Key Trends in Globalisation

Key Trends in Globalisation has published two articles on: (i) the contribution of capital investment to GDP growth in developed and developing economies,(1) (ii) differing patterns of labour inputs in developed and developing economies.(2) These are based on analyses of the major database on international growth published by Jorgenson and Vu (Jorgenson & Vu, 2007b). The reason for such detailed analysis is both the importance of the issues involved and a relation to long standing research topics. The present article introduces these articles.

The most fundamental issue involved is that of the tendency of the contribution of investment to economic growth to increase with economic development. This trend was first analysed by Adam Smith and affirmed by other economists including Keynes.(3)However, it was rejected in analyses of economic growth put forward by various mid 20th century theorists. The latter asserted, against the analysis flowing from Adam Smith, that the division of the economy between investment and consumption remained constant with economic development – this is, of course, a central assumption of the widely employed Cobb-Douglas production function, of the economic growth model put forward by Solow (Solow, 1957), and continues to be repeated in many(4), although no longer all,(5) economic textbooks.

As discussed in detail elsewhere (Ross, 2009), the present author from the early 1970s concluded, on the basis of the long term historical data on growth that was then beginning to be published, than Adam Smith and those who followed his analysis were clearly correct. Despite the fact that the theories of Solow et al of a constant contribution of investment to GDP growth were the prevailing orthodoxy they were clearly contradicted by the historical data. Jorgenson has outlined more general reasons for the breakdown of such econometric models. (Jorgenson D. W., 2009) The theory that the proportion of the economy devoted to investment remained constant, rather than rose with economic development, was erroneous and classical economics was correct.

Initial statistical unclarity in this discussion was undoubtedly aided by the fact that the US is untypical in that, unlike the great majority of other economies, the proportion of the US economy devoted to fixed investment has indeed not risen for the approximately 150 year period for which reliable statistical data exists. (Ross, 2008a) (Barro & Sala-i-Martin, 2004).(6) Analyses based on generalisations from the US, therefore, arrived at the erroneous generalisation of a constant, rather than rising, share of investment in GDP.(7)

A consequence of the difference between the pattern in the US economy and the general international trend of a rising share of investment in GDP, is that the US share of fixed investment in GDP, which was above the international average in the 19th and first halt of the 20th century, has now fallen below the international average – in particular the US level of investment in GDP has fallen below the level of rapidly growing Asian economies. This contributes to the slow growth of the US economy compared to Asian competitors, the US balance of payments deficit with Asia, and present international financial developments. (Ross, 2008b)

The question of whether the role of fixed investment in economic growth rises with economic development, or remains constant, has numerous practical economic implications. The key pieces of evidence demonstrating the rising contribution of fixed investment to GDP growth with economic development, prior to the publication of the database of Jorgenson and Vu, included:

1. Trends in leading international growth economies. The analysis of leading growth economies, in successive historical periods of economic development from the 18^th century, carried out by the present author from the 1970s onwards, showed that each such leading economy – in chronological succession the UK, the US, West Germany, Japan, South Korea and now China – was characterised by a higher percentage of fixed investment in GDP than the preceding lead growth economy. This trend is shown in Figure 1.

Figure 1

2. The comprehensive comparative analyses, published by Angus Maddison, of economic growth in developed economies since World War II, including his Phases of Capitalist Development (Maddison, 1982) and Dynamic Forces in Capitalist Development (Maddison, 1991), demonstrated that capital investment was the largest contributor to post-World War II GDP growth in a wide range of advanced economies. Maddison demonstrated over a longer time frame than the post-World War II period that both non-residential fixed investment rates and savings rates, which were correlated with fixed investment rates, rose with time in most advanced economies – the US, as already noted, being an exception and not a rule. (Maddison, 1992)

3. Studies by Jorgenson and his co-authors demonstrated that capital investment was the largest single contribution to GDP growth in the US, the G7 and a number of developed economies.(8)

While these studies analysed a wide range of developed, and a number of leading developing, economies they were however not entirely comprehensive in coverage – in particular they did not include a comprehensive range of developing economies. The publication by Jorgenson and Vu (Jorgenson & Vu, 2007b) of a comprehensive growth accounting base for up to 122 economies, constituting more than 95% of world GDP, therefore provides an opportunity to fill this major gap.

A striking trend that may be analysed in its data, in addition to those drawn attention to by Jorgenson and Vu themselves, is that GDP growth in developed economies is capital-intensive while GDP growth in most developing economies is labour- intensive. The path of economic development is therefore a transition from labour intensive growth to capital intensive growth. The East Asian developing economies may be seen as an intermediate group between the majority of developing economies and the developed economies.

Such a pattern is, of course, consistent with the other evidence showing the rising contribution of investment to GDP growth with economic development. However, such a comprehensive database for evaluation of these trends has not previously been available – in particular it allows an integration of trends in developing economies with those in developed economies. It is for this reason that these three analyses of trends in the data of Jorgenson and Vu for capital and labour inputs in different stages of economic development have been published.

Summary

It is clear on the basis of the above data that there is overwhelming evidence of a tendency for the contribution of investment to GDP growth to rise with economic development. In light of such clear evidence it is evident that the assertion that the contribution of investment to GDP growth remains constant with time, rather than rising, is erroneous.

Economic models and theories therefore must take into account that the contribution of investment to GDP growth increases with economic development – Adam Smith and those who followed him on this issue were correct.

The implications of this for economic theory and practice of such a trend are numerous as has been analysed elsewhere (Ross, 2008a).

The normal disclaimer must, of course, be made that while these papers utilise calculations based on data produced by Jorgenson and Vu they do not bear responsibility for the conclusions drawn.

* * *

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.

Notes

(1) (Ross, 2010a)

(2) (Ross, 2010b)

(3) In 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) Keynes, arrived at the same conclusion of an increasing role of capital investment in economic development via a somewhat different chain of reasoning related to savings behaviour: ‘the richer the community, the wider will be the gap between its actual and its potential production… For a poor community will be prone to consumer 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.’ (Keynes, 1983, p. 31) For a wider discussion see (Ross, 2009).

(4) Romer for example asserts ‘The growth rates of output and capital has been about equal (so that the capital-output ratio has been approximately constant).’ (Romer, 2006, p. 17) Blanchard asserts: ‘the savings rate does not appear to systematically increase or decrease as a country becomes richer.’ (Blanchard, 2006, p. 226)

(5) It is clearly rejected, as noted below, in (Barro & Sala-i-Martin, 2004)

(6) The initial data on which the present author arrived at the conclusion of confirmation of a rising share of investment in GDP was based on calculations from (Deane & Cole, 1967), (Feinstein, 1972), (Mitchell, 1980), (Economist, The, 1982), (Lister, 1989). Barro and Sala-i-Martin note: ‘For the United States, the striking observation… is the stability over time of the ratios for domestic investment and saving… The United States is, however, an outlier with respect to the stability of its investment and saving ratios; the data for the other seven countries [analysed] show a clear increase in these ratios over time… The long-term data therefore suggest that the ratios to GDP of gross domestic investment and gross national savings tend to rise as an economy develops, at least over some range. The assumption of a constant gross savings ratio, which appears… in the Solow-Swan model, misses the regularity in this data.’ (Barro & Sala-i-Martin, 2004, p. 15) Baro and Sala-i-Martin do not, however, draw out all the implications of this.

(7) Similar assertions were, however, also made by those who were centred on the UK economy – despite the fact that the UK economy showed a clear tendency for the proportion of investment in GDP to rise with time. Kaldor for example, in a widely cited paper, claimed as one of his ‘stylised facts’ on economic growth: ‘Steady capital-output ratios over long periods; at least there are no clear long term trends, either rising or falling, if differences in the degree of utilisation of capacity are allowed for. This implies, or reflects, the near identity in the percentage rates of growth of production and the capital stock – i.e. that for the economy as a whole, and over long periods, income and capital tend to grow at the same rate.’ (Kaldor, 1961, p. 178)

(8) See for example (Jorgenson & Yip, 2001), (Jorgenson D. W., 2003). Other authors have, of course, also noted the rising proportion of investment in GDP growth – see for example (Jones, 1995) and (De Long & Summers, 1992).

Bibliography

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Blanchard, O. (2006). Macroeconomics. Upper Saddle River: Pearson Prentice Hall.

De Long, J. B., & Summers, L. H. (1992, revised October 1992). Equpment investment and economic growth. Retrieved August 22, 2010, from http://j-bradford-delong.net/pdf_files/Brookings_Equipment.pdf

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Jones, C. I. (1995). Time series tests of endogenous growth models. The Quarterly Journal of Economics , 110 (2), 495-525.

Jorgenson, D. W. (2003). ‘Information technology and the G7 economies’. World Economics , 4 (4), 139-169.

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

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. (2010). Potential growth of the world economy. Journal of Policy Modeling (doi:10.1016/j.polmod.2010.07.011).

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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

Jorgenson, D. W. (1995). ‘Productivity and postwar US economic growth’. In D. W. Jorgenson, Productivity (Vol. 1, pp. 1-23). Cambridge, Massachusetts: The MIT Press.

Jorgenson, D. W., & Vu, K. M. (2007a). ‘Information technology and the world growth resurgence’. German Economic Review , 8 (5).

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).

Jorgenson, D. W., Gollop, F. M., & Fraumeni, B. M. (1987). Productivity and US Economic Growth. Harvard University Press.

Keynes, J. M. (1936). The General Theory of Employment, Interest and Money. London: MacMillan.

Krugman, P. (1994). ‘The myth of Asia’s miracle’. Foreign Affairs , 62-78.

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

Smith, A. (1999). The Wealth of Nations. London: Penguin.

Vu, K. M. (2007). ‘Determinants of economic growth over the period 1995-2005′. Retrieved from http://docs.google.com/viewer?a=v&q=cache:s7odRXb7owsJ:www.spp.nus.edu.sg/Handler.ashx%3Fpath%3DData/Site/SiteDocuments/wp/wp0907.pdf+%22Determinants+of+Economic+Growth+Over+the+Period+1995-2005%22+Vu&hl=en&gl=uk&pid=bl&srcid=ADGEESj9omj1MsLK6PX0-ns9×4Gvz

Zheng, J., Bigsten, A., & Hu, A. (2009). ‘Can China’s growth be sustained? A productivity perspective’. World Development , 37 (4), 874-888.

Data released by the German statistical service shows how much Germany, until this year the world’s largest exporter, and still the second largest, relies on its European market – particularly in a period of severe economic downturn such as 2009.

Approximately three quarters of German exports were to European countries. 63% of all exported German goods were delivered to the member states of the European Union.

Asia, the second most important market for German export goods in 2009, trailed far behind with 14% of German exports. The US accounted for 10%.. Africa and Oceania (including Australia) accounted for only 2% and 1% of German exports.

In terms of imports Germany was almost equally Europe dominated. 71% of Germany’s imports came from Europe, with 18% from Asia and 9% from the US. Goods from Africa and Oceania represented just 2% and 0.4%, of Germany’s imports.

Germany’s economy, in short, is not really a balanced ‘international’ one – in particular in an economic downturn. It is, in export terms in particular, a European continental economy with secondary add ons in Asia and the US.

What implications flow from this?

The first is to reinforce the decisiveness of preserving the Eurozone for Germany – as against somewhat facile talk that the Euro may split or disintegrate. Germany has by far the highest percentage of exports in GDP of any major economy – 47.1% on the eve of the international financial crisis in the 2nd quarter of 2008. This has increased hugely, from 28.0%, since the introduction of the Euro.

The fact that Germany is operating in a continental scale economy, Eurozone Europe, with a fixed exchange rate, allows it to gain or maintain tremendous economies of scale. Conversely introduction of unstable exchange rates,including the possibility for major European trading partners to carry out competitive devaluations, would almost certainly make it impossible for Germany to maintain such a high proportion of exports in its economy – that is it would greatly weaken the ‘continental’ scale of its economy. The Euro, in short, is not a ‘monetary union’ but a decisive mechanism for Germany to enjoy the advantages of a continental scale economy. As the gains are great German economic policy, being rational, can pay a major price to maintain the Euro – something to be kept in mind in the coming battles over debt in Greece, Portugal and Spain.

Second, the trade data casts an important light on the optimal size of a modern economy. It is well known that the world’s largest and most productive economy, the US, has only a relatively small share of foreign trade in GDP. In the 2nd quarter of 2008, prior to the recent decline in world trade, exports accounted for 13.6% of US GDP and imports for 18.5% – evidently far below German levels. Exports of goods and services were only 5.7% of US GDP in 1929, 3.4% of US GDP in 1938, and 7.0% of US GDP in 1950.

The reason for the far more self-contained character of the US economy, of course, is the fact that it was the first continental scale integrated economy in history. The second continental scale economy was the USSR, which has since disintegrated, the third is China and the fourth is India. Germany’s economic configuration is that of the single most important component of a continental scale economy attempting to come into existence in Europe. Whether it succeeds or not of course depends on the future course of European integration.

These parameters also cast a very interesting light on possible future dynamics of China’s economy. China’s economy is far more open than any economy of its scale has been historically. In real, that is parity purchasing power (PPP), terms China’s has already been the second largest economy in the world for several years. In PPP terms China’s economy is slightly over half the size of the US – on IMF calculations $7.9 trillion compared to $14.3 trillion. In terms of percentage of GDP, at official exchange rates, China’s exports of goods and services peaked at 39.1% of GDP in 2006 – far exceeding the ratio of exports to GDP of the US. By 2008, under the impact of the upward movement in the exchange rate of the RMB, and the beginning of the international financial crisis, exports of goods and services had fallen slightly to 35.9% of China’s GDP.

If China’s exports in dollars are compared to a parity purchasing power figure for its GDP, however, then  exports are only 20% of GDP. This is still above the figure for the US but not vastly so. It is entirely possible that as the size of China’s GDP at official exchange rate grows towards US levels, both through economic growth and revaluation of the RMB, the percentage of exports in China’s GDP will actually decrease. Unlike the historical pattern of most economies, which developed on the basis of their domestic markets and then expanded into exports, China may develop on the basis of exports and then statistically partially  ‘retreat’ into a large scale domestic market. This would be a type of economic ‘convergence’ towards the type of $15 trillion GDP economy which is the scale represented by both the US and the EU.

Such a development would, of course, not be a retreat of China from globalisation – the absolute scale of China’s exports, imports and inward and outward investment would continue to rise, but it casts the present rebalancing of China’s economy towards domestic demand in not only a tactical but a strategic light. The only proviso that needs to be made, because of some confusions expressed in sections of the press, is that ‘domestic demand’ for China, as for every country, does not consist only of domestic consumption but also domestic investment. The present rise in the proportion of both domestic investment and domestic consumption in China’s GDP, at the expense of its trade surplus, would constitute part of that process.

The process of ‘globalisation’ should therefore not hide the reality that the present is also an epoch of the integrated continental scale economy – with a common state to sustain a common currency, a unified budget, and the other features of an integrated economy. The US, China, and India have all created this, even if they are at different levels of economic development. Europe has not. Champions of ‘national sovereignty’ in Europe in fact lead their own nations towards decline. Whether Europe succeeds in creating a real integrated continental scale economy, or retreats into individual country units which are too small to be economically efficient in a modern world economy, will largely determine not only the continent’s fate but that of the individual countries within it.

Germany’s trade data shows the strength of the forces leading to the creation of a real European continental scale economy. The present parochial state of European politics – increasingly influenced by obsessions about banning minarets, immigrants, discussion of non-existent threats to ‘ convert Europe to Islam’, and other forms of xenophobia and racism – leads the continent and the individual countries within it to decline.

It is a common pattern that a European country reached a peak of power followed by a prolonged period of fall – Italy in the 15th century, Spain in the 16th, Holland in the 17th, Britain in the 18th and 19th. Europe, which for several centuries was the world’s most powerful continent, seems on the political level intent on pursuing the same path.

It remains to be seen whether the forces expressed in Germany’s continental scale economy, and the parallel processes in other countries, can reverse the processes of decline which are expressing themselves in European politics.

The Financial Times carries an article, by Richard Milne, on the situation of small and medium business in Europe during the international financial crisis. This contains some interesting information on economies of scale and productivity in Europe and the US.

In the US 45% of employment is by enterprises with more than 250 employees, compared to only 33% in the European Union (EU). The definition of a small and medium enterprise (SME) used was that it employed less than 250 people, a small enterprise was defined as employing 10-49 staff, and a micro-enterprise as one with under 10 employees.

The EU contained 20.4 million SMEs and only 43,000 large companies. Of the SMEs 92% were micro-enterprises.

Taking the ratio of SMEs to population the country with the smallest ratio of SMEs to population was Germany – Europe’s most successful economy.

The average productivity of labour in European small and medium enterprises was significantly lower than in large enterprises. EU SMEs in 2005, the latest year for which data is available, accounted for 67% of jobs but only 58% of value added. Because of lack of economies of scale EU SMEs had a productivity that was only 86% of the EU average.

The conclusions which flow from this are evident.

First, the higher productivity of the US compared to the EU remains correlated with its higher proportion of the workforce employed in large enterprises – putting another nail in the coffin of ’small is beautiful’ confusions.

Second this is almost certainly not only a correlation but a causal connection. If US large enterprises are more productive than SMEs in the same way as the EU pattern, which is highly likely, then the greater proportion of large scale enterprises in the US compared to the EU helps explain the US’s higher productivity.

The same pattern appears if the number of SMEs in a country is looked at. Germany, Europe’s most competitive economy, had only 20 SMEs per 1,000 inhabitants compared to around 25 for the UK, 40 for the average for the EU, 65 for Italy and 80 for Portugal.

The talk that ’small and medium enterprises’ are the key to the economy’, ‘the future lies with small and medium enterprises’ is simply not true – no matter how much it is an ideology which allows right of centre political parties to appeal to the small enterprises which form a key part of their electoral support. The key to high levels of productivity remains, as it has always been, the creation of large scale enterprises. Not for nothing was the US, the world’s most productive economy, the home of ‘big business’. It is one of the weaknesses of the teaching of academic economics that it has failed to sufficiently integrate the work of Alfred Chandler and other classic historians of US company and industry structure.

The conceptual caution that must be made is first that, as every industry is specific, large scale company development has to be a development of market, or quasi-market, forces and cannot simply be imposed administratively – as was attempted in the former Soviet system. Second, size of company must not be confused with the physical size of units of production. A company may include several physical sites of production – and it is company size, not physical size, which is crucial.

The data in the Financial Times however clearly confirms the correlation of scale of enterprise and productivity. Large scale enterprises, not small and medium ones, continue to represent the ‘wave of the future’ – the most powerful instrument for raising the productivity of an economy.
Note

In addition to the main theoretical interest of the article noted above it also analyses the squeeze on small and medium enterprises (SMEs) in a number of European countries – for example in Portugal the number of SMEs has fallen by 45% from 489,000 in 2005 to 267,000 at present.

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

The 4^th quarter US GDP figures confirm that the economic downturn, in its domestic aspect, is taking the classic form of an investment led decline.

As seen in Figure 1 US fixed investment already started to fall from the 1^st quarter of 2006 onwards – US consumer expenditure and GDP, in contrast, continued to rise until the 2^nd quarter of 2008. US government consumption is still rising.

US GDP has so far declined by 1.1 per cent since its peak. Consumer expenditure has fallen by 1.8 per cent – also since its peak. However US fixed investment has already declined by 8.8 per cent since the first quarter of 2006.

In order to illustrate the ‘classic’ form of the current downturn Figure 2 shows the decline in US GDP after 1929.

As may be seen the pattern of the current decline is almost identical to that after 1929 – with, of course, the dimensions of the latter case being much greater than those during this downturn.

US GNP (Gross National Product) fell by 29.7 per cent between 1929 and 1933. Personal consumption fell by 19.7 per cent in the same period. US government expenditure continued to rise throughout the depression. But US private domestic fixed investment fell by 73.9 per cent from its 1929 level.

Given the classic form of the present recession the key issue is therefore whether the decline in investment can be halted by indirect means – in particular, as this embodies most governments current thinking, whether it can be halted by ‘Keynesian’ methods.

Keynes believed that a decline in investment, driving a recession, could be halted by indirect means such as reduction in interest rates, government spending etc. It was not necessary for the state to directly control investment.

As Keynesian writers such as Graham Turner have consistently stressed, based on analysis of the economic crisis in
Japan during the 1990s, neither the US nor Britain is as yet applying real Keynesian methods. The most crucial issue in a Keynesian perspective is not primarily large budgetary deficits but driving down borrowing costs – pushing interest rates below the anticipated return on capital and therefore making investment profitable.

In the present situation driving down interest rates requires central bank purchase of government bonds and debt – that is ‘quantitative easing’.

An increasing number of governments, including the US, are, slowly being forced to consider this, although none has as yet implemented it.

China, however, is pursuing an alternative path. Its large state company sector means that it does not have to use only indirect methods to control investment – state owned companies can be directly instructed to increase their investment programmes. Simultaneously the state owned banking system means financial institutions can be directly
instructed to increase lending not simply to the state but to the private sector. A rapid expansion of credit is taking place in China with the money supply, as measured by M2, rising at 18 per cent year.

China is therefore relying on a combination of direct (via state companies) and indirect (budget deficits, increase in bank lending) means to counter the economic downturn.

Neo-liberal or monetarist economic solutions are currently not being pursued by the government of any economically developed country. The US, Japan and Western Europe are all attempting to meet the economic downturn by  ‘Keynesian’ methods – starting with large scale budget deficits and moving towards quantitative easing. While some small countries are being urged to undertake deflationary measures the major ones are pursuing a quite different path.

To see what will be the difference in outcome between the Keynesian methods which governments in the US, Japan and
Europe, conceive they are using, compared to Keynesianism accompanied by more direct methods of state intervention being used in China, is not only a test of their different economic theories but also will be of great importance for the world economy.

The theme of Key Trends in Globalisation is that 'It is an error to think globalisation is purely an economic process – it has deep social, cultural and environmental consequences.'

Nothing could illustrate this more than the meeting that will take place on 15 November in Washington to discuss the world financial crisis. The four most powerful people in the room, indeed the four most powerful people in the world, are illustrated above – Barack Obama – ther next President of the United States, Hu Jintao – President of China, Manmohan Singh – Prime Minister of India and Taro Aso – Prime Minister of Japan.

Do you notice anything? Not one of them is white.

It is economically, culturally, socially and ideologically a turning point in the history of the world. The end of the era which symbolically began on 12 October 1492 – the day Christopher Columbus arrived in the Caribbean.

For the next 500 years Europe spread through the world and conquered it. Its greatest offshoot, the United States, extended that European dominance for the 20th century. That Europe created, in racism, a uniquely evil ideology used to justify the greatest crimes in the history of the world – the Atlantic slave trade, the history of colonialism, the Holocaust.

Everyone understands the significance of the fact that for the first time in its history the United States will elect a black president. Everyone who is not a racist bigot in the world will rejoice. For black people it is an event the full significance of which no one who is white can understand. A liberatory moment in history to savour.

But even this president of the United States is not powerful enough to deal with the economic storm that is raging in the world. That is why the leaders of the 20 leading economies are being invited to Washington. It is the admission that the US no longer has the power to control the world. Without the help of others it cannot stablise even its own economy.

And who does the US have to invite? China, Japan, India. These are the three most powerful economic states outside the US – Europe has no comparable voice as long as it remains fragmented and none of the individual European states is an economic power to match the three big Asian economies. Whether Europe succeeds in getting itself together, or slides into further decline, remains to be seen.

On 15 November two great, and interlinked, processes will come together. The first black president of the United States will meet the leaders of the three great Asian states, who represent the future of the world economy. For the first time for 500 years there will not be one white person taking the most important decisions in the world.

It will take decades, even centuries, for all the implications of that to work through and to consolidate. But on 15 November a new epoch in the history of the world will begin.

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.

Read more…