infrastructure anddevelopment plans, which take into account the needs of the region as a whole.

The Asian integration process now appears to be moving along these lines,although one key element is still missing: stronger institutional and politicalcooperation between the Asian states. This is essential to sustain anddevelop economic integration in a world where economic systems arebecoming more open, more complex and more interdependent every day.

For this reason the EU’s experience is instructive, as its ‘acquiscommunautaire’ – the body of EU law which all new Member States mustsign up to – is the minimum necessary for a functioning integrated economy.

Learning from European integration

The story of European integration highlights some critical issues which mustbe borne in mind:

Relations with the outside world: Relationships with the rest of the worldmust be governed by common institutions and based on shared decisions,at least on economic issues. If every country were allowed to deal with thirdcountries individually, it would be impossible to achieve cohesion in theregion unless the economic systems of the member states were very similar,which is not the case in either Europe or Asia.

Differences between economic systems are a serious problem, even forareas with high levels of coordination. Finding a compromise between thedifferent interests at stake can be difficult and external shocks can haveimportant asymmetrical effects on the region, as the story of Europe’seconomic relationships with the United States and the WTO demonstrates.

Common rules are essential: Common rules, clearly defined by treaties and enforced by ad hoc institutional bodies, are essential to foster

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06cooperation – rather than competitiveness – between Member States and tomake it difficult, if not impossible, to cheat (always a strong temptation forsignatories to any agreement).

Abolishing veto rights: As far as possible, individual members should nothave a right of veto over decisions. The EU has learned this lesson andunanimity is no longer required for all but the most sensitive of issues andchanges to the EU treaties.

Making a regional currency unit work: A regional currency unit can onlywork if: a) the rules allow for flexibility – the ECU exchange rate was “fixedbut adjustable”; b) there is a strong institutional framework – the ECUsucceeded because coordination between Europe’s central banks wasinstitutionalised and any modification of the exchange rate had to bediscussed and approved by this body; and c) the international scene isrelatively stable.

A regional currency unit, and the complex and delicate mechanisms itrequires, cannot survive a shock which has significantly asymmetrical effects,as happened in Europe in 1992. Only a single currency governed by a singlecentral bank can deal with serious problems on the international market.

The European story shows that it is difficult to integrate an area with differenteconomic characteristics and with a long history of divisions and wars, butit is possible – and the result is economic and social development for thewhole region.

Asian integration

Asian countries also have different economic characteristics, a long history of divisions and wars, and perhaps even less in common with each other than we Europeans. This means that integration will not be easy, but it is achievable, particularly if Asian countries learn fromEurope’s experience.

A significant level of economic and monetary integration in Asia would have a profound impact on the whole world. It could mark a turning point in international economics, with the emergence of three regionalgroupings – North America, Europe and Asia – which could act as theengines of the world economy by ensuring the stability of the global macroeconomic system.

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06 This would have many important and wide-ranging consequences foreverything from the economic sphere to geopolitics, with two meritingparticular attention.

Firstly, it would demonstrate the feasibility of regional economic integrationto the world and could provide fresh impetus to revive cooperation in LatinAmerica and encourage cooperation in Africa and the Middle East – two ofthe world’s most critical regions from both an economic and political pointof view.

Regional economic integration is important for many reasons. Economically,it boosts intra-regional exchanges and the division of labour on a regionalscale, which is a precondition for benefiting from global economicdevelopment. Today, the main trade flows are not of products from differentsectors (as was the case when British economist David Ricardo developedhis theories) or even whole products – now more than two-thirds of international trade flows are of different components that make up a single product.

Economies which remain wedded to an outdated form of internationalspecialisation will lose market share and miss out on developmentopportunities. Regional economic integration is a way to bridge this gap. This has been the driving force behind a string of key projects in Europe sincethe 1980s: the creation of the Single Market in 1992; the “Delors’ WhiteBook” on Growth, Competitiveness and Employment in 1993; and, morerecently, the Lisbon Agenda adopted in 2000.

The integration process also fosters the development of peacefulrelationships and the institutions and tools needed to resolve conflictsbetween Member States. This has been especially important in Europe,where the path of regional integration chosen in the 1950s stemmed more from a desire to make new wars between the nations of Europe (especially France and Germany) unthinkable than fromeconomic goals.

Second, a strongly-integrated regional grouping in Asia, with its own currency, could pave the way for global monetary stability, based on cooperation between three currencies (as outlined above). Such stability is a precondition for returning to a regime of fixed exchange rates (or ‘fixed but adjustable’ rates, in line with the ECU model).

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06Monetary stability is essential to develop production and boost the trade ingoods and services on a global scale by eliminating the ‘monetaryspeculation’ effect from international economic flows.

As we now know from studies on the role of ‘international stabilisers’(developed mainly by American economist Charles P. Kindleberger), thisdifficult role can be more easily performed by a single-power state – as theUK did during the 19th century and the US did after World War II – than bya collective stabiliser. However, the complexity of the modern world makesit very difficult – if not impossible – for a single country to play this role: acollective stabiliser is probably the only real solution.

A multipolar world and a collective stabiliser provided by Europe, NorthAmerica and Asia, would necessitate rethinking the role, goals andstructures of the main international institutions – the World TradeOrganization, the International Monetary Fund and the United Nations – and their reorganisation on the basis of integrated regional groups.

Claudio Grua is an Assistant Professor and lecturer in the Economics ofEuropean Integration at the University of Turin.

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06 Asia’s faltering steps towards political integration

by Axel Berkofsky

Over the last couple of years, there has been growing debate in Asianacademic and policy-making circles over whether the EU can be used as amodel for Asian integration.

These discussions normally centre on the question of whether EU-styleintegration can be copied in Asia, and whether it holds any lessons for movingbeyond economic integration by means of regional, bilateral and multilateralfree trade agreements.

Although it is probably too early to give a definite answer to this question,it is clear that emerging or existing geostrategic rivalries, differencesbetween political systems, governance, the level of democracy and humanrights among countries in the region, and differing levels of economicdevelopment, mean that Asia will not experience anything like EU-styleintegration any time soon.1

Add to this list an almost total lack of a political will to share sovereignty, analmost ‘sacred’ adherence to the ‘principle of non-interference in internalaffairs’ in some Asian countries, and unresolved territorial conflicts anddisputes in the region, and the prospects for further meaningful politicalintegration look even bleaker2 – particularly as in the European model,integration was (and still is) about sharing sovereignty and interfering ineach others’ affairs.

That is the bad news. The good news is that Asia has recently madesignificant efforts to foster regional economic and political integration, evenif the political rhetoric about the envisioned East Asian Community (EAC)has yet to catch up with political reality.

No ‘big bang’ at the East Asia Summit

The first, widely-advertised East Asia Summit (EAS) last December broughttogether ASEAN+3 (the ASEAN countries plus China, Japan and SouthKorea), India, Australia and New Zealand. However, this did not usher in anew era of Asian integration, let alone the ‘big bang’ for regional integrationwhich some Asian policy-makers and scholars had been hoping for in therun-up to the meeting.

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06Despite intensive lobbying by Indonesia, Japan and Singapore, the US was notinvited to the summit, and took this as grounds for regarding the EAS as aBeijing-driven exercise aimed at reducing American influence on – andinvolvement in – Asian affairs. (It is noteworthy that Washington only began toquestion the summit’s raison d’être, with the State Department referring to itas a ‘black box’ devoid of substance, after it was clear that it would not begiven a seat at the table.)

Whatever the shortcomings of the EAS, participants did at least agree tomeet on an annual basis from now on, although there are no plans to turnit into a regional institution equipped with the instruments and mechanismsto implement legally-binding decisions.

Realistically, it was always wishful thinking on the part of Asian integrationists toexpect a breakthrough at the three-hour summit in December, although theirdisappointment that its official declaration did not even mention creating theEAC as a long-term goal is understandable. Instead, it limited itself to hoping thatthe EAS “could play a significant role in community-building in the region”.3

Unclear horizon for the East Asian Community

What then, if anything, did the EAS contribute to Asian regional integrationand the creation of the EAC? It is too early to say, as the main features andcharacteristics of the EAC remain entirely unclear.4

Different governments have different priorities and, judging by the politicalrhetoric emanating from Asian capitals, it could be anything from an intra-regional Asian free-trade zone covering East, South-east and parts ofSouth Asia; a community based on common values or a common identity,like the EU; or a loose association of like-minded nations discussing issuesrelevant to Asian stability, peace and security.

However, the EAS Chairman’s Statement – and the reference to a number ofissues relevant to Asian security which are to be tackled jointly in the EASframework – was more substantial. Maritime security, the de-nuclearisation ofthe Korean Peninsula, terrorism, infectious diseases and sustainable economicdevelopment were all mentioned, although no details were given of exactlywhat role the EAS would play in strengthening the envisioned cooperation.5

Furthermore, many of these issues are already being dealt with in otherregional and global fora, and it is doubtful that discussing the nuclear crisis

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06 on the Korean Peninsula or international terrorism within the EAS frameworkwill have any significant impact.

Officially, ASEAN is in charge of steering both the EAS and EAC, but China’scurrent willingness to let ASEAN mastermind the community-buildingprocess in East Asia may turn out to be short-lived. There is widespreadspeculation that this will come to an end once Beijing has devised a strategyfor exerting regional leadership with non-East Asian countries (India,Australia and New Zealand) at the negotiating table.6

In any event, the official rhetoric coming out of Beijing suggests that it hasbig plans for the EAC and eventually wants to see it turn into a grouping orblock of like-minded nations able to match the economic potential of NorthAmerica and the EU. To this end, it argues that the long-term goal of the EASshould be to establish an East Asia Free Trade Area (EAFTA).7

Asia’s reluctance to implement legally-binding EU-style rules defining thescope and extent of integration, the principle of non-interference and thedifferent levels of political, economic and social development in the regionmay not, however, be the main obstacles to further meaningful regionalintegration. Rather, there is growing consensus amongst scholars andanalysts that Sino-Japanese and Indo-Chinese geopolitical and geostrategicrivalries will be the key stumbling block.8

According to J. Mohan Malik, of the Asia Pacific Center for Security Studies, the EAS was in fact a setback for regional integration, because it “intensifiedold strategic rivalries and forced smaller Asians nations to choose sides”.9

Sino-Japanese tensions cloud the atmosphere

Current Sino-Japanese tensions over disputed territories and differinginterpretations of the history of World War II will ensure that China andJapan will not (at least for the time being) become the France and Germanyof Asia, jointly steering and promoting regional integration.

During the EAS, the Chinese representatives refused to meet their Japanesecounterparts on a bilateral basis and, in the months since the summit, Sino-Japanese relations have gone from bad to worse, at least on the politicallevel. (By contrast, economic and business relations between Tokyo and Beijingare flourishing, with bilateral trade amounting to $200 billion per year andJapanese investments in China reaching $6.5 billion last year.)

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06If Sino-Japanese political relations are as bad in December 2006 as theywere in December 2005, there is little hope that Tokyo and Beijing willpresent a “joint roadmap for community-building” at the next EAS in thePhilippines – as Hitoshi Tanaka, former Japanese Deputy Foreign Ministerand currently Senior Fellow at the Japan Center for International Exchange(JCIE), has proposed.10

Worsening political relations between China and Japan, and mutual distrustof each others’ regional foreign and security policies, are currently capturingheadlines in the international press, but there is also a significant degree ofmutual distrust between India and China which has important implicationsfor the region.

Indo-Chinese relations hampered by rivalry

Even if a solution to the Indo-Chinese ‘border dispute’ is no longer out of the question since the high-level talks on the issue in 2003, territorialdisputes over Chinese-controlled territory in Ladakh, Kashmir (claimed byIndia) and the Indian state Arunachal Pradesh (claimed by China) willcontinue to dog the bilateral agenda for years to come.

Furthermore, Delhi’s recently announced ‘Look East’ policies are beginning toraise suspicions in Beijing about India’s policies and intentions in China’s ‘backyard’. This has prompted fears that India’s increasing economic and political influence will, in the long term, challenge China’s quest for economic, political and (last but not least) militarydominance in East Asia.

While China was initially against Indian participation in the EAS, ASEAN(with the exception of Malaysia) was strongly in favour of inviting Delhi to the negotiating table, mainly to counterbalance Chinese influenceand power in the regional grouping.11 China’s proposal, presented on theeve of the summit, to divide EAS participants into so-called ‘core members’(the ASEAN+3 nations) and ‘outsiders’ (India, Australia and New Zealand)did nothing to increase trust between Delhi and Beijing either.

However, India does not appear keen to get more involved in East Asiangeopolitical power games for now, as its main security concerns still lie inSouth Asia. Its priorities are to secure a sustainable peace with Pakistan andconsolidate its (contested) leadership role in the South Asian Association forRegional Cooperation (SAARC).

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06 As far as the envisioned EAC is concerned, economic and financial (asopposed to political and security) integration clearly top Delhi’s agenda.Indeed, in the run-up to last year’s summit, Indian officials repeatedlyemphasised that the government was looking forward to the emergence ofan East Asian Economic Community.12

Besides, India first wants what China already has: a permanent seat on theUnited Nations Security Council and the international global power statusthat China has been enjoying in recent years.13 Consequently, India’senthusiasm for playing a more active role in East Asian community-buildingis likely to remain limited until Delhi and Beijing enjoy similar levels ofglobal economic and political clout.

The good news again is that both India and China are, above all,preoccupied with securing sustainable economic development and growthat home, reducing the risk that Cold War-style geostrategic rivalries andcompetition will translate into military tensions or open conflict. RecentIndo-Chinese energy cooperation and rapidly-expanding bilateral trade andbusiness relations have boosted hopes that mutually beneficial cooperationwill continue to triumph over Cold War-style geopolitics.

No Asian Union for the foreseeable future

However, history shows that rising powers are usually very reluctant to sharesovereignty, power and influence, and the EAS is very unlikely to changethat. In fact, 21st century Asia resembles Europe at the beginning of the 20th

century, with rising economic and military powers competing with eachother for regional influence and dominance.

Leaving geostrategic rivalries aside, Asia’s diversity in terms of economicdevelopment, prosperity and GDP per capita will – with or without the EAS – continue to be an obstacle to further regional integration, and politicalintegration in particular.

The enormous differences in GDP per capita within Asia (GDP per capita isabove $30,000 in Japan and Singapore, and below $500 in Cambodia andLaos) will ensure that interest in political integration remains low in Asia’sdeveloping countries.

If one accepts the (admittedly Western) reasoning that democracy, a lack ofgeostrategic rivalries and tensions, and a willingness to share sovereignty are

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06the pre-conditions for meaningful integration, then an ‘Asian Union’ is noton the cards for a long time.

Asia is clearly not yet ‘ripe’ for EU-style integration and institutionalisation.In the coming years, it will need to continue focusing on strengtheningeconomic and trade relations, taking what is often referred to as a“functional approach towards regional integration”.14

Axel Berkofsky is an Associate Policy Analyst at the European Policy Centre.

Endnotes

1. See Jusuf Wanandi ’Challenges of building an East Asian community’, The Jakarta Post, 7 April 2005; alsoAxel Berkofsky, ’Tokyo lacking community spirit’, The Asia Times, 5 October 2005, and Ralph Cossa, SimonTay, Chung-min Lee ‘The emerging East Asian Community: should Washington be concerned?’, Issues &Insights Vol.5, No.9, Pacific Forum CSIS, Honolulu, Hawaii, August, 2005.2. See Philip Bowring ’An Asian Union? Not yet’, The International Herald Tribune, 16 December 2005; alsoBarry Desker ‘Why the East Asia Summit matters’, The Asia Times, 13 December 2005.3. See Clarence Fernandez ‘East Asia Summit-mere talk, or a step forward?’ Boston.com. www.boston.comEdward Cody ‘East Asian Summit marked by discord’, The Washington Post, 14 December, 2005.4. See David Camroux ‘Towards an Asian Community: The East Asia Summit’, Kuala Lumpur, January 2006.www.ceri-Sciences-po.org5. See Chairman’s Statement of the First East Asian Summit, Kuala Lumpur, 14 December 2005;www.aseansec.org/18104.htm; also Kuala Lumpur Declaration on the East Asia Summit, Kuala Lumpur, 14 December 2005. http://aseansec.org/6. See Michael Vatikiotis ‘East Asia club leaves US feeling left out’, The International Herald Tribune, 6 April 2005.7. Nuria Okfen ‘Towards an East Asian Community? What ASEM and APEC can tell us’, CSGR Working Paper;also Barry Desker, ‘Southeast Asia casts wide net for cooperation’, Yale Global at http://yaleglobal.yale.edu/display.article?id=74848. Amongst many others see e.g. Matsubara Hiroshi ‘Asia/Asian community remains distant goal’, The AsahiShimbun, 8 March 2006.9. See e.g. J. Mohan Malik ‘The East Asia Summit’, India News Online, 26 December 2005. http://news.indiamart.com/news-analysis/the-east-asia-summit-11248.html 10. See Hitoshi Tanaka ‘Japan and China at the crossroads’, East Asia Insights-Towards Community-Building;Japan Center for International Exchange (JCIE) No.1. March 2006; also Hitoshi Tanaka ‘The ASEAN+3 andthe East Asia Summit: A two-tiered approach to community-building’, East Asia Insights-Towards Community-Building; Japan Center for International Exchange (JCIE) No.1. January 2006 11. David Hale ‘The East Asia Summit’, AsiaMedia, Media News Daily, 12 December 2005; University ofCalifornia (UCLA); www.asiamedia.ucla.edu12. On the concept of an East Asian Economic Community see e.g. Makoto Taniguchi ‘Higashi Ajia keizaikeno teisho suru’ (Time to establish an East Asian economic zone), Sekai, October 2003.13. See ‘Rivals and partners’ survey: India and China’, The Economist, 3 March 2005; see also ‘The tiger infront-India and China’, The Economist, 3 March 2005.14. See Hadi Soesastro ‘Building an East Asian Community through trade and investment integration’ CSISWorking Paper, Economics Working Paper Series, Center for Strategic and International Studies (CSIS) Jakarta,Indonesia April 2003.

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06 V. HOW OTHERS ARE RESPONDING TO THE CHALLENGE

Taming the dragon and marching in step with the elephant

by Pramit Mitra and Melissa Murphy

The challenge of a ‘rising’ China

In contrast to some parts of Europe, historical legacies combined withcurrent strategic concerns compel American leaders and the public alike toview the rise of China as more of a challenge than an opportunity.

While opinions vary as to the correct response to this challenge – from treatingChina as a threat to encouraging it to become a ‘responsible stakeholder’ in theinternational community – recognition that China is already a competitoreconomically, and increasingly politically, is evident in US foreign policy.

In the wake of September 11 2001, voices within the Bush administration whichhad been calling for a tougher US policy, in recognition that China wasbecoming a ‘strategic competitor’ rather than ‘strategic partner’, weretemporarily silenced as Beijing’s cooperation was sought and received in the waron terrorism. Unlike Europe, however, the US – as the dominant power in Asia – is directly confronted by a rising power on its doorstep and the challengeto American strategic interests in the region means that China is never far off the radar.

Despite Beijing’s commitment to ‘peaceful development’, the lack oftransparency over the modernisation of its military forces and the passage ofthe Anti-Secession Law regarding Taiwan in 2005 have once again lentcredence to those who question China’s intentions and advise caution.

While America’s security commitment to Taiwan has the greatest potentialto bring the US into direct military conflict with China, broader concernsabout North Korea, China’s rising influence in South-east Asia and an aggressive energy-sourcing policy that has contributed to deterioratingSino-Japanese relations animate the policy debate in Washington.

At present, the Bush administration is pursuing a “candid, cooperative andconstructive” relationship with China, pursuing areas of mutual interest

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06where possible but also hedging against it by strengthening its defence andsecurity ties with Beijing’s neighbours, including Australia, Japan, SouthKorea and even India, which will be discussed in more detail below.

Different strategic interests and concerns thus underlie the divergent viewsheld in Europe and the US regarding the potential impact of China’s rise andthe appropriate policy response, which became apparent during the rift intransatlantic relations over the EU’s proposed lifting of its arms embargo onBeijing in 2004-2005.

Opposition to ending the ban is one of the few foreign policy issues whichhas galvanised broad agreement in the US, not only between the executiveand legislative branches and within the bureaucracy itself, but even acrossDemocrat and Republican Party lines.

While the US response was viewed, rightly or wrongly, as alarmist in someEuropean capitals, any move that could contribute to the modernisation of theChinese military is now viewed by American leaders and the public alike as athreat to US security interests in the Pacific Asian region.

The closer and more complex US-China economic relationship (each is nowthe other’s second largest trading partner) is also the source of more potentialconflict between the two than between China and the EU.

Chief among American concerns is the growing US bilateral trade deficit,which hit $202 billion in 2005. Among the major causes of this deficit is thecontinued under-valuation of China’s currency, despite Beijing’s reform ofthe exchange rate regime in July 2005 in the face of intense US pressure.

Another major source of trade friction is China’s continuing failure to protectAmerican firms’ intellectual property rights. It has thus replaced Japan in thepopular imagination as the leading mercantilist trader in Asia and theleading cause of lost manufacturing jobs in middle America, not only amongthe public but also among members of the US Congress.

Putting pressure on the Bush administration to deal more aggressively withChina on the currency issue, Senators Charles Schumer and Lindsey Grahamhave threatened to push through legislation that would impose 27.5% punitivetariffs on Chinese goods. A bill by Senators Chuck Grassley and Max Baucuscalling on the US Treasury to refer the issue to the International Monetary Fund(IMF) is also pending. Congressional opposition, prompted by the economic and

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06 security concerns mentioned above, also effectively ended the bid by ChinaNational Offshore Oil Corporation (CNOOC) for the US-based oil companyUnocal in 2005.

Although the Bush administration has resisted congressional pressure to sponsorpunitive economic measures against China - in May 2006, the US Treasury againfailed to designate Beijing a “currency manipulator” – the United States TradeRepresentative (USTR) Office and Department of Commerce have neverthelesstaken a tough line in negotiations with Beijing on trade disputes.

In November 2005, the US exacted a textile agreement from China afterthree months of contentious talks and launched four new anti-dumpinginvestigations during the year.

In March 2006, the US joined with the EU for the first time to lodge a rarejoint complaint with the World Trade Organization, accusing China ofmaintaining illegal trade barriers against imported auto parts. The US wasalso the first country to file a WTO case against China in 2004 over Beijing’stax policy on semiconductors and it continues to deny the country MarketEconomy Status, which would significantly reduce the anti-dumping tariffsapplied to Chinese goods.

A range of particular strategic interests, concerns and priorities are thereforelikely to continue to animate the debate in the US regarding China’s rise, itspotential impact and the appropriate policy response. While opinions spanthe political spectrum, from those who view China’s intentions asmalevolent to those who view them as benign, no one in Washingtonunderestimates the competitive challenge that China’s rise presents to theUS and global community in the coming decades.

A new departure in US-India relations

President George W. Bush’s visit to South Asia in March 2006 marked a new departure in relations between the US and India, which have beenundergoing a major transformation for more than a decade.

The agreement on nuclear cooperation between the two countriesrepresented a potentially historic willingness on both sides to accommodateeach other’s concerns and could change the priorities and operation of thenon-proliferation system, although implementing it will require a great dealof work, especially on the US side.

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06Significantly, the low profile of India-Pakistan issues during this visitreflected a strong US interest in having bilateral relations with both countrieswhich stand on their own without being linked. But it should not be misreadas lack of US interest in their peace dialogue.

The nuclear deal

The highlight of the Bush trip to India was the nuclear deal. A joint statementreleased by President Bush and Prime Minister Manmohan Singh on 2 March announced a major step forward on the US-Indian agreement oncivil nuclear cooperation unveiled in July 2005.

Spelling out the general commitments contained in the July agreement,India undertook to designate 14 of its 22 nuclear reactors as civilian (upfrom the original six), placing them under safeguards with the InternationalAtomic Energy Agency (IAEA) in perpetuity.

This arrangement will apply to a number of plants that India has built andfueled with its own resources – something it had not been willing to do inthe past. The plants outside the civilian sector will not be constrained, so theonly brakes on India’s ability to use them for military purposes will be theavailability of domestic fuel and the economics of its drive to increasenuclear electricity generation.

The safeguards will be phased in between now and 2014. In return, the US agreed to a provision intended to protect India’s civilian reactors against interruption of fuel supply, recalling that, in the 1970s, the US had been obliged to cancel a 30-year supply contract for the Tarapur reactor.

Both Delhi and Washington are keen to highlight the breadth of therelationship. The joint statement issued by the two leaders listed animpressive number of cooperative programmes on economics, trade, energysecurity, the environment, agriculture, health, space exploration, globalsecurity and deepening democracy.

Some of these were programmes that had already been announced and inwhich new milestones had been reached, such as the CEO Forum, whichmet during the Bush visit. Others were new, including the KnowledgeInitiative on Agriculture, which aims to link academic and scientificinstitutions and includes a three-year financial commitment.

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06 Other particularly noteworthy items included India’s admission to theInternational Thermonuclear Experimental Reactor (ITER), a new MaritimeCooperation Framework to promote maritime security, and India’s intentionto join the Container Security Initiative.

The US administration was especially pleased by India’s willingness to become more active in the international effort to promote democracy. The statement also briefly mentioned the ten-year agreement on defence cooperation that the US and India signed in June 2005. Notmentioned, but on the minds of many observers, was the potential for US military sales to India, which the Bush administration would like toexpand greatly.

President Bush sent an important message to Indian policy-makers by offering the nuclear deal: the US is prepared to de-link its relations with rivals Pakistan and India, and chart an independent relationship with each. Itregards India as a rising power with which it can collaborate in the multilateralarena, on global issues as well as regional concerns such as maintaining the security of the sea lanes through the Indian Ocean, managing the turmoilin Nepal and addressing rising militancy in Bangladesh.

The strategic connection with India

As India’s influence grows, the US hopes to expand its cooperation with one of the few countries favourably disposed toward it in the post-Iraq world.

A June 2005 Pew Global Attitudes survey found that 71% of Indians had afavourable opinion of the US, the highest among the 16 nations surveyed.Interestingly, India was also the only country where people believedSaddam Hussein’s removal from power had made the world a safer place.

Looking ahead

From the US perspective, recent changes in Asian and global security haveprovided the strategic context for the dramatic changes in US-India relationsin the past decade, as well as for the nuclear bargain.

China is rising economically and militarily; uncertainty about the future ofthe Korean Peninsula is high. This Bush administration, building on thelegacy of the previous one, sees this situation as a powerful argument forcloser collaboration with Asia’s other rising power, India.

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06The US-India rapprochement started with expanded economic ties (mainlyin the high-tech sector) during the 1990s, but security relations and agrowing overlap in the two countries’ security interests have been the mostdynamic element over the past five years, especially after 9/11.

The two countries also have many serious differences. For instance, the UShas not endorsed India’s hopes for a permanent seat on the United NationsSecurity Council, with Washington remaining most reluctant to agree to anysignificant expansion of the Council. India’s historically warm relationshipwith Iran is also a cause of real concern on Capitol Hill.

But for the moment, the two governments have their hands full implementingthe nuclear agreement.

Pramit Mitra is a Research Associate, South Asia Program, Center for Strategicand International Studies (CSIS) in Washington. Melissa Murphy is a ResearchAssociate, Freeman Chair in China Studies, CSIS.

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06 Japan and the new Asian reality

by Yukio Okamoto

Europeans are only slowly waking up to the emergence of economic powersover the horizon in Asia.

This is understandable given the enormous geographic, political andcultural distance between the two continents, compounded by thewithdrawal of Europeans from their former colonies in the region. It alsohelps explain why the rise of China and India is only now being recognisedas a bold challenge to the world’s existing economic and trade frameworks.

So how is all this being viewed by Japan, the one member of the club ofadvanced industrialised nations located in Asia?

Japan has been developing its own responses to the new global economicreality – only for it, the reality is neither new, nor purely economic.

For more than a decade and a half, Japan has been grappling with a muchbroader challenge encompassing domestic politics, energy security,politico-military affairs, regional integration, currencies, the environmentand human exchange. The country is enmeshed in a web of differingresponses to many, separate challenges – each with its own characteristicsand puzzling interactions.

Trade with China

The most talked-about challenge is the breathtaking expansion in China’strade surplus. Its rapid export growth, and the concurrent rise in its appetitefor resources to feed its export machine, have sparked fears of a loomingglobal trade conflict that will pit China’s desire for rapid economic growthagainst its trading partners’ desire for balanced trade relations.

The recent Chinese take-off began from a low base after the Internet bubbleburst in the second half of 2000 and following the post-9/11 slowdown.Nevertheless, annual increases in exports of more than 20% in everydirection – even for an economy the size of China’s – are stunning.

The following figures show that China’s entry into the World TradeOrganization in 2003 affected the EU, US and Japan in a similar way. However,

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06more recent statistics indicate that while the cycle of rapid growth in importsfrom China into Japan may have past its peak, it is still a politically-sensitiveissue for Europe and the US.

A look at exports to China shows how the paths being taken by the EU, theUS and Japan are diverging still further.

In 2001, EU and US exports to China rose at much the same rate, whileJapan lagged behind. However, this was followed by an explosive increasein Japan’s exports to China and a smaller, but still strong, rise in the USfigures. The picture is far gloomier for the EU, as Chinese imports into theUnion are rising at a far faster rate than EU exports to China.

The political implications of these figures for advanced economies are clear.Consumers in all three major economic regions are benefiting from stableor falling prices for many goods, as cheaper Chinese products replace moreexpensive domestic or imported goods. In the US and Japan, a healthy

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Year-on-year growth in imports from China, in %

Country 2001 2002 2003 2004 2005

EU 9.9 9.8 17.6 20.4 24.6USA 2.3 22.4 21.7 29.1 23.8Japan 1.9 6.4 21.5 25.3 15.7

Sources: Eurostat, US-China Business Council, JETRO

Year-on-year growth in exports to China, in %

Country 2001 2002 2003 2004 2005

EU 18.6 14.1 18.1 16.9 7.4USA 18.7 15.1 28.5 22.2 20.5Japan 3.2 24.7 43.4 29.0 8.9

Sources: Eurostat, US-China Business Council, JETRO

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06 growth in exports to China has offset some of the previously corrosiveimpact on local manufacturing, with Japanese businessmen confirming thatexports to China between 2002 and 2005 provided the demand whichjump-started their country’s economic recovery.

Europe’s declining trade balance with China has little to do with thedesirability of EU products. Rather, it results from the fact that China, Japanand the US have all managed their economies in ways which have endedup hurting Europe. The value of the euro and sterling have soared relative tothe currencies of the Pacific trading nations, leading to Europe’s current highimport/low export growth pattern.

Structural similarities

Many of the challenges facing Japan resemble those facing Europe.

Japan is a country of 127 million people, one-tenth the size of China, one-eighth the size of India and one-third the size of ASEAN. Like Europe, itssociety is ageing rapidly, with more than 20% of the population now over theage of 65 and only about 20% under 20. For China, the comparable figures are8% of the population over 65, 30% under 20; and for India, 5% over 65 and40% under 20. This suggests that Japan is at a significant disadvantage both interms of its potential consumer market and its potential pool of labour.

Of course, the mere size and shape of a country’s population does not tell thewhole story about its economic potential. Japan has a low birth rate, but itspeople live long, healthy lives in relative wealth, with high levels of generaleducation. This contrasts sharply with their counterparts in China and India, whoface poverty, live shorter lives and have low levels of education.

Like Europe, Japan has relied on its technological prowess to compensate fora relative scarcity of resources. About 100,000 engineering studentsgraduate from Japanese universities every year – twice the rate in the EU,which has 200,000 engineering graduates a year, and four times the rate inthe US, with only 60,000. However, both China and India are producingeven more, with 351,000 engineering degrees awarded annually in Chinaand about 122,000 in India.

With the advent of the Internet, low-cost telecommunications and cooperativesoftware, the world is entering an era in which engineering talent abounds:Japan will have to provide more than just good engineering in future.

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06Accepting an adjustment in stature

For the last century and a half, Japan has enjoyed an unusually dominantposition within Asia.

A combination of geography and the policy of sakoku (closing the countryto the outside world) meant that it avoided being swept up in the two great waves of European imperialism – the Portuguese-Spanish wave of the 16th and 17th centuries, and the Northern European wave of the 18th

and 19th centuries. Indeed, Japan itself became an empire, attacking and subjugating its immediate neighbour Korea and occupying large areas of China.

China and India were the continent’s population giants and home to someof the world’s most ancient civilisations, but were nevertheless cast intocolonial or semi-colonial status, with South-east Asia largely carved upbetween Britain, France and Holland.

Japan’s economic status in the region remained high even after the defeat ofits formal empire in 1945, Indian independence in 1947, the founding of thePeople’s Republic of China in 1949, and independence for the South-eastAsian countries. By integrating its economy into a global financial andtrading system, and thanks to a conservative electoral democracy and analliance with the US, Japan emerged from the ashes of World War II tobecome the world’s number two economic power.

Meanwhile, China embarked on a 30-year period of veering betweencollectivisation, dictatorship, revolutionary politics and military adventurism,and India staggered down a slow developmental path, balancing an opendemocracy with economic self-sufficiency and an aggressive approach towardthe defence of its borders.

When Japan’s speculative bubble burst in 1989, this was widely seen as thetrigger for the decline of its strength in Asia. However, it was but one ofmany revolutionary changes which redrew the economic map.

The fall of the Berlin Wall and the collapse of the Soviet Union in 1991eliminated the raison d’être of the Cold War security structure. The Tien An MenSquare protests prompted the Chinese government to refocus its efforts onpromoting an increase in incomes and boosting national unity by introducinga nationalist curriculum of ‘patriotic education’. In India, the rupee crisis of

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06 1991 and the need to turn to the International Monetary Fund for help beganthe process of unshackling the energies of its entrepreneurial class from thestrictures of the ‘License Raj’.

Meanwhile, the countries of South-east Asia continued to experience rapidgrowth, stimulated by investment by Japanese multinationals and soft yenloans. This prompted what was known as the ‘flying geese’ theory ofregional development: Japan would provide technology, financing andconsumer markets for the tiger economies while hiving off low-techindustries to the countries trailing in its wake.

This image persisted even after Japan’s economy slipped into stagnation and the South-east Asian version of the Japanese miracle came crashing down in 1997.

All of this is important to understand the Japanese approach today, becauseit explains its relative passivity in the face of the rise of the new Asian giants.

Japan recognises that trying to remain at the apex of the Asian economicorder forever is futile, and it is therefore unwise to see the inevitable rise ofChina and India to great politico-economic power status as a threat. Japan’spast record in China and Korea has also tarnished its image in the eyes ofboth countries’ governments, and reduced its chances of being seen as theregion’s leader.

The greatest threats to Japan are not a few years of cheap Chinese goodsflooding its market or ceding the production of some software to inexpensiveIndia computer-code writers. It is the destabilisation of either of these twogreat powers.

Japan needs a strong China and a strong India. Japanese economic diplomatsmight push for more balanced trade or rational growth, but politicalconsiderations are sometimes more important.

Japan also recognises that competition, friendly or otherwise, is the new reality.For example, when it deploys the diplomatic weapons at its disposal – such asOfficial Development Assistance – it must always expect and anticipate aChinese countermove.

The rapid economic growth in India and China is creating enormousproblems of environmental degradation and energy demand. However,

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06Japan’s focus is on the effect that economic expansion is having on themilitary and security climate.

Chinese resentment over the humiliations of the 19th and 20th centuriespersists. Chinese policy-makers believe that the Japan-US military alliance ispreventing their country from fulfilling its historical destiny by uniting Taiwanwith the mainland. There is a serious risk that such feelings may put China andJapan on a collision course unless areas of conflict are carefully managed.

All this makes Japan wary about its growing economic integration withChina. In stark contrast, it has warmly welcomed India’s rise.

The two countries joined forces to propose, with Brazil and Germany,expanding the permanent membership of the United Nations SecurityCouncil (although the initiative was blocked by China following an intensivelobbying effort in the developing world). Japan wants India to be includedin an expanded ASEAN-led coordination of Asia’s trade and commerce, andhas insisted that India, Australia and New Zealand become members of theEast Asian Summit.

While Japan’s official relations with India are warm and those with Chinafrosty, it is locked in a tightening economic embrace with the latter. JapaneseForeign Direct Investment (FDI) in China totalled $6.5 billion in 2005,pushing it to the top of national investment league ahead of South Korea and the US.

According to China’s Ministry of Commerce, Japanese corporations areproviding work for 9.2 million Chinese. Just one Japanese manufacturer,Matsushita Electric (Panasonic), has 70,000 Chinese employees and nearly115,000 Japanese now live in China, with 40,000 of them in Shanghai.There are now more than 510,000 Chinese legally resident in Japan and theJustice Ministry estimates that another 30,000 are living in the countryillegally (although the real figure is almost certainly much higher).

Complex economic and individual ties contrast with the lack of relationsbetween the two governments. A freeze in bilateral summits between theleaders of the two countries (and between Japan and South Korea) preventsprogress on pressing issues: China’s damaged environment; its appetite forraw materials and energy products; its extremely inefficient use of capital;the slow adjustment of its currency vis-à-vis the dollar; and the CommunistParty’s promotion of an anti-Japanese school curriculum.

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06 Future challenges

Of the two great emerging economies, India causes far fewer worries for Japan.The Indian government does not base its management of the economy ontrade: Indian goods and services are still largely produced for domesticconsumption; the country’s exporters are private firms, not former arms ofgovernment ministries; and its English language-based business services sectorcomplements, rather than competes with, the work of Japan’s multinationals.

Internally, land ownership by farmers and the rule of law help to foster social stability in rural areas, while representative government remains the primary safety valve for relieving the pressures stemming from India’s economic transition.

As a result, the integration of India’s 1.1 billion population into the globaleconomy is a relatively non-threatening development for Japan. The impactof China’s economic leap is less certain.

It has a surplus of all the means of production. It has 400 million peopleliving in cities (only slightly less than the entire EU population). Many tensof millions of them are unemployed, an even larger number are under-employed, millions more are in line to lose their jobs in unreformedstate-owned enterprises, and there are 900 million landless peasants in theChinese countryside, providing a vast pool of potential workers.

The country also benefits from a huge influx of capital. Since it began reformingthe economy in 1979, China has absorbed $600 billion in FDI. It also has anational savings rate of 46%. Taken together, these two factors provide Chinawith a cushion of financial capital capable of sustaining an extraordinary fixedasset investment ratio of more than 45% of GDP – a rate which promises thatever more productive capacity will come on line in the near future.

As for land, as one American economist commented, whatever else theChinese Communist Party may be, it is certainly a very successful real estatedeveloper. If an official sets his sights on constructing a factory, a road or aset of high-rise apartments, the bulldozers just come in and flatten whateveris there. The ability to secure land for an officially-approved project isessentially absolute.

When a country can take British economist David Ricardo’s three factors ofproduction – labour, capital and land – and simply dismiss the threat of any

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06of them becoming scarce, it is bound to have a large and unpredictableeffect upon the world’s economy and politics.

There are huge social divides in China between its rural and urbanpopulations, and between its coastal provinces and interior provinces. This,combined with its impact on international climate, its historical baggage, itslarge and ever-more sophisticated military forces, and the absence ofsignificant legal domestic channels of protest and conflict mediation, makesit impossible to ever be completely at ease with China’s economic rise.

In Japan, we strongly desire a peaceful rise for all of Asia. We also know thatwe must prepare for the possibility that we may not get what we want. Thebalance between all the factors at play – political, diplomatic, military,trade, commercial and personal – will remain a delicate one.

Japan will continue to keep its economy open to goods and services fromthe new economic powers, but the real moment of challenge will come ifits security is threatened. The quest for a solid, regional entente to augmentJapan’s military alliance with the US is indeed the precondition for stableeconomic interaction.

Yukio Okamoto is the President of Okamoto Associates, Inc., a politicalmanagement consultancy, and was a Special Advisor to Prime MinistersRyutaro Hashimoto and Junichiro Koizumi.

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06 VI. GLOBALISATION WITH A SMILE?

The communications challenge

by Kristina Persson

One of world’s leading branding experts, Arnhol, recently advertised themost difficult job in information and communications: to define andcommunicate what the European Union is all about. There is probably onlyone job that is even more difficult – to communicate the challenges andopportunities of globalisation.

In a sense, they are both about the same thing: one of the answers toglobalisation is closer and more efficient political cooperation in Europe;i.e. the European Union. However, the fundamental changes that Europeaneconomies and societies are going through must be communicated to, anddiscussed with, people if they are to be accepted. Politics must constantlyrespond to these ongoing changes and the need for change must be widelyunderstood and supported by the public.

But is it really all that difficult? Maybe it is we scholars, politicians, businessleaders, civil servants, journalists and others who have not tried hard enoughto enter into a dialogue about what is happening.

The only thing that we know for sure is that globalisation and globalchallenges will not go away. The magnitude of the task to explain, enlightenand discuss the issues this raises is not an excuse to abstain from doing so. Politics has many obligations; one is to assume leadership with highpedagogical ambitions. But many politicians appear hesitant about bringingup questions to which they do not have definite answers. The media play an important, but not always very helpful, role as they focus so much onshort-term problems, conflicts and criticism.

Not long ago, the word ‘globalisation’ did not even feature in the publicdebate; the term used instead was ‘internationalisation’. Today,‘globalisation’ is used frequently – as a threat, a scapegoat and (more rarely)a saviour.

The word may conjure up different things to different people, but most acceptthat it encompasses a number of political, technological and economic

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06changes that have taken place over the past 15-20 years, and that thesechanges have ushered in a more intense phase of global economic integration.

To some, globalisation brings clear benefits, such as new opportunities to travel and work abroad or attain ever-higher living standards. Othersperceive it as a threat to local jobs and welfare systems.

While some see the solution in more deregulation, others scream for moreprotective measures. However, history and recent statistics show that freetrade and increased economic integration lead to increased economicwelfare for the world as a whole. Over the last 15 years, global per capitaincome has doubled and it is those regions with low levels of participationin the global economy that have experienced slow or stagnant growth.

But history also shows that economic growth is not spread equally and thatglobalisation appears to contribute to a more uneven distribution of wealth.The solution is not, however, increased protectionism or nationalism, as thiswould exacerbate the problem rather than solve it.

So what should leaders in society do to communicate these changes andprovide platforms for dialogue about the necessary reforms? How do wemake complex issues easier to understand and how can we best illustratethe many links between the local and the global? How do we initiate adebate on long-term and global issues in a world where national and localpolitics focus on the results of the next elections, companies are moreinterested in their next quarterly report, and the media demand concreteanswers in 30-second sound bites?

Where there is a will, there is a way

Politicians lack the will to discuss long-term challenges and global issues.

In the run-up to elections, like the one in Sweden this September, it becomesclear that long-term and global issues are not really on the national politicalagenda. Nor do present-day national politics provide us with the answersthat today’s global challenges demand.

It would be very refreshing – and a good way of starting a debate – ifsomeone was prepared to say: “Yes, there are important changes going onin society which will change the national political environment. We believewe can meet these challenges. We may not know all the answers, but we

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06 think the world can be a better place for all. But this requires reforms andmuch greater cooperation between different interests and countries. I havea vision for where I think Sweden and the world could be in the next 25years, and this is what I think we should do now to start working on it…”

Instead, an ever-growing number of people are beginning to doubt that thereis anything we can do but watch what is happening, go with the flow, andview development and the negative effects of globalisation as something wejust have to accept.

Closer cooperation is key

There is also a lack of cooperation between different actors in society,especially between business, national politicians and academia.

In an era when a holistic view is needed, when everyone needs to contributetheir own piece to the jigsaw, we are instead becoming increasinglyspecialised in our different tasks and roles. Younger generations engage inspecific activities and find traditional politics too slow or outdated. There is nonew structure in place to provide a more holistic view.

Furthermore, there is very little room in the daily media for theseperspectives. Journalists seem to have too little knowledge of – or notenough interest in – reporting on the different aspects of globalisation.

The ’governance gap’ must be filled

The lack of regional and global governance is another key problem.

Globalisation creates the conditions for increased growth and welfare, butalso poses greater risks in terms of threats to the environment, access tostrategic commodities, security and growing interdependence.

It must therefore be matched by increased political cooperation betweencountries and regions. We need to see serious efforts to create new andmore effective global political structures, instead of defending perceivednational interests and national sovereignty.

In the absence of an ability to act, everyone’s power will diminish. This is a crisis for global leadership. Today’s multilateral organisations were all born in the aftermath of the World War II. Must new catastrophes

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06like those of previous centuries occur again for collective reason andinitiatives to triumph?

Global Challenge – a new way of thinking, doing and communicating

What is needed are new initiatives designed to promote learning, dialogueand debate about the political, economic and social changes the world is facing. Global Challenge is a project which is trying to do just that in Sweden.

It brings together people with different experiences and knowledge, in the belief that progress comes from teamwork which draws on everyone’s experience, ideas and creativity. The idea is to act both as a think tank that explores the issues in depth and as a more popular communications channel or arena for an open discussion aboutalternatives. The project is run by young people and aims to connectyoungsters with more experienced experts, academics, politicians andbusiness leaders.

One of the underlying reasons for this initiative is that many people feel threatened by the effects of globalisation. This, combined with the growing confidence gap between the general public and the decision-makers, risks becoming a serious problem if it is not addressed. There is an obvious danger that it will foster increasednationalism, demands for protectionism, and intolerance between cultures and religions.

Global Challenge has set up five ‘think-and-do tanks’ covering:

■ The changing labour market: where are the new job opportunities?■ Welfare, solidarity and international competition;■ Sustainable development – legislation, technology and/or lifestyle?■ The new threats to our security;■ Globalisation and democracy.

These ‘meeting places’ are working to identify key issues and challenges of particular concern to our key target group: young people aged between 18 and 30. The issues will be addressed in open ‘Global Dialogue Meetings’ held around the country, which bring together keyplayers in society who do not usually sit down and talk to each other – the young environmentalist meets the CEO of a leading energy company

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06 and they agree (at least in principle) on the best ways to curb climate change. The results of their work will be presented in attractive andaccessible reports.

There is a great deal of information available, but it is not beingcommunicated in a way which reaches out to a wide audience. The keys toreaching that audience are to have a good story to tell, to adopt a personaltone, and to adapt the message and language for every audience. We try toavoid preaching and pointing fingers, and instead focus on importantquestions or ideas.

Global Challenge also organises annual international conferences. The 2006event took place on 16-18 August, looking at the social dimension ofglobalisation, with a focus on welfare both in the countries which industrialisedearly and in developing countries. We also intend to establish close cooperationwith other projects or think tanks in Europe with similar goals to ours.

Conclusion

Although Europe is struggling with continued economic challenges, such ashigh unemployment or low growth, the big crisis in Europe is – as I see it – noteconomic but political.

Part of it stems from a lack of ability to communicate with the public. However,politics and economics are strongly interlinked – if politics delivered betterresults, democratic discontent would decrease.

One dilemma is that when changes are necessary in the long term, butunpopular in the short and medium term (as structural reforms often are), youneed leaders who not only have ideas and vision, but also the skill to educatethe public and win the support of voters; or, as Luxembourg Prime MinisterJean-Claude Juncker said some months ago: “We know what we should do, butwe do not know how to win elections after doing it.”

So courage and trust in people’s ability to think for themselves are otherqualities that are missing in politics today.

Dialogue about long-term and global issues must become much morewidespread. Without a dynamic democracy, we will have neither the leadersnor a public which can show the way towards sustainable economic andsocial structures in Europe and the world.

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06The Global Challenge strategy to improve communications is based on fivekey principles:

1. Think dialogue and exchange of perspective, not presentations and monologues.

2. Adapt your message to your audience and the local context, and bring upconcrete examples that demonstrate the links between the individual, thelocal and the global.

3. Be honest about the magnitude of the challenges, but also about theopportunities they bring.

4. Let different people present different perspectives, and work together toprovide a more updated map of the world.

5. Describe a vision for the future!

Kristina Persson is Deputy Governor of the Swedish Central Bank. Shealso founded Frejas Fond in 1991 and took the initiative, in this capacity,to launch the Global Challenge project in 2005.

Global Challenge was founded in 2005 by Frejas Fond, The Bank ofSweden Tercentenary Foundation and the Knowledge Foundation. Today,some 20 large Swedish companies, central trade union and otherorganisations support the project and are members of the steering board.They include Swedbank, Electrolux, Vattenfall, SAAB, the Ministry forForeign Affairs and the Swedish Trade Union Confederation. For moreinformation, visit the website: www.globalutmaning.se

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06 ANNEX: KEY FACTS AND FIGURES

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Gross Domestic Product based on purchasing-power-parity (PPP) per capita GDP in US dollars

Country 1995 2000 2005

China 2,495,860 3,852,518 6,193,421India 1,809,919 2,445,578 3,315,702Japan 22,523,849 25,893,762 31,405,673

Source: WTO World Economic Outlook database September 2005

Gross Domestic Product, constant prices, annual percent change

Country 2000 2001 2002 2003 2004 2005

EU (25)* 3.9 1.9 1.2 1.2 2.4 1.6China** 8.0 7.5 8.3 9.5 9.5 9.0India** 5.4 3.9 4.7 7.4 7.3 7.1Japan** 2.4 0.2 -0.3 1.4 2.7 2.0

Source: * Eurostat, ** IMF World Economic Outlook September 2005

Gross Domestic Expenditure in R&D (GERD as % of GDP)

Country 1999 2000 2001 2002 2003 2004

EU (25)* 1.87 1.89 1.93 1.93 1.92 1.90China** 0.76 0.90 0.95 1.07 1.31 1.23India*** 0.78 0.85 n.a n.a n.a n.aUSA*** 2.65 2.72 2.74 2.67 n.a n.aJapan*** 2.95 2.98 3.06 3.01 3.15 n.a

Source: * Eurostat ** China Science and Technology Statistics Databook *** UNESCO Institute for Statistics

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Imports into EU (25) – all products (in €1,000 millions)

Country 2000 2001 2002 2003 2004

China (excludingHong Kong) 74.73 81.62 89.60 105.40 126.91India 12.80 13.41 13.59 13.97 16.24USA 205.64 202.53 181.82 157.39 157.67Japan 91.84 80.88 73.73 72.01 73.74

Source: Eurostat

Exports from EU (25) – all products (in €1,000 millions)

Country 2000 2001 2002 2003 2004

China (excludingHong Kong) 25.76 30.55 34.87 41.17 48.13India 13.63 12.89 14.27 14.52 17.03USA 237.59 244.88 247.04 226.53 234.14Japan 45.46 45.49 43.43 40.95 43.21

Source: Eurostat

Foreign Direct Investment – EU (25) – Stocks (in €1,000 millions)

Country 2001 2002 2003

China (excludingHong Kong) 638 517 746India 625 680 1,360USA 704,815 659,920 772,671Japan 60,067 62,910 72,959

Source: Eurostat

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EU (25) Foreign Direct Investment – Abroad – Stocks (in €1,000 millions)

Country 2001 2002 2003

China (excludingHong Kong) 19,309 19,969 19,865India 6,276 6,398 6,570USA 915,251 760,153 731,310Japan 36,340 52,025 55,557

Source: Eurostat

Foreign Direct Investment – EU (25) – Flows(in €1,000 millions)

Country 2001 2002 2003 2004

China (excludingHong Kong) 547 241 295 111India 108 133 631 34Japan 8,816 8,331 3,097 6,538

Source: Eurostat

EU (25) Foreign Direct Investment – Abroad – Flows(in €1,000 millions)

Country 2001 2002 2003 2004

China (excludingHong Kong) 2,293 3,103 3,000 2,968India 3,353 1,075 0,657 1,076Japan 8,875 10,193 5,847 8,116

Source: Eurostat

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CO2 emissions from energy use (millions of tonnes)

Country 1980 1985 1990 1995 2000 2003

EU (25) n.a n.a n.a 3705 3714 3884China 1396 1728 2256 2977 2935 3719India 299 425 598 796 979 1050Japan 869 872 1013 1098 1159 1201USA 4668 4556 4842 5112 5707 5729World 18075 18698 20736 21791 23391 24983

Source: OECD Fact book 2006: Economic, Environmental and Social Statistics

Life expectancy at birth in years – women

Country 1999 2000 2001 2002 2003

EU (25)* 80.4*** 80.8*** 81.1*** 81.2*** 81.2***China** 71.0 73.0 73.0 73.0 73.0India** 61.0 63.0 62.0 62.0 63.0Japan* 83.9 84.0 84.2 84.3 84.3

Source: * Eurostat, ** World Health OrganizationNote: *** Eurostat estimate

Life expectancy at birth in years – men

Country 1999 2000 2001 2002 2003

EU (25)* 73.8*** 74.4*** 74.7*** 75.0*** 75.1***China** 68.0 69.0 70.0 70.0 70.0India** 60.0 60.0 60.0 60.0 60.0Japan* 77.4 77.5 77.6 77.5 77.6

Source: * Eurostat, ** World Health OrganizationNote: *** Eurostat estimate

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Country 2000 2001 2002 2003

Austria 332 392 415 462Belgium 292 310 328 386China 17 26 46 63Cyprus 177 218 294 337Czech Republic 97 147 256 308Denmark 392 429 513 ---Estonia 272 300 328 444Finland 372 430 510 534France 144 264 314 366Germany 301 376 436 473Greece 95 86 135 150Hungary 71 148 158 232India 5 7 16 17Ireland 179 233 280 317Italy 230 269 352 337Japan 300 385 449 483Latvia 62 72 133 404Lithuania 61 68 144 202Luxembourg 228 364 370 377Malta 131 253 303 ---Netherlands 438 491 506 522Slovak Republic 94 125 160 256Slovenia 151 301 376 ---Spain 137 183 193 239Sweden 456 516 573 ---UK 264 330 423 ---

Internet users – per 1,000 people

Source: World Development Indicators database

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Country 2000 2001 2002 2003

Austria 278 335 369 ---Belgium 224 233 241 318China 16 19 28 ---Cyprus 221 247 270 ---Czech Republic 122 147 177 ---Denmark 507 542 577 ---Estonia 153 175 210 440Finland 396 423 442 ---France 304 329 347 ---Germany 336 380 431 485Greece 71 81 82 ---Hungary 87 95 108 ---India 5 6 7 ---Ireland 359 391 421 ---Italy 180 195 231 ---Japan 286 315 358 382Latvia 140 153 172 188Lithuania 65 71 110 ---Luxembourg 456 523 594 ---Malta 205 230 255 ---Netherlands 394 428 467 ---Slovak Republic 137 149 180 ---Slovenia 275 276 301 ---Spain 145 168 196 ---Sweden 507 561 621 ---UK 338 366 406 ---

Source: World Development Indicators database

Personal computers – per 1,000 people

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HDIRank Country 1985 1990 1995 2000 2003

1 Norway 0.898 0.912 0.936 0.956 0.9634 Luxembourg 0.858 0.884 0.911 0.929 0.9496 Sweden 0.886 0.897 0.929 0.958 0.9498 Ireland 0.845 0.870 0.894 0.929 0.9469 Belgium 0.878 0.899 0.929 0.949 0.945

11 Japan 0.895 0.911 0.925 0.936 0.94312 Netherlands 0.893 0.908 0.928 0.939 0.94313 Finland 0.879 0.901 0.914 0.940 0.94114 Denmark 0.890 0.898 0.913 0.932 0.94115 UK 0.863 0.883 0.921 0.948 0.93916 France 0.881 0.903 0.921 0.932 0.93817 Austria 0.871 0.894 0.914 0.933 0.93618 Italy 0.866 0.889 0.907 0.921 0.93420 Germany 0.869 0.888 0.913 0.927 0.93021 Spain 0.868 0.886 0.904 0.918 0.92822 Hong Kong,

China (SAR) 0.827 0.862 0.882 --- 0.91624 Greece 0.864 0.872 0.876 0.895 0.91226 Slovenia --- --- 0.853 0.884 0.90427 Portugal 0.826 0.849 0.878 0.898 0.90429 Cyprus 0.813 0.836 0.858 0.883 0.89131 Czech Republic --- --- 0.843 0.857 0.87432 Malta 0.791 0.825 0.852 0.874 0.86735 Hungary 0.808 0.807 0.812 0.843 0.86236 Poland --- 0.803 0.816 0.845 0.85838 Estonia --- 0.814 0.795 0.833 0.85339 Lithuania --- 0.823 0.787 0.828 0.85242 Slovakia --- --- --- --- 0.84945 Croatia --- 0.806 0.799 0.826 0.84148 Latvia 0.805 0.799 0.765 0.812 0.83655 Bulgaria 0.789 0.795 0.784 0.795 0.80864 Romania --- 0.772 0.768 0.773 0.79285 China 0.594 0.627 0.683 --- 0.755

127 India 0.476 0.513 0.546 0.577 0.602

Human Development Index (trend)

Source: United Nations Development Programme

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Country Changes2005 2005 2004 2004-Rank Score Rank 2005

Finland 1 5.94 1 0Sweden 3 5.65 3 0Denmark 4 5.65 5 1Netherlands 11 5.21 12 1Japan 12 5.18 9 -3UK 13 5.11 11 -2Germany 15 5.10 13 -2Estonia 20 4.95 20 0Austria 21 4.95 17 -4Portugal 22 4.91 24 2Luxembourg 25 4.90 26 1Ireland 26 4.86 30 4Hong Kong SAR 28 4.83 21 -7Spain 29 4.80 23 -6France 30 4.78 27 -3Belgium 31 4.63 25 -6Slovenia 32 4.59 33 1Cyprus 34 4.54 38 4Malta 35 4.54 32 -3Czech Republic 38 4.42 40 2Hungary 39 4.38 39 0Tunisia 40 4.32 42 2Slovak Republic 41 4.31 43 2Lithuania 43 4.30 36 -7Latvia 44 4.29 44 0Greece 46 4.26 37 -9Italy 47 4.21 47 0China 49 4.07 46 -3India 50 4.04 55 5Poland 51 4.00 60 9

Growth Competitiveness Index

Source: World Economic Forum

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