Economic life, like life in general, is full of reversals. Less than a year ago there were still many businessmen who had nothing but praise for Mexico; only three or four years ago there were many who believed that Japan's economy could do no wrong. Right now there is nearly universal agreement that the economic future of Asia--with the possible exception of Japan--is extremely bright. This conventional wisdom is based on considerable evidence--after all, Asian economic performance has indeed been astonishing over the past generation. Yet there are some reasons to worry about whether this success will continue. Let us look at these reasons.
I find it useful to separate concerns about Asian growth into two kinds. First are doubts about the sustainability of high growth rates. Such doubts need not involve any catastrophic visions--if I predict that, say, South Korean growth over the next decade will be 4 percent rather than the 9-10 percent of the last few years, I am hardly predicting disaster. Nonetheless, because expectations for Asian growth are extremely high, even a slowdown to growth rates that the rest of the world would consider excellent would be a major disapppointment. The other kind of concern involves fears that Asian economics may contain fatal weakness that will lead not merely to a slowing of growth but to an economic crisis. This is a very different sort of worry. And in general the two types of concern may be entirely separate. For example, the economy of the United States in 1929 turned out to be very vulnerable to economic crisis--that economy suffered a far worse slump during the 1930s than most other advanced nations. Yet the technological and productivity leadership of the Unhed States did not falter; indeed, it emerged from the crisis with its world leadership stronger than ever. On the other hand, Britain after World War II delivered consistently poor productivity growth, and gradually slipped into the position of a fourth-rate economic power. Yet until the mid-1970s its economy was impressively stable, delivering consistent and widespread if fairly modest prosperity.
In fact, the current situation in Asia suggests that there are reasons for both kinds of concern. And while the two sorts of concern are in general separate, it is possible to argue that they are related in this case. That is, there are some very good reasons to suspect that the high growth of the last 20 years in much of Asia will not continue at the same rates for the next 20; and some (less compelling) reasons to suspect that there may be serious problems of economic stability, problems that Japan is already experiencing.
Can Asia continue growing?
Let me begin with the fairly clear issue of long-term growth prospects. Nobody can or should try to belittle the Asian achievement to date. Two generations ago Japan was a nation in ruins; today it is in many though not all ways among the world's most advanced nations. A generation ago it was common to assert that poor countries simply could not advance into the ranks of the industrial nations; today there are eight Asian economies that have made spectacular progress in industrialization, some of them managing growth rates never before seen on this planet.
How can anyone raise doubts about this kind of success? And yet there are some reasons to question, not the reality of the achievement, but the ability of the countries to continue growing in the future as they have in the past.
The main issue concerns the sources of growth. "Growth accounting" is an economic concept that can be made to sound mysterious, but it is actually fairly straightfoward. We are all accustomed to the idea that the growth of a country's output can be summarized by a single number like "real gross domestic product." Yet any economy produces thousands if not hundreds of thousands of distinct goods. How can this complex mixture of output be combined into a single number? The answer is that we weight different goods by their market prices. In the United States, a moderate-priced automobile costs about the same amount as 30,000 cups of coffee; so when we calculate real GDP, we use an index of output in which each automobile counts the same amount as those 30,000 coffees. It is possible to justify this procedure in terms of the theory of rational consumers, for whom the utility from a marginal dollar or yen must be the same in terms of all goods. But surely it is a generally sensible procedure in any case.
Well the idea of growth accounting is, in essence, simply to apply the same principle to a country's inputs. Over time, a country's labor force grows; its workers become more educated; its stock of machinery and buildings increases. What the economist does is to use market prices to add these up into a single index of input in which a worker with 10 years of education counts as more than a worker with three years in proportion to the going wage differential, in which a dollar invested in capital is evaluated at the market return. (For technical reasons the actual procedure looks a little different, but that is what it amounts to.) Again, it is possible to justify this in terms of economic theory--in this case, by arguing that if firms are minimizing costs, a dollar or yen spent on each input should add the same amount to production--but the procedure is sensible even if you do not fully accept the theory. In effect, the economist supplements the familiar measure of gross domestic product--of a country's total output--with another measure, its gross domestic input.
Once one has these two indexes, of course, the natural thing is to compare them--to ask how much of output growth can be explained by the growth in inputs. This exercise has been carried out many times in advanced countries, and yields a standard answer: a significant part of the growth cannot be explained by increased inputs. Instead, much of it is due to the "residual," the increase in output per unit of input. And in fact, this residual is what makes very long-term growth possible. The reason is that growth simply by increasing inputs inevitably runs into diminishing returns. The higher the amount of capital per worker, the lower the rate of return and thus the harder it is to raise output by adding still more capital. As for human capital there are obvious diminishing returns as the average person spends a longer and longer fraction of his potential working years in school. So the only way to have output growth that goes on generation after generation is through an increase in the output per unit of input.
Much of the analysis of economic growth has focused on trying to explain this positive residual in advanced countries. The consensus view is that it represents the growng stock of knowledge, that it is all about technological progress. And until resently the general assumption--an assumption that I shared--was that the rapid growth of Asian economies should be understood as being due to their ability to absorb the existing stock of technology from more advanced countries. That is, the standard view was that Asian economies were able to grow so fast because they had very large positive residuals, achieved through technology spillover.
This view seemed to suggest that Asian growth might well continue at very high rates for a very long time. The reason is that with the exception of Japan the Asian nations are still far behind Western nations in per capita income, suggesting a large technology gap. To take the most powerful case. China still has a per capita income of less than 10 percent that of the United States. If you believe that China has mastered the art of borrowing technology from the West, and will be able to grow very rapidly as long as there is still a large gap in productivity, you may well conclude that China can grow at double-digit rates for decades to come, until its economy is several times as large in absolute terms as that of the United States, with its far smaller population.
But it turns out that if you actually try to measure the source of Asian growth, the picture is not as so many people, myself included, saw it. Instead, it turns out that the developing Asian countries have not achieved extraordinarily high rates of growth in output per unit of input.
Savings and education
Rather, they have grown in large part simply by massive mobilization of inputs. That is, if you do the growth accounting exercise on East Asian developing countries you find that much if not all of the growth in output is explained by the growth in inputs.
This finding has been a source of much dispute; but it seems to be unavoidable once you have looked at the numbers. For example, the World Bank published an influential study called "The East Asian Niracle." The authors of that study adopted an eclectic approach; they tried to avoid giving growth accounting too prominent a role. But there is a startling table in which they try to measue the degree of change in the "technical efficiency" of East Asian nations, the rate at which their output per unit of input was converging on that of the advanced countries. Surprise: of the seven developing countries considered, four were actually falling further behind the advanced nations in this measure. To a first approximation, Asian nations had achieved growth rates faster than the West not by borrowing technology but simply by making massive efforts at saving and education.
Prospects for growth limited
What's wrong with that? Nothing--but it does set limits to the prospects for Asian growth, because of the problem of diminishing returns. The average East Asian economy has been able to achieve a consistent high rate of growth because it has moved many workers from low-wage jobs in agriculture to higher-wage jobs in the cities; because it has brought many women into the labor force; because it has gone from a barely literate population to one with a high level of education; because it has pushed the savings rate from 10 or 15 percent of GDP to 30 or 40 percent. Unfortunately, none of these actions is repeatable; and as a result the growth must be expected to drop over time.
A useful way to think about this is to imagine Asian countries as converging, not toward the Western level, but toward a long-run growth trend whose rate is set by the growth of the population plus technological progress. What the evidence from growth accounting suggests is that this long-run rate of growth may not be very high--perhaps no higher than the trend growth of Western economies, say 2 percent per year. But how, then, can some Asian economies currently be growing at 8 or 9 percent annually? Because they have not yet converged to that long-run growth path. We should therefore expect their growth rate gradually to decline toward Western levels.
But how fast is "gradually"? That is a familiar question to growth modelers, sometimes posed as the question of "half-life." That is, how long will it take half of the difference between the recent growth rate of a developing country--saY 8 percent--and its long-run rate of 2 percent to be eliminated?
The honest answer is that nobody knows. Rough exercises with economic models suggest, however, that a plausible range of estimates for the half-life might range from as low as eight years to as high as 15 years.
Suppose for a moment that the half-life is really only eight years, and that the long-run growth rate is 2 percent. Then an economy that is currently growing at 8 percent might find that within eight years its growth rate will fall to 5 percent, and that within 16 years it will fall to about 3.5 percent. This would hardly be an economic disaster--most nations in the world would be happy to have such prospects. But for those Asian nations that have quickly begun extrapolating from recent growth trends, and have begun to imagine themselves only a few decades from advanced-country status, such performance would be deeply disappointing. Perhaps they should be a little cautious before beginning grandiose projects, such as new capital cities. (Brasilia, that sad monument to overblown expectations, was built at a time when Brazil routinely achieved growth rites of 8 or 9 percent and was confident of its destiny. Only later did the wry joke become familiar: "Brazil is the country of the future--and always will be.")
The diagnosis of "input-driven growth," then, suggests that Asian developing countries may not have the growth prospects they imagine, but does not suggest any looming crisis. And yet economic crises do happen. Where are the risks for Asia?
One risk is suggested by the example of Brazil. If a country's government comes to believe in the nation's imperial destiny, in advance of the actual achievement, it can all too easily overreach. If you want to look for the signs of Asian developing countries that seem to be getting carried away, they are there to see--not just Malaysia's grandiosity, but Indonesia's apparent determination to build an aircraft industry, and China's military buildup. There is surely a risk that some Asian nations will decide that their growing wealth entitles them to power or prestige that is not yet within their grasp, and they could drag down some of their neighbors in the process.
The other risk is that macroeconomic or financial difficulties will produce a crisis. To see that this is a real risk, one need look no further than Japan, now in its fifth year of economic stagnation.
To a large extent the Japanese crisis reflects bad management at the top. The Bank of Japan has been extremely slow to respond to the stagnant economy by aggressively expanding credit--apparently it is so paralyzed by fears of another financial bubble that it cannot see the other dangers. The government of Japan has also been incredibly immobile, doing hardly anything to stimulate demand. This is all incredible to practiced economists; a modern, advanced nation, with all its monetary and fiscal powers, is not supposed to sit paralyzed in the face of a simple Keynesian slowdown--not in this day and age.
It is possible that bad policy is the whole story of Japan's slump. If so, the country is paying a huge price. Not only has the economy sacrificed tens of trillions of yen in potential output; it has also slid into a deep banking crisis (again helped by a seemingly paralyzed government), and it is storing up trouble as the country's labor market institutions fray under the pressure. It is entirely possible that Japan will wake up one day and discover, like the Europeans, that the cyclical slump has become structural--that the "temporary" lack of jobs that is now so severe has been converted into a permanently higher unemployment rate.
But it is also possible--and this is worrying--that the slump represents more than bad policy. The Bank of Japan has done too little, too late; but interest rates are now very low, and still the economy remains depressed. Why? One begins to wonder if there is not simply a shortage of investment opportunities in Japan. After all, Japan continues to have a very high savings rate compared with other advanced countries. This did not imply a low rate of return on investment during the high-growth years, when Japanese efficiency was soaring. But in recent years Japanese efficiency has grown only slightly faster than that of other advanced countries.
This raises the real possibility that Japan has fallen into what economists used to call "secular stagnation": a situation where no interest rate is low enough to induce investors to invest all that households want to save. In that case the economy can remain consistently in a slump. The only way out would then be to export a lot of capital. But that means running massive trade surpluses--which the rest of the world is reluctant to accept. In sum, it is possible--not certain--that Japan has finally reached the point where its high savings are actually bad for growth.
Japan in 'stagnation'?
Let me say that this is only a hypothesis, one which I regard as at least as likely to be wrong as to be right. I won't conclude that Japan is in "secular stagnation" unless the economy fails to respond to a truly massive credit and fiscal expansion, the kind of policy that should have been followed for several years now. But the fact that we can even raise the possibility is new, and offers some worries for the rest of Asia.
For the fact is that the Japanese syndrome could very easily emerge in other Asian nations. Suppose that it is really true that, as the numbers suggest, South Korea is not closing the efficiency gap with the West, but is instead growing only through capital accumulation. Then won't the rate of return on capital 10years from now be very low--perhaps too low to allow the economy to function effectively? (Perhaps the South Koreans should welcome unification: it might provide an outlet for their surplus capital.)
All of this is, again, speculative. The point is that there are real risks to Asian growth. It is unlikely to continue at its recent pace, and there are enough dangers that nobody should be complacent.
What should Asia do about all this? For the moment, not much. Japan is the exception: it should reflate its economy, urgently, with no hesitations. For the other Asian countries, the message is simply one of caution and humility. Despite the incredible achievements of recent decades, it is too soon for triumphalism. Asia's future is promising, but it is not assured.
Originally published, 10.24.95