Key Trends in Globalisation

Summary

One of the most important databases and analyses regarding the international economy released in the recent period is that calculated by Jorgenson and Vu to evaluate the relative contributions of capital, particularly information technology (IT), and labour inputs compared to that of total factor productivity (TFP) in GDP growth ((Jorgenson & Vu, 2007a), (Vu, 2007)) This has formed part of the World Bank’s International Comparison Programme (Jorgenson & Vu, 2009)). Because of the comprehensive nature of the published data trends can be identified in addition to those emphasised by Jorgenson and Vu themselves.

One of the most important of such trends is clear evidence that as economies become more developed the contribution of capital inputs to GDP growth increases relative to that of labour inputs, i.e. ‘capital-intensive’ growth replaces ‘labour-intensive’ growth. Such a pattern of transition from labour-intensive to capital-intensive growth with economic development would be important in itself and indicate a confirmation of analyses in classical economic theory.

The present article outlines these trends. It should be pointed out that while this paper utilises calculations based on data produced by Jorgenson and Vu they do not bear responsibility for conclusions drawn in the present article.

Source of economic growth in developed and developing economies

Table 1 sets out annual average GDP growth, together with the percentage contributions of capital, labour, and TFP, for 109 economies, 22 developed and 87 developing, for the ten year period 1995-2005. The calculations are from the data set out by Vu (Vu, 2007). Subgroups for developed and developing economies are shown. Table 2 sets out similar calculations from the data for periods defined by Jorgenson and Vu – 1989-1995, 1995-2000 and 2000-2005 (Jorgenson & Vu, 2007b).

In addition to periodisations, other differences between the two tables should be noted. Table 1 shows unweighted means and medians – i.e. the significance of each country is treated as equal, whereas the data of Jorgenson and Vu in Table 2 is weighted. In Table 1 improvements in labour quality are included in TFP, as in the data presented by Vu (Vu, 2007), whereas in Table 2 improvements in labour quality are included in labour inputs (Jorgenson & Vu, 2007b). There are 109 countries in Table 1 compared to 122 countries in Table 2. As will be seen, however, such differences do not alter the qualitative trends found.

The dominance of factor inputs in GDP growth

One of the fundamental findings of Jorgenson and Vu, shown in both Table 1 and Table 2, is the dominance of factor inputs of capital and labour compared to TFP in international economic growth. Taking all economies in Table 1, the mean percentage of growth accounted for by increases in inputs of capital and labour is 74.8% and the contribution of TFP growth is 25.1%. Taking the three periods defined by Jorgenson and Vu in Table 2, the contribution of factor inputs of capital and labour to GDP growth is 83.7%, 76.8% and 64.3%. From their data Jorgenson and Vu conclude: ‘We allocate the growth of world output, as measured in the World Bank’s International Comparison Program, between input growth and productivity. We find… that input growth greatly predominates. ‘(Jorgenson & Vu, 2009)

Role of capital inputs

Turning to a more detailed breakdown, the greatest contribution to GDP growth is from increase in capital inputs. Taking all economies in Table 1, the mean percentage contribution of increases in capital to GDP growth is 39.6% and the median contribution is 42.6% – which is above the mean of 35.2% and median of 35.1% for the contribution of increase in labour hours, which itself exceeds the mean contribution of TFP growth of 25.1% and median contribution of 25.1%.

Taking the periods defined by Jorgenson and Vu, the contribution of capital inputs to GDP growth is greater than either labour hours or TFP in all periods – at 54.1%, 46.4% and 40.7%. Jorgenson and Vu conclude: ‘About 40-45% of world growth can be attributed to the accumulation and deployment of capital and another 25-33% to the use of labour input… productivity accounted for only 20-35% of growth.’ (Jorgenson & Vu, 2009)

The different pattern of growth in developed and developing economies

Taking the data in Table 1, however, there is a clear contrast in the pattern of growth between developed and developing economies. The contribution of increases in capital inputs is significantly greater in the developed economies than in the developing ones – i.e. developed economies follow a ‘capital-intense’ path of development compared to developing economies. Considering all economies in Table 1, the mean contribution of capital inputs to GDP growth in developed economies is 52.9%, significantly above the 36.3% in developing economies. The median contribution of capital inputs to growth in developed economies is 50.6% compared to 39.3% in developing economies.

Table 1

Table 2 

In contrast to developed economies ‘capital-intense’ path of growth, the contribution of labour inputs to GDP growth is significantly higher in developing economies than in developed ones – i.e. in contrast to developed economies, developing economies have a ‘labour intense’ path of growth. The mean contribution of inputs of labour hours to GDP growth is 38.3% in developing economies compared to only 23.1% for developed economies, while the median contribution of increase in labour hours to GDP growth is 40.6% in developing economies compared to 23.8% for developed economies.

Summary of trends

Consolidating the above data, capital inputs are the dominant contribution to GDP growth in developed economies whereas the role of labour hours exceeds capital inputs in developing economies even if improvements in labour quality are included in TFP. The mean contributions to GDP growth in developed economies are, in order of percentage contribution, capital 52.9%, TFP 24.0%, and labour hours 23.1%, compared to, in developing economies, 38.3% labour hours, 36.3% capital, and 25.4% TFP. The median contributions to GDP growth in developed economies are capital 50.6%, TFP 26.0%, and labour hours 23.8%, compared to 40.6% labour hours, 39.3% capital, and 25.0% TFP in developing economies.

To see these trends visually, the mean percentage contribution of capital, labour hours and TFP to GDP growth for developed and developing countries is shown in Figure 1 and the median contributions in Figure 2.

Figure 1

Figure 2

Periodisation of Jorgenson and Vu

Jorgenson and Vu in their papers do not present a consolidated figure for all developed and all developing economies but the same pattern as in Table 1 may be seen from the data in Table 2:(1)

• In Jorgenson and Vu’s data, the percentage contribution of capital inputs to GDP growth in the G7 economies is the highest for any group in all periods. In all three periods capital investment contributed more than 50% of GDP growth in G7 economies. The capital-intensive path of development of G7 economies is therefore evident.

• The contribution of capital to GDP growth for the non-G7 developed economies is lower than for the G7 in all periods, but it is also higher than in the non-Asian developing countries in all periods. The contribution of capital to GDP growth for the non-G7 developed economies is higher than in the developing Asian economies for two periods and lower in one. This overall pattern confirms that, after the G7, the group of economies most dependent on capital investment for GDP growth is the non-G7 developed economies – although the gap with the East Asian developing economies is not great.
• The contribution of capital to GDP growth in the developing Asian economies is higher than for all other groups of developing economies in all periods – i.e. among developing economies the Asian economies most resemble the developed economies in the high intensity of capital investment in GDP growth.

• For the Latin American, Sub-Saharan African, and North African and Middle Eastern developing country groups, with only one exception, Sub-Saharan Africa in 2000-2006, the contribution of labour inputs to GDP growth exceeds the contribution of capital inputs to GDP growth in all periods.

• Eastern Europe(2), undergoing transition from Communism to capitalism, differs sharply from all other groups in that growth has weak inputs of capital and labour and relies primarily relied on TFP increases.

Therefore, although Jorgenson and Vu do not present a consolidated figure for developed and developing countries, the more capital-intensive character of economic growth in the developed economies compared to most developing economies is clear in their periodisation. Developing Asian economies constitute an ‘intermediate’ group between the majority of developing economies and the developed economies. The percentage contribution of capital to GDP growth in the periods and for the country groups defined in Jorgenson and Vu is shown visually in Figure 3.

More detailed analysis by country group within the above overall trends will now be considered.

Figure 3

The G7

The ‘capital-intensive’ pattern of development of the G7 economies is clear.(3) Taking the period 1995-2005 the G7 is the most capital-intensive in terms of its pattern of growth of any economy group. The mean contribution of capital inputs to GDP growth is 60.3% for the G7 compared to 39.6% for all economies, and the median contribution of capital inputs to GDP growth in the G7 is 50.9% compared to 42.6% for all economies – see Table 3.

Taking the periodisations of Jorgenson and Vu, shown in Table 2, the percentage contribution of capital inputs to GDP growth in the G7 is 60.0%, 53.4% and 56.3% – the highest of all groups for all periods.

The relative contribution of increases in labour hours to GDP growth in the G7 economies is low – a mean of 11.3% in the G7 economies compared to 35.2% in all economies and a median of 15.9% in the G7 economies compared to 35.1% for all economies. Taking the periodisation of Jorgenson and Vu the percentage contribution of labour inputs to GDP growth in the G7 is below the average for all economies in all periods.

The G7 economies therefore have a clear ‘capital intensive/low growth of labour inputs’ pattern of development.

Table 3

Non-G7 developed economies

The pattern of development of the non-G7 developed economies also shows a capital intensive path of development compared to developing economies.(4) Taking the period 1995-2005, the mean contribution of capital inputs to GDP growth is 49.5% for non-G7 developed economies compared to 36.3% for developing economies – the median contribution is 50.3% compared to 39.3% for developing economies. Compared to the G7, the contribution of capital inputs to GDP growth for non-G7 developed economies is either slightly lower or the same as for G7 economies – the mean for G7 economies being 60.3% and that for non-G7 developing economies being 49.5%. The median for the G7 economies is 50.9% and the median for non-G7 developed economies is 50.3%.

Taking the periodisation of Jorgenson and Vu, the non-G7 developed economies have a higher percentage contribution to GDP growth of capital inputs than all developing economy groups in all periods with the one exception of the East Asian developing economies in 2000-2005 – i.e. the more capital-intensive path of economic development in the non-G7 developed economies compared to developing economies is clear.

Given both G7 and the non-G7 developed economies have a more capital-intensive pattern of growth than developing economies, the more capital intensive growth of developed economies compared to developing economies is clear.

Table 4

East Asian and Asian developing economies

Jorgenson and Vu analyse the developing Asian economies as a single group – see Table 2. It may be preferable to divide them into an East Asian and a South Asian group – although the distinction is not vital from the point of view of the trends considered in this article. First the East Asian group will be considered and then the developing Asian economies as a whole.

The pattern of growth of the East Asian developing economies in the period 1995-2005 is shown in Table 5.(5) The East Asian group of developing economies are slightly less capital intensive in their path of development than the G7 and non-G7 developed economies – although the difference is not great. The mean percentage contribution of capital to GDP growth is 60.3% in the G7, 49.5% in the non-G7 Developed Economies and 47.2% in the East Asian Developing Economies, while the median contribution is 50.9% in the G7, 50.3% in the non-G7 Developed Economies and 48.4% in the East Asian economies. Overall, however, the East Asian developing economies clearly show a relatively similar capital-intensive path of GDP growth as the developed economies.

Taking the periodisation of Jorgenson and Vu, as shown in Table 2, and considering the developing Asian economies as whole, then as already noted the developing Asian economies have a lower percentage contribution to GDP growth of capital inputs compared to the G7 for all periods and compared to the non-G7 developed economies for two out of three periods. However, the developing Asian economies have a higher percentage contribution of capital inputs to GDP growth than all other groups of developing economies for all periods. The intermediate situation of the Asian/East Asian developing economies, in terms of capital-intensity of growth, between the developed economies and the other developing economies is therefore clear.

The developing East Asian/developing Asian economies are, however, not equidistant between the developed and the developing economies in their pattern of growth. Their pattern of growth, while not as capital-intensive as the developed economies is nevertheless closer, in its capital-intensity, to the developed economies than to the majority of developing economies.

Table 5

Other developing economies

Turning to wider groups of developing economies, Table 6 shows the pattern of GDP growth for the period 1995-2005 for developing economies excluding East Asia, which have already been examined, and Eastern Europe – which is analysed below. This covers 63 developing economies in South Asia, (6) Latin America,(7) Sub-Saharan Africa(8) and the Middle East and North Africa(9). This constitutes the majority of developing economies. The pattern of growth of these developing economies, compared to the developed economies and the developing East Asian/developing Asian economies, is clear. Unlike the developed economies and East Asian developing economies, GDP growth in these other groups of developing economies is dominated by labour inputs.

Taking the period 1995-2005 the mean contribution of inputs of labour hours for the 63 developing economies is 50.1% – compared to 28.8% for the East Asian developing economies, 28.5% for the non-G7 developed economies, and 11.3% for the G7 economies. The median contribution of inputs of labour hours is 44.2% compared to 26.9% for the East Asian developing economies, 24.5% for the non-G7 developing economies and 15.9% for the G7 economies.

Taking the periodisation of Jorgenson and Vu, as set out in Table 2, and taking their groupings of Sub-Saharan African, Latin American, and North African and Middle Eastern developing economies, the percentage contribution of inputs of labour is the highest input to GDP growth in all groups in all the periods up to 2006 except for Sub-Saharan Africa in 2000-2006.

The more labour-intensive path of growth of the majority of developing countries is clear.

Table 6

Eastern Europe and the former USSR

It may be seen from Table 2 that the pattern of economic changes in Eastern Europe in the period studied differed fundamentally from the rest of the world economy.(10)
The East European economies suffered severe falls in production in the early 1990s – this lasting until 1998 in the case of the former USSR.(11) The percentage contribution to GDP growth of input of labour hours in Eastern Europe and the former USSR was negative. The contribution of increase in capital inputs to GDP growth was very weak by comparison to the rest of the world economy. Taking the periodisation of Jorgenson and Vu, as shown in Table 2, after being negative in 1989-95, TFP accounted for 136.1% of GDP growth in Eastern Europe in the period 1995-2000, and for 88.9% in the period 2000-2005 – i.e unlike the rest of the world economy growth in Eastern Europe was overwhelmingly due to TFP increases.

This unique situation in the East European economies statistically raises the percentage contribution of TFP to GDP growth for the total economies in Table 1 and Table 2. However as Eastern Europe accounted for only 6.6% of the GDP of all countries analysed in 1989-1995, and only 5.5% in 1995-2000 and 2000-2005, the combined size of these economies is too small to alter substantively either the overall balance between inputs of capital and labour and TFP, or the capital intensive pattern of GDP growth of the developed economies.

The dependence of economic development on TFP growth in Eastern Europe may be regarded as either a unique one off event, due to the collapse of the former economic system in Eastern Europe and the former USSR, therefore not giving general lessons for economic growth, or treated as that in any period there will be statistical outliers. A case can therefore be made for excluding Eastern Europe and the former USSR from comparisons, on the grounds of their undergoing a unique experience, which would lower the average international contribution of TFP to GDP growth. However, in order to avoid the suggestion of selective inclusion of data, the case considered here is that of all economies including Eastern Europe.

Relevance to the path of development in classical economic theory

The finding that developed economies follow a capital-intensive path of growth compared to most developing economies, with the East Asian/Asian developing economies forming an intermediate group between the developed economies and other developing economies would be, of course, important in itself. It however would also cast light on an important issue in economic theory.

In the classic founding work of modern economics, The Wealth of Nations, Adam Smith analysed that the role of capital and intermediate inputs, which he jointly termed ‘stock’, would increase as an economy developed. Smith noted: ‘As the accumulation of stock must, in the nature of things, be previous to the division of labour, so labour can be more and more subdivided in proportion only as stock is previously more and more accumulated… As the division of labour advances, therefore, in order to give constant employment to an equal number of workmen, an equal stock of provisions, and a greater stock of materials and tools than what would have been necessary in a ruder state of things must be accumulated beforehand.’(Smith, 1999, p. 372) Other economists, including Keynes, arrived at the same conclusion of an increasing role of capital investment in economic development via a somewhat different chain of reasoning.(12) (For a wider discussion see Ross, 2009).

Smith, of course, had no systematic econometric data of the modern type with which to verify his findings – his conclusion was based on theoretical reasoning drawn from particular observations. Jorgenson and his collaborators have, however, already found that intermediate inputs, one element of Smith’s category of ‘stock’, grow more rapidly than capital, labour or TFP.(13) The finding in the data of Jorgenson and Vu that the percentage contribution of capital inputs to GDP growth is higher in developed than in developing economies is therefore also in line with, and casts important light on, Smith’s analysis and that of his successors.

Contrast of classical economic formulations with others

The pattern in the data calculated by Jorgenson and Vu is in line with classical economics. It however does not support other more recent theories regarding economic development. These contrasting views of the pattern of economic development are:

• Classical economic theory, as originally formulated by Adam Smith, foresaw a dynamic of transition from labour-intensive growth to more capital-intensive growth during economic development.

• Alternative theories, for example popularised by Krugman in regard to the East Asian economies (Krugman, 1994), instead suggested that the dynamic in economic development is one from growth dominated by factor inputs of capital and labour to one dominated by TFP growth in the most developed economies. (14)

The data presented by Jorgenson and Vu provides substantial evidence for the analysis of classical economics that economic development is accompanied by a transition from labour intensive to capital intensive growth. It however provides no evidence for the view that economic development leads to a greater role being played by TFP rather than factor inputs. Taking the six comparisons in the periodisation of Jorgenson and Vu (the two sets of developed economies, the G7 and the non-G7, times the three periods 1989-1995, 1995-2000, 2000-2005) TFP growth makes a lower percentage contribution to GDP growth in the developed economies than the average for all economies in four periods and a higher contribution in only two.

Conclusion

Jorgenson and Vu, in analysing their data, have emphasised:

• that capital and labour inputs predominate over TFP in GDP growth,
• the increasing role of IT investment in GDP growth,

However, a further significant trend is that their data shows a pattern whereby capital is the predominant input to GDP growth in developed economies – i.e. as economies develop they make a transition from labour-intensive to capital-intensive growth. Such a finding is of considerable importance:

• It indicates that, given such a pattern, an economy and its policy makers should anticipate growth becoming more capital intensive as an economy moves towards developed economy status.
• East Asian developing economies form an ‘intermediate’ group between the developed economies on the one side and the majority of developing economies on the other – although in greater reliance on capital inputs for growth than most developing economies they more resemble developed economies.
• Most developing economies are more dependent on labour inputs compared to capital inputs for GDP growth compared to developed economies.
• Such a transition from labour-intensive growth to capital-intensive growth as economies develop is in line with classic formulations of economic theory flowing from Adam Smith.
• Jorgenson and Vu’s data provides clear evidence in line with the classical economic view that as an economy develops its pattern of growth becomes more capital intensive, but it provides no evidence supporting views that as economies become more developed the role of factor inputs in GDP growth declines relative to TFP.
• Such a transition from labour intensive to capital intensive growth with economic development, while foreseen by classical economics, is not theorised in a number of standard contemporary treatments of economic growth – for a brief historical review see (Ross, 2009).(15)

The data produced by Jorgenson and Vu, and the trends it reveals, is therefore of great importance both from the practical point of view of view of study of economic growth and policy making, and from the point of view of economic theory.

* * *

Since this analysis was carried out Jorgenson and Vu have extended their data to 2008. (Jorgenson & Vu, 2010) The new data does not alter the main trends analysed above. A detailed analysis from the angle of approach in this article will be published here.

Notes

(1) Jorgenson and Vu note that for Latin America ‘The contribution of labour input was 1.77 before 1995, 1.70 from 1995-2000 and 1.82 after 2000, accounting for the lion’s share of regional growth.’ They also note for Sub-Saharan Africa: ‘As in Latin America, the contribution of labour input predominated throughout the period 1989-2004’ (Jorgenson & Vu, 2007a, p. 15).They do not however, make a generalisation to an overall pattern for developed and developing countries. It should also be noted that their data in the revised tables they have published (Jorgenson & Vu, ‘Information technology and the world growth resurgence – updated tables’, 2007b) differs from the original data in their article (Jorgenson & Vu, 2007a) in that its shows capital was the main percentage contributor to GDP growth in the non-G7 developed economies whereas the original data in their article indicated that labour input exceeded capital input in these economies and they had noted: ‘the non-G7 economies maintained rapid growth after 2000… The contribution of labour input predominated over capital input throughout the period 1989-2004.’ (Jorgenson & Vu, 2007a, p. 14)

(2) For conciseness Eastern Europe in this paper is to be taken as including the former USSR unless otherwise stated.

(3) Economies in the G7 are Canada, France, Germany, Italy, Japan, the UK and US.

(4) Countries in the Non-G7 Developed group are Australia, Austria, Belgium, Denmark, Finland, Greece, Ireland, Israel, Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, and Switzerland.

(5) Countries included in the East Asia developing economies group are Cambodia, China, Hong Kong China, Indonesia, Malaysia, Philippines, Singapore, South Korea, Thailand, Vietnam.

(6) Countries in the South Asia group are Bangla Desh, India, Nepal, Pakistan and Sri Lanka.

(7) Countries in the Latin American group are Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Ecuador, El Salvador, Guatemala, Honduras, Jamaica, Mexico, Nicaragua, Panama, Paraguay, Peru, Trinidad & Tobago, Uruguay, and Venezuela.

(8) Countries in the Sub-Saharan Africa group are Benin, Botswana, Burkina Faso, Cameroon, Central African Republic, Chad, Republic of Congo, Cote d’Ivoire, Ethiopia, Gabon, Ghana, Guinea, Kenya, Madagascar, Malawi, Mali, Mauritania, Mauritius, Mozambique, Namibia, Niger, Nigeria, Senegal and South Africa.

(9) Countries in the Middle East and North Africa group are Algeria, Egypt, Iran, Jordan, Lebanon, Morocco, Syrian Arab Republic, Tunisia, Turkey and Yemen.

(10) Countries in the East European group are Albania, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Russia, Slovak Republic, Slovenia and Ukraine.

(11) The latter states collectively experienced the largest declines in GDP in peacetime in the history of any modern economies

(12) Keynes derived the tendency of a rising role of investment with economic development from savings behaviour. It formed a cornerstone of his analysis of effective demand and crisis: ‘the richer the community, the wider will tend to be the gap between its actual and is potential production; and therefore the more obvious and outrageous the defects of the economy system. For a poor community will be prone to consume by far the greater part of its output, so that a very modest measure of investment will be sufficient to provide full employment; whereas a wealthy community will have to discover much ampler opportunities for investment if the saving propensities of its wealthier members are to be compatible with the employment of its poorer members. If in a potentially wealthy community the inducement to invest is weak, then in spite of its potential wealth, the working of the principle of effective demand will compel it to reduce its actual output, until, in spite of its potential wealth, it has become so poor that its surplus over its consumption is sufficiently diminished to correspond to the weakness of the inducement to invest.’ (Keynes, 1983, p. 31)

(13) For example analysing US industrial sectors Jorgenson, Gollop and Fraumeni found that intermediate inputs were the largest source of growth. They noted:

‘the contribution of intermediate input is by far the most significant source of growth in output. The contribution of intermediate input alone exceeds the rate of productivity growth for thirty six of the forty five industries for which we have a measure of intermediate input… the predominant contributions to output growth are those of intermediate, capital and labour inputs. By far the most important contribution is that of intermediate input.’[xiii] (Jorgenson, Gollop, & Fraumeni, 1999, p. 200)

Considering such findings for the US in more detail, Jorgenson concluded:

‘The analysis of sources of growth at the industry level is based on the decomposition of the growth rate of sectoral input into the sum of the contributions of intermediate, capital and labour inputs and the growth of sectoral productivity… The sum of the contributions of intermediate, capital, and labour inputs is the predominant source of growth of output for 46 of the 51 industries…

‘Comparing the contribution of intermediate input with other sources of growth demonstrates that this input is by far the most significant source of growth. The contribution of intermediate input exceeds productivity growth and the contributions of capital and labour inputs. If we focus attention on the contributions of capital and labour inputs alone, excluding intermediate input from consideration, these two inputs are a more important source of growth than changes in productivity… The explanatory power of this perspective is overwhelming at the sectoral level. For 46 of the 51 industrial sectors… the contribution of intermediate, capital and labour inputs is the predominant source of output growth. Changes in productivity account for the major portion of output growth in only five industries. (Jorgenson D. W., 1995, p. 5)

Regarding studies of rapidly growing Asian economies, Ren and Sun found for China that in the period 1981-2000, subdivided into 1984-88, 1988-94 and 1994-2000: ‘’Intermediate input growth is the primary source of output growth in most industries.’ (Ren & Sun, 2007). For Taiwan, analysing 26 sectors in 1981-99, Chi-Yuan Liang found regarding intermediate material inputs: ‘Material input is the biggest contributor to output growth in all sectors during 1981-99, except… seven’. (Liang C.-Y. , 2007). For South Korea Hak K. Pyo, Keun-Hee Rhee and Bongchan Ha found: ‘The relative magnitude of contribution to output growth is in the order of: material, capital, labour, TFP then energy.’ (Pyo, Rhee, & Ha, 2007)

(14) For an attempt to apply such an analysis to China see (Zheng, Bigsten, & Hu, 2009).

(15) For standard surveys of theories of economic growth see (Barro & Sala-i-Martin, 2004) or (Acemoglu, 2009).

Bibliography

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Jorgenson, D. W., & Vu, K. M. (2007b). ‘Information technology and the world growth resurgence – updated tables’. Retrieved from Dale Jorgenson: http://www.economics.harvard.edu/faculty/jorgenson/recent_work_jorgenson

Jorgenson, D. W., & Vu, K. M. (2009). ‘Growth accounting within the International Comparison Programme’. The ICP Bulletin , 6 (1).

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Liang, C.-Y. (2007). ‘Industry-wide total factor productivity and output growth in Taiwan, 1981-1999’. In D. W. Jorgenson, M. Kuroda, & K. Motohashi (Eds.), Productivity in Asia: Economic Growth and Competitiveness (pp. 146-184). Cheltenham: Edward Elgar.

Pyo, H. K., Rhee, K.-H., & Ha, B. (2007). ‘Growth accounting and productivity analysis by 33 industrial sectors in Korea (1984-2002)’. In D. W. Jorgenson, M. Kuroda, & K. Motohashi (Eds.), Productivity in Asia: Economic Growth and Competitiveness (pp. 113-145). Northampton: Edward Elgar.

Ren, R., & Sun, L. l. (2007). ‘Total factor productivity growth in Chinese industries, 1981-2000’. In D. W. Jorgenson, M. Kuroda, & K. Motohashi (Eds.), Productivity in Asia, Economic Growth and Competitiveness (pp. 76-112). Northampton: Edward Elgar.

Ross, J. (2009, September . ‘The Asian and Chinese economic growth models – implications of modern findings on economic growth’. Retrieved from Key Trends in Globalisation: http://ablog.typepad.com/keytrendsinglobalisation/2009/09/the-issue-of-whether-chinas-economic-stimulus-package-and-the-asian–growth–model-in-general-is-correct-and-therefore-its.html

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The outcome of the vote in the British general election corresponds to the trends analysed on this blog before it – as the figures below confirm.

That it was possible to foresee these trends beforehand demonstrates that the results of the election appear ’surprising’ or ‘confused’ only if a wrong analysis of the situation had been made – although such mistakes were made by many commentators, which led them to take it for granted for two years that the Tories would stroll to victory.

The real trends of the 2010 vote also have important features, in particular regarding the Tories and the Liberal Democrats, differing from the analysis still being presented after the election in sections of the media – these commentators are repeating the mistakes in analysis they made before the election. This article therefore looks at the real trends in the voting, why it was possible to foresee them, and what is their dynamic.

The election was the expression of long term trends

This blog noted before the election that the reason many commentators expressed ’surprise’ about the trends during the British general election campaign was that these were often presented as though they were a consequence of unanticipated short term events in the election such as the introduction of TV debates between the party leaders. Such a view was wrong. The only serious uncertainty at the election was the rather lottery like way in which the undemocratic features of the British voting system would allocate seats in parliament. The trends of support for the parties in the election were the logical continuation of long term social electoral trends.

The Tories

The way in which the trends in the results of the 2010 general election continue long term processes may be seen first in Figure 1 which shows the analysis of the Tory vote first presented by the present author in the book Thatcher and Friends and updated to include the result of the 2010 election as indicated by the BBC this morning – the final few results to declare will not shift the figures significantly.

It shows that while naturally there have been short term oscillations from election to election, which help produce individual Tory victories or defeats, the steady downward trend of support for the Conservative Party is entirely clear.

Tory support in the 2010 election was simply the latest oscillation within this declining fundamental trend and reveals that the decline in Tory social support has now reached the point where they are unable to form a majority government.

Figure 1

The Conservative vote has fallen progressively from its highest ever level, of 60.7% in 1931, to its post-World War II peak of 49.6% in 1955, to 41.9% the last time it won a majority of seats in an election in 1992, to 32.3% at the general election 2005.

Typically the Conservative vote, each time the party won a general election, was lower than at the one it won previously, and each time it lost an election its vote fell to a lower level than the previous defeat.

The result of the Tories at the 2010 election, at 37% of the vote, is 4.9% below the level they received the last time they were the largest party and therefore is clearly an oscillation within this fundamental declining trend.

Liberal Democrats

Turning to the Liberal Democrats a number of commentators have been misled by the Liberal Democrats poor showing in terms of seats at this election into believing that Liberal Democrat support had somehow declined. This is false – as may be seen from Figure 2.

In reality the 23% of the vote secured by the Liberal Democrats at this election is the highest achieved by the Liberals alone since World War II and is only a small margin behind the 25.4% achieved in alliance with the SDP in 1983. The fundamental trend of rising Liberal support for the last fifty years is clear from Figure 2. The Liberal Democrats were robbed by the electoral system. Their actual vote rose compared to the last election and its upward underlying trend was clear.

Figure 2

Labour

The Labour vote, at 29% at this election on current projections, was also a logical continuation of its previous long term trend – as may be seen in Figure 3.

Labour’s long term electoral support rose to a peak of slightly less than 50% in 1945-66 and then, with a temporary sharp depression in the 1970s and early 1980s, it has declined. Even in the 1997 landslide Labour only received 43.2%.

Conservative unpopularity, not high support for New Labour is why the Labour party was in office from 1997 onwards.The present decline continues that underlying trend.

Figure 3

Conclusion

The outcome of the 2010 general election was therefore the expression of profound and long term social processes – the long term decline of the social base of Tory support, the fact that Liberal Democrat support has been on a rising trend, the inability of Labour to raise its vote. These processes will therefore not be halted by whatever are the immediate steps after the election and whoever immediately forms the government.

If, as appears most likely immediately after the election, the Tories are able to temporarily form a minority government due to ‘tolerance’ by the Liberal Democrats, this will not stop the trend of Tory decline. As the Liberal Democrats would be tying themselves to a ’sinking ship’, and in the middle of an economic crisis, it is likely this would lead to a downward oscillation of the Liberal Democrats and a revival of Labour.

Britain is therefore still heading to a new political era of proportional representation and coalition government. The apparent ‘confusion’ coming from the 2010 general election were due to it being part of the break up of the old system. Because these processes are so deep and so powerful a minority Tory government will be incapable of halting them.

Britain is heading to a new political system.

Normally this blog deals with economics, and the implications of economics, rather than immediately  political trends. Readers with no interest in British politics can therefore skip this post and the discussion of voting patterns below.

But many commentators, not just in the UK, have expressed ‘surprise’ or ‘uncertainty’ about the present trends in the British general election with its outcome later this week .The trends in electoral support the campaign has revealed are often presented as though they were a consequence of unanticipated short term events in the election campaign such as the introduction of TV debates between the party leaders.This view is  wrong – as the figures below will demonstrate.

The only serious uncertainty in this election is actually the rather lottery like way in which the undemocratic features of the British voting system will allocate seats in parliament. Unlike most European countries the British electoral system has no element of proportionality in it. It allows governments to be formed on relatively extremely small proportions of the vote – indeed it is theoretically, and practically, possible in Britain that a party with only a little over one third of the vote may have a majority over parties which between them have received the vote of almost two thirds of the electorate. .

In reality the trends of support in the present British general election are the logical expression of long term social trends and they actually are related to economics. Twenty seven years ago the author of this blog wrote a book, Thatcher and Friends: the Anatomy of the Tory Party, demonstrating that the traditional governing party in Britain, the Conservatives, were a party suffering a long term decline in support and analysing the economic and social reasons for this and the consequences for other parties. The intervening period has confirmed these trends. So it is worth outlining, for those watching the election, the way in which the trends revealed in the British general election campaign are a result of long term processes.

The Conservative Party

Taking first the long term trend of the vote for the British Conservative party this is shown in Figure 1. This  shows that while naturally there have been short term oscillations from election to election, which help produce individual Tory victories or defeats, the steady downward trend of support for the Conservative Party is entirely clear.

Figure 1

The Conservative vote has fallen progressively from its highest ever level, of 60.7% in 1931, to its post-World War II peak of 49.6% in 1955, to 41.9% the last time it won an election in 1992, to 32.3% at the last general election 2005. Typically the Conservative vote, each time it won a general election, was lower than at the one it won previously, and each time it lost an election its vote fell to a lower level than the previous defeat. Tory support has therefore oscillated within a clear downward trend.

If the trend of the Tory votes were extrapolated mechanically to the current general election then it would receive slightly under 39% if they were to win this election and 33% if they were to lose it. Given this long term trend of decline of the Tory vote, which on the long term trend would fall in a range of 33-39%, it is naturally not surprising that the level of support for the Tories at this election has been lower than they, and much of the media, anticipated. It is very difficult to win an overall majority at an election with a maximum vote of 39%. This is why the Tories have failed to simply stroll to the easy victory at the polls that the media had taken for granted for the last two years.

The Liberal Democrats

Turning to the trend of the Liberal Democrat vote this is shown in shown in Figure 2. The clear upward trend, again naturally with short term oscillations, of the Liberal vote for the last half century is clear. The post-World War II share of the Liberal vote reached its lowest point at 2.6% in 1951. Its highest post-war share so far, in an explicit alliance with the Social Democratic Party (SDP), the majority of which later fused with the Liberals to form the Liberal Democrats, was 25.4% in 1983. The Liberal Democrat vote fell to 16.8% in 1997, the year of the great Labour Party landslide, but this was still far above its previous post-World War II lows. The Liberal Democrat vote then rose again to 22.1% in 2005.

Figure 2

The overall rising trend of the Liberal Democrat support is clear. If the current opinion polls are any guide, this will continue at this election.

This clear long term rising trend confirms that it was not ‘accidents’ which in this election campaign produced a high level of Liberal Democrat support – the normal ‘accident’ cited being the first ever TV debate between the party leaders. As someone said ‘history is the natural selection of accidents’ and the TV debate was simply the ‘accident’ the underlying social forces attached themselves to and expressed themselves via. Indeed, as the British website Political Betting has correctly pointed out, the Liberal Democrat rise in support started before the first TV debate between the party leaders on 15 April. Already by 8 April an ICM opinion poll showed that Liberal Democrat support in marginal seats had risen by 5% and in a national poll, most of which was carried out before 15 April, Liberal Democrat support had already risen to 27%.

Finally the Labour share of the vote is shown in Figure 3. This could overall be said to have shown a rise to a peak in 1945-66 followed by a decline since, except that there is a marked depression of the Labour vote in the 1970s and 1980s which breaks the simple trend – making the graph of support look rather like a round cheese with a bite out of it! However overall the rising trend of Labour support to a sustained peak in 1945-66, and then decline since, is clear.

The peak Labour vote in 1945-66 was slightly less than  fifty percent, before falling in the 1970s and reaching a trough in 1983, after the breakaway of the SDP, of 27.6%. It then rose to 43.2% in the landslide victory of 1997 and Labour received 35.2% at its last victory in 2005. The Labour landslide of 1997, and its maintenance of office since, was therefore not due to a high level of support for Labour by historical standards – most British governments have received far higher proportions of the vote, but was due to the huge fall of support for the Conservatives. Conservative unpopularity, not a high level of support for ‘new Labour’ is why the Labour Party was in office from 1997 onwards.

Figure 3

The continuing trends in British politics

Finally what do these trends show about the future course of British politics? If the British electoral system were seriously democratic, in the sense of reflecting in Parliament even remotely proportionately the levels of popular support for the parties, the outcome of the election would already be known. No party would receive an overall majority and we would already be into the issue of which coalitions would be formed to govern the country. But, as already noted, the unrepresentative character of the British electoral system means there is still a chance that one party could secure a majority in Parliament.

But such an outcome would not halt the long term processes. Britain is heading towards a new era of coalition politics and proportional representation. Not because of ‘accidents’ in the election campaign but because of the long term working out of powerful social trends.

In his blog from Davos Martin Wolf, chief economics commentator of the Financial Times, notes: ‘I am listening to Lawrence Summers as I write. He has emphasised that we cannot maintain global integration if it is seen as a source of domestic disintegration. This tension – that between the global economy and domestic politics – is a central challenge of our time. It affects everything we try to do.’

Martin Wolf is a very strong supporter of global economic integration for reasons he set out in Why Globalisation Works and numerous other writings. The danger he warns against is that popular backlashes in favour of protectionism will undermine the process of global economic integration. In the US and a number of European countries popular sentiment in favour of protectionism has increased – although its effect on those who make economic policy, as regards the most important issues, is as yet far more limited.

For slightly different reasons to Martin Wolf this blog is also strongly in favour of the process of global economic integration and against protectionism. The reason for this is that division of labour, followed by investment, is the most powerful force in economic growth and in the modern era participation in increasing division of labour is necessarily international in scope. Preventing popular, indeed any, backlashes in favour of protectionism is therefore an important question.

In dealing with this issue Martin Wolf could reflect on the difference in sentiment between India and China on the one hand and the US and Europe on the other. In India a government pledged to take the country down the strategic path of integration in the international economy was re-elected with a convincing mandate. In China, as anyone who visits the country knows, popular support for the ‘opening up process’ (official terminology for the country’s orientation towards globalisation) remains high. The contrast in popular mood between India and China on the one hand and the US and Europe on the other is therefore striking.

Part of this difference is, of course, the much more rapid growth of India’s and China’s economies compared to Europe and the US. However, simply rapid growth is not sufficient to maintain popular support for international economic integration – and while the US and European economies have been expanding less rapidly than India and China they were, prior to the current recession, still growing.

The former BJP government in India achieved rapid economic growth but was tossed out of office by the electorate. Entirely rationally the population will not support globalisation if this merely yields higher GDP figures recorded in statistical works,. They will support globalisation only if it delivers better living standards for them. The majority of India’s population considered the BJP’s rapid economic growth had not delivered for them and therefore voted against the government.

The strategic concept of the new Congress government under Manmohan Singh was, and remains, ‘inclusive growth’. It aimed at rapid growth, using global economic integration as a key means to achieve this, but did not rely on ‘trickle down’ to make sure the mass of the population shared in its benefits. Conscious programmes of redistribution of resources to rural areas, and less well off sections of the population, were part of the bedrock of ‘inclusive growth’.

It is also notable in China that Hu Jintao’s ‘harmonious society’ has included direct measures to redistribute the benefits of growth to those who were not previously perceived as having gained sufficiently. In China’s stimulus package to confront the international financial crises, price reductions on consumer durables were targeted on rural areas, the government has reintroduced free education, a major expansion of the health care system is taking place, large scale investment is taking place in the less well off inland provinces etc.

In short, both India and China have abandoned ‘trickle down’ as the method of ensuring all share in the growth produced by international economic integration.

In the US and Europe, on the contrary, the movement has been towards greater reliance on unfettered free markets. The evidence shows, however, that unfettered operation of the market increases inequality sharply. The most notable result of this is that median wages in the US have relatively stagnated for two decades at the same time as relatively sustained economic growth occurred – it is necessary to look no further than this to understand populist backlashes in the US. In the US the gap in income and wealth between the bottom and top of society has widened greatly, as it has in Britain. The US and Britain by relying on ‘trickle down’, by the operation of the free market, have therefore sharply increased inequality – and, in the case of the US, deterioration of the economic situation for significant layers of the population has occurred.

India and China, in short, have abandoned ‘tickle down’ while the US and Europe have embraced it. In India and China support for strategic global economic integration remains high. In the US and Europe a backlash against it has developed.

Martin Wolf, in his entirely justified argument against the US and Europe embarking on protectionism,  can therefore consider the contrast in the popular mood in India and China. It may indicate why, to maintain popular support for globalisation, the US and Europe also need to abandon reliance on ‘trickle down’.

Preparing for a panel discussion with Paul Krugman at Jiao Tong University in Shanghai led to reflection on how different the parameters of practical policy making are from those of academic economics. The questions asked and point of approach are frequently divergent

In policy making all theoretical and other arguments have to be aligned and concentrated around one settling one decisive issue – ‘what should be done’. That is, what is involved is a synthetic decision – assembling issues, and giving them their specific weights, around one point. In academic discussion exploration of distinctions and points can be pursued without settling the decisive practical question of what difference it makes to what should be done.

This particular reflection was reinforced by re-reading, to prepare the debate, Paul Krugman’s well known 1995 paper, ‘The Myth of Asia’s Miracle’. This analysis, arguments from which are still frequently used today, drew heavily on two quantitative papers by Alwyn Young on growth in the four Asian Tigers/Newly Industrialised Economies (NICs) of South Korea, Singapore, Taiwan and Hong Kong.[1]

In analysing the Asian Tiger economies Young/Krugman were attempting to deal with a theoretical/analytical issue. Was the rapid rate of growth of the South East Asian Tigers based on, or substantially contributed to, by a particularly high rate of growth of productivity – whether of labour, capital, or total factor productivity? Or to what degree was it based on quantitative growth of factors of production – i.e. accumulation of labour and capital?

It should be noted that the quantitative results of Young’s work has come under criticism – notably from Chang-Tai Hsieh. However, for the moment, leave statistical criticism aside and assume, for the sake of argument, that Young’s quantitative conclusions were correct – although, to be clear, this is done as a hypothesis and is not an acceptance of Young’s calculations per se. Then what follows?

Writing in 1995 Young noted that for the period 1960-85 the four Asian Tigers constituted four out of the five countries with the fastest growth of GDP per capita in the world – the fifth, Botswana, was an economy sufficiently small that no general conclusions would be drawn from it. However, after subtracting growth due to the increase in labour input (including increased participation in the workforce, higher educational achievement etc) and the rate of additions and improvements to capital, Young concluded that the growth of total factor productivity in the Asian Tiger economies was not remarkable. Summarising his article, Young wrote that he:

‘presents estimates of “total factor productivity” in the sample economies… the ranks of Taiwan and South Korea [among economies placed in descending order of growth of total factor productivity] are now reduced to 21st and 24th, respectively. While this remains a strong performance, it is no longer dramatically differentiated from that of the rest of the world economy. Fully 81 of the 118 sample economies lie within one standard deviation… of Taiwan and South Korea. Surprisingly, economies such as Bangladesh, Uganda, Iceland and Norway are now seen to have outperformed Korea and Taiwan, whose productivity growth is only 0.5% greater than that of a renowned laggard, the United Kingdom. Singapore, where participation and investment rates have risen faster than any of the NICs, is reduced to a rank of 63rd in the world economy.’

So, therefore, Young finds the growth of productivity in the NICs was average or slightly above average and their rapid growth was not primarily due to extraordinary growth in total factor productivity but was due to large scale quantitative inputs of capital and labour. To which the appropriate answer, from the point of view of economic growth, is: ‘yes, that is quite adequate, even very encouraging. For it shows that if it is possible to combine average productivity growth with very large quantitative inputs, then the economy’s rate of growth will be far higher than the average and very rapid in absolute terms – enough to industrialise a country in a single generation (which is what the NICs achieved).’

The point is a simple arithmetic one. The effectiveness of the contribution of investment, for example, to economic growth depends on the combination of its quantity and how efficiently the economy utilises it. This blog has noted on numerous occasions that there is a fundamental logical error in judging an economy’s growth potential by economic approaches which concentrate only on the efficiency of the use of investment rather than also analysing the quantity of investment. The quantitative relation of the relative scale of investment and the relative efficiency of investment is the critical one. If, for example, economy A utilises investment 20% more efficiently from the point of view of generating growth than economy B, but nevertheless economy B invests 50% more as a proportion of GDP, then economy B will grow more rapidly than A despite the fact that economy A uses its investment more efficiently.[2]

Young/Krugman demonstrate that the rate of productivity growth of the Asian Tiger economies is not below average, but only average, as a result of which these economies quantitative advantage in growth of inputs of investment and labour ensures much more rapid growth that economies with higher rates of total factor productivity growth but much lower rates of input growth.

This is why, for example, criticisms that countries such as South Korea, during their phases of rapid growth, allegedly allocated capital inefficiently compared to more ‘liberal’ economies such as Britain or the United States entirely miss the point. An economy such as South Korea invested so much more as a proportion of GDP, almost double the rate of the US, that unless, from the point of view of growth, its' efficiency of investment was only half that of the US the South Korean economy would still have grown more rapidly than the US.

Put in properly formulated economic terms the quantitative level of macro-economic allocation of resources to investment may be more important from the point of view of economic growth than the marginal efficiency of investment. Put crudely, when it comes to investment and growth, 'quantity' may simply be more important than 'quality'. That, for example, would by itself be enough to vindicate the present very high rates of investment in India and China.

Whether it has proved in practice a more viable growth strategy to have an average rate of growth of productivity, combined with very high quantitative inputs of investment and labour, or whether it is more effective to aim at the highest rate of growth of total factor productivity, with much smaller quantitative inputs of investment and labour, may be illustrated rather graphically by showing the rank order of countries produced by Young’s calculation.

Young found that the top five countries in terms of growth of total factor productivity, after he has carried out his adjustments, were as set out in Table 1. 

Table 1

In short, if highest possible growth in total factor productivity is the variable that should be targeted, then Egypt, Pakistan, Congo and Malta, together with Botswana, should be taken as the most successful economies in the world – the economic models to be emulated.

If, however, the key criteria of success is increase in GDP per capita, achieved, according to Young’s calculation, by the Asian Tiger economies combining average rate of growth in total factor productivity with massive quantitative inputs of investment and labour, then in contrast Table 2 shows the world ranking of economies.

Table 2

Which economic variable is in practice decisive in determining real economic outcomes may be shown graphically by taking the case of by far the worst performing case of total factor productivity according to Young/Krugman’s account – Singapore.

Singapore, poorly performing in terms of total factor productivity, has today, in Parity Purchasing Power terms, the 5th highest GDP per capita in the world – a level 9% higher than the United States. Egypt, which is better performing in terms of growth of total factor productivity, ranks 101st in the world with a GDP per capita only 13% that of the United States. While the second ranking, from the point of view of total factor productivity growth, Pakistan ranks 130th in the world with a GDP per capital 6% that of the US.

In short, taking for arguments sake Young and Krugman's calculations as entirely correct, then the route to actual economic success, in terms of economic growth and a high living standard, lay in the average rate of increase of total factor productivity, combined with massive quantitative inputs of capital and labour, of Singapore rather than in the high total factor productivity, combined with far lower quantitative growth of inputs, of Egypt, Congo and Pakistan. Or, put in deliberately shocking terms, 'quantity' (growth of factor inputs) was much more successful in determining growth in GDP per capita than 'quality' (growth in total factor productivity)!

It is, of course, possible to have a rate of growth of total factor productivity that is so low (potentially a negative number) that even the greatest increases in quantitative inputs cannot produce viable growth – the USSR in its final period represents such a case. But the case of the Asian Tiger economies showed that provided close to average increases in total factor productivity can be achieved then quantitative increases were the decisive ones. Put formally, the evidence is that provided an average, or near to
average, rate of total factor productivity growth can be achieved then
ensuring very large quantitative inputs proved a more viable growth
strategy than aiming to maximise efficiency – i.e. total factor
productivity growth.This is simply the arithmetical outcome of multiplying the rate of growth of factor productivity by the rate of growth of inputs. The criteria which must decide the strategy chosen is therefore that which maximises the rate of growth of GDP per capita, not the abstract theoretical one of maximising rate of growth of factor productivity.

Turning to India and China this has an immediate practical consequence. It means that even if it were to be assumed, for the sake of argument, that the efficiency of their use of investment were average, or even somewhat below average, then they might well be right to concentrate on massive inputs – to take the Singapore route. That, in turn, evidently raises the question of whether investment in India and China actually is inefficient – which goes beyond the scope of the present article, but will be returned to in a future article. But it should be noted from the above that even if, for the sake of argument, it were assumed that Krugman and Young’s quantitative premises are correct then this does not constitute a valid argument, from the point of view of the key variable of maximising the rate of growth of per capita GDP, against the effectiveness of the growth model followed by either the South East Asian Tiger economies or current policies pursued by India or China.

As stated at the beginning of this article, in economics quantity in some cases may simply be more important than quality.

Notes

[1] The argument of all three papers by young and Krugman was that the rapid growth of the NICs was based on quantitative accumulation of inputs of labour and capital and not on any productivity growth that was remarkable by international standards. The same analysis was then applied to China in Young’s 2003 paper ‘Gold into Base Metals: Productivity Growth in the People’ Republic of China during the Reform Period’.

[2] Ideally, of course, a combination of the maximum level of efficiency of investment from the point of view of economic growth and the maximum level of inputs would be achieved. However, while this is optimal in a purely abstract theoretical model in practice it may be necessary to chose between the two. An evident case of this is heavily state influenced financial systems aimed to maximise savings, as for example existed in Japan and South Korea during periods of rapid growth, versus those which are aimed to maximise the efficiency of use of savings. General discussion of this point, however, goes beyond the scope of this article.

This blog has analysed on several occasions that the current decline in financial markets, including share prices, has continued for 17 months to match in rapidity that after 1929 – i.e. the most severe recorded.
As may be seen from Figure 1 the rise in share prices on Wall Street in the trading week 9-13 March week did not break out of this declining trend. The shift so far has simply moved the rate of descent closer to the declining trendline that has been operating since October 2007 following several weeks of more precipitate than average falls.

As may be seen from the comparison in Figure 2 the rate of descent of the Dow Jones Industrial Average since October 2007 continues to be as rapid as in 1929 – i.e. it greatly exceeds in speed any other major share decline, apart from 1929, seen since the beginning of the 20th century.

Considering the relation between the financial decline and the productive economy, an article on this blog earlier this month also noted that, for the major industrialised economies, the annualised rate of decline in exports in the last three months has actually been more rapid than in 1929.

The latest statistical data released by the Organisation for Economic Co-operation and Development (OECD) for world trade up to December 2008, with data for more recent months in a few cases, allows the calculation of a picture for a wider range of countries that confirms this trend in striking fashion.

Due to the extremely rapid shift in the situation three indicators have been calculated for exports – the actual year on year decline to December 2008, the actual decline in exports since the peak month for each country or area last year, and the change during the three months to December 2008 on an annualised basis.

In order to give a historical scale of comparison the decline of US exports, in current prices, was 22.5% in 1929-30, 32.7% in 1930-31, 32.4% in 1931-32 and 4.0% in 1932-33 after which partial export recovery commenced – i.e. the most rapid annual rate of decline of US exports in the Great Depression, and the most rapid on record to date, was 32.7% in 1930-31. By 1933 US exports had fallen 66.2% below their 1929 level.

Considering first the OECD area as a whole, and the situation in the European region, the data is set out in Table 1. As can be seen for the OECD region as a whole exports have already declined by over 30% since their peak in April 2008 – essentially equaling the rates of decline of the worst year of the 1930s. The annualised rate of decline in three months up to December 2008 was an astonishing 64%.

For the major G7 economies the decline was only slightly less severe – with a decline of 26.9% since the peak in July and an annualised rate of decline of 57.8% in the three months to December 2008.

Within the Euro area the annualised rate of decline for the three months to December 2008 was 50.4% and for the OECD European region, which includes some East European states, the annualised rate of decline was 67.0%.

It may therefore be clearly said that in the field of trade, as in that of financial markets, the current decline is full comparable in speed of descent to the onset of the Great Depression. The difference, so far, is not in the speed of fall but in its duration. The decline in exports after 1929 continued for four years whereas so far the current decline has been occurring for a year.

Table 1

Turning to individual countries, Table 2 shows the figures for the largest OECD economies – the G7. As may be seen all have seen declines in exports of over 25% since their peak levels last year and in the three months to December 2008 all witnessed annualised rates of decline of more than 50%.

In short, the precipitate decline in world trade, at 1930s rates of descent, is not confined to smaller economies but fully affects the largest ones.

Table 2

Table 3 shows the rates of decline of exports for the non-G7 European OECD states. As may be seen with the exception of two small economies, Luxemburg and Ireland, which have done better than others, all OECD European countries have seen actual export declines of at least 25% and annualised rates of decline of 50% or more.

It is possible that the rate of decline for Spain, an incredible 99.7% annualised rate in the three months to December 2008, is a statistical freak or error but the annualised rates of decline for Sweden, Poland, and Norway are almost as severe – respectively, 79.1%, 82,8%, and 83.1%. Such rates may rightly be characterised not as decline but of collapse of exports in at least the short term.

Table 3

Turning to non-European economies, the data is set out in Table 4. Again, with the exception of the small economies of Iceland and New Zealand, the highly publicised decline of Chinese exports by 22.3% since their peak last year year, and at an annualised rate of 53.0% in the three months to December, are themselves actually significantly smaller than for other countries. Mexico and South Korea have already seen actual declines of exports of over 30% and South Africa and Turkey have seen falls of over 40%. The annualised rates of decline of exports for South Korea, Brazil, Indonesia, South Africa, and Turkey – at 70.7%, 72.4%, 78.2%, 82.1%, and 90.1% respectively – are clearly catastrophic.

Table 4

Countries for which OECD data is available for January confirm continuation of the same trend – as shown in Table 5. The chief difference is that with the extra month the actual declines in exports, as opposed to only the annualised rates of fall, have become more serious.

The actual falls recorded from the maximum levels of exports are 29.8% for Switzerland, 41.1% for South Africa, 41.4% for Sweden, 46.3% for Norway and 47.5% for Turkey. There is nothing in this pattern which indicates results for other countries are likely to show an improved tendency.

Summarising the above data, of the 34 countries studied 14 had annualised rates of decline of exports of more than 70% and 20 had rates of decline of more than 60%. The widely publicised reports of declines of exports in the last three months of last year such as the annualised 51.9% for Japan, 53.0% for China, or 54.0% for the US, which attracted much publicity, are actually modest compared to the falls in most countries.

While the annualised rates of decline show the extremely striking implosion of world trade during the last three months of 2008 an annualised rate, naturally, indicates an, in this case extremely severe, tendency. What is equally disturbing is the factual falls in exports recorded from the maximum levels last year. Seven countries registered actual falls in exports of more than 40% and 19 of more than 30%.

It should be noted that trade today plays a more significant role in the world economy than at the onset of the 1929 crisis. Exports in an economy with relatively low exposure to trade such as the US now account for 12% of US GDP compared to 7% in 1929 – the figures for most countries are of course much higher. The result of any continuation of such rapid rates of decline of trade therefore, all other things being equal, would be more severe than in 1929.

The transmission mechanisms of the financial crisis into the productive economy are also made clear by such trends. As has been noted previously, initially in the present crisis there was a disjunction between the decline in financial markets, which was of 1929 magnitude, and the situation of the productive economy – which was of a severe but not equivalent decline. As such a disjunction is highly unlikely to continue either financial markets would recover, having overshot on the downside, or the trends and statistics in the productive economy would be shown to have been a lagging indicator and they would adjust downwards to the tendencies indicated in financial markets.

The extraordinarily powerful falls in world exports shown in the latest figures for all major economies indicate that the decline in trade is operating as a key mechanism by which the crisis revealed in financial markets is beginning to affect the productive economy. It may now be said that in two areas of the world economy, financial markets and trade, rates of decline are fully comparable to 1929 scale. How powerful the transmission mechanisms from the international sector are into domestic economies must clearly be carefully studied. The duration of the crisis is also critical – the so far unique severity of 1929 was not only due to the rapidity of the fall but by its duration. The decline in US trade and GDP in the 1930s continued for four years whereas the current decline in financial markets has lasted 17 months,  the decline in trade slightly under one year, and the fall in GDP approximately six months.

Nevertheless quite sufficient data are now in to say with certainty that in the last three months of 2008 a convulsion in world trade occurred. The extreme rapidity of the fall in world trade, as with the situation in financial markets, confirms that the benchmark for present analyses must be not only post-World War II recessions but also 1929 itself.

Notes to Tables – peak month for exports in 2008

1. Peak January 2008
2. Peak March 2008
3. Peak April 2008
4. Peak May 2008
5. Peak June 2008
6. Peak July 2008
7. Peak August 2008
8. Peak September 2008

Data on long term trends in investment and economic growth

This post deals with the historic trend of investment and economic growth. This may appear a relatively esoteric topic. In fact, however, it has decisive economic and strategic business consequences – in particular for understanding the more rapid growth of the key Asian economies relative to the US and Europe and why this will continue for a prolonged period. Before dealing with these and other more detailed implications, however, the factual data is set out.

Figure 1 shows the percentage of fixed investment (gross fixed capital formation) in GDP for a series of major countries over the longest periods of time for which data is available. [1]

Figure 1

The pattern is clear and striking. By far the strongest trend is for the proportion of GDP devoted to fixed investment (gross domestic fixed capital formation) to rise with time. This in turn, as will be shown, is associated with progressively rising rates of economic growth.

Considering countries in the chronological order in which a new peak in the proportion of GDP devoted to gross fixed domestic capital formation appeared the following is the historical pattern.

·        Commencing with the period immediately antedating the industrial revolution, the proportion of GDP devoted to fixed investment in England and Wales, at the end of the 17^th century, was 5-7 per cent. [2] This rose slightly, although current estimates are that it did not rise greatly, during the 19^th century – peaking at over ten percent of UK GDP prior to World War I. 

This level of investment was sufficient to launch the first industrialisation of any country but at a rate of growth which, while unprecedented at the time, was extremely slow by contemporary international standards – about two per cent a year. With such a growth rate it takes 35 years for an economy to double in size and 70 years to quadruple.

·        Turning to the latter part of the 19th century, the proportion of US GDP devoted to fixed investment had risen to considerably exceed that for the UK – reaching a level of 18-20 per cent of GDP by the last decades of the century.

A sharp fall in the proportion of the US economy devoted to fixed investment commenced in the late 19^th century, and was particularly pronounced during the period between World War I and World War II – being associated with the great depression of the inter-war period. After World War II the US resumed its pattern of 18-20 per cent of GDP being devoted to gross fixed capital formation. This generated an average growth rate of 3.5 per cent a year. With such a growth rate an economy doubles in size every 20 years and quadruples in size every 40 years.  It was on the basis of this historical level of investment, and growth rate, that the US overtook Britain to become the world’s greatest economic power.       

·        In the period following World War II Germany achieved a level of fixed investment exceeding 25 per cent of GDP – peaking at 26.6 per cent in 1964. This period 1951-64 was that of the post-war German ‘economic miracle’ with average growth of 6.8 per cent a year – with such a growth rate an economy doubles in size every 11 years and quadruples in 22 years. 

·        Starting at the beginning of the 1960s Japan achieved a level of gross domestic fixed capital formation of more than 30 per cent of GDP. This reached a peak in the early 1970s, at 35 per cent of GDP, before later sharply falling. During that period the average annual rate of growth of the Japanese economy was 8.6 per cent. With such a growth rate an economy doubles in size in eight and half years and quadruples in size in 17 years.

·       From the 1970s onwards, South Korea similarly achieved a level of fixed investment of 30 per cent of GDP. During the 1980s this rose above 35 per cent of GDP.  The other East Asian ‘Tiger’ economies – Singapore, Hong Kong and Taiwan – showed a similar pattern.  South Korea’s economy confirmed the relation between fixed investment and economic growth illustrated by Japan by growing in this period by an average 8.3 per cent a year. At such a growth rate an economy doubles in size in nine years and quadruples in 18.

Such growth rates in Asia showed that something unprecedented in human history was now possible – that it was possible to industrialise an economy, and achieve a ‘first world’ level of development, in a single generation.

·        From the early 1990s onwards China achieved sustained rates of fixed investment of 35 per cent of GDP with, from the beginning of the 21^st century, this rising to more than 40 per cent of GDP – a level never before winessed in human history. The result was average 9.8 per cent a year economic growth over a sustained period – also the most rapid sustained economic growth ever seen in human history. On that basis an economy doubles in size every seven and a half years and quadruples in size in 15 years.

·       To complete the chronological picture, the proportion of GDP devoted to fixed investment for two countries recently undergoing rapid economic growth, India and Vietnam, is shown.

The proportion of Indian GDP devoted to fixed investment has not reached the Chinese level but has become high – reaching 34 per cent of GDP in 2007. On this basis, in the last five years, India has achieved an average growth rate of 8.8 per cent a year. At that rate of growth India’s economy doubles in size in slightly over eight years and quadruples in sixteen and a half years.

In Vietnam the proportion of GDP devoted to fixed investment rose from 13 per cent in 1990 to 25 per cent in 1995 to 37 per cent in 2007. Economic growth has accelerated rapidly, rising to an average of 7.9 per cent a year in the five years up to 2007. At that rate of growth Vietnam’s economy doubles in slightly under 9 years and quadruples in size in 18 years.

Considering these trends, such a high level of investment is a necessary condition for rapid economic growth. No substantial country without comparable high levels of fixed investment has achieved such rapid rates of growth on a sustained basis. [3] But it is not a sufficient condition: the high level of investment is also linked to the scale of production, that is the size of the market being produced for. In a modern economy only large scale production can be efficient in the decisive sectors of production, requiring an orientation to the international market – this is particularly evident with such high levels of investment.

No purely national market, not even the US or China, is sufficiently large to maintain the most efficient level of production. As many others have frequently correctly stressed, high levels of investment must therefore be accompanied by an export orientation. [4] It is this high level of investment, accompanied by an export orientation, which was responsible for the rapid economic growth of South Korea, China, India and Vietnam.

Implications of different investment levels

There are a number of clear consequences of these factual trends (it must be stressed that this data, of course, deals only with long and medium term trends and is not a guide to short term fluctuations).  Among the most important of these implictions are:

·         It provides a clear historical framework for understanding the present rapid growth of (primarily Asian) economies and why they will continue to grow far more rapidly than the US and Europe. 

·        China’s economy will continue to outperform India’s and the gap between the two will grow – and not shrink as some have suggested.

·        There is no serious historical evidence for the thesis sometimes presented that China is oversaving/overinvesting. China therefore should seek to maintain, and not cut, its current savings and investment levels.

·        Current US/UK economic policy, with its overwhelming emphasis on microeconomic efficiency of resource allocation, fails to address the most important economic issues and therefore will be unsuccessful – which will deepen the tendency for the key Asian economies to grow more rapidly than the US and Europe. The also provides a background to current issues in the credit crunch.

Taking these issues in more detail:

First, these trends place in wider historical context the present rapid growth of a number of (primarily Asian) economies. The latter represent the latest high point in the trend for higher and higher proportions of GDP to be devoted to fixed investment. Consideration of such trends therefore provides a clear theoretical underpinning for the evident current empirical fact that not only is Asia growing substantially more rapidly than the US and Europe but that it will continue to do so. The investment rates in the key Asian economies are not aberrantly high but merely the latest point in an historical trend.

Seen in long term historical perspective it is US and European savings and investment rates that are too low, not Asian savings and investment rates that are too high. 

Second, given these historic trends, it is clear that on the basis of current macroeconomic trends China’s economy will continue to expand more rapidly than India’s and that China will increase its economic lead over the latter.

This naturally does not mean anything other than that India is an extraordinarily important market. India’s economy is, at a realistic exchange rate, in Parity Purchasing Power (PPP) terms, the fourth largest economy in the world after the US, China and Japan.[6] India’s economic  growth, running at around at 8-9 per cent a year, is the second largest for any major economy in the world after China. However, China’s economy is already approximately two and a half times the size of India’s in PPP terms and is continuing to grow at one to two per cent a year more rapidly than India – this combination ensuring that the gap between China and India is widening and not narrowing.

There is also no evidence from consideration of historical data that the factors invoked to claim that India’s economy will grow more rapidly than China’s, for example different demographic profiles, are crucial. The historical evidence is that it is the proportion of the economy devoted to gross fixed capital formation that is decisive. The fact that, until the present, the Chinese economy continues to devote a significantly higher proportion of the economy to fixed investment than India – 43 per cent compared to 34 per cent to take the latest available years, indicates that unless India catches up with China in terms of this area China will grow more rapidly than India.

Third, there is no evidence from this historical trend data for the argument that China is facing a basic crisis of oversaving/overinvestment, and therefore that China needs to lower its total savings level (i.e. savings including private, public and corporate saving) and to increase consumption – as some commentators, including the Financial Times chief economics commentator Martin Wolf, have stated. [5]

It is evident that China’s level of investment and saving is far higher than that of the US or UK. However the historical data make clear that China’s is simply the latest stage in the long term trend for an increasing proportion of GDP to be devoted to gross fixed capital formation. Given this rising historical trend it is entirely likely that in the future another country, or China itself, will have a higher proportion of GDP devoted to saving/investment than China today – yielding a higher rate of growth. 

While, of course, short term fluctuations and adjustments may be required there is no historical evidence that China’s savings and investment rate is excessively high – it is merely the latest stage in a long term international historical trend. Reduction of China’s investment and savings rate would lead to slowdown not only of China’s economy but also, because of its locomotive role in the world economy, a slowdown in the global economy. China should therefore be seeking to maintain, not reduce, its current high investment and savings levels.

Fourth, there is no evidence from the historical data that the ‘quality of entrepreneurship’ plays any crucial role in economic development. Or more precisely, and what is another way of saying the same thing, the quality of entrepreneurship and managerial effectiveness appears to be randomly distributed and therefore cannot explain differences in economic growth rates. There are no cases where, due to the ‘quality of entrepreneurship’, countries have experienced rapid growth without high levels of gross domestic fixed capital formation in GDP.

Fifth, present US/UK government economic policy, by according overwhelming centrality to dealing with microeconomic efficiency, is addressing relatively minor issues in terms of international competitiveness compared to that of dealing with inadequate saving and investment rates. The economic priorities of a number of rapidly growing Asian economies will therefore clearly be more effective than that of the US and UK.

Put in other terms, the implications for governments’ economic policies of the long term trends outlined here is that in a balance between seeking microeconomic efficiency in the allocation of resources,  and seeking a high level of savings and investment, the high level of savings and investment is more important that the emphasis on microeconomic efficiency  from the point of view of creating economic growth.

There is an entirely reasonable supposition that the microeconomic allocation of investment in South Korea or China, given the use of subsidised loans, cross forms of ownership in different branches of industry, higher capital/output ratios etc, is less microeconomically efficient than in the UK or the US.  However the rate of growth of the South Korean or Chinese economies is much more rapid, over a sustained period, than that of the UK or US.

Quantitatively the greater microeconomic efficiencies in allocation of resources in the US or UK, to generate an equal rate of growth, would have to compensate for their lower savings and investment ratios and there is no evidence that it does so. It is the higher savings and investment rates in Asian economies that predominate over greater microeconomic efficiency.  Therefore any quality of microeconomic priorities in the US and UK will be overwhelmed by the quantity of investment in the rapidly growing economies of Asia.

Ideally, of course, both high microeconomic efficiency and high savings/investment levels should be sought. However there is evidence that the two are contradictory. For example  the policies pursued in the US and UK have been accompanied by massive declines of savings rates which have undermined the competitiveness of the economy – leading into present sharp financial problems.  It is therefore likely that current US and UK economic policy will be unsuccessful, and these economies will remain under financial pressure created by lack of competitiveness for a prolonged period. The credit crunch is a one periodic form of the manifestation of this loss of competitiveness by the US and UK.

Conclusions

The following clear conclusion may be drawn from this data:

There is a clear historical trend for the proportion of the economy devoted to gross domestic fixed capital formation to rise. This is the key determinant of rising rates of economic growth.

Five key historic stages in the rise in this proportion of the economy devoted to fixed investment may be identified: the achievement of a 5-7 per cent investment rate in Britain in the 18th century permitting the launching of the industrial revolution; an 18-20 per cent of GDP fixed investment rate from the latter part of the 19th century, achieved by a number of countries led by the US, which permitted the United States to replace the UK as the world’s leading economic power; a 25 per cent of GDP fixed investment rate in Germany in the immediate post-World War II period which accompanied the German ‘economic miracle’; a more than 30 per cent of GDP rate of fixed investment achieved in Japan, and then the other East Asian ‘Tiger’ economies, from the mid-1960s which permitted growth rates of more than 8 per cent a year; a more than 35 per cent of GDP fixed investment rate in China from the 1990s onwards which has permitted sustained growth rates approaching 10 per cent a year.

On the basis of this differential in investment rates a number of the key Asian economies will continue to outperform the US and Europe in terms of economic growth for a prolonged period.

China will continue to increase its economic lead over India – although the latter will experience rapid economic growth.

There is no historical evidence China is oversaving or overinvesting and it should seek to strategically maintain, and not cut, its present investment and saving rates.

Current US and UK economic policy addresses secondary issues and therefore is unlikely to be successful.

The current blog Key Trends in Globalisation is intended to be accessible to readers without  specialised economic knowledge and for those who do not necessarily wish to be follow detailed economic issues. The current post is placed here because the issue its deals with are of very great importance for understanding current trends in the world economy.
A companion blog Key Trends in the World Economy has therefore been established to deal with a wider range of economic issues. Notification of links to posts on Key Trends in the World Economy will be given on the current blog. But the full posts will not be reproduced here in order to maintain accessibility.

References – for detailed references see continuation of article

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One of the reasons for US economic dynamism compared to the UK and Europe has been its openness to immigration. Current immigration into the US is 1.3 million a year. This is projected to rise to two million a year by the middle of the century. http://www.nytimes.com/2008/08/14/washington/14census.html?_r=1&hp&oref=slogin
Immigration into the US has been particularly strong from Latin America and Asia – two of the most dynamic sectors of the world economy which therefore strengthens links between the US and these key economic regions as well as boosting the US population and labour force itself.
The current trend of immigration into the US is beginning to surpass the great wave at the beginning of the 20th century, when the proportion of the US population born abroad reached its peak at 15 per cent in 1910. The proportion of the population of the US born abroad is expected to rise from 12 per cent today, to 15 per cent in 2025, to 20 per cent in 2050.

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On a recent trip to India I had a meeting with a director of a leading Indian motor manufacturer. It gave many insights into relevant issues in the industry but the most striking was a much more general observation.
We were discussing – as is an inevitable topic of conversation with any foreign business figure – the deplorable state of Heathrow airport. This led to a discussion about the relative merits of various US airports which were considered preferable.
I remarked that I was suprised that he had not mentioned Singapore or Hong Kong, as these seemed to me superior even to the US airports he mentioned – or even Shanghai compared favourably to some he discussed. He replied: ‘Well yes, of course, but you can’t expect Asian standards in the US or Europe.’
Note the structure of the thought. He automatically considered the US and Europe on a lower standard of comparison than the most advanced Asian ones. Not that this applies, of course, to all Asian airports – Delhi or Mumbai themselves do not yet come up remotely to the best European or US standards. But he already internally judged that the highest levels set in Asia were on a far higher level than the US or Europe who had become ‘poor cousins’. This from a leading business figure.
Thirty years ago such a view would have been inconceivable. Today few outside Asia understand it exists. But it confirms once again just how much globalisation is not a purely economic process. It will transform perceptions as well. Not only an economic but a cultural earthquake is developing.

Most companies and commentators in the US and Europe, except at the very top, still greatly underestimate both the form and the scale of challenge that is coming not only from the BRIC economies but from Asia more generally.
To some extent the economic power of Asia is understood – although even here there is still frequent underestimation of the scale of the shift taking place. But the way in which this will progressively spread into other fields is still not adequately grasped. This process is only beginning but it will continue to deepen.
Fortune on 11 July therefore carries a particularly illuminating article on the effect that is beginning in the academic field.
http://postcards.blogs.fortune.cnn.com/2008/07/11/business-schools-new-tests/
Linda Livingstone, dean of Pepperdine’s Graziadio School of Business and Management, notes in an interview the process that is beginning to occur in terms of salaries paid for recruitment of some academic staff:
‘It used to be that students around the world, seeking a global business education, studied in the U.S. or Europe. Today, they sign up for MBA programs in China or India—or Abu Dhabi, Dubai or Qatar. “Hong Kong and Singapore are putting tremendous effort into their MBA programs,” Livingstone adds, “and hiring business faculty has become very competitive.” One professor she knows got an offer from a business school in Singapore for three times his U.S. salary.’
This concerns an academic area closest to business, MBAs, but sheer weight of money will make its way in the world. In the same way that, due to their dynamism, the Asian economies can outbid the US and Europe for oil they are able to outbid them for academic staff – greatly reinforcing their academic and cultural positions.
This process is only at its beginning and, except in Japan, it will take a whole period to raise the ’stock’ of Asian academic excellence, including in this the facilities available for research, to the same level as the US and Europe. But a number of Asian governments are consciously preparing this process. One of the most groundbreaking pieces of research carried out anywhere in the last period was the ‘cultural audit’ carried out by Shanghai – which London under Ken Livingstone took as a model for its own research in the field.
http://www.london.gov.uk/mayor/culture/docs/cultural-audit.pdf
http://www.thisislondon.co.uk/standard-mayor/article-23451724-details/Ken%27s+move+to+boost+London+as+world+culture+capital/article.do
This audit evidently underlay a systematic plan by Shanghai to raise its academic and cultural investment over a prolonged period – with the short term focus being strengthening its position in creative industries. The conclusion of the audit was that to achieve this Shanghai must undertake large scale investment over a prolonged period. But China has entirely adequate resources for this.
In the cultural and academic fields, compared to the economic, the shift in favour of Asia is only just beginning but is consequences will be deep.