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MONDAY, JULY 07, 2025
The other side of economic growth

Economy

Abhijit Banerjee and Esther Duflo
26 December, 2019, 12:10 pm
Last modified: 26 December, 2019, 03:57 pm

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The other side of economic growth

In countries facing a situation in which resources are being used badly, the first benefits of reform may come from moving resources to their best uses

Abhijit Banerjee and Esther Duflo
26 December, 2019, 12:10 pm
Last modified: 26 December, 2019, 03:57 pm
The other side of economic growth

One of the most worrying news stories of 2019 did not receive the coverage one might expect from media outlets in the US or Europe. But the economic slowdown in China, and the potentially steep deceleration in growth in India, will most likely receive considerably more attention in 2020.

The International Monetary Fund (IMF), the Asian Development Bank (ADB), and the OECD have downgraded their growth estimates for India in 2019-20 to around 6%, which would be the lowest since the beginning of the decade. Others claim that even this is optimistic and project much more dire narratives. For example, Arvind Subramanian, until recently the Indian government's chief economic adviser, has argued, based on triangulating evidence on various economic indicators, that growth may sink as low as 3.5%.

In China, gross domestic product (GDP) growth has slowed from 14.2% in 2007 to 6.6% in 2018. The IMF projects that it might fall to 5.5% by 2024. Rapid growth there and in India have lifted millions out of poverty, and the slowdown is likely to impede progress on improving the lives of the poor.

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What should China and India do? Or, rather, what should they not do? While writing our book Good Economics for Hard Times in 2018, before the bad news about India started coming out, we were already concerned about a potential downturn there (the slowdown in China was already known). Anticipating the fall in growth, we warned that "India should fear complacency".

The point we were making is simple: in countries that start from a situation in which resources are being used badly, as in China under communism or India did in its days of extreme dirigisme, the first benefits of reform may come from moving resources to their best uses. In the case of Indian manufacturing firms, for example, there was a sharp acceleration in technological upgrading at the plant level and some reallocation toward the best firms within each industry after 2002. This appears to be unrelated to any changes in economic policy, and has been described as "India's mysterious manufacturing miracle".

But it was no miracle, just a modest improvement from a rather dismal starting point. One can imagine various reasons why it happened. Perhaps it resulted from a generational shift, as control passed from parents to children, often educated abroad, more ambitious, and savvier about technology and world markets. Or, maybe the accumulation of modest profits eventually made it possible to pay for the shift to bigger and better plants. Or, maybe both causes – and others – played a role.

More generally, perhaps the reason why some countries, like China, can grow so fast for so long is that they start with a lot of poorly used talent and resources that can be harnessed to more valuable activities. But as the economy sheds its worst plants and firms and solves its most dire misallocation issues, the space for further improvement naturally shrinks. Growth in India, like that in China, had to slow. And there is no guarantee that it will slow only when India has reached the same level of per capita income as China. India may be caught in the same "middle-income trap" that ensnared Malaysia, Thailand, Egypt, Mexico, and Peru. The trouble is that countries find it hard to kick the growth habit. There is a risk that policymakers will flail wildly in their quest to make growth come back. The recent history of Japan should serve as a useful warning.

If Japan's economy had maintained the growth rate that it recorded over the decade 1963-73, it would have overtaken the US in terms of GDP per capita in 1985 and in overall GDP by 1998. What happened instead is enough to make one superstitious: in 1980, the year after Harvard's Ezra Vogel published Japan as Number One, the growth rate crashed, and never really recovered. For the entire period 1980-2018, Japan's real GDP grew at an anemic 0.5% average annual rate.

There was a simple problem: low fertility and the near-complete absence of immigration meant Japan was (and is) ageing rapidly. The working-age population peaked in the late 1990s, and has been declining at an annual rate of 0.7% (and will continue to decline). Moreover, during the 1950s, 1960s, and 1970s, Japan was catching up after the disaster of the Pacific War, with its well-educated population gradually being deployed to its best possible uses. By the 1980s, that was over. In the euphoria of the 1970s and 1980s, many people (in Japan and abroad) convinced themselves that Japan would nonetheless sustain rapid growth by inventing new technologies, which probably explains why the high investment rate (in excess of 30% of GDP) continued through the 1980s. Too much good money chased too few good projects in the so-called bubble economy of the 1980s. As a result, banks ended up with many bad loans, which led to the huge financial crisis of the 1990s. Growth ground to a halt.

At the end of the "lost decade" of the 1990s, Japanese policymakers might have started to realize what was happening and what they had to lose. After all, Japan was already a relatively wealthy economy with much less inequality than most Western economies, a strong education system, and many important problems to address, chief among them being ensuring a decent quality of life for its ageing population. But the authorities appeared unable to adjust: restoring growth was a matter of national pride.

Successive governments vied to devise a series of stimulus packages, spending trillions of dollars mostly on roads, dams, and bridges that served no obvious purpose. Perhaps predictably, the stimulus did nothing to increase economic growth and led to a huge increase in the national debt, to some 230% of GDP in 2016 – by far the highest of the G20 countries and a possible harbinger of a massive debt crisis.

The lesson for policymakers in China and India is clear: they must accept that growth will inevitably slow. China's leaders are aware of it, and have made a conscious effort to manage public expectations accordingly. In 2014, President Xi Jinping talked about a "new normal", of 7% annual growth, rather than 10% or more. But it is not clear that even this projection is realistic, and in the meantime, China is embarking on enormous global construction projects, which doesn't necessarily bode well.

The key, ultimately, is not to lose sight of the fact that GDP is a means and not an end. It is a useful means, no doubt, especially when it creates jobs or raises wages or plumps the government budget so that it can redistribute more. But the ultimate goal remains to raise the average person's—and especially the worst-off person's—quality of life. And quality of life means more than just consumption. Most human beings care about feeling worthy and respected, and they suffer when they feel that they are failing themselves and their families.

While living better is indeed partly about being able to consume more, even very poor people also care about their parents' health, about their children's education, about having their voices heard, and about being able to pursue their dreams. Higher GDP is only one way to achieve this, and there should be no presumption that it is always the best one. This brings us back to the slowdown in India and China. There is a lot that policymakers in both countries can still do to improve the welfare of their citizens and help us cling to some hope about our planet's future. A myopic focus on increasing the rate of GDP growth could squander that chance.

Abhijit Banerjee & Esther Duflo are professors at MIT, and co-founders and co-directors of J-PAL at MIT. They both won Nobel Pize in Economics this year.

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Economic Growth / Abhijit Banerjee / Esther Duflo

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