The outlook for advanced economies

Citation:

Jorgenson, Dale W., and Khuong M. Vu. “The outlook for advanced economies.” Journal of Policy Modeling (2017).

Abstract:

According to the authoritative estimates of Angus Maddison, the United States was the world’s largest economy throughout the twentieth century.[1] International economic cooperation among the world’s industrialized countries began to take its contemporary form with the formation of the G7 in 1975 and 1976. The G7 includes the U.S., the four major European countries – France, Germany, Italy, and the U.K – as well as Canada and Japan.

During most of the twentieth century a fundamental transformation of the world economy seemed a remote and unlikely prospect. However, in the twenty-first century the balance of the world economy is shifting from the industrialized economies, led by Europe, Japan, and the United States, to the emerging economies of Asia, especially China and India. The massive shift in the world economy is generating a new world order.

The World Bank’s 2005 International Comparison Program (ICP2005) showed that China had overtaken Japan in terms of purchasing power more than a decade earlier.[2] By 2012 India had overtaken Japan and has continued to grow much more rapidly. The World Bank’s 2011 International Comparison Program (ICP2011) revealed that China’s output achieved parity with the United States in terms of purchasing power in 2014.[3]  

Our first major finding is that world economic growth has accelerated during the twenty-first century. While world economic growth will continue at a rapid pace, we project that all the members of the G7 will grow more slowly that the world economy, while China and India will continue to grow more rapidly. However, Chinese economic growth has already slowed and Indian growth will follow. The Chinese and Indian economies will continue to increase in relative importance during the twenty-first century as the rate of growth of the world economy gradually declines.

In 2001 Jim O’Neill, then a Goldman-Sachs economist, originated the terminology “BRIC” economies -- Brazil, Russia, India, and China.[4] For many purposes the G7 was superseded by the G20 in 2009, including the G7 as well as the four BRIC countries, eight other countries, and the European Union. The four BRIC countries formed a group to meet before the G20 and added South Africa, becoming the “BRICS”.  The G7 countries participate actively in the G20 and have formed a similar group.  

The second major finding of this paper is that Brazil and Russia, as well as Germany, Japan, and the United States, will grow more slowly than the world economy. The leading economies in developing and implementing the Asian model of economic growth were, first, Japan, then the Asian Tigers – Hong Kong, Singapore, South Korea, and Taiwan – and finally China and India. The performance of these Asian economies has changed the course of economic development in Asia and around the world.

The Asian model of economic growth relies on globalization and investment in human and non-human capital, rather than innovation. This new growth paradigm places a high premium on skillful management by public and private authorities. Of course, investment and innovation are analytical categories for characterizing different aspects of the complex processes that generate long-term growth and structural change.

The third major finding of this paper is that replication rather than innovation is the major source of growth of the world economy. Replication takes place by adding identical production units with no change in technology. Labor input grows through the addition of new members of the labor force with the same education and experience. Capital input expands by providing new production units with the same collection of plant and equipment. Output expands in proportion with no change in productivity. By contrast, successful innovation involves the creation of new products and new processes, so that productivity increases.

Recovery of the industrialized economies from the Great Recession that began in the United States in 2007-2009 has been slow and fitful. The United States has emerged with low unemployment but reduced prospects for growth. Japan has continued to languish in the Lost Decades, awaiting the successful implementation of a new growth strategy. The fiscal and financial burden of public debt and the challenges of coping with the financial crisis in Greece pose potential threats to the restoration of growth in Europe.

The most significant impact of the Great Recession on the emerging economies of Asia was the collapse of trade in late 2008 and early 2009. This was quickly reversed and the leading Asian economies have continued to grow more rapidly than the world economy. The challenges facing these economies are different but equally daunting. Can China cope with the financial and economic pressures that followed a vast expansion of lending in response to the economic crisis? Will India succeed with fiscal consolidation and restoration of growth?

The growing significance of the Asian model is overturning long-established theories of economic growth and accelerating overdue revisions of the official economic statistics. The ruling theories of growth of the twentieth century put enormous weight on innovation, which has played a relatively modest role. This view has neglected investments in human and nonhuman capital, which are much more important for advanced economies as well as emerging economies. The new economic order will help to establish this empirically-based view of the sources of economic growth.

In this paper we set aside short-term threats to the world economy to focus on the potential for long-term growth. We show that the fundamentals of the world economy remain sound. We recognize the emergence of Asia from the underdevelopment that persisted until the middle of the twentieth century as the great economic achievement of our time. Trends established in the watershed reforms of China and India more than two decades ago have produced the dramatic changes of economic leadership in the twenty-first century.

 

[1] Angus Maddison (2001), The World Economy: A Millennial Perspective, Paris, Organisation for Economic Co-Operation and Development, 2001. See:  http://theunbrokenwindow.com/Development/MADDISON%20The%20World%20Economy--A%20Millennial.pdf

[2]  World Bank (2008), 2005 International Comparison Program, February. See: http://siteresources.worldbank.org/ICPINT/Resources/ICP_final-results.pdf.

[3] World Bank (2014) , 2011 International Comparison Program, October. See: http://siteresources.worldbank.org/ICPEXT/Resources/ICP_2011.html

[4] O’Neill’s book describing the progress of the BRIC was published in 2011: Jim O’Neill (2011), The Growth Map: Economic Opportunity in the BRICs and Beyond, New York, Penguin.

Publisher's Version

Last updated on 08/11/2017