1. The World in 2050 -- Perspective on Global Economic Competition and the Role of China John Hawksworth Head of Macroeconomics PricewaterhouseCoopers Beijing, 16 May 2006

2. PricewaterhouseCoopers LLP Date16 May 2006 Page 2 Agenda Methodology - Growth model and key assumptions - Market exchange rates vs PPPs Key results: focus on China and India Implications for OECD and Chinese companies Public policy issues Q&A

3. PricewaterhouseCoopers LLP Date16 May 2006 Page 3 Study covers the 17 largest economies in the world in 2004 based on GDP at PPPs (World Bank estimates) G7 plus Spain, Australia and South Korea E7 economies - BRICs (Brazil, Russia, India and China) - Indonesia, Mexico and Turkey Note: methodology could easily be extended to other countries (though probably not small, very open economies like Ireland)

4. PricewaterhouseCoopers LLP Date16 May 2006 Page 4 Growth model structure Each country modelled individually but with linkages via US productivity growth (the global technological frontier) Cobb-Douglas production function with human capital included Growth driven by: - Investment in physical capital - Working age population growth (UN projections) - Investment in human capital (rising average education levels) - Catch-up with US productivity levels (at varying rates: 0.5-1.5% per annum of the TFP gap closed each year) Real exchange rates vary with relative productivity growth

5. PricewaterhouseCoopers LLP Date16 May 2006 Page 5 China India US BrazilRussia UK

6. PricewaterhouseCoopers LLP Date16 May 2006 Page 6 How to compare GDP: Market exchange rates or PPPs? GDP at PPPs a better indicator of: - Relative living standards (GDP per capita) - Volume of outputs or inputs (oil, carbon emissions etc) GDP at market exchange rates better for assessing current market size for investors/exporters into emerging economies - but need to allow for real exchange rate changes in longer term projections

7. PricewaterhouseCoopers LLP Date16 May 2006 Page 7 Projected real exchange rate changes: ratio of MERs to PPPs MERs as % of PPPs

8. PricewaterhouseCoopers LLP Date16 May 2006 Page 8 Projected real exchange rate changes: ratio of MERs to PPPs MERs as % of PPPs

9. PricewaterhouseCoopers LLP Date16 May 2006 Page 9 India US UK China Brazil Russia

10. PricewaterhouseCoopers LLP Date16 May 2006 Page 10 UK Russia China India Korea

11. PricewaterhouseCoopers LLP Date16 May 2006 Page 11 Key model results GDP growth Relative size of economies GDP per capita levels Sensitivity analysis

12. PricewaterhouseCoopers LLP Date16 May 2006 Page 12 India China Brazil Russia US Japan

13. PricewaterhouseCoopers LLP Date16 May 2006 Page 13 Projected average real GDP growth: 2005-50 % real GDP growth p.a.

14. PricewaterhouseCoopers LLP Date16 May 2006 Page 14 Projected average real GDP growth: 2005-50 % real GDP growth p.a.

15. PricewaterhouseCoopers LLP Date16 May 2006 Page 15

16. PricewaterhouseCoopers LLP Date16 May 2006 Page 16 Relative size of E7 vs G7 economies: 2005, 2025 and 2050 Index: G7 GDP = 100

17. PricewaterhouseCoopers LLP Date16 May 2006 Page 17 China and India vs US GDP in 2050 Index: US = 100

18. PricewaterhouseCoopers LLP Date16 May 2006 Page 18 China and India dominate E7 economies (relative GDP at MERs) Index: US = 100

19. PricewaterhouseCoopers LLP Date16 May 2006 Page 19 Relative size of Big 4 economies: market exchange rates Constant 2004 US $bn

20. PricewaterhouseCoopers LLP Date16 May 2006 Page 20 Relative size of Big 4 economies: PPP exchange rates Constant 2004 US $bn at PPPs

21. PricewaterhouseCoopers LLP Date16 May 2006 Page 21 US UK Russia Brazil China India Germany Korea E7 still well below G7 on income per capita at PPPs

22. PricewaterhouseCoopers LLP Date16 May 2006 Page 22 Sensitivity analysis Results are particularly sensitive to assumptions on: - investment rates - education level trends - catch-up rates for E7 economies - real exchange rate relationship to productivity (for GDP at MERs) Perfectly possible that China relative to US could be 30% higher or lower than base case in 2050 – but would not alter the broad direction of change Model allows effect of alternative assumptions to be explored

23. PricewaterhouseCoopers LLP Date16 May 2006 Page 23 What might derail growth in China and India? Macroeconomic instability: - Overheating in China - Fiscal deficit in India Energy, water and transport infrastructure constraints Over-investment without proper capital allocation mechanisms (c.f. Japan in 1980s/1990s) Protectionism in key export markets (US/EU) Political instability Environmental crises

24. PricewaterhouseCoopers LLP Date16 May 2006 Page 24 How can the OECD economies compete with China, India and other E7 economies? Competitive advantage vs comparative advantage - Some commentators focus on the former -> relative pessimism - Economists tend to focus on the latter -> relative optimism (though there will be winners and losers) - recent PwC survey suggest multinational CEOs also mostly positive about opportunities in BRICs

25. PricewaterhouseCoopers LLP Date16 May 2006 Page 25 China ranks highest on cost reduction India ranks highest on skilled talent pool

26. PricewaterhouseCoopers LLP Date16 May 2006 Page 26 China is top priority on most measures

27. PricewaterhouseCoopers LLP Date16 May 2006 Page 27 China and India have different comparative advantages India has strengths in: - IT skills and technologies - low cost English speaking staff for offshoring services - younger population China has advantages in: - low cost manufacturing - higher average education levels - higher savings and investment rates Should create potential for mutually beneficial trade But: also competing for resources to support growth

28. PricewaterhouseCoopers LLP Date16 May 2006 Page 28 Relative competitiveness rankings: China vs India 5731Business competitiveness index 5033- Macroeconomics environment sub- index 5256- Public institutions sub-index 5564- Technology sub- index 5049Overall global competitiveness index IndiaChinaCountry rankings (out of 117) Source: World Economic Forum Global Competitiveness Report 2005

29. PricewaterhouseCoopers LLP Date16 May 2006 Page 29 Potential impact on OECD companies over next 10 years Winners Retailers Global brand owners Business and financial services Creative industries Healthcare and education providers Niche high value added manufacturers Losers Mass market manufacturers (both low tech and increasingly hi-tech) Financial services companies not able to penetrate E7 markets who become vulnerable at home to E7 entrants Companies that over-commit to E7 without right local partners and business strategies

30. PricewaterhouseCoopers LLP Date16 May 2006 Page 30 Potential longer term challenges for Chinese companies Gradual loss of cost advantages to other emerging markets Rising input costs (energy, metals etc) Competition from OECD companies in domestic market as effects of WTO membership continue to feed through Overseas investments: choosing the right targets and not overpaying for them (c.f. Japan) Moving from technological imitation to innovation Developing domestic capital markets Adapting to an ageing labour force

31. PricewaterhouseCoopers LLP Date16 May 2006 Page 31 Public policy issues for China (and other countries) Danger of protectionist response from US/Europe Capital market development and banking sector reform Rural-urban income inequalities (land reform?) Energy and water supply Education Environmental issues - Domestic: air and water quality, soil erosion, deforestation etc - Global: challenge of climate change

32. PricewaterhouseCoopers LLP Date16 May 2006 Page 32 Rise of China and India will push up C02 emissions unless offsetting measures taken to reduce energy/carbon intensity Source: IPCC scenarios (2000), preliminary PwC model estimates GtC

33. PricewaterhouseCoopers LLP Date16 May 2006 Page 33 Summary The E7 are coming! - US, China and India to be three major economies by 2050 - India could actually grow faster than China beyond c.2015 - Brazil, Russia, Indonesia, Mexico and Turkey smaller but also potentially significant Potential win-win for the UK and other OECD economies if they can remain open, flexible and focused on human capital China and India potential partners as well as rivals Major public policy challenges … not least climate change