No More Growth Miracles

Dani Rodrik

08 August 2012

CAMBRIDGE A year ago, economic analysts were giddy with optimism about the prospects for economic growth in the developing world. In contrast to the United States and Europe, where the growth outlook looked weak at best, emerging markets were expected to sustain their strong performance from the decade preceding the global financial crisis, and thus become the engine of the global economy.

Economists at Citigroup, for example, boldly concluded that circumstances had never been this conducive to broad, sustained growth around the world, and projected rapidly rising global output until 2050, led by developing countries in Asia and Africa. The accounting and consulting firm PwC predicted that per capita GDP growth in China, India, and Nigeria would exceed 4.5% well into the middle of the century. The consulting firm McKinsey & Company christened Africa, long synonymous with economic failure, the land of “lions on the move.”

Today, such talk has been displaced by concern about what The Economist calls “the great slowdown.” Recent economic data in China, India, Brazil, and Turkey point to the weakest growth performance in these countries in years. Optimism has given way to doubt.

Of course, just as it was inappropriate to extrapolate from the previous decade of strong growth, one should not read too much into short-term fluctuations. Nevertheless, there are strong reasons to believe that rapid growth will prove the exception rather than the rule in the decades ahead.

To see why, we need to understand how “growth miracles” are made. Except for a handful of small countries that benefited from natural-resource bonanzas, all of the successful economies of the last six decades owe their growth to rapid industrialization. If there is one thing that everyone agrees on about the East Asian recipe, it is that Japan, South Korea, Singapore, Taiwan, and of course China all were exceptionally good at moving their labor from the countryside (or informal activities) to organized manufacturing. Earlier cases of successful economic catch-up, such as the US or Germany, were no different.

Manufacturing enables rapid catch-up because it is relatively easy to copy and implement foreign production technologies, even in poor countries that suffer from multiple disadvantages.

Remarkably, my research shows that manufacturing industries tend to close the gap with the technology frontier at the rate of about 3% per year regardless of policies, institutions, or geography. Consequently, countries that are able to transform farmers into factory workers reap a huge growth bonus.

To be sure, some modern service activities are capable of productivity convergence as well. But most high-productivity services require a wide array of skills and institutional capabilities that developing economies accumulate only gradually. A poor country can easily compete with Sweden in a wide range of manufactures; but it takes many decades, if not centuries, to catch up with Sweden’s institutions.

Consider India, which demonstrates the limitations of relying on services rather than industry in the early stages of development. The country has developed remarkable strengths in IT services, such as software and call centers. But the bulk of the Indian labor force lacks the skills and education to be absorbed into such sectors. In East Asia, unskilled workers were put to work in urban factories, making several times what they earned in the countryside. In India, they remain on the land or move to petty services where their productivity is not much higher.

Successful long-term development therefore requires a two-pronged push. It requires an industrialization drive, accompanied by the steady accumulation of human capital and institutional capabilities to sustain services-driven growth once industrialization reaches its limits. Without the industrialization drive, economic takeoff becomes quite difficult. Without sustained investments in human capital and institution-building, growth is condemned to peter out.

But this time-tested recipe has become a lot less effective these days, owing to changes in manufacturing technologies and the global context. First, technological advances have rendered manufacturing much more skill- and capital-intensive than it was in the past, even at the low-quality end of the spectrum.

As a result, the capacity of manufacturing to absorb labor has become much more limited. It will be impossible for the next generation of industrializing countries to move 25% or more of their workforce into manufacturing, as East Asian economies did.

Second, globalization in general, and the rise of China in particular, has greatly increased competition on world markets, making it difficult for newcomers to make space for themselves. Although Chinese labor is becoming more expensive, China remains a formidable competitor for any country contemplating entry into manufactures.

Moreover, rich countries are unlikely to be as permissive towards industrialization policies as they were in the past. Policymakers in the industrial core looked the other way as rapidly growing East Asian countries acquired Western technologies and industrial capabilities through unorthodox policies such as subsidies, local content requirements, reverse engineering, and currency undervaluation. Core countries also kept their domestic markets open, allowing East Asian countries to export freely the manufactured products that resulted.

Now, however, as rich countries struggle under the combined weight of high debt, low growth, unemployment, and inequality, they will apply greater pressure on developing nations to abide by World Trade Organization rules, which narrow the space for industrial subsidies. Currency undervaluation à la China will not go unnoticed. Protectionism, even if not in overt form, will be politically difficult to resist.


Manufacturing industries will remain poor countries’escalator industries,” but the escalator will neither move as rapidly, nor go as high. Growth will need to rely to a much greater extent on sustained improvements in human capital, institutions, and governance. And that means that growth will remain slow and difficult at best.

Dani Rodrik is a professor at Harvard University’s Kennedy School of Government and a leading scholar of globalization and economic development. His writings are a compelling combination of international and development economics, history, and political economy, and often challenge prevailing orthodoxy about which policies best promote growth. His most recent book is The Globalization Paradox: Democracy and the Future of the World Economy.

August 8, 2012 6:46 pm

Americans need to face the harsh truth and pay more tax

One of the guiding principles of contemporary tax policy in the US is the notion that Americans are terribly overtaxed. Both candidates are running on not raising taxes for the middle classes and Mitt Romney wants to not only make the George  W. Bush tax cuts permanent, he wants to cut income tax rates another 20 per cent across the board.

Yet, data from the non-partisan Congressional Budget Office reveal that, when it comes to federal taxation, US households are less taxed now than 30 years ago, and that is not just a function of the recession. The CBO data began in 1979 when the typical, or median, household paid 19 per cent of their income in federal taxes. In 2009, that share had fallen to 11 per cent.

Both economic and policy changes account for the decline in “effective tax rates”. In recessions, progressive tax systems provide automatic tax cuts as declining incomes push households into lower tax brackets. Middle-income households lost an average $6,000 in market-based income, an 11 per cent decline, between 2007 and 2009, but their federal tax bill fell $2,300, or 24 per cent. Thus their effective tax rate fell from 14 per cent to 11 per cent.

But policy changes also played a significant role and the Bush tax cuts have had a large impact on the fall of tax rates ever since. Over the 1980s and 1990s, the overall effective tax rate fluctuated within a narrow band of 20.2 per cent to 22.7 per centlower in the Ronald Reagan years, a bit higher in the Bill Clinton years. But from 2000-07, before the recession took hold, they fell by almost 3 percentage points, equal to about $300bn in revenue, or 2 per cent of gross domestic product.

Policy changes lowered taxes in the recession, too. That’s a perfectly legitimate use of tax cuts, but such cuts are supposed to be temporary and reset once the downturn has passed. Yet, every time a tax cut nears expiration, the deafening cry of “tax increase!” frightens politicians such that today’s tax policy is solidly asymmetric: rates can only go down. That makes it impossible to get on a sane fiscal path.

For Republicans who have signed the Grover Norquist pledge to never raise taxes, the misleading mantra that we are overtaxed serves two purposes. First, the wealthiest households get the biggest income boost from any across-the-board cuts.

Second, once the villainy of tax increases is widely accepted, the only way to achieve any deficit savings is through spending cuts. But this is very dangerous logic. The House Republican budget, for example, as authored by Mr Romney or Paul Ryan, would get virtually every government function outside of Social Security, healthcare and defence.

Barack Obama, backed by Senate Democrats, is calling for the upper-income Bush tax cuts to expire. But contrary to popular belief, Mr Obama has already been an aggressive tax cutter. His cuts have helped considerably in reducing recessionary damage to family incomes, but there needs to be a more robust plan to return to fiscal health.

That plan will have to include tax increases beyond just the wealthiest households, although that is the right place to start. But what should happen next? In Washington, the standard position is “comprehensive tax reform” where we “lower the rates and broaden the base”. While I agree with that in theory, in practice it has become a ruse. From the highly touted Bowles-Simpson plan to the Paul Ryan budget plan, we see many concrete ideas for lower rates, which is what got us into this mess in the first place, and precious few specifics on broadening the base.

The best thing to do, once the economic recovery is solidly under way, is to simply let the Bush tax cuts expire and return to the tax structure that prevailed under Bill Clinton. It cannot be plausibly argued, based on economic outcomes, that the rate structure in those years was counterproductive. Oh, and it also helped deliver a budget surplus.

While I understand and support the fairness argument, I’d urge Democrats to be forthright with the fact that we’re way below where we need to be in terms of revenue collection. We simply can’t begin to meet the challenges we face on the lowest effective tax rates in decades.

It may not be the conventional wisdom, but it is the truth.

The writer is the former chief economic adviser to US vice-president Joe Biden, and a senior fellow at the Center for Budget and Policy Priorities

Copyright The Financial Times Limited 2012.

Gold Outlook Still Bullish And Ripening For Melt Up

August 8, 2012

by: Chris Vermeulen

Gold has enjoyed a 12-year run of higher prices. Gold bears and the lovers of paper money are asking whether this is the year when gold finally ends its run and finishes the year lower than last year's close of $1,566.80 an ounce. This question is of utmost interest to holders of any of the gold ETFs including the SPDR Gold Trust GLD), the iShares COMEX Gold Trust IAU) and the ETF Securities Swiss Gold Shares SGOL).

Obviously, the more than decade-long rally must end sooner or later, as nothing goes up in price forever or as the old adage says, "Trees don't grow to the sky." Gold has been consolidating now, since its peak last September at $1920 an ounce, for longer than any other time since the bull market began. It is down about 17% from the peak, which is not a good feeling for those who bought at the peak. But bear in mind that during gold's run in the 1970s-80s, it went down by around 50% before eventually gaining eightfold in value.

A few recent research reports also suggest that the yellow metal is not dead yet, and that conditions are still ripe for higher prices for gold. Bullion Vault recently pointed out the fact that in the last ten years, every time the gold price has sat around doing nothing for about a year, it has subsequently gained on average 33% the following year.

(click to enlarge)Gold Price Chart

In his annual In Gold We Trust report, Ronald Stoeferle of Austria's Erste Bank states that the basis for new all-time highs is firmly in place. His main thesis is that interest rates in the developed economies will continue to be kept near zero so that the governments can continue their huge and rapidly growing debts.

Basically, Mr. Stoeferle is saying what most gold bulls already know. Governments and central banks in the developed world will continue to act together to hold borrowing costs down by printing as much paper currency as needed to purchase government bonds. That translates to debasement of their currencies versus the only currency that is not solely backed by 'the full faith and credit' of any nation, namely gold.

Mr. Stoeferle pointed to another factor supporting gold: negative interest rates. When interest rates are below the rate of inflation, that obviously is bad for savers, forcing some at least to think about gold (and silver) as a means to preserve their wealth. During the inflationary 1970s, real interest rates were negative in 54% of the months. Since 2000, real interest rates have been negative 51% of the time, which in the words of Mr. Stoeferle, "constitutes an optimal environment for gold".

This is especially true in emerging markets, such as China. The emerging markets, in the last five years, drove 70% of the demand for gold. A quote from the In Gold We Trust report states:

The gold price in terms of purchasing power in China and India is currently about 80% lower than in 1980. This means that, to Asian investors, gold is still amazingly cheap.

Although governments can interfere with that price signal. Just look at India, where its central bank is waging war on gold.

The message from this research for gold investors? No one knows for certain how long this consolidation period in gold will continue, but the environment seems ripe for higher gold prices in the months and years ahead.

The balance of payments
BoP until you drop
For the first time since 1998 more money leaves China than enters it
Aug 4th 2012
. .

MAINLAND China can now boast over 1m wealthy citizens (qianwan fuweng) each with over 10m yuan ($1.6m), says the latest edition of the “Hurun Report”, which keeps track of China’s capitalist high-roaders. But the mainland seems to be having trouble keeping them. According to the report, published on July 31st, more than 16% of China’s rich have already emigrated, or handed in immigration papers for another country, while 44% intend to do so soon. Over 85% are planning to send their children abroad for their education, and one-third own assets overseas.


The affluent 1m have profited handsomely from China’s economic boom. But only 28% of those asked expressed great confidence in the prospects over the next two years, down from 54% in last year’s report. That unease may also be visible in a more obscure report released on the same day, by China’s State Administration of Foreign Exchange (SAFE). It showed that China’s balance of payments had recorded a deficit in the second quarter, for the first time since 1998. Put simply, more money was leaving China than arriving.

The same phenomenon can be described less simply. The balance of payments records two different kinds of transactions: cross-border payments for goods and services (ie, exports and imports), which are recorded in the “current account”, and cross-border payments for assets.

China’s current account is still in surplus, largely because its exports exceed its imports. China is also attracting plenty of direct investment from foreigners eager to buy or build companies on the mainland. But both these inflows of foreign exchange were outdone by a record outflow of other kinds of capital, amounting to a net $110 billion. This left China’s overall balance of payments in deficit, diminishing China’s international reserves by $11.8 billion (or just under 0.4%).


The drop in reserves was such an unfamiliar twist in the data that Reuters initially reported it with the wrong sign. A SAFE spokesperson felt the need to say that these outflows did not amount to a mass rush for the exits. The exits are, in any case, partially blocked by China’s capital controls. Still, such regulations can stop neither multinational companies, which may repatriate profits, nor determined wealthy individuals, who travel frequently, hold foreign bank accounts and run their own cross-border businesses. Chinese individuals may take up to $50,000 out of the country each year without special permission. Victor Shih of Northwestern University reckons that the richest 1% of Chinese households own $2 trillion-5 trillion of property and liquid assets. If they took fright, they could overwhelm even China’s vast foreign-exchange reserves.

China’s rich often have inside knowledge of the economy’s condition, Mr Shih has pointed out. If their money is leaving, everybody else should take note.

But Zhiwei Zhang, chief China economist at Nomura, a Japanese bank, is more sanguine. He thinks the capital outflow is not an alarming sign in itself, but just reflects economic worries that are already well-known. It is no surprise that firms and investors should reshuffle their portfolios given disappointments in China’s property market and the interruption in the yuan’s rise against the dollar.

Indeed, downward pressure on the currency is both a cause and a consequence of the capital outflows. From June 2010 to February this year, the yuan appreciated by over 8% against the dollar. Since then, it has slipped by 1% or so. The number of wealthy Chinese, according to the “Hurun Report”, may be growing strongly. But 10m yuan is not what it was.

August 7, 2012 7:12 pm

StanChart will not be the last bank to be stung by the US

Standard Chartered, a British bank, has found itself on the receiving end of a bluntly worded message: do business with Iran, and the US will punish you for it. Executives at the bank are not the only ones wondering: “Who are these Americans to penalise a British bank for doing business with a third country? What gives Washington the right to strong arm European regulators into supporting US foreign policy plans?” The answer: the same Americans who do not want to see Iran develop a nuclear weapons capability but who are not prepared to provoke another Middle Eastern war by dropping bombs to destroy it.

For the past several years, market anxiety over Iran has focused on the risk of military strikes on the country’s nuclear programme. When will Benjamin Netanyahu, Israeli prime minister, give the order to drop the bombs? Will Barack Obama help? Will Iran block the Strait of Hormuz, the bottleneck through which about 40 per cent of the world’s seaborne crude oil passes each day? Are we heading towards another war in the world’s most volatile region?

As Standard Chartered has learnt the hard way, military conflict, even a limited one, is not the likeliest market-moving Iran-related risk. Sanctions are not simply the opening act to a more dangerous moment, Iran’s equivalent of the shortlived Kofi Annan mission to Syria. Sanctions are the headline risk.

They will remain so for the foreseeable future. The potential costs of an Israeli attack on Iran are high; other strategiessanctions in particular – will be given time to work. Add the Obama administration’s unwillingness to kick the hornets’ nest, particularly in the lead-up to November’s elections, and the importance of sanctions comes into sharper focus.

Sanctions, of course, are a long-term project, one that has been gradually ratcheting up pressure on Tehran over several years. It takes time to build a coalition and to expand the scope and severity of restrictions: denying Iran parts for its aeroplanes, constraining its banking (including central banking) transactions and restricting its all-important energy exports.

The latest round from Washington will further squeeze foreign companies, add new pressure on importers of Iranian oil, ban the purchase of Iran’s petrochemical products, and impose tough penalties on firms that trade with the country’s Revolutionary Guard.

Iran and its people have endured tough times before, and there are no credible signs that the country is on the verge of political upheaval. Iranian officials regularly shrug off sanctions with stories of the hardships imposed by the Iran-Iraq war and the legendary fortitude of Iran’s people in surviving them.

However, in a country where 60 per cent of the population is not old enough to remember that conflict, in which communications within the country and across borders is available to an unprecedented percentage of the population, and in which expectations for higher standards of living are on the rise, sanctions are having an impact and the regime is increasingly on edge.

In the end, it is the economic and financial restrictionsnot military action or even cyber-sabotage – that will determine whether Iran crosses the nuclear threshold. Perhaps the force of sanctions will persuade Iran’s leaders to accept a face-saving deal that allows for a civilian nuclear programme, the enrichment of uranium outside Iran’s borders, and a robust and credible international monitoring process. Or perhaps Iran will simply muscle its way through towards nuclear breakout, accepting risks to economic and social stability along the way.

In either case, it is clear that financial tools, not air strikes, are the market-moving risk to watch. Many companies and financial institutions understand this. Standard Chartered will not be the last company to face heavy fines and new restrictions on its ability to operate in the US but European, Japanese and some other companies have seemingly done a better job than Standard Chartered in taking this risk seriously. Sanctions are a lot less eye-catching than air strikes or a blockade but it is now clearer than ever that they are the primary market risk to watch.

Those who do not understand this are liable to take an unsympathetic beating from US officials.

The writer is president of the Eurasia Group and author of ‘Every Nation for Itself: Winners and Losers in a G-Zero World’

Copyright The Financial Times Limited 2012.