CARNEGIE COUNCIL - Transcript - Remarks E-mail
Monday, 16 May 2011 12:06
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Thank you so much. Good morning, ladies and gentlemen. It's a real pleasure to be with you.

We don't have much time, so I'll just launch in.

The storyline is the one Joanne mentioned. We had negligible economic growth in the world for eight or nine centuries. Then the pattern shifted, for reasons that economic historians still study, and we had the British Industrial Revolution, absorbed then in continental Europe and what Angus Maddison calls "the European offshoots." That's the U.S., Canada, Australia, and New Zealand.

Fifteen percent of the world's population started to go off in a different direction, and that ended up being the set of countries that we now call industrialized or advanced. The rest of the world basically stayed where it was, probably for complex reasons, but having to do with the inherent asymmetries associated with colonialism and all that went with it.

Then, after World War II, several things came together. A bunch of very wise people decided that what we did after World War I shouldn't be repeated, and so a serious effort was made to restore order and build the vanquished countries back up. We created the GATT [General Agreement on Tariffs and Trade], which systematically opened the economy. Technology produced a huge tailwind in integrating the global economy in a way that none of us could see at the time.

I was born during World War II. In my young life, I thought developing countries were—we used then the term "backward"—and the terminology is fun; I talk about it in the book—and then "Third World," then something else, and eventually "developing." It was the first time we acknowledged that something might be happening to change things. So it went on like that.

But by now, we can clearly see that this pattern of 15 percent going in one direction and everybody else staying where they were was reversed at that time. There were a lot of false starts. There are still places that are stuck and not growing that are of some importance, but basically we are on a track that I characterize as a century-long journey in which we'll end up with something on the order of 75 to 80 percent of the people in the world living the way we do in advanced countries.

I wanted to do two things in the book. One is to say that, and to say these are such enormous changes that we all have to think about whether the planet will withstand it, and how we govern this thing.

Just to give you one data point. At very conservative estimates of global growth rates, in the next 20 years, we will more than triple global GDP. We already have a pretty big global economy. If you triple it, you have an extraordinary set of pressures on natural resources, energy, the environment, and so on.

Then I spent some time—and this I did in large part because as I went around the world and talked to people, including investors and businesspeople, they would ask: Is the growth at 7 to 10 percent in China sustainable? Is there something wrong with this model? Will it stop?

They weren't really asking me for a yes/no answer; they were asking, can the dynamics, the forces that produce a machine running this fast, be understood well enough so that you could make judgments about where the risks are, where the potential blockages are?

I spend a fair amount of time in in the first half of the book trying to explain the dynamics of high-speed growth. And they are fairly straightforward.

The key first input is the open global economy, which, in a sense, was a gift. It was created by the advanced countries, led by the United States. If you take it away, you can't get this kind of result. The global economy gives you three things, in principle, two of which are genuinely crucial. One is knowledge. We don't talk about it as much as we probably should. My colleague Paul Romer does. This growth is called catch-up growth, and the key element in it is the inbound transfer of what we have learned over 200, 250 years into these countries, so they don't have to learn it all over again, to invent it. That increases their potential output.

That brings us to the second key component, which is that they invest and save, when they are growing at very high rates. China in 1978, when it started growing rapidly, was investing and saving—meaning funding their own investment—at 35 percent, or a third of GDP. It's now up to a ridiculous 45 to 50 percent. But that's an outlier. That's a statistic for most people.

If a country's income per capita is $500 and you set aside a third of that to invest in the future or your children and grandchildren's future via growth and running this engine, then you are, in effect, left with two-thirds of $500. That is an extraordinary choice. Indeed, if you look across developing countries, not all of them are able to make this choice. Some of them are stuck in a trap at a low level. It's not really an economic trap. It's an unwillingness—which is understandable, if you are that poor—to make this kind of investment. It's easier once you get going.

A question you might want to walk away with is, why is the United States investment rate 13 percent of GDP in 2010, and the savings rate below that, because we are running a current account surplus? But that's not my subject for today.

The third thing that is really important—and this goes all the way back to Adam Smith—is that these countries have to sell what they make. If you look at the dynamics and watch it running, what happens is, there are a whole bunch of people in agriculture and traditional sectors in these economies, and they come into the modern sector, in the way that Sir W. Arthur Lewis described. That sector is usually the export sector. It's a sector in which they can find something to do that takes advantage of educated but relative low-skilled labor, and it's usually labor-intensive. The image now is labor-intensive, process-oriented manufacturing. They sell it to the global economy.

That turns out to be the other critical input. The domestic economy isn't big enough and doesn't buy the stuff that they are good at making. In a poor country the domestic economy spends most of its time generating housing and food, and consuming a bit of energy, and you can't scale up the economy selling to the domestic economy. The demand side won't tolerate it. Adam Smith described this somewhat mysteriously as, "Specialization is limited by the extent of the market." But it's basically right.

So these countries invest at very high rates, increase the size of this modernizing part of the economy, draw labor into it that is surplus labor, so it doesn't cost them anything to take the labor in, and then sell into a global economy.

One way to think about it is, suppose they have done this for a while and their global market share is 2 percent. Then they grow 50 percent the next year, so now it's 3 percent. The point I'm trying to make is that it doesn't make a dent in the global economy. The only country that finally got big enough to make a dent is China. China actually turns prices against itself, both on the output side, by driving prices down, and on the input side, by driving the prices, like energy, cement—name any commodity, and China is a factor in driving the prices up.

But that's not the normal case. So this engine runs, we would say in economics, linearly.

The final key piece of this dynamic is very important. That is something the Indians decided they would call "inclusiveness." It's a term that has been adopted almost everywhere. This has to do with equity, distribution, and equality of opportunity. It turns out—we can't find any counterexamples to this—that a major failure on that front, blockage of batches of people away from the opportunity, will produce some kind of bad result that cuts off the growth process. It could be violence. It could be political disruption, chaos, and so on.

I talk a fair amount about that. There are a lot of countries that are either still stuck or, at best, just starting this journey that others did. In this you will find things that, given your knowledge in general of the global economy, are fun.

There are 13 economies that have grown at 7 percent or more for 25 years or more. Why do we pick those numbers? Because you double every decade at 7 percent, and in 25 years, you have made a significant amount of progress. The first was Japan. Brazil was the second—a fascinating case. It grew very quickly and then, around 1975, just stopped for 25 years. Now it's starting again. There is a huge variety in size. A lot of the countries are Asian—the Asian Tigers and so on.

There is a lot of variety in governance. You have autocratic systems, dominant single parties, full-fledged multiparty democracies. So it's  an interesting sort of array to just think about as you ponder the ingredients of all this.

I didn't try to settle the issues. I reached my own conclusions and I suggested them without pretending that they are scientific fact.

It seems to me that the governments that succeed have benefited from leadership which brings multi-stakeholders together. They pick approximately the right economic model, dynamic model. That is, they get the elements I described before right. Finally, they are benign in the sense that they intend this to improve the lives of all their people over time.

The governments that fail do something else. Just look around the world at, in economic terms, failing performance. There is usually a governing group that is pursuing its own interests somehow or the interests of a subset of people. Paul Collier says that countries with natural-resource wealth tend to perform poorly in governments, and therefore in economic performance.

Why? Because the pie is bigger than it is in a poor country, and so the game turns into getting your share or expanding your share of the pie rather than increasing it.

A final thought on this. Economists forecast, and they are usually wrong, so you should discount everything I say. But in the 1950s economists believed that Africa would be the star performer in the developing world and Asia would be the basket case. What we got wrong is fairly easy to see with the benefit of hindsight. We thought that economic wealth came from natural-resource wealth, and Africa is knee-deep in natural-resource wealth, compared to any continent in the world.

Asia, which had very little of this, looked around and said, "Well, we've either got nothing or we've got people, lots of them." Asia was the poorest part of the world right after World War II. They said, "We'd better give it a try. We'll see if we can use the people." So they educated them. The global economy opened, and sure enough, that turns out to be the durable basis of the creation of wealth, human capital—a terrible term—human beings, creativity, innovation, and so on.

Very briefly, looking forward: First of all, the advanced countries should take credit and be reasonably proud of finally having created an environment in which this could happen. In ethical terms, having something on the order of 70 percent of the world's population rise from miserable poverty to enjoying the kinds of opportunities that we have—nobody cares about growth, but they do care about productive employment, contributing to society, creativity, kids and their opportunities. They make extraordinary sacrifices for that. It's a wonderful story.

But there are challenges going forward. In America, we have lots of very fine features of our economy. We are innovative. There are portions of our tradable sector that benefit from and operate in the high-growth parts of the global economy. They are doing very well.

But we are under-investing and we need to up our game. The way I describe it to people—and myself, actually—is that there are two scenarios. This is not a zero-sum game. We are going to have lots more friendly competitors in the future than we did before when the global economy is three to four times its size. But there's no reason to think we can't compete and thrive in that environment.

But we are going to have to start investing in people, knowledge, technology, and infrastructure. We are going to have to have a sensible energy policy. We are going to have to have a sensible tax system that encourages this kind of investment and creates employment. We have a fairly difficult few years, in the short- to medium-run, to deal with.

To refer briefly to some research I did after I wrote the book, last fall, in the 18 years from 1990 to 2008, just before the crisis, if you look at where the American economy created jobs—and there were a lot of them, 27 million, to be precise—almost all of them, 98 percent of them, were created in the nontradable sector. The nontradable sector of the economy is the part where other people can't compete.

I don't think that trend can continue. It was driven by health care, government, and so on. There's nothing wrong with that. People have different views on that. The tradable sector is growing, profitable, and functioning in the global economy, but it's not creating employment. So it's starkly different, for example, from the German economy, which is another advanced economy that has, for reasons we need to understand better, taken a different path. It has more employment in the industrial sector and so on.

These are all issues that will be debated and discussed in the advanced countries, maybe later than is ideal. There are problems and issues that will come to the advanced countries.

There is a set of governance issues. The governance institutions in the global economy are just way behind the market integration. This is a well-known fact. That's a world in which you can have accidents, crises, and mismanagement or incomplete management. We are trying to do something about it in the area of financial regulation, post-crisis, and that's probably going to help. There's a bit of progress there. These are hard things.

The G20 is supposed to be the main place where priorities are set and where this is coordinated. It's struggling to do that. So we create an institution that captures the major economies and puts them together. The jury's out.

Then there is an enormously important set of challenges which have to do with what the Chinese call "lifestyle." Now, there's going to be a communication problem between them and us, and I'll tell you why.

When they say "lifestyle," they mean that they are starting to realize that they can't follow the path that we followed in terms of energy intensity and impact on the environment, and they can't follow the path their predecessors in high-growth mode followed either.

The reason is that there are 3.8 million people in Asia. They are going to account for a very large fraction of the growth in the global economy in absolute terms—not rates—in the future, and they are saying to themselves that this is not something that's likely to succeed. That is, "We'll stop ourselves, by virtue of impact on natural resources and the environment." So they are going to try to change the path. They already started. If you read carefully the Twelfth Five-Year Plan in China, which we can think of as a beginning of this path, there is a pretty aggressive start on lower energy.

So Asia will probably be the driving force in trying to find incentives.

Why do they call it lifestyle? I'll conclude with this. To us, lifestyle is a thing that an individual or a family chooses. Lifestyle belongs clearly in that rather broad spectrum that we attach to where individuals make choices, individual freedom.

In Asia they don't think that way. They draw that line differently, and they don't draw it as rigidly. They draw the line wherever there is a reasonable balance between individual freedom, on the one hand, and collective interest, on the other. If they drew a line in one place and that destroys the environment, they will feel free to redraw it, with more constraints on how cities are built, how many people have cars, what kinds of cars, how the transportation works, et cetera. So they have, in some sense, a greater degree of self-imposed freedom to make those choices, and they will do it in their self-interest, meaning the ability to sustain the rest of the journey to being like us in terms of income wealth and opportunity.

I'm 67. I don't think I'll see the end of this journey, but many of you in this room will. But I sure would like to. It's really quite extraordinary. I'm not fundamentally pessimistic about it. There is a question that people have on their minds that is more short-run, which is, if we in the advanced economies have a difficult period of unemployment, relatively low growth, potential instability—Europe, Japan, and the U.S. are obviously struggling with these issues and the fiscal situation—can these emerging economies that, 20 years ago, depended entirely on our growth to create the demand that fueled their growth—can they sustain this growth? For the first time in this 100-year journey, it looks like the answer to that is yes. They look like they can generate enough of the right kind of demand, a big enough market, to sustain this growth.

So that's what is called partial decoupling. We're there. On the other hand, if America has a big second downturn—I hope not—or Europe, that would slow them down. So it's not completely decoupling.

Let me stop there and turn it over to you.

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