Perspectives from Around the World
The Rise of Developing Asia and the New World Order
Dale W. JORGENSON
Samuel W. Morris University Professor, Harvard University
For Dale W. JORGENSON's full bio,
This paper draws on Dale W. Jorgenson and Khuong M. Vu, "The Rise of Developing Asia and the New World Order," Journal of Policy Modeling, September-October 2011.
As the world economy recovers from the Great Recession of 2007-2009, the revival of growth in the U.S., Japan, and other industrialized countries has been slow and fitful. International imbalances and fiscal consolidations have become more pressing, both economically and politically. A successful recovery will require adroit withdrawal from policies adopted to cope with the downturn. Could a new and perhaps unexpected shock interrupt the recovery?
An obvious threat to the restoration of economic growth is the continued worsening of the sovereign debt crisis in Europe and the inability of international institutions to cope with a fiscal and financial crisis in large countries like Spain and Italy. Among the emerging economies the challenges are different, but equally daunting. Can China successfully handle the inflationary pressures following the vast expansion of lending in response to the financial crisis? Will India be able to undertake a fiscal consolidation without threatening rapid growth?
In this paper I will shift attention from threats to the short-term growth of the world economy, as formidable as these may be, to growth potential over the next decade. The fundamentals for the world economy are strong. Moreover, it is time to recognize the emerging trends that have developed since the watershed reforms of China and India more than two decades ago. My theme will be that a massive reconfiguration of the world economy is unfolding and will be completed in the next ten years.
I will focus on the Rise of Developing Asia. This refers to sixteen economies of East and South Asia excluding Japan. These include China and India, the two largest countries of the world in population and two of the most rapidly growing economies. Developing Asia also includes the Newly Industrialized Economies of Asia--Hong Kong, Korea, Singapore, and Taiwan. Developing Asia has emerged from the Great Recession of 2007-2009 with growth trends largely intact. This reflects "lessons learned" during the Asian Crisis of the 1990's and the deployment of substantial international reserves as buffers against the recessionary shock.
The first of the major trends in the world economy to be realized within the next decade is that China will overtake the U.S. One of the most heralded economic developments of 2010 was that China overtook Japan as the world's second largest economy. In terms of purchasing power parities China overtook Japan more than five years ago. What was the hullaballoo? In 2010 China overtook Japan in terms of exchange rates rather than purchasing power parities. The International Monetary Fund's World Economic Outlook for April 2011 calls for parity in 2016 between China and the U.S. While the U.S. has been the world's largest economy for more than a century, my first conclusion is that the most likely date for China to become No. 1 in terms of purchasing power parities, as defined by the World Bank, is 2018.
The second major trend is that Developing Asia will overtake the G7. This trend will be largely driven by the rapid growth of China, but India will also make a significant contribution. Growth in the Asian Tigers--Hong Kong, Singapore, South Korea, and Taiwan--will continue to slow, but all except Hong Kong will grow more rapidly than the world economy. Indonesia's growth will equal that of the world economy. The final long-term developments are that India will overtake Japan, Russia will overtake Germany, and Brazil will overtake the U.K., leading to a New World Economic Order in 2020: China, the U.S., India, Japan, Russia, Germany, and Brazil.
None of this is news to international policy-makers. In 2009 the G20, including the largest industrialized economies and major emerging and transition economies like Brazil, Russia, India, and China, replaced the G7 for international deliberations. The G7 was established in 1975 as a group of the six leading advanced economies, including Japan and the U.S., and Canada was added in 1976. The emergence of Brazil, Russia, India, and China is hardly news. In 2001 Jim O'Neill, then a Goldman Sachs economist, originated the terminology "BRIC economies". The BRICS have organized a sub-group that meets regularly before G20 meetings and recently added South Africa, one of the members of the G20, but not one of the larger emerging economies.
In making projections of economic growth, it is important to recall that productivity is defined as the ratio of output to input. Why is this important? Economic growth occurs through two different processes. The first is replication of existing technologies by hiring more workers and investing more capital. The growth of output increases in proportion to the growth of input, so that there is no contribution of productivity growth. The second process is innovation through changes in technology. This is far more difficult and much more risky. However, innovation holds out the promise of achieving increases in output that exceed the growth of inputs, so that productivity rises. Input growth greatly predominates over productivity as a source of U.S. economic growth. For the world economy and all of the economies I will discuss, replication greatly outstrips innovation.
After 2005 productivity growth in the world economy was negative. This poses a paradox: How could productivity growth, reflecting changes in technology, be negative? How can we forget the technology we already know? The answer is that the period after 2005 is dominated by the world-wide financial and economic crisis of 2007-2009. This opened a wide gap between potential output, determined by supplies of capital and labor inputs and productivity, and actual output. The actual level of output also reflects the deficiency of aggregate demand that accompanied the crisis. Negative productivity growth after 2005 reflects both advances of technology, which are positive, and the widening output gap, which is negative. Negative productivity growth has characterized all of the G7 economies after 2005.
I have limited my analysis to potential economic growth, leaving projections of actual growth to forecasters with more country-specific information like the IMF. I have tried to capture trends in demography and technology in the major countries. For example, the growth of the U.S. population and labor force will slow somewhat, but will continue to be relatively robust. Growth of the population and the labor force in Germany, Japan, and Russia will be negative. India's population will grow much more rapidly than China's.
World economic growth has undergone a powerful revival since 1995. The GDP growth rate jumped more than a full percentage point from 2.20 percent during 1990-1995 to 3.37 percent in 1995-2000 and then to 3.71 percent in 2000-2005. Not surprisingly, given the world-wide financial and economic crisis of 2007-2009, the growth of world GDP decelerated to 3.06 percent in 2005-2009. It is easy to appreciate the significance of more rapid growth by observing that GDP growth of 2.20 percent doubles world output every 32 years, while 3.71 percent growth doubles world output in less than 19 years.
Growth of output per capita in the United States will decline from 1990-2009 to 2010-2020, due mainly to slower upgrading of the labor force through education and experience. The baby boomers have already begun to retire, reducing the average level of experience. The educational attainment of age cohorts leaving the educational system has been steady for more than three decades and will be difficult to improve. These forces will reduce the growth of labor input and the rate of capital deepening, defined as the growth rate of capital input per capita.
Second, U.S. GDP growth will decline a bit more than growth of GDP per capita, due to a modest decline in labor force growth. In short, the U.S. growth rate of the past two decades will be nearly impossible to sustain. This could only occur under very optimistic assumptions about the development of technology and the additional capital deepening that this would induce. We also present a pessimistic scenario, based on the continuation of low growth rates of productivity like those that prevailed after 2005 and before 1995. Note the wide differences between optimistic and pessimistic scenarios, reflecting the enormous uncertainty of these projections.
Japanese growth in GDP per capita was 1.78 percent per year during 1990-2009 and will decline to 1.40 percent due to a slight decline in the upgrading of the labor force and a continuing slowdown in the rate of capital deepening. However, the continuing decline in the rate of growth of the labor force in Japan will reduce the growth of GDP from 0.84 percent from 1990-2009 to only 0.43 percent from 2010-2020. These projections are also subject to considerable uncertainty. A continuation of the slow growth of productivity before 1995 and after 2005 could reduce the Japanese growth rate of GDP to zero, while the more rapid growth of productivity during 1995-2005 could generate growth of one percent per year.
Growth of the world economy will decline by less than a quarter of a percentage point, relative to the robust growth of the past two decades. This is due mainly to the gradual slowing of labor force growth around the world and the reduced capital deepening that will result. Growth in the G7, already relatively low during the past two decades, will decline further. While the feverish growth of Developing Asia will also slow, the growth rate differential between the two regions will be more than four percentage points.
Turning, finally, to the emerging and transition economies, the outlook for China and India continues to be very sanguine, but quite different. Growth rates in China will fall, relative to the blistering pace of the past two decades, while remaining in the neighborhood of 7.5 percent per year. India's growth rate will rise to 6.5 percent, which is not sufficient to avoid a considerable fiscal consolidation. Russia's growth will be sufficient to double the size of the Russian economy within two decades and Russia will overtake Germany in 2019. Brazil will grow at the same rate as the world economy and will overtake the U.K. in 2012.
I have emphasized the enormous uncertainty in my projections for the U.S. and Japan. There are similar uncertainties for each of the leading economies. For example, China's double-digit growth for the past three decades has produced substantial imbalances, both internal and external. The ratio of investment to GDP has risen to historic highs while the ratio of personal consumption to GDP has steadily fallen. External imbalances like China's continuing accumulation of foreign exchange to preserve the undervaluation of the Chinese currency are also problematical. None of these trends is sustainable.
The emergence of Asia from the underdevelopment that persisted until the middle of the last century is the great economic achievement of our time. This has created a new model for economic growth built on globalization and the patient accumulation of human and nonhuman capital over decades. The new growth paradigm places a premium on skillful management by public and private authorities. The performance of the leading countries in developing this paradigm--Japan, then the Asian Tigers, and now China and India--has changed the course of economic development in Asia and around the world.
The role of the U.S., Japan, and other members of the G7 in the world economy has permanently diminished and will continue to decline in relative terms. This could strengthen populist forces on the left and right, diverting attention from the policy issues that have emerged from the financial and economic crisis. Ideological battles threaten to overwhelm the unfinished agenda of formulating and implementing sustainable fiscal and monetary policies.
The United States, Japan, and other industrialized countries will remain far in advance of China and India in terms of per capita GDP. But the experience of Japan and the four Asian Tigers tells us the advanced economies can emerge outside Europe and North America. It is only a matter of time until these developments spread to China, India, and the other major countries of Developing Asia. However, the time required will be measured in decades rather than years, providing an opportunity to accelerate the process of adjustment to the New World Economic Order in Japan, the United States and Europe. This is in the very early stages and will require rethinking our approach to business, the economy, and the political system.
January 1, 2012
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