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The Future of Economic Convergence

It appears increasingly plausible that the balance of economic activity will partly shift away from the United States and its post-World War II allies and toward the new potential economic superpowers, China and India. But that shift will not necessarily change the way the world works.

WASHINGTON, DC – Who can now sustain rapid economic growth? The answer to this question will determine not just the geography of prosperity in the coming decades, but also what the balance of global economic activity will look like in 2030 or 2050. Increasingly, it appears plausible that this balance will partly shift away from the United States and its post-World War II allies and toward the new potential economic superpowers, China and India. But that shift will not necessarily change the way the world works.

On paper, economic growth – a sustained increase in productivity– may seem simple. An economy’s productivity, or output per capita, is a function of capital stock, labor (the number of workers and how educated they are), and an admittedly vague residual known as “total factor productivity,” which refers to how capital and labor are organized. The basic idea behind modern economic growth – which started in the late eighteenth century – is that it involves constructing physical capital (buildings, machines, and infrastructure), increasing education levels, and combining these “factors of production” in a way that raises productivity. Technological innovation, either homegrown or imported, typically helps.

There are no profound secrets here. Countries have been growing in this manner for more than 200 years. You can tailor a growth strategy based on your natural resources, such as abundant coal or access to the sea. You can grow by relying on a stronger role for the government (as in Singapore) or by relying mostly on the private sector (as in Hong Kong).

Why, then, have so many countries found it hard to grow in a sustained manner? For at least 50 years after World War II’s end, there was remarkably little convergence in per capita income. Rich economies (Western Europe, the US, Canada, and Australia) moved steadily ahead, while most poorer countries, despite some episodes of decent growth, did not move significantly closer to the leaders’ productivity and income levels.

The relatively few major positive growth surprises in the past 50 years have almost all been in Asian countries that focused initially on exporting cheap manufactured goods and then found ways to improve quality and offer more sophisticated products. Japan may be considered the first non-European country to have used this development path; Korea, Singapore, Hong Kong, and others have followed. China’s development is often considered to follow broadly similar lines, as documented in a recent McKinsey Global Institute report.

The most straightforward explanation is that elites in those countries figured out that they would do well from exports and associated economic growth. Consequently, they sorted out the politics, kept corruption under control, and arranged for government to be run in a reasonable manner.

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Looking at the recent data on economic performance across the world, Arvind Subramanian, former chief economic adviser to the Indian government, and his colleagues argue that convergence in per capita income is taking hold more broadly. This is entirely plausible, and may signify – in my interpretation – that more elites now favor growth. The demonstration effect of China may be compelling, with the lesson being that it is possible to implement the reforms needed to grow fast while staying in power. This may sound cynical but it is actually an optimistic message, at least in terms of the outlook for reducing poverty around the world.

As a result, there is good reason to think that China and India may be able to sustain annual growth rates of around 7%, while developed countries such as the US tend to average 2-3% growth. Extrapolating from these growth rates suggests that emerging markets could account for well over 50% of world GDP measured at market exchange rates by 2030. Surely there will be bumps in road, but steady progress seems likely.

The impact on the global system, with its existing structure of multilateral institutions (such as the International Monetary Fund, the World Bank, and the World Trade Organization) and myriad standard-setting and consensus-building organizations, may be smaller than one thinks. It is hard to create new rules and norms. As the existing system allows for growth, why not just work within it?

For the US, as long as the dollar remains the world’s main reserve currency and safe haven of choice, the impact of falling to second or perhaps even third place in terms of economic output may not be so great. In fact, the US could do well as a source of innovation and new products, selling to a larger global market.

The main factors undermining the prospects for US prosperity are mostly the result of its own political decisions. Unsustainable fiscal deficits, questionable trade policy, a high level of inequality, crumbling infrastructure, underperforming schools, and unaffordable health care are the result of domestic choices. Whether or not Americans come to grips with those issues has little to do with China or India.

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