Daily Times

Today marks the day when, in terms of purchase power parity, China’s GDP exceeded that of the US. This means that China has become the most productive economy in the world, ending over two centuries of western dominance. This is a fundamental tectonic shift in global economic power, going on for the last four decades. Europe, which had been the bastion of prosperity for the last two centuries, is marred by a severe financial crisis. To come out of the crisis, policymakers are debating remedies ranging from growth stimulus to fiscal discipline. In both approaches, what is not said openly is that Europe is at a juncture where it will have to choose between lowering of standards of living or massive inflation leading to the erosion of wealth of individuals in the medium-term.

Both approaches have one thing in common: they assume that if the necessary pill is swallowed, Europe will ultimately recover and will maintain its status as the bastion of prosperity and high standards of living. This is where economists and policymakers alike are ignoring the most obvious reality. Europe, as a continent with few exceptions, has grown poorer and will have to live with this unless there is a miraculous economic/innovation revolution. What we are witnessing in the world around us is the greatest flow of real wealth in the entire human history from Europe to East Asia.

The fundamental reason behind this is how Europe achieved its prosperity. This crisis has impacted two types of countries in Europe the most. First are the countries on the peripheries that were traditionally the second or third world for the last two to three centuries, and have benefitted from the prosperity in neighbouring Europe post World War II. Greece is a typical example of such nations. Second are the old colonial powers. It is not a coincidence that among the big economic houses of Europe, Spain, Portugal, France, Netherlands and the UK are the most impacted by the crisis while Germany and Scandinavian economies are relatively robust.

The prosperity of Europe mainly hinged on two events that took place around two centuries ago. One was the steam engine led Industrial Revolution that gave Europe a technological edge over the rest of the world. Second, of course, was the colonisation that coincided with the industrial revolution. The invention of mechanical engines gave the west the technology to industrialise, which, coupled with resources coming as a result of colonization, led to the Industrial Revolution. This revolution gave Europe the prosperity that it has lived on for the last century and a half.

The steam engine and automation were a huge competitive advantage. But, like all competitive advantages, with time, other nations were to catch up and thus the advantage eroded. The time to catch up on new technologies is fast shrinking, reducing the competitive advantage of nations that innovate. However, one advantage that made Europeans lead the last couple of centuries was control of resources through colonisation. Cheap, almost free, resources coming from colonies gave the manufacturing sectors of colonisers a competitive edge over the others. With colonisation ending post World War II, the manufacturing bases of these colonisers started shrinking too.

To understand this, take the example of the UK. Its colonies gained independence in the 1950s and 1960s, and in the 1970s and 1980s its economic map underwent major restructuring. Its competitive advantage in industries like textile, car making etc. was all gone as the former colonies started taking control of their economic policies. The divestments from non-competitive sectors led to the freeing of resources that were invested to create an economy based on consumption and services. For the next two decades, real estate, retail and capital markets became the hallmarks of the UK’s economy. However, the UK was not manufacturing to sell to others. Its competitive advantage in old industries was gone as it lost control of resources of the colonies and its economy (unlike the US) did not innovate enough to reap the rewards of the next boom: Information Technology. The result? Real wealth is shrinking and the UK has become a society that is living way beyond its means in a world where the production of major goods and services has shifted to Asia.

Contrast this with Germany. The Germans’ colonisation experiment began late and was a disaster. Their economy was built on a strong manufacturing base without reliance on cheap resources from colonies. Germany managed to retain its competitive advantage in manufacturing even in an era when eastern economies started taking the lead in production. Based on production patterns, unless European colonial powers hit the next steam engine moment, their wealth is bound to shrink. The world is heading towards an era where, because of the shift in manufacturing base, Asia will become richer and Europe, with few exceptions, will become poorer till they reach a new balance based on new economic realities.

The process, of course, will be gradual and the balance, of course, will not be permanent for there will be shifts in competitive advantage and new innovations will change the economic map. However, European prosperity built on colonisation is losing its lustre and wealth is moving eastwards.

The author can be reached on twitter at @aalimalik