I have a new article in Shanghai Daily analysing China's attempt to develop high value added production. It shows that China is rightly emphasising technology. But an equally key issue, that of high quality design, is not receiving the attention which is required. The article looks at the examples of Apple, Intel and Samsung and their lessons.
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.
The following study on the international relation of investment, savings and economic growth is based on a paper produced by the author for Antai College of Economics and Management, Jiao Tong University Shanghai. It originally appeared on the blog China in the International Financial Crisis.
Introduction
This is the first of two papers devoted to the evidence on the relation between investment, savings and growth with particular regard to present economic issues facing China in relation to the international financial crisis. The two papers, although interrelated, are produced separately for the following reasons.
The first paper is an historical and comparative examination of the factual relation between investment rates and economic growth rates. The economic evidence it produces is clear. A very high rate of investment is required for rapid economic growth of the 8% a year level China requires. It is a high level of investment, not a high level of consumption, which is indispensable for rapid economic growth rates – there are no examples of countries with low rates of investment and very high economic growth. Those who argue that China, to maintain its level of economic growth, must increase its consumption level and reduce its rate of investment must produce evidence to justify that claim – and will be unable to do so.
However, from an underlying strategic economic issue such as the
above, it is not possible in a one to one mechanical way to derive
immediate policy conclusions – something the present author is acutely
aware of from both theoretical considerations and practical experience.
In order to judge a specific immediate policy it is necessary to have
not only an overall framework but also detailed knowledge of concrete
economic circumstances. The issues dealt with here affect economic
strategy and other concrete factors must be taken into account in
framing short term economic policy responses.
Investment and savings
In relation to the international financial crisis significant discussion has taken place regarding the US and China’s savings rate. However, from the point of view of China’s economic growth rate, the issue with the most direct effect is China’s rate of investment. The savings’ rate’s effect on growth is indirect.
This distinction may be easily illustrated by noting that while savings are necessarily required to finance investment it is both theoretically and practically possible, for example, for a country to have a high savings rate but to have relatively low or moderate investment and economic growth rates – Saudi Arabia and Libya are examples. In such cases a high savings rate is not used to maintain a high rate of domestic investment, with an associated high rate of economic growth, but instead foreign assets or exchange reserves are accumulated.
It is therefore investment which directly affects the rate of national economic growth. For that reason, regarding the potential for strategic economic growth, analysis should commence with the investment rate.
Confusion of domestic demand and domestic consumption
This strategic issue relates to a further, more immediate, economic question. In sections of the media stimulation of ‘domestic demand’ is sometimes treated as though it were the same issue as the stimulation of ‘domestic consumption’. This is self-evidently theoretically false. Domestic demand consists of two components, investment and consumption. Stimulation of domestic investment is just as much stimulation of domestic demand as is stimulation of domestic consumption.
The consequences of different allocations of GDP resources to investment and consumption are, however, extremely different from the point of view of China’s economic growth. As will be seen in detail below a very high level of fixed investment in GDP is a precondition for a high economic growth rate in any country - including China. Lowering the proportion of China’s investment in GDP, that is raising the proportion of consumption in GDP, will lead to a much slower rate of growth of China’s GDP. From this more immediate angle also the first key macro-economic issue that should be examined is the investment rate.
This paper, therefore, examines the relation of the rate of investment and the rate of economic growth both from a fundamental historical perspective and from the point of view of the recent international experience of high growth rate economies.
The tendency of the proportion of the economy devoted to fixed investment to rise
Considering first the investment rate from a long term historical perspective, one of the most factually well established historical trends of economics is that the proportion of the economy devoted to fixed investment historically rises with time - and that this rise is correlated with increasingly rapid rates of economic growth.
This process can be clearly measured over a three hundred year period, and can also be seen to operate dramatically in the period since World War II. All major economies that have grown rapidly have a high level of fixed investment. There are no examples of major economies which have grown rapidly with a low rate of investment.
These facts have evident conclusions for the discussion of the model of economic growth and for China’s investment level.
After considering this from the point of view of a long timescale, setting out the factual data, it will be examined from the point of view of the experience of high growth economies since World War II.
The historical trend of the proportion of investment in GDP
Figure 1 shows the percentage of fixed investment (gross fixed capital formation) in GDP for a series of major countries over the longest periods of time for which data is available. [1]
Figure 1
The historical correlation of increasing proportions of GDP devoted to investment with rising rates of GDP growth
Considering this historical trend in more detail, and analysing countries in the chronological order in which a new peak in the proportion of GDP devoted to gross fixed domestic capital formation appeared, the following is the historical pattern.
- Commencing with the period immediately antedating the industrial revolution, the proportion of GDP devoted to fixed investment in England and Wales, at the end of the 17th century, was 5-7 per cent. [2] This rose slightly, although current estimates are that it did not rise greatly, during the 19th century - peaking at over ten percent of UK GDP prior to World War I.
This level of investment was sufficient to launch the first industrialisation of any country but at a rate of growth which, while unprecedented at the time, was extremely slow by contemporary international standards - about two per cent a year.
- Turning to the latter part of the 19th century, the proportion of US GDP devoted to fixed investment had risen to considerably exceed that for the UK – reaching a level of 18-20 per cent of GDP by the last decades of the century.
A sharp fall in the proportion of the US economy devoted to fixed investment commenced in the late 19th century, and was particularly pronounced during the period between World War I and World War II – being associated with the great depression of the inter-war period. After World War II the US resumed its pattern of 18-20 per cent of GDP being devoted to gross fixed capital formation. This generated an average growth rate of 3.5 per cent a year. With such a growth rate an economy doubles in size every 20 years and quadruples in size every 40 years. It was on the basis of this historical level of investment, and growth rate, that the US overtook Britain to become the world’s greatest economic power.
- In the period following World War II Germany achieved a level of fixed investment exceeding 25 per cent of GDP – peaking at 26.6 per cent in 1964. This period 1951-64 was that of the post-war German ‘economic miracle’ with average growth of 6.8 per cent a year - with such a growth rate an economy doubles in size every 11 years and quadruples in 22 years.
- Starting at the beginning of the 1960s Japan achieved a level of gross domestic fixed capital formation of more than 30 per cent of GDP. This reached a peak in the early 1970s, at 35 per cent of GDP, before later sharply falling. During the period of a high and rising rate of investment in GDP the average annual rate of growth of the Japanese economy was 8.6 per cent.
- From the 1970s onwards, South Korea similarly achieved a level of fixed investment of 30 per cent of GDP. During the 1980s this rose above 35 per cent of GDP. The other East Asian ‘Tiger’ economies – Singapore, Hong Kong and Taiwan – showed a similar pattern. South Korea’s economy confirmed the relation between fixed investment and economic growth illustrated by Japan by growing in this period by an average 8.3 per cent a year.
Such growth rates in Asia showed that something unprecedented in human history was now possible – that it was possible to industrialise an economy, and achieve a ‘first world’ level of development, in a single generation.
- From the early 1990s onwards China achieved sustained rates of fixed investment of 35 per cent of GDP with, from the beginning of the 21st century, this rising to more than 40 per cent of GDP – a level never before witnessed in human history. The result was average 9.8 per cent a year economic growth over a sustained period – also the most rapid sustained economic growth ever seen in human history.
- To complete the chronological picture, the proportion of GDP devoted to fixed investment for two countries recently undergoing rapid economic growth, India and Vietnam, is shown. The proportion of Indian GDP devoted to fixed investment has not reached the Chinese level but has become high – reaching 33.7% of GDP in 2007 and 37.6% of GDP by the second quarter of 2008. On this basis, in the last five years, India has achieved an average growth rate of 8.8 per cent a year.
In Vietnam the proportion of GDP devoted to fixed investment rose from 13 per cent in 1990 to 25 per cent in 1995 and then to 37 per cent in 2007. Economic growth has accelerated rapidly, rising to an average of 7.9 per cent a year in the five years up to 2007.
Considering these trends, such a high level of investment is a necessary condition for rapid economic growth. No substantial country without comparable high levels of fixed investment has achieved such rapid rates of growth on a sustained basis. But while such a high level of investment is a necessary condition for rapid economic growth it is not a sufficient condition. Other elements which must accompany a very high rate of investment in GDP to produce rapid economic growth are considered below.
Recent experience of countries with high rates of economic growth
Turning to analysing post-World War II examples of sustained high economic growth, only 21 countries have achieved 8% growth a year sustained over a 20 year period since World War II. Leaving aside two extremely small states, Botswana (population 1.6 million) and Swaziland (population 1.1 million), which have economies dominated by individual projects, these countries that have undergone at least an 8% growth rate over a twenty year period fall into only two categories.
The first are eight Asian economies which have experienced prolonged periods of rapid growth - China, Japan, Singapore, South Korea, North Korea, Taiwan, Thailand, and Hong Kong. These form the primary focus of this study as their economies are not dominated by direct and indirect effects of the single commodity oil.
The second group are oil producers, or states adjacent to oil producers, in which rapid economic growth has been due to the direct and indirect effects of producing this commodity.[3] Growth rates based on oil are evidently not available to countries that do not have oil reserves and therefore do not form a generalisable model of development or are not immediately adjacent to countries which are large oil producers – for this reason the growth pattern of economies dominated by oil production are not considered in detail here.
Investment levels in the high growth Asian economies
To illustrate the decisive role played by high investment rates in sustaining high growth rates the percentage of Gross Fixed Capital Formation (fixed investment) in GDP for six of the eight high growth Asian economies is shown in Figure 2 - comparable IMF data for North Korea and Taiwan is not available. India has been added to this comparison due to the size of its economy and its recent rapid growth.
The evident feature of these economies countries is that all have had, during their periods of rapid growth, very high percentages of Gross Domestic Fixed Capital Formation in GDP. Taking the peak years for each country, Gross Domestic Fixed Capital Formation reached 35.6% of GDP in Hong Kong, 36.4% of GDP in Japan, 39.1% of GDP in South Korea, 41.6% of GDP in Thailand, 42.7% of GDP in China and 47.4% of GDP in Singapore.
Figure 2
It may be seen that no cases at all of rapid sustained economic growth without such a high rate of investment are to be found in such high growth economies. It is therefore evident that the economic evidence demonstrates that a high percentage of gross domestic fixed capital formation is a precondition for rapid economic growth. It is a high proportion of investment in GDP, not a high proportion of consumption, that forms the precondition for rapid economic growth.
Furthermore detailed examination makes clear that in those countries in which investment declined as a proportion of GDP – Japan, Hong Kong, South Korea and Singapore – this led to a marked decline in economic growth. On the contrary in those economies in which investment rose as a percentage of GDP, China and India, economic growth accelerated. The correlation between a high rate of growth and a high rate of investment is therefore evident.
In the data below the annual rate of growth is stated as the average over a five year period - in order to smooth out purely short term fluctuations in business cycles.
Japan
Measured in PPP terms Japan is Asia’s second largest economy. Japan’s rate of Gross Domestic Fixed Capital Formation peaked at 36.4% of GDP in 1973 but then fell to 23.3% of GDP by 2007.
Over the same period of time Japan’s annual rate of GDP declined from the 8.4% per cent rate in 1973 to only 2.1% (see Figures 3 and 4).
Figure 3
Figure 4
South Korea
South Korea is the Asia’s 4th largest economy - after China, Japan and India. South Korea’s level of Gross Domestic Fixed Capital Formation in GDP peaked at 39.1% in 1991, although the 1996 level of 37.5% was only marginally lower.
Thereafter South Korea’s level of Gross Fixed Capital Formation declined sharply to 28.8% of GDP in 2007. South Korea’s annual rate of GDP growth fell in parallel from 9.4% in 1991, and 7.3% in 1996, to 4.4% in 2007 (see Figures 5 and 6).
Figure 5
Figure 6
Thailand
Thailand’s percentage of Gross Domestic Fixed Capital Formation peaked at 41.6% of GDP in 1990 and 41.1% of GDP in 1995. It then fell to 26.8% of GDP in 2007.
Thailand’s annual rate of GDP growth over the same period fell from 10.9% in 1991, and 8.6% in 1995, to 5.6% in 2007 (see Figures 7 and 8).
Figure 7
Figure 8
Singapore
Singapore saw one of the most sustained high levels of investment in GDP in any country in world history with more than 30% of GDP devoted to fixed investment for 30 years from 1970-2000. Singapore’s Gross Domestic Fixed Capital Formation peaked at 47.4% of GDP in 1984, remained at 38.7% of GDP in 1997 and fell to 24.9% of GDP in 2007.
Singapore’s annual rate of GDP growth over the same period fell from 8.5% a year in 1984, and 9.7% a year in 1997, to 7.1% a year in 2007 (see Figures 9 and 10).
Figure 9
Figure 10
The percentage of Hong Kong’s GDP devoted to Gross Domestic Fixed Capital Formation, amid significant fluctuations, fell from 35.6% in 1964 to 35.6% and to 20.3% in 2007.
Hong Kong’s annual average growth rate fell from 10.5% in 1964 to 6.4% in 2007 (see Figures 11 and 12).
Figure 11
Figure 12
China and India
India and China show a clear contrast to Japan, South Korea, Singapore and Hong Kong.
Whereas in Japan, South Korea, Singapore and Hong Kong there was a decline in the proportion of the economy devoted to investment and a decline in the rate of economic growth, both India and China India have systematically increased the share of investment in their GDP and have seen an acceleration of their growth rates. Because this pattern in India and China is so strikingly different to Japan, South Korea, Singapore and Hong Kong it is worth looking at in some detail.
India’s Gross Domestic fixed Capital Formation increased from 17.9% of GDP in 1977 to 22.7% of GDP in 2000 and to 33.9% of GDP in 2007. By the third quarter of 2008, before the onset of the international financial crisis, India’s Gross Domestic Capital Formation reached 37.6% of GDP. Over the same period India’s annual GDP growth rate accelerated from 4.5% in 1977 to 6.0% in 2000 and to 8.8% in 2007.
Unlike those who advocate a reduction in investment and savings rates, Manmohan Singh, who is not only India Prime Minister but an excellently trained economist, has constantly stressed the need to raise India’s savings and investment rates and has made this a foundation of his economic policy – with considerable success, as has been seen, in terms of sustaining high growth rates.
Manmohan Singh considered China’s high savings and investment rates as the foundation of superior economic performance. For example in 2003 when asked, ‘is it legitimate to compare India and Chinese economies?,’ he replied: ‘There is nothing wrong in the comparison. It is good to try and achieve the growth rate of China. But we must remember that the Chinese savings rate is 42 per cent of the Gross Domestic Product, whereas savings in India is hovering at 24 per cent.’
Before he became Prime Minister in May 2004 Singh set out clearly the investment rate without which India’s target growth rate could not be achieved: ‘at a Delhi seminar, Dr Manmohan Singh spoke out regarding the targeted eight per cent growth rate in the Tenth Plan... he opined that an eight per cent growth rate would require a 30 per cent ratio of savings to income and a substantial rise in the tax-GDP ratio.’
Therefore in 2006, after assuming office, Prime Minister Singh noted with satisfaction the increase in India’s savings rate and set the goal of increasing it further together with a concomitant rise in the the investment rate: ‘Our statisticians now tell me that our savings rate has shot up in the last couple of years to about 27 to 28 percent of our GDP… we are a country where the proportion of young people to total population is increasing. All demographers tell me that if we can find productive jobs for this young labour force, that itself should bring about a significant increase in India's savings rate in the next five to ten years. If our savings rate goes up, let us say, in the next ten years, by 5 percent of GDP, we would have generated the resources for investment in the management of this new urban infrastructure that we need in order to make a success of our attempt at modernization and growth.’
By 2007 Prime Minister Singh therefore welcomed the further increase in India’s savings and investment rates. According to India’s premier financial paper, the Economic Times: ‘The investment and saving rate is as high as 35 percent of national economic output, Singh said at a meeting of his Congress party in this southern Indian city, the hub of a 50-billion-dollar IT industry at the vanguard of the country's economic resurgence.’
Similarly, India’s finance minister, P Chidambaram , called in February 2007 for a further increase in India’s savings and investment rates: ‘India’s savings and investment rate as percentage of GDP have gone up by 2 per cent each. But to sustain the revised growth rate of 9 per cent in the 11th Plan, he [ P Chidambaram] said: “Both savings and investment as proportion of GDP must be raised further.”
By February 2008 Prime Minister Singh noted the continued advance of the savings rate and the new high reached in India’s investment rate: ‘Highlighting the strong fundamentals of the economy, Dr. Singh said that the savings rate in the country has touched almost 35 per cent of Gross Domestic Product (GDP) and the investment rate is at an all time peak of over 36 per cent of the GDP.’
The orientation of India to very high savings and investment rates, and the relation of this to rapid economic growth, is therefore clear (see Figures 13 and 14)
Considering China its fixed investment increased from 27.8% of GDP in 1978 to 34.3% of GDP in 2000 and to 42.7 % of GDP in 2007 42.7%. In the same period China’s rate of GDP growth accelerated from 4.9% in 1978 to 8.6% in 2000 and to 10.8% in 2007.
Figure 13
Figure 14
Conclusion
The conclusion from economic evidence is therefore clear.
A high percentage of fixed investment in GDP is an indispensible precondition for a rapid rate of growth – there are no examples of countries with rapid rates of GDP growth and low proportions of the GDP devoted to fixed investment. It is a high level of investment in GDP, not a high rate of consumption, that is necessary for rapid GDP growth.
In those countries in which the rate of investment in GDP fell – Japan, South Korea, Singpore and Hong Kong – the rate of economic growth also fell substantially. In those countries – India and China – in which the percentage of GDP devoted to investment rose the rate of economic growth also increased.
In short all evidence establishes clearly that it is the high rate of investment which is decisive for rapid GDP growth.
This overwhelming factual evidence, of course, supports what is evident from a theoretical point of view. Consumption, by definition, does not add to productivity potential or production capacity and therefore increasing the rate of consumption does not raise GDP growth. If China lowers its proportion of the economy devoted to investment its economic growth rate will also fall - as is confirmed by the international experience noted above.
* * *
The paper draws on earlier
material which appeared in 'Why Asia will continue to grow more rapidly than the US
and Europe - a historical perspective' on the blog Key Trends in Globalisation.
References
[1] The figure for England for 1688 is that in Angus Maddison, The World Economy, OECD Paris 2006 p395. UK figures after 1688 and up to 1947 are calculated from One Hundred Years of Economic Statistics, The Economist, London 1989 p74. Figures from 1948 are calculated from International Monetary Fund, International Financial Statistics (August 2008) Minor adjustments have been made to chain the earlier statistics to be consistent with the IMF data – in no case does this make any significant difference to the pattern shown. The data for fixed investment for the earlier period used by The Economist One Hundred Years of Economic Statistics are based on calculations in C H Feinstein and Pollard Studies in Capital Formation in the United Kingdon 1750-1820, Oxford University Press, Oxford 1988. Other commentators have suggested that Feinstein and Pollard's figures are somewhat too high - see for example. N F R Crafts British Economic Growth during the Industrial Revolution, Clarendon, Oxford 1986 p73. None of these revisions and differences however is of sufficient magnitude to alter the fundamental pattern shown here. US figures prior to 1948 are calculated from One Hundred Years of Economic Statistics, The Economist, London 1989 p74. Figures from 1948 are calculated from International Monetary Fund, International Financial Statistics (August 2008) Data for the earlier period give only private fixed capital formation whereas that after 1948 is for total fixed capital formation – i.e. including government fixed capital formation. There are no reliable estimates of government fixed capital formation in the earlier period and therefore data for the earlier period have been adjusted upward by the difference between the two in 1948 – which is slightly over two per cent of GDP. This has the effect of revising upwards slightly the percentage of GDP allocated to fixed investment in the earlier period but the difference is too small to affect the overall pattern. Figures for Germany prior to 1960 are calculated from One Hundred Years of Economic Statistics, The Economist, London 1989 p202. Figures from 1960 are calculated from International Monetary Fund, International Financial Statistics(August 2008). There is however no significant statistical difference between the two. Figures for Japan, South Korea, China, India and Vietnam calculated from International Monetary Fund, International Financial Statistics.
[2] Phyllis Deane and W A Cole in British Economic Growth 1688-1959, Cambridge University Press, Cambridge 1980 p2 being closer to the lower figure while further studies have tended to revise the figure upwards slightly. The higher estimates for the earlier period have been taken here so as to avoid any suggestion of exaggerating the degree to which the proportion of GDP devoted to Gross Domestic Fixed Capital Formation has risen. The precise figure used here is that calculated by Maddison in Angus Maddison, The World Economy, OECD Paris 2006 p395. The higher figure, as can be seen, makes no difference to the overall trend.
[3] These countries are Iran, Iraq, Equatorial Guinea, Kuwait, Israel, Jordan, Oman, Qatar, Saudi Arabia, Libya, Gabon, Equatorial Guinea, and the United Arab Emirates.
Data on long term trends in investment and economic growth
This post deals with the historic trend of investment and economic growth. This may appear a relatively esoteric topic. In fact, however, it has decisive economic and strategic business consequences - in particular for understanding the more rapid growth of the key Asian economies relative to the US and Europe and why this will continue for a prolonged period. Before dealing with these and other more detailed implications, however, the factual data is set out.
Figure 1 shows the percentage of fixed investment (gross fixed capital formation) in GDP for a series of major countries over the longest periods of time for which data is available. [1]
Figure 1
The pattern is clear and striking. By far the strongest trend is for the proportion of GDP devoted to fixed investment (gross domestic fixed capital formation) to rise with time. This in turn, as will be shown, is associated with progressively rising rates of economic growth.
Considering countries in the chronological order in which a new peak in the proportion of GDP devoted to gross fixed domestic capital formation appeared the following is the historical pattern.
· Commencing with the period immediately antedating the industrial revolution, the proportion of GDP devoted to fixed investment in England and Wales, at the end of the 17th century, was 5-7 per cent. [2] This rose slightly, although current estimates are that it did not rise greatly, during the 19th century - peaking at over ten percent of UK GDP prior to World War I.
This level of investment was sufficient to launch the first industrialisation of any country but at a rate of growth which, while unprecedented at the time, was extremely slow by contemporary international standards - about two per cent a year. With such a growth rate it takes 35 years for an economy to double in size and 70 years to quadruple.
· Turning to the latter part of the 19th century, the proportion of US GDP devoted to fixed investment had risen to considerably exceed that for the UK – reaching a level of 18-20 per cent of GDP by the last decades of the century.
A sharp fall in the proportion of the US economy devoted to fixed investment commenced in the late 19th century, and was particularly pronounced during the period between World War I and World War II – being associated with the great depression of the inter-war period. After World War II the US resumed its pattern of 18-20 per cent of GDP being devoted to gross fixed capital formation. This generated an average growth rate of 3.5 per cent a year. With such a growth rate an economy doubles in size every 20 years and quadruples in size every 40 years. It was on the basis of this historical level of investment, and growth rate, that the US overtook Britain to become the world’s greatest economic power.
· In the period following World War II Germany achieved a level of fixed investment exceeding 25 per cent of GDP – peaking at 26.6 per cent in 1964. This period 1951-64 was that of the post-war German ‘economic miracle’ with average growth of 6.8 per cent a year - with such a growth rate an economy doubles in size every 11 years and quadruples in 22 years.
· Starting at the beginning of the 1960s Japan achieved a level of gross domestic fixed capital formation of more than 30 per cent of GDP. This reached a peak in the early 1970s, at 35 per cent of GDP, before later sharply falling. During that period the average annual rate of growth of the Japanese economy was 8.6 per cent. With such a growth rate an economy doubles in size in eight and half years and quadruples in size in 17 years.
· From the 1970s onwards, South Korea similarly achieved a level of fixed investment of 30 per cent of GDP. During the 1980s this rose above 35 per cent of GDP. The other East Asian ‘Tiger’ economies – Singapore, Hong Kong and Taiwan – showed a similar pattern. South Korea’s economy confirmed the relation between fixed investment and economic growth illustrated by Japan by growing in this period by an average 8.3 per cent a year. At such a growth rate an economy doubles in size in nine years and quadruples in 18.
Such growth rates in Asia showed that something unprecedented in human history was now possible – that it was possible to industrialise an economy, and achieve a ‘first world’ level of development, in a single generation.
· From the early 1990s onwards China achieved sustained rates of fixed investment of 35 per cent of GDP with, from the beginning of the 21st century, this rising to more than 40 per cent of GDP – a level never before winessed in human history. The result was average 9.8 per cent a year economic growth over a sustained period – also the most rapid sustained economic growth ever seen in human history. On that basis an economy doubles in size every seven and a half years and quadruples in size in 15 years.
· To complete the chronological picture, the proportion of GDP devoted to fixed investment for two countries recently undergoing rapid economic growth, India and Vietnam, is shown.
The proportion of Indian GDP devoted to fixed investment has not reached the Chinese level but has become high – reaching 34 per cent of GDP in 2007. On this basis, in the last five years, India has achieved an average growth rate of 8.8 per cent a year. At that rate of growth India’s economy doubles in size in slightly over eight years and quadruples in sixteen and a half years.
In Vietnam the proportion of GDP devoted to fixed investment rose from 13 per cent in 1990 to 25 per cent in 1995 to 37 per cent in 2007. Economic growth has accelerated rapidly, rising to an average of 7.9 per cent a year in the five years up to 2007. At that rate of growth Vietnam’s economy doubles in slightly under 9 years and quadruples in size in 18 years.
Considering these trends, such a high level of investment is a necessary condition for rapid economic growth. No substantial country without comparable high levels of fixed investment has achieved such rapid rates of growth on a sustained basis. [3] But it is not a sufficient condition: the high level of investment is also linked to the scale of production, that is the size of the market being produced for. In a modern economy only large scale production can be efficient in the decisive sectors of production, requiring an orientation to the international market – this is particularly evident with such high levels of investment.
No purely national market, not even the US or China, is sufficiently large to maintain the most efficient level of production. As many others have frequently correctly stressed, high levels of investment must therefore be accompanied by an export orientation. [4] It is this high level of investment, accompanied by an export orientation, which was responsible for the rapid economic growth of South Korea, China, India and Vietnam.
Implications of different investment levels
There are a number of clear consequences of these factual trends (it must be stressed that this data, of course, deals only with long and medium term trends and is not a guide to short term fluctuations). Among the most important of these implictions are:
· It provides a clear historical framework for understanding the present rapid growth of (primarily Asian) economies and why they will continue to grow far more rapidly than the US and Europe.
· China’s economy will continue to outperform India’s and the gap between the two will grow - and not shrink as some have suggested.
· There is no serious historical evidence for the thesis sometimes presented that China is oversaving/overinvesting. China therefore should seek to maintain, and not cut, its current savings and investment levels.
· Current US/UK economic policy, with its overwhelming emphasis on microeconomic efficiency of resource allocation, fails to address the most important economic issues and therefore will be unsuccessful – which will deepen the tendency for the key Asian economies to grow more rapidly than the US and Europe. The also provides a background to current issues in the credit crunch.
Taking these issues in more detail:
First, these trends place in wider historical context the present rapid growth of a number of (primarily Asian) economies. The latter represent the latest high point in the trend for higher and higher proportions of GDP to be devoted to fixed investment. Consideration of such trends therefore provides a clear theoretical underpinning for the evident current empirical fact that not only is Asia growing substantially more rapidly than the US and Europe but that it will continue to do so. The investment rates in the key Asian economies are not aberrantly high but merely the latest point in an historical trend.
Seen in long term historical perspective it is US and European savings and investment rates that are too low, not Asian savings and investment rates that are too high.
Second, given these historic trends, it is clear that on the basis of current macroeconomic trends China’s economy will continue to expand more rapidly than India's and that China will increase its economic lead over the latter.
This naturally does not mean anything other than that India is an extraordinarily important market. India’s economy is, at a realistic exchange rate, in Parity Purchasing Power (PPP) terms, the fourth largest economy in the world after the US, China and Japan.[6] India's economic growth, running at around at 8-9 per cent a year, is the second largest for any major economy in the world after China. However, China’s economy is already approximately two and a half times the size of India’s in PPP terms and is continuing to grow at one to two per cent a year more rapidly than India – this combination ensuring that the gap between China and India is widening and not narrowing.
There is also no evidence from consideration of historical data that the factors invoked to claim that India’s economy will grow more rapidly than China’s, for example different demographic profiles, are crucial. The historical evidence is that it is the proportion of the economy devoted to gross fixed capital formation that is decisive. The fact that, until the present, the Chinese economy continues to devote a significantly higher proportion of the economy to fixed investment than India – 43 per cent compared to 34 per cent to take the latest available years, indicates that unless India catches up with China in terms of this area China will grow more rapidly than India.
Third, there is no evidence from this historical trend data for the argument that China is facing a basic crisis of oversaving/overinvestment, and therefore that China needs to lower its total savings level (i.e. savings including private, public and corporate saving) and to increase consumption - as some commentators, including the Financial Times chief economics commentator Martin Wolf, have stated. [5]
It is evident that China’s level of investment and saving is far higher than that of the US or UK. However the historical data make clear that China’s is simply the latest stage in the long term trend for an increasing proportion of GDP to be devoted to gross fixed capital formation. Given this rising historical trend it is entirely likely that in the future another country, or China itself, will have a higher proportion of GDP devoted to saving/investment than China today - yielding a higher rate of growth.
While, of course, short term fluctuations and adjustments may be required there is no historical evidence that China's savings and investment rate is excessively high - it is merely the latest stage in a long term international historical trend. Reduction of China’s investment and savings rate would lead to slowdown not only of China’s economy but also, because of its locomotive role in the world economy, a slowdown in the global economy. China should therefore be seeking to maintain, not reduce, its current high investment and savings levels.
Fourth, there is no evidence from the historical data that the 'quality of entrepreneurship' plays any crucial role in economic development. Or more precisely, and what is another way of saying the same thing, the quality of entrepreneurship and managerial effectiveness appears to be randomly distributed and therefore cannot explain differences in economic growth rates. There are no cases where, due to the 'quality of entrepreneurship', countries have experienced rapid growth without high levels of gross domestic fixed capital formation in GDP.
Fifth, present US/UK government economic policy, by according overwhelming centrality to dealing with microeconomic efficiency, is addressing relatively minor issues in terms of international competitiveness compared to that of dealing with inadequate saving and investment rates. The economic priorities of a number of rapidly growing Asian economies will therefore clearly be more effective than that of the US and UK.
Put in other terms, the implications for governments’ economic policies of the long term trends outlined here is that in a balance between seeking microeconomic efficiency in the allocation of resources, and seeking a high level of savings and investment, the high level of savings and investment is more important that the emphasis on microeconomic efficiency from the point of view of creating economic growth.
There is an entirely reasonable supposition that the microeconomic allocation of investment in South Korea or China, given the use of subsidised loans, cross forms of ownership in different branches of industry, higher capital/output ratios etc, is less microeconomically efficient than in the UK or the US. However the rate of growth of the South Korean or Chinese economies is much more rapid, over a sustained period, than that of the UK or US.
Quantitatively the greater microeconomic efficiencies in allocation of resources in the US or UK, to generate an equal rate of growth, would have to compensate for their lower savings and investment ratios and there is no evidence that it does so. It is the higher savings and investment rates in Asian economies that predominate over greater microeconomic efficiency. Therefore any quality of microeconomic priorities in the US and UK will be overwhelmed by the quantity of investment in the rapidly growing economies of Asia.
Ideally, of course, both high microeconomic efficiency and high savings/investment levels should be sought. However there is evidence that the two are contradictory. For example the policies pursued in the US and UK have been accompanied by massive declines of savings rates which have undermined the competitiveness of the economy – leading into present sharp financial problems. It is therefore likely that current US and UK economic policy will be unsuccessful, and these economies will remain under financial pressure created by lack of competitiveness for a prolonged period. The credit crunch is a one periodic form of the manifestation of this loss of competitiveness by the US and UK.
Conclusions
The following clear conclusion may be drawn from this data:
There is a clear historical trend for the proportion of the economy devoted to gross domestic fixed capital formation to rise. This is the key determinant of rising rates of economic growth.
Five key historic stages in the rise in this proportion of the economy devoted to fixed investment may be identified: the achievement of a 5-7 per cent investment rate in Britain in the 18th century permitting the launching of the industrial revolution; an 18-20 per cent of GDP fixed investment rate from the latter part of the 19th century, achieved by a number of countries led by the US, which permitted the United States to replace the UK as the world's leading economic power; a 25 per cent of GDP fixed investment rate in Germany in the immediate post-World War II period which accompanied the German 'economic miracle'; a more than 30 per cent of GDP rate of fixed investment achieved in Japan, and then the other East Asian 'Tiger' economies, from the mid-1960s which permitted growth rates of more than 8 per cent a year; a more than 35 per cent of GDP fixed investment rate in China from the 1990s onwards which has permitted sustained growth rates approaching 10 per cent a year.
On the basis of this differential in investment rates a number of the key Asian economies will continue to outperform the US and Europe in terms of economic growth for a prolonged period.
China will continue to increase its economic lead over India - although the latter will experience rapid economic growth.
There is no historical evidence China is oversaving or overinvesting and it should seek to strategically maintain, and not cut, its present investment and saving rates.
Current US and UK economic policy addresses secondary issues and therefore is unlikely to be successful.
Note on future postings
A companion blog Key Trends in the World Economy has therefore been established to deal with a wider range of economic issues. Notification of links to posts on Key Trends in the World Economy will be given on the current blog. But the full posts will not be reproduced here in order to maintain accessibility.
References - for detailed references see continuation of article
The latest figures on the emerging pattern of global investment present a massive challenge to the next [UK] government. The likely future we can extrapolate from these figures will come as a shock to many, particularly those who subscribe to the theory of 'post-fordism' which became fashionable in the 1980s. According to this thesis, the era of mass assembly line output, pioneered by the Model T Ford, was superseded. New forms, based on ‘flexible batch production’, were playing the leading role in the economy.
A series of interrelated concepts were advanced linked to this — that a tendency towards small(er) scale production had replaced the huge units of output of ‘Fordism’, that service industries were replacing manufacturing, that a ‘segmentation’ of markets had/was taking place etc.. In a typical formulation of the period: ‘The new terrain is that of high technology, of small firms, computers and information technology’. This concept led, in terms of rhetoric, to various views that the large scale economy of the manufacturing period was bypassed and instead ‘small is beautiful.’
This thesis was based on ripping individual aspects of the situation out of context, exaggerating them, and using this to destroy any quantified, precise or balanced consideration of reality, and thereby obscuring the real tendencies of development.
The real economic trends were, and are, the exact opposite of ‘small is beautiful.’ In the context of the issues discussed here, they might be termed ‘big is flexible.’
The most advanced sectors of modern production are, indeed, characterised by extraordinary flexibility — compared to the standardisation caricatured in Henry Ford’s famous ‘you can have it any colour provided its black.’ But this emphasis on the outward forms of flexibifity, segmentation, and individualisation obscures the underlying economic reality. The necessary precondition, and foundation, for the flexibility of ‘post-Fordist’ production is an historically unprecedented level of investment and associated scale of production.
This trend is evident not merely in direct investment within industry — i.e. the technology which makes possible flexible manufacturing, but in the processes necessary to co-ordinate extremely large scale production — telecommunications systems, transport, computerisation of stock control etc. These, in turn, require radical expansion of the educational system — the creation, on a new and unprecedented scale, of skilled labour which is the indispensable precondition for operating this new, more capital intensive, production.
The enormous concentrations of capital which make flexible production possible have a number of aspects. One, analysed by in 'Fundamental Economic Implications of a Single European Currency', is that the necessary scale of production, of the most advanced industries, can only be carried out, on an efficient basis, on a scale which exceeds the nation state. It is this which is the ultimate root of globalisation — and why all attempts to pull production back into the scale of nation state are purely utopian.
This article concentrates on a second aspect — that of the scale of investment required for modern production. This is considered from both an ‘extensive’ and an ‘intensive’ point of view. The ‘extensive’ is the spread of successively higher ratios of investment to GDP into the most successful contemporary economies. The ‘intensive’ is the penetration of high levels of investment into the new service sectors in the most advanced economies. This combination makes clear that what is being seen is not a retreat to the ‘small’ but a new upward twist in the role of large scale investment within the economy.
The implications of this for the U.K. are evident. Britain historically suffered from an inadequate level of investment — a phenomenon illustrated again here. But under 18 years of Tory government this chronic historic problem has become acute — with investment having now fallen to its lowest share of GDP for forty years. The material analysed below shows that far from the rise of the service sector leading to a lessening of the requirements for investment, it will raise them still further — together with the demand for an educated labour force capable of operating this investment.
The last 18 years of Conservative government have not corrected (he historical distortions of the U.K. economy, but deepened them still further. An emphasis on investment by the next Labour government is the essential precondition for tackling any of the problems which face the British economy.
Ken Livingstone MP
* * *
The historical rise in the proportion of the economy devoted to fixed investment is one of the most well established of long term economic processes. It will be illustrated below in considering the overall trend of fixed capital formation from the industrial revolution to the present. Current conjunctural trends, the development of very rapid economic growth in South East Asia, and the transformations within the service sectors of the most advanced economies, may then be clearly understood against this backdrop.1
The industrial revolution
While estimates for investment for early historical periods are extremely difficult to make, it is clear that at the time of the industrial revolution in the U.K., at the end of the 18th century, less than 10% of the U.K.’s GDP was allocated to fixed capital formation. To give an historical contrast, by the 1990s rates of investment had reached, in extreme cases, 35-40% of GDP. A rate of fixed capital formation of 30% of GDP, or above, is typical for Japan and the East Asian Newly Industrialising Countries (NICs) (Figure 1).
Sharp increases in investment
It is also clear from historical data that increases in the rate of investment do not occur gradually, but in (relatively) short periods that are frequently reflected in shifts in international economic leadership — i.e. such upward shifts in investment are ‘revolutionary’ rather than ‘evolutionary’.
Since the industrial revolution four such waves of sharp increases in the proportion of GDP allocated to investment have taken place — with, arguably, a fifth occurring at present. Using as titles the countries which provided the ‘leading edge’ of such periods of increased investment, these may be termed the ‘UK period’, the ‘US period’, the ‘West German period’, and the ‘Japanese period’. The fifth may be termed the ‘Chinese/South East Asian period’ — although it remains to be seen if this is a new higher phase, or a generalisation of the preceding Japanese one.
These periods will be considered in chronological order.
The UK rate of investment
Historical studies indicate that, following the industrial revolution, the U.K.’s domestic fixed capital formation was less than 10% of GDP and that no fundamental increase in the proportion of UK GDP devoted to fixed capital formation took place during the following century. While the U.K.’s savings rate became substantially higher than this level of domestic investment, the capital created was invested abroad. By the eve of World War I, U.K. annual overseas investment was larger than investment in its domestic economy — this tendency to substitute investment abroad for investment at home being one of the chief historical features of the U.K. economy, and substantially accounting for its weak character compared to its rivals. By 1885 UK fixed domestic capital formation was still only seven per cent of GDP.2
Only after World War II did U.K. domestic investment substantially rise as a proportion of GDP, and even then it remained lower than its rivals — while, simultaneously, its rate of investment abroad remained higher, in proportionate terms, than its competitors.
The US rate of investment
While the UK level of domestic investment remained fixed at under 10% for over a century, the U.S., by the period following the end of the civil war, had qualitatively surpassed this rate — to achieve an historically unprecedented level of capital formation of 15-20% of GDP. This rate of fixed capital formation, being double that of the UK, accompanied the establishment of the US as the world’s leading economy — replacing Britain in the period from the nineteenth century until the end of World War II. Furthermore, the U.S. did not become a substantial investor abroad until after the two world wars, and even then its accumulation of foreign investment remained proportionately lower than that of the U.K.
It is clear that the US has not succeeded in seriously raising this rate of investment since the period in which it was established. The post World War II US economy saw fixed capital formation still averaging 15-20% of GDP.
The West Germany rate of investment
Data for German rates of investment prior to World War II are, unfortunately, not available. There is no evidence they surpassed US rates. However, by the early 1950s, West Germany had achieved a new historical peak of fixed investment of 20-25% of GDP — for the first time achieving a level clearly exceeding that of the U.S..
This level of investment, due to the competitive power/example of the West German economy, became generalised throughout Europe during the period of post-war boom from the 1950s-70s — with the exception of the U.K, in which the rate of investment remained lower. This pattern of investment, at a ‘West German level,’ underlay the process of economic convergence in Western Europe in this period. The failure of the U.K. to achieve this level of investment explained why it fell behind its European rivals, and was, and is, unable to participate in their process of convergence.
On the international field, this new historically higher rate of fixed capital formation was accompanied by Western Europe achieving a more rapid rate of economic growth, and productivity increase, than the United States in the period from the 1950s to the early 1970s.
The Japanese rate of investment
From 1960 onwards Japan, which had commenced its post-war economic growth with levels of investment comparable to those of West Germany, achieved a new historical peak in investment rates — reaching levels of gross fixed capital formation of 30% of GDP and, at its peak, 35% of GDP. Such a rate of investment had, historically, only been previously seen once before — during Stalin’s period of rapid industrialisation of the USSR in the 1930s.
Japan’s rate of fixed capital formation has now been sustained for a quarter of a century indicating a new historical level in the proportion of GDP devoted to fixed investment.
The international accompaniments of this ‘Japanese’ rate of investment are well known. During the 1960s and 1970s Japan achieved rates of growth exceeding that of not only the U.S. but also Western Europe.
The Chinese/South East Asian rate of investment
Since the beginning of the 1980s a rate of investment exceeding that of Japan has been achieved by China, and a number of the South East Asian NICs. Their levels of fixed capital formation have reached levels of 35-40% of GDP (Figure 2). If this is maintained it will, of course, represent a new higher period of rate of investment. However, this level has, so far, been sustained only for a relatively short period — a decade. It is, therefore, necessary to reserve judgement as to whether a new ‘plateau’ of investment, exceeding that of Japan, has been achieved or whether they will slip back to the Japanese level.
The consequences of such rates of investment are, however, clear. The four ‘Asian Tigers’ — South Korea, Hong Kong, Singapore and Taiwan — have been transformed from underdeveloped countries to advanced industrial states in a single generation. China is undergoing the most rapid sustained growth seen by any large underdeveloped country in history.
Successive rises in the rate fixed capital formation
Summarising the above data the four, possible five, historically characteristic periods of rates of fixed investment can clearly be seen. These were:
• the UK rate, from the industrial revolution to the late nineteenth century, with levels of fixed capital formation of 5-10% of GDP;
• the post-civil war level US with investment at 15-20% of GDP:
• the post-World War II West German level of fixed capital formation of 20-25% of GD?;
• the post-1960 Japanese level of investment of 30% of GDP;
• a possible Chinese/South East Asian level of investment of 35% of GDP.
‘Leaps’ in the rate of investment
It is evident that, at least in the modern period, such characteristic increases in the rate of fixed capital formation do not take place gradually but in relatively sudden spurts. The West German level of investment was achieved in ten years between the end of World War II and 1955; the Japanese level of investment was achieved in a rapid surge between 1950 and 1960; the Chinese/South East Asian rate of investment was achieved in the ten year period after 1980.
‘Extensive’ increases of rates of investment
It is, furthermore, evident that once a ‘leading country’ of a given period has achieved the new higher proportion of GOP devoted to fixed capital formation this rate is ‘sticky’ — i.e. it is hard to achieve a higher rate. Once the UK had achieved the level of fixed capital formation of the industrial revolution its level of domestic investment rose only slightly over the next 150 years — a substantial increase only occurring in the post-World War II period. After the US had achieved its post-civil war level of investment this did not significantly increase in the next 130 years. West Germany did not succeed in rising above its post-World War II peak of investment. Such ‘stickiness’ of the rate of investment evidently reflects the fact that the relations between social groups, established by a given investment rate, would require major political upheaval to modify that level of investment.
The result of such ‘stickiness’ is the ‘extensive’ spread of increases in the rate of investment. In each case the new, higher, level of fixed capital formation was accompanied by a shift in the geographical locus of the most rapid economic growth. This ‘leading edge’ of investment and growth rates passed successively from the UK to the United States in the late nineteenth century and the first half of the twentieth; to Western Europe, immediately after World War II; to Japan from the 1960s; and to China and the East Asian NICs from the 1980s onwards. A spiralling outwards from the first industrial countries occurred.
The rise of the ‘service economy’
The rise of, first, the Japanese and now the EastlSouth East Asian economies is, of course, a commonplace observation of modern economics — although its place in the systematic successive increases in rates of investment is not so widely appreciated. But what is involved in the second characteristic process taking place within the already advanced economies themselves — that of the rise of the service sector?
It is in this field, in particular, that the idea of ‘smallness’ is thrown up. The level of investment in a ‘Fordist’ car plant is evident in its sheer physical size. Does, therefore, the rise of the service economy represent a retreat to a new, lower, level of investment? To illustrate the actual processes, Tables 1, 2 and 3 [at the end of this article] show, for those sectors for which data exists, the percentage of value added that is constituted by consumption of fixed capital in the U.S., Japan and Germany — i.e. in the most advanced economies. Consumption of capital, as a percentage of value added, is the most appropriate measure of the capital intensity of production.
A number of features stand out in this data which are not connected to the rise of the ‘service economy’ — in particular the extremely capital intensive character of the extractive industries (oil, gas, coal, mining in general etc.), and agriculture (which in all three economies has a higher capital intensity than the average for the economy as a whole). But the most striking feature, for present purposes, is that in all three economies the level of capital intensity in manufacturing is lower than the average for the economy as a whole — i.e. manufacturing does not represent a peak level of investment, from which a decline then takes place. Other things being equal a shift out of manufacturing would be associated with a rise in the level of capital intensity, not a fall.
Distinctions within the service sector
The process involved in this striking fact that manufacturing represents a sector of lower than average, not higher than average, capital intensity may be seen clearly by examining the service sectors in Tables 1 to 3. Certain service sectors have a low, common, capital intensity in all three economies — indicating that these are sectors that, at least at the present stage of economic development, are less capital intensive than manufacturing. These are notably the wholesale and retail distribution system and provision of government services. But considering the U.S. economy, that is the most advanced in the world, a whole series of service sectors have capital intensities significantly above the average — and substantially above those for manufacturing. These include communications and telecommunications, hotels, recreational and cultural services, finance, non- dwelling real estate and transport.
These named service sectors are, however, precisely the core of the expanding areas that form the base of the modern ‘service economy.’ That is, the movement of the U.S. economy out of manufacturing, and into services, is not a shift into sectors with a lower capital intensity than manufacturing, but into those with a higher capital intensity.
Some of the reasons for this trend are evident. These U.S. service sectors, which are the most advanced in the world, have undergone a massive process of computerisation in almost all areas. This process of computerisation has interlinked with that of telecommunications — the necessary precondition of efficient organisation of very large scale, including ‘globalised,’ production. Whole service sectors, such as finance, transport, and hotels, are now entirely dependent on such systems.3 These trends, together with others, result in a situation, as illustrated by the data, whereby the capital intensity of these service sectors actually exceeds that of manufacturing.
The process of rising capital intensity, in the most advanced service sectors, can be seen clearly by making a comparison of service sectors where capital intensity in the U.S differs sharply from the other economies noted — particularly for Germany, for which more comprehensive data is available than for Japan. In Germany, sectors such as communications and transport have high capital intensities — as in the U.S. But sectors such as financial institutions and restaurants and hotels do not — as is also the case for the U.K., Norway, Sweden, Finland, Austria and New Zealand for which OECD data are available.4 The higher level of capital intensity of these sectors in the U.S. is, evidently, linked to their more advanced development.
Increasing scale of production
A feature accompanying this rising capital intensity in the service sector is its increasing scale of production — the bringing of the service sector under the sway of large scale concentrations of capital. The process of creation of such concentrations in banking, entertainment, music, sport, broadcasting etc., is now on a scale equaling that in manufacturing. It was accurately described in Business Week:
‘Almost without warning, the U.S. has entered a new era of bigness... Chase-Chemical, Disney- ABC, Time Warner-Turner - these are just the tip of an economy wide move toward combination and consolidation.
‘Today’s deals are not the financially driven hostile takeovers and leveraged buyouts that dominated the 1980s. No raiders are carrying out bags of cash this time around. Now it’s the corporate leaders of America... Their goal: to acquire the size and resources to compete at home and abroad, to invest in new technology and new products, to control distribution channels and guarantee access to markets. “We are moving toward a period of the megacorporate state in which there will be a few global firms within particular economic sectors,” says Steven Nagourney, chief investment strategist for Lehman Brothers Inc.’s private client group.
‘That’s certainly true in the media industry, where the race to lock up key distribution channels such as television, and cable networks just got more frenzied. Market dominance is also driving such mergers in the drug industry, Merck’s & Co.’s purchase of Medco Containment Services Inc. ‘As your competitors get bigger, you’re almost forced to get bigger to stay equal’, says Norman S. Selby, Head of McKinsey & Co.’s pharmaceutical practice. ‘It’s a continual game of catch-up’.
‘Other deals are driven by a need to bulk up as U.S. companies take on global competitors. The Chemical-Chase merger produces a bank that’s No 1 in the U.S. but only 21st in the world, by assets. And the combination of Upjohn Co. and Sweden’s Pharmacia, announced on Aug. 20, will create a titan that only ranks about ninth in sales among drugmakers worldwide.
‘Besides adding sheer size, acquisitions can provide an instant presence in foreign markets. Scott Paper Co. was acquired by Kimberly-Clark Corp., in large part, because Scott had strengths in Europe that Kimberly lacked....
‘Companies are taking advantage of deregulation to make ever- larger combinations. New rules lifting barriers on interstate banking set to take effect in September, for example, will ignite a new round of cross-country mergers. And the proposed elimination of the Interstate Commerce Commission, which reviews railroad mergers, may spark more combinations among real carriers. One possibility: a Norfolk Southern Corp., takeover of Contrail Inc.
‘The passage of the telecom deregulation bill, expected this year and next, may be the signal for some of the biggest mergers of all time, especially if the old Bell system starts reassembling itself. ‘It’s not unreasonable to see several (regional Bell operating companies) merging over the next several years’, says Daniel Rein gold, vice-president at Merrill Lynch & Co. The most likely candidates: Bell Atlantic Corp. and Nynex Corp., which already jointly run a cellular service...
‘Inevitably, some once-mighty players will be trampled in the stampede for market dominance. Apple Computer Inc., with only about 10% share of the personal- computer market, may find that software developers opt to concentrate their efforts on the much larger Windows market.’
As Business Week noted, even in ‘classical’ service sectors:
‘Entertainment — just about everyone is trying to dominate this very hot U.S. export. Reason: vertical integration is supposed to yield clout in the Information Age. Result: Disney, Seagram and Westinghouse are all doing huge deals. Now, Time Warner is wooing Turner Broadcasting. Financial services — the goal here is to squeeze out costs and earn economies of scale. That’s a big reason behind Chemical’s $10 billion merger with Chase and First Union’s $5.4 billion acquisition of First Fidelity Bancorp.’5
The Wall Street Journal noted precisely the same trend driving the process of mergers which now extends well into the service sector:
‘The deals come tumbling out, one upon another. Chase/Chemical. Sandoz/Ciba-Geigy. Bell Atlantic/Nynex. British Telecom! MCI. Boeing/McDonnell Douglas. Morgan Stanley/Dean Witter.
‘It is a merger boom the likes of which the business world hasn’t seen since 1960s, when assembling conglomerates out of dozens of smaller companies was the rage. Except that it isn’t really like those eras. It is bigger, for one thing. And the forces behind it are different.
‘First, a few figures. The volume of mergers and acquisitions done world-wide last year added up to $1 trillion. That included 10,000 transactions in the U.S. alone, worth more than $650 billion — nearly twice the dollar volume and the number of deals for the peak year of the 1980s.
‘Many have been huge: Six last year topped $10 billion. Indeed, one-fifth of last year’s total dollar volume was squeezed into just 10 mega-mergers. The year saw more than 100 billion-dollar-plus transactions, a record...
‘This year there is no letup: 26 billion-dollar announcements so far and already a few giant ones, such as Morgan Stanley/Dean Witter and Banc One /First USA. It is the fastest pace since the current merger boom began...
‘Some of the causes aren’t far to seek... Above all, a globalizing economy in which companies often find they must become big to compete, either by acquiring or by being acquired. “There are all kinds of related factors, but the fundamental determinant of the overall level of activity is the expansion of the global economy,” says Scott Lindsey, co-head of mergers at Credit Suisse First Boston Corp.
‘As these elements suggest, the mergers of today are overwhelmingly being done for strategic business reasons. Thus, this merger boom differs from that of the 1980s, when some buyers were financial types simply angling for undervalued assets that could resell, and also from the conglomerate era that began in the early 1960s...
‘At its most fundamental level, today’s merger wave is about efficiency and market clout. Look at the union last year of Chemical Bank and Chase Manhattan. Where there had been two banks, with two. chairman, two corporate-loan departments, roughly 600 branches and over 75,000 employees, there is today just one bank. One chairman. One loan department. Eventually 100 branches will be shuttered, and 12,000 jobs will be eliminated...
‘A common theme in modern mergers is sheer size. Size is advantageous in many ways. Tyco international in Exeter, New Hampshire, by buying a packaging maker called Carlisle Plastics and wrapping it into its own Armin plastics, has doubled the volume of its purchases of low- density polyethylene film and gained new clout with suppliers. Banc One, by buying credit-card issuer First USA and its U.S. portfolio of 16 million card holders, gains a national platform in a key business.
‘And British Telecommunications’ $21 billion purchase of ‘MCI can now aggressively pursue a local strategy without worrying about near-term earnings impact,’ notes Salomon Brothers analyst Jack Grubman...
‘Size also matters in trying to capture as much business as possible from a given client. Companies like to offer customers “end- to-end solutions”. So Duke Power bought gas-pipeline giant PanEnergy, creating one the biggest energy suppliers in the U.S. Citing Duke’s contract to manage First Union’s energy needs over its entire 12-state network. Duke Chairman William Grigg says:
“Customers want companies to manage their whole energy requirements.”
‘Mergers are happening even in technology, historically an industry devoted to creating new products and services in-house. Cisco Systems, whose stock has been one of the great performers of the 1990s, last year spent a speck of it for a little-known company called Granite Systems Inc. Granite had no revenue, only a great idea: a promising switching technology, a crucial piece of the puzzle for networking companies. Like Duke, Cisco wanted to be better able to provide end-to-end solutions. And it wanted to do so fast.
‘For Cisco, with a $40 billion stock-market value, ‘to pay $200 million and potentially ride the next wave is a trivial insurance policy if it works,’ says Charlie Federman of Broadview Associates, a technology-oriented investment bank. “Time-to-market is absolutely critical, and you can’t be one or two months late.”..
‘The Clinton administration and the Republican Congress enacted the Telecommunications Act of 1996, opening up the long- distance phone business and the TV and radio markets, That helped spawn some of the biggest combinations ever, such as the $22 billion pending Nynex-Bell Atlantic merger and WorldCom’s $14 billion acquisition of MFS Communications. Westinghouse’s purchase of Infinity Broadcasting, combining Nos. 1 and 2 in the radio business, couldn’t have happened without the same legislation.’6
This scale of concentration of capital, now spreading far into the service sector, is simply a counterpart of the increased capital intensity of production — reflected in the figures for the most advanced service sectors.
Summary
Considered from a fundamental point of view three of the most striking features of the new world economy — globalisation, the explosive growth of the Asian economies, and the rise of the service economy — are merely different manifestations of the same process — the continuing sharp rise in the proportion of the economy devoted to investment, and the scale of production which results from this. In its outward form flexible production appears small and precise — involving ability to produce smaller runs of differentiated products and utilising physically smaller units of production as parts of large concentrations of capital. But this physical aspect is merely the outward form. The underlying reality which makes such ‘flexible production’ possible, its precondition, is levels of investment, and a scale of production, on an unprecedented level.
The implications for the U.K. are evident. The fact that Britain’s is a mature economy, which must rest on the most advanced spheres of manufacturing and on services, does not obviate its need for investment — or lessen the crippling effects of its historical inadequacy in this field. It merely gives this problem unprecedented acuteness.
Notes
1. An earlier analysis of part of this material was given in ‘Behind the Threat of a Global Credit Crunch’, May 1991. This article both updates these international trends and considers the situation within the service sector of the advanced economies.
2. All historical figures, unless otherwise stated, are from One Hundred Years of Economic Statistics, Economisy publications, London 1989. Where more recent data is available from the OECD this has been used.
3. This process of cornputerisation of transportation has affected no simply obvious areas, such as civil aviation, but also lies behind the revival of the U.S. railway system. For an excellent analysis of this see Barnaby Feder, ‘What drives U.S. rail rebirth,’ International Herald Tribune 2 November 1996.
4. The only exception to this is the hotel and restaurant sector in Sweden, the capital intensity of which is above that of the Swedish economy as a whole.
5. Michael Mandel, Christopher Farrell, Catherine Yank, ‘Land of the Giants,’ Business Week 11 September 1995.
6. Steven Lipin, ‘Corporations Dreams Converge on One Idea: Its ‘lime to Do a Deal.’ Wall Street Journal 26 February 1997.
