Key Trends in Globalisation

Summary

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

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

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

Source of economic growth in developed and developing economies

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

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

The dominance of factor inputs in GDP growth

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

Role of capital inputs

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

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

The different pattern of growth in developed and developing economies

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

Table 1

Table 2 

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

Summary of trends

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

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

Figure 1

Figure 2

Periodisation of Jorgenson and Vu

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

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

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

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

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

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

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

Figure 3

The G7

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

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

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

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

Table 3

Non-G7 developed economies

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

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

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

Table 4

East Asian and Asian developing economies

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

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

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

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

Table 5

Other developing economies

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

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

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

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

Table 6

Eastern Europe and the former USSR

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

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

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

Relevance to the path of development in classical economic theory

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

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

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

Contrast of classical economic formulations with others

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

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

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

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

Conclusion

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

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

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

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

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

* * *

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

Notes

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Bibliography

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Jorgenson, D. W., & Vu, K. M. (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

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

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

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One of the favourite comparisons of those who predict economic failure in China is to make analogies with the situation of Japan in the 1990s. The news that Japan’s consumer price index has fallen for the 13th consecutive month in the year to December, by 1.3%, shows the falsity of this analogy.

Japan in the 1990s, after the bursting of the bubble economy, is one of the classic illustrations of Irving Fisher’s analysis of economic depression as due to deflation/debt. Fisher noted how under conditions of deflation, which has existed repeatedly in Japan since the 1990s, the real value of debt increases – trapping the economy in depression. The latest figures illustrate that Japan remains in that deflationary situation.

In China, on the contrary, inflation remains the risk. Deflation did occur in China for a short period during the early part of 2009, under the impact of the world financial crisis, but was rapidly overcome. China’s CPI rose by 1.9% in December – a higher than expected level and with an accelerating trend.

This difference clearly illustrates the differences between China and Japan. There are more underlying causes which create this situation – Japan is one of the most closed major economies in the world while China is one of the most open, investment in Japan has persistently fallen whereas in China it has risen etc – but the radical difference in price trends between inflationary China and deflationary Japan by itself shows the falsity of the entire attempt to make analogies between the present situation in China and that of Japan in the 1990s.

An earlier article noted that the US has been overtaken as the world’s greatest source of finance for investment (i.e. savings/capital) by China. This represents a major turning point in world economic history.

This article adds data for three further major economies – Japan, Germany and India. The calculations are made in dollars at current exchange rates for the latest year for which annual data are available – i.e. 2008.(1)  The results are shown in Figure 1.

Figure 1

Analysing the results in detail, China’s lead in generation of investible finance flows from the combination of the large size of its economy, $4.399 trillion in 2008, and its high savings rate of around 54% of GDP. China’s savings in 2008 were $2.381 trillion. Recent further upward revision of China’s GDP data indicates that the savings figure given for China here is probably slightly conservative. (2)

The position of the US as the world’s second largest source of investible finance is determined exclusively by the large size of its economy. As is well known the US savings rate is extremely low. Contrary to  some claims to the contrary in the media, the US savings rate has fallen further and not risen during the financial crisis. The calculated US savings rate in 2008 was 13.3% of GDP, and the measured rate 12.6%. US calculated savings were $1.926 trillion and measured savings $1.824 trillion.

Japan, despite the well known severe problems of its economy in the last two decades, still occupies third place in terms of generation of capital due to the large size of its economy and a relatively high, 26,7% of GDP, savings rate. Japan’s generation of capital in 2008 was $1.310 trillion.

In order to illustrate the drastic changes in the relative positions of China, the US, and Japan in terms of generation of capital Figure 2 shows the total savings in dollars for each country since 1975. As may be seen Japan temporarily overtook the US in the late 1980s and early 1990s before the collapse of its ‘bubble economy’. Total savings in Japan then fell precipitately and have never regained their 1995 level in absolute terms. This sharp fall in Japan’s savings accompanied the well known stagnation of its economy. The extremely rapid rise of China to overtake both the US and Japan is evident.

Figure 2

Turning to other states, Germany occupies fourth place in terms of generation of capital with a savings rate of 26.0% of GDP and savings of $0.946 trillion.

Due to the rapid growth of its economy a calculation for India is given. India’s savings rate is high, 35.7% of GDP, but its total savings remain lower than that of other major countries due to its smaller economy – particularly when expressed at official exchange rates. India’s total savings in 2008 were $482 billion. This means China’s total savings, that is finance available for investment, were almost five times those of India in 2008.

Notes

1. The US publishes data for measured total savings as part of its quarterly GDP data. Most countries do not. However savings are, by accounting definition, equal to gross domestic fixed capital formation, plus inventories, plus the balance of payments surplus/deficit. As data for these latter figures are published for all countries concerned it is a simple matter to calculate savings. To ensure relative uniformity of sources in all cases data from the IMF’s International Financial Statistics is used. Use of national sources of data yields figures differing in detail from the results here but in no case do these alter the qualitative picture outlined. Cross checking with countries for which measured savings data is published shows, as would be expected, minor differences between measured and calculated savings. This disparity, however, is not sufficient to alter the rankings or essential dimensions of savings given above. To illustrate this point the graph below shows measured and calculated savings rates for the US expressed as a percentage of GDP.

2. China’s 2008 GDP has recently been revised upwards to $4,600 trillion. It is likely that this will show China’s savings to be above the level calculated here. However no breakdown of the new data which would allow a calculation of the savings rate has been published yet. Therefore the former, that is more conservative, figures are used here to avoid any suggestion of exaggeration. The difference will however almost certainly be marginal.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Table 1

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

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

Table 2

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

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

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

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

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

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

Notes

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

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

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

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

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

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

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

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

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

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

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

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

Table 1

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

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

Table 2

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

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

Table 3

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

Table 4

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

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

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

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

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

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

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

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

Notes to Tables – peak month for exports in 2008

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

Media reports on the latest release of official 4th quarter US GDP figures have concentrated on the headline revision of the annualised rate of decline of GDP from 3.8%, in the first published estimate, to 6.2% in the new one. It has also been stressed that this decline was significantly worse than the average of independent projections – which was for a 5.4% annualised fall.

However concentration on the headline GDP figure has distracted from examination of the detailed trends of the components of GDP, some of which are of very significant magnitude.

Until now the apparent ‘paradox’ of the international financial crisis was that, as Key Trends in Globalisation has analysed, the decline in financial markets was entirely comparable in rapidity to 1929, however the decline in the productive economy was far less severe than after 1929.

Such a paradox is highly unlikely to be maintained. The first possibility is that it will be shown that financial markets had overshot, that their decline is excessive, that there will not be anything approaching a post-1929 scale fall in production, and consequently financial markets will adjust back upwards – i.e. the variant that there will be an economic recession not a depression. An alternative is that it will be found that the 1929 scale financial falls are justified, and that it is merely a matter of a delay in time before the productive economy adjusts very severely downwards by the amounts that would justify a 1929 scale financial fall – i.e. the perspective not simply of a recession but of something approaching an economic depression.

The significance of the details of the 4th Quarter US GDP figures is that the rates of decline of components of GDP indicate that there is now a higher possibility of the second variant.

Such a trend does not, of course, necessarily imply that the scale of decline in US GDP will be the same as in the Great Depression – when GDP fell by 29.7%. But it would mean falls far exceeding in magnitude any post-World War II recession – the most severe recession in post-war US history being 1981-82 when GDP declined by 1.9%.

According to the new data, in the 4th quarter of 2008 US GDP declined at an annualised rate of 6.2%, consumer expenditure declined at an annualised 4.3%, private fixed investment fell at an annualised 20.8%, exports declined by an annualised 23.6%, and imports dropped at an annualised 16.0%.

The decline in US investment was not accounted for solely by the fall in the residential sector, produced by the sub-prime mortgage crisis, as the latter dropped by 22.2% – only marginally more than the overall investment decline.

To grasp the scale of magnitude of such rates of decline it is worth making a comparison to the actual falls in 1929-30 in the US – i.e. in the first year of the onset of the Great Depression. In that year US GDP fell by 9.4%, consumer expenditure by 6.7%, private fixed investment by 23.4%, exports by 15.4% and imports by 11.0%.

Comparing the two sets of figures, the annualised decline in US GDP in the fourth quarter of 2008 was about two thirds as rapid as the actual yearly decline in 1929-30 and the fall in consumer expenditure was similarly about two thirds of the first year of the Great Depression. But the rate of fall in investment in the 4th Quarter of 2008 was almost as severe as in 1929-30 and the rate of fall in US exports and imports was actually worse than in 1929-30.

Having made such a comparison it is necessary to state immediately that an annualised rate of decline is not the same as an actual annual rate of decline which has occurred as in 1929. It remains to be seen what will be the actual drop in US GDP during 2009. However the rates of decline of US investment, exports and imports in the last quarter of 2008 were fully comparable to those in 1929-30.

Other international data which goes in the same direction of post-1929 scales of fall are the extremely rapid rates of decline in Asian trade and industrial production. Exports by Japan, for example, dropped by 45.7% in January 2009 compared to a year earlier and its industrial production was down 30.0% over the same period. While these figures are undoubtedly exacerbated by the slowdown in the whole Asian economic region caused by the Chinese lunar New Year festival falling unusually early this year, in January, nevertheless anything approaching such scales of decline are figures fully comparable to 1929.

In short, elements are now appearing in the productive economy of a number of countries which overcome the’ paradox’ of the gap between the rate of decline of financial markets and the rate of decline of the productive economy in the negative variant – i.e. by the onset of declines in the productive economy of post-1929 magnitudes. Such trends are, of course, only just appearing and as yet are not consolidated. However the appearance of such tendencies clearly means that governments, policy makers and companies should not be seeking to minimise the gravity of what is taking place. It is more imperative at present to prepare for worse case scenarios than optimistic ones.

Talk simply of ‘recession’ is misleading. The issue is whether what will take place will be ‘merely’ the most serious recession since World War II or whether an actual economic depression will set in.

*   *  *

Antai College of Economic and Management at Jiao Tong University in Shanghai provided research facilities for this study.

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 fundamental assessment presented on this blog, for underlying macro and structural economic reasons, has been that the financial events of 2008 portend a deep world recession but not an economic depression of the type witnessed in the 1930s. This deep recession will be accompanied by a major strengthening of their positions in the world economy by China and India, and to a lesser extent Russia. [1]
To gauge the degree of seriousness of the economic crisis it is evidently merely necessary to consider the depth of the fall in financial markets. The decline in asset prices in 2008, as discussed in detail below, was fully comparable to 1929 – and greatly exceeds any fall seen in the period since. However whatever the similarities in financial markets the world macro-economic situation differs significantly to 1929.

In 1929 the US was not only the world's largest but also the world's most dynamic economy with the highest rates of savings and investment. When the US financial system entered deep crisis in 1929, therefore, there was no external economic force that could pick up either it or the world economy – no economic backstop. The financial implosion in the US in 1929, therefore, necessarily dragged the world economy down into the abyss of prolonged depression.

In 2008 the configuration of world economic forces differs significantly. China and India are today the world's most dynamic large economies. with the world's highest savings and investment rates and the most rapid economic growth. Furthermore China has sufficient economic weight, in terms of world savings, not to prevent international recession but to be a significant counterbalance to the situation in the US.

China's savings and investment rates are not only far higher than the US as a proportion of GDP but are also now approximately equal to those of the US in absolute terms. India's internal savings and investment rates, now at over 30 per cent of GDP, are also far higher than those of the US – enabling it to maintain significant economic growth in what is, in real terms, now the world's fourth largest economy.

For the relative trends in US, Chinese and Indian investment rates see Figure 1.

Figure 1

The world economy has already been saved once from the consequences of US financial crisis in the last economic period. Following the 1987 US stock market crash the export of financial resources from Japan, carried out via an ultra-expansionary monetary policy, played a crucial role in stabilising both US and world financial markets. Whether Japan was wise to purse these policies in the particular form it did, in light of the consequent Japanese 'bubble economy' and financial crash which commenced in 1990, is another issue, but it showed that there was now an 'economic backstop' for the US in the world economy in a way that one had not existed in 1929.

This economic strength of China, and to a lesser extent India, therefore significantly alters the situation of the world economy compared to 1929 – despite any apparent parallels on financial markets. Provided there are not disastrous economic policy miscalculations by the US, which of course are possible, international macro-economic fundamentals mean there need be no 1930s style depression. However there will be, instead, a deep recession of the global economy out of which China and India will emerge significantly strengthened in their relative weight in the world economy. This is therefore the conclusion which flows from consideration of international economic fundamentals.

Nevertheless, first it is possible that the US government will make disastrous economic miscalculations. The reason for this is that a rational economic course by the US administration requires it accepting its reduced role in the world economy – one in which the US is the world's largest economy but no longer an unchallengeable economic superpower. It is possible therefore that there may be future, George W Bush type, US administration attempts to escape a rational economic outcome which may fundamentally destabilise the international economic situation – posing the risk of turning a recession into an economic depression.

Second, it is constantly necessary to check economic fundamentals against facts – the weight of individual elements may be misjudged or factors that were not taken into account may be operating. Macro-economic data that would verify, or disprove, an assessment of 'deep recession but not economic depression' is not yet available for the period following the decisive financial events of September 2008. However trends for financial markets are available. The end of 2008, therefore, represents a convenient opportunity to sum up the qualitative situation revealed by financial markets and to compare it to the assessment of economic fundamentals.

Considering first the area in which the financial crisis originally manifested itself, that is in US house prices and sub-prime mortgages, the decline of US house prices is now more rapid than at the time of the Great Depression following 1929. US house prices in October 2008 were 18 per cent lower than a year previously – the fall being 2.2 per cent in October alone. The rate of decline is still accelerating. The annual fall in individual US cities such as Phoenix, Las Vegas and San Francisco was greater than 30 per cent. The decline in the price of US housing assets at the end of 2008 totaled around $7.1 trillion.

Turning to shares, the fall in the Dow Jones Industrial Average in 2008 was 33.8 per cent – the worst annual fall since 1931 in which year the decline was 52.7 per cent. Share prices in the US financial sector declined by 57 per cent in 2008.

The most relevant, because most long term and fundamental, comparison continues to be that of the current decline in US share prices with the fall in US shares after 1929. Figure 2 confirms that the fall in US share prices, since their peak in October 2007, continues to far exceed the other major declines of the 20^th century – either that following the beginning of the international recession in 1973 or the collapse of the dot com bubble in 2000. Only the fall in US share prices following 1929 is comparable to, or exceeds, those which have occurred over the last year. There is, therefore, no element of exaggeration to say this is the worst fall in financial assets since 1929 nor are comparisons to that date, in the financial field, unjustifiable exaggerated.

Figure 2

Considering the comparison with 1929, 31 December 2008 was 313 trading days after the peak of share prices during the current cycle on 9 October 2007. The Dow was 38.0 per cent below that peak. On the equivalent trading day following 1929 the Dow was 52.0 per cent below its peak in that cycle.
The wider based S&P 500 fell by 41 per cent in 2008, the worst decline since a parallel measure would have dropped by 47.1 per cent in 1931.

The slightly lesser decline of the Dow and S & P 500 in the current cycle, compared to 1929, is however primarily due to the relative stabilisation of US share prices since large scale state financial intervention commenced from late September 2008.

This relative stabilisation of US share prices ran in parallel with the improved conditions in interbank lending similarly created by huge state intervention – see Figure 3.

US Federal Reserve loans rose from $900 billion in September 2008 to $2.2 trillion by December 2008. Already projected Federal Reserve exposures range up to $5 trillion.

Figure 3

However, as may be seen from Figure 2, the most important difference between the present decline in share prices and that after 1929 is the duration of the fall. Following 1929 US share prices continued to fall for three years, with the worst decline being in the second full year of the drop in 1931. So far the decline in US share prices in this cycle has progressed for only just over a year before being halted, at least temporarily, by massive transfers of resources by the state.

Taking non-US stock exchanges in 2008, the UK FTSE 100 declined by 30.9 per cent and the FTSE All Share index fell 32.8 per cent – its worst annual fall since losing 55.3 per cent in 1974. The Germany Xetra Dax fell 40.3 per cent, the Paris CAC 40 fell by 42.1 per cent and the FTSE Eurofirst 300 suffered an annual decline of 44.7 per cent.

The Nikkei 225 index in Tokyo ended by recording a 42.1 per cent fall in 2008, worse than its previous biggest annual loss of 38.7 per cent in 1990. Korea's Kospi index ended the year with a decline of 40.7 per cent.

The conclusion from these trends so far, therefore, is that massive state intervention succeeded in both reducing interbank interest rates and stabilising share prices during the final two months of 2008. But what is its capacity to fundamentally reverse the decline in asset prices that created the crisis in the first place – for, as noted elsewhere, it is the fall in asset prices which is creating the pressures to a liquidity crisis, and not a liquidity crisis that caused the fundamental decline in asset prices?

It is here that the other valid scale of comparison is that with Japan following the bursting of its national asset price bubble in 1990. As may be seen from Figure 4, the decline of the Japanese Nikkei share index after 1990 remains, in terms of duration, considerable worse than that of US shares following 1929. Japanese property prices, equally, remain deeply depressed 18 years after the bursting of the asset bubble.

Such experience indicates that there must, therefore, be no automatic presumption that there will be any V shaped recovery of share prices or asset values – i.e. that the fall in asset prices will be merely short lived followed by recovery. Contemporary, as well as historical, experience indicates that the depression of asset prices below their levels of 2007 may be of long duration.

Figure 4

Such economic processes create a new configuration between the state and the financial system.

Given the magnitude of the financial shifts it is evident that the international financial system is in intensive care with its artificial respiration system being currently powered by state finance. Nor, given the scale of the resources involved, is this situation likely to be reversed in the short term – any perspective that the state will be able to sell back, without huge losses for the taxpayer, the assets it has acquired in any short time frame are illusory. The economic rise of China and India is, therefore, being accompanied by a massive increase in the role of the state in the US and Western Europe.

The scale and pattern of the decline in asset prices means that a world economic depression can, as noted at the beginning of this article, be avoided. But a fundamental change in the configuration of the world economy cannot.

Notes

[1] In Latin America the outcome is not yet determined and will depend on the policies adopted.

The rise of Asia, in particular China, in world export markets is well known. The aim of this post is, however, to provide a more systematic overall examination of trends in world visible exports – i.e. exports of goods and not including trade in services (to avoid excessive repetition all references to exports below are to be taken to be referring to visible exports unless otherwise specified).

The most fundamental, twenty year, tendency is shown in Figure 1. This is the well known consistent trend, since the late-1980s, for a major rise in the share of developing countries in world exports – and the decline of the share of already industrialised countries.

The share of industrialised countries in world exports fell from 70.3 per cent in 1988 to 53.3 per cent in 2007. In the same period the share of developing countries rose from 27.9 per cent to 45.2 per cent.

 

Figure 1

 

 

Considering these trends in greater detail, Figure 2 divides exports from developing countries between those in Asia and those outside Asia. Again the trend is clear.

 

The rising share of developing countries in Asia in world exports is continuous throughout the last quarter century – the share of developing Asian countries in world exports nearly tripling from 8.3 per cent in 1980 to 23.7 per cent in 2007.

 

For the initial part of the period after 1980 the share of non-Asian developing countries in world exports fell – this was particularly accounted for by a decline in the value of the share of world exports from the Middle East associated with the decline in the real price of oil in that period. However since the early 1990s the share of non-Asian developing countries in world exports has been rising steadily. The share of non-Asian developing countries in world exports rose from 13.5 per cent in 1992 to 21.5 per cent in 2007, while in the same period the share of Asian developing countries in world exports rose from 15.2 per cent to 23.7 per cent.

 

Since 1992, therefore, the increase in the proportion of world exports accounted for by Asian and non-Asian developing countries has been almost equal – the increase in the share of world exports accounted for by Asian developing countries being 8.5 per cent and the increase in the share of non-Asian developing countries being 8.0 per cent.

 

It is the combination of this rising share of world exports from both Asian and non-Asian developing countries that accounts from the strong overall rising trend in the share of developing countries in world exports. The phenomenon since the beginning of the 1990s is therefore one of developing countries in general and not one only of Asia.

 

Figure 2

 

 

 

Considering these trends in more detail, the huge role played by the development of China is evident. Figure 3 shows the share of world exports for China, developing Asia excluding China, and, to provide a comparison for the developed Asian economy, Japan.

 

The rise of China is evident – China's share of world exports rose from 1.0 per cent in 1980 to 9.8 per cent in 2006 – the last year for which full figures are available. In the same period the share of other developing Asian countries in world exports rose from 7.3 per cent to 13.7 per cent. Therefore, in this period, China alone accounted for 58 per cent of the increase in the share of developing Asian countries share of world exports – China's increase in the share of world exports being 8.8 per cent compared to 6.4 per cent for all other developing countries in Asia. Particularly since 1990 China's increase in the share of world exports has considerable exceeded that for the rest of the other developing Asian countries put together.

 

In contrast, to take the main developed country in Asia, the declining importance of Japan in world trade is evident.

 

In 1980 Japan accounted for almost as high a share of world trade as all the other developing countries in Asia combined. Since 1986 the share of Japan in world exports has declined sharply – falling from 10.3 per cent in that year to 5.3 per cent in 2007. In 1980 the developing Asian countries, including China, accounted for 8.3 per cent of world exports and Japan for 6.5 per cent. By 2006 the developing Asian economies, including China, accounted for 23.7 per cent of world exports and Japan for only 5.3 per cent. In 1980 Japan's exports were equivalent to 78 per cent of those from the developing Asian countries, while by 2006 Japan's exports were equivalent to only 22 per cent of those of the combined exports of the developing Asian countries.

 

The relative decline in importance in world of exports of Japan, and the rise of the developing Asian countries, above all China, is evident.

 

Figure 3

 

 

The more detailed trends for Asian developing countries, other than China, are shown in Figure 4. This confirms continuing strong export growth by South Korea. However Singapore, and more recently Malaysia, having been losing some world visible export share. Vietnam has been gaining export share steadily but from a very low base.

 

India stands out clearly as a large economy but with a very low share of world exports. India's share of world exports is only just over one per cent and has not been rising very strongly.

 

Figure 4

 

 

Such figures illustrate strikingly the different path of development being undertaken by China and India – the contrasting development in shares of world exports for India and China is shown in Figure 5.

 

India's economy is growing rapidly, but essentially within its domestic economy. India's share in world exports remains both very low and only slowly growing.

 

India's economy, in short, shows no signs of being strongly competitive on an international scale despite known  strength in individual sectors such as software. China's economy is growing even more rapidly than India and enjoying rapid export growth – China's economy, in short, shows far more signs of being competitive internationally than India's. This is line with the the data on the much greater size and development of Chinese firms compared to India that has been analysed elsewhere.

 

Both India and China are extremely important markets but China's economc fundamentals and competivity continue to be significantly stronger than India's.

 

Figure 5

 

 

Turning to non-Asian developing countries, the overall picture is shown in Figure 6. The main trend in the early part of the period considered is the sharp fall in the share of exports coming from the Middle East – reflecting the fall in the relative real price of oil after the beginning of the 1980s. It may also be noted that, despite the increase in the price of oil in the most recent period, the Middle East has only moderately increased its share of world exports, from relatively depressed levels, and its has not retained the position held at the beginning of the 1980s – in terms of trade surpluses, as opposed to share in world exports, a number of Middle East countries continue to be extremely important.

.

In contrast, the share of world exports from developing countries in Eastern Europe has risen significantly – from 4.4 per cent of world exports in 1999 to 8.0 per cent in 2007. Within this total the share of Eastern Europe excluding Russia rose from 3.1 per cent of world exports to 5.8 per cent, while Russia's share rose from 1.4 per cent to 2.6 per cent.

 

Over the period as a whole Africa's share of world exports fell from 4.5 per cent in 1980 to 2.6 per cent in 2007- although there has been a small recent revival from the extremely depressed levels in the mid-1990s.

 

The share of developing countries in Latin America and the Caribbean (Western Hemisphere) in world exports fell significantly in the mid 1980s but has since risen again. The rate of increase, however, is still modest compared to countries in Eastern Europe and even more so when compared to Asia. Latin America and the Caribbean's share of world exports rose from 4.3 per cent in 1992 to 5.9 per cent in 2007.

 

Figure 6

 

 

 

 

Considering the situation within Latin America there was an increase in Mexico's share of world exports in the 1990s but this has since fallen back significantly. No Latin American country has gained world export share in the way that has been experienced in Asia. This is shown in Figure 7.

 

Figure 7

 

 

Summarising these developments overall the following the following key trends emerge.

 

The increase in the share of world exports from developing countries started in Asia, however since the early 1990s this trend has become substantially more generalised. The increase in the share of world exports coming from Asian and non-Asian developing countries was essentially equal in the 15 years 1992-2007. 

 

The success of China is even greater when placed in a comparative framework than when considered by itself. China is now the world's largest visible exporter – overtaking the US and Germany.

 

Asia outside China in the recent period has ceased to gain world market share in visible exports, after an exceptional performance for several decades. South Korea continues to show outstanding visible export performance but several other Asian developing economies have lost world market share. India's share of world exports continues to be extremely low for such a large economy and shows no strong trend to rise.

 

East European developing countries, both Russia and non-Russian, have an export performance which is second only to Asia – although lagging substantially behind Asian success.

 

Latin America and Africa's role in world exports has not yet increased – despite the commodity boom.

Among the largest economies the immediate focus of the international financial crisis in the last three weeks has significantly shifted to Japan – where the government has been loosing its battle to hold down the yen's exchange rate.

This trend is illustrated in Figure 1 - showing the exchange rate of the yen against the dollar since the beginning of 2000. From 2000 to March 2008 the yen remained below its 3 January 2000 exchange rate of 101.7 yen to the dollar. This low exchange rate was maintained by fairly consistent intervention by the Japanese authorities – which saw such a low exchange rate as critical to aiding the competivity of Japan's exporters.

Therefore when in March 2008, under the impact of the gathering financial crisis, the yen moved above its beginning of 2000 exchange rate Japan again intervened vigorously to drive it down again. At that time it succeeded - essentially driving he yen below its beginning of 2000 exchange rate until mid-October.

How since mid-October, despite continuing Japanese Central Bank intervention, the yen's exchange rate has moved upwards – by 5 December rising to a level 10.3 per cent above its beginning of January 2000 exchange rate.

The result was sharp falls on the Japanese stock market amid fears that at the new higher exchange rate Japanese exporters would be uncompetitive and their profits would fall.

Thus, to take international comparisons, during the last three weeks share prices in the US have been essentially directionless. The Dow Jones Industrial Average hit its low for the current downturn on 20 November at 7552.3 – a fall of 46.7 per cent from its peak in October last year. Since then this low has not been seriously tested – although neither has any trend of recovery set in. This is shown in Figure 2.