Growth momentum has flagged across developing Asia since the global financial crisis. Policymakers in Asia Pacific need to recognize and respond with supportive policies to counter the slowdown in potential growth by increasing the region’s productivity, says a new Asian Development Bank (ADB) report.
Potential growth, or the maximum level of economic output consistent with full employment and stable inflation, is the subject of the special theme chapter in the Asian Development Outlook 2016 report—ADB’s flagship annual economic publication. Potential growth is calculated as the sum of productivity growth and labor force growth.
“Potential growth depends on both the growth of the labor force and the growth of labor productivity,” says Shang-Jin Wei, ADB’s Chief Economist.
“While altering demographics is not something that can be accomplished within a few years, many developing economies still have tremendous room to use structural reforms to remove distortions in the labor, capital, and land markets, and to improve incentives for private sector investment, all of which lead to higher productivity and therefore higher potential growth.”
Asia’s average growth declined by 2.0% between 2008 and 2014, the report notes, and about 40% of that drop was due to moderating potential growth. Since economies in Asia and the Pacific account for over a quarter of the world’s gross domestic product, improving the region’s productivity is essential for the world’s rebound as well.
The report notes that a declining labor force is a critical factor in the post-financial crisis slowdown in potential growth. A one-percentage point decline in working-age population growth shaves the same amount off potential output.
Negative demographics affect a number of countries in the region that are seeing a slowdown in new entrants into the labor market and ageing populations. Demographic pressures will intensify in the coming decades, depressing developing Asia’s potential growth by as much as 0.4 percentage points through 2020.
Implementing productivity-enhancing reforms to increase tertiary education, improve labor market flexibility and institutional quality, and to increase trade openness and financial capital integration, could increase growth potential up to 0.7 percentage points per year during the next decade.
Other factors that could improve productivity include investment in modern technology and equipment; increased government effectiveness, and closing the productivity gap with the US.
Sound macroeconomic management, which helps smooth out volatility, can also add as much as 0.1 percentage points to potential growth in the region, the report says.