An Analysis from the Supply-side

1. INTRODUCTION

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In his blog, Michael Pettis examines the sources of GDP growth from the demand-side. He has frequently pointed out, and correctly so, that there are only three sources of GDP growth, namely, (a) increase in Consumption, (b) increase in Investment, and (c) increase in Net-Exports. By way of specific example, Michael has often mentioned the following:

(a) Consumption is the main source of growth in the US

(b) Investments are the main source of growth in China

(c) Net-exports are the main source of growth in Germany

Source: http://mpettis.com

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Michael's careful and insightful demand-side analysis has revealed enormous problems with imbalances in Asian, European, North American economies. His demand-side research, however, does not say much about the Latin American and Sub-Saharan African economies. In the aggregate, they do seem more or less balanced from the demand-side. So are they home free? Should they be patting themselves on the back for having avoided the demand-side imbalance problems Michael has exposed?

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Interestingly enough, when we do a complementary supply-side analysis of the situation, the position completely reverses. The Asian, European  & North American economies seem more or less balanced when examined from the supply-side. On the other hand, it is the Latin American and Sub-Saharan economies that reveal massive problems when examined from the supply-side. In order to get a complete picture, therefore, it is necessary for us to go beyond Michael's demand-side research and also have a look at supply-side sources of growth in economies across the world.

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2. ANALYSIS

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Let us begin with an examination of the inner components of Per Capita GDP:

.....Per Capita GDP = Output/Population

.....Per Capita GDP = (Output/Workers) X (Workers/Population)

.....Per Capita GDP = (Output/Workers) X (Workers/Workable) X (Workable/Population)

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Using standard World Bank definitions of terms, we can express the above relation as:

.....Per Capita GDP = Productivity X Participation Rate X Demographic Profile ----(I)

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Therefore, it follows that there are only three sources of per capita GDP growth, viz.,

.....(i) Increase in Productivity,

.....(ii) Increase in Participation Rate, and,

.....(iii) Improvement in Demographic Profile.

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For those who are in the habit of using total GDP growth (instead of per capita GDP growth) as the measure for tracking economic growth, the extension of (I) is quite straightforward:

.....GDP = Per Capita GDP X Population ----(II)

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Inserting (I) into (II), we get:

.....GDP = Productivity X Participation Rate X Demographic Profile X Population ---(III)

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Therefore, it follows that that there can be only four sources of GDP growth, viz.,

.....(i) Increase in Productivity,

.....(ii) Increase in Participation Rate,

.....(iii) Improvement in Demographic Profile, and,

.....(iv) Increase in Population.

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Having delineated the supply-side sources of GDP growth, we are now fully-equipped to go on a global expedition and see what is actually happening in the various economies of the world.

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3. CASE STUDIES

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3.1: Brazil (from 1980 to Present)

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(a) Total GDP shows reasonable growth

http://alturl.com/pxt8b

(b) GDP per capita also shows some growth

http://alturl.com/2x99c

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But from where did this growth come? What were its sources?

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(i) There was really no increase in Productivity (Alarm bell!)

http://alturl.com/96342

(ii) There was only a small increase in the Participation rate

http://alturl.com/w8vtp

(iii) There was an excellent improvement in the Demographic Profile

http://alturl.com/zge8n

(iv) There was a strong increase in Population.

http://alturl.com/zu65x

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Summary: We note that (ii),(iii) & (iv) are one-off or exhaustible sources. Once these are exhausted, Brazil will enter into a zombie-like state of eternal stagnation, unless it starts doing something right now to address its lack of increase in productivity.

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3.2 Zambia (from 1980 to Present)

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(a) Total GDP shows some growth

http://alturl.com/n3iip

(b) GDP per capita shows no growth (Alarm bell!)

http://alturl.com/brgcn

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Clearly, if GDP per capita is not growing, but total GDP is growing, then the only source of growth is, by definition, an increase in population.

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(i) There was really no increase in Productivity (Alarm bell!)

http://alturl.com/fanss

(ii) There was really no increase in the Participation rate

http://alturl.com/fr62y

(iii) There was no improvement in the Demographic Profile (Alarm bell!)

http://alturl.com/vpu8c

(iv) There was just a strong increase in Population.

http://alturl.com/v6c8j

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Summary: We note that (iv) alone is not a sustainable source of growth. If left uncontrolled, it will lead to disaster, and Zambia will enter into a state of social & political chaos, unless it starts doing something right now to address, at the very least, its demographic profile.

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3.3: China (from 1980 to Present)

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(a) Total GDP shows spectacular growth

http://alturl.com/rkuid

(b) GDP per capita also shows astonishing growth

http://alturl.com/fnw5b

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But from where did this growth come? What were its sources?

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(i) There was a strong rise in Productivity

http://alturl.com/c2prh

(ii) There was really no increase in the Participation rate

http://alturl.com/odsvn

(iii) There was an excellent improvement in Demographic Profile

http://alturl.com/ct9gs

(iv) There was a strong increase in Population.

http://alturl.com/od3fu

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Summary: Clearly, China's problems are not the same as the one Brazil is facing with its almost complete absence of productivity growth. China's problems lie elsewhere, and since Michael has been blogging extensively about them by way of his excellent demand-side analysis, we will dwell on them here no further.

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3.4 United States (from 1980 to Present)

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(a) Total GDP shows excellent growth

http://alturl.com/2p5dv

(b) GDP per capita also shows strong growth

http://alturl.com/ma3wm

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But from where did this growth come? What were its sources?

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(i) There was a very strong rise in Productivity

http://alturl.com/c9ny6

(ii) There was really no increase in the Participation rate

http://alturl.com/u8p2a

(iii) There was really no change in Demographic Profile

http://alturl.com/npo7d

(iv) There was a good increase in Population

http://alturl.com/kt986

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Summary: Clearly, the problems of the US are neither the ones Brazil is facing, with its almost complete absence of productivity growth, nor the ones China is facing, with its problems well-described in Michael's blog. The problems of the United States lie elsewhere, and since Michael will (I guarantee it) be blogging about them about 4-5 years from now, let us discuss them some other time.

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4. SYNOPSIS OF DATA

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I picked Brazil, Zambia, China & the US, not because there is anything inherently exceptional about these countries, but because I thought that they were economies that are representative of their type of economy. For example, in the case studies above:

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(A) Brazil represents most Latin-American economies, with perhaps Chile being an exception. Therefore, once we have understood the sources of growth in Brazil, we would approximately have understood the sources of growth in almost all countries of Latin America. Here are the general trends in Latin-America that Brazil typifies:

.....(1) Stagnant Productivity: http://alturl.com/myfrm

.....(2) Improving Demographics: http://alturl.com/appvb

.....(3) Increasing Participation-rates: http://alturl.com/bo69a

.....(4) Managed Population-growth: http://alturl.com/43syf

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(B) Zambia represents a lot of the economies of Sub-Saharan Africa (minus South Africa), with the some of the major commodity-exporters countries, like Botswana, being exceptions. Therefore, once we have understood the sources of growth in Zambia, we would approximately have understood the sources of growth in many of the countries of Sub-Saharan Africa. Here are the general trends in Sub-Saharan Africa that Zambia typifies:

.....(1) Stagnant Productivity: http://alturl.com/a6ufj

.....(2) Stagnant Demographics: http://alturl.com/fn7vw

.....(3) Flat Participation-rates: http://alturl.com/ob957

.....(4) Unmanaged Population-growth: http://alturl.com/c99wg

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(C) China represents most developing Asian economies, including India & ASEAN, with perhaps Philippines being an interesting exception. Therefore, once we have understood the sources of growth in China, we would approximately have understood the sources of growth in almost all the Sinitic, Indo-Sinitic and Indic developing-countries of Asia. Here are the general trends in developing Asia that China typifies:

.....(1) Rising Productivity: http://alturl.com/u58so

.....(2) Improving Demographics: http://alturl.com/p7wqr

.....(3) Flat Participation-rates: http://alturl.com/fnpzr

.....(4) Managed Population-growth: http://alturl.com/umi7n

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(D) The United States represents most developed economies, with perhaps rapidly-aging Germany & Japan being slight exceptions in some ways. Therefore, once we have understood the sources of growth in the US, we would approximately have understood the sources of growth in almost all fully-industrialized countries. Here are the general trends in developed countries that the US typifies:

.....(1) Rising Productivity: http://alturl.com/3vj6n

.....(2) Stagnant Demographics: http://alturl.com/9n2or

.....(3) Stagnant Participation-rates: http://alturl.com/e6yod

.....(4) Slow Population-growth: http://alturl.com/fax84

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5. CONCLUSIONS

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Michael's original demand-side analysis had clearly divided the world into three distinct camps:

(I) 'Over-consuming' economies (i.e. Consumption-driven economies). Examples of this type of economy are the United States, the United Kingdom and Greece.

(II) 'Under-consuming' economies (i.e. Investment and/or Net-Exports driven economies). Examples of this type of economy are China, Germany, Singapore, Netherlands and Saudi Arabia.

(III) 'Balanced' economies (i.e. economies that are not a major part of the global imbalances revealed by Michael's analysis). Examples of this type of economy are Mexico, South-Africa and Egypt.

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This complementary supply-side analysis, on the other hand, indicates the world could alternatively be divided in a different way and into four distinct camps:

(I) Productivity-driven economies. This type of economy is found in advanced, developed or fully-industrialized countries, some of whom may well be heading into a high-income trap* soon. Examples of this type of economy are the United States, the United Kingdom, Spain, Greece, Germany, Italy, Netherlands, Korea and Japan.

(II) Demographics-driven economies. This type of economy is found in middle-income countries that have low productivity-growth and have hence become caught in a middle-income trap. Examples of this type of economy are Brazil, Mexico, Philippines, South Africa, Ecuador and Guatemala.

(III) Productivity and Demographics driven economies. This type of economy  is found in developing countries that are rapidly-industrializing. Examples of this type of economy are China, Vietnam, Indonesia, India and Thailand.

(IV) Stagnant economies.  This type of economy  is usually found in under-developed countries with stagnant per capita income, where GDP-growth comes from population growth alone. Such countries are said to be caught in a low-income trap and include countries like Zambia, Kenya, D.R. Congo, Senegal and Niger.

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Comparative Visualization: The following graphs compare the various supply-side sources of growth between three of the camps, with Brazil representing Camp (II), China representing Camp (III) and Zambia representing Camp (IV):

.....1) Comparing Productivity trends: http://alturl.com/kqdde

.....2) Comparing Demographic trends: http://alturl.com/nkttp

.....3) Comparing trends in Participation-rates: http://alturl.com/f3v48

.....4) Comparing trends in Population-growth: http://alturl.com/6evhw

.....5) Comparing trends in per capita GDP: http://alturl.com/fbypo
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*What is a high-income trap? Whereas the terms 'middle-income trap' and 'low-income trap' are widely used and well-understood, the term 'high-income trap' is a bit unusual. In light of this, it would help to elaborate on this term a bit further. To put it succinctly, a 'high-income trap' is a demographics-triggered trap, in which any increase in productivity is negated by a deterioration in the demographic-profile. As seen in equation (I), they may well cancel out each other, thereby leading to a stagnation of per capita GDP (i.e. a state of zero growth in per capita income). In addition, as seen in equation (II), if this stagnation of per capita GDP is further accompanied by either a stagnant population or a declining population, then it would additionally lead to either zero GDP-growth (i.e. a stagnant economy) or negative GDP-growth (i.e. a shrinking economy), respectively. A preliminary analysis of the available data indicate that Japan is about to enter into this high-income trap and Germany may well follow in 5-10 years time. If Italy were also to follow Germany & Japan into this trap, then the final humiliation of the Axis-powers would be complete.

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APPENDIX

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In the examples cited, we have just covered and categorized Brazil, India, China & South-Africa ('BICS') from Jim O'Neil's much-ballyhooed 'BRICS' group. But where is the 'R' of Russia? Where does Russia stand in this supply-side analysis? What are Russia's sources of growth? What type of economy does Russia have?

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Special Case: Russia from 1998 (End of Post-Soviet Depression) to Present

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(a) Total GDP shows strong growth
http://alturl.com/t4rqn

(b) GDP per capita also shows strong growth
http://alturl.com/i6fjw

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But from where did this growth come? What were its sources?

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(i) There was a very strong rise in Productivity (partly due to rising oil & gas prices)

http://alturl.com/5ksp5

(ii) There was a tiny increase in the Participation rate

http://alturl.com/r36ba

(iii) There was a small improvement in Demographic Profile

http://alturl.com/ozgv5

(iv) There was a unusual decrease in Population (Alarm bell!)
http://alturl.com/ct9ai

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Summary: Clearly, the problems of Russia are neither the ones Brazil is facing, with its almost complete absence of productivity growth, nor the ones China is facing, with its problems well-described in Michael's blog. The problems of the Russia lie in the vodka-induced collapse of health statistics for men (i.e. a social depression), which in turn is leading to a decimation of the population, as seen here:
1) Probability of living past 65 for men: http://alturl.com/n92h2
2) Life expectancy at birth for males: http://alturl.com/u8hmh
3) Birth-rate (compare to death-rate): http://alturl.com/sx5pb
4) Death-rate (compare to birth-rate): http://alturl.com/2udmt
5) Results in shrinking population: http://alturl.com/4h2s9
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