The West and the Rest in the International Economic Order

The international economic order has changed in the last 40 years and will no doubt go on changing, as leading economist, Angus Maddison, explains.*

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In 1962, we usually divided the world into three regions. The advanced capitalist group was then known as the developed world. The second was the “Sino-Soviet bloc”. Countries “in course of development” were the third world. The China-USSR split occurred in the early 1960s; most of the communist regimes collapsed around 1990, and the hostility of the cold war has largely faded away. The income gap between the former communist countries and the advanced capitalist group has become very much wider than it was. For this reason, a tripartite division of the world economy is no longer appropriate.

For rough comparisons, it is now useful to divide the world in two and compare developments in the advanced capitalist group with the aggregate for lower-income countries – designated as the “West” and the “Rest” in our tables. On average, the West increased its income per head fourfold from 1950 to 2001 – a growth rate of 2.8% a year. In the rest of the world there was a threefold increase – a growth rate of 2.2%. In both cases this was much better than earlier performance. From 1820 to 1950, income grew 1.3% a year in the West and 0.6% in the Rest. Though the gap in income level was still increasing, the acceleration in performance was bigger in the Rest.

Population of the West rose by half from 1950 to 2001 (0.8% a year), about the same pace as in 1820-1950. In the Rest, the situation was very different. Population grew by 2.0%, compared with 0.6% in the earlier period. This reflected a major improvement in welfare as mortality declined and life expectation rose from 44 to 65 years in 2001 – much faster than in the West. In the past two decades birth rates have fallen rapidly – a demographic transition which happened earlier in the West.

The West is now a relatively homogeneous group in terms of living standards, growth performance, economic institutions and modes of governance. Over the past five decades there has also been significant convergence in most of these respects. This is not true of the Rest. There are more than 180 countries in this group. They have nearly all increased their income levels significantly since 1950, but the degree of success has varied enormously. Most of Asia is experiencing fast per capita income growth. Most African countries are fairly stagnant. Most Latin American countries found it very difficult to keep a steady trajectory of advance in the 1980s and 1990s. Population growth is fastest in Africa, a good deal slower in Latin America and slower still in Asia. Life expectation and levels of education are lowest in Africa, better in Latin America, and better still in Asia.

Between 1950 and 2001, the Asian group increased per capita income fivefold and narrowed the relative gap between their incomes and the West. In other regions there was no convergence. Latin American income rose more than twofold, in the former command economies of Eastern Europe and the USSR less than twofold and in Africa about two thirds.

The divergence was even more striking in 1990-2001. In this period the Western group increased their income by a fifth, the Asian group by half, Latin America by a sixth, Africa stagnated and in the former communist countries per capita income fell by a quarter.

American policy since 1973 has been much more successful than that of Western Europe and Japan in realising potential for income growth. The incidence of unemployment is now about half of that in Western Europe, whereas in 1950–1973 it was usually double the European rate. Labour force participation increased, with employment expanding from 41% of the population in 1973 to 49% in 1998, compared with an average European rise from 42 to 44%. The percentage drop in working hours per person was half of that in Western Europe. These high levels of activity were achieved with a rate of inflation which was generally more modest than in Western Europe.

US policymakers have been less inhibited in operating at high levels of demand than their European counterparts. Having the world's major reserve currency, and long used to freedom of international capital movements, they generally treated exchange rate fluctuations with benign neglect. The Reagan administration made major tax cuts, and carried out significant measures of deregulation in the expectation that they would provoke a positive supply response that would outweigh potential inflationary consequences. The US operated with more flexible labour markets. Its capital market was better equipped to supply venture funds to innovators. Its economy was as big as Western Europe but much more closely integrated. Demand buoyancy was sustained by a stock market boom in the 1990s.

The United States was a major gainer from the globalisation of international capital markets. In the postwar period until 1988, US foreign assets always exceeded liabilities, but thereafter its net foreign asset position moved from around zero to minus $1.5 trillion (more than 20% of GDP). Thus the rest of the world helped to sustain the long American boom and financed the large US payments deficit.

Future prospects

The table provides a quantification of growth performance of eight major regions of the world economy and some very tentative projections for development up to the year 2015.

The demographic projections are those of the United Nations Population Division, and indicate a continuing decline in the rate of population growth in virtually all parts of the world. Nevertheless there will still be a very striking difference between the advanced capitalist group and Africa. At 0.33% a year it would take 210 years to double population in the first group. In Africa it is likely to happen within 32 years.

In making per capita GDP projections, I assumed a continuance of 1990-2001 rates of performance in Western Europe and Japan and a mild slowdown in the USA, where the information technology bubble of the 1990s has burst, and where the capital inflow which financed its trade deficit seems likely to slacken substantially. Aggregate per capita growth in the “West” seems unlikely to slow down very significantly, but combined with the demographic slowdown, it means that aggregate GDP growth would be about 2% a year. This pace would be similar to that in 1913-1950. Growth momentum transmitted by the “West” is likely to be more modest than in 1870-1913 and 1973-2001.

Asia (excluding Japan)

The most buoyant part of the world economy since the early 1970s has been Asia (excluding Japan). These economies have grown faster than those of the West and their buoyancy has been sustained in great part by their own policies. Their weight in the world economy is much larger than any other non-Western region. I assumed that their per capita growth 2001-2015 will be at the same pace as in 1990-2001.

These economies are catching up with the West and are still at a level of development where “opportunities of backwardness” are unlikely to erode. The combination of high investment rates and rapid GDP growth means that their physical capital stock has been growing more rapidly than in other parts of the world. The East Asian economies also have a high ratio of employment to population. This is due to falling fertility and a rising share of population of working age, but also reflects the traditionally high labour mobilisation of multi-cropping rice economies. In all cases which are documented they had high rates of improvement in education and the quality of human capital. Equally striking were the rapid growth of exports, the high ratio of exports to GDP, and a willingness to attract foreign direct investment as a vehicle for assimilation of foreign technology. These characteristics of China, South Korea and Chinese-Taipei have made for super-growth, but there is a second tier of countries whose growth is accelerating rapidly. The most notable case is India which has the potential to join the super-growth club. There are other economies where prospects are more problematic, but these are only a sixth of the Asian total. The projections assume no substantial change in their performance.

Latin America

Latin America is the second largest non-Western region with about 8% of world product and a slightly bigger share of world population. Until the 1970s, economic policy was different from that in the advanced capitalist group. Most countries never seriously tried to observe the fixed rate discipline of Bretton Woods. National currencies were repeatedly devalued, IMF advocacy of fiscal and monetary rectitude was frequently rebuffed, high rates of inflation became endemic. Most countries reacted with insouciance to the worldwide explosion of prices, and governments felt that they could accommodate high rates of inflation. They were able to borrow on a large scale at negative real interest rates to cover external deficits incurred as a result of expansionary policies.

However, the basic parameters had changed by the early 1980s. By then, the OECD countries were pushing anti–inflationary policy very vigorously. The change to restrictive monetary policy initiated by the US Federal Reserve pushed up interest rates suddenly and sharply. Between 1973 and 1982, external debt increased sevenfold and the credit worthiness of Latin America as a whole was grievously damaged by Mexico's debt delinquency in 1982. The flow of voluntary private lending stopped abruptly, and created a massive need for retrenchment in economies teetering on the edge of hyperinflation and fiscal crisis. In most countries resource allocation was distorted by subsidies, controls, widespread commitments to government enterprise and detailed interventionism. Most of them also had serious social tension, and several had unsavoury political regimes.

In the 1930s, most Latin American countries resorted to debt default, but it was not a very attractive option in the 1980s. World trade had not collapsed, international private lending continued on a large scale. The IMF and World Bank had substantial facilities to mitigate the situation, and leverage to pressure Western banks to make involuntary loans and legitimate a substantial degree of delinquency.

In the 1980s, the attempts to resolve these problems brought major changes in economic policy. But in most countries, changes were made reluctantly. After experiments with heterodox policy options in Argentina and Brazil, most countries eventually embraced the neoliberal policy mix pioneered by Chile. They moved towards greater openness to international markets, reduced government intervention, trade liberalisation, less distorted exchange rates, better fiscal equilibrium and establishment of more democratic political systems.

The cost of this transition was a decade of falling per capita income in the 1980s. After 1990, economic growth revived substantially but the process was interrupted by contagious episodes of capital flight.

My projections for Latin America assume some modest improvement in per capita performance in 2001-2015.

Africa

Africa has nearly 13% of world population, but only 3% of world GDP. It is the world's poorest region. Its population is growing seven times as fast as in Western Europe. Per capita income in 2001 was below its 1980 peak. African economies are more volatile than most others because export earnings are concentrated on a few primary commodities, and extremes of weather (droughts and floods) are more severe and have a heavy impact.

As a result of rapid growth, little more than half the population is of working age. Almost half are illiterate. They have had a high incidence of infectious and parasitic disease (malaria, sleeping sickness, hookworm, river blindness, yellow fever). Over two thirds of HIV-infected people live in Africa. As a result the quantity and quality of labour input per head of population is much lower than in other parts of the world.

European powers became interested in grabbing Africa in the 1880s. Twenty-two countries eventually emerged from French colonisation, 21 from British, 5 from Portuguese, 3 from Belgian, 2 from Spanish. Germany lost its colonies after the First World War, Italy after the Second. The colonialists created boundaries to suit their own convenience, with little regard to local traditions or ethnicity. European law and property rights were introduced with little regard to traditional forms of land allocation. Hence European colonists often got the best land and most of the benefits from exploitation of mineral rights and plantation agriculture. African incomes were kept low by forced labour or apartheid practices. Little was done to build a transport infrastructure or to cater for popular education.

Colonisation ended between 1956 and 1974. In South Africa, the mass of the population did not get political rights until 1994. Independence brought many serious challenges. The political leadership had to try to create elements of national solidarity and stability more or less from scratch. The new national entities were in most cases a creation of colonial rule. There was great ethnic diversity with no tradition or indigenous institutions of nationhood. The linguistic vehicle of administration and education was generally French, English or Portuguese rather than the languages most used by the mass of the population. Africa became a focus of international rivalry during the cold war. China, the USSR, Cuba and East European countries supplied economic and military aid to new countries viewed as proxies in a worldwide conflict of interest. Western countries, Israel and Chinese-Taipei were more generous in supplying aid and less fastidious in its allocation than they might otherwise have been. As a result, Africa accumulated large external debts which had a meagre developmental pay-off.

There was a great scarcity of people with education or administrative experience. Suddenly these countries had to create a political elite, staff a national bureaucracy, establish a judiciary, create a police force and armed forces, send out dozens of diplomats. The first big wave of job opportunities strengthened the role of patronage and rent-seeking, and reduced the attractions of entrepreneurship. The existing stock of graduates was too thin to meet the demands and there was heavy dependence on foreign personnel.

The process of state creation involved armed struggle in many cases. Many countries have suffered from civil wars and bloody dictators. These wars were a major impediment to development.

In many African states, rulers have sought to keep their positions for life. In most states, rulers relied for support on a narrow group who shared the spoils of office. Corruption became widespread, property rights insecure, business decisions risky.

A major factor in the slowdown since 1980 has been external debt. As the cold war faded from the mid-1980s, foreign aid levelled off, and net lending to Africa fell. Although the flow of foreign direct investment has risen it has not offset the fall in other financial flows

The challenges to development in Africa are greater than in any other continent, the deficiencies in health, education and nutrition the most extreme. It is the continent with the greatest need for financial aid and technical assistance. The per capita GDP projections assume that these kinds of aid will be increased and that per capita growth will be positive. However, it is unlikely that African countries will, by 2015, be able to establish a trajectory of rapid catch-up such as Asian economies have achieved.

Eastern Europe

In Eastern Europe, the economic system was similar to that in the USSR from 1948 to the end of the 1980s, and so was economic performance. In 1950-1973, per capita growth more or less kept pace with that of Western Europe, but faltered badly as the economic and political system began to crumble. From 1973-1990, it grew at 0.5% a year compared with 1.9% in Western Europe.

The transition from a command to a market economy was difficult in all of the countries. The easiest part was freeing prices and opening of trade with the West. This ended shortages and queuing, improved the quality of goods and services and increased consumer welfare. However, much of the old capital stock became junk; the labour force needed to acquire new skills and work habits; the legal and administrative systems and the tax/social benefit structure had to be transformed; the distributive and banking networks to be rebuilt from scratch. The travails of transition led to a fall in average per capita income for the group from 1990 to 1993, but it rose by over 3% a year from then to 2001. My projection assumes that this pace of advance can be maintained at least until 2015. In fact, these countries can probably do better than this if they can be integrated into the European Union with better access to its goods, labour, and capital markets, its regional and other subsidies, than they have thus far enjoyed. Present real income levels are only a third of those in Western Europe. Wages are also much lower, but the disparity in skills is much less. The Eastern economies are therefore capable of mounting a catch-up dynamic similar to that of Asia if the integration takes place.

Successor states of former USSR

Fifteen successor states emerged from the collapse of the Soviet Union in 1991. In all of them, there was already a very marked deceleration of economic growth in 1973-1990. There was colossal inefficiency in resource allocation, a very heavy burden of military expenditure and associated spending, depletion and destruction of natural resources.

Capital/output ratios were higher than in capitalist countries. Materials were used wastefully. Shortages created a chronic tendency to hoard inventories. The steel consumption/GDP ratio was four times as high as in the US. The average industrial firm had 814 workers in 1987 compared with 30 in Germany and the UK. Transfer of technology from the West was hindered by trade restrictions, lack of foreign direct investment and very restricted access to foreign technicians and scholars. Work incentives were meagre, malingering on the job was commonplace.

The quality of consumer goods was poor. Retail outlets and service industries were few. Prices bore little relation to cost. Consumers wasted time queuing, bartering or sometimes bribing their way to the goods and services they wanted. There was an active black market, and special shops for the nomenklatura. There was increasing cynicism, frustration, growing alcoholism and a decline in life expectation.

Soviet spending on its military and space effort was around 15% of GDP in the 1970s and 1980s, nearly three times the US ratio and five times as high as in Western Europe. There were significant associated commitments to Afghanistan, Cuba, Mongolia, North Korea, Vietnam and Soviet client states in Africa.

In the 1950s a good deal of agricultural expansion was in virgin soil areas, whose fertility was quickly exhausted. Most of the Aral sea was transformed into a salty desert. Exploitation of mineral and energy resources in Siberia and Central Asia required bigger infrastructure costs than in European Russia. The Chernobyl nuclear accident had a disastrously polluting effect on a large area of the Ukraine.

In 1985-1991 Gorbachev established a remarkable degree of political freedom and liberated Eastern Europe but had no coherent economic policy. From then to end 1999, Yeltsin broke up the Soviet Union, destroyed its economic and political system and moved towards a “market” economy. The economic outcome was a downward spiral of real income for the mass of the population. On average, GDP was nearly 30% lower in 2002 in the 15 republics than in 1990. Fixed investment and military spending fell dramatically, so the drop in private consumption was milder. There were very big changes in income distribution. Under the old system, basic necessities (bread, housing, education, health, crèches and social services) had been highly subsidised by the government or provided free by state enterprises to their workers. These all became relatively more expensive, the real value of wages and pensions was reduced by hyperinflation, and the value of popular savings was destroyed. There were major gains in the income of a new oligarchy.

The new “market” economy is grossly inefficient and unfair in allocating resources. There has been legislation to establish Western style property rights, but in practice accountancy is opaque and government interpretation of property rights is arbitrary. Many businesses are subject to criminal pressure. Property owners such as shareholders or investors are uncertain whether their rights will be honoured. Workers are not sure their wages will be paid.

* This article is an adapted extract from Angus Maddison’s chapter, “The West and the Rest in the International Economic Order”, in Development is Back, OECD Development Centre, 2002.

LATE NOTE: Angus Maddison passed away on 24 April 2010. See tribute.

References

Visit www.theworldeconomy.org/

IMF (2002), World Economic Outlook, Washington DC.

Maddison, A. (2001), The World Economy: A Millennial Perspective, OECD Development Centre, Paris.

OECD (2001), Agricultural Policies in OECD Countries: Monitoring and Evaluation, Paris.

Stiglitz, J. E. (2002), Globalization and its Discontents, Norton, New York.

World Bank (2002), Global Development Finance, Washington, DC.

© OECD Observer No. 235, December 2002



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