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The only caveat

The UNDP’s Human Development Report 2013, ‘The Rise of the South: Human Progress in a Diverse World’ is a vindication of the assertion that the future of world economic growth largely lies in the developing world. Emerging economies have shown great resilience in the wake of the financial crisis that has gripped the world since 2007.

The report says that: “The South has arisen at an unprecedented speed and scale. For example, the current economic takeoffs in China and India began with about one billion people in each country and doubled output per capita in less than 20 years – an economic force affecting a much larger population than the Industrial Revolution did”.

Undoubtedly, human development indicators and per capita income in the developing countries have registered an increase but convergence of per capita income as postulated long ago by growth economists still remains a distant dream. Moreover, growth in the developing world is highly uneven. The report itself admits: “All developing countries are not yet participating fully in the rise of the South”. Growth has not been inclusive since inequality has sharpened in those countries that witnessed impressive growth.

However, at the same time it cannot be disputed that economic growth is necessary for prosperity. It contributes towards poverty reduction at least through two very distinct channels: first, it creates opportunities of gainful employment and second, it enhances tax revenues that the state can spend on education, health and transfer payments.

The report raises a few fundamental questions. Why is the South showing respectable economic growth compared to the North? Is the financial crisis the real cause of sluggish growth in the North? Or is the financial crisis just a symptom and the underlying causes lie somewhere else? What should we expect in the coming years?

A simple and straightforward interpretation using standard economic theory is that the economies of the rich countries are already operating on the production possibility frontier, ie near their potential, while developing countries have still to catch up. If the developing countries put in place good economic institutions and follow sound economic policies, they may rapidly catch up with the growth witnessed by the advanced countries.

So the argument runs that a developing country does not necessarily need to make huge investments for research and development. Impliedly, it is not some genuine innovation rather a capacity to imitate and exploit their unutilised potential that can accelerate economic growth.

On the contrary, innovation and constant improvements in technology are a must for a developed country to sustain its growth. It needs to push the production possibility frontier outwards, economists say – which implies that faltering innovation in a developed country is like a death knell to economic growth.

Professor Robert Gordon of Northwestern University has raised the issue of innovation in the US in his paper, ‘Is US economic growth over? Faltering innovation confronts the six headwinds’. He says that the assumption of the modern growth theory that growth is a persistent phenomenon is not true as there was no growth before 1750. Economic growth began in the 1750s, the fastest growth rates were reached in the middle of the 20th century and began to slow down since then. The process of slowdown is continuing and may persist for long.

Why did growth pick up in the 1750s and persist for almost 250 years? According to Professor Gordon, the pace of growth during this period is in a sequence of three distinct revolutions. The first industrial revolution owed itself to the inventions like the steam engine, the cotton gin and early railroads, though the impact of the railroad came later. It took almost 150 years for the first industrial revolution to have its full impact.

The second industrial revolution (1870-1900) made had a huge impact on people’s lives. Useable electricity, the internal combustion engine, the telephone, the phonograph, and motion pictures were all invented during this period. Although a lot of progress had been made by 1870 and machines had started replacing humans and animals, overall life was dark and tasteless.

The second industrial revolution dramatically changed the living standards of the people but many improvements this revolution brought could only happen once. The growth in productivity increased remarkably and, after touching its peak, diminishing returns set in. The invention and emergence of computers, the Internet and e-commerce (third industrial revolution), however, continued to bolster economic growth in the US.

By the 1970s, even before the coming of PCs, retying had become obsolete owing to memory typewriters. Web and e-commerce were developed rapidly after 1995 but this process was almost completed by 2005. Personal computers, web and e-commerce directly contributed to economic growth by augmenting the efficiency and productivity of labour but after 2005 economic growth started faltering – and this trend is likely to continue.

What about inventions and innovations made in the last decade like the iPod and smartphones? Are they not innovations? According to Gordon’s thesis, such inventions are not labour-saving innovations as were computers and robots etc. Such innovations are more focused on entertainment and communication. They do not replace labour as has been the case with earlier innovations and as such are not significant contributors to economic growth. Their impact on labour productivity or the standard of living is far less compared to the electric light, motor cars, and indoor plumbing etc.

Even Professor Kenneth Rogoff of Harvard University, who believes that the recession in the global economy is an aftermath of the systemic financial crisis, does not altogether rule out the faltering innovation as a cause of the stalled economic growth in the North. In his article ‘Innovation crisis or financial crisis?’ he writes: “Attributing the ongoing slowdown to the financial crisis does not imply the absence of long-term secular effects, some of which are rooted in the crisis itself.

Credit contractions almost invariably hit small businesses and start-ups the hardest. Since many of the best ideas and innovations come from small companies rather than the large, established firms, the ongoing credit contraction will inevitably have long-term growth costs. At the same time, unemployed and under-employed workers’ skill sets are deteriorating”.

Faltering innovation means that you have limited choice to replace human labour with machines and capital more efficiently. Further, economic growth in the North is also constrained by demographic composition. An ageing population is becoming a big challenge for these societies. Emancipation of women had a direct bearing on the economic growth of the North as women became part of the labour workforce. Contrary to this, in most of the developing countries the majority of the women are still not part of the labour market. A huge human resource is still lying untapped in such countries.

Contrary to innovation and ageing crises in the North, a developing country like Pakistan has immense untapped potential which, if utilised to the best possible extent, can put the country on the track of sustainable economic growth. The only caveat is that we set our house in order. We do not necessarily require big innovations to ignite growth in Pakistan. It is not our inability to acquire modern technology that is hindering us, rather distorted incentive structures, poor governance, and corruption that are the actual culprits for the malaise afflicting us.

The writer is a graduate of Columbia University. Email: jamilnasir1969@ gmail.com

Jamil Nasir, "The only caveat," The News. 2013-04-25.
Keywords: International economics , Economic growth , Financial crisis , International development , Economic policy , Economy-United States , Foreign investments , Policy making , Tax revenue , Corruption , Unemployment , Poverty , Robert Gordon , Kenneth Rogoff , United States , China , India , UNDP