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‘This is serious thinking, on essential issues.’ OLIVIER BLANCHARD, Chief Economist, IMF
THE NEXT CONVERGENCE THE FUTURE OF ECONOMIC GROWTH IN A MULTISPEED WORLD
MICHAEL SPENCE NOBEL PRIZE WINNER FOR ECONOMIC SCIENCES
THE NEXT CONVERGENCE
Also by Michael Spence
Market Signaling: Informational Transfer in Hiring and Related Screening Processes Industrial Organization in an Open Economy (with R. E. Caves and M. E. Porter) Competitive Structure in Investment Banking (with Samuel Hayes and David Marks)
THE NEXT CONVERGENCE The Future of Economic Growth in a Multispeed World
MICHAEL SPENCE
RANDOM BUSINESS
RANDOM BUSINESS USA Canada UK Ireland Australia New Zealand India South Africa China Random Business is part of the Penguin Random House group of companies whose addresses can be found at global.penguinrandomhouse.com
First published by Random House India 2011 Copyright © Michael Spence 2011 All rights reserved 10 9 8 7 6 5 4 3 2 ISBN 9788184001884 For sale in the Indian Subcontinent only
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For Giuliana
A man only becomes wise when he begins to calculate the approximate depth of his ignorance. Gian Carlo Menotti
Those who cannot change their minds cannot change anything. George Bernard Shaw
My belief is that every good cause is worth some inefficiency. Paul Samuelson
Contents
Preface Introduction
ix 3
Part One: The Global Economy and Developing Countries 1. 2. 3. 4. 5. 6.
1950: The Start of a Remarkable Century Static Views of a Changing World Postwar Changes in the Global Economy The Origins of the Global Economy Economic Growth Common Questions About the Developing World and the Global Economy
11 15 18 26 31 42
Part Two: Sustained High Growth in the Developing World 7. The High-Growth Developing Countries in the Postwar Period 53 8. The Opening of the Global Economy 56 9. Knowledge Transfer and Catch-up Growth in Developing Countries 58 10. Global Demand and Catch-up Growth 64 11. The Internal Dynamics of Sustained High Growth 69 12. Key Internal Ingredients of Sustained High-Growth Recipes 71 13. Opening Up: An Issue of Speed and Sequencing 89 14. The Washington Consensus and the Role of Government 92 15. Managing One’s Currency in the Course of Growth 97 16. The Middle-Income Transition 100
viii
Contents 17. The Political, Leadership, and Governance Underpinnings of Growth 18. Low-Growth Economies in the Developing World 19. Natural Resource Wealth and Growth 20. The Challenge for Small States 21. The Adding-Up Problem
104 112 116 120 122
Part Three: The Crisis and Its Aftermath 22. 23. 24. 25. 26. 27. 28. 29.
Emerging Markets During and After the Global Crisis Instability in the Global Economy and Lessons from the Crisis Stimulus in the Crisis and the Need for Cooperative Behavior Rebalancing the Global Economy and Its Consequences for Growth The Excess-Savings Challenge in China The Openness of the Global System and the WTO Legacies of the Crisis: Slow Growth and Sovereign-Debt Issues in Advanced Countries Periodic Systemic Risk and Investment Behavior
131 140 148 150 161 166 169 174
Part Four: The Future of Growth 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41.
Can the Emerging Economies Sustain High Growth? China and India China’s Structural Challenges India’s Growth, Diversification, and Urbanization Brazil’s Growth Reset Energy and Growth The Challenge of Climate Change and Developing-Country Growth Information Technology and the Integration of the Global Economy European Integration and Transnational Governance Global Governance in a Multispeed World The G20, the Advanced Countries, and Global Growth Sustaining Growth: The Second Half Century of Convergence
187 191 194 199 203 206
Notes Index
275 283
209 222 244 247 260 270
Preface
In 1999, I completed nine years as Dean of the Graduate School of Business of Stanford University, ending fifteen years of academic administration, the preceding six as the Dean of the Faculty of Arts and Sciences at Harvard. It was a wonderful period in my professional life, one I would not have given up, even with the knowledge that hindsight brings of the rewards, challenges, and petty tribulations. I learned a great deal about management and implementation, about organizations, incentives, and motivation. Though this was not the purpose, I think it has made me a better “older” economist. But the truth is that fifteen years is a long time, long enough to drift fairly far away from the day-to-day debates in economics. Some colleagues have referred to me as a former economist, causing me to wince a little, even if there was an element of truth in it. Prior to academic administration, I would have been described as an applied microeconomic theorist, with an interest in the details of market structure and performance and a special interest in the information structures in markets—markets where there are informational gaps and asymmetries that affect market performance. Market functioning and performance in the presence of informational gaps had been the focus of my doctoral work. The work on market signaling was an attempt to assess how markets would try to close informational gaps, and it was recognized by the Nobel Prize in Economics in 2001, in the excellent company of George Akerlof and Joseph Stiglitz. One can think of market signaling as being an attempt to understand how sellers of high-quality products
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send credible signals to potential buyers in a market environment in which the buyers do not have the quality information separate from the functioning of the market and the embedded signaling. In 1999, when I stepped back from academic administration, Internet mania was in full bloom. The potential of the Internet and the World Wide Web to have a major impact on markets, industries, and indeed whole economies was starting to come into focus. The Internet bubble in the stock markets and in venture capital was under way and inflating rapidly. Companies were being formed and financed in some cases without even a hint of where the revenues, let alone profits, were going to come from. Venture capital flowed like water from a decapitated fire hydrant. Companies went public early in their life cycle and traded at values determined largely by day traders, many of whom could not describe the business of the company or its products except in the vaguest of terms. It was uncharted territory with little historical data to constrain the expectations and enthusiasm, at least for a while. Then reality set in, revenues and profits in many cases did not materialize, and of course the period of overvaluation came to an end, as so often happens, with startling rapidity. The fact that there was a bubble and then a burst bubble led some to conclude that there was nothing there in the first place. That was not and is not right. Overvaluation does not imply the absence of fundamental change. Often it is associated with an overestimate of the speed of change. It seems clear that in this case, the principal mistake lay not in forecasting huge impacts on economic systems and processes, but rather in overestimating the pace of adoption. This gap between the potential of an innovation and its widespread adoption is one of those lessons that we learn and then tend to forget, or we don’t learn it because of inattention to history and its lessons about human and organizational behavior. As I thought about the potential uses of the Internet, it started to become clear that the informational structures in markets, supply chains, and transaction systems—indeed, the whole global economy—were set for a fundamental and permanent shift. With a background in this part of economics, I decided to set out to try to make sense of what all this meant for the functioning of markets and economies. I talk about that in Part IV. Information technology is one of the most powerful forces
xi now affecting growth and the distribution of economic activity in the global economy. The information layer that surrounds, organizes, and governs the real economy and all its parts is gravitating to the Internet; that is, to networks of computers and people. Time and distance and cost are compressed in the information layer. Many of the costs associated with being remote, from markets and head offices, were expected to decline with this new technology, and in fact they are declining rapidly. I asked myself the question, “Where is the largest long-run impact of the technology surrounding the Internet likely to occur?” Once you note that time and distance and related costs are compressed, and that remoteness loses some of its significance, the answer seems obvious: the big impact is likely to be in international markets, global supply chains, in access to information and services in places that have been remote from them—in short, in the global economy, and especially in the developing countries. As I embarked on this line of inquiry, an unexpected call came from the World Bank asking if I would deliver a keynote lecture in 2005 at the principal annual conference held by the Poverty Reduction and Economic Management Network in the Bank. The proposed subject was growth in the developing world. Now, I thought to myself, it is true that, in light of the route just outlined, I am interested in this. But giving a lecture on the subject in an institution with several thousand of the world’s most knowledgeable people on the subject of development struck me as slightly risky. I voiced this doubt. The response I got was that new views from outsiders are sometimes useful, that I had a background in microeconomics and some experience with investment, and that growth as an essential enabler of poverty reduction and progress had experienced a period of underemphasis. I wasn’t entirely persuaded, but resorting to my past, I thought if it goes badly, it will be a useful signal and I can move on. And if it doesn’t go badly, that signal will be useful too. I enjoyed it, seemed not to bomb, and, to cut a long story short, after some discussion in partnership with the World Bank and a number of other sponsors, we decided to ask a group of distinguished political and policy leaders from developing countries to join a commission focused on growth: on learning from their experience and that of others in mul-
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tiple countries and from academic research. The goal was to deliver the results of this learning process over the past fifteen years back in a form that provided useful guidance to their counterparts, leaders in developing countries, and to the next generation of leadership. Forming the commission would itself be a screening device. If the distinguished leaders whom we asked said no, we planned to conclude it was probably not a useful exercise at this stage and to drop the project. But they didn’t say no, and we launched the Commission on Growth and Development (CGD) in the spring of 2006. Its work concluded in June of 2010. The written work product can be found on the archived website of the CGD. Interacting with these developing-country leaders, their colleagues, and literally hundreds of my academic colleagues was the experience of a lifetime—for me, a high-speed learning process that was, to say the least, exhilarating and humbling. I learned about growth and development, about complexity, pragmatism, and persistence, and about leadership. For an economist trained in an advanced economy, it was startling to see how incomplete and imperfect were the frameworks and models available to guide policy choices in developing countries. It was even more startling to see how effectively the developing countries navigated this sea of complexity and uncertainty. I came to see the process as akin to a long sea voyage undertaken with incomplete and sometimes contradictory charts, not unlike the early explorers who set out to discover, explore, and map the contours of the planet and to exploit its resources. In doing this work over four years, I visited the commissioners in their home countries and talked with their colleagues, as well as with business, labor, and civil-society leaders. While an outsider can never achieve the level of institutional knowledge that insiders possess, I made some progress in seeing the world through their eyes; not through the lens of a Western business or policy agenda item, but from within the framework of the hopes, aspirations, and goals embedded in their own growth and development agendas. In the course of my own voyage of discovery, I realized that the pattern of growth and poverty reduction in the developing world was spreading and accelerating, and along with it a growing sense of optimism. It also dawned on me, later in the process, that the high dependence on the advanced economies has started to decline, especially in the last ten years, and that the developing world is becoming a large and
xiii increasingly important part of the global economy, with all the opportunities and challenges that go along with this growth. The largely separate worlds of the advanced and developing countries are converging. As a consequence, the growth of the developing world will increasingly be part of the lives of everyone, regardless of where they live and work. A year or so ago I described to my oldest friend—we grew up together— a plan to write a book about the high-speed growth in the developing world and the rapidly changing profile of the global economy. His advice was to make sure that the book “is about me as well”—meaning him, and his children and grandchildren, those who live in the advanced countries. I thought a lot about that. He wanted the book to include an assessment of what the growth of the developing world meant for his offspring and their children. I think it has come out that way. The huge asymmetries between advanced and developing countries have not disappeared, but they are declining, and the pattern for the first time in 250 years is convergence rather than divergence. This is a world in which vast numbers of people look with greater optimism at their own future and that of the next generation. But it is also a world facing large new challenges that are a consequence of the expanding prosperity. The real story of the future of growth is how well the coming generations understand our evolving interdependence, its positives and negatives, and then creatively find ways to manage and govern it. In writing this, I have relied on the energy, insight, and generosity of spirit of a large number of people whom I admire. Prominent among them are the members of the Commission on Growth and Development who have helped lead the economic, political, and social transformations of their countries. My colleagues in universities and research institutions have been extraordinarily generous in sharing their research and insights with practitioners. The high quality of the interaction between these two groups during a set of workshops on growth and development was for me one of the most rewarding parts of the past four years. Roberto Zagha at the World Bank was secretary to the commission. I owe him a great debt for his breadth of vision in guiding the work of the CGD, for guiding me through the learning process, and for his ideas and idealism. Mohamed El-Erian, now the CEO and co-CIO of Pimco, is a friend and teacher—about investment, the global economy, the global financial system. We have discussed the issues and written about them
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together. I have included in Part IV of this book adaptations of two of our joint efforts on global governance and on the sustainability of emerging economy growth post crisis. Bob Solow, the creator of modern growth theory, was the other academic on the growth commission, and the most important one. It is not possible (no matter how many superlatives one uses) to overstate the impact he had on my thinking and that of all of us. It was, in many ways, a microcosm of the enormous influence he has had on the concepts and values that form the foundation of modern economics. Andrew Wylie and Scott Moyers encouraged me to try to write this book and guided me through the unfamiliar process of writing for a nonacademic audience. Andrew has done this for many authors with diverse backgrounds. He is a master at it. I am very grateful to Eric Chinski and his colleagues at Farrar, Straus and Giroux for their help and support in getting the manuscript into good shape, and for their editorial insight and support. My wife, Giuliana, and my family were incredibly supportive as I logged vast numbers of miles in the air, as part of the work of the CGD and in the writing of this book. That plus a large dose of encouragement and enthusiasm made it possible to complete the work. I finished the editing of the manuscript in Bonassola, a small town on the coast of Liguria in Italy. I am grateful to the very kind folks at the Gelateria Delle Rose for letting me work at their bar close enough to the wi-fi access point. It became il mio ufficio for part of the summer.
‘By far the best book I have seen on today’s historical growth transformations.’ MOHAMED A. EL-ERIAN, author of When Markets Collide With the Industrial Revolution, part of the world’s population (Europe, America, and Japan) started to experience extraordinary economic growth yet four-fifths of humanity remained mired in poverty. Till the Second World War the world remained a profoundly unequal place. Then the pendulum began to swing the other way. Some countries, mainly in Asia, started growing at unprecedented rates at about 7 percent a year. More recently, the two most populous countries in the world—China and India—have begun to grow at rates close to 10 percent. This convergence between the developing and developed worlds—a revolution just as profound as the Industrial Revolution—is reshaping the world today argues Nobel Prize-winning economist Michael Spence. Spence looks at what caused this dramatic shift, the implications of this new convergence, and the challenges these growing economies face. He argues that maintaining the high growth rates in developing countries presents serious difficulties for them in governance, international coordination, and ecological sustainability. The implications for those living in the advanced countries are also great but little understood. The Next Convergence is big picture economics at its finest—a lucid, deeply intelligent analysis of the global economy and a riveting introduction to the most critical debates today. ‘Among the many books written on the new world economy this is one of the most profound. A must-read for everyone interested in the mega-trends shaping the future of the world economy.’ JUSTIN YIFU LIN, Senior Vice President and Chief Economist, World Bank ‘The emergence of China is just part of an amazing catching up process going in the world. We all feel this profound change, but few of us have the ability to step back, put it in perspective, analyse the past and guess where the future is taking us. Mike Spence has it, and he delivers. This is serious thinking, on essential issues.’ OLIVIER BLANCHARD, Chief Economist, IMF ‘If you are looking for a lucid, readable, consistent, unprejudiced picture of what has been happening and what might happen next in the world economy, this is an excellent place to find it.’ ROBERT SOLOW, winner of the 1987 Nobel Memorial Prize in Economic Sciences http://www.thenextconvergence.com Cover design by Christopher Tobias Jacket illustration by Sara Mills Paperback jacket by Nupur Mathur
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www.penguin.co.in For sale in the Indian Subcontinent only