Don’t Look Now, But the World Economy Is Booming

Worth A Look, Globalization, Frontier Centre

The world economy is booming. To see the evidence, check out the back page of The Economist. There is a column showing the GDP growth rates of 27 developing countries. In a typical copy from the late 1990s as many as one-third to one-half of these could have minus signs in front of them.

Today, every single one of these developing countries’ growth rates is positive. Substantially positive. The slowest growth rate, in Brazil, is still a respectable 3.4 percent.

In the 1990s, the GDP of developing countries grew at an average of 3.6 percent. Now a faster rate of growth seems to have set in. In 2003, developing countries’ economies grew by 5.6 percent. In 2004, they achieved a sizzling 7.1 percent, then settled back to a still-impressive 6.4 percent in 2005. Rich countries are growing, too — the OECD economies grew at 3.2 percent in 2004 and 2.7 percent in 2005 — but at more a pedestrian pace.

If anything, 2006 looks to be even better. China’s economy grew at 11.3 percent in the second quarter of 2006. India’s busy economy is growing at about 8 percent. US GDP grew at a 5.6 percent annual rate in the first quarter.

The Beginnings of Convergence?

When poor countries grow faster than rich ones, the result is convergence, a narrowing of worldwide economic inequality. Economists have long predicted convergence, which should be caused by technology transfer, international trade and capital flows, and (to a small extent) foreign aid and migration. There have been intermittent signs of it. But real, unmistakable convergence has never seemed to materialize. Until now?

It’s not just India and China anymore. In the 1990s, strong growth in China and India, with their gigantic populations, caused a slight narrowing in worldwide individual inequality, despite the ongoing crisis in Africa, economic collapse in the former Soviet bloc, and stagnation in Latin America and the Middle East. By contrast, today economic growth has spread to all major regions of the world.

The biggest turnaround is in the former Soviet bloc, where average annual economic growth from the fall of the USSR to 1998 was negative 6.9 percent, but, from 1999 onward, has bounced back to positive 6.9 percent.

But every region except Western Europe is beating its 1990s average. Latin America was regarded as under-performing in the 1990s, averaging 3.4 percent GDP growth. It grew at 6 percent in 2004, 4.4 percent in 2005, and is expected to grow 5 percent in 2006. The Middle East and North Africa region grew at 3.8 percent in the 1990s. It grew at 4.7 percent in 2004 and 4.8 percent in 2005. Sub-Saharan Africa has improved from 2.9 percent average GDP growth in the 1990s to 5.6 percent in 2004 and 5.3 percent in 2005. East Asia (excluding Japan) is beating even its sizzling 1990s average of 8.5 percent; in 2004, it grew at 9.1 percent, in 2005, 8.8 percent.

What’s the explanation for this global economic boom? Well, here are a few hypotheses.

High Commodity Prices Spread the Wealth

Think of developing countries as of two kinds: sweatshop countries and non-sweatshop countries.
Sweatshop countries are those where entrepreneurs find it worthwhile to build factories specializing in labor-intensive industrial activities; the Pacific Rim countries of East Asia are sweatshop countries par excellence. First Japan, then Korea, Taiwan, Hong Kong and Singapore, then Malaysia and Thailand, now Vietnam, China and Indonesia, got their start in labor-intensive, low-skilled industries like apparel. They earned very low wages at first for stitching garments or making Nike shoes. After all, cheap labor was about all they had to offer. But soon they got plugged into the global economy, and started learning by doing and moving up the value chain. They acquired capital, skills, and a good name, and then moved on to higher-value-added activities. By now, some of them have outsourced the most labor-intensive jobs, thus becoming ex-sweatshop countries and turning poorer neighbors into sweatshop countries.

Being a sweatshop country is not as easy as it sounds. It’s not enough to have a large supply of cheap labor. Lots of countries have that. Economic openness isn’t enough, either: people won’t invest in a country with lazy workers, lousy infrastructure, and a high risk of investments being expropriated, even if tariffs are low. Arnold Kling has suggested that the deep preconditions for economic growth are three “growth ethics”: a work ethic, a public service ethic,and a learning ethic. A work ethic makes your sweatshops competitive. A public service ethic makes government create a good business environment and not steal too much. And a learning ethic enables a country to acquire skills, learn the ins-and-outs of global markets, and absorb foreign technology. A lack of these ethics is one reason that there are still so many non-sweatshop countries in the developing world.

It’s the non-sweatshop countries, which export commodities and import (or, worse, try not to import) industrial goods, that are the basketcases. For one thing, commodities prices are volatile, and in the two decades before 2004, the terms of trade generally shifted against them. But in 2004, commodity prices turned around, as shown in the table below:

As the table shows, most commodity prices drifted downward until about 2002, then started inching upward. Then, in 2004, metals and energy prices began zooming upward. Four of the lines in the table are broad indices. The fifth is copper, included in honor of Zambia, a very poor copper exporter in sub-Saharan Africa. In his 2002 book The Elusive Quest for Growth, estranged World Bank economist Bill Easterly gave Zambia as a sad example of a country whose economy was devastated by adverse price trends outside its control that lasted for decades. Now, with copper prices soaring, Zambia’s having a bit of luck, at last!

High commodity prices help to spread economic growth from high-performing sweatshop and ex-sweatshop countries to struggling commodity exporters. One reason economic growth is no longer concentrated in clever, industrious East Asia, but is occurring worldwide is high commodities prices. And a key reason for high commodity prices is China.

In the year 2004, China got big enough to carry world commodity markets on its shoulders. China is now the world’s biggest importer of steel
, copper, stone
, soybeans, and the second largest importer of oil. It may be the world’s biggest importer, full stop, by 2010. If China sustains its fast pace of growth, expect commodity prices to stay high. For a long time, the US has been the “locomotive” of the world economy. Now we’ve got company.

The Demographic Transition

Look through the pages of the World Bank’s 2005 Little Data Book, and you will notice one striking regularity: in every single developing country in the world, the birth rate (births per woman) in 2003 is equal to or lower than in 1990. The only countries where the birth rates rose were rich countries: Denmark, France, and the Netherlands.

A lower birthrate is both a cause and a consequence of economic development. Why richer people have fewer kids is not entirely clear. But the explanation of why a fall in the birthrate tends to cause a big jump in the level of per capita income is straightforward.

A society with a high birthrate has to support a lot of kids. Also, population growth means a growing labor supply, which holds down wages. On the plus side, it has relatively few old people to support: lots of grandkids for every grandma.

When the birthrate falls, the first effect is that there are fewer kids to support and educate. At the same time, there are still relatively few old people. This situation is called a low dependency ratio, meaning that people who don’t work (children and seniors) are a small share of the population. A low dependency ratio means low public spending.

At the same time, workers are saving for their old age, so savings rates are high. Entrepreneurs turn savings into investment, and capital formation accelerates. And fewer children means less growth in the labor supply. As workers become scarcer, and capital more abundant, wages and living standards rise. Eventually, the dependency ratio rises again, as a baby-boom of workers turns into a baby-boom of retirees, and growth slows down again. But before that happens, a country has a window of opportunity to achieve especially rapid growth.

This process is called the demographic transition. It was part of the reason for the explosive growth performance of East Asia over the past generation. Now, with birthrates falling everywhere, a worldwide demographic transition is underway. Incidentally, this also explains the “savings glut” which Ben Bernanke (now Fed Chairman) posited last year as an explanation for why dollar interest rates remain low, in spite of America’s huge budget and trade deficits.

The Market-Capitalist System Is Doing Its Work

Never in history has the market-capitalist system been so widespread. A golden age of capitalism started in the 1990s, when the Soviet Union fell, India hit a financial crisis and embarked on market reforms, Deng urged the Chinese to “plunge into the sea” of market competition, and Latin American countries beat inflation and tried out the Washington Consensus. Market capitalism was the only game in town, but not everyone understood how to play it. What Russia enacted turned out to be a cruel parody of capitalism, East Asian countries’ cronyism and lack of transparency led them into a financial crisis (though they rebounded quickly), and the economies of China and Japan were distorted by insolvent financial systems that the government wouldn’t allow to fail.

These days, triumphalism about the magic of the market is passĂ©. There are more secure property rights, convertible currencies, and trade and capital mobility than there was in the 1990s. During the post-Soviet economic collapse, the 1997-8 financial crises, the years of Latin-American under-performance, economists often promised that adherence to Washington Consensus “orthodoxy” would pay off “in the long run.” A lot of people got disillusioned with those promises, but maybe they were right after all.

When countries want to pursue market-capitalist policies, they often turn to the itinerant eggheads of the IMF and the World Bank. Some libertarians and classical liberals applaud the spread of capitalism, but want to abolish the IMF and the World Bank. How do they think policy ideas spread — by telepathy?

The End of Poverty?

The economist Jeffery Sachs’ book The End of Poverty came in for a lot of criticism. With good reason: Sachs has too much faith in the power of government-to-government foreign aid to raise living standards. But the book is not as utopian as it sounds, because Sachs’ title really means “the end of extreme poverty,” as opposed to the relative poverty that exists in places like the US, Europe and Japan. America and Europe have already ended the kind of poverty Sachs is talking about, and if we can do it, so can others.

If growth in the developing world continues at its present pace, they will. If GDP per capita in developing continues growing at its current rate of about 5 percent, their incomes will double in 14 years, and quadruple in 28 years. There are about 1.1 billion people today who live on less than $1 per day, the World Bank’s measure of extreme poverty. Most of them live in countries with less than $1,000 GDP per capita in nominal terms. If all developing countries’ per capita incomes quadruple, there will only be ten countries left with less than $1,000 GDP per capita. When you think about it that way, the goal doesn’t seem so far out of reach. (And I am not proposing a big foreign aid push.)

Growth might not last, of course. Developing-world GDP growth briefly topped 5 percent in 1996-7 and again in 2000, only to be hit by the Asian financial crisis in 1997-8, then by the post-9/11 recession in 2001. In the past few weeks, many developing-country stockmarkets have taken a tumble in anticipation of tighter monetary emanating from the Federal Reserve. If there’s a worldwide recession next year, I’ll feel pretty silly for writing this article. But for now, we’re on the right track. Let’s try not to screw it up.

Nathan Smith is a TCS Daily contributing writer.