Agoracom

From The Times
August 27, 2008
World develops stronger immune system
David Wighton: Business Editor's Commentary

It used to be said that when America sneezed, the rest of the world caught a cold.

That still appears to hold true for Britain and the eurozone, but the rest of the world seems to have developed a stronger immune system.

The global economy is forecast to grow at about 4 per cent this year, which is still pretty healthy given that many of its largest members are under the weather.

The resilience stems largely, of course, from the breakneck growth of China. But will it continue?

Many economists have argued that China's economy would catch a nasty chill if Western demand for its exported goods dropped.

This prediction has quickly overtaken the previously fashionable “decoupling” theory, which suggested that China's economy was driven largely by domestic consumption and could, therefore, shrug off a slowdown in the West.

The large mining companies, which have made billions of dollars in profits from supplying China's resource-hungry industries, have tended to fall into the decoupling camp.

They have a strong vested interest in the theory, of course, as continued demand for their products will keep share prices high and investors happy.

But, to be fair, the miners have a pretty good handle on what is going on in China because they are closer to China's diverse and fragmented industrial sector than most. If the miners say that China's economy will survive a drop in demand for dangerous plastic toys, they are probably right.

Tom Albanese, the chief executive of Rio Tinto, presented a strong defence of the decoupling argument yesterday by pointing out how little of China has benefited from the recent surge in growth.

Most of the development has been concentrated on the east coast around three cities: Beijing, Shanghai and Tianjin. There are a couple of dozen more provinces in the interior that have yet to experience a boom and their economies have little exposure to export industries. For example, exports account for only 4 per cent of GDP in the province of Hebei, which has a similar-sized population to Britain. The development of these regions must, therefore, be driven by domestic consumption, which should keep China's economy (and the world's) growing at a healthy pace.

Rio is also expecting a short-term boost to commodity prices by the lifting of restrictions on industrial activity around Beijing, which the Government imposed to ease pollution during the Olympics.

Soaring commodity prices helped to boost Rio's underlying earnings by 55 per cent to a record $5.5 billion (£2.99 billion) in the first half. But they were just as beneficial for BHP Billiton, its rival mining giant, which is bidding $130 billion for Rio.

Rio's market value has represented 36 per cent of a combined company for the past year. And when Rio talks up its prospects thanks to Chinese growth, BHP also gains and the balance in share values stays the same.

BHP claims that this makes its offer, which would give Rio shareholders 44 per cent of the enlarged company, a good deal.

But the problem with companies that are in such lock-step is that regulators may take a dim view of putting them together.

Rio's future will have less to do with who catches an economic cold than with the remedies demanded by competition authorities.

Copyright 2008 Times Newspapers Ltd.