Long-term global economic outlook

India is set to benefit from its demographic dividend, whereas China is expected to slow tremendously

Capital Economics, a highly respected and independent economic research consultancy, recently released their forecasts for the global economy for the coming 20 years. They provided forecasts for the global economy as a whole, specific EM (emerging markets) regions as well as more granular country specific details, for 10 major countries including India.
 
Their forecasts are quite interesting, as in a major break from the current sell-side consensus, they do not believe that the future belongs to China. They are on the contrary more bullish than most on the US and India, both for different reasons.
 
Some of the interesting highlights of their study are as follows: 

• They believe that over the coming 20 years (till 2040), World GDP will average about 3 per cent growth, compared to 3.5 per cent over the last 20 years. The world economy will expand by 80 per cent at PPP (purchasing power parity) exchange rates during this period. The GDP of the advanced countries of the West will increase by about 50 per cent, while the EM cohort will see a 100 per cent increase. EM countries will account for about 70 per cent of the world economy by 2040, compared to 60 per cent today and account for nearly 80 per cent of global growth.
• While the EM cohort as a whole will do fine and gain share of the global economy, there will be major divergences in economic performance among individual countries. China will be the largest EM economy, but will slow tremendously over the coming 20 years. According to Capital Economics, China faces severe structural challenges, with its working age population declining by 12 per cent in the coming 20 years and slowing capital accumulation. The country already has more public capital stock per capita than any other economy in history at this stage of its development. With seemingly limited appetite for structural reforms, which could improve capital allocation, reduce the role of the government, and hence boost productivity, the authors predict that China’s sustainable growth rate will drop to near two per cent in the forecast horizon from current levels of near 6 per cent. With a declining working age population and slow productivity improvements, slowing growth is just simple maths. The study projects that China’s share of global GDP will actually drop from 19 per cent today to 17 per cent by 2040 (on PPP basis). Again this goes counter to all conventional wisdom. Most reports talk of this being the Chinese century. While China’s GDP per capita will increase by 70 per cent in the coming 20 years, this is a far cry from the near five-fold jump in this metric in the last 20 years, as China dominated global growth. The study projects that for China, its GDP per capita will level out at about one third of US levels, from where the convergence will slow dramatically. 

On India, the paper is far more bullish. The authors expect India to deliver growth of 5-7 per cent for the next 20 years, making it the fastest growing major economy by a large margin. On these projections, the Indian economy will triple in size, and its share of global GDP will increase from 8 per cent  today to 15 per cent (PPP basis). Even on market exchange rates, India will be the third largest economy in the world. India’s GDP per capita will move from 10 per cent of US levels to almost 25 per cent, the biggest increase among major EM economies.
 

Illustration by Ajay Mohanty

The bullish view on India’s growth is based on the surge in working age population (India will cross China in size of labour force by 2025) and an improving female labour force participation. They are also bullish on the outlook for productivity, given the scope for catch-up and convergence, as India deepens its capital stock and moves workers into higher productivity jobs. Slow and steady structural reforms, already under way, will improve capital allocation and economy wide productivity. The report marks out India as the star performer among all EM countries.
 

• The report is also very positive on the US. The authors expect productivity to accelerate across all the advanced economies, but with the US leading the pack. New technologies like AI, robotics and autonomy are expected to have significant impact on labour productivity across the economy as these technologies move towards mass adoption. The US will lead the way given how competitive and open its product and labour markets are. The pickup in productivity growth will more than compensate for the ageing population and retirement in the baby boomer generation.

 
Since 2005 productivity growth in the US has slowed to just about 1 per cent, compared to 2.3 per cent during the mid 1990s. In the report, the authors project that US productivity will once again accelerate, rising slowly to 2 per cent by 2030.
 
The surge in productivity, will lead to an acceleration in GDP growth for the US from the 1.5 per cent we have seen in the past decade to 2.6 per cent in the mid 2030s. Almost no one is expecting a growth revival of this magnitude in the US. Capital Economics and their focus on an expected productivity surge linked to mass adoption of new technologies is out on a limb here. They are actually projecting that the US will overtake China in terms of growth rates by the mid-2030s, a controversial view to put it mildly.
 
If Capital Economics are right in their forecasts, then not only will the US maintain its position as the most wealthy major economy in terms of GDP per capita, but actually increase the gap with other advanced countries.
 
Among the eurozone economies, the authors are very negative on Italy. It has the worst demographic profile in Europe and a poor track record on productivity. Its economy will stagnate, and will remain a stress fracture for the whole eurozone. While France and Germany will have decent productivity growth, their demographics will remain a huge headwind.
 
When one goes through reports like this, the long term bull case for India seems intuitively obvious. The country is riding on demographics, productivity catch-up and the quality of entrepreneurship and aspiration among the young. Structural reforms, while slow, have been put in place. Economic growth and corporate earnings should accelerate. It may be helpful to keep all this in mind as we go through the next few months. It is likely to be an ugly election. Many statements of economic intent will be made by all political parties. There is a risk of some very populist sound bites from across the political spectrum. Like always, investors need to focus on actions and not words. All investors need to be anchored in the long term potential of the country and not get swayed by the sound and fury of the coming election sloganeering.

The writer is with Amansa Capital