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Catch-Up Growth: Snippets in History - Outside View by Nitin Gregory
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Catch-Up Growth: Snippets in History
Oct 19, 2015

In our previous discussions, we spoke about the fundamental components of growth. However, a few pieces of the growth puzzle are still missing. Growth has not favoured everybody equally. We see advanced economies at the frontier of technology and developing ones that have scope for further growth.

Can developing economies grow faster than their advanced counterparts and eventually catch up?

The most visible contender today is China. It has demonstrated a period of high growth and increasing living standards for close to half a billion people. The telltale marks of capital (high savings rate, government lending, and foreign investment) along with labour (demographic advantage) and technology (productivity improvement) are evident in China's growth story.

In the 1980s, Deng Xiaoping opened the Chinese economy to foreign trade and technology. Technology that existed in the West could then be gradually adopted in China. Productivity improvements did not have to go through the risky process of trial and error. By following the course already charted by advanced economies China experienced faster growth - 'catch-up growth'.

Catch-up growth takes place when developing countries grow at faster rate than developed countries to the point of convergence.

Developing countries are characterized by low capital stock per worker, which means any incremental investment in capital stock will result in productivity improvements.

For example, a fabric maker in a developing country may not use machines. The fabric maker can purchase machinery from an advanced country and increase output per worker. Combined with low wages, you the result is a product that is competitive in a global market. This means higher demand and even more output (growth) for the fabric maker.

Following this model, China grew leaps and bounds. Some favourable conditions also contributed:

  1. High capital availability (high savings rate, government lending, and foreign investment)
  2. A growing workforce
  3. Access to global markets (growing demand)
  4. A template of technology from advanced economies.

During this period, China accumulated large foreign exchange reserves because of exports to the US, causing some tensions related to currency valuations and forex reserves. The period also saw high investment as a percentage of GDP (circa 40%) and a growing role of government institutions (state-owned enterprises).

So now the question is - was this a one-time phenomenon?

What does history tell us? What are the lessons here for other developing countries?

As the saying goes, history does not repeat, but it does rhyme.

The late nineteenth century saw similar scenario in the land of the rising sun. The Meiji restoration opened Japan to foreign education systems and industrialisation. During this period, Japan absorbed the technology that already existed in the West. They sent students to foreign countries and hired Westerners to help adapt the once-isolated nation to modern technology.

After the Second World War, Japan rebuilt its industry and began aggressive exportation. This gave Japan access to global markets, and the country saw a strengthening of government institutions, high investment rates (capital deepening), and a growing forex reserve. And as with China today, political tensions flared around the exchange rate and forex surplus (hear the rhyme?).

The period of Japanese history should be encouraging for developing nations: Favourable levels of capital and labour along with access to global markets can lead to high growth. Indeed, Japan proves not only is catch-up growth possible, but developing nations can themselves become global economic leaders.

However, more recent history in Japan provides a tale of caution. Capital allocation is complicated, especially at the technology frontier, which can be riddled with inefficiencies. Japan saw a large misallocation in real estate that resulted in a crash and then a painful two-decade recession.

China has been showing signs of overheating, and real estate has experienced some price corrections. But China still has a long way to go before catch-up growth is completed (GDP per capita in China is estimated to be 25% of US levels in terms of purchasing power parity).

So what ails Japan? What kind of growth awaits the developing county that has completed its catch-up growth? We'll add another piece to the puzzle next time...

This column is authored by Nitin Gregory. Nitin, who graduated from IIM-Calcutta, is currently pursuing a finance role with an automotive major. He has a deep interest in Macroeconomics and pens a blog at Gregonomics.

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1 Responses to "Catch-Up Growth: Snippets in History"

Nita

Oct 28, 2015

Very well written

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Equitymaster requests your view! Post a comment on "Catch-Up Growth: Snippets in History". Click here!

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