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Asia and Policymaking for the Global Economy
BROOKINGS INSTITUTION PRESSCopyright © 2011 ASIAN DEVELOPMENT BANK INSTITUTE
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Chapter OneIntroduction and Overview
KEMAL DERVIS, MASAHIRO KAWAI, and DOMENICO LOMBARDI
Less than a decade ago, most economists and economic historians, looking at the nineteenth and twentieth centuries as a whole, or looking at the last decades of the twentieth century, still remarked that the process of global economic growth had been accompanied by a process of "divergence" of per capita incomes between a small group of rich countries and a large number of lower-income economies. The words of renowned growth theorist Elhanan Helpman are representative of most thought on the subject until quite recently: "Although the differences in income per capita among rich countries have declined in the postWorld War II period, the disparity between rich and poor countries has widened. At the same time the number of middle income countries has dwindled. We now have two polarized economic clubs: one rich, the other poor" (Helpman 2004).
This "divergence" had been a puzzle for growth theorists, because essential aspects of growth theory, notably Robert Solow's neoclassical growth model, suggested that diminishing returns to capital deepening would lead to "convergence" of per capita incomes (Solow 1956; Oxford Review of Economic Policy 2007). These models suggested that for a while the developing countries with less capital per worker would grow more rapidly than the mature economies with their higher capital-labor ratios, as these richer countries were farther along in the process of diminishing returns to capital accumulation. The developing countries did not grow more rapidly, however, in the decades following World War II, when development economics became a subdiscipline within the economics profession. Clearly the process of technological change that accompanied capital accumulation had been such that it more than compensated for the diminishing returns to capital in the advanced countries and allowed them to maintain their relative lead. Over the past two decades, and particularly since the turn of the twenty-first century, this has changed, with huge implications for the nature of the world economy, its growth dynamics, and the requirements for a system of global economic governance.
The global financial crisis of 200709 made the new convergence process due to more rapid growth in many emerging market economies very apparent. But the crisis merely underlined and accentuated a fundamental structural change in the world economy that had been taking place since the early 1990s. Convergence seems to have replaced the divergence referred to by Helpman. Emerging Asia is at the heart of the change, and the chapters in this book examine some of the key dimensions of this shift, which is continuing at full speed as we enter the second decade of the twenty-first century.
In the period following the Second World War, aggregate growth rates in the advanced industrial economies and growth rates in the rest of the world were not very far apart. Both groups saw much variation, with some countries and regions growing rapidly for certain subperiods and then far more slowly at other times. Parts of Latin America, for example, grew rapidly in the period from 1950 to 1980, and then stagnated during the 1980s and into the 1990s, before picking up new speed after the turn of the century. Many African countries experienced a few years of rapid growth after they gained independence, but soon most of them lost their growth momentum and many experienced negative per capita growth rates. Many developing countries also experienced high volatility, with good years followed by years of crisis and negative growth, often brought on by balance of payments difficulties.
Among the advanced countries, Japan grew spectacularly until 1990, and stagnated thereafter. From 1950 to 1970, Europe grew at a steady pace, even somewhat faster than the United States, but European growth slowed down significantly after the first oil crisis in the early 1970s. The United States also grew rapidly in the 1950s and 1960s, slowed down in the 1970s and 1980s, but picked up the pace in the 1990s. Overall, the period from 1950 to 1990 cannot be characterized as either a period of divergence or a period of convergence in per capita incomes, with the aggregate relative income gap between the advanced industrial economies and the emerging and developing countries neither widening nor narrowing significantly.
The picture started to change perceptibly in the 1990s, mainly because of the growth performance of the Asian countries. Growth in some Asian economies, such as Hong Kong, China; the Republic of Korea (henceforth, Korea); Taipei, China; and Singapore (the "Asian Tigers") had already reached relatively high levels in the mid-1960s. Growth in the People's Republic of China (henceforth, PRC) picked up from the late 1970s onward, and in India it started in the 1980s. Nonetheless, since the four Asian Tiger economies had small populations and the PRC and India were still very low-income economies, the weight of Asia remained small in the world economy until the 1990s, and the rapid Asian growth did not compensate for the sluggish growth in many other developing countries in terms of impact on the aggregate relative per capita income gap between advanced and developing economies. By 1990, Asia had gained enough weight in relative GDP that its rapid growth started to lead to a narrowing of the aggregate income gap between advanced and developing economies, despite continuing slow growth in Latin America and Africa. This new "convergence trend" continued into the twenty-first century, after a brief interruption at the time of the Asian crisis in 1997 and 1998, reinforced after the turn of the century by substantially better performance, also in Latin America and Africa.
While the nineteenth and twentieth centuries were times of divergence, it appears that the twenty-first century will be a century of convergence in the world economy. Looking at the very long run, it now seems that the nineteenth and twentieth centuries, with their colonial empires and Western domination, may turn out to be a limited period, a kind of parenthesis in world history. As the twenty-first century unfolds, the world may become much less divided by income levels than it has been since the Industrial Revolution, returning to a structurethough at much higher levels of income and prosperitythat existed for centuries before the Industrial Revolution. Per capita income differences between the traditionally rich countries and the developing world will persist for decades, but they are likely to decline over time, while the overall size of the rich economies will soon be overtaken by the aggregate size of the developing country economies, even when measured at market prices. At purchasing power parity prices, the emerging and developing countries have already caught up, in terms of aggregate size, with the advanced rich economies.
Climate and the environment may of course develop into new challenges, constraining growth for large parts of the world, advanced and developing; and there is unfortunately always the threat of devastating conflict that could create unforeseen upheaval. Some developing and emerging countries are particularly vulnerable to natural disasters. Moreover, some of the least-developed countries, where there is internal conflict and "state failure," are still "diverging," and extreme poverty remains a huge challenge, even in many middle-income countries. But looking at the world as a whole, a large percentage of the global population now lives in "emerging" countries that are closing the income gap that separates them from the mature advanced economies. Emerging Asia leads this process.
This volume analyzes the dynamics of growth in Asia comparatively and historically in a global context (chapter 2); appraises the scope for policy coordination among systemically important economies of the world (chapter 3); analyzes financial stability in Emerging Asia (chapter 4); and assesses the implications of the rise of Asia in the newly emerging global economic governance by focusing on the reform of the international monetary system (chapter 5). This introductory overview provides a brief summary of the topics analyzed in greater detail throughout the volume.
Structural Transformation in Asia and the World Economy
In chapter 2, Kemal Dervis and Karim Foda analyze the sources of the greatest structural transformation that the world economy has ever experienced in a three-decade period. Emerging Asia (EA), led by the PRC in terms of size and rate of growth, is very likely to reach close to one-quarter of world GDP at market prices by 2020, compared to 6.6 percent in 1990. The weight of EA in the world economy approached 16 percent in 2010. These percentages are much higher when output is measured at purchasing power parity (PPP) prices. Barring any cataclysmic political events, it is likely that this group of countries will sustain its strong growth momentum through the next decade, at least from the supply side.
To a degree, the rise of EA is in some ways similar to the rise of Japan during the postwar period. Over the three decades from 1960 to 1990, the share of Japanese GDP rose from 3.3 percent of world GDP to 13.3 percent. But the Japanese story involved about 120 million people, while the EA story involves close to 3 billion peopleabout 40 percent of the world's population. Japan's remarkable growth performance allowed it to join the club of the advanced economies. EA's growth performance is transforming in a very fundamental way the overall structure of the world economy and relocating its center of gravity.
In their analysis, Dervis and Foda point to two defining characteristics of the EA group: GDP growth rates and ratios of investment to GDP. In the aggregate, both investment rates and growth rates have been sufficiently high in EA countries to set them apart from most other countries. From 1999, the year after the Asian financial crisis, to 2008, EA growth was about three times as rapid as growth in the advanced economies and about twice the rate of growth in other emerging and developing economies. Over the same period, investment rates were high in EA countries, rising from about 29 percent of aggregate GDP in 1999 to about 38 percent in 2008, much higher than in any other part of the world.
Despite high investment rates, EA ran a significant current account surplus over the same period, indicating that the region has saved a higher proportion of income than the already high proportion it invests. This savings behavior has been providing the region with the ability to finance its own investments, and as EA's high growth rates indicate, the region has displayed the capacity and institutional effectiveness to translate investment into rapid economic growth.
EA has achieved this through the combination of rapid capital accumulation, driven by sustained high investment rates and fairly rapid technological progress as measured by the growth of total factor productivity. This is in contrast to what happened in the Soviet Union, which also had very high investment rates but was unable to generate much total factor productivity growth. Much of the growth in total factor productivity in EA can be attributed to the importation and adaptation of frontier technology (catch-up growth facilitated by openness to the world economy), large-scale rural-urban migration (moving labor from low- to higher-productivity activities), and improved factor allocation within the "modern sector" across industries and firms. In addition, many indicators of human capital formation, such as years of education, enrollment rates, and gender parity, have significantly improved in EA. In the PRC and Korea, tertiary school enrollment increased 16 and 18 percentage points, respectively, between 2000 and 2007.
The supply-side factors mentioned above will continue to be at work over the next decade at least, allowing growth at a pace similar to that of the recent past. The future sustainability of growth will also depend on the demand side. As a region with higher savings than investment, and thus a current account surplus, EA has shown that, in the aggregate, it does not need net foreign capital inflows to finance its high investment rates, but requires net foreign demand to ensure that potential growth is realized.
The debate over whether EA can sustain growth from the demand side centers on "global imbalances," where imbalances refer to current account surpluses or deficits. Most EA countries have run significant surpluses, with the PRC running the largest at $400 billion, or in the range of 1012 percent of GDP, at its peak in 200708. On the other side of the Pacific, the United States runs very large current account deficits, which reached $800 billion, or 6 percent of GDP, at their peak in 2006.
In addition to EA running large current account surpluses, it has accumulated large volumes of foreign exchange reserves, a strategy that originated in the wake of the Asian financial crisis of 199798, partly, at least, as an attempt to self-insure against volatile international capital flows. Emerging countries more generally adopted this strategy, adding $4.7 trillion to their foreign exchange reserves between 1999 and 2008, with EA accounting for most of this accumulation. On the other hand, the United States experienced a current account deficit of $5.7 trillion over the same period. It is possible, to a certain extent, to view the EA surplus and the U.S. deficit as mirror images, although both the United States and Emerging Asia traded with a multitude of other countries in other regions as well.
Some argue that the existence of current account imbalances should not necessarily be considered a major problem, because globalization should be expected to reduce home bias in the allocation of savings. In a globalizing world, countries or regions should not be expected to balance their current accounts. However, in a world of sovereign nations, national currencies, herd behavior in markets, and volatile capital flows, not to mention national authorities that intervene in foreign exchange markets and accumulate foreign exchange reserves, the situation is much more complicated. A truly integrated world economy driven entirely by efficient markets does not exist.
Going forward, there is broad agreement that the United States cannot continue to run its pre-crisis current account deficits and that EA cannot continue its pre-crisis surpluses, because, among other reasons, the United States is unlikely to be able to sustain high domestic demand owing to the deleveraging process, large household debt, the need to rebuild household assets, high unemployment, and lack of investment demand. In other words, a rebalancing of supply and demand around the world is needed to help ensure sustainable growth in the long run. In particular, the high-surplus PRC should increase the share of its domestic demand in total growth, offsetting a desirable decline in domestic demand as a share of total U.S. demand. This "rebalancing" need not, and should not, however, involve only the United States and the PRC. Too rapid and too drastic a decline in the Chinese "structural" surplus might not be feasible in the short run without triggering a decline in the Chinese growth rate, which would hurt not only the PRC but world growth as a whole (on this, see also chapter 3 by Rajiv Kumar and Dony Alex).
There is also the special case of Germany, with a large surplus but a currency that could be dragged downward by weakness elsewhere in the euro zone, a paradoxical dilemma that poses a particular challenge to global (and intra-European) rebalancing. Moreover, many emerging and developing economies outside Asia have high returns to investment but relatively low savings rates. Given the huge need for infrastructure and other investments in these countries, and the much improved macroeconomic frameworks in many of them, it would seem reasonable that they be net capital importers and run a moderate current account deficit in the aggregate. This would help counter the tendency for "ex ante" world savings to exceed "ex ante" world investment and help rebalance the world economy.
Dervis and Foda argue that it would be useful for policymakers to focus on the overall structure of savings and investment globally when trying to "rebalance" the world economy, as was tentatively agreed at the Seoul G-20 meeting in November of 2010. In this context it would be particularly desirable if more long-term capital could safely flow to capital-poor developing countries without creating the damaging "stop-and-go" cycles of the past. Besides private flows, official lending and guarantees from development banks can and should play an important role in reducing volatility and lengthening maturities. Official development finance remains relevant also in the context of resource transfers needed to fight climate change.
Excerpted from Asia and Policymaking for the Global Economy Copyright © 2011 by ASIAN DEVELOPMENT BANK INSTITUTE. Excerpted by permission of BROOKINGS INSTITUTION PRESS. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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