China’s slowdown may have rattled markets, but optimism over the region’s longer-term prospects could be blinded by “Asiaphoria” similar to Japan’s earlier rise, according to U.S. economists.
The warning in a research paper by former U.S. Treasury Secretary Lawrence Summers and fellow Harvard economist Lant Pritchett has added to concerns over Asia’s ability to remain the powerhouse of the global economy, amid a sluggish world recovery.
According to the two U.S. economists, growth in Asia’s billion-plus population “giants” of China and India is more likely to slow to a developed world pace of 2 percent a year than maintain current rates, a “full regression to the mean” that challenges optimistic forecasts over the region’s eventual global economic dominance.
“India and even more so China are into essentially historically unprecedented episodes of growth. China’s super-rapid growth has already lasted three times longer than a typical episode and is the longest ever. The ends of episodes tend to see full regression to the mean, abruptly,” the paper said.
“It is impossible to argue that either China or India have the kinds of ‘quality institutions’ that have been associated with the steady dynamic of growth in the currently high productivity countries. The risks of ‘sudden stops’ are much higher with weak institutions and organizations for policy implementation. China and India have very different modalities of this risk, but both have tricky paths to continued prosperity.”
Despite the warnings, the global economy’s future has been premised on the continuation of the super-rapid growth of these two giants. Those days could soon be over, the economists suggest.
“Extrapolation of current growth rates into the future is at odds with all empirical evidence about the strength of regression to the mean in growth rates…Developing country growth rates are strongly episodic and large (and apparently discrete) shifts in medium-term growth rates of 4 [percent per annum] or more [are] common — and particularly prominent are large slowdowns. Episodes of super-rapid growth tend to be of short duration and end in decelerations back to the world average growth rate,” the paper said.
They added, “We are not arguing that one can predict with any degree of accuracy or confidence a slowdown but certainly policymakers need to be prepared for a wider range of extended slow-growth outcomes in these Asian giants that those that currently dominate the discourse.”
According to the economists, while Asia has seen the rise of Japan followed by the “Asian Tigers” of East Asia and then Southeast Asia, its fourth stage, the rise of China and India, is less than certain of meeting expectations. This could make a $42 trillion difference to future economic gains, should the two “giants” see their next 20 years’ growth rates revert to the mean. Under such a scenario, China’s forecast gross domestic product (GDP) in 2033 would reach around $14 trillion instead of $60 trillion at the 2000-10 pace of 9.7 percent. India would slip to $3 trillion, less than half the near $7 trillion GDP predicted at a 6 percent annual growth rate.
For the rest of the world, the impact of China and India falling back to the field would see global growth slow to around 2.5 percent a year, erasing billions of dollars of economic gains.
According to the economists, episodes of “super-rapid” growth last nine years on average, yet China has sustained such a rate for a record 32 years. Once this period ends, however, growth typically slows to just 1.85 percent a year.
The authors point to previous episodes of “Asiaphoria” in highlighting the danger of blind optimism in the region’s economic potential.
“Japan’s rapid growth from the 1960s (though decelerated already by the 1970s) led to a popular and academic literature explaining why Japan succeeded and would continue to succeed. While there were some concerns raised about a bubble in Japanese real estate, we remember almost no one predicting in 1991 that Japan’s real GDP per capita would be only 12 percent higher in 2011 than 20 years earlier (a growth rate of only 0.6 per annum),” the paper said.
The second recent period of “Asiaphoria” was during the 1990s, when Southeast Asia’s larger economies of Indonesia, Malaysia and Thailand “appeared to be booming” but were hit by the Asian financial crisis. While most recovered quickly, none have managed to resume above-average growth since the 1997/98 bust.
The U.S. economists contend that the predicted slowdown for China and India will be the result of a lack of “rule of law” and corruption disrupting business confidence, particularly in communist-ruled China.
“There is a strong cross-national relationship between the extent to which a country is (or is rated as) a ‘democracy’ and GDP per capita,” the authors argue.
“For China to continue to have rapid economic growth while maintaining its current level of democracy….would make it more and more anomalous.”
Should China’s communist rulers be unseated, the nation could expect a sharp deceleration in growth in the subsequent decade post-democratic transition, similar to Indonesia following the end of the Suharto regime, the authors suggest.
The warning for China follows calls by the Asian Development Bank (ADB) for structural reforms “to support innovation and technological upgrading in its pursuit of high-income status.” ADB President Takehiko Nakao has urged Beijing to foster “inclusive growth and environmental sustainability,” reform state-owned enterprises and allow the market to pick winners instead of the state.
With the International Monetary Fund cutting its global forecasts and even seasoned business executives such as General Electric’s chief executive Jeff Immelt warning of geopolitical risks, policymakers have plenty to worry about. For Asia though, avoiding hubris similar to the “Japan as number one” predictions of the 1980s may be key to preventing disaster.