Friday, July 25, 2008

How the Economic World is Changing

I heard Mohamed El-Erian interviewed on the Charley Rose show. I want to post on three things he said:
  • The motors of international economic development are changing,
  • The international pattern of savings is changing and thus so too is the international flow of investment.
  • Our indicators created for the earlier economic patterns failed to warn us of the nature of the current economic problems and we need new indicators more attuned to the current reality.
Growth in the world's economy is the aggregate of growth in national economies, weighted by the relative magnitudes of the nations' GDPs. In the decade after World War II the economy of the United States was so great a portion of the economy of the free world that its growth rate also dominated world growth. It is generally believed that developed nations have lower growth rates than the most successful developing nations because it is harder to grow at the economic frontier than to play catch up. What ever the reason, economically successful developing countries such as China and India have economic growth rates much higher than that of the United States, Europe and Japan. As their GDP's grow to more nearly approximate those of Europe and the United States in size, their growth will represent an even larger portion of global economic growth. In this sense the United States is being replaced as the global motor for development by a multi-engine system with big motors in Asia being added to the big motors of North America and Europe.

It seems likely to me that the faster the increase in GDP, the more rapid the technological innovation. So it seems likely that China and India, as well as Russia, Brazil and other rapidly growing nations are also motors of global technological innovation.

The invention of new technologies is perhaps a more important motor for long term economic growth, and this is perhaps less directly correlated with the rate of GDP growth, and more related with a combination of variables including the size of the economy, its rate of increase of GDP, its gross expenditure on research and development, and the "distance" between its current technology and the global technological frontier.


El-Erian points out that the United States has a very low saving rate, and indeed has been borrowing against the appreciation of its real estate to finance high levels of consumption while many the Asian economies are sustaining very high rates of saving. In the distant past rich countries were using their wealth to invest in poor nations; now there is an important flow of savings from Asian nations to the United States.


I can't really comment on why our leading investment advisors missed the current crisis for so long as it developed.

It does seem to me that another change as the United States is making the transformation from an industrial society to a knowledge based society is that we are investing more in human resources, knowledge creation and knowledge management systems. It also seems to me that our current indicators of savings and investment don't do very well with the new forms of savings and investment. Someone who withdraws from their job for a while to learn and master a new skill is counted currently as a reduction of GDP rather than as a savings and investment in knowledge and human resources.

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