The outbreak of pessimism about the global economic outlook, which seems easy to justify in the case of the developed economies, has now begun to spread to the emerging economies as well. For example, John Plender and Michael Pettis have recently warned that “miracle” rates of growth in the emerging world, notably in China and the rest of Asia, cannot be expected to compensate for failing growth in the US and Europe. These warnings require us to ask some deeper questions about the longevity of the Asian growth miracle.
Before the financial crash, economists tended to attribute the explosion of growth in the emerging world to three main factors: improvements in fiscal and monetary policy, legal reforms to property rights and reductions in barriers to trade in order to encourage integration with world markets. It was widely believed that these three ingredients were both necessary and sufficient to unleash a process of convergence, whereby emerging economies would gradually import technology from the developed world, and would consequently close the productivity gap with countries such as the US.
Some thought that the convergence process, once started, would become semi-automatic, and would persist until the productivity gap had been closed entirely. This view (discussed by Ricardo Haussman in this 2006 paper) is the core reason why many economists’ medium term extrapolations of growth show the share of global GDP produced in the emerging markets increasing almost indefinitely.
Other economists, however, believe that the process of convergence is not automatic, but is the outcome of complex institutional forces which might not remain in place as economies and political systems develop. Harvard’s Dani Rodrik, a leading advocate of this view, presented fascinating new evidence on the subject in a paper at the Jackson Hole conference last week. His work demonstrates that it is in fact quite rare for a growth take-off to persist for as long as three successive decades (China’s started in the early 1990s), and it is quite common for the convergence process to stall in mid stream.
Rodrik shows that the outcome depends to a large extent on which sector of the economy dominates the growth process. In the case of manufacturing, the convergence process appears to be almost automatic, in that it tends to persist regardless of the institutional conditions which apply in a given economy through time. However, productivity convergence does not seem to persist in many private service sectors and government sectors, unless a series of complicated policy changes are brought into effect. Therefore those countries which can continuously shift resources into manufacturing sectors (primarily China and much of Asia) are likely to experience self-sustaining growth while others (like those in Latin America in previous decades, and possibly still today) do not.
So far, then, it seems that Asia should remain on its high growth path for a long time to come. Many Asian economies have induced labour to shift continuously from rural employment into urban, manufacturing jobs. They have done this by favouring their domestic manufacturing sectors through trade protection, industrial subsidies, government preference and undervalued exchange rates. This has resulted in an elusive combination where the manufacturing sector not only sees its productivity levels converge on western levels, but it also sees its relative size in the overall economy rising as well. (A necessary corollary of this process is that fixed investment needs to rise rapidly, a factor which John Ross has frequently identified as the crucial ingredient in China’s growth miracle.)
So where is the problem? Rodrik argues that the ability of China and other Asian economies to pursue their growth strategy will be increasingly circumscribed by two factors: the onset of political maturity, and the refusal of other economies (emerging and developed) to run ever-increasing trade deficits with Asia.
Political maturity matters because it complicates a country’s ability to run a strategy which requires low wages, the subsidisation of manufacturing industry, and simultaneously the suppression of financial returns to household savings. We can already see that this combination might become politically unacceptable fairly soon in some Asian economies. And trade relationships matter because partners like the US will become increasingly opposed to Asian imports now that they have a chronic problem with excessive unemployment at home. International pressures to reduce domestic subsidies to Asian exporters, and to raise real exchange rates, will intensify.
Rodrik reckons that the rise in Asian real exchange rates will be particularly important. His work suggests that a 20 per cent rise in the real value of the yuan will slow the growth process sufficiently to reduce trend GDP growth in China by 2 per cent per annum. This, he says, “would push China dangerously close to the minimum threshold …necessary to maintain social peace and avert social strife”.
To which I would reply….maybe.
The Asian growth model is likely to run into more problems in the 2010s than it did in the 2000s, for the reasons which Rodrik and Pettis suggest. But it is all a matter of degree. China’s real exchange rate has in fact already risen by 20 per cent since 2005, and trend growth does not seem to have fallen at all, even in the face of a deep global recession. Meanwhile, domestic wages are beginning to rise, and the subsidisation of manufacturing industries is being progressively phased out as a condition of World Trade Organisation membership. Even so, export growth remains above 20 per cent per annum as China boosts its sales to other emerging economies.
Of course, growth in Asia cannot defy gravity forever. There may well be boom and bust cycles, as there have been in many emerging economies in the past. But the underlying growth process identified by Rodrik and others is unlikely to disappear overnight. China’s leadership has embarked on a process of gradual adjustment, and they might well be able to pull it off in the next decade. Growth might progressively slow down, but would still remain extraordinarily high by any historic standard.