Key Trends in Globalisation

Claims of big success by 'Abenomics' are a fake

The claims 'Abenomics' is a big success are so far fake.

Headlines have appeared such as 'Japan revises up Q1 growth to annual 4.1%' with commentary this, 'was much higher than the preliminary estimate of 3.5 per cent, which was already the fastest rate recorded by any Group of Seven economy.' This ignores that this annualized 4.1% growth in the 1st quarter of 2013 was only recovery from a 3.6% fall in the second quarter of 2012.

Year on year GDP growth in Japan in the 1st quarter of 2013 was only 0.2%, the lowest since the 4th quarter of 2011 - see Figure 1, Table 1, and Figure 2

Figure 1

Table 1

Figure 2

 

Japan’s GDP remains 1.2% below its peak in the 1st quarter of 2008 and its recovery remains slow – Figure 3.

Figure 3

 

At best all ‘Abenomics’ has done so far is stop the renewed decline which commenced in Japan’s economy in 2011. But the ‘Abe recovery’ is simply in line with the trend since 2009. Only if the growth seen in the 1st quarter of 2013 continued for a significant period could ‘Abenomics’ really claim any significant success.

In short the claims to date of a big success by ‘Abenomics’ are fake.

China and developing economies will determine the chances for world growth in 2012

China’s economic growth has become a key factor not only for itself but for world markets. As the scale of China's impact is still too frequently underestimated it should be noted that, measured in current dollars and at market exchange rates, i.e. in terms of actual effective demand, in the three years following the start of the international financial crisis China contributed 33.4 per cent of global market growth – more than four times as much as the US 8.1 per cent (Table 1). While final data for 2011 is not yet available, it is already clear from the first three quarters figures that China’s market last year expanded by over $1 trillion – approximately twice as much in dollars as the US, despite US growth having resumed. Table 1 makes clear no other economy has approached China in terms of market/global aggregate demand expansion.

It is therefore a key question whether China will continue essentially the same scale of market growth in 2012. The answer is ‘yes’  - but because of the issue’s importance the reasons should be clearly outlined. Interlinked with this is the decisive role played by developing economies in recovery from the financial crisis – the interlinking being that China is by far the largest developing economy, while the developing economies have become China’s largest trade partners.

In the three years covering the period from the beginning of the international financial crisis to the latest available annual data, i.e. in 2007-2010, developing economies accounted for 78.6 per cent of world market growth and developed economies for only 21.4 per cent. Considered from another angle, simply taking different classifications, either the BRIC economies (Brazil, Russia, India and China), or China plus Latin America, contributed the majority of world market/effective demand expansion – either of these groupings accounting for more than twice as much market expansion as the developed economies.

Table 1

 

Turning to more detailed trends, the first feature determining China’s continued dominant position in world market expansion, one the consequences of which are insufficiently frequently noted, is that as China’s economy becomes larger a similar percentage yearly growth necessarily turns into an increasingly large annual absolute market increase - in inflation adjusted terms, China’s economy expanded by 2.3 trillion RMB in 2008, 2.4 trillion RMB in 2009, and 3.1 trillion RMB in 2010.

But even frequently cited constant price growth figures underestimate the expansion of China’s position in the world market. Actual sales, and therefore changes in aggregate demand, use real money which is affected by exchange rate shifts and inflation – further figures in this article are therefore at current market exchange rates and prices unless otherwise stated. In 2009, when China froze the RMB’s exchange rate due to the international financial crisis, China’s economy grew by $469 billion – compared to a US contraction of $353 billion. In 2010, when China allowed the RMB exchange rate to rise, its annual economic expansion rose to $935 billion and the figure will be over $1 trillion in 2011 – roughly twice US market expansion.

Table 1 also makes clear the second reason China’s market will continue  its expansion. World growth is now dominated by developing economies and China is their most rapidly expanding trading partner.

Considering trends among developing economies, China accounting for 33.4 per cent of global market expansion. Latin America was second – constituting 17.3 per cent of world growth, with Brazil accounting for 58 per cent of this. China and Latin America together accounted for 50.7 per cent of world market growth..

Among other developing economic regions, South Asia contributed 8.0 per cent to world market growth, with India accounting for 84 per cent of this. Developing East Asian economies, excluding China, accounted for 7.0 per cent of world growth – Indonesia constituting 54 per cent of this. The Middle East and North Africa accounted for 6.1 per cent of world growth with no single dominant regional economy – the largest contributor, Egypt, constituted only 19.9 per cent of the total. Developing countries in Europe and Central Asia accounted for 4.5 per cent of world growth – of which 55 per cent was Russia. Sub-Saharan Africa grew rapidly, but due to its low starting point only contributed 2.1 per cent of world growth.

Turning to developed economies, Japan illustrates the importance of currency movements for shifts in markets measured in dollar terms. Due to the yen’s sharp exchange rate rise, Japan contributed 14.9 per cent of the dollar expansion of the world market despite Japan’s economy contracting in inflation adjusted terms. The US contributed 8.2 per cent to world market growth, despite the US not having grown in constant price terms, due to the dollar rising against other currencies,

The ‘disaster area’ for world markets was the developed European economies with a decline of $668 billion - equivalent to subtracting 9.2 cent from world growth.

It is already clear 2012 will show no fundamental change in this pattern. Developed European economies will again be the worst performing region – suffering a recession possibly magnified by a low Euro exchange rate. The US should expand, but slowly compared to previous upswings in US business cycle. Therefore if the world economy is to grow this will again have to be primarily due to developing  economies.

Fortunately, the large developing economies are slowing but still growing substantially more rapidly than developed ones. China, the dominant factor in the equation, even on pessimistic estimates is likely to grow by at least 7-8 per cent in real terms this year which, after increases in the exchange rate of the RMB and inflation is take into account, means an expansion of its market of probably 12-15 per cent in dollar terms. Minimum real growth estimates for India are at least seven per cent.

It is also clear from the pattern in Table 1 why BRIC economies will again dominate world growth – in 2007-2010 they contributed 52.5 per cent of world market expansion. Not only are the BRICs individually the largest developing economies but each is the centre of a major regional economic area. While Brazil has slowed, Russia’s economy has been accelerating, and it is in any case China and India which are the dominant dynamic BRIC economies.

This overall situation clearly interrelates with China as it already carries out the majority of its trade with developing economies – 54 per cent of total trade, 49 per cent of exports and 60 per cent of imports.

The implications for China’s markets are clear. China has not only the world’s most rapidly expanding domestic market, and declining inflation gives it extra room for domestic economic loosening/stimulus in 2012, but its biggest trading partners are the most rapidly growing regions of the world economy. It is this combination of domestic and international factors which determines that  China will continue to remain the world’s most rapidly expanding market/supplier of increased aggregate demand in 2012. Given the negative prospects in Europe, and slow growth in the US, it will then be the situation in the developing economies, which is increasingly related to the situation in China, which will necessarily determine the overall prospects for world growth in 2012.

*   *   *

This is an expanded version of an article which originally appeared in Shanghai Daily.

The weakness in world trade - pre-crisis trade levels only regained in Asia and Latin America

Europe’s economy is probably entering a double-dip recession. The indications from world trade, as analysed previously, are so far that the world economy as a whole is facing slowdown but not renewed recession. However a detailed breakdown shows extreme unevenness in the trade recovery - with only Asia and Latin America surpassing pre-financial crisis levels. Regional trends for imports and exports, using a three month moving average to smooth short term fluctuations, are shown in Figures 1 and 2.

Considering trends in detail, pre-crisis world trade peaked in April 2008. In the latest month for which data is available, September 2011, world trade was 2.3 per cent above its pre-crisis maximum on individual month comparisons and 3.6 per cent above on a three monthly moving average.

Table 1 shows a detailed breakdown of trade since the financial crisis by region. This data shows that only in developing Asia and Latin America are both exports and imports clearly above pre-financial crisis levels. Taking three monthly moving averages, imports are up from pre-crisis levels by 16.7 per cent in developing Asia and 9.4 per cent in Latin America, with exports up 17.0 per cent in developing Asia and 6.9 per cent in Latin America. In the US exports are slightly above pre-crisis levels but imports are significantly below. In all other regions – the Euro area, Africa and the Middle East, Central and Eastern Europe, and Japan – both exports and imports remain below pre-crisis levels.

The recovery of world trade to above pre-crisis levels is therefore due to the situation in two developing regions. The weakness of trade in the Euro area is worse than most regions, particularly in terms of imports, but not really exceptional. Trade in most areas of the world economy remains significantly below pre-crisis levels.

Table 1

 

Trade with China

Among the largest economies the chief beneficiary of this pattern of world trade is China - although it is likely the pattern itself is in significant part a result of the dynamics of China's trade.

In the period between China's peak pre-crisis level of exports and imports, in July 2008, and September 2011 China's exports to Asian developing economies rose by 22.9 per cent and its imports from these economies rose 31.4 per cent. China's exports to Latin America rose by 53.0 per cent and its imports by 59.9 per cent. These are clearly exceptional growth rates. China is the main trade partner for most developing Asian economies as well as for a significant number of Latin American economies including Brazil.

The patterns of world trade since the financial crisis therefore indicate the consolidation of a dynamic trading interaction between China, developing Asia and Latin America. China's economy and trade is not yet sufficiently large to offset a global scale recession in the EU and/or US, but there is clear evidence that China's economy is sufficient to produce the most dynamic of post-crisis world trade interactions centred on Asia and Latin America.

Figure 1

Figure 2

During the last four years the EU's economy has grown by -0.3%, the US by 0.6%, and China by 42.2%

The full scale of the difference in economic performance of China compared to the US, Europe and Japan during the international financial crisis is shown in Figure 1. It is summarised in the following figures:

• In the four years to the latest available data, for the 3rd quarter of 2011, China’s GDP expanded by 42.2%
• In the four years to the latest available data, also for the 3rd quarter of 2011, US GDP increased by 0.6%.
• In the four years to the latest available data, for the 2nd quarter of 2011, European Union (EU) GDP shrank by 0.3%.
• In the four years to the latest available data, for the 2nd quarter of 2011, Japan’s GDP contracted by 5.2%.

Figure 1

 

 

These are evidently extraordinary statistics. During this four year period China’s economy expanded 70 times as fast as the US.

Such data also clearly refutes the current attempt to claim that in China there is an economic ‘crisis’ in some sense equivalent to that in the US or Europe. Such arguments are intellectually sloppy (at best) attempts to undermine rational thought by destroying any serious quantitative comparisons.  

To give examples of such claims, a recent article by Nouriel Roubini and Ian Bremmer in the Wall Street Journal is introduced: ‘With Europe, China and the U.S. in crisis, the real question is which of them will stumble first.’ Similarly Will Hutton in the UK’s Observer claims: ‘Nobody would start from here – an ill-designed single currency interacting with an insupportable burden of private debt created by oversized, undercapitalised banks. And it's as much a problem in the US and China as in Europe.’

The data given above shows such claims are false. GDP growth of 42.2% in China, an annualised 9.8%, is not remotely comparable to the US’s annualised 0.2%, or the EU’s annualised minus 0.1%.

Naturally it is impossible to have an annual 9.8% growth rate for almost four years and have no problems at all – in fact no economy ever has no problems! China has had consumer price inflation, primarily due to international commodity price increases, which reached 6.5% before falling and it has had excessively high house price increases – which are also now falling. But none of this constitutes a ‘crisis’ on anything quantitative scale remotely approaching that of the US and Europe.

Nor, to take Hutton’s point, does the EU financial crisis have anything like the same impact in China, or even the US, as in the EU. The effect of the decline in imports from the EU on China’s exports is noticeable but only in the sense that it reduces China’s overall export growth from a very high to a high rate of growth – 15.8% last month, in a factual situation in which none which China’s GDP growth in the last four years has come from net trade. Indeed reduction of China’s trade surplus means that net trade has been a subtraction from China’s GDP growth during that period. The exposure of China’s banks to Europe’s debt crisis is also minimal. While the financial exposure of the US to the Eurozone is certainly higher than China’s there is also no indication that the actual scale of crisis or defaults in Europe is pushing the US into recession – whereas a double dip recession in Europe itself is extremely possible.

Hutton, in short, is engaging in inflated rhetoric to attempt to create a relative equals sign between the situation in China (and the US) and that in Europe when none exists. Inflated rhetoric is merely a form of destroying the quantitative scale of comparison which is a precondition for rational thought.

The GDP data for China, US and Europe GDP data should also end attempts by Kate Mackenzie the Financial Times and Nouriel Roubini to present the US’s Michael Pettis, and similar analysts, as having had a correct analysis of China. Michael Pettis runs an objectively moderated blog on China but his analysis of China has been factually shown to be quite erroneous – claiming that: 'the US would be the first major economy out of the crisis and China one of the last.’ Evidently a situation where China has grown by 42.2% and the US has grown by 0.6% shows the reverse has been the case. Claims that it is too early to judge whether China or the US has been more successful in coming through the financial crisis are just attempts to avoid the test of facts that has taken place. Even if, against the evidence, China’s economy were now to slow significantly the scale of growth it has already achieved demonstrates that has come through the financial crisis far more successfully than the US or Europe.

The basis of any serious analysis or theory is facts. Those who refuse to refer to the data of the relative performance of China, the US or Europe during the last four years do so only because their analyses will not stand the test of examination by these facts.

China in face of the West's 'Great Stagnation'

I have a new article at China.org.cn which analyses the impact of the present 'Great Stagnation' in the developed economies on the prospects for China's economy.

It concludes:'Given extremely slow growth in the developed economies, and that examination of underlying macro-economic factors such as savings and investment indicates no reason to expect a substantial growth acceleration, this places China in a new international economic situation. For almost the entire period since China launched its economic reforms in 1978, it has been growing more rapidly than other economies but in an international context where the developed economies were growing significantly. The only serious previous recession in the advanced economies during China's reform period was right at its beginning, in 1980-81, when China was scarcely integrated in the international economy. The international slowdowns in 1990 and 2000 were brief and mild and while the 1998 South East Asian financial crisis impacted China significantly, it did not originate in the developed economies...

'In economics and business there is no virtue in either optimism or pessimism, there is only a virtue in realism. Given current trends, China has to base itself on a perspective that for several years there will be slow growth of the developed economies and therefore slow growth of their imports. Developing economies, while growing more rapidly than developed ones, will not in the very short term be able to fully compensate China's exports for stagnation in developed economies.

'The international framework for China's economy is therefore clear. It is important to understand that what is faced is a 'Great Stagnation' not a new 'Great Recession' - that is there is no reason to anticipate major international economic downturn of the 2008 type. China therefore does not need a new huge stimulus program of the type it launched in 2008 - which would lead to severe economic overheating. But the international economic situation requires adjustments in emphasis.

'First, even more than previously, China has to rely on developing domestic demand. Greater analytical clarity on this is important as at present domestic demand is frequently confused with domestic consumption - the two are not the same.

'Second, while developing economies will not immediately be able to fully make up for the negative pressure on China's exports from the 'Great Stagnation', they provide an important addition to China's domestic demand - in the last fifteen years the percentage of China's exports going to developing economies have risen from 35 percent to 50 percent. All developing economies face the Great Stagnation, therefore all face constriction on exports to developed countries, while China's imports are continuing to expand. This will produce greater integration of developing economies with China in both exports and imports.

'Within developing economies many of China's top companies, such as Huawei, Haier, and Lenovo already have high brand values and the present situation therefore creates opportunities to further enhance the positions of China's international brands.'

The full article, including a brief comparative analysis of the 3rd quarter US GDP figures with previous US post-war business cycles, may be found here.

More than three years without full economic recovery in the developed economies – the latest GDP figures in context

The publication of the European Union (EU) and German 2nd quarter GDP figures, following those for the US and Japan, completes the data regarding the state of the business recovery in the main developed economies. The picture is completely clear – Figure 1:

• By the 2nd quarter of 2011 none of the major regions among the developed economies has recovered their peak level of GDP more than three years after the high point of the previous business cycle.
• US GDP is 0.4% below its peak level in the 4th quarter of 2007.
• EU GDP is 1.8% below its peak level in the 1st quarter of 2008.
• Japan’s GDP is 6.0% below its peak level in the 1st quarter of 2008 – Japan’s data is of course affected by the earthquake and tsunami.

Overall, taking the period as a whole, this represents over three years of net negative growth in the developed economies. The key economic issue is not the possibility of a double dip recession, which the media is speculating on, but this extremely low growth rate even without one.

For comparison it may be noted that China’s economy has grown by over 30% in this same three year period.

Figure 1

What is China's present stage of economic development?

I have a new article at China.org.cn comparing China's present stage of economic development to the historical growth of Japan and South Korea. Its conclusion is:

'Today, China's Haier is the world's largest domestic appliance manufacturer, Huawei is likely to overtake Ericson as the world's largest telecoms equipment producer in the next two years, and China is already the world's largest manufacturer of high speed trains.In short, China's development today is entirely equivalent to Japan or South Korea at a similar stage of their economic growth.'

This provides the basis during the next years for international extension of China's leading brands - as occurred with Japan and South Korea..

Trends in investment and labour inputs with economic development, as indicated in the data of Jorgenson and Vu

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

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

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

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

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

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

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

Figure 1

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

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

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

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

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

Summary

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

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

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

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

* * *

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

Notes

Labour inputs in stages of economic development – trends revealed in the data of Jorgenson and Vu

Summary

An earlier article (Ross, 2010 August) analysed trends in the contribution of capital investment to GDP growth in the database published by Jorgenson and Vu of growth accounting data for economies compromising more than 95% of world GDP. (Jorgenson & Vu, 2007b) Jorgenson and Vu themselves drew attention to two trends:

• Factor inputs of capital and labour greatly predominate over total factor productivity [TFP] in percentage contribution to international GDP growth.
• The increasing role played by capital investment in information technology (IT).

Analysis of this database by the present author showed another trend. (Ross, 2010 August)

• Developed economies have a capital-intensive path of growth compared to developing economies – i.e. the percentage contribution of capital investment to GDP growth is higher in developed than developing economies. The East Asian/Asian developing economies are an intermediate group - the percentage contribution to GDP growth of capital investment in these economies is greater than in the majority of developing economies but less than in developed economies.

This previous article looked only at investment in capital. It did not examine improvements in labour quality, which typically requires investment in human capital. This was because the percentage contribution to GDP growth of investment in physical capital in developed economies considerably exceeds that of improvements in labour quality and, for clarity, it was therefore helpful to concentrate on the primary trend.

It is, however, also revealing to analyse the combined contribution of physical capital and improvements in labour quality – in particular given this has direct practical implications. Investment in physical capital and improvements in labour quality require expenditure/investment – the latter in education, training etc. Taking capital investment and improvements in labour quality together, therefore, gives an indicator of the different patterns of such expenditure and investment in economies at different stages of development.

The present article therefore supplements the previous one by analysing the contribution of labour inputs in different economy groups.

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

Capital-intensive and labour-intensive patterns of growth

The basic data for the present analysis is set out in Table 1 and Table 2. These show the percentage contribution to GDP growth of capital, labour and TFP, and of labour hours and labour quality, in economy groups for the periods 1995-2000, 1995-2000, and 2000-2006 as calculated from the data set out by Jorgenson and Vu (Jorgenson & Vu, 2007b). The pattern of the contribution of capital investment to GDP growth in the different economy groups was already analysed in the previous article and is therefore merely summarised here. (1) If the non-generally applicable case of East European economies, experiencing transition from Communism to capitalism, is left aside the patterns of growth of economies fall into two large groups according to their stage of economic development.

• The first are developed economies – the G7 and the 15 additional non-G7 developed economies. In the developed economies the percentage contribution to GDP growth of capital inputs exceeds the contribution of either labour or TFP in all periods – i.e. developed economies display capital-intensive growth.
• The second group are the majority of developing economies - in Sub-Saharan Africa, Latin America, the Middle East and North Africa. In these, with only one exception, Sub-Saharan Africa in 2000-2006, the percentage contribution of labour inputs exceeded the contribution of either capital or TFP in all periods – i.e. the majority of developing economies show labour-intensive growth. (2)

The Asian developing economies, in particular East Asian developing economies, are ‘intermediate’ between the developed and the majority of developing economies.

• In the Asian/East Asian economies the percentage contribution of capital inputs to GDP growth was larger than in the other developing economy groups in all periods. However in no period was the percentage contribution of capital inputs to GDP growth in the Asian/East Asian developing economies as high as in the G7. In two periods out of three the percentage contribution of capital inputs to GDP growth was lower in the Asian/East Asian developing economies than in the non-G7 developed economies.

It is notable that neither in the developed economies groups nor in the majority of developing economies was TFP growth the main percentage contributor to GDP growth. (3) This trend in developed and developing economies is of course in line with the overall conclusion of Jorgenson and Vu: ‘‘We allocate the growth of world output, as measured in the World Bank’s International Comparison Program, between input growth and productivity. We find… that input growth greatly predominates. ‘(Jorgenson & Vu, 2009)

Trends in labour inputs will be analysed in conjunction with this overall framework.

Trends in labour inputs

First labour inputs in the developed economies will be considered in Jorgenson and Vu's data and then those in differing groups of developing economies.

i. The Developed Economies

As already noted, both the G7 and the non-G7 groups of developed economies follow a pattern of capital-intensive growth – i.e. in all periods the contribution of capital inputs to GDP growth exceeds the contribution of either labour or TFP. However, G7 and non-G7 economies differ in the role played by different forms of labour inputs.

The contribution of increases in labour hours in all periods is smaller in the G7 than in the non-G7 economies.

In the G7 economies, in two periods out of three, the percentage contribution of labour quality to GDP growth exceeds that of increase in labour hours, whereas in two periods out of three in non-G7 developed economies the contribution of labour hours exceed the contribution of labour quality. That is, the bias in G7 economies within labour inputs is towards a higher percentage contribution of labour quality than labour hours, whereas in the non-G7 economies the bias is towards a higher contribution of labour hours than labour quality.

There is also a difference between forms of labour input and TFP growth in the G7 and non-G7 developed economies. In the G7 economies, in two out of three periods, the percentage contribution of TFP exceeds the total contribution of labour inputs, and in all periods the percentage contribution of TFP to GDP growth exceeds the contribution of either labour hours or labour quality considered individually. In contrast, in all periods, in the non-G7 developed economies the contribution of labour inputs exceeds the contribution of TFP growth.

In short, in both G7 and non-G7 developed economies the predominant contribution to GDP growth comes from capital inputs. But the pattern of growth in the G7 economies is predominantly based on ‘capital investment, plus increases in TFP and labour quality’, whereas in the non-G7 developed economies the pattern of growth is predominantly based on ‘capital investment, plus increases in labour inputs - in particular increases in labour hours’.

The dominance of capital inputs and labour quality in the G7 economies may be seen clearly in Table 1. The combination of capital inputs plus labour quality inputs plays an overwhelmingly dominant role in the contribution to GDP growth in the G7 economies – accounting in successive periods for 74.9%, 61.6% and 68.5% of GDP growth.

ii. Developing economies in Sub-Saharan Africa, Latin America, and the Middle East and North Africa

The dominant role played by labour inputs in GDP growth in the developing economies of Sub-Saharan Africa, Latin America, and the Middle East and North Africa is shown in that in all groups and periods except one, Sub-Saharan in 2000-2006, labour inputs exceeds either the input of capital or the input of TFP to GDP growth.

The contribution of labour inputs to GDP growth exceeds the contribution of TFP in all these economy groups in all periods .

Within this framework the dominance of increases in labour hours over increases in labour quality is clear. The percentage contribution of increases in labour hours exceeds the percentage contribution of increases in labour quality in all three economy groups in all three periods.

The pattern of growth of the majority of developing economies is therefore not only labour-intensive, but within that framework it is dominated by increases in labour hours rather than increases in labour quality.

iii. Developing Asian economies

In the developing Asian economies the percentage contribution of capital to GDP growth exceeds the contribution of labour in all periods. The percentage contribution of TFP also exceeds that of labour in all periods. In this overall pattern of higher inputs of capital and TFP than of labour inputs Asian developing economies are closest to the G7 group.

However, the pattern of labour inputs in the developing Asian economies differs markedly from the G7 economies. In all periods in the developing Asian economies, the percentage contribution of labour hours exceeds the percentage contribution of labour quality.

The pattern of growth of the Asian developing economies is therefore primarily based on inputs of capital, TFP and labour hours with a smaller percentage contribution from improvements in labour quality. If the developing Asian economies resemble the developed economies in the dominance of capital inputs over labour inputs, nevertheless within labour inputs the Asian economies resemble developing economies in that increases in labour hours predominate over increases in labour quality.

The Asian developing economies may therefore be taken as being ‘intermediate’ between the developing and developed economies in a dual sense.

• In terms of the contribution of capital inputs to GDP growth the Asian developing economies have clearly moved out of the ranks of developing economies closer to the capital-intensive pattern of growth in the developed economies - although the contribution of capital investment to growth in the developing Asian economies has still not yet reached the level of the developed economies.
• The developing Asian economies, unlike in particular the G7 economies, however continue to have a pattern of development similar to the majority of developing economies whereby inputs of labour hours are greater contribution to labour inputs than increases in labour quality.

Conclusion

These trends may now be summarised.

• The fundamental pattern of development whereby developed economies follow a pattern of capital-intensive growth and developing economies one of labour-intensive growth has already been noted. (Ross, 2010 August)
• Developing Asian/East Asian economies may be understood as occupying a position of transition from developing to developed status, with a capital-intensity of development that is higher than the other groups of developing economies but not as high as that of the developed economies.

In may, however, be seen from the present analysis that a second trend also occurs within labour inputs.

• The pattern of GDP growth of the developing economies is not only labour-intensive but, within that framework, is primarily dominated by increases in labour hours rather than by increases in labour quality.
• In the G7 group, in contrast, increases in labour inputs are somewhat more determined by increases in labour quality than by increases in labour hours.
• In the percentage contribution within labour inputs, the Asian/East Asian developing economies remain closer to developing economies than to the G7 in that the contribution of labour hours is greater than the contribution of labour quality.
• In terms of labour inputs, the Asian/East Asian developing economies are closer to the non-G7 developed economies than the G7, in that, unlike the G7, both groups tend to remain far more dependent on increases in labour hours than increases in labour quality for labour inputs.

There therefore appears to be a progressive development pattern, in terms of labour inputs, whereby most developing economies, including in this case Asia, have a larger contribution of labour hours than labour quality, the non-G7 developing economies retain this characteristic on a lesser scale, and the G7 economies have the greatest percentage contribution of increases in labour quality compared to increases in labour hours.

The pattern of economic development shown in the data of Jorgenson and Vu is therefore of an increase in the percentage contribution of capital to GDP growth compared to labour, and of an increase of improvements in labour quality compared to labour hours.

* * *

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

Table 1

Table 2

 

Bibliography

Japan's price fall shows falsity of comparison with China

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

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

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

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

Savings in India, Germany, Japan, the US and China - by John Ross, Dong Nan and Li Hongke

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

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

Figure 1

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

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

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

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

Figure 2

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

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

Notes

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

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

Comments on Paul Krugman and Alwyn Young on The Myth of Asia's Miracle - why 'quantity' may be more important than 'quality' in economics

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 convulsion in world trade

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

Figure 1

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

Figure 2

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

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

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

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

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

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

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

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

Table 1

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

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

Table 2

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

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

Table 3

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

Table 4

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

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

Table 5

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

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

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

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

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

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

Notes to Tables - peak month for exports in 2008

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

4th Quarter US GDP figures show shift to post-1929 rates of decline

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

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

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

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

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

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

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

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

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

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

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

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

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

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

*   *  *

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

US 4th quarter GDP - a classic investment led downturn

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

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

Figure 1

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

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

Figure 2

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

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

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

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

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

In the present situation driving down interest rates requires central bank purchase of government bonds and debt - that is 'quantitative easing'. An increasing number of governments, including the US, are, slowly being forced to consider this, although none has as yet implemented it.

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

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

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

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

The decline in US asset prices and the perspectives for the global economy

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

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

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

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

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

Figure 1

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

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

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

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

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

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

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

Figure 2

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

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

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

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

Figure 3

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

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

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

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

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

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

Figure 4

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

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

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

Notes

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

The share of developing countries in world exports

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

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

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

 

Figure 1

 

 

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

 

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

 

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

 

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

 

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

 

Figure 2

 

 

 

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

 

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

 

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

 

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

 

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

 

Figure 3

 

 

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

 

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

 

Figure 4

 

 

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

 

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

 

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

 

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

 

Figure 5

 

 

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

.

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

 

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

 

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

 

Figure 6

 

 

 

 

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

 

Figure 7

 

 

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

 

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

 

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

 

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

 

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

 

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

Japan feels the full weight of the financial crisis

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

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

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

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

Figure 1

 

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

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

Figure 2

 

 

 

The contrast to the situation on the Japanese stock market since mid-October is shown in Figure 3 - which graphs the trend of the US and Japanese stock markets measured in days elapsed since their their previous peaks. The share price cycles taken for comparison are, respectively, the US stock market following September 1929, the US stock market following October 2007, and the Japanese stock market since the bursting of the 'bubble economy' at beginning of 1990.

 

The sharp downward movement in the last period in the Japanese stock market is evident from Figure 3. Furthermore, the trend of the Japanese Nikkei share index is now significantly worse, in terms of the duration of depressed share prices, than that of the the Dow Jones after 1929.

The low point of the decline of the Nikkei since the bursting of the 'bubble economy' at the beginning of 1990 was on 27 October this year with a decline of 81.6 per cent. On 5 December the Nikkei was still 79.7 per cent below its level at the end of 1989 - at the same period of time after the crash of 1929 the Dow was 52.5 per cent below its peak level.

The Nikkei's performance after 1990 is therefore now clearly the worst of any major stock market in history.

Figure 3

 

 

 

China and the 'third Asian financial crisis'

Having spent the last week attending the Mayor of Shanghai's International Business Leaders Advisory Council, giving a talk to and discussing with Shanghai financial and government officials, and then going on to Beijing to discuss with more business and government figures, it is possible to form a fairly clear view of how the international financial crisis appears in China. It presents a rather different aspect to that as seen in Europe or the US.

Direct financial turmoil is not a key feature in China. China's banks had almost no exposure to now heavily discounted, or worthless, sub-prime mortgage or similar financial products. While in Hong Kong there is some concern over the direct financial fallout, no mainland Chinese bank has suffered significant losses in this field. The immediate issue for China is the effect on its productive economy and on the renminbi’s exchange rate. But underlying these is a still more fundamental issue – maintenance of China’s savings and investment rates.

Indeed. seen from China, the international financial crisis might be posed from a different angle. It may be viewed as the 'third great Asian financial crisis' – the first being that of Japan and the yen in 1973-90, and the second that of the South East Asian debt and currency crisis of 1997. To emerge successfully will require from China an enormous response and a new stage of its economic development.

Key Trends in Globalisation has noted that the fundamental determinant of the much higher rates of growth of a number of Asian economies, compared to the US or Europe, is their far higher investment rates. Therefore for the US and Europe to regain competitiveness with Asia one of two things has to happen. The US and Europe have to raise their investment rates up to Asian levels, or the Asian economies have to lower their investment rates down to US and European ones.

These two courses have very different implications for world economic growth. If the US and Europe raise their investment levels towards Asian ones then Asia will essentially maintain its present economic growth rate and that of the US and Europe will increase – i.e. world economic growth will accelerate. If, however, Asian investment levels are reduced towards US and European levels then the growth rate of the Asian economies will also fall, while economic growth in the US and Europe will not increase – i.e. world economic growth will decline. It is, therefore, far preferable that the US and Europe increase their investment rates rather than that those in Asia fall.

Nevertheless, in successive economic crises of the last thirty years, the outcome was the opposite of the preferable one  – the US and Europe did not increase their investment rates, indeed those in Europe fell, but the investment rates of a number of Asian economies declined.

To illustrate this process in more detail, Figure 1 shows the level of fixed investment as a percentage of  GDP for the US, Germany and France. As may be seen, the US fixed investment level has been essentially constant for the last half century at around 20 per cent of GDP – itself a continuation of a very long term trend in US investment rates. The German and French levels were somewhat higher than that for the US for the period up to the early 1970s, at around 25 per cent of GDP, and then fell to levels comparable to the US. Such investment levels generate rates of growth of 1.5-3.5 per cent a year.

Figure 1

If these US and European trends are compared to the situation in Asia there is a clear contrast. Asian economies have achieved far higher levels of investment, reaching over 40 per cent of GDP, and far higher rates of growth – in some case approaching or achieving double digit rates. However, the effect of both the post-1973 crisis in Japan, and the 1997 crisis in South East Asia, was to reduce these investment rates and with them also rates of growth of growth of GDP.

Considering this trend in a number of Asian countries in greater detail, Figure 2 shows the proportion of GDP accounted for by gross fixed capital formation in Japan. Japan’s fixed investment level peaked at 36.4 per cent of GDP in 1973. At this time, averaging the preceding five years, the annual average rate of growth of Japan’s GDP growth was 9.3 per cent.

Figure 2

The economic events which commenced in 1973, and which were accompanied by the first ‘oil shock', greatly affected Japan. The proportion of GDP devoted to gross domestic fixed capital formation declined to 27.5 per cent by 1986, and Japan’s average annual rate of growth of GDP, over the preceding five years, fell by two thirds to 3.1 per cent. By 1986 the Japanese economy, which had been expanding almost three times as fast as the US in the early 1970s, was growing more slowly than the US – in comparison in 1986 the average annual growth rate of US GDP over the preceding five years was 3.5 per cent.

Japan’s investment rate then temporarily rose under the impact of the hyper lax monetary regime during the  ‘bubble’ economy in the late 1980s – a consequence of Japanese financial policies introduced to aid US economic stability following the 1987 Wall Street stock market crash. Following the bursting of Japan's financial bubble in 1990, the investment rate fell again and by 2002 gross domestic fixed capital formation had declined to 25.8 per cent of GDP while Japan’s five yearly annual growth rate of GDP had declined to 0.2 per cent.

Summarising these processes, under the successive impacts of the oil price increase and the monetary effects in Japan of the measures it chose to take to respond to the 1987 Wall Street crash, the proportion of the Japanese economy devoted to fixed investment fell by 10.6 per cent of GDP, and Japan’s annual growth rate decelerated from 9.3 per cent to 0.2 per cent - a 98 per cent decline.

If Japan post-1973 was the first great Asian economic/financial crisis, the second was the debt and currency crisis of the South East Asian economies in 1997. The similarity of the outcome to the earlier crisis in Japan’s is striking.

Figure 3 therefore shows South Korea’s rate of gross domestic fixed capital formation. This rose progressively to 39.0 per cent of GDP in 1991. By that year the average annual rate of growth of South Korea’s GDP over the preceding five years was 9.4 per cent.

By 1996, the last year before the currency crisis, South Korea was still investing 37.5 per cent of GDP and its five yearly annual average rate of growth of GDP was 7.3 per cent.

Following the 1997 debt and currency crisis, however, the proportion of South Korea’s GDP devoted to fixed investment fell sharply, to only 28.8 per cent of GDP in 2007, and its five yearly annual average growth rate of GDP declined by almost half to 4.4 per cent.

Figure 3

Figure 4 shows the similar process in Thailand. By 1996 the proportion of Thailand’s GDP devoted to fixed investment was 41.1 per cent of GDP – although this level was clearly unsustainable as it far exceeded the domestic savings available to finance it, resulting in a balance of payments deficit of 8.2 per cent of GDP. Thailand’s five yearly average annual rate of GDP growth was 8.1 per cent.

Following the currency crisis, by 2007 the proportion of Thailand’s GDP devoted to gross domestic fixed capital formation had declined to 26.8 per cent and the five yearly average annual rate of GDP growth had fallen to 5.6 per cent.

Figure 4

Figure 5 shows the similar process in Malaysia. By 1996, the last year before the debt/currency crisis, Malaysia’s gross domestic fixed capital formation was 42.5 per cent of GDP - although again this was being unsustainably financed by a balance of payments deficit. Malaysia’s five yearly annual average rate of growth of GDP was 9.6 per cent.

By 2007, ten years after the currency crisis, the proportion of Malaysia’s economy devoted to fixed investment had fallen to 21.7 per cent and the five yearly average annual rate of growth had dropped to 6.0 per cent.

Figure 5

Therefore, although the mechanisms of the crises were different, the outcomes in Japan in 1973-90, and South East Asia in 1997, were essentially the same - the proportion of the economy devoted to investment fell drastically and therefore so did the growth rate.

The impact of these two previous Asian economic crises, therefore, clearly illustrates the challenge facing China. China’s level of investment is significantly higher than Japan’s in 1973 – China's fixed investment rate is over 40 per cent of GDP compared to Japan's 30-35 per cent at that time. China's annual average annual rate of growth for the last five years is over ten per cent compared to Japan's nine per cent in 1973. In a number of South East Asian states, on the eve of the 1997 crisis, their very high investment rates were unsustainable, as they far exceeded domestic savings levels and were financed through extremely high balance of payments deficits. In contrast China’s savings level, running at over 50 per cent of GDP at nominal exchange rates, is even higher than its level of investment – see Figure 6. China, therefore, does not fact the international financial constraints facing South East Asia in 1997. There is, therefore, nothing inherently financially unsustainable in China’s very high investment rates. It has more than adequate domestic savings to finance its current investment levels and, therefore, approximately its present growth rate.

Figure 6

But it is the international context that has changed significantly and poses the economic challenge. With many economies moving into recession, and virtually all slowing, China's export growth will become significantly harder - even more so as simultaneously the renminbi is becoming a ‘hard’ currency.

As illustrated in Figure 7, the renminbi's exchange rate moved up against the dollar prior to the outbreak of the international financial crisis and it has remained constant against the dollar since its onset. As, however, the dollar has moved up against almost all currencies, except the yen, this means that the renminbi has undergone an upward revaluation against almost all other currencies.

Figure 7

 

China’s exporters, therefore, face a double squeeze. First, the markets in the economies into which they are exporting are either contracting or growing far more slowly. Second, the renminbi’s exchange rate is rising. This combination squeezes China’s exporters while simultaneously cheapening imports. China's balance of payments surplus may, therefore, decrease from its current level – the last available data being for 2007 showing a surplus of $372 billion.

However, statistically, the balance of payments is necessarily equal to the difference between domestic savings and investment - China’s balance of payments surplus reflecting that its savings level is even higher than its investment level. If China’s balance of payments surplus declines this can therefore only be achieved by its investment level moving up towards its savings level or its savings level declining  towards its investment level, or a combination of the two.

Which of these two occurs will have a huge influence on both the Chinese and the world economies. As already noted, in the case of both Japan and the South East Asian economies, faced with crisis,  investment levels fell. Their economies consequently drastically decelerated – negatively influencing the rate of growth of the world economy. A major deceleration of China’s economy, particularly under conditions of recession in other major economies, would have very negative consequences for international growth.

The health of the world economy, therefore, requires that if China’s balance of payments surplus is to shrink this should be by moving its domestic investment rate up towards its savings rate, not by its savings level falling towards its investment rate.

Domestic economic requirements China push in the same direction. The exchange rate of the renminbi has not merely moved upwards but will remain higher due to the underlying strength of China’s economy. A clear lesson of the current crisis is  that any primary use of China’s financial resources not for domestic investment but fundamentally to attempt to maintain a low exchange rate of the renminbi will not work as a strategy – even in cases where the renminbi is stabilised against the dollar it moves up against other currencies.

China will, therefore, have to learn to compete at a higher exchange rate. This requires that its whole economic mechanism become more efficient, which can only be achieved through investment. China will cease to compete as a pure low wage economy – Vietnam and other economies now occupy the place China did twenty years ago. High levels of investment are therefore vital if China's economy is to compete in this new context.

Put in other terms, China's traditional strategy has been to keep its currency's exchange rate down to the level of productivity of its economy. In the future China will have to raise the level of productivity of its economy up to its appreciating exchange rate - requiring gigantic further investment in its productive  base.

Consequently the cyclical requirements of economic management, that is ‘Keynesian’ anti-recessionary measures, coincide with the structural requirements of a high investment level. So far the Chinese government is heading in the right direction in announcing successive waves of infrastructure and other investment – railways, roads, housing. The fact that China has a large state owned economic sector allows it to take far more direct ‘Keynesian’ measure to sustain investment than are available in the US or Europe.

Nevertheless the scales of the programme’s which are required are gigantic. If, to take a hypothetical example, China’s balance of payments surplus were to fall by half under the impact of pressure on exporters and cheaper imports due to the higher exchange rate, while its savings level remained the same, this would required $175-$200 billion extra a year investment in China’s domestic economy. While there is no financial constraint on this, due to the high savings rate, the task of physically gearing up the economy for such a scale of extra-investment programmes is gigantic.

Naturally this particular example is arbitrary, and China’s balance of payments surplus may not fall to this degree, but it shows the scale of economic forces and shifts which are involved.

At the same time China faces new economic challenges it has not experienced previously. The fact that China is acquiring a 'harder' currency will undoubtedly lead to central banks of other countries wishing to hold the renminbi as part of their foreign exchange reserves – an issue China has not faced on a significant scale before.

Simultaneously China will come under pressure to use its financial resources for measures other than investment in its domestic economy. The US has announced that it is arranging dollar swaps for four economies that it considers systemically crucial – Brazil, Mexico, Singapore, and South Korea. But there will be a whole series of much weaker economies in deep trouble and it will undoubtedly be proposed that China should finance these, probably via intermediaries such as the IMF, rather than investing its resources in its domestic economy. When China attends the international economic summit in Washington on 15 November the US will also almost certainly propose that China accelerate a programme of buying US Treasury bonds.

So far China is rightly adopting the approach that 'the most important task for us now is to manage our own affairs well', as vice-premier Wang Qishan put it. But pressure put on China to change that stance, and divert resources away from its key goals, will increase. In other words many other people also have their eye on the funds which China could invest in its domestic economy.

With all these pressures, together with domestic programmes of improving social welfare and attempts to improve conditions in rural areas taking place simultaneously, not to mention other issues to manage, Chinese economic policy makers are going to be kept extremely busy in the coming months.

However, as noted, while there are many specific issues to tackle they are all within the framework of  one decisive strategic choice. If China responds in the same way that Japan did in 1973-90, and South East Asia did in 1997, that is by reducing its savings and its investment levels, this will be bad not only for the Chinese economy but for the world economy. If, however, China is able to maintain its savings and investment levels through the present ‘third’ Asian currency crisis, which is a crucial aspect of how the international financial crisis appears from its perspective, not only will that be good for the world economy but it will be one of the greatest pieces of macro-economic management, not to speak of practical management of huge investment programmes, ever seen.

China since 1979 has achieved one of the greatest economic miracles in history. Confronted with the third great Asian financial crisis China again faces a gigantic challenge to its macro-economic management. How successfully it confronts that will have profound consequences not only for its own but for the entire world economy.

On 15 November a new era in world history begins

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

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

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

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

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

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

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

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

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

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

 

Economics and politics in Japan's decision to step in to stop the rise of the yen

For the first time this week a foreign country with substantial resources decisively and openly intervened to aid the US in the current financial crisis. The Japanese government and Central Bank, deeply concerned by the rise in the yen’s exchange rate, which was threatening to seriously cut into the competivity and profits of Japan's export industries, as well as destabilise Japan's internal political situation, widely leaked that Japanese interest rates would be cut while simultaneously the Central Bank began to sell yen, and buy dollars, in order to try to drive down the yen's exchange rate. These two moves opened the financial taps to Japanese money to flow into dollars, and into the US, producing an immediate sharp upward movement on the US stockmarket.

Japan is the country with the second largest foreign reserves in the world, at $997 billion, together with an annual current account surplus of $197 billion. Only China, with a $372 billion balance of payments surplus and $1,905 billion in foreign exchange reserves, has greater foreign currency resources for intervention.

The economic reason that Japan decided to intervene may be seen clearly in the graph below. It has been one of key goals of Japanese economic policy to attempt to prevent the exchange rate of the yen rising against the dollar - unlike the situation with the euro, where the eurozone countries have been content to see the euro rise strongly against the dollar. Until the current financial crisis Japan had successfully kept the exchange rate of the yen at its 2000 level or below. Under the impact of the global financial crisis, however, the yen had soared upwards against the dollar, rising by 15 per cent since the beginning of September - from 108.7 yen to the dollar on 2 September to a peak of 92.6 yen to the dollar on 24 October.

The specific configuration of Japan's economy is that a highly internationally competitive series of exporting companies, centred in manufacturing, exist in the context of highly uncompetitive small businesses in most other sectors. The rising yen would both put competitive pressure on the price of Japanese exporters and, by decreasing the price of imports, would place much greater competitive pressure on the large and uncompetitive small business sector.

Strategically economically it would be better for Japan to rationalise this small business sector. But the ruling Liberal Democratic Party (LDP) does not wish to do this for political reasons. The large, and inefficient, small business sector forms a crucial part of the LDP’s political support. The LDP attempts to defend its electoral base even at the expense of lowering the efficiency of the Japanese economy.

This uncompetitive small firm sector cannot be used to stimulate the Japanese economy and indeed is a major drag on it. The LDP therefore, in order to attempt to square this economic circle, centres policy on maintaining a low exchange rate that will allow Japan’s exporting manufacturing companies to flourish, while at the same time the low exchange rate safeguards the small inefficient company sector from foreign competition. For this reason when the Japanese government saw the rapid rise of the yen it felt economically compelled to intervene to drive down the yen through large purchases of dollars - the latter aiding the US financial situation.

Over and above this economic and domestic political imperative is the political one that the United States wants from Japan, in return for military protection, an accommodating financial policy This international political pressure goes in the same direction as the domestic ones.

The result of this intervention by the Japanese authorities is that two major resources are now being deployed to attempt to shore up the US banking system. The first is the transfer of resources from US taxpayers - represented by the Paulson bank bail out plan. This, however, is likely to create political discontent in the US. The second is now aid to the US from Japan.

Japan's willingness to such give aid is, of course, a serious addition to US resources to meet the financial crisis and helps account for the rapid rise in share prices on Wall Street. However two issues are still posed.

First, will the combination of squeezing US taxpayers and Japanese aid be enough to stabilise the US financial system? At least at present the answer is that the situation within the US financial system is stabilised but at the expense of more peripheral parts of the world economic system suffering shortage of resources.

Second, what will be the consequences in Japan itself? The last time Japan made such a large scale intervention to aid the US was after the 1987 Wall Street crash. This intervention was decisive - the reason the US economy was fairly easily stabilised following the 1987 crash was Japan’s aid in the form of a super lax interest and credit rate policy. The result, however, was Japan's late 1980s bubble economy followed by the now 18 year long share market and property market crash and depression that followed from 1990 onwards. It will be interesting to see the price Japan will pay this time.

Whatever it is, however, it is at present considered by the LDP to be a necessary one which is preferable to the rationalisation of Japan's small business sector to withstand a higher yen exchange rate.

Fundamental driving forces of the financial crisis

It is superfluous to note on this blog that the world economy is passing through the most severe financial crisis since 1929.[1] Its results are also beginning to be well understood: the era of increasing deregulation has ended and instead increased, in the US very large scale, state intervention in the economy has begun.[2]

But what type of crisis is this - which greatly affects what its eventual outcome will be?

The most trivially superficial explanation, put forward in tabloid newspapers and demagogic political speeches, is that this is an extremely severe short term convulsion caused by the activities of ‘financial spivs’ and ‘short sellers’– modern embodiments of the ‘gnomes of Zurich’ denounced by British Prime Minister Harold Wilson in the 1960s, Slightly less superficially it is ascribed to subjective, widespread, miscalculation by financial institutions.[3] A related view is that the

fundamental factor is psychology.[4] Therefore, there is a widely asserted view that the key issue is ‘confidence' or 'lack of confidence’.

If any of the above were true then, although the present financial convulsion is severe, the adjustments that will follow will eventually be relatively minor. Once current psychology is reversed, that is ‘confidence is restored’, there can be a return to something approximating the previous situation – doubtless with some individual changes.

Such analyses are false. The present financial crisis is not rooted in psychology or subjective mistakes. It is rooted in long term economic trends. Its roots are therefore objective not subjective. Psychology is not driving the objective economic forces but following them.

The unfolding of the financial crisis does, however, show the importance of considering long term trends, and underlying developments, rather than merely considering short term shifts or individual facts taken out of context - as occurs in many newspaper commentaries. Misunderstanding of the preceding period, through failure to consider the overall situation, inevitably led to confusion regarding present events. 

The outcomes, and conclusions regarding the real driving forces of the present financial crisis, will be considered at the end of this article. First, however, the decisive data on the situation will be set out.

The most fundamental cause driving the present financial crisis was dealt with in a previous post on this blog - 'Why Asia will continue to grow more rapidly than the US or Europe'. This showed that the US now lags far behind the key Asian economies in the proportion of its economy which is invested - with a consequent continuing decline in the international competitiveness of the US economy.

This trend can be seen in Figure 1 - which is a simplified form of the graph in the previous post. It shows the investment levels (gross domestic fixed capital formation) as a proportion of GDP in the US, China and India. The US invests only 18-20 percent of its GDP whereas India invests over 30 percent and China more than 40 per cent. Similar, if less striking, graphs would show the same pattern for other key Asian economies. The result is China’s economy is growing at 9-11 percent a year, India’s at 7-9 per cent a year, and the US at only 3 percent a year.

Figure 1 

   

Given this US lag in investment, which is a key factor in competitiveness, the US economy, at any given exchange rate, becomes progressively less competitive over time. Consequently, given this decreasing underlying competitiveness, as long as the US does not raise its investment levels to that of other economies the only way for it to remain competitive is to steadily lower its exchange rate – that is to progressively devalue the dollar.

This declining competitiveness of the US economy is illustrated clearly in Figure 2, showing the US balance of payments. That the US runs a large balance of payments deficit is well known, but this graph shows the phases in the unfolding of that process.

Figure 2

• The US balance of payments first began to slide into sharp deficit in the early 1980s - the deficit initially reaching over 3 per cent of GDP by the mid-1980s

• There was a short lived recovery in the early 1990s - due to dollar devaluation, recession at the beginning of that decade, and a large one off payment from the Gulf states to finance the first Gulf war.

• This short recovery was followed by an even greater US balance of payments deficit after 1991 - which reached a peak of well over 6 per cent of GDP, or over well $700 billion a year, by 2006.

To show this development over a longer period Figure 3 shows net US ‘lending’ to the rest of the world since 1956 – a negative number showing US borrowing from the rest of the world. The deterioration of the competitiveness of the US economy is evident from these trends.

Figure 3

    

Given that the low US level of investment means the only fundamental mechanism by which it can remain competitive is dollar devaluation therefore Figure 4 shows the long term exchange rate of the dollar against two of the world's three most important non-US currencies, the euro and the yen - comparisons over the same period with the third, the yuan, are not meaningful as until the early 1980s China had an artificially set exchange rate which was not aimed at participation in international trade.

Figure 4

  

Three clear periods of developments in the US exchange rate are evident.

• From the immediate post-war period to the early 1970s the US maintained fixed exchange rates under the Bretton Woods currency system.

• From 1973 until the mid-1980s, via sharp short term fluctuations, a substantial dollar devaluation took place.

• From the mid 1980s onwards, while there were considerable short term fluctuations, and formally a floating exchange rate system operated, in fact the long term trend of the dollar’s exchange rate was stable.

The worsening US balance of payments situation, already shown in Figure 2, was an inevitable result of the the two circumstances which operated after the mid-1980s. The combination of

• a deteriorating competitiveness of the US due to its low investment rate

• a stable dollar exchange rate which prevented competitiveness being maintained by devaluation

necessarily meant an increasing movement into deficit of the US balance of payments - precisely as shown in Figure 2. In otherwords the dollar became progressively overvalued compared to the underlying competitiveness of the US economy.

The means whereby this dollar exchange rate remained stable, despite the worsening balance of payments deficit and the fact that the exchange rate was not formally fixed, is shown in Figure 5. Net foreign purchases of US debt instruments, Treasury Bonds and others, rose from around zero per cent of GDP in the early 1980s to 5.6 per cent of GDP in 2007 or $770 billion. The large inflow of investment in US debt instruments counterbalanced the deteriorating current exchange deficit to maintain a stable dollar exchange rate.

Figure 5

 

It is, however, impossible to cheat underlying economic forces. The history of all economies shows that attempts to artificially maintain a high exchange rate against the pressure of underlying economic forces will eventually fail. In short, at some point, there would inevitably be a dollar devaluation.

The consequences of an overvalued dollar for asset values denominated in dollars are also clear. The values of assets held in overvalued dollars are themselves necessarily overvalued in real international terms. There would, therefore, eventually be a revaluation of such assets downwards to their real, that is lower, values.  As that downward revaluation takes place it will erode or destroy the balance sheet of the institutions holding such assets – this is the process which is at present occurring, unleashing the wave of bankruptcy of US financial institutions.

As the dollar devalues, and assets decline towards their real competitive values, two other processes occur. 

• Foreign holders of dollar assets suffer losses – given that last year alone such inflows, as noted, amounted to $770 billion in US debt instruments any such losses would be large. Japan is estimated to hold $860 billion in US debt instruments, including Treasury Bonds and $75 billion in debt issued previously by the recently nationalised US mortgage institutions Fannie May and Freddie Mac. China is estimated to hold large quantities of US Treasury Bonds and up to $400 billion in Fannie Mae and Freddie Mac debt.

• Given the decline in the value of US assets, a political struggle breaks out between different groups in the US population over who will bear the cost of such a fall.

Given the preceeding overvaluation of the dollar it is inevitable that such shifts should take place. In essence the current financial crisis in the US is a classic one of the attempt to maintain an overvalued exchange rate - the type of crisis which affected Mexico in 1982, Russia in 1998, or Argentina in 2001. In each of these cases the inevitable collapse of the attempt to maintain an overvalued currency wrought havoc on the financial institutions of the country concerned.  In the case of the US the fact that its economy is on a much larger scale, and plays a pivotal role in the global economy, makes the consequences of such a crisis far more severe.

Why, however, If the crisis is of a rather classical form is there confusion over its driving forces - of the type outlined at the beginning of this article?

The confusion has arisen because a number of commentators in the preceeding period, instead of considering  fundamentals and overall trends, took individual facts out of context and created a false ‘narrative’ regarding developments. This perspective was that the US economy was becoming more competitive - to the point where it had created a ‘new economy’. This false perspective was rationalised by looking at a few individual sectors, notably high technology, in which the US is indeed highly competitive. But, as shown in the balance of payments figures, overall the US economy was becoming less, not more, competitive.

The financial crisis is therefore not rooted in psychology nor in short term developments. It is rooted in objective economic processes operating over long periods. The outcome and unfolding of this crisis will, however, be determined by political factors.

The interrelation of these economic and political elements will be looked at in a future post. But the fundamental factors in the situation are clear and flow from the above trends.

If the US were to seek to achieve a level of investment to match its Asian rivals this would, in the short term, due to the huge transfer of resources from consumption to investment that would be required, unleash a wave of popular discontent in the US that would destabilise the political situation - for that reason it is highly unlikely to occur in the short term. The only other way to restore competitiveness in the short term, that is dollar devaluation, would cause radical financial destabilisation as the value of dollar assets declines - destroying the balance sheets of financial institutions holding such assets.Either course will produce strong pressure on the living standards of the US population and therefore have major political impact in the US.

 

References - for detailed references see continuation of article

Why Asia will continue to grow more rapidly than the US and Europe - a historical perspective

 

Data on long term trends in investment and economic growth

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

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

 

Figure 1

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Implications of different investment levels

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

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

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

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

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

Taking these issues in more detail:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

Conclusions

The following clear conclusion may be drawn from this data:

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

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

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

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

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

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

Note on future postings

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

References - for detailed references see continuation of article

Big is Flexible - New Patterns in World Investment

Introduction

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.