Industrialised World Must Adapt to Rising China and India

TOKYO - The world economy is undergoing a transformation that occurs only once every century or two. Japan and other mature industrialised countries must adapt.

Building on revolutionary technological innovation, the globalisation that started in the 1990s is accelerating and dramatically altering the international division of labour.

The main players are China, India, the East European states and Russia. They have abandoned the socialist model of economic development and are rapidly altering international patterns of production, distribution and consumption.

Today's combination of industrial revolution and globalisation is similar to that of the late 19th century when the leading players were the United States, Canada, Australia and Argentina.

Their emergence, coupled with the first telecommunication and distribution revolutions, triggered a dramatic decline in costs and prices.

From 1870 to 1896, there was a significant increase in world production, with falling costs and prices. Just as then, the global deflation of today is a structural rather than a monetary phenomenon.

The older industrialised or industrialising nations need to work out how to adapt to this profound shift.

It is not the first time China and India have had a big influence on the world economy. In the early 19th century, China was the No 1 economic giant, with India not far behind.

China is estimated to have accounted for nearly 29 per cent of global gross domestic product in 1820, and India for 16 per cent. They are re-entering the world economy with some positive legacies, including ports and other infrastructure, as well as a human network of overseas settlers around the world.

If China can sustain its dynamic growth, it could be a manufacturing giant within a decade. India has emerged as a world software and information technology hub and will probably continue in that role.

Other Asian nations that may feel threatened by China and India should not demonise the emerging giants.

Both have weaknesses. For example, China has many serious vulnerabilities, such as the non-performing assets of its state-owned banks and a widening disparity of income and wealth among its nearly 1.3 billion people.

China must maintain fast growth to remain stable. It needs foreign investment and technology to sustain growth. Japan and the rest of Asia should cooperate with China to form a new regional division of labour.

Despite the immediate threat of Japan's economy being hollowed out as companies shift production to China to cut costs and get direct access to the Chinese market, such a move would eventually benefit all concerned.

The only way for Japan to compensate for manufacturing sector job losses is to promote a vigorous service sector.

It is already a service economy. Jobs in the sector account for more than 70 per cent of employment. The major problem is that Japan's services are tightly regulated and heavily subsidised.

Looking at the sector, one could be forgiven for thinking Japan was a socialist country. The iron triangle of vested interests formed by the governing Liberal Democratic Party, the bureaucracy and industry has so far blocked any meaningful structural reform.

To adapt to the new international division of labour and the need for regional cooperation, rapid deregulation of services in Japan is an absolute must.

Deregulation of Japan's agriculture and food processing industries, and the opening of those markets, is also key to close cooperation with the rest of Asia.

Japan must open both its service and agriculture sectors to survive and participate in the new division of labour in Asia.

This is the only way to overcome the long-term stagnation of the economy.