Wednesday, October 16, 2013

Two kinds of growth

Much has been written about how China and other developing nations are growing much faster than the developed nations in general, and the US in particular.  The growth of China's GDP over the last decade has averaged nearly 10%, while that of the US has been below 3%. 

This difference, it is implied, is due to the superiority of the Chinese model over the US model, which is now seen as faltering.  I think this kind of comparison is unfounded.  There are really two kinds of growth which I will term: Innovative growth, and Catch-up growth.

Developed nations, like the US, are operating near their potential production.  Although recently the recession has put a major dent in this.  What being near potential production means is that the economy is at full employment using state-of-the-art technology and is producing the maximum possible output.  More importantly the per capita production is maximal.  Any increase in production has to come from either increases in efficiency of current methods or innovations of new methods of production.  And, in any case, the former is usually a form of the latter.  So, for an advanced developed nation like the US to grow it has to innovate.  Innovation is risky, expensive, and time consuming.  Innovation forms a cost to current consumption that promises an increase in future growth, albeit at an uncertain rate.  The rate of growth in a developed country is mainly determined by the rate of investment in innovation.

In a developing country like China, the state of technology is generally far behind that of the developed countries.  That's pretty much the definition of developed and less-developed nations.  So, for that country to develop further it must first acquire existing technologies from the developed countries and implement them domestically.  The developing country must catch up technologically with the developed countries.  Importing technology is much simpler, cheaper, less risky, and less time consuming than creating new innovation themselves.  So, the developing country can grow much faster than the developed country.

The real issue for the US is that investment in innovation and new production has fallen, which limits the rate of growth of the economy.  But, even when those pick up again, a growth rate much above 3% is unlikely due to the need for massive investment in innovation to spur such high growth rates.  A massive level of investment does not seem likely without some government mandate for some great national cause.

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