The government was proud of its indicative planning system, which left ample room to private initiative while keeping the growth rate both high and stable. Together with other Western European countries, France was fast catching up with the US.
Then came the first oil shock. In 1973, OPEC, the oil cartel, abruptly raised the price of a barrel from 3 to 12 dollars, triggering a global recession. After France recovered in 1976, growth resumed. But in spite of all government efforts, its pace remained significantly lower than before the shock. The new normal proved disappointing: whereas per capita growth had been 4.4% in the decade before the oil shock, it was only 1.6% in the decade that followed. Even today the French still speak of the glorious pre-1973 years (les Trente Glorieuses) as a paradise lost.
Fast forward and consider Japan in the 1980s, where companies like auto maker Toyota and consumer electronic group Sony dominated the world landscape. Pundits in the US were wondering out loud why their country had lost its competitive edge, and many took at face value the provocative title of a 1979 book by Harvard’s Ezra Vogel: Japan as Number One. The Japanese growth rate was not spectacular (3.4% per capita in the 1980s), but still solid for a highly developed country, and more than one percentage point higher than in the US. At that pace, Japan’s GDP per capita was set to reach the US level by 2015.
Then, in 1989-90, the bubble burst. Both the stock market, which had risen by 400% since 1980, and land prices, which had increased by 250%, went into free fall. Massive long-hidden bank losses disrupted the credit mechanism. Growth slowed down and the economy eventually went into recession in 1993. Inflation declined, soon reaching negative territory. The subsequent recovery was feeble (another recession took place in 1998), and the dream of catching up with the US vanished: the per capita growth differential between the two countries switched from +1% in the 1981-90 decade to –1.5% in the 1994-2003 decade.
Fast forward again and look at South Korea before the 1997-98 Asian crisis. Per capita growth rate was an astonishing 7.5%, a stellar performance for a country whose GDP per capita was already close to half the US level. The crisis was traumatic: Korea experienced capital flight, a collapse of the exchange rate, a steep recession and was subjected to an IMF-led adjustment programme. It recovered fast, however, and its development level is now comparable to that of the advanced European countries. Nonetheless, growth has declined to a more moderate rate.
These three cases highlight a more general pattern documented in recent research by Lant Pritchett and Larry Summers of Harvard University: far from being smooth, growth processes tend to be affected by sharp discontinuities. In particular, slowdowns are often abrupt and large rather than smooth. Moreover, the sudden adjustments are often unanticipated by forecasters, who tend to extrapolate prevailing trends.
Economists do not have a ready-made explanation for such a pattern. Most models imply that the growth rate of potential output (i.e. the one that would prevail in the absence of fluctuations in demand) only changes gradually. In the standard model, growth slows down because as a country develops, returns on physical and capital diminish and the gain from adopting world-class technologies becomes less important. Smoothness also characterises endogenous growth models that depart from the logic of diminishing returns. Even the innovation-based models developed by Philippe Aghion of the Collège de France, which envisage divergent fates for frontier innovation economies and imitation-based economies, describe a gradual process.
Two factors account for the abrupt declines in growth. First, there is quite simply a tendency to believe that what has been the case for successive years and even decades will continue unabated. Expectations tend to be based on past experience, irrespective of the underlying strength of the economy. And as expectations play a major role in investment, credit and consumption behaviour, they contribute to growth inertia until a sharp slowdown eventually forces everybody to come to terms with reality. If, for example, firms, banks and households believe that the economy is set to grow at 7%, they will behave accordingly. If the true growth potential is 5%, there will temporarily be excess investment, wages, credit and consumption and as a consequence an accumulation of imbalances. As in the cartoon where Wile E. Coyote continues running after going over a cliff and only falls when he realises what he is doing, adjustment is delayed and takes the form of a sudden drop. The trigger for it is often an external event such as a global shock or a financial crisis.
Second, the government may add to the problem by resisting the slowdown. A growth decline can always be countered temporarily by piling up more and more capital. Even if the return on new investment is desperately low, each new plant adds to the production potential and each new road better connects producers to consumers. But there is a limit to what can be achieved by excess capital accumulation: the building of plants and roads sustains demand, but once they are finished they only contribute to growth if economically profitable.
Furthermore, a growth strategy based on excess investment almost inevitably results in making the eventual adjustment more painful. Think of an economy whose natural growth rate is 5% but achieves more by letting capital expenditures grow at 10%. As a consequence, the stock of capital – that consists of several periods of past investment – grows faster than output. But this can only be the case temporarily: eventually, the ratio of capital to output must stabilise. For this to happen, however, it is not sufficient for investment to grow at the pace of output. This is because after a capital expenditure surge, the capital stock continues to increase even if investment remains flat,. Rather, adjustment to the new normal requires a decline in the investment-to-GDP ratio, which can only happen if investment grows at a slower pace than output.
Such a decline of the investment rate was observed in France, Japan and Korea. It was particularly pronounced in the Japanese case, where investment fell from 35% of GDP in the late 1980s to 25% in the mid-2000s. Throughout the latter period capital expenditures contributed on average minus 0.7% per year to GDP growth. So on top of being structurally slower, growth was further diminished by this drag.
The big question is whether China is set to experience an abrupt adjustment of its growth rate. Unlike in France, Japan or Korea at the time, authorities recognise the inevitability of a slowdown, which is positive. They have already lowered the growth target several times. But they hope that the process can be gradual and controlled, and they currently tend to use investment as a lever to keep growth at the still high 7% plateau. According to official statistics, the investment rate is 47%, only marginally lower than when the annual growth rate was 10%. This is way too high for an economy with a growth rate of 7%, let alone for one growing at 6% or 5%. For this reason, investment growth must fall significantly below output growth.
This adjustment is bound to be a significant curb on growth in the years to come. Can it be offset by higher exports or higher consumption? China now represents too big a share of the global economy to rely on export-led growth. Reliance on consumption is a safer bet. Steps have been taken in this direction. But for consumption to become the engine of growth, further, more ambitious changes will be required in income distribution and the provision of social services. Whatever the path taken, this is likely to be a delicate transition.
Auteurs
