Sunday, September 21, 2014
19

No More Growth Miracles

CAMBRIDGE – A year ago, economic analysts were giddy with optimism about the prospects for economic growth in the developing world. In contrast to the United States and Europe, where the growth outlook looked weak at best, emerging markets were expected to sustain their strong performance from the decade preceding the global financial crisis, and thus become the engine of the global economy.

Economists at Citigroup, for example, boldly concluded that circumstances had never been this conducive to broad, sustained growth around the world, and projected rapidly rising global output until 2050, led by developing countries in Asia and Africa. The accounting and consulting firm PwC predicted that per capita GDP growth in China, India, and Nigeria would exceed 4.5% well into the middle of the century. The consulting firm McKinsey & Company christened Africa, long synonymous with economic failure, the land of “lions on the move.”

Today, such talk has been displaced by concern about what The Economist calls “the great slowdown.” Recent economic data in China, India, Brazil, and Turkey point to the weakest growth performance in these countries in years. Optimism has given way to doubt.

Of course, just as it was inappropriate to extrapolate from the previous decade of strong growth, one should not read too much into short-term fluctuations. Nevertheless, there are strong reasons to believe that rapid growth will prove the exception rather than the rule in the decades ahead.

To see why, we need to understand how “growth miracles” are made. Except for a handful of small countries that benefited from natural-resource bonanzas, all of the successful economies of the last six decades owe their growth to rapid industrialization. If there is one thing that everyone agrees on about the East Asian recipe, it is that Japan, South Korea, Singapore, Taiwan, and of course China all were exceptionally good at moving their labor from the countryside (or informal activities) to organized manufacturing. Earlier cases of successful economic catch-up, such as the US or Germany, were no different.

Manufacturing enables rapid catch-up because it is relatively easy to copy and implement foreign production technologies, even in poor countries that suffer from multiple disadvantages. Remarkably, my research shows that manufacturing industries tend to close the gap with the technology frontier at the rate of about 3% per year regardless of policies, institutions, or geography. Consequently, countries that are able to transform farmers into factory workers reap a huge growth bonus.

To be sure, some modern service activities are capable of productivity convergence as well. But most high-productivity services require a wide array of skills and institutional capabilities that developing economies accumulate only gradually. A poor country can easily compete with Sweden in a wide range of manufactures; but it takes many decades, if not centuries, to catch up with Sweden’s institutions.

Consider India, which demonstrates the limitations of relying on services rather than industry in the early stages of development. The country has developed remarkable strengths in IT services, such as software and call centers. But the bulk of the Indian labor force lacks the skills and education to be absorbed into such sectors. In East Asia, unskilled workers were put to work in urban factories, making several times what they earned in the countryside. In India, they remain on the land or move to petty services where their productivity is not much higher.

Successful long-term development therefore requires a two-pronged push. It requires an industrialization drive, accompanied by the steady accumulation of human capital and institutional capabilities to sustain services-driven growth once industrialization reaches its limits. Without the industrialization drive, economic takeoff becomes quite difficult. Without sustained investments in human capital and institution-building, growth is condemned to peter out.

But this time-tested recipe has become a lot less effective these days, owing to changes in manufacturing technologies and the global context. First, technological advances have rendered manufacturing much more skill- and capital-intensive than it was in the past, even at the low-quality end of the spectrum. As a result, the capacity of manufacturing to absorb labor has become much more limited. It will be impossible for the next generation of industrializing countries to move 25% or more of their workforce into manufacturing, as East Asian economies did.

Second, globalization in general, and the rise of China in particular, has greatly increased competition on world markets, making it difficult for newcomers to make space for themselves. Although Chinese labor is becoming more expensive, China remains a formidable competitor for any country contemplating entry into manufactures.

Moreover, rich countries are unlikely to be as permissive towards industrialization policies as they were in the past. Policymakers in the industrial core looked the other way as rapidly growing East Asian countries acquired Western technologies and industrial capabilities through unorthodox policies such as subsidies, local content requirements, reverse engineering, and currency undervaluation. Core countries also kept their domestic markets open, allowing East Asian countries to export freely the manufactured products that resulted.

Now, however, as rich countries struggle under the combined weight of high debt, low growth, unemployment, and inequality, they will apply greater pressure on developing nations to abide by World Trade Organization rules, which narrow the space for industrial subsidies. Currency undervaluation à la China will not go unnoticed. Protectionism, even if not in overt form, will be politically difficult to resist.

Manufacturing industries will remain poor countries’ “escalator industries,” but the escalator will neither move as rapidly, nor go as high. Growth will need to rely to a much greater extent on sustained improvements in human capital, institutions, and governance. And that means that growth will remain slow and difficult at best.

Read more from our "Zombie Growth" Focal Point.

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  1. CommentedDavid Donovan

    In the last 30 years almost 1 billion people have escaped poverty and entered the middle class. And almost all of them are in newly-capitalistic countries (China, India, Russia, eastern Europe, etc.).

  2. CommentedAly Kamadia

    Excellent article. Amongst alluding to numerous problems/challenges, it pointed out the idea that perhaps "No More Growth Miracles" may be in the Global Economy's cards - something contrary to what forecasters were all too confident about (as you point out).

    I think its important to note that Economists, and forecasters in general, shouldn't be extremely confident about specific proclamations about the distant future (by distant, I mean half a century or more... and I'm referring to the social sciences). And as fundamental as history is as a tool when looking into a crystal ball, there are far too many variables in the air to justify far reaching forecasts.

    Nonetheless, given the work you've done, I certainly think the conclusions (last paragraph) are merited, and worth serious consideration; at least if we're not looking into the far distant future. I'm going to post a link to this article - Kamadia.ca

  3. CommentedMatt Russo

    @Anton Martin Agreed, and thanks for filling in with some of the real historical economic details in re E. Europe.

    Always left unmentioned is both the remaining 4-5 billion in developing countries, and the ~1 billion in the "developed" (or as I prefer, "undeveloping") countries. It is inevitable that capitalism applied to an underdeveloped country will raise the living standards of a variable %age of the population, depending on the internal political regime and the countries' leverage in the world market. Unlike feudalism, etc. - and I would add, unlike the "hybrid" system that existed in E. Europe/USSR that, having features of both, was neither capitalist nor socialist as a whole and was therefore fundamentally incoherent as a system - capitalism is a dynamic system that by definition must expand simply to remain in existence.

    And for a capitalist political regime to survive, it has to ensure that a sufficient amount of the fruits of development are accessible to enough of a minority to sufficiently lend support to the regime and the policy (hence the science is properly called *political* economy, not the scientistic "economics"). But even 25% won't be good enough over the longer run. And we know that the other 75% aren't waiting in line to join the 25% - the line doesn't exist. Or are we to believe that the countries of E.E., ex-USSR and China, with long experience with state intervention in the economy (even before 1945), simply tossed it over the fence to the "magic" of Ronald Reagan's marketplace? Poland still has state-provided health care for all last I checked

    And then there are the ~1 billion in the "undeveloping" world. Now all modern countries contain "socialistic" economic elements embedded of necessity in their capitalist systems. When a US right winger says Social Security, Medicare, trains (yes, just ask George Will!) are "socialist" - they are right (and the first two are very popular, the third sadly unknown outside the NE Corridor). But the capitalist political regimes in those countries have been "salami-slicing" away at these socialistic elements for the last 30 years, gradually undermining them in the hope that they will lose popularity, though it looks like they are about to take a sledgehammer to them now. And over that same period the "middle class" in those countries have experienced stagnant to declining living standards, since 2000 an absolute decline. Shouldn't that tell us something like more capitalism = less middle class in W. Europe, USA and Japan?

  4. Commentedmoogdho mahzab

    'Growth' the answer to all mysteries to achieve development is now for sure will not be able to do the trick as it was doing before. So far another engine to drive an economy forward beside Growth is 'Income Distribution'. But unfortunately 'Trickle Down' theory is or I might say was so dominant that this second engine remained always 'Second' in almost every developed and developing economies' policies. With he current unfolding of 'No more Growth Miracle', now I feel 'Income Distribution' targeting to bridge the gap between top 5% with the bottom 5% will be on top of our list. I think admitting the fact that 'Growth' has temporarily lost its venom, policy makers should give their first priority to distributional income and lets see if it can be the current panacea of such global economic slowdown.

  5. CommentedAakash Gautam

    In India's case, there is a dire need for improvement in human capital and governance. Accessibility to basic infrastructures are missing in many places. Most policies that have been formulated have been marred with implementation weaknesses.
    In this era, with the help of technology, improvement in accessibility to infrastructures could be done in a short time. Similarly, policy implementation could also be improved with the use of technology. Hence, I remain optimistic regarding the future of developing countries including India.
    With proper planning, there could be a second phase of "growth miracle", one that is more inclusive and sustainable.

  6. CommentedMark Pitts

    In the last 30 years almost 1 billion people have escaped poverty and entered the middle class. And almost all of them are in newly-capitalistic countries (China, India, Russia, eastern Europe, etc.).

    In other words, the number of people free from poverty has doubled since 1980 - a remarkable achievement by any standard.

      Commentedjibreel landers

      Do you factor into this debt? Unpaid debt? Most people in the middle class face perpetual debt. They have house payments and car payments, which they must work (often for hourly rather than on salary) to pay off.

      Poverty by any other name...

      CommentedAnton Marten

      Dear Mark, go back to the school, learn history, and then try again analize emerging markets. Eastern Europe was industrialized, and full of human capital long time before China - this is not a question of last 30 years :-)) but last 90 years or more. Czechoslovakia was one of more developed countries in Europe before II WWW, Poland - started strong developing in 1930-ties, and than sharply developed in 1950-ties, 60-ties and 70-ties. The same Hungary (in the less scale), DDR, Jugoslavia. It was no question of industrialization, more - problem of communist wrong institutions, so great midddle class and workers groups were really developed as consumers, but too often (not constantly), they coudn't meet their needs (not every of course). Soviet Union was different: heavy industrialized in 30-ties, 40-ties,50-ties and so on, but with no developed consumption. 23 years ago the situation changed again, especially in Poland, Czechoslovakia, DDR, Hungary, Jugoslavia - in some countries it was quickly "westernization", but not industrialization :) Rather - changing of profiles, with most population already in towns for decades. When I read such "analists" like you, I am not surprised with all this bullshit and wrong decisions or outlooks about the global or regional economy.

  7. CommentedTony Phuah

    Hi Mark Pitts, did the economic growth last 2 decades really help to reduce "the suffering of almost 5 billion people who still live in poverty" (especially those in Africa)? Rich-poor gap grows bigger, and high global food price since 2007 make them even more suffering.

    Share vision, get committed, improve ourselves.

      CommentedMark Pitts

      In the last 30 years almost 1 billion people have escaped poverty and entered the middle class. And almost all of them are in newly-capitalistic countries (China, India, Russia, eastern Europe, etc.).

      In other words, the number of people free from poverty has doubled since 1980 - a remarkable achievement by any standard.

      CommentedGary Marshall

      Well, maybe Tony the leaders and their employ of those poor nations should stop plundering their own people and adopt some of the policies of the wealthy nations! How is that for sharing a vision?

      Nothing much springs from countries whose leaders have no respect for private property and the rule of law.

      The US President is about to discover these principles in November when the US electorate register their distaste for the criminals now in office.

      GM

  8. CommentedRobert Guy Danon

    It is quite interesting to highlight the limits of industrialisation in today’s economic environment and how this may hamper future growth prospects but more importantly I feel is to address the possible economic model which may form the foundation for the workings of the world’s economies.
    It is evident that the growth model which was based on the short sighted vision of maximisation of profits through the corporate identity as represented by its shareholders and its executive arm is no longer able to provide the basis for the creation of wealth in an equitable and collective way. It became progressively more reliant on the extension of the business cycle both through the furtherance of the globalisation process and increased merchanting of trade but equally through the enormous leveraging of corporates and households based on unfounded expectations of endless growth and fuelled of course by the ever decreasing long term and short term interest rates with the blessing of the ever supportive central banks. The resultant inevitable collapse of this house of cards left US households with negative equity and an inability to drive final demand, sovereigns constrained by fiscal overextension either in an attempt to keep their economies from falling over the cliff or because they have been undertaking fiscal austerity as a precondition for good housekeeping and created record wealth and income inequality the result of a miscued process of distribution amidst an unfavourable tax system.
    So what has been the catalyst for this current state of affairs and how could we put an end to this pessimism and the inability of both fiscal and monetary policy to affect current economic activity and ultimately growth and employment. Joe Stiglitz has been fervently pointing out how income & wealth inequality is exacerbating the situation and how an equitable redistribution process in some form or another can rescue the economy. I couldn’t agree more but I would suggest that the most efficient way to do this is to alter the corporate model. More on this on my blog www.rgdanon.blogspot.gr

  9. Commentedjracforr jracforr

    It is quite correct to say there will be no more growth miracle for now, but the cause will not be the issues addressed in this article ie industrialization or the lack thereof. Rather the inequitable distribution of wealth derived from labor is now the problem. A new bubble created by income inequality wherein labor is starved of capital and Investors conserve excess capital or indulge in speculative activities is now the real threat to the world's economy. The basic necessities of life are still lacking among enormous numbers of cash starved workers and this is the real demand that drives any economy. Correct income inequality and the worlds economy will grow for many more years
    China's industrial prowess may well stifle other nations if they are prepared to tolerate it, but it only proves that the market being catered to is miniscule,compared to the potential demand that truly exists. The slight improvement in wages among Chinese workers and the attendant threat to their jobs caused by it is proof that CAPITALISM AS IS CURRENTLY BEING PRACTICED, IS A FRAUD

      CommentedEvan Schein

      "Correct income inequality and the worlds economy will grow for many more years."

      How would you propose we do this?

  10. CommentedProcyon Mukherjee

    Cannot agree more that growth paradigms have shifted from intrinsic factors like resource endowments or demographics to institutional factors that allow broad improvements and productivity to be sustained. The example of Sweden (or even a better one, Switzerland) helps us to draw the conclusion why competitive advantage of nations cannot simply be built on its resource based assets. The convergence of human skills and assets, entrepreneurial spirit, social acceptance of divergent views that could be synthesized for greater common good and the ability to attract capital and talent and channelize them into building of structures and processes that create the foundation of growth are some of the factors that differentiate nations.

    For success of institution building that could coalescence the local and provincial constituencies into accepting the growth path that benefits the broader majority, it needs more than what democracy could achieve through exercise of choice. It needs engagement of polity and people combined through active participation that the Swiss Gemainde provides as excellent example.

    Procyon Mukherjee

      CommentedGary Marshall

      Hello Pro,

      Waving the white flag are you now that big, corrupt, squandering government is going down for the final count in Europe and so many other places?

      Prospects are limited because the results of socialist and corrupt governments are limited. So nothing can be done. What a shame!

      Well, time to step aside and let the professionals show you how to do things.

      GM

  11. CommentedZsolt Hermann

    This article is positive in a way that at least it is recognizes that the previously expected exponential quantitative growth is not possible any longer, but it still falls short on identifying the main reason for it thus cannot draw useful conclusions.
    We are still stubbornly staying in the illusion that constant quantitative growth is possible, although we have all the signs and facts around us showing a different picture.
    First of all we live in a closed, finite natural system.
    As markets, workforce, natural resources become saturated or depleted there is simply no more space to grow in a quantitative manner.
    Besides the major driver, the natural principles of the profit oriented expansive, and mostly exploitative economic model brought to light unsolvable social inequalities, changes not only in the developing countries, but even at the top of the pyramid. These problems cannot be solved while maintaining the same mentality, approach that is the basis of the profit oriented economy.
    Moreover the whole economic model is based on excessive overproduction and consumption of goods that are simply unnecessary and many times harmful. In order to increase profit, manufacturers, companies are inventing products "out of nothing", then market them aggressively in a sophisticated brainwashing manner, so people keep on buying things they simply do not need and never had natural desire for. Tis consumer hysteria forces people and nations to go way beyond their resources, means creating the debt crisis all over the world.
    Basically our whole system is based on an illusion, a dream, a huge bubble that had to burst sooner or later.
    It has burst in 2008, and since then we simply try to plug the multiple leaking holes by virtual money transfers or restrictions, cosmetic changes and "solutions", while waiting for a miracle that the growth will return although we have no factual basis for this belief.
    Until we stop pretending and finally look into the mirror recognizing ourselves, our basic greed, self obsessed nature as the root of the problem, and start gradually rising above ourselves in order to build a new, mutually responsible and considerate human system, living within necessities and resources we will continue our slide into an abyss any recovery or escape will get increasingly more difficult.

      CommentedMark Pitts

      Anyone who opposes future economic growth is obviously indifferent to the suffering of almost 5 billion people who still live in poverty.

  12. CommentedThomas Haynie

    “Unorthodox methods” ? According to Ha June Chang this is more the norm than the exception even for the large industrialized powers. Their paths to power were not along those suggested. Once a critical mass is reached it would seem that policy prescriptions change. A little protectionism probably isn’t a bad thing. Free trade is great unless your partners are using strategic trade (or are even mercantileist).

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