What will drive global growth?

Ageing populations are likely to slow capital formation in North Asia, hurting global growth

In Tessellatum in the last three months, we have discussed three of the major implications of Asia’s ageing: That demographic shift in 10 major Asian economies (the A-10: China, India, Indonesia, Japan, the Philippines, Vietnam, Thailand, Korea, Malaysia, and Taiwan) is faster than the economic transition, that workforce quality is likely to trump quantity, and that Asia will continue to provide savings to the world. In this, the last of the four-part series, we see what this means for global growth.

Over the past three decades, the contribution of A-10 economies to incremental global gross domestic product (GDP) growth has risen steadily, reaching 70 per cent between 2014 and 2019, from 40 per cent in the previous five years, and less than 10 per cent in the 1994-1999 period. While China’s rise has been the main driver, steady growth in India and the Asean economies, compounded over multiple decades, has also contributed.

While analysing, it helps to split GDP growth into three factors: Labour input, capital input, and total factor productivity (TFP). Put simply, one can grow output by adding more workers, or getting them to work more hours. Output growth can also be achieved by adding capital, say by adding machines or working capital. The TFP is a measure of efficiency: How well the human and capital inputs are used to generate output. For example, if we need to increase the number of research reports written by a firm, we can add more analysts (labour input), give them access to more purchased databases and faster computers (capital input), get them to collaborate and use external data more creatively (more ideas = higher TFP).

Labour size has not been a large driver of growth for at least the last 15 years. Even in the 1999–2004 period, when working population was expanding in all A-10 economies other than Japan, labour was growing at 0.8 per cent annually, and was less than a sixth of total growth. Labour growth slowed to 0.4 per cent a year in the 2005–14 period, and 0.3 per cent between 2014 and 2019, with limited contribution to overall growth. Thus, even as ageing populations slow down the number of available workers or the number of hours they can work every week, there would be limited incremental impact on growth.

A substantial part of the growth deceleration in A-10 GDP between 2015 and 2019 has been due to weaker TFP growth. It was remarkably strong in India and Thailand over this period, but slowed meaningfully for other economies and turned negative for China. This was before trade wars started and geopolitical tensions began to overshadow economic collaboration (the transfer of knowledge and skills is an integral part of productivity improvement in economies that are away from the productivity frontier), implying that there may be deeper challenges. The contribution of TFP to overall GDP growth can be large over time, though the underlying changes driving it are slow and steady — for example, the footprint of the state receding or growing in an economy, which adds or shrinks the space available to the private sector.

Illustration: Binay Sinha

The risk, in our view, is in capital formation, which has been the largest contributor to GDP growth in the A-10 in the last two decades. There has been considerable jump in capital use in several countries, including India, Indonesia, and the Philippines, but China’s growth has been disproportionately driven by capital inputs.

Unlike labour inputs, where change is generally slow and somewhat intrinsic, capital inputs are affected by regulations (like the level of regulatory reserves in financial institutions, which balances safety of the financial system with the necessity of growth; the decision to open the economy to foreign capital; or allowing savings to flow into housing) and risk-appetite.

Demographics also play an important role in the demand for investments, especially for real-estate and infrastructure.

This is where China’s real-estate problems could be a growth headwind for the world. As discussed widely in economic literature, China’s disproportionately high capital growth has been due to its focus on infrastructure spending and the surge in real estate investment. In a recent paper, Kenneth Rogoff and Yuanchen Yang show that nearly 80 per cent of the stock of housing (as measured in square meters of construction) in top cities is in Tier-3 cities, where population fell 2 per cent in 2021, and prices are down more than 15 per cent from the start of 2021. Further, these cities accounted for a large part of infrastructure construction (for example, 92 per cent of the roads built in 2020), which are funded disproportionately by land sales to real-estate developers. An expert on Chinese real estate told the Credit Suisse team in November last year that given existing inventories and price declines, recovery in the real estate markets in Tier 3 to Tier 5 cities could take four to five years.

Real estate contributes 15 per cent to China’s GDP, versus around 5 per cent for the developed Asian markets with ageing populations. By slowing capital formation, slowing real-estate construction in Tier-3 cities in China could be a significant growth headwind, not just for China, but also the world. The real-estate cycle in India is turning positive after a nearly decade-long downturn (see Tessellatum “The Shovel Returns”, December 2021). It should support India’s growth in coming years, but it is not large enough to affect global growth yet.

Thus, the impact of an ageing A-10 on the world is less due to labour supply, and more due to sluggish growth in capital deployment in demographically challenged North Asia. Slowing total factor productivity growth in some major A-10 economies is another headwind.

There are lessons for Indian policymakers from this growth framework too. Given that labour input is hard to change, and TFP changes slowly, GDP growth acceleration can only occur with faster growth in capital input. For this, policies that facilitate inbound foreign investment can help. For example, foreign manufacturers who want to use India for manufacturing, may want to sign advance pricing agreements (APA): These currently take six months or more. Keeping in mind that two-thirds of Vietnam’s exports are by foreign companies operating in the country, making these more templatised and easier to sign may be a way forward.

The writer is co-head of APAC Strategy for Credit Suisse