Month: August 2023

In a previous post (link) the stages of development were discussed in the context of the transition from a traditional rural society to a modern capitalistic consumer-driven economy.  Initially, abundant labor and high returns on capital  spark lengthy periods of “miraculous” growth. Later, as labor becomes scarce and the technology frontier is approached, returns on capital decline and GDP growth has to be driven by household consumption.  In this post, the factors of production (labor and capital) are looked at in detail.

The expenditure approach is commonly used in macroeconomics to describe economic output in terms of the money spent by consumers (households and government) and investors (private business and government). Net exports are added to measure whether an economy captures foreign consumer demand through exports  or relinquishes foreign demand through imports. For example, as a net exporter China is repressing domestic consumption to capture foreign consumer demand, while as a net importer, the United States is  stimulating domestic consumption and relying on foreign producers. Another approach to understand economic output is to measure the contribution to GDP growth coming from the  factors of production: labor and capital.

The Conference Board database on national accounts (link) provides a long-term view on productivity. The data illustrates what factors of production are driving the economy, and it is useful to measure the evolution of productivity over time.

As an economy begins to  modernize, labor productivity growth will be high and investors can deploy capital with high returns. As rural migration accelerates and more capital is deployed, countries experience stages of “miracle” growth when both labor and capital productivity are high. Eventually, a country achieves a significant degree of integration into the modern global capitalistic economy. At this time, labor becomes scarce and capital returns muted. Mature economies come to rely for growth mainly on the expansion of consumer services and hard-to-achieve technological innovation.

The charts below, based on the Conference Board data, aim to illustrate how the process plays out over time for countries at different stages of the development process. The first section looks at the United States and several mature emerging markets that have already experienced a one-time phase of “miracle” growth. The second section looks at India and Vietnam, two economies currently experiencing high growth

I. Mature Economies

The United States 

The United States has been a mature economy at the technology frontier since the early 2oth century. A broad expansion of consumption in the 1950s and 1960s drove high GDP growth. GDP Growth trended down from over 4% in the 1950s to below 2% in the 2020s, and has become  dependent on debt accumulation and Fed-driven asset appreciation. Contribution to GDP growth from labor has gradually declined over the period, despite high immigration, a huge one-time increase in female participation in the workforce, and steady improvements in the quality of labor. Growth in the working age population is projected to be near zero in the 2020s. Despite the United States’s dominant position in technological innovation, total factor productivity (the residual increase in growth that is not driven by capital and labor) has fallen from 1.5% in the 1950s to zero over the past decade.

 

Brazil

Brazil’s economy took off in the 1950s and experienced “miraculous”growth in the 1960s and 1970s, driven by high levels of investment and labor growth. Since the 1980s, Brazil has been mired in a “middle-income trap” caused by  a massive expansion of unproductive government spending, a stagnant consumer, a failure to promote innovation, and institutional breakdowns (i.e. corruption). Since 1980, GDP growth has averaged about 2%, falling to near zero over the past 12 years.

Labor quantity growth in Brazil is now near zero, though labor quality continues to improve.  Capital investment has not been driving growth, due to low returns on investment. Remarkably, total factor productivity, which was high in the 1950-1980 period, has now been negative over the past 40 years, and fell by 1.4% annually during the 2010s.

Korea

Korea’s economy took off in the 1970s and experienced its economic miracle between 1983 and 1997. Real GDP growth was very high for nearly three decades (1969-1997). As the economy  achieved advanced economy status, growth has slowed down over the past 20 years. GDP growth has fallen from 7% annually in the 1990s, to 4.5% in the 2000s and 2.5% over the pat 12 years. Over the past decade, labor quantity growth has been near zero, and though still positive, labor quality improvements are well below those of the miracle years. Total factor productivity has fallen from the 2.5% annually of the miracle years to 0.5% over the past decade. Korea is now a mature economy operating at the technology frontier. This means it competes directly in innovative products with developed nations, while facing strong competition from China on traditional products.

China

China’s economy took off in the 1970s, and then entered a 30-year period of “miraculous” growth with Deng Xiaoping’s reform in the 1980s. This extended period of growth allowed China’s coastal areas to reach a significant level of economic maturity, though much of the hinterlands remained isolated from the modern economy. China’s growth was driven by massive rural immigration and  high levels of investment by both the government and foreign enterprises, which converted China into the “workshop of the world.” The growth model followed closely what Paul Krugman described in his 1994 paper “The Myth of Asia’s Miracle,” which pointed out that growth in Korea, Thailand and Malaysia was driven by extraordinary growth in inputs like labor and capital rather than productivity.

China (Alternative)

China’s economic growth is considered by many economists to be overstated by the Chinese government. This is particularly valid over the past decade as the quality of growth has declined because of unproductive investments. The Conference Board provides an alternative measure of GDP which may be more realistic. According to the Conference Board’s alternative estimates, China’s GDP growth for the past twenty years was 7.1% compared to the 8.6% recognized by the government (and reported by institutions like the IMF and World Bank). If the alternative numbers are accepted, then China’s GDP output can be considered to be 30-40%  less than reported. Alarmingly, under the alternative analyst, investment drove almost all growth over the past twenty years, and the contribution to growth from total factor productivity has been negative over the period (-0.1 annually compared to 1.3% annually reported officially.)

Thailand

Thailand took off in the 1950-1970 period, with high GDP growth fueled by a healthy combination of labor, capital and total factor productivity. It enjoyed its “miracle” growth phase between 1980-1997, marked by slower labor growth, more moderate TFP growth, and, as Krugman pointed out, increasing reliance on the capital input. The “miracle” came to an end with the “Asian Financial Crisis” (1997-1990), and since then growth has moderated, with a decline in both labor and TFP growth. Since the financial crisis, TFP growth has averaged 0.6% annually and labor quantity growth has been a meager 0.1% annually, turning negative over the past decade. Apart from the high growth take-off period of 1950-1970, Thailand’s growth has relied heavily on capital inputs.

 

Malaysia

Malaysia, more than Thailand, fits Krugman’s observation that Asian growth is overly driven by capital.  Malaysia took off in the 1960s, and like Thailand, had a period of “miracle” growth in the 1980s and 1990s, ending with the 1997 Asian financial crisis. Growth recovered in the early 2000s, but since then has drifted down to moderate levels. Malaysia’s growth throughout this entire period has been driven by capital expansion, with only moderate contribution from labor and, remarkably, none from total factor productivity. Malaysia had some moderate growth in TFP during the 1960s take-off period, but since then TFP’s annual contribution to GDP growth has been negative every decade. Labor’s contribution has been healthier, providing a constant contribution of around 1% annually over the past five decades.

 

New “Miracle Economies”

India

India’s economy initiated a moderate take-off in the mid-1980s, with the launching of structural reforms. Growth accelerated in the 1990s, reaching high miracle-like levels in the 200os. Growth slowed to mid-single digit levels in the 2010s and is expected to remain at this level, which is high for current international parameters, but low in comparison to previous “miracle” economies. India has displayed Asian-style reliance on the capital input, with unusually low contribution to GDP from growth in labor inputs. India had a brief surge in labor in the 1970s, but this had fallen to 0.5% annually in the 200os and zero annually during the 2010s. This is an anomaly compared to other developing countries at this stage of growth when rural labor is very abundant. It can perhaps be explained by( 1)  scarce growth in mass production, labor-intensive manufacturing, (2) very low levels of female incorporation into the workforce, and (3) government initiatives to improve living conditions in rural villages. TFP was low to negative in the decades before structural reforms were implemented.  TFP’s contribution to annual GDP growth rose to 1.1% in the 1980s and 0.9% in the 1990s, 1.1% in the 2000s and 2.2% in the 2010s. For the miracle-like growth enjoyed by India in the decade prior to the pandemic to persist, it will be necessary for TFP contribution to remain high and for labor quantity growth to improve considerably.

Vietnam

Vietnam’s economy took off in the 1980s, supported by massive migration and capital deployment. Investment surged in the 1990s and has remained high since then, converting Vietnam into an alternative manufacturing  center for many multinationals. Labor growth remained high through the 2000s, but fell sharply in the 2010s. Vietnam fits squarely in Krugman’s description of a capital intensive Asian “tiger.” Total factor productivity has had negative contribution to GDP growth for most of postwar Vietnam’s economic history, turning positive only during the 2010s. A combination of high TFP growth, a resumption of labor growth and continued foreign direct investment will be needed for Vietnam to sustain high GDP growth levels. So far, Vietnam has closely followed the growth path of China. However, if its Communist Party  follows the ideological course taken by Xi’s China, foreign investors are likely to quickly move on.

 

 

 

 

As countries develop, they follow a process of gradual absorption of both labor and capital into the “modern” economy. This model of development was described in Walter Rostow’s book The Stages of Development (1960), and the concept has influenced policy decisions since that time. Rostow’s five stages are outlined in the chart below.

The process is driven by the migration of labor from rural to urban locations, followed by the decline in fertility and family size. In Europe, it started in the late Medieval period (13^th century) with the rise of city-states in Italy and the Netherlands, though serfdom persisted in Eastern Europe into the 19^th century. The rise in urbanization allows for increased labor specialization and industrialization. Migration provides abundant labor which promotes investment and capital accumulation, until, eventually, as fertility declines wages rise, and consumption expands. The five stages are detailed below. It is important to stress that the stages are not clear cut either chronologically or geographically. For example, India’s current standing covers the first three stages; though the country is arguably on the verge of take-off, it has a large traditional rural population. Though China can be categorized as mature, one third of its population remains in a traditional rural condition. Brazil is also is a mature economy with a significant population of subsistence farmers.

Stage 1- Traditional Rural – Populations are rural and consist of subsistence farmers with minimal engagement in commerce. Much of sub-Saharan Africa, rural India and rural Indonesia are still at this stage today. At this stage, capital deployment and economic output are minimal.

Stage 2- Pre-take Off – Migration from farm to city provides cheap labor and initiates specialization and capital accumulation. The poor consume little, the rich consume luxury goods.

Stage 3- Take Off – The culmination of stage 2: super-abundant labor and rapid industrialization lead to high growth and capital accumulation and great fortunes (“robber barons”). This is the period of “economic miracles,” also called Golden Ages: England (1850-1870); United States (1870-1910); Argentina (1880-1900); Brazil (1950-1970); China (1980-2008), etc… Arguably, India is in this stage today, ruled by an alliance of robber barons and politicians.

Stage 4 – Maturity – Labor becomes scarcer, leading to pressure for higher wages and political conflict. Organized labor gains bargaining power, with the support of politicians. Wages rise, boosting consumption, but returns on capital decline:  Western Europe (starting in the 1870s), the United States starting in 1900, Brazil in the 1970s, China starting in 2015 (despite Xi’s efforts to stifle dissent). Mercantilist countries (Germany, the Asian Tigers, including China) seek to repress labor by capturing foreign demand.

Sometime between Stage 4 and Stage 5, the Lewis Turning Point occurs. This concept describes the moment when excess rural labor is fully absorbed into the manufacturing sector, causing unskilled industrial  wages to rise. Economists guesstimates for the turning point are:  England (1890), France (1900), the U.S. (1910), Japan (1965), Brazil (1975), Korea (1975), Mexico (2000) and China (2015). India, Indonesia and Vietnam are expected to reach the Lewis turning point in the next 15 to 20 years.

Stage 5  – Mass Consumption – Most developed countries now have economies dominated by the consumer. These countries are at or near the technological frontier and have highly developed physical infrastructure and costly labor, conditions that result in the share of GDP coming from consumption dominating that revived from investment. Mercantilist countries like Germany and Japan reduce consumption to some degree by repressing wages, allowing them to capture through exports some of the consumption demand from countries like the U.S., France and Spain. East Asian “Tigers” have delayed the mass consumption stage by implementing mercantilist policies which enable them to capture foreign demand through exports. Latin American countries have badly managed the transition from maturity to mass consumption, and they find themselves in the “Middle-income Trap,” with low returns on investment and insufficient consumer demand from most of their citizens.

Below, a few graphic examples of the different stages are shown. The data measures the components of GDP (World Development Indicators, World Bank)

Senegal (Traditional Rural, entering Pre-Take Off): Senegal is a low-income country with a large part of the population engaged in low-tech farming. Household consumption has dominated the economy but is now declining quickly as investment is ramping up. The current account is negative, as the country imports capital to finance investment.

 

 

Indonesia (Take-off): Indonesia entered the Pre-Take Off stage in the late 1960s, as migrants left subsistence farming to settle in urban areas. Take-off occurred in the 1980s (briefly interrupted by the Asian financial crisis). Rising capital accumulation and investment have brought high GDP growth and caused a reduction in the consumption share of GDP.  As Indonesia approaches the Lewis Turning Point in the 2030s, investment can be expected to start declining and consumption should rise.

India (Take-off): India entered the Pre-Take Off stage with economic reforms in the 1980s, leading to a long period of high GDP growth, rising investment contribution to GDP and declining consumption share of GDP. India is now in a typical Take-Off, with high capital accumulation and obscenely rich “robber barons” dominating the economy (like China in 2000).  India should reach the Lewis Turning Point over the next 20 years, at which time returns on investment will decline and the economy will become driven more by consumption.

China (Maturity):  China had its Pre-Take Off (with plenty of ups and downs) in the 1950s and 1960s. Take Off came with the economic reforms in 1980, resulting in very high GDP growth driven by investments and marked by enormous capital accumulation concentrated in few hands. The 1980-2005 “economic miracle” saw investments reach extremely high levels and plummeting of consumption’s share of GDP. The economy started losing steam in the 2000s because of high debt and declining returns on investments.  China reached the Lewis Turning Point around 2015. It now has approached the technology frontier and faces rising labor costs and low returns on investment. In this Maturity stage, investment share of GDP should decline, and consumption contribution should rise, but China is finding it difficult to abandon its debt-fueled investment model because of entrenched political interests. This raises the possibility of a long period of low growth and a “Middle-Income Trap.”

 

Korea (Maturity): Korea had its Pre- Take Off and Take Off stages in rapid succession in the 1960s. A twenty-year “Economic Miracle” was marked by high levels of investment and capital accumulation and a plummeting of the consumption share of GDP. The country reached the Maturity Stage in the 2000s, and now operates largely at the technology frontier. Korea, like China, is finding it difficult to move to a more consumer-driven economy. The country has been able to pursue mercantilist policies to secure demand from abroad for its exporters, so that it can delay increasing domestic consumption.