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Wednesday, January 5, 2011

CONVERGENCE CATCH-UP GROWTH AND THE RISE OF CHINA, INDIA, AND BRAZIL. OR AMERICAN DECLINE REDUX, NEWEST VERSION

                             Today's Buggy Commentary Was Inspired By

. . . an article written by the gifted Financial Time's contributing economic specialist, Martin Wolf, and on the subject captured faithfully by prof bug's subject-title above.  

Start by clicking on Mr. Wolf's stimulating argument and reading it in full.   Then note how prof bug was able to post only about 40% of his lengthy rejoinder in the comments section that followed at the Financial Time.  What follows is the entire buggy post, broken down into six sections. 

Section one follows here on the home page.  Click on continue at the bottom of that section to read the other sections.

Section One

A very stimulating article, Mr. Wolf.  The diagrams are especially informative.  Thank you. 

1) Note, though, a totally unforeseen event since the post-WWII fast-growth period for all the rich economies in Europe, the USA, and Japan in 1974-75 . . . those two years, as it happens, marking the watershed point in GDP and per-capita income growth-rates that were disrupted by the huge oil-price increases by OPEC and the emergence of stagflation in the advanced industrial countries. That unforeseen event? A total reversal of convergence catch-up growth, which you use in your commentary here.

More specifically, since the start of 1974, the USA ---the richest country among the advanced industrial economies in West Europe, plus Japan --- inverted three decades of being the slowest growing economy among them and instead racked up the fastest growing record of them all in the next three decades down through 2007. . . with, please note, two minor exceptions.  Tiny Ireland and tiny Norway ---the latter, the world's third largest oil exporter, and each of them with about 4.6 million people --- grew somewhat faster. ( If you want a good up-today chart of GDP growth rates, go to the blog run by Professor Lane Kenworthy that's called "Consider the Evidence", and see the commentary there for January 4th 2010.)

The outcome? 

Though Germany and Japan reached per capita income levels by the mid- and late-1980s that were about 85% to 90% of American levels, the big breakthroughs in information and communication technologies that began to raise productivity massively in the USA economy in the early 1990s  --- together with the market-oriented reforms carried out by the Reagan, Bush-Sr., and Clinton administrations after 1980 - vindicated the impressive performance of American innovation and upped both economic and productivity growth.  By 2005, accordingly, per capita income in the USA was about 30% higher than in Germany and Japan, not to forget the rest of West Europe or Taiwan and South Korea in Pacific Asia.

 Click on the continue button just below.

Section Two

2) What happened?  Why this reversal of standard convergence catch-up growth-theory? 

For the answer, consider briefly economic growth theory as it has evolved since the early 1950s. First set out in the work of Robert Solow and his Nobel prize-winning neo-classical growth-model of the mid-1950s, then refined later in the 1980s and 1990s by William Baumol, Paul Romer,and Douglass North and his followers, growth theory entails the combination of catch-up growth and convergence for poorer "follower" countries compared to the rich "lead" country on the technological frontier and the near-leader ones not far behind. 

  • Solow's model stressed that long-term per capita income growth in a country depended on inputs of capital investment and the growth of the labor force, later qualified for the quality of the workers. He assumed that ultimately capital accumulation would grow so large that diminishing returns to more investment at the margin would eventually fall to zero in a (hypothetical?) long-run condition called the "steady state" . . . where new capital investment couldn't raise the rate of GDP growth.  Worse, in such an end steady-state, the growth of the labor force would entail diminishing returns at the margin to the wage-growth of the labor force.  In principle, per capita income could even begin to fall for average workers.  

True, Solow emphasized that technological innovation could potentially ignite the rates of GDP and labor productivity again, and so the "steady state" rates of growth might not ever materialize; but--- the crucial shortcoming of the Solow model --- such innovation remained a causal influence entirely outside the model's explanatory variables and remained therefore as inexplicable and unpredictable as "manna from heaven."

What followed for convergence catch-up theory?

Well, Solow and his followers regarded technological innovations --- even major breakthrough ones, which (like those in the pc-era since the 1970s) could transform entire national economies like the USA’s (75% of the Fortune 500 largest corporate firms in the late 1990s hadn’t existed 25 years earlier) ---as “public goods”: patents made no sense, didn’t protect proprietary rights, and so even radically new technologies would soon be diffused throughout the world. The outcome? Sooner or later, all the countries of the world would end up converging on the same levels of productivity and per capita income.

  • William Bamoul coined the concept of a "convergence club" Only certain countries would converge ultimately in per capita income and productivity-levels: those, to be specific, that had educated and disciplined labor-forces able to work effectively with modern technologies.

  • Paul Romer managed about the same time in the 1980s to improve on Solow's neo-classical model, which featured steady rises in capital accumulation and the growth of the labor force as "endogenous" explanatory variable inside the model, leaving the major long-term cause of economic growth --- technological innovation --- outside the model itself as an unexplained "exogenous" variable that saved the rich countries from "steady-state" stagnant growth in fully unpredictable ways. Romer's improvement was to endogenize the technological variable and hence make it a three explanatory variable in the model's explanation of long-term economic growth.

  • Meanwhile, the earlier work of Douglass North in explaining why certain countries were rich and the rest poor --- the differences were due to sounder and more efficient institutions in the legal, political, bureaucratic, and economic systems across countries --- spawned rapid interest in these different institutions.

The outcome of these theoretical developments in economic growth modeling?.  Only those countries with certain institutional systems in place, along with a disciplined and educated work-force able to make good use of modern technologies developed by the rich lead country at the technological frontier --- or others close to it --- would converge on both the levels of productivity and long-run development.  It was these economic ideas that underpinned the belief in "relative" American decline that flourished from the late 1970s until the middle of the 1990s, and again since the Great Recession at the end of the last decade.  Catch-up growth and convergence would ensure this.

Or as Mr.. Wolf argues with vigor here, the China, India, Brazil, and maybe a few other "emerging" countries will sooner or later reach approximately the levels of current American per capita income and labor and multi-factor productivity.  And so, as he has noted in earlier commentaries in the Financial Times, the liberal global economic system currently rule-bound and institutionalized in a host of global and regional organizations --- the World Trade Organization (WTO), the IMF, the World Bank, and the EU above all ---will be invariably changed as these new dynamic economic giants in Asia and Latin America come to insist on changes in the rules and institutions that suit their own economic and political interests more faithfully than they do now.

Section Three

3) A query rears up here: Why should the lead country at the technological frontier --- the USA after WWII (and still there in most advanced high-tech industries, including ICT or information and communication technologies, nano-technology, and bio-technology, though not for the time being in alternative energies) --- grow more slowly than the follower countries?  :

The answer, and in both neo-classical Solow and post-Solow growth theories, is this:   The lead country, given that it had highest per capita income and productivity levels, is stuck having to innovate constantly in order to sustain its economic growth.  Otherwise, its huge capital accumulation would entail ever lower rates of investment-returns, in which case, as its labor force grew in size, its wages would increase more and more slowly, working with ever less profitable capital investments made by the firms in many or most of the rich lead-countries' industries.  Eventually, real wages might even begin to fall . . . at any rate, without more innovation and the freeing up of labor to move into the newer, more promising industries. 

Meanwhile, even as innovation goes on, note what else would likely happen (and did so) to the older, increasingly standardized industries in the lead-country on the technological frontier, and the countries nearest it --- meaning, since the 1950s, the USA as the lead country and West European countries, Japan, South Korea, Taiwan, Hong Kong, and Singapore as the closest and richest follower countries.   SImply said, their major firms began to relocate much of the production in these standardized industries abroad in countries with disciplined labor forces in parts of Latin America and then East and Southeast Asia.  In service industries, even advanced ones, a fair amount of jobs were re, simultaneously, the growth of its high-wage labor force eats away at the rate of per capita income growth.  Nor is that all.  In an era of rapid globalization, American, Japanese, Korean, Taiwanese, and European multinationals will relocate and offshore much of their standardized industrial production to the low-wage economies of China, Southeast Asia, India, and parts of Latin America . . . the only way for them to remain profitable, what with their high wage labor, standardized industrial technologies, and slow economic growth as they approached the technological frontier led by the USA. 

 Observe quickly. 

These pressures to innovate constantly for the lead or near-leader countries are expensive.  Poorer follower countries with sound institutions, economic policies, and a disciplined low-wage labor force were able, it was estimated by some specialists in the early part f the last decade, to import all the American breakthrough technologies in ICT --- information and communication technologies --- for $30 billion.  This, please note, despite American firms having spent close to $400-500 billion in R&D to innovate throughout the late 1970s until 2000 or so. 

Not to forget the social and economic dislocations involved in the transition from an industrial economy of the late 1960s to a post-industrial economy based on avant-garde high-technologies in ICT, pharmaceuticals, bio-tech, and nano-technology.  Such dislocations entailing, in the terminology of Joseph Schumpeter, constant "creative destruction."  Meaning?  Meaning the deliberate run-down of labor forces and capital investment in standardized industries in order to free up capital, skilled labor, scientists, and engineers for these more promising innovative industries.  So far, only the USA has let the forces of such creative-destruction play out in its economy, along with the disruptions that have materialized their wake, though (to their credit) Germany, Holland, Switzerland, and Sweden and Denmark have moved in that direction with vigor in the last few years as well.

Section Four

4) Which brings us full circle to the "rise" of China, India, and Brazil . . . some of it reminiscent of faster catch-up growth that West Europe and Japan, and later the small dynamos of East Asia, enjoyed vis-à-vis the USA in the period before 1975. 

Note the stress on "some" of that growth.  The reason for it: all three countries remain very poor compared to American per capita income and productivity levels in 2011 . . . far poorer than was ever the case for West Europe after the post WWII-recovery, and with Japan (as Mr. Wolf notes) an exception.  They are also far more variegated in their regional growth as well as their ethnic composition than West Europe and Japan and Korea and Taiwan are . . . yes, even China far more varied, with 10% of its giant population of 1.3 billion on the crucial frontier-lands.  With, additionally, China's 60-million strong Communist Party members not showing any evidence of wanting to give up their monopoly of power, prestige, and orgies of self-enrichment that have had no parallel in the statist capitalist-economies of South Korea or Japan in the early stages of their fast economic growth. 

And with, come to that, the World Bank having reduced China's official GDP by 40% in 2006 thanks to discovering 300 million more poor people not living in the booming coastal areas or in Beijing.  India, far more open politically and in terms of information and communication-flows to new ideas and influences from outside the country, is even more divided ethnically and religiously with more poverty than China now endures.  Ditto Brazil, its southern regions dynamic and innovative in farming and other industries, while most of the rest of the country remains backward and undeveloped. 

And Russia, sometimes mentioned as another emerging country?  It looks like the authoritarian Czarist regime of pre-Soviet days, except for having few non-Russian minorities to tyrannize over and with relatively the same levels of censorship of the media and the same absence of a rule-of-law  . . . not to mention a rapidly declining population that is swiftly aging . . . the Chinese not much different on the latter score either, similar to the Japanese and Germans in the inevitable decline of the numbers of active

Section 5

5) So is America decline --- remember, always measured in relative terms compared to other dynamic countries --- far more likely these days than in the past?

It can't be excluded, except that the claim moves across a slippery slope of wrong predictions made from the 1970s through the mid-1990s.  Convergence catch-up itself remains a theory, or varieties of a theory, that has no clear historical outcome to pin down and point to as a clear example except for Britain by the turn of the 19th century to the early 20th

But then Britain was the industrial pioneer; others who industrialized later like the USA and Germany and Japan in Asia were far larger in population, and they didn't have a huge colonial empire falling apart for internal domestic reasons in the Middle East, Africa, South Asia, and Southeast Asia.  And anyway, come to that, the neo-liberal reforms of the Reagan era were paralleled in Britain by Mrs. Thatcher's governments of the 1980s that revived and reinvigorated the British economy, with results that left Britain with a per capita income 15% higher than Germany's or France's by 2006 . . . the exact opposite percentages that prevailed in 1980.  (Similar remarks apply to the neo-liberal reforms carried out in New Zealand, Australia, Ireland, and eventually in the late 1990s and after in Canada, all of which led to vigorous economic growth after long slow-growth eras.) 

All of which leaves an observer wondering when China, India, and Brazil are supposed to match the USA as superpowers in economic wealth, technological innovation, financial influence, military clout (assuming American policymakers have finally learned not to fight large wars on Eurasian lands), and as a country --- unlike Germany, Japan, China, India, and Brazil --- willing to endure current account deficits that allow poorer countries around the world to enjoy export-led growth for their development. 

6) One last point. 

None of the buggy argument here denies that the dominant status-quo great power (and its allies) haven't ended up in hegemonic warfare of a global sort in the past: the Napoleonic wars, World War I, World War II, and the Cold War (and proxy wars that followed) testify to that.  But as happened in the Cold War, a shared interest in avoiding mutually suicide nuclear war is likely to limit any Chinese-American warfare to at most limited skirmishes, not to forget that China's strangely belligerent diplomacy of the last two years --- taking on West Europe at times, Japan and other Asian countries other times with its naval policies and provocation, and India with its efforts to build naval bases in Miramar (Burma) and now Pakistan, not to forget its hands-off-policies until recently toward North Korea and its acerbic rhetoric on the exchange-rate with the $US ---has shown that the other countries of Pacific Asia and most of Indian-ocean Asia  bandwagon to the USA, rather than cave-in to Chinese intimidation. 

So far, though --- unlike in the Cold War --- China has been far more integrated into the USA-European structured global economic system than the Soviet Union ever was; and despites its official rhetoric of late, China has clearly been a big beneficiary of that system.  The long-term likelihood here?  There is no reason why a combination of effective American and allied diplomacy, patience with Chinese efforts to reorient some of its export-led growth toward domestic-driven growth, and closer military cooperation with Japan, South Korea, the Philippines, India, Thailand, Vietnam, and Indonesia --- possibly even with Russia --- won't succeed in moderating Chinese foreign and security policies and yet, no less important, let Chinese prestige and peaceful influence expand in ways thatavoid a disastrous hegemonic showdown war.

Agreed: this buggy claim is set out categorically with little back-up evidence, and purposefully so.  The reason: prof bug intends to devote a couple of follow-up commentaries on China and the Communist Party and military leadership's beliefs that the country is destined to become the new lone superpower globally . . . thanks to its long-history as a great civilization and  its people's related sense of superior cultural superiority, now being vindicated again, in widespread Chinese assumptions, by the country's impressive pace of modernization and rapid economic growth --- now recently joined by an associated belief, rife in elite circles it seems, that the USA's economic performance over the last few years signals our country's inevitable relative decline in power and influence.  These are all mistaken beliefs, including the inexorable future of China's superpower destiny and American decline, which --- as you'll see --- are now reflected in a reorientation of American diplomacy and security policies toward China. 

Call that reorientation a new sober realism, matched moreover by equally realistic reappraisals in virtually all of China's neighboring countries from South Korea through Southeast Asia (including the Phillipines and Indonesia) to Vietnam, Thailand, and India.