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2. Why China's development demands a strategic response from Scotland

China's rapid economic development is reshaping the global economy with important implications for Scotland and other advanced economies. This section summarises China's dramatic emergence, looks at its future prospects and considers the implications for Scotland.

Up until the industrial revolution, China was the world's largest economy, reflecting its relatively high level of technological advancement and large population. In 1820, China accounted for around a third of the global economy. However, through the 19th and 20th centuries, Western economies came to dominate global economic activity as a result of industrialisation. By 1950, China's share of the global economy had fallen to below 5%.

In 1978, a series of economic reforms was started that gradually opened up and liberalised the Chinese economy. Since that date, Chinese real GDP growth has averaged nearly 10% per annum - meaning that China's economy has been doubling in size every 8 years or so. As a result, at the dawn of the 21st century, China had already regained its place among the world's most important economies - as shown by the information in Box 1. So far this century, China has contributed more to global economic growth than all of the G7 major advanced economies combined. The only parallel to this in history was the rise of the United States in the second half of the 19th and early 20th century.

China's economic growth and development has much further to run. With income per capita at around $1,700, China is still classified as a developing country: Scotland's income per capita is around 18 times higher. As China continues its transition from a largely agrarian and heavy-industry based, closed, command economy to an advanced, open market economy, so the size of its economy will increase significantly.

Figure 1

Source: Goldman Sachs (2005)

Long-term economic projections are always laced with uncertainty and it is clear that China's growth will slow down considerably over time from its current rapid pace. Figure 1 shows one well-known set of projections for China with other key economies shown for comparison. Although there are risks associated with these projections, and they may turn out to overstate China's growth prospects, they set useful working assumptions for current decision making, in particular for how we in Scotland should respond.

China and the evolving global economy: implications for Scotland

As the Chinese economy continues to grow, so China's influence will increasingly be felt internationally - not merely in terms of its impacts on the global economy but also in terms of its cultural, social and political impacts. In terms of economic impacts, we in Scotland will increasingly feel the ramifications of China's emergence. These might take the form of higher prices for certain primary commodities (for example, Chinese demand has played an important role in driving up oil prices); lower prices for manufactured goods (ranging from clothing to computers); and expanding markets for our exports.

China's development, along with that of other major emerging markets, will also have an important bearing on the nature of economic activity in Scotland. There will be intense competitive pressures in product markets in which Chinese firms specialise. Labour cost differentials make it extremely difficult to compete on cost alone: average wages in Scotland in 2005 were around £410 per week; in China they were only around £18 per week. ²

This does not mean that, in aggregate, China will take jobs away from Scotland. The Scottish economy will continue to evolve - as it has done over the past decades and centuries - with job opportunities increasingly being created in new, higher value-added areas.

We need to make China's advantages an integral part of Scottish businesses' supply chains, releasing domestic resources for use in higher value-added sectors to the benefit of Scottish consumers and producers. Procuring components more cheaply from China is helping many Scottish companies to become more globally competitive, thus safeguarding jobs at home. While this may involve some adjustment, in time we expect China's emergence to contribute towards both more and better jobs overall in Scotland.

Rapid growth in China and other emerging economies, alongside rapid technological change and increasing integration in the global economy, presents Scotland with significant new opportunities for wealth creation. However, it also poses challenges to industries and sectors that have historically been the preserve of advanced economies. This process of structural change requires economic flexibility, dynamism and entrepreneurship - that enable the productivity growth required by businesses to maintain international competitiveness - supported by a flexible and responsive welfare state.

Government has an important role to play in ensuring that Scotland is best positioned to harness these global economic developments and to meet the challenges and opportunities that China poses. The Scottish economy benefits from the stable macroeconomic foundations of the UK economy, which are helping to enhance confidence, promote stability and enable a strong investment climate. Working with UK partners we need to strive to promote flexibility in labour, product and capital markets and to invest in the necessary public infrastructure and public services that enable us to be globally competitive. We need to remain at the forefront of research and innovation - transforming our scientific and technological advances into commercial successes. We need to continue to invest in the skills of the Scottish workforce. And we need to ensure that businesses and people have the capacity and opportunity to respond flexibly and effectively. But it is important that flexibility is accompanied by fairness, through policies that support individuals through periods of change: enabling them to obtain the skills they need to adapt, and to protect the vulnerable.

Global competitiveness is not a new concept for the Scottish government to be addressing. It already provides the international backdrop to the challenges outlined in Scottish Ministers' Framework for Economic Development and, in turn, the global connections theme of A Smart, Successful Scotland. These documents together present a blueprint for a globally competitive Scotland. In particular they emphasize the importance of knowledge flows into and out of Scotland as a vehicle for sustained growth.

The China Strategy complements this economic framework by addressing the specific challenges and opportunities presented by China. In essence, the strategic objectives seek to expand flows of knowledge between Scotland and China. These flows take many forms: education; cultural and scientific ideas; business skills; technology, etc. We believe that expanding these knowledge flows with China will significantly enhance both our economies.

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