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19-10-2014, 11:35 PM
Asia’s days as engine of growth numbered, warns Harvard duo
THE AUSTRALIAN OCTOBER 20, 2014 12:00AM
David Uren
Economics Editor
Canberra
World growth if China, India hit average
World growth if China, India hit average Source: TheAustralian
GROWTH in China and India is much more likely to drop to about 2 per cent than it is to continue at anything close to current rates, while an extended period of recession is probable, according to a new paper by Harvard University’s, Larry Summers.
Summers, who is a former US Treasury secretary and one of the world’s most eminent economists, warns that Asia’s days as the fastest-growing region in the world are numbered, adding this will have profound implications for commodity and energy exporters like Australia.
The paper, which Summers has co-written with fellow Harvard economist Lant Pritchett, extends a study published last year and says the history of countries enjoying rapid growth is that they return to the global average rate, usually very suddenly. This likelihood is greatest in those countries with authoritarian governments. “Regression to the mean is the single most robust finding of the growth literature and the typical degrees of regression to the mean imply substantial slowdowns in China and India relative even to the currently more cautious and less bullish forecasts.
“China’s super-rapid growth has already lasted three times longer than a typical episode and is the longest-ever recorded. The ends of episodes tend to see full regression to the mean, abruptly.”
The paper says that just as with shares, past national growth rates are a poor guide to the future. “Many of the great economic forecasting errors of the past half century came from excessive extrapolation of performance in the recent past and treating a country’s growth rate as a permanent characteristic rather than a transient condition.”
The paper notes the 1961 edition of the famous economic textbook by Paul Samuelson forecast the Soviet Union would overtake the US by 1980. During the 1980s, Japan was also expected to overtake the US. However, productivity which had doubled over the 30 years to 1991 is now 6 per cent lower than it was then, while per capita growth has risen only 0.6 per cent a year. No one in 1980 would have predicted that Brazil, which had just enjoyed 13 years of growth above 5 per cent, would then experience two decades with zero per-capita growth.
Yet forecasts are routinely made that China and India’s extended run of growth will continue indefinitely. Treasury has been susceptible to what the authors term “Asiaphoria”, with forecasts in the former government’s Asia Century white paper envisaging China would average 7 per cent growth out to 2025 and India 6.75 per cent. The World Bank and OECD have projected growth rates for these two nations of 5 to 6 per cent over the next two decades.
Summers and Pritchett take the growth of all nations back to 1950 and show that knowing the growth in any one decade explains only 20 to 30 per cent of the growth in the next decade. “Knowing the current growth rate only modestly improves the prediction of future growth rates over just guessing it will be the world average.”
Growth rates of 6 per cent are more than two standard deviations away from the average world growth, which is only 2 per cent. If China and India continued growth of the past decade for another 20 years, China’s GDP would reach $60 trillion, while if it reverted to 2 per cent, it would only reach $14 trillion (about 20 per cent smaller than US is now).
The study looks at the 28 episodes where countries have enjoyed growth rates of more than 6 per cent over at least eight years. China, which has now been growing that fast for 33 years, is the longest-lived expansion, with only Taiwan’s run between 1962 and 1994 coming close. The average is only nine years. Nearly all ended with an abrupt deceleration, with median growth slowing to the world average rate of 2 per cent. Among advanced countries, the past can explain the future precisely because their growth rates do not vary much around the global average. A forecast of Denmark’s per capita output in 2010 made in 1916 based on extrapolating growth since 1890 would be out by only $200. But growth in developing countries is more volatile. The 83 countries with per capita incomes of between $2000 and $10,000 spend between 66 and 75 per cent of the time growing at average rates of more than 5 per cent, but the rest is in recession, with an average annual contraction of between 4.6 and 4.8 per cent. In rich countries by contrast, 84 per cent of years are positive, with average growth of 3.9 per cent, while the rest are in recession, with average contraction of 2.3 per cent.
A key reason for the difference is institutional quality. China’s rapid growth over the past three decades shows that “organised” corruption can be a “veritable greenhouse” for growth. Firms can reach arrangements with the state that deliver high and secure profitability. “As firms either ‘seize the state’, or are the state or are chosen by the state, the official legal and regulatory environment — or more particularly its implementation — are bended to provide great, if super local and specific, conditions for growth.”
But when power shifts, relationships are severed and there are no institutions to fall back on. Growth slows dramatically.
The new paper, published by the US National Bureau of Economic Research, comes just weeks after the IMF endorsed Summers’ analysis last year that large sections of the advanced world may be suffering “secular stagnation”, with even zero interest rates not enough to stimulate investment.
The IMF is sticking to its forecasts that both China and India will keep growth at more than 6 per cent out to at least 2019. But it is increasingly emphasising the risks to that outlook, particularly for China. The fund is concerned about the build-up of corporate debt, which has risen from less than 100 per cent of GDP before the financial crisis to 141 per cent now, with that debt concentrated in weak real estate, construction and state-owned enterprises.
“Although banks appear to be prepared for some pick-up in corporate defaults, the non-bank sector is more directly exposed because of a combination of higher-risk lending (especially to the real estate sector) and thin capital cushions.”
Summers argues that at the very least, forecasters should insert a much wider range of possible outcomes for countries whose growth rates are far from the mean. “Given the sensitivity of commodity demands in particular to growth rates in Asia, this suggests substantial uncertainty about the medium-term path of commodity prices,” he says.
THE AUSTRALIAN OCTOBER 20, 2014 12:00AM
David Uren
Economics Editor
Canberra
World growth if China, India hit average
World growth if China, India hit average Source: TheAustralian
GROWTH in China and India is much more likely to drop to about 2 per cent than it is to continue at anything close to current rates, while an extended period of recession is probable, according to a new paper by Harvard University’s, Larry Summers.
Summers, who is a former US Treasury secretary and one of the world’s most eminent economists, warns that Asia’s days as the fastest-growing region in the world are numbered, adding this will have profound implications for commodity and energy exporters like Australia.
The paper, which Summers has co-written with fellow Harvard economist Lant Pritchett, extends a study published last year and says the history of countries enjoying rapid growth is that they return to the global average rate, usually very suddenly. This likelihood is greatest in those countries with authoritarian governments. “Regression to the mean is the single most robust finding of the growth literature and the typical degrees of regression to the mean imply substantial slowdowns in China and India relative even to the currently more cautious and less bullish forecasts.
“China’s super-rapid growth has already lasted three times longer than a typical episode and is the longest-ever recorded. The ends of episodes tend to see full regression to the mean, abruptly.”
The paper says that just as with shares, past national growth rates are a poor guide to the future. “Many of the great economic forecasting errors of the past half century came from excessive extrapolation of performance in the recent past and treating a country’s growth rate as a permanent characteristic rather than a transient condition.”
The paper notes the 1961 edition of the famous economic textbook by Paul Samuelson forecast the Soviet Union would overtake the US by 1980. During the 1980s, Japan was also expected to overtake the US. However, productivity which had doubled over the 30 years to 1991 is now 6 per cent lower than it was then, while per capita growth has risen only 0.6 per cent a year. No one in 1980 would have predicted that Brazil, which had just enjoyed 13 years of growth above 5 per cent, would then experience two decades with zero per-capita growth.
Yet forecasts are routinely made that China and India’s extended run of growth will continue indefinitely. Treasury has been susceptible to what the authors term “Asiaphoria”, with forecasts in the former government’s Asia Century white paper envisaging China would average 7 per cent growth out to 2025 and India 6.75 per cent. The World Bank and OECD have projected growth rates for these two nations of 5 to 6 per cent over the next two decades.
Summers and Pritchett take the growth of all nations back to 1950 and show that knowing the growth in any one decade explains only 20 to 30 per cent of the growth in the next decade. “Knowing the current growth rate only modestly improves the prediction of future growth rates over just guessing it will be the world average.”
Growth rates of 6 per cent are more than two standard deviations away from the average world growth, which is only 2 per cent. If China and India continued growth of the past decade for another 20 years, China’s GDP would reach $60 trillion, while if it reverted to 2 per cent, it would only reach $14 trillion (about 20 per cent smaller than US is now).
The study looks at the 28 episodes where countries have enjoyed growth rates of more than 6 per cent over at least eight years. China, which has now been growing that fast for 33 years, is the longest-lived expansion, with only Taiwan’s run between 1962 and 1994 coming close. The average is only nine years. Nearly all ended with an abrupt deceleration, with median growth slowing to the world average rate of 2 per cent. Among advanced countries, the past can explain the future precisely because their growth rates do not vary much around the global average. A forecast of Denmark’s per capita output in 2010 made in 1916 based on extrapolating growth since 1890 would be out by only $200. But growth in developing countries is more volatile. The 83 countries with per capita incomes of between $2000 and $10,000 spend between 66 and 75 per cent of the time growing at average rates of more than 5 per cent, but the rest is in recession, with an average annual contraction of between 4.6 and 4.8 per cent. In rich countries by contrast, 84 per cent of years are positive, with average growth of 3.9 per cent, while the rest are in recession, with average contraction of 2.3 per cent.
A key reason for the difference is institutional quality. China’s rapid growth over the past three decades shows that “organised” corruption can be a “veritable greenhouse” for growth. Firms can reach arrangements with the state that deliver high and secure profitability. “As firms either ‘seize the state’, or are the state or are chosen by the state, the official legal and regulatory environment — or more particularly its implementation — are bended to provide great, if super local and specific, conditions for growth.”
But when power shifts, relationships are severed and there are no institutions to fall back on. Growth slows dramatically.
The new paper, published by the US National Bureau of Economic Research, comes just weeks after the IMF endorsed Summers’ analysis last year that large sections of the advanced world may be suffering “secular stagnation”, with even zero interest rates not enough to stimulate investment.
The IMF is sticking to its forecasts that both China and India will keep growth at more than 6 per cent out to at least 2019. But it is increasingly emphasising the risks to that outlook, particularly for China. The fund is concerned about the build-up of corporate debt, which has risen from less than 100 per cent of GDP before the financial crisis to 141 per cent now, with that debt concentrated in weak real estate, construction and state-owned enterprises.
“Although banks appear to be prepared for some pick-up in corporate defaults, the non-bank sector is more directly exposed because of a combination of higher-risk lending (especially to the real estate sector) and thin capital cushions.”
Summers argues that at the very least, forecasters should insert a much wider range of possible outcomes for countries whose growth rates are far from the mean. “Given the sensitivity of commodity demands in particular to growth rates in Asia, this suggests substantial uncertainty about the medium-term path of commodity prices,” he says.
