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Davos Dispatch: Nobelist Spence on ‘Next Convergence’

Davos is full of egos as large and forbidding as the surrounding mountains. But few people at the World Economic Forum are as down to earth, or wear their celebrity and achievement as lightly, as Michael Spence, the Nobel Prize-winning economist, occasional guest on the Daily Ticker and author of The Next Convergence.

The Next Convergence is a story about how the 85 percent of the world's population that has heretofore been shut out of prosperity is rapidly boosting its wealth and living standards. (See my review of the book here.) The thesis rests in part on the ability of massive-but-poor countries like China and India to rack up 8 percent growth year after year after year, and the willingness and ability of already-rich countries to help lift countries out of poverty through trade and aid.

But recent events may call for a recalibration of the thesis. In some ways, convergence between rich and poor may be happening more quickly than we think — because living standards in wealthy countries such as Greece, Portugal and Ireland, are showing signs of declining. On the other hand, growth seems to be slowing in China, India and Europe.

I sat down with Spence for a reality check. "It looked after the crisis as if the emerging economies could sustain relatively high growth in an environment in which the advanced economies are flat, but relatively stable," he said. But that's not quite what is happening now. With the U.S. mired in slow growth, Europe shrinking and uncertainty rampant, "that's knocked off enough demand to slow the emerging economies down some."

Growth in China, while still raging, has slowed down. Skeptics might point to property bubbles and social unrest and question whether the world's growth juggernaut can continue. Spence breaks China's predicament into "short-term challenges and big structural changes." In the short term, China is coping with inflation, municipal debt, non-performing loans and a range of other challenges. But Spence believes China's central government has the balance sheet, resources and skills to deal with them. "Unlike in Western countries, the government balance sheet in China is enormous, with low debt and a large amount of assets." The upshot: "I give them a likely pass on the short-term challenges." On the long-term structural challenges, however, "the jury is still out." China needs to reform and restructure its economy, with less reliance on investment and more reliance on consumption.

Spence is more concerned about the short-term trajectory of India, whose massive population has much to gain from the Great Convergence. A loss of momentum for reform of the economy — efforts to open up the retailing sector to foreign investment were recently rolled back — and political corruption have deterred some investment. "They have a continuing challenge of infrastructure, with limited public resources to get things done."

Spence points to another trend that could potentially benefit India — and harm China. In the next several years, as wages and standards of living rise in China, it is likely to export tens of millions of jobs to lower-cost locations. Just as companies have concluded that it makes more economic sense to offshore jobs from the U.S. to China, companies currently manufacturing in China may soon find that it makes more economic sense to manufacture elsewhere in Asia, or in South Asia, or in Africa. "It's a huge opportunity for developing countries, and I think India ought to be in the running for some of them," Spence said. "And it's not clear to me that they're taking this possibility entirely seriously."

Daniel Gross is economics editor at Yahoo! Finance.

Follow him on Twitter @grossdm; email him at grossdaniel11@yahoo.com.