Examination of long term historical experience shows that the decisive issue in determining the rate of growth of any country’s economy is the proportion of the economy devoted to investment (gross domestic fixed capital formation). This is itself determined by the total (i.e. private, company, and government) savings level as every act of investment must be financed by an equivalent act of saving.
To illustrate this Figure 1 below shows the percentage of fixed investment (gross fixed capital formation) in GDP for a series of major countries over the longest periods of time for which data is available.[1]
The pattern is clear and striking. By far the strongest trend is for the proportion of GDP devoted to fixed capital formation to rise with time. This rising proportion of fixed investment in GDP in turn, as will be seen, is associated with rising rates of economic growth.
Taking the countries in the chronological order of when a new peak in the proportion of GDP devoted to gross fixed domestic capital formation appeared the following pattern appears.
• Going back to the period immediately antedating the industrial revolution, the proportion of GDP devoted to fixed capital formation in England and Wales, at the end of the 17th century, was 5-7 per cent. This rose slightly, although current estimates are that it did not rise greatly, during the 19th century - peaking at over ten percent of UK GDP prior to World War I. This level of investment was sufficient to launch the first industrialisation of any country, but at a rate of growth that, while unprecedented for the time, was extremely slow by contemporary standards - about two per cent a year. On that basis of such a growth rate it takes 35 years for an economy to double in size and 70 years to quadruple.
• Turning to the latter part of the 19th century, the proportion of US GDP devoted to gross domestic fixed capital formation had grown to considerably exceed the UK - rising to 18-20 per cent of GDP by the last decades of the century. A sharp fall in the proportion of the US economy devoted to investment commenced in the late 19th century and was particularly pronounced during the period between World War I and World War II – being associated with the great depression of the inter-war period. After World War II the US resumed its pattern of 18-20 per cent of GDP being devoted to gross fixed capital formation. This generated an average growth rate of 3.5 per cent a year. With such a growth rate an economy doubles in size every 20 years and quadruples in size every 40 years. It was on the basis of this level of investment, and growth rate, that the US overtook Britain to become the greatest economic power in the world.
• In the period following World War II Germany achieved a level of fixed investment exceeding 25 per cent of GDP – peaking at 26.6 per cent in 1964. This period 1951-64 was the post-war German ‘economic miracle’ with average growth of 6.8 per cent a year. On that basis an economy doubles in size in slightly every 11 years and quadruples in 22 years.
• Starting at the beginning of the 1960s Japan achieved a level of fixed investment of more than 30 per cent of GDP. This reached a peak in the early 1970s, at 35 per cent of GDP, before later sharply falling. During that period the average annual rate of growth of the Japanese economy was 8.6 per cent a year. On that basis an economy doubles in size in eight and half years and quadruples in size in 17 years.
• From the 1970s onwards, South Korea also achieved a level of fixed investment of 30 per cent of GDP. During the 1980s this rose above 35 per cent of GDP. The other East Asian ‘Tiger’ economies – Singapore, Hong Kong and Taiwan – showed a similar pattern. South Korea’s economy confirmed the relation between fixed investment and economic growth illustrated by Japan by growing in this period by an average 8.3 per cent a year. At such a growth rate an economy doubles in size in nine years and quadruples in 18. Such growth rates in Asia showed that something unprecedented in human history was now possible – that it was possible to industrialise an economy, and achieve a ‘first world’ level of development, in a single generation.
• From the early 1990s onwards China already achieved sustained rates of fixed investment of 35 per cent of GDP. From the beginning of the 21st century China achieved rates of gross domestic fixed capital formation of more than 40 per cent of GDP – a level never before seen in human history. The result was average 9.8 per cent a year economic growth over a sustained period. On that basis an economy doubles in size every seven a half years and quadruples in size in 15 years. The result in China was the most rapid economic growth ever seen in human history.
• In order to complete the chronological picture, the proportion of GDP devoted to fixed investment for two countries recently undergoing rapid economic growth is also shown - India and Vietnam. The proportion of Indian GDP devoted to fixed investment has not achieved the Chinese level but has become extremely high – achieving a level of 34 per cent of GDP in 2007. On this basis, in the last five years, India has achieved an average growth rate of 8.8 per cent a year. At that rate of growth its economy doubles in size in slightly over eight years and quadruples in sixteen and a half years. In Vietnam the proportion of GDP devoted to fixed investment rose from 13 per cent in 1990, to 25 per cent in 1995, to 37 per cent in 2007. Economic growth has accelerated rapidly rising to an average of 7.9 per cent a year in the five years up to 2007. At that rate of growth its economy doubles in size in slightly under 9 years.
Such a high level of investment is a necessary condition for rapid economic growth – no country without such high levels investment has achieved such rapid rates of growth on a sustained basis. But it is not a sufficient condition. The high level of investment is also crucially linked to the scale of production – that is the size of the market which is being produced for.
In a modern economy only large scale production can be efficient in the decisive areas of the economy and that requires an orientation to the international market. No purely national market, not even the US or China, is sufficiently large to maintain the most efficient level of production. High levels of investment must therefore be accompanied by an orientation which, from the beginning, aims also at exports and not purely domestic production.
It is this high level of investment, accompanied by an orientation including exports, which was responsible for the rapid economic growth of South Korea, China, India and Vietnam. Such rapid rates of growth, in turn, produced sustainable rapid growth of living standards of the population.
These issues however pose clearly the issue of economic strategy for Venezuela. The single most important strategic economic choices that need to be made are those concerning savings and investment levels in the economy. The potentials that exist in this area for Venezuela will be discussed in future posts on this blog.
Notes
[1] The figure for England for 1688 is that in Angus Maddison, The World Economy, OECD Paris 2006 p395. UK figures after 1688 and up to 1947 are calculated from One Hundred Years of Economic Statistics, The Economist, London 1989 p74. Figures from 1948 are calculated from International Monetary Fund, International Financial Statistics http://www.imfstatistics.org/imf/. Minor adjustments have been made to chain the earlier statistics to be consistent with the IMF data – in no case does this make any significant difference to the pattern shown.
US figures prior to 1948 are calculated from One Hundred Years of Economic Statistics, The Economist, London 1989 p74. Figures from 1948 are calculated from International Monetary Fund, International Financial Statistics http://www.imfstatistics.org/imf/. Data for the earlier period give only private fixed capital formation whereas that after 1948 is for total fixed capital formation – i.e. including government fixed capital formation. There are no reliable estimates of government fixed capital formation in the earlier period and therefore data for the earlier period have been adjusted upward by the difference between the two in 1948 – which is slightly over two per cent of GDP. This has the effect of revising upwards slightly the percentage of GDP allocated to fixed investment in the earlier period but the difference is too small to affect the overall pattern.
Figures for Germany prior to 1960 are calculated from One Hundred Years of Economic Statistics, The Economist, London 1989 p202. Figures from 1960 are calculated from International Monetary Fund, International Financial Statistics http://www.imfstatistics.org/imf/. There is however no significant statistical difference between the two.
Figures for Japan are calculated from International Monetary Fund, International Financial Statistics http://www.imfstatistics.org/imf/.
Figures for South Korea are calculated from International Monetary Fund, International Financial Statistics http://www.imfstatistics.org/imf/.
Figures for China are calculated from International Monetary Fund, International Financial Statistics http://www.imfstatistics.org/imf/.
Figures for China are calculated from International Monetary Fund, International Financial Statistics http://www.imfstatistics.org/imf/.
[2] Phyllis Deane and W A Cole in British Economic Growth 1688-1959, Cambridge University Press, Cambridge 1980 p2 being closer to the lower figure while further studies have tended to revise the figure upwards slightly. The higher estimates for the earlier period have been taken here so as to avoid any suggestion of exaggerating the degree to which the proportion of GDP devoted to Gross Domestic Fixed Capital Formation has risen. The precise figure used here is that calculated by Maddison in Angus Maddison, The World Economy, OECD Paris 2006 p395. The higher figure, as can be seen, makes no difference to the overall trend.
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