Asian Century or Middle Income Trap?

Will Asia come to dominate the global economy during the 21st century? The Asian Development Bank published a thoughtful report on the subject in August called \”Asia 2050: Realizing the Asian Century.\” The Executive Summary is available here; the full report is available by searching the web. Despite the triumphalist-sounding title, the report actually has a cautionary focus. 

\”The rapid rise of Asia over the past 4-5 decades has been one of the most successful stories of economic development in recent times. Today, as Asia leads the world out of recession, the global economy’s center of gravity is once again shifting toward the region. The transformation underway has the potential to generate per capita income levels in Asia similar to those found in Europe today. By the middle of this century, Asia could account for half of global output, trade, and investment, while also enjoying widespread affluence.

While the realization of this promising outcome—referred to as the “Asian Century”—is plausible, Asia’s rise is by no means pre-ordained. Given Asia’s diversity and complexity, this rapid rise offers both important opportunities and significant challenges. In its march towards prosperity and a region free of poverty, Asia will need to sustain high growth rates, address widening inequities, and mitigate environmental degradation in the race for resources. In addition, Asian economies must avoid the middle income trap in order to realize the Asian Century.\”

As a starting point, the report offered a useful simplification for thinking about the huge region of Asia. Seven countries in Asia have roughly three-quarters of the region\’s population, and about 90% of the region\’s GDP. So in thinking about prospects for the the Asian region, one can reasonably focus on China India, Indonesia, Japan, the Republic of Korea, Thailand and Malaysia.

In the \”Asian century\” scenario, the region of Asia will regain the position in the world economy that it last held in the 1700s–that is, the region will produce more than half of all global output.

 Much of the report is a lots of discussion of possible issues that could derail this pattern: governance, urbanization, an aging population in some countries, education, regional cooperation, energy, environment, others. Here, I will pick out just a couple of broad theme.

A primary concern for Asia is the \”Middle Income Trap.\” For an illustration, consider per capita growth of Korea compared with that of South Africa and Brazil. Korea has kept per capita income generally rising, even after terrible shocks like the 1997-98 financial crisis in east Asia. In contrast, Brazil, much of Latin America, and South Africa have been stuck at more-or-less the same place for several decades.

The report explains: \”But many middle-income countries do not follow this pattern. Instead, they have bursts of growth followed by periods of stagnation or even decline, or are stuck at low growth rates. They are caught in the Middle Income Trap—unable to compete with low-income, low-wage economies in manufactured exports and with advanced economies in high-skill innovations. Put another way, such countries cannot make a timely transition from resource-driven growth, with low-cost labor and capital, to productivity-driven growth.\”

If the rising economies of Asia go follow the pattern of Latin America over most of the last 3-4 decades, then the world economy in 2050 will not look dramatically different than it does today. Instead of the Asian region producing over half the world\’s GDP by 2050, in this scenario it would produce just 31% of global GDP by 2050– not far above current level. In this scenario, by 2050 the U.S. economy would be larger than the economies of China and India combined.

The closing words of the report are: \”Asia’s future is fundamentally in its own hands.\” That statement is a bit evasive: referring to \”its own hands\” seems to imply a more unitary identity for Asia than is actually true. A great many hands will be involved in shaping the region\’s future. However, the statement also contains a deeper truth is worth considering. U.S. and Europe will surely influence the outcomes in Asia in modest ways, but Asia is a huge region, with huge population and huge resources. While exporting to the U.S. and western economist has jump-started growth in the region, it surely the capability at this point of generating continued growth from within.  Of course, whether that capability will be realized remains to be seen.

Given that the U.S. isn\’t going to determine what happens in Asia, how should it regard the possibilities?  If Asia falls into the Middle Income Trap, the U.S. can focus less on that area, both economically and politically. I personally would hope for continued economic growth in the region, because it would improve the standard of living so dramatically for several billion people. In this Asian Century scenario, the U.S. should be striving to find a way to connect its human, managerial, technological, financial, and other resources with all that vibrant economic growth, so that we can benefit from it. If the world economy is going to be pulled ahead by an Asian locomotive, the U.S. had better start figuring out how to reserve some good seats on the train. 

For a previous post on this topic, see Will Emerging Economies Dominate the World Economy? from July 22, 2011. For posts in the last few months on China catching up to and perhaps surpassing the U.S. economy, see Will China Catch Up to the U.S. Economy? from June 27, 2011, and Is China\’s Economic Dominance in the Long Run a Sure Thing? from September 9, 2011.

Is China\’s Economic Dominance in the Long Run a Sure Thing?

Arvind Subramanian writes \”The Inevitable Superpower: Why China\’s Dominance is a Sure Thing\” in the September/October 2011 issue of Foreign Affairs. The article is available at the Peterson Institute website here or (free registration may be needed ) from the Foreign Affairs website here. It is adapted from his book Eclipse: Living in the Shadow of China\’s Economic Dominance.

The United States used its economic power against the United Kingdom in the 1956 Suez crisis

\”During the 1956 Suez crisis, the United States threatened to withhold financing that the United Kingdom desperately needed unless British forces withdrew from the Suez Canal. Harold Macmillan, who, as the British chancellor of the exchequer, presided over the last, humiliating stages of the crisis, would later recall that it was \”the last gasp of a declining power.\” He added, \”perhaps in 200 years the United States would know how we felt.\” Is that time already fast approaching, with China poised to take over from the United States?\”

Measuring China\’s forthcoming dominance

\”My forthcoming book develops an index of dominance combining just three key factors: a country\’s GDP, its trade (measured as the sum of its exports and imports of goods), and the extent to which it is a net creditor to the rest of the world. …No other gauge of dominance is as instructive as these three: the others are largely derivative (military strength, for example, depends on the overall health and size of an economy in the long run), marginal (currency dominance), or difficult to measure consistently across countries (fiscal strength).     I computed this index going back to 1870 (focusing on the United Kingdom\’s and the United States\’ economic positions then) and projected it to 2030 (focusing on the United States\’ and China\’s positions then). The projections are based on fairly conservative assumptions about China\’s future growth …  To take account of these costs, I project that China\’s growth will slow down considerably: it will average seven percent a year over the next 20 years, compared with the approximately 11 percent it has registered over the last decade. … Meanwhile, I assume that the U.S. economy will grow at about 2.5 percent per year, as it has over the last 30 years….
     The upshot of my analysis is that by 2030, relative U.S. decline will have yielded not a multipolar world but a near-unipolar one dominated by China. China will account for close to 20 percent of global GDP (measured half in dollars and half in terms of real purchasing power), compared with just under 15 percent for the United States. At that point, China\’s per capita GDP will be about $33,000, or about half of U.S. GDP. In other words, China will not be dirt poor, as is commonly believed. Moreover, it will generate 15 percent of world trade — twice as much as will the United States. By 2030, China will be dominant whether one thinks GDP is more important than trade or the other way around; it will be ahead on both counts.
     According to this index and these projections, China\’s ascendancy is imminent. Although the United States\’ GDP is greater than China\’s today and the two countries\’ respective trade levels are close, the United States is a very large and vulnerable debtor — it hogs about 50 percent of the world\’s net capital flows — whereas China is a substantial net creditor to the world. In 2010, the United States\’ lead over China was marginal: there was less than one percentage point difference between their respective indices of dominance. In fact, if one weighed these factors slightly differently, giving slightly less weight to the size of the economy relative to trade, China was already ahead of the United States in 2010.
     China\’s ascendancy in the future will also apply to many more issues than is recognized today. The Chinese economy will be larger than the economy of the United States and larger than that of any other country, and so will its trade and supplies of capital. The yuan will be a credible rival to the dollar as the world\’s premier reserve currency. …
     My projections suggest that the gap between China and the United States in 2030 will be similar to that between the United States and its rivals in the mid-1970s, the heyday of U.S. hegemony, and greater than that between the United Kingdom and its rivals during the halcyon days of the British Empire, in 1870. In short, China\’s future economic dominance is more imminent and will be both greater and more varied than is currently supposed.

China is already exercising its economic power

\”In fact, despite China\’s relatively low per capita GDP today, it is already dominant in several ways. China convinced the African countries in which it invests heavily to close down the Taiwanese embassies they were hosting. With $3 trillion in foreign reserves, it has offered to buy Greek, Irish, Portuguese, and Spanish debt to forestall or mitigate financial chaos in Europe. … China has also used its size to strengthen its trade and financial relationships in Asia and Latin America: for example, trade transactions among several countries in both regions can now be settled in yuan. …
     Beijing is already exercising other forms of dominance. For example, it can require that U.S. and European firms share their technology with Chinese firms before granting them access to its market. And it can pursue policies that have systemic effects, despite opposition from much of the world. Its policy of undervaluing its exchange rate is a classic beggar-thy-neighbor strategy that undermines the openness of the world\’s trading and financial systems while also creating the conditions for easy liquidity, which contributed to the recent global economic crisis. Chinese dominance is not looming. In some ways, it is already here.\”

How vulnerable will the U.S. be to Chinese economic pressure in the future?

\”Now, imagine a not-so-distant future in which the United States has recovered from the crisis of 2008-10 but remains saddled with structural problems: widening income gaps, a squeezed middle class, and reduced economic and social mobility. Its financial system is still as fragile as before the crisis, and the government has yet to come to grips with the rising costs of entitlements and the buildup of bad assets in the financial system, which the government might have to take over. … China has an economy and a trade flow twice as large as the United States\’. The dollar has lost its sheen; demand for the yuan as a reserve currency is growing.
    Much as in 1956, when Washington was suspected of orchestrating massive sales of sterling in New York to force the British government to withdraw its troops from the Suez Canal, rumors are swirling that China is planning to wield its financial power; it has had enough of the United States\’ naval presence in the Pacific Ocean. … A repeat of the Suez crisis may seem improbable today. But the United States\’ current economic situation does leave the country fundamentally vulnerable in the face of China\’s inescapable dominance.\”

Will China Catch Up to the U.S. Economy?

Mark A. Wynne of the Dallas Fed asks: \”Will China Ever Become as Rich as the U.S.?\” The standard answer here is that the total size of China\’s economy may well exceed that the total size of the U.S. economy within a couple of decades, but because China has nearly four times the U.S. population, it will take much longer for China to catch up in per capita terms.

Wynne writes: \”The simplest approach is to measure GDP in U.S. dollars at 2005 prices and use 2005 exchange rates. Doing so results in estimated 2010 Chinese GDP of $3.88 trillion in 2005 dollars, or just less than 30 percent of U.S. GDP. China\’s economy will exceed that of the U.S. in 2025 if it continues expanding at its past-decade rate of just more than 10 percent a year and the U.S. keeps growing at the 1.7 percent annual rate it experienced during the period. Per capita GDP allows us to compare the relative well-being of residents of the two nations. Based on the 2010 U.S. population of 309 million, per capita GDP was $42,874 last year. China, with a 2010 population of 1.34 billion, had per capita GDP of $2,893 last year, or 6.7 percent of the U.S. figure.\”
Of course, it is not inevitable that China will continue at this rapid rate of growth for the next several decades. Wynne points out that on average, countries with lower per capita GDP have faster growth rates. However, it also seems to be true that as countries reach some level of middle-income, their growth rates slow down. On explanation for this \”middle income trap\” is that the growth policies that help in catch-up growth do not work as well as an economy reaches higher-income levels.  Wynne offers a nice figure to illustrate how the G-7 economies caught up to the U.S. economy since 1950, at least to some extent, but then seemed to stop catching up up when they hit (very roughly) 80% of U.S. per capita GDP. The figure also puts China\’s growth path in perspective. 
I wonder whether China isn\’t likely to experience more than one \”middle income trap\” as its economy expands. The Chinese pattern of growth in the last decade or so from a macro perspective has been based on extremely high savings rates, rapid growth in heavy manufacturing, large trade surpluses, and huge internal migration of labor. Over the years and decades to come, as these patterns evolve, China\’s economic growth will almost inevitably have some fits and starts.