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regular-article-logo Sunday, 16 June 2024

Modest assessment

A continuation of past trends — namely, ageing populations and slowing investments and productivity growth together lead to the anticipated slowdown of the world economy by 2030

Renu Kohli Published 21.05.24, 06:55 AM
Diminished returns.

Diminished returns. Sourced by the Telegraph.

Last month, the International Monetary Fund had forecast world output to grow at the same pace in 2024 and in 2025 as last year. This is reassuring. However, a 3.2% growth of the world economy is low by historical standards and the agency’s outlook beyond that is more sober. The world economy, it has been foreseen, would slow down to 2.8% by the end of the decade which is one percentage point lower than its pre-pandemic average. It notes that medium-term growth prospects have consistently been revised downward since the 2008-09 financial crisis. The roots of this decline are traceable to the early 2000s for advanced economies, whereas for emerging market and developing economies, where India is grouped, the trend set in after 2008-09. The research identifying the factors depressing medium-term growth has significant takeaways for India, which is basking in its recent economic performance.

Taking stock of India’s short-term growth trajectory is useful to start with. The IMF’s April 2024 economic outlook projects real GDP growth slowing to 6.8% and 6.5%, respectively, this year and the next, following a 7.8% increase in 2023-24. These growth rates do stand out in a cross-country perspective. However, we must take a longer, analytical perspective. This is necessary for improved sight on the future path and for better policy planning and response.

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First, the 9.7%, 7.0%, and 7.6% real GDP growth in succession after the pandemic still leaves national economic output 8% lower than it would have been if the economy had not contracted by -5.8% in 2020-21 and grown at trend 6.5% throughout instead. Some economists peg India’s trend growth to be lower at 6%, in which case the size of the economy is ~6% smaller. To put this more generally, the economy is still a laggard by at least one and a half years, if not more, despite the strong recovery from the pandemic. Therefore, there’s a significant amount of catch-up growth that remains in the pipeline.

One can internalise this further at the per person level for a better understanding of the extent of income loss or setback in economic well-being and living standards, or the weakened spending capacity of the average Indian in the period. What is important to grasp here is that given the extent of output loss that is still to be recouped after the pandemic, these growth rates should not surprise us. The recuperation is only to be expected. Rather attention ought to be on the medium-term prospects. Estimates of India’s economic size, the year by which it will reach a higher world ranking, abound in the public discourse. More seriously though, once past economic losses have been regained, could the Indian economy individually succumb to a medium-term slowdown as seen globally before the pandemic, one that is projected to continue? Are there features to note and counter in the changed settings of high interest rates and public debt, geoeconomic fragmentation and so on?

The in-depth research provides useful insights. Fifty per cent of the global growth decline after 2008-09 is accounted for by slower growth of total factor productivity — the efficiency with which capital and labour are used. The rest is attributable to a fall in private investment and slower population growth in the major economies. While demographic features are structural, what explains the shortfall in business investments worldwide? About half of the private investment slowdown since 2008 is owing to weaker economic activity or growth; the rest of the constraints are due to decreases in firms’ expectations of future productivity and profitability along with debt, which was a prominent factor for the emerging markets.

A continuation of past trends — namely, ageing populations and slowing investments and productivity growth together lead to the anticipated slowdown of the world economy by 2030. Unless, of course, some concerted actions are taken. There are variations underlying this aggregate outcome; for instance, labour supply does not necessarily decrease in the low income or in all emerging market economies. Capital is likely to contribute less on average than it did before the pandemic because of public spending cuts to lower debt as well as lesser business investments on dimmer economic prospects and lower employment and productivity.

The conclusions cannot be dismissed as being overly pessimistic. In fact, they are reasonably convincing because the trend and the shortfalls have been observed across nations even if their future continuation is not agreed upon. Localise this to India where a youthful, growing labour force or positive demographics will add to GDP growth in the forthcoming years. However, nearly half the working population, an increased percentage in recent years, is engaged in agriculture, a low-productivity sector. It is, therefore, a relatively less efficient use of this endowment.

Changes in the economic structure also represent productivity trends as these vary by sector — producing goods or manufacturing is typically high-productivity compared to agriculture and services. How resources or capital and labour are distributed in the process of economic growth can reflect efficiency of allocation as a further investigation of 20 countries shows. This does not include India but the insights are as applicable. Sectoral share shifts accounted for one-third of annual productivity decline overall, but it was double or 60% of the misallocation impact upon China’s productivity. The clear lesson for India, where structural transformation has progressively increased services’ share with manufacturing being stagnant, is to address sub-optimal allocations of labour and capital. This assumes more relevance as the business investment deficit since 2008 is a shared global characteristic along with a constraint on public finance that has already set in.

This mix of factors dragging down medium-term growth should be of concern. The advocacy for interventionist policies to raise productivity includes structural reforms, where India has a striking achievement record, although they are yet to bear fruit. Concerted efforts to grow manufacturing have been made in recent years; geopolitics is commonly regarded favourable due to China de-risking. However, geoeconomic fragmentation will impact trade in uncertain ways. We cannot be sanguine about medium-term growth prospects.

Renu Kohli is an economist with the Centre for Social and Economic Progress, New Delhi. Views are personal

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