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The Ingredients and Challenges of Sustained Growth Michael Spence Cape Town June 2007 Outline • Sustained High Growth – Ingredients – China and India • Income inequality • Comparative Advantage • Leadership and political transitions • Urbanization • Demand Shock • Resource rich economies Sustained High Growth • • • • Growth > 7% for twenty plus years There are 11 cases 8 in Asia (Botswana, China, Hong Kong, Indonesia, Korea, Malaysia, Malta, Oman, Singapore, Taiwan and Thailand) • Japan was close - India is about to join in • All post WW II • All leverage the global economy 21st? Growth is a Recent Phenomenon Ingredients • • • • Functioning market system High levels of savings and investment – Public and private Resource mobility – The microeconomic evolution of a rapidly growing economy Leveraging the global economy – Demand – Comparative Advantage – Technology and know-how China and India • China has been in this high growth mode since 1978 • India is about to jump into the high growth category • India’s current five year plan (just started) has average growth over 9% accelerating to over 10% • There are formidable challenges for each country • They will have substantial and increasing impacts on their neighbors, other developing countries, and the global economy The two most populous countries, accounting for 40% of the world’s population, are the fastest growing economies in the world, one a complex democracy and the other a socialist market economy China: GDP per capita and Poverty Reduction POVERTY IN PERCENTAGES 4500 4000 80 3500 70 3000 2500 REAL GDP PER CAPITA 2000 REAL GDP PER WORKER 1500 50 $1/DAY 40 $2/DAY 30 20 1000 10 500 0 1970 60 0 1980 1990 2000 2010 1960 1970 1980 1990 2000 Poverty in China and India 45 40 35 30 25 20 15 10 5 0 China Poverty gap at $1 a day (PPP) (%) China Poverty gap at $2 a day (PPP) (%) India Poverty gap at $1 a day (PPP) (%) India Poverty gap at $2 a day (PPP) (%) 1987 1990 1993 1996 1999 2000 2001 Income Inequality GDP per capita: China and India (constant 2000 US$) 1600 1400 1200 India GDP per capita (constant 2000 US$) 1000 800 China GDP per capita (constant 2000 US$) 600 400 200 2004 2002 2000 1998 1996 1994 1992 1990 1988 1986 1984 1982 1980 0 Rural Populations Decline Rural Population Percentage 85 80 75 70 China Rural population percentage 65 India Rural population percentage 60 55 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 50 Saving and Investment Savings and Investment in India and China 45 40 35 30 25 20 15 10 5 0 1980 1984 1988 1992 1996 2000 2004 Investment Rate (% of GDP) India Savings Rate (% of GD) India Gross capital formation (% of GDP) China Gross savings (% of GDP) China Leveraging the Global Economy Trade in Relation to GDP China 70 60 China NE.IMP.GNFS.ZS Imports of goods and services (% of GDP) 50 40 China NE.EXP.GNFS.ZS Exports of goods and services (% of GDP) 30 20 10 2004 2002 2000 1998 1996 1994 1992 1990 1988 1986 1984 1982 1980 0 Trade in Relation to GDP India Trade in Relation to GDP India 19 80 1980 19 82 1982 19 84 1984 19 86 1986 19 88 1988 19 90 1990 19 92 1992 19 94 1994 19 96 1996 19 1998 98 20 2000 00 20 2002 02 20 2004 04 45 45 40 40 35 35 30 30 25 25 20 20 15 15 10 10 5 5 0 0 Imports % o f GDP India Imports % o f GDP India Exports % of GDP India Exports % of GDP India Trade Surplus Exports of goods and services (% of GDP) Imports of goods and services (% of GDP) Trade Surplus China 04 20 02 20 00 20 98 19 96 19 94 19 92 19 90 19 88 19 86 19 84 19 82 19 80 40 35 30 25 20 15 10 5 0 -5 -10 19 XMS China Trade Surplus In addition to lower prices, FDI drove rapid export growth in China Manufactured exports growth $ billion 300 FDI backed exports 250 200 Per cent of total exports • China 150 100 50 • India 0 1984 1988 1992 1996 2000 Source: CMIE, China Statistical Yearbook, McKinsey CII Report • China • India 60.0 4.5 Public debt: China 24.4% of GDP (2005 est.) China vs India - Infrastructure Formation US$ bn 270 240 210 180 150 120 90 60 30 0 China (LHS) US$50 bn over the next 3 years India (RHS) 1985 1987 1989 1991 1993 1995 China Source: The World Bank; Deutsche Bank; CMIE 1997 1999 2001 2003 India 2005 Literacy Rates: India and China 100 90 80 70 60 50 40 30 20 10 0 1990 2004 Literacy adult women China Literacy adult men China Literacy adult women India Literacy adult men India Deng Xiaoping’s biography in brief Secretary of Party under Mao Banished to a tractor factory in Cultural Revolution Returned under wing of Zhou Enlai Banished by Gang of Four Replace Hua Guofeng Left Hua in Central Committee (essentially for life) Challenges for China • Maintaining high growth is the overriding goal – Managing economic relations with the rest of the world • Managing Rural to Urban Migration – 13 to 15 Million People a Year • Absence of social insurance and services • Huge urban-rural productivity differentials • State Owned Enterprises – SOE’s – Government Ownership Capital Markets and Diversifying Sources of Growth • Capital Markets and investment efficiency – Capital markets are quite underdeveloped • Exchange Rate and External Imbalance – PBC (our Federal Reserve) accumulation of foreign reserves • Diversifying sources of growth – Manufacturing sectors – Service sector – Domestic Market • “China is several different economies at different stages of development” Capital Composition Aside: Global Capital Markets Gradual Appreciation of Currency is Likely • The continuing need for direct credit and other controls on investment – Response to interest rates unclear • Continuing capital controls are required to have a monetary policy targeted to inflation and growth and at the same time retain some control over the exchange rate. • In addition with immature capital markets, there is the risk of destructive volatility – without capital controls • Phasing these out at the proper rate as the capital markets develop is a key policy challenge • Building capital markets and increasing efficiency of investment is a high current priority Internal and External Balance China is at A in internal balance and way out of external balance The outside world says move to B China is likely to go gradually from A to D R ep ub lic In di a Ko re a an ) us si a (T ai w So ut h hi na R G er m an y Si ng ap H on or e g K on g, C hi na of C hi na Ja pa n C Billions $ Reserves Foreign Reserve Holdings at the End of 2006 1200 1000 800 600 400 200 0 Recent Trends • In – – – – – – – – – 2007 in China GDP: $2.8 trillion Forecast trade surplus: $250-$300 billion Surplus/GDP 10% or more Investment/GDP: 40-45% Savings/GDP: 50-55% Exports + Imports as percentage of GDP: 70% Reserves at the end of 2006: $1.2 trillion Likely reserve additions: $400 billion or more Reserves at the end of 2007: $1.6 trillion China During Currency Crisis 1997-1998 120 110 Japanese Yen Chinese Renminbi 100 90 80 70 Taiwan $ Korean Won 60 50 Thai Baht 40 Jun 97 Source: Bloomberg October 22, 2003 Challenges (continued) • Environment Problems - these are huge • Energy efficiency and security – China plans to double its energy efficiency in the next decade – Economic growth will still cause energy consumption to rise • Rising Income Inequality • Overinvestment in infrastructure - underinvestment in higher education • Internal market fragmentation – developing the domestic market • Restoration of pension system and medical care – especially in the rural areas India Assets • Higher Education • Optimism and Sense of Momentum • IT/BPO Outsourcing – Projected growth is 30% per year and India is the dominant player • Financial Sector and Reserve Bank of India • Growth in Trade in Services Has Room to Grow – – – – R&D Medical Services Political Speeches Editing of newspapers • and TV – Grading exams But • This is not enough to produce and sustain high and inclusive growth – Doesn’t employ enough people • India needs an additional powerful productive employment-generating engine • This is very well understood by India’s leaders • Labor intensive manufacturing and exports – Add the China approach to the portfolio • Open up to FDI • Special Export Zones (400+) Investment and Policy Challenges Education Infrastructure Efficiency and Investment in Agriculture Impacts on Global Economy • Rapidly growing trade with each other • Very large regional impact in east and south Asia – Demand and imports from each other and more advanced neighbors – Intense competition for less developed neighbors • Competitive pressure on advanced economies – Europe in particular with less flexible labor markets and social safety nets that constrain competitive responses Demand for Energy and Commodities • Large incremental demand for raw materials and commodities with effects of prices (China’s equivalent of our interstate highway system is an example) • Potential scramble for energy security – because of the size of the demand shock • Increased influence in Africa and other parts of the world China’s Trade with Africa Magnitude of Impacts Becoming Material • In 1980 when China grew ten percent, the absolute increment to global GDP and global demand was insignificant. • Now the GDP is about 2.22 trillion $, and a ten percent increment is large in absolute terms – The rough equivalent (in terms of global demand) of about a 1.78% increment in US GDP growth Demonstration Effects • India has been galvanized by China’s growth • High growth is possible in a complex democracy • Can other developing countries compete with China and India – locating comparative advantage • Quality of the economic policy debate The Latest Entrant: Vietnam Vietnam: GDP per capita 3000 2500 Growth Rate 5.88% 2000 1500 1000 500 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 0 GDP per capita, PPP (constant 2000 international $) South Africa: GDP/capita PPP adjusted constant dollars 12000 10000 8000 6000 4000 2000 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 0 South Africa: Saving and Investment 19 81 19 83 19 85 19 87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 Se rie s Na m e 40 35 30 25 20 15 10 5 0 Gross capital formation (% of GDP) Gross domestic savings (% of GDP) 20 04 20 02 20 00 19 98 19 96 19 94 19 92 19 90 19 88 19 86 19 84 19 82 19 80 South Africa Gini Coefficient 70 60 50 40 30 20 10 0 Rising Income Inequality and Resistance to Globalization • Developed Countries – Middle income lag – Protectionist sentiment – Trade in services and globalization of some labor markets – Impact of technology • Developing Countries – Rising inequality side effect of benign growth dynamics (China and India) – “Inclusiveness” – Unequal distribution of assets can retard growth 16.00 12.00 2.00 8.00 4.00 0.00 0.00 Income Bottom Bottom Low Lower Middle Upper High Top Growth 4.00 Grow th Factor Grow th Rate Growth Rate China: Total Growth and Growth Rate: Per Capita Income: 19952004 Gini Coefficients Global Warming • Decision making under extreme uncertainty – Very long time horizons – Large ranges in the estimates of climate impacts – These will decline over time as the science becomes more precise • The stocks and the flows of green house gases – The Kyoto impasse – How to allocate the emissions rights equitably Three Major Sets of Issues • 1. Mitigation – Allocation of emissions rights across countries – Efficiency – carbon trading market mechanisms • 2. Technology – Reduction of the costs of mitigation – Subsidies and rapid transfer globally • 3. Adaptation – Capacity to adapt to climate change that does occur – Poorer country problem • RESPONDING TO CLIMATE CHANGE IS A MAJOR TEST OF OUR COLLECTIVE CAPACITY Demand for Energy and Commodities • Large incremental demand for raw materials, commodities, and energy with effects on prices (China’s construction of the equivalent of the US interstate highway system is an example) • For developing countries with commodity exports, the effect can be beneficial in the short run – but rising commodity prices is not a basis for sustained growth • Generally rising energy costs hurt poor countries more than richer ones • Potentially damaging scramble for energy security – because of the size of the demand shock – and the potential for supply problems in unstable regions Global “Imbalances” United States Savings and Foreign Reserves Foreign Reserve Holdings at the End of 2006 1200 1000 600 400 200 ng ap or Ko e ng ,C hi na G er m an y In di a H on g Si Ko re a an ) ut h So (T ai w us si a R of C hi na Ja pa n ep ub l ic R hi na 0 C Billions $ 800 US Household Assets H o u si n g P r i c e I n d e x : 10 0 i n y e a r 2 0 0 0 180 14 12 10 8 6 4 2 0 15 10 5 0 160 140 2001 2002 2003 2004 2005 120 100 80 60 40 20 0 2000 2001 2002 2003 2004 So u r c e : O F H E O U n i t e d St a t e s G o v t 2005 Mortgages Growth Rate Growth Rate Trillions of dollars US Total Mortgages Recent Trends • In – – – – – – – – – 2007 in China GDP: $2.8 trillion Forecast trade surplus: $250-$300 billion Surplus/GDP 10% or more Investment/GDP: 40-45% Savings/GDP: 50-55% Exports + Imports as percentage of GDP: 70% Reserves at the end of 2006: $1.2 trillion Likely reserve additions: $400 billion or more Reserves at the end of 2007: $1.6 trillion