growth Vs GDP per head

• Growth tends to slow when GDP per head reaches a certain threshold. China is getting close.The economic crisis may have been debilitating for the rich world but for emerging markets it has been closer to a triumph. In 2010 China overtook a limping Japan as the world’s second-largest economy. It looks sets to catch America within a decade or two. India and Brazil are growing rapidly. The past few years have reinforced the suspicion of many that the story of the century will be the inexorable rise of emerging economies. If projections of future growth look rosy for emerging markets, however, history counsels caution. The post-war period is rich in examples of blistering catch-up growth. But at some point growth starts to disappoint. Gaining ground on the leaders is far easier than overtaking them.
• Rapid growth is initially easy because the leader has already trodden a clear path. Developing countries can borrow existing technologies from countries that have already become rich. Advanced economies may be stuck with obsolete infrastructure; laggards can skip right to the shiniest and best. Labour productivity soars as poor economies shift workers from agriculture to a growing manufacturing sector. And rapid income growth among young workers boosts savings and fuels investment.
• But the more an emerging economy resembles the leaders, the harder it is to sustain the pace. As the stock of borrowable ideas runs low, the developing economy must begin innovating for itself. The supply of cheap agricultural labour dries up and a rising number of workers take jobs in the service sector, where productivity improvements are more difficult to achieve. The moment of convergence with the leaders, which once seemed within easy reach, retreats into the future. Growth rates may slow, as they did in the case of western Europe and the Asian tigers, or they may falter, as in Latin America in the 1990s.
• The world’s reliance on emerging markets as engines of growth lends urgency to the question of just when this “middle-income trap” is sprung. In a new paper* Barry Eichengreen of the University of California, Berkeley, Donghyun Park of the Asian Development Bank and Kwanho Shin of Korea University examine the economic record since 1957 in an attempt to identify potential warning-signs. The authors focus on countries whose GDP per head on a purchasing-power-parity (PPP) basis grew by more than 3.5% a year for seven years, and then suffered a sharp slowdown in which growth dipped by two percentage points or more. They ignore slowdowns that occur when GDP per head is still below $10,000 on a PPP basis, limiting the sample to countries enjoying sustained catch-up growth. What emerges is an estimate of a critical threshold: on average, growth slowdowns occur when per-head GDP reaches around $16,740 at PPP. The average growth rate then drops from 5.6% a year to 2.1%.
• This estimate passes the smell test of history. In the 1970s growth rates in western Europe and Japan cooled off at approximately the $16,740 threshold. Singapore’s early-1980s slowdown matches the model, as does the experience of South Korea and Taiwan in the late 1990s. As these examples indicate, a deceleration need not precipitate disaster. Growth often continues and may accelerate again; the authors identify a number of cases in which a slowdown proceeds in steps. Japan’s initial boom lost steam in the early 1970s, but its economy continued to grow faster than other rich nations until its 1990s blow-up.
• In the right circumstances the good times may be prolonged, allowing an economy to reach a higher income level before the inevitable slowdown. When America passed the threshold it was the world leader and was able to keep growing rapidly so long as its own innovative prowess allowed. Britain’s experience indicates economic liberalisation or a fortunate turn of the business cycle may also prevent the threshold from binding at once.
• Openness to trade appears to be a potent stimulant: the authors attribute the outperformance of Hong Kong and Singapore to this effect. Lifting consumption to just over 60% of GDP is useful, as is a low and stable rate of inflation. Neither financial openness nor changes of political regime seem to matter much, but a large ratio of workers to dependents reduces the odds of a slowdown. An undervalued exchange rate, on the other hand, appears to contribute to a higher probability of a slowdown. The reason for this is not clear but the authors suggest that undervaluation could lead countries to neglect their innovative capacity, or may contribute to imbalances that choke off a boom.
• The authors are careful to say that there is no iron law of slowdowns. Even so, their analysis is unlikely to cheer the leadership in Beijing. China’s torrid growth puts it on course to hit the $16,740 GDP-per-head threshold by 2015, well ahead of the likes of Brazil and India. Given the Chinese economy’s long list of risk factors—including an older population, low levels of consumption and a substantially undervalued currency—the authors suggest that the odds of a slowdown are over 70%.
• It is hazardous to extend any analysis to a country as unique as China. The authors acknowledge that rapid development could shift inland, where millions of workers have yet to move into manufacturing, while the coastal cities nurture an ability to innovate. The IMF forecasts real GDP growth rates above 9% through to 2016; a slowdown to 7-8% does not sound that scary. But past experience indicates that slowdowns are frequently accompanied by crises. In East Asia in the late 1990s it became clear that investments which made sense at growth rates of 7%, say, did not at expansion rates of 5%. Political systems may prove similarly vulnerable: it has been many years since China has to deal with an annual growth rate below 7%. Structural reforms can help to cushion the effects of a slowdown. It would be wise for China to pursue such reforms during fat years rather than the leaner ones that will, eventually, come

the reformation

• An  disjoint attempt made by IMF to refine it’s thinking on capital control. Foreign capital fled the emerging world in the throes of the economic crisis. Now, lured by their better growth prospects and repelled by rich countries’ low interest rates, money has gushed back into countries like Brazil, Peru, South Africa and Turkey. Paulo Nogueira Batista, Brazil’s executive director at the fund, calls it an “international monetary tsunami”.
• Usually emerging markets welcome foreign capital, which can help finance much-needed investment. But the recent surge has them worried, partly because of its speed and fears of an equally rapid reversal. The IMF reckons that gross inflows have risen to 6% of emerging-world GDP in about a quarter of the time taken for a similar spike before the crisis. Policymakers also fear that this flood of capital could lead to asset-price bubbles and overvalued currencies. Many have implemented measures to stem the tide, from Brazil’s tax on portfolio inflows to Peru’s higher charge on non-residents’ purchases of central-bank paper.
• Such policies—particularly capital controls that apply specifically to foreign investors or treat them differently from nationals—have long been controversial. Countries that use them are often accused of doing so to keep their currencies artificially undervalued. Critics reckon that with their prospects improving emerging markets should just let their currencies rise. But emerging economies retort that the reason capital is flooding their way may have less to do with their long-term prospects than with temporary factors such as unusually loose rich-world monetary policy, over which they have no control. Adding to the confusion is the absence of any internationally accepted guidelines about what is acceptable when it comes to managing capital flows.
• The IMF is the natural arbiter of such issues. It has already stepped back a little from its historical antipathy to capital controls. In February 2010 a research paper by a team of economists at the fund led by Jonathan Ostry cautiously endorsed the use of controls in situations where a country facing a capital surge had a currency that was appropriately valued, had already built up enough reserves and had no further room to tighten fiscal policy. The fund now reckons these conditions are not all that rare. It finds that 9 out of 39 emerging markets studied would have been justified, as of late 2010, in resorting to such controls because they had exhausted other options. There is a need, therefore, for more clarity on which measures are justified, and when.
• On April 5th the IMF released two documents designed to achieve just that. The  first, a “framework” for policy advice that is approved by the fund’s board, lays out the institution’s official thinking. The other, by Mr Ostry and his colleagues, provides the analytical backing for the framework paper and explains the conditions under which various kinds of policy instruments might help manage capital flows. The two papers aim to ensure that the advice the IMF gives member countries is consistent. But several curious differences between them suggest that the fund’s own thinking on managing capital flows is far from settled. In at least two respects the new paper by Mr Ostry’s team marks a further evolution of the fund’s position on capital controls. But the board-endorsed policy framework seems less inclined to budge.
• Earlier IMF papers emphasised that capital controls should be imposed only in the face of temporary surges in inflows, arguing that the exchange rate should adjust when it came to permanent shocks. But Mr Ostry’s team now points out that persistent inflows might be even more dangerous in terms of asset-price bubbles. It concedes that controls may be useful to target inflows that are expected to endure, because of the threat to financial stability. The framework paper is much more conservative, arguing that capital-flow measures “are most appropriate to handle inflows driven by temporary or cyclical factors”.
• The IMF has historically been more favourably disposed towards “prudential” measures, which are designed to stop inflows from destabilising financial systems and do not explicitly discriminate between residents and foreigners, than towards capital controls, which erect barriers designed to stop the exchange rate from rising. Mr Ostry and his colleagues point out that some prudential measures distinguish between local-currency and foreign-currency transactions. This makes them more like capital controls since most foreign-currency liabilities are likely to be owed to foreigners. It may thus make sense to treat such prudential measures and capital controls similarly. The framework paper, however, maintains that countries should “give precedence to capital-flow measures that do not discriminate on the basis of residency (such as currency-based prudential measures)” over those that do. The disconnect is glaring and confusing.
• The fund’s attempts to flesh out what countries threatened by a surge of capital should do come up against a more fundamental problem, too. Many emerging economies argue that the IMF is focusing on the wrong players. Mr Nogueira Batista told a Brazilian newspaper that he objected to “countries that adopt ultra-expansive monetary policy to get over the crisis [and] provoke an expansion of liquidity on a global scale”, and which then insist on guidelines about how recipients should behave. (Indeed, emerging economies were firmly opposed to the fund’s original plan to refer to what is now a “framework” for policy advice as the more prescriptive-sounding “guidelines”.) The fund acknowledges that these “push factors” are important, and should be addressed. Its own analysis suggests that American interest rates have a larger effect on flows to emerging economies than those economies’ own growth performance.
• A fund insider says that negotiations around the new framework on capital-flow measures were “the most contentious that any staffer can remember”. It shows.