The peculiarities of today’s growth spurt

In: Uncategorized

29 Jan 2007

There follows a news analysis by me from today’s issue of Fund Strategy. It starts to examine, in a schematic way, the particular character of the current period of strong global economic growth.

It has become commonplace to assert that for the past four years the world economy has grown at its fastest rate since the 1970s. While this is true, its implications are often left unclear. Strong economic growth is usually taken to mean that equities will do well, but there is far more to the story than straightforward stockmarket performance.

To understand the dynamic of the contemporary world economy, it is necessary to look beyond growth rates alone. The character of the growth is as important as its speed.

Nor is it good enough to simply say that the world has become more globalised. It is true that the world economy has become steadily more integrated in recent years, with trade and cross-border investment growing faster than GDP. But globalisation is only part of the story.

There are at least three key factors distinguishing growth in recent years from earlier periods: economic volatility is lower; developing countries are playing a larger role; and the end of the Cold War has changed the political context. All of these factors are important, although the last is probably the most critical, and the least understood.

Anyone wanting to understand the significance of long-term economic shifts is fortunate that a huge amount of data is now available to put them into context. In particular Angus Maddison, widely acknowledged as one of the world’s leading experts on long-term growth, has produced invaluable long-term statistics (for link see bar on the left).

From studies by Maddison and others, the long-term patterns are clear. The global economy was virtually static until 1800, when it started to grow rapidly. During the 19th and early 20th centuries, the general pattern of growth was strong. Then in the period from 1913-1950 – a time that encompassed two world wars and the great depression of the 1930s – there was a relative slowdown in growth. Of course there were important variations between different countries and in different years. But it is best to start by examining the world economy in aggregate before drilling down to more detailed studies.

It is the post-war boom, from 1950-1973, that provides the immediate backdrop to the contemporary discussion. During that time the world economy grew faster than in any period before or since. If there ever was a golden age of economic advancement, this was it. The prolonged growth spurt ended during the “stagflation” of the mid-1970s. A painful combination of economic stagnation and high inflation seemed to have brought the good times to an end.

The current discussion of the best growth spurt since the 1970s is an implicit contrast to the post-war boom. To anyone familiar with economic history, the implication that this is the best period of growth since the years that followed the Second World War is clear. What is being said is that we have virtually returned to a golden era of economic growth.

It is certainly true that growth is strong and that a rapidly expanding economy should be welcomed. The more rapidly the economy grows, the greater the ability of human beings to live more prosperous lives. But the differences between the post-war period and more recent growth are at least as important as the similarities.

Perhaps the most obvious is that it is now the developing world that is growing much more rapidly than the developed world (see graph). East Asia in particular, with China at its centre, is emerging as the new workshop of the world. In contrast, during the post-war boom the focus of growth was on the developed world. Japan and West Germany in particular enjoyed rapid growth as their economies recovered from the ravages of the Second World War.

Also fairly widely recognised, at least by economists, is the muting of the business cycle over the past two decades. Or, to put it in different terms, economic volatility has fallen sharply. Economic growth is no longer punctuated by periods of restructuring, with firms going bust and unemployment rising. Although the cycle still exists, it has become a far gentler affair than in the past. Ben Bernanke, governor of America’s Federal Reserve, has referred to this process as “the great moderation”.

The backdrop to these changes is the end of the Cold War in the 1980s. This had enormous implications for both domestic politics and international relations. There were various ways in which the demise of the Soviet Union had a global impact, but the most important is the demise of the socialist model. It suddenly seemed there was no viable alternative to the market as a form of economic organisation.

In international relations, one of the effects of this was to allow the opening up of much of the developing world, such as China and India, to the global economy. During the Cold War their participation was relatively marginal. But the demise of the Soviet Union meant that socialist states such as China were keener to open themselves up to the market. Even India, while never formally aligned to the Eastern bloc, had a relatively closed economy until the 1980s.

In the domestic sphere the end of the Cold War meant the demise of organised labour. Although trade unions still exist, they are not the force they once were. Their concerns are typically focused on such issues as pensions and financial services rather than militant battles with employers. This changing relationship with unions has given employers more flexibility to restructure their businesses without having to worry about any opposition from unions.

It is this final factor, the end of the Cold War, that probably more than any other explains how growth has become stronger and less volatile in recent years. It also accounts for the closer integration of the developing world into the global economy.

However, it would be a mistake to assume that everything will be straightforward from here on. Although there are undoubtedly new opportunities ahead, there will also be new challenges to face.