Regime change in the global economy

In 1979, W. Arthur Lewis received the Nobel Prize in Economics for his analysis of the dynamics of growth in developing countries. With good reason: his conceptual framework has proven invaluable in understanding and guiding structural change in a range of emerging economies.
The basic idea Lewis emphasized is that developing countries grow initially by expanding their export sectors, which absorb surplus labor in traditional sectors like agriculture. As incomes and purchasing power increase, domestic sectors develop alongside market sectors. Productivity and incomes in largely urban and labor-intensive manufacturing sectors tend to be 3-4 times higher than in traditional sectors, so average incomes rise as more people go to work in the expanding export sector. But, as Lewis noted, it also means that wage growth in the export sector will remain depressed as long as there is a labor surplus elsewhere.
As the availability of labor is not a constraint, the key factor for growth is the level of capital investment, which is necessary even in labor intensive sectors. The returns from these investments depend on the conditions of competition in the global economy.
This dynamic can produce surprisingly high growth rates that sometimes continue for years or even decades. But there is a limit: when the supply of surplus labor is exhausted, the economy reaches what is known as the Lewis turning point. Typically, this happens before a country has moved out of the lower middle income bracket. China, for example, reached its Lewis turning point 10 to 15 years ago, which brought about a major shift in the country’s growth momentum.
At the Lewis turn, the opportunity cost of moving more labor from traditional sectors to modernizing sectors is no longer negligible. Wages are starting to rise across the economy, which means that if growth is to continue, it must be driven not by a shift of labor from low-productivity to high-productivity sectors. higher productivity, but by increases in productivity within sectors. Because this transition often fails, the Lewis turn occurs when many developing economies fall into the middle-income trap.
Lewis’ growth model is worth revisiting because something similar is happening today. When the global economy began to open up and become more integrated several decades ago, massive amounts of labor and productive capacity previously disconnected and inaccessible in emerging economies moved into the sectors manufacturing and exporting, producing spectacular results. Manufacturing activity has shifted away from developed countries and exports from emerging economies have grown faster than the global economy.
Due to the magnitude of relatively cheap labor in emerging economies (particularly China), wage growth in tradable sectors in advanced economies has been subdued, even when activity is slack. is not shifted to emerging economies. The bargaining power of labor has been reduced in developed economies, and the negative pressure on middle and low income wages has spread to non-tradable sectors as labor moved into the industry has shifted to non-tradable sectors.
But that process is largely over. Many emerging economies have become middle-income countries and the global economy no longer has large pools of cheaply accessible labor to fuel the earlier momentum. Of course, there remain reservoirs of underutilized labor and potential productive capacity, for example in Africa. But these workers are unlikely to enter productive export sectors fast enough and on a sufficient scale to sustain the pre-turnaround momentum.
The Lewis turn will have profound consequences for the global economy. The forces that have depressed wages and inflation over the past 40 years are receding. A wide range of emerging and developed economies are ageing, reinforcing the trend, and the Covid-19 pandemic has further reduced labor supply in many sectors, perhaps permanently. Under these conditions, the four-decade decline in labor income as a share of national income is likely to be reversed – although automation and other rapidly advancing labor-saving technologies may counteract this process to some extent.
In short, now that decades of growth in developing countries have exhausted much of the world’s spare productive capacity, global growth is increasingly constrained not by demand but by supply and supply dynamics. of productivity. It is not a transitory change.
An obvious consequence of this process is that inflationary forces have shifted dramatically. After disappearing or flattening for an extended period, the Phillips curve (which describes an inverse relationship between inflation and unemployment) is probably back, permanently. Interest rates will rise alongside inflationary pressures, which are already forcing major central banks to withdraw liquidity from capital markets. — Project syndicate

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