Quo Vadis, Economy?

From a historical perspective, economic prosperity is a very recent human achievement. In the decades preceding the roaring twenties, the US economy grew merely at a rate of 2-3%. Considering population growth rate in the same period, the per capita economic output essentially remained flat. From the forties through the sixties, the US and Western European economies registered an unprecedented rate of growth of 5-6%. Today's economic growth rate stands at 1.3% for Western Europe and 2.4% for the US. To put these numbers in perspective, excluding the recent refugee influx from the Middle East, the European Union has experienced a population growth rate of 0.11%, while the US has experienced a current population growth rate of 0.7%. After discounting for the population growth, real economic growth barely ekes past 1%.

One might ask, so what? Do we really need economic growth? Do we really have a compelling reason to increase our industrial output? How can we justify increasing our consumption at a time when our habitat is at risk from environmental degradation and climate change; our health imperiled by poor air and water quality?

Unfortunately, the present economic order will not sustain without growth. Without growth, our governments will be in serious trouble in servicing national debt. Consider this: the national debt in the US is currently at growing at a rate of $1 trillion/year when our total national debt is around $18 trillion. That is a growth rate of 5.6%. If the economy grows at a rate of 2-3% and the national debt grows at a rate of 5-6%, prospects for a better future look bleak. Governments in the US, Japan, and across Europe will be forced to cut back on social security and other welfare programs that transfer wealth to the retirees and the indigent, roiling economic growth further. Our governments are hooked on economic growth without which government transfers will cease and economic disparities will mount.

Much of economic consumption in western liberal democracies is fueled by credit. Imagine a world without inflation. In such a world, consumers will not feel nudged to make purchases, making it difficult to sustain equilibrium. Thus, growth is needed to sustain our credit based economy.

Some economists believe that we have entered a phase of secular stagnation, characterized by low growth in demand with large industrial capacity, making it difficult to raise prices. What has caused demand to decline? The explanation is twofold: after heady growth in the past century, the population in the industrialized world has not only stabilized, but is at the precipice of decline. This naturally lowers the level of demand. Second, changes in satiation have shaped demand curves. Life from the 19th century to early 20th century was poor, miserable and short; there was not any incentive to postpone consumption. As people are living longer and more satisfying lives, they are also postponing consumption, creating a glut of savings and depressing demand. On the other hand, development in technology has enabled industrial capacity to scale up rapidly, banishing the kind of inflation known in the past.

The narrative is quite different in some developing countries like China and India. China's share of current global economic output in terms of purchase power parity is $18.5 trillion out of total global output of $108 trillion. Compare that to $18 trillion for EU countries, $17.5 trillion for the US and $7.4 trillion for India. The Chinese economy is currently growing at a rate of 6.9% while India is growing at a rate of 7.4%. These two economies currently account for more than 40% of the global economic growth. Two important factors are driving this growth: the size of the labor force, and improvement in labor productivity. Quality of workforce, particularly in China, has improved rapidly. China produces more than 50,000 PhDs a year, ahead of the US by several thousands. The quality of the labor force is certainly paying dividends for China.

Why should the developed world care about growth in China and India? There are reasons aplenty. First, China is the third largest buyer of US goods after Canada and Mexico. India, currently ranks ninth in US trade but is growing at a fast clip. Growth among any of the large trading partners will translate into growth in the US economy.

While China is a formidable trade partner, India looks more favorable for future growth with its youth bulge. Two thirds of Indians are below the age of 35; nearly half of all Indians are below the age of 25. If India can turn the favorable demography to a productive economy, it can enjoy its demographic dividend. Many economists, however, have cautioned that a demographic dividend is not a foregone conclusion--if the youth bulge surpasses economic capacity, India's demographic dividend can also turn into a demographic disaster as can be seen in certain Middle-Eastern countries like Egypt. To build the economic capacity for productive labor, India needs to invest in infrastructure, health and education, necessitating high levels of capital investment.

Presently, western nations have surplus capital simply sloshing around for good investment choices anywhere. With the right policies, this money can easily find its way into Indian infrastructure. For that to happen, India has to loosen up its restrictions on foreign ownership and foreign holdings of domestic equity and real estate.

However, investment alone will not drive growth in US export; companies also need to adapt their products for export. When Toyota started selling their cars in India, the gear ratios were not adapted for the Indian road conditions. Drivers in India rarely used higher gears and they disliked the fact that they were stuck using only low gears, costing them in fuel efficiency. All big motor companies learned this lesson and adapted their products for the Indian market. KFC in China serves congee, a rice porridge which is difficult to make at home, but popular with Chinese customers. While large conglomerates have done their research and adapted products for local market condition, other exporters are lagging. Adapting products to local needs sometimes requires innovating completely new products. As Unilever found out, Indians with meager earnings also aspire to consumer products that are nominally out of their reach. In response, Unilever started packaging their shampoos and detergents in sachets to bring these products in smaller quantities, gaining them enormous market success.

Global economic growth is in a nation's self-interest. We should be working to promote growth wherever the ground is fertile. While national self-interest is decidedly local, enlightened self-interest is surely global!