Naysayers, feel the Asiaphoria

Lowy Interpreter

Convergence – the catch-up process whereby poor economies grow substantially faster than the mature economies – may be the most important economic story in the past 50 years. It is transforming the world, shifting hundreds of millions out of abject poverty while simultaneously shifting the globe’s economic centre of gravity.

There have always been dissenters from this narrative. Some saw the fast growth as a temporary spurt. Others predicted that countries would stagnate in the ‘middle income trap’, unable to progress further after they had picked the low-hanging fruit of development.

Larry Summers, one of the biggest names in economic policymaking, has joined the dissenters, aiming to deflate the ‘Asiaphoria’ that foresees a continuation of Asia’s remarkable growth.

Summers (former US Treasury Secretary and member of the 1998 ‘Committee to Save the World’) and his Harvard colleague Lance Pritchett argue that the correct growth story is ‘reversion to the mean’: economies might have a purple patch where they grow faster than normal, but just as a gambler can have a lucky streak before reverting to the mean over time, growth rates will revert to the mean too. Moreover, this is not the mean of their own past growth (which might make intuitive sense, and would leave the convergence story intact), but the global growth mean.

Why are these dissenters so gloomy? There were earlier episodes of Asiaphoria which ended badly: Japan before the ‘lost decades’; the rest of Asia until the 1997 crisis. What's more, the mature economies got rich slowly but steadily while the fast-growing emerging countries stumble more frequently. And the institutions (economic and political) in emerging countries are much more fragile.

But the dissenters' evidence is tailored to fit their story.

Their statistical analysis shows that, for all countries taken together, one decade’s growth is not closely correlated with growth during earlier decades, suggesting fast-growing Asian economies could find themselves growing more slowly later. But this is the aggregate story, and no one said every country is on a convergence path.

Their data analysis also shows that one year’s growth rate is not a good predictor of growth over the following 20 years. But this just confirms that fast growth tends to be variable; a combination of some fast growth and some average growth will still leave the country ahead of the pack.

More generally, if reversion to the mean is the rule, how did so many countries come so far along the catch-up path?

The dissenters are also unimpressed by China’s 30 years of almost 10 per cent annual growth in per capita income, pointing out that this is an outlier. This is a stand-out performance, although South Korea and Taiwan come close. Moreover, they note 70 episodes where per capita income has grown one standard deviation faster than the average (4 per cent instead of less than 2 per cent) during a period of at least eight years. The dissenters don’t bother to note that this growth differential is the difference between doubling income in 35 years or doubling in just 18 years.

The counter-evidence is compelling. It begins with the four Asian tigers: Taiwan, South Korea, Hong Kong and Singapore. Then came a raft of other countries which started later and didn’t do quite as well but easily outpaced the advanced economies. Indonesia averaged 7 per cent per year growth for 30 years under Soeharto, and Thailand and Malaysia did just as well.

The post-1960 history also shows plenty of poor countries that didn’t get on the convergence path. India was so slow getting its act together that the term ‘Hindu growth rate’ was coined. Others got onto the path, only to fall off. By the 1970s Brazil was identified as the ‘country of the future’; it then spent 22 years with unchanged per capita GDP. Pakistan was the star pupil of the Harvard Institute for International Development in the 1960s.

Even the most cock-eyed optimist doesn’t argue that convergence is inevitable. But anyone observing Indonesia in the 1970s saw how little it took to shift a basket-case onto a path which doubled income every decade. With political stability, competent macro-policies and a bit of borrowed foreign technology, the economy will bound forward, with entrepreneurs coming out of the woodwork to seize opportunities, shift low-paid workers into more productive jobs, make a buck and then reinvest in the next opportunity.

It’s easy to understand why Summers and Pritchett might rail against simple extrapolation of current growth rates. Forecasting is hard. Just as it’s easiest to forecast that the weather will go on doing what it’s doing now, simple extrapolation is the lazy way. But serious forecasters do better than this. Of course China will slow – the convergence story implies it and demographics alone make it almost inevitable. But it’s unlikely to revert to the global average any time soon.

The emerging economies are likely to go on growing at around twice the pace of advanced countries. Within this aggregate, some will do much better, some much worse and the fast growers are likely to suffer set-backs. Trying to understand the reasons for these differences is still the central challenge for development economists. This task seems more fruitful than simple ‘reversion to the mean’ analysis.

Originally published by The Lowy Institute publication The Interpreter. Republished with permission.