Long-Term Economic Outlook: Another Reversal of Fortune?


April 28, 2024

When analyzing countries, we often delve deeply into their short-term growth prospects. However, what about the long-term outlook? Our findings indicate a sluggish growth trajectory and a relative decline in the size of China’s economy, juxtaposed with India's remarkable performance in the coming decades.

We conducted an exercise to establish a simple benchmark for long-term growth, utilizing the Solow growth model in its simplest form, considering only capital and raw labor as inputs. Throughout this exercise, we endeavored to be as empirical as possible, estimating model parameters based on historical data. We utilized the UN’s latest population projections (medium variant) for the future potential labor force size, along with a conservative estimate of the convergence of the employment ratio (the percentage of the working-age population employed). Moreover, we assumed that investment ratios would converge in the long run, leading to convergence in capital stock to labor ratios over time. Initial capital stock data were drawn from the Penn World Tables or estimated based on their data.

In the long run, this model is primarily driven by demographics and productivity convergence. However, based on our empirical assumptions, it takes several decades to reach this stage. For instance, while we assumed productivity convergence (where productivity in poorer countries grows faster than in richer ones), we did not assume that countries would immediately jump to the average convergence curve. Therefore, in this model, we do not expect underperforming or overperforming countries to suddenly achieve average performance upon projection initiation. History is assumed to be relevant. Hence, this model embodies cautious optimism – all countries eventually converge to the level of richer ones, albeit gradually. Past underperformance likely indicates structural impediments that can only be overcome gradually.

Presented below is a chart illustrating the initial results for major economies, depicting total GDP size in terms of Purchasing Power Parity. "EUU" denotes the European Union.

One notable feature is the deceleration of the Chinese economy, exacerbated by unfavorable demographics, with the working-age population having already declined for approximately a decade. Conversely, India exhibits strong performance. While China is poised to maintain its position as the largest economy in PPP terms for decades, it's worth noting that the gap between its economy and that of the USA stops widening after about 2030. The USA economy is outperforming the EU, mainly on more favorable demographics. Russia, on the other hand, faces dire demographic challenges according to UN data, which contributes to its lagging performance. Reality could potentially be bleaker due to accelerating out-migration and combat-related fatalities.

India is at a demographic sweet spot, its working age population is still growing fast while its fertility rate has declined to the replacement rate of about 2.1 and it old population is still relatively small. Also, the working age population is relatively underemployed, at least based on the World Bank employment statistics – there are opportunities to increase (formal) employment as a share of the working age population. India has also shown decent productivity increases lately, which has an impact in our model for the near future.

The discussion above primarily focuses on the absolute sizes of economies, which are crucial in terms of geopolitical competition. However, per capita GDP is a measure that more directly affects the population’s well-being. In per capita terms, India is projected to remain significantly less affluent than the USA or Switzerland in our projections, even though the gap narrows over time. 

[Written by Istvan Zsoldos]