By Dr. Nayyer Ali

April 29, 2005

Growth and Investment

The biggest story of the next fifty years will be the tremendous growth of Asia. What has happened in the last twenty-five is a mere prelude. The four largest Asian nations, China, Indonesia, India, and Pakistan, have all reached levels of income that approximate where the US was about 1920. Indonesia and China are 30% ahead of where India and Pakistan are, but in overall terms they are all just getting started. By 2050, each of these countries will have achieved living standards roughly comparable to present-day Western Europe or the United States.
So who will be the winner of the race? Will all be equally wealthy in 2050, or will some countries have done much better than others? It is rather hard to predict, but even slight differences in annual growth rates can make huge differences in outcomes after 50 years. Just a 1.5% difference in annual growth rate over 50 years will lead to the faster country ending up with twice the per capita income of the slower.
In the long run, having an economy that grows 7.5% per year versus 6% per year is of monumental significance.
Of all the Asian economies, the country that has done the best in the last ten years has been China. It has been growing at the phenomenal rate of over 9% per year since the early 90’s. Back then, China and India had the same living standard, but by now the 3% edge that China has enjoyed for over 10 years has created a large gap. India’s growth rate after the reforms of the early 90’s has accelerated but only up to the 6% level on average.
Pakistan’s long-term growth has been a bit above 5% per year since independence. This has been sufficient to catch up to India’s head start at partition, and by the late 1980’s Pakistanis were clearly doing significantly better than Indians. In the 90’s, growth slowed in Pakistan, while it surged in India, and the gap closed, but Pakistan still has a small statistical edge. At current market exchange rates, Pakistan’s GDP per capita is about 10% higher than India.
Where are future trends heading? Who will be ahead in 50 years? That far down the line it is very hard to predict, but clearly the country with the most efficient economic system will be able to sustain the highest growth rates in the long run. China’s 9% rate is unsustainable, and will eventually slow down.
The key to understanding who is best positioned is to look at investment levels, and more importantly, the efficiency of that investment. The purpose of investment is to build new plant and equipment, and to improve human and capital resources so that companies produce more goods and services. This increased production is what is being measured when we look at “growth”.
When we look at the various economies, we find something very interesting. China is currently investing 45% of its GDP, while India invests 25% of GDP, and Pakistan is investing 20% of GDP. There is a huge gap in how much each economy is investing. But when we look at the return on that investment, by looking at actual growth that is generated, we find that China is growing at 9%, India at 6.5%, and Pakistan at 7.5%.
China invests massively more than the other two nations, but gets little extra growth. This is due to “diminishing returns” as much of the investment is wasted. It is the end result of the communist system of state run enterprises that misuses much of China’s investment. If we divide the amount invested by the growth return, we get a measure of the efficiency of investment in each economy. In China one needs to invest 5 dollars to get 1 dollar of growth, India needs 3.85 dollars invested for one dollar of growth, and Pakistan needs only 2.67 dollars invested for one dollar of growth. The US invests about 20% of GDP and generates growth of 3-4% per year for that, which seems rather inefficient, but that is due to the high investment demands for achieving growth in leading edge economies.
Pakistan has a more open and efficient economy which allows investment to be effectively deployed. The person to thank for that is Shaukat Aziz, whose free market policies have made Pakistan a much more vibrant economy. Aziz plans to raise economic growth rate to 8% next year and keep it there for the next decade. This can be done by raising Pakistan’s investment rate to 25% of GDP, which is a realistic figure.
For India and China, the issue is not how to find investors. There is plenty of investment flowing into both economies, and in China one could certainly argue that it is excessive and beyond the absorptive capacity of China’s economy. What the efficiency numbers are saying is that both nations need to reform their economic systems if they want to sustain high growth.
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